Djokovic servingDouble faulting is one of the most discouraging aspects of tennis. Watching Djokovic double fault the 2nd set away (and to end up losing the match) this morning during a tiebreaker against Berdych in the Wimbledon semifinal match shows that even the number 3 player in the world can feel pressure, fear and nerves on a critical point. Giving away points to an opponent after working hard is extremely aggravating and mentally difficult to overcome.

The tennis serve is very dependent on a good, consistent ball toss–it is so easy to get the wrist involved and throw the toss in all directions and to lower the head (anticipating the return of the serve) during the serve and serve into the net. It's almost better to serve long and try to add more spin than it is to dump a serve into the net. It is also important to think positive thoughts and not tighten up–that little voice in the head can easily lead you to a double fault.

Regular cues and ball bouncing rituals can be helpful.

It's shame though to lose a match due to choking or self-defeating behavior, and you don't see it that much amongst the top pros, but when it happens it is a hard thing to get out of the head. And more particularly when your nickname is "Joker" the press has an easy rhyming headline to use to remind you of your past failures.

Ralph Vince adds: 

McEnroe servingRE: it is also important to think positive thoughts and not tighten up.

This is SO absolutely true, and SO difficult to really define–that being loose, yet in a controlled pace without any real slack on the line. This is vital to performance in anything, be it tennis, fighting…or even thinking through problems. The Old Frenchman would say, "C'est toujours la meme chose," (It's always the same thing).

Think of anytime you've ever choked at anything– the aforementioned mental and physcial state was absent. Think of ANY fight you've ever been in. They always, ALWAYS tighten up, succumbing to fear and adrenaline.

I think pro athletes really understand this, and not just in the individual sports like tennis or golf, but even when these guys are shooting foul shots in basketball. Learning that mental groove is worth more than all the years one can spend in school I think. It's the kind of thing that one learns only by doing it, learned only through the prompting of pain and discomfort until it is found.

Learning things any other way is not really learning. 

Charles Pennington adds:

The serve has got to be the most non-intuitive and difficult-to-learn shot in tennis. Whenever I look at slow motion video showing the trajectory of the racquet, I am amazed that it's possible for a human to do it.

Here's a video of McEnroe serving, showing the fundamental steps–the weight shift, the toss, the swing of the racquet, and the line call argumentation.

Nigel Davies writes:

I wonder if the frequency of this kind of mistake may increase in proportion to a player's muscle mass. The 'nerves' might be a simple chemical equation.



Tinsley vs. ChinookI was having a discussion with a colleague on the topic of Chess vs. Checkers. Somewhere I had the impression that Checkers had been "solved" –that it is ultimately an elaborate version of tic-tac-toe, i.e. there is a well-defined correct move to make in every situation. Chess though is different, as I understood it–there is no known correct way of playing in every situation, either because it can't be known in principle or because the computers just haven't found it yet. Can someone set me straight on this topic? (Background: I haven't played chess or checkers in over 30 years, but I am quite good at tic-tac-toe.

Nigel Davies weighs in: 

As I understand it there is no 'solution' as such to either game and that with checkers in particular it is quite easy to make it considerably harder by playing on a larger board and with more pieces (one can also play 'big chess', though this looks somewhat artificial to my eye). With regard to board games being 'computer proof' it's also worth checking out Shogi and (especially) Go where computers are still rather mediocre compared to the best humans.

From the point of view of educating children all of these games are wonderful in that they can teach the young to falsify their own ideas. In order to play 'well' one must find out what's wrong with a move before playing it on the board.

One major consideration in the choice of game might be the number of opponents to be found. In the West at least I believe this is where chess shows to advantage.

Hope this helps. 

Pitt T. Maner III writes:

TinsleyDr. Schaeffer wrote an appreciation of one of the best checker players ever, Marion Tinsley, who actually liked the challenge of facing a computer (nicknamed Chinook).

After Chinook's first game against Tinsley in 1990, we started analyzing the game. Tinsley began recounting the history of the line we played, recalling games he played in the 1940's! The move sequences flowed easily from him without hesitation, sometimes annotated with the name of the opponent, date or place where the game was played! 1947 was as vivid in his memory as if it were only yesterday. The second facet to his play was his incredible sixth sense. A glance at a position was sufficient to tell Tinsley everything he needed to know. For example, in 1990 Chinook was playing Tinsley the 10th game of a 14 game match (won by Tinsley 1-0 with 13 draws). I reached out to play Chinook's 10th move. I no sooner released the piece when Tinsley looked up in surprise and said "You're going to regret that". Being inexperienced in the ways of the great Tinsley, I sat there silently thinking "What do you know? My program is searching 20 moves deep and says it has an advantage". Several moves later, Chinook's assessment dropped to equality. A few moves later, it said Tinsley was better. Later Chinook said it was in trouble. Finally, things became so bad we resigned. In his notes to the game, Tinsley revealed that he had seen to the end of the game and knew he was going to win on move 11, one move after our mistake. Chinook needed to look ahead 60 moves to know that its 10th move was a loser. In my experience with tournament chess and checker players, the sixth sense is experience. It is well-known how intensely Tinsley studied the game, analyzing anything from a Grandmaster game to a game between novices. His uncanny ability to know good from bad and safe from dangerous, is the direct result of all his hard work. Strong chess players have the same ability, but perhaps it is not quite as evident as it was with Tinsley .

Nigel Davies writes:

Seems like we get a whisker away from quite deep philosophical questions. My personal belief is that the goal of 'replacing humanity' in the cause of 'efficiency' is a deeply flawed one. It always feels to me like the attempt to show that computers can 'play' these games much better makes our attempts at self-improvement appear futile, an idea which many people will buy into. Is it too fanciful to suggest that they represent a 'greater goal' of being looked after by machines whilst humans have mindless 'fun'? Nigel Davies

David Hillman writes:

This is not unlike giving up the warm, tactile sensation of the paper page in a book for the slick plastic of a Kindle, or the daily newspaper's beautiful scent of cheap pulp and ink replaced by the netbook's display. The aromas of silicone and polymers do not mix as kindly with the scent of espresso wafting on the morning air. My own livelihood is derived from computer-based industrial productivity and efficiency systems, but my life is kept on a yellow legal pad with a #2 pencil. Balance, always balance. To paraphrase Queen, "we need it all and we need it now." The Deep Blue's, Chinook's, etc. may be wondrous, but there is simply no mineral nor petrochemical-based substitute for the hug of a happy child, for the lap of a caring spouse upon which to lay one's head at the end of a bad day, or for the twinkle in a grand-master's eye across the chessboard when he mates you in 6 moves.

Nigel Davies responds:

I don't think it's the same thing David. An analogy with having a kindle versus a book would be to play chess against a human via your PC. Having computers do the playing and trying to demonstrate their 'superiority' is more like having them write the books, and purportedly do it more efficiently than humans; fewer words for the same meaning perhaps, 'War and Peace' reduced to 10 pages.

Chris Tucker agrees:

I agree with you completely Alan, my point is just that programmers are not out to replace us completely (yet, anyway), but they are out to codify decision making. Games are a good place to do this because the rules and possible moves are very limited, even though the number of possible outcomes can be astronomical. The arena is structured and they can test and validate their ideas within this framework. The idea of game playing is much deeper, philosophically, (as Nigel suggests) than most care to admit. I will leave that bit for you two to explore. Machines that can replace the humanity of squaring off with an opponent do not exist, there are simply too many levels of interaction there. 

Nigel Davies replies:

Chris, there is no decision making in the programs or any attempt to replicate human thinking, they simply use brute force to analyze all the possibilities (with chess slapping in a primitive evaluation function) and the mathematical limitations of the games enable them to get away with it and 'win'. Perhaps when they started out the intention was to create 'artificial intelligence', but I don't see that this claim can be maintained given the route they have taken. Looks like an ego driven attempt to 'beat mankind' of the type which enables a car to go quicker than someone on two legs. 

Dave Bacon addresses the original question:

I believe Checkers on a standard sized board has indeed been solved. The reference is Science, Sept. 2007, Vol. 317. no. 5844, pp. 1518 - 1522.

“Checkers Is Solved” Jonathan Schaeffer, Neil Burch, Yngvi Björnsson, Akihiro Kishimoto, Martin Müller, Robert Lake, Paul Lu, Steve Sutphen

The game of checkers has roughly 500 billion billion possible positions (5 x 10^20). The task of solving the game, determining the final result in a game with no mistakes made by either player, is daunting. Since 1989, almost continuously, dozens of computers have been working on solving checkers, applying state-of-the-art artificial intelligence techniques to the proving process. This paper announces that checkers is now solved: Perfect play by both sides leads to a draw. This is the most challenging popular game to be solved to date, roughly one million times as complex as Connect Four. Artificial intelligence technology has been used to generate strong heuristic-based game-playing programs, such as Deep Blue for chess. Solving a game takes this to the next level by replacing the heuristics with perfection.



 The following is not a rhetorical question; I genuinely don't know the answer. The 12 hours of school, music lessons…sports programs–is that really what's going to be best for these kids?

There seem to be fewer and fewer pre-scripted routes to success these days. Alan Corwin wrote about highly skilled database programmers who found themselves obsolete. Medicine has gone from being very cushy to modestly cushy. (A few pathways that might still exist: 1] do well academically/go to law school/ become partner at law firm, 2] get a government job, or 3] be nice to your very wealthy parents) Increasingly you have to invent yourself.

So what happens to regimented and highly educated kids when they grow up? They can hit a passable forehand, play some of Beethoven's piano sonatas, and do integrals (on Matlab), but they grow up and find that what they really need out there is something that's unique, which they don't have. Most of the successful people that I know personally had unstructured lives as children, and they had to figure out for themselves what to do with all that time. Most unsuccessful people though had the same situation! That's why my question is a real one, not a rhetorical one, one in fact that I'm facing with my own children.

Scott Brooks writes:

Having an unstructured life as a child equating into success as an adult depends on your upbringing, parental guidance, and environment. I saw a lot of my friends growing up living unstructured lives because of single family households (mother couldn't do much more than work to support family), alcoholism of one or more parent, or other factors.

I think a lot of these kids would be much better off if they were in a structured environment that allowed them freedoms most of their day (12 hours or more), at least 6 days a week.

The problem is that the kids who need this environment are stuck in some kind of a governmental system whereby the teachers unions control the environment. I believe that is what has lead us to being a country of non-thinking sheeple and is destroying our children today.

Jeff Rollert writes:

Improv is the best training I've had, and I use the trapped time in the car to make the kids do it. Doesn't matter if it is story telling, music, jokes, etc.The only consistent skill I've seen in life that doesn't get obsolete is on-the-fly storytelling.

Jack Tierney comments:

 This is an important question and one that has great significance for the future. Recently I've come across more and more articles regarding this cohort and their predicaments.

The recent spike in student loan defaults has highlighted the fact that many of our "highly educated kids" have gone deeply into debt. Unfortunately, many have been highly educated in specialties that offer little opportunity to secure a wage sufficient to pay off the debt and live in a manner to which they've become accustomed.

In many of these households, the parental unit(s) have also taken on substantial debt to provide the education; unfortunately, their 401Ks and pension plans have been whacked by the market, and chances that junior will be offered a comfortable, all-meals-provided, rent-free existence dwindle daily.

I recently re-read "The Grapes of Wrath" for a discussion group. There was some conversation on whether current events could lead to a re-run of those days; it was suggested that our many undocumented immigrants would supplant the equally powerless and under-educated Okies. I suggested, however, that while both groups presented problems for their times, our well educated but un- or under-employed youth could present a significantly greater one.

During my lifetime it's been rare that major anti-establishment protests have been led and peopled by the under-classes…the poor rarely had enough time or resources to be regular participants or prisoners. Those movements were conducted by an educated but unhappy coterie that was rarely underfed or unqualified for well paying positions. Tomorrow's protest leaders could well be both.

Another disturbing element in this education scam is the adult re- education programs being offered and underwritten by the Feds and the States. There's heavy emphasis on computer skills, auto repair, finance, education, business admin, accounting, and nursing - fields in which there already exist many unemployed but experienced professionals, and others which have little future.

I can appreciate Dr. Pennington's concern. Of my three sons, only one appears to be moderately secure. All are now in their forties, so options are limited and not very promising. For my grand-daughter and grand-son (I have one of those now), I have major concerns as I feel they, too, are being offered yesterday's curricula for yesterday's jobs. Will they be tomorrow's Joads?

Stefan Jovanovich writes:

We already have Steinbeck's world here in California; but the traffic is heading east away from the state. The only people driving to our state are the people behind the wheels of the empty rental vans. (I urge List members to check out the differential rental rates to and from California.) People here are literally packing up and heading out because there is no work; and they know there will not be any.

Not to argue with John but the "anti-establishment protests" in American history have never been led and peopled by the underclasses. The Homestead strike was by the best-paid steel workers who were protesting the hiring of cheaper immigrants who spoke languages other than English. The Reuthers, the founders of the UAW, were skilled machinists; so were the auto workers who staged the sit-down strikes in the 1930s. The poorest workers - the blacks, the hillbillies - had already been laid off. The Wobblies my grandfather knew were skilled miners who had learned their crafts in the European mines before coming to America; the "scabs" (sic) were the Mexicans and poor white Southerners. Now, riots - like the Rodney King uproar - are another thing; then, the underclass comes out to smash windows.



 I was recently asked by a golfer:

Here's a basic physics question for you. One golfer's clubhead speed is 100mph at impact with the ball and 105mph immediately after. He has an accelerating swing. Another golfer has 100mph clubheadspeed at impact but only 95mph immediately after. He has a decelerating swing. Assuming everything else is constant (type of ball, wind speed, etc), does one drive go farther than the other?

My attempt to answer:

The question is a surprisingly hard one, and I've thought about this kind of question in tennis as well. Here are two extreme scenarios that are easy to understand:

1) If the club (racquet) is much, much, much heavier than the ball (hitting a golf ball with a sledgehammer), then the speed of the club is all that matters.

2) On the other hand, if the club (racquet) is much, much lighter than the ball (hitting a bowling ball with a badminton racquet ), then the speed prior to collision hardly matters, and all that matters is how much you shove through during the actual collision.

In any sports/ bat/ ball/racquet situation, you're always somewhere in between the two extreme scenarios described above because that's the best way to design the bat/racquet/club. (It is analogous to having your car in the right gear for the speed that you're driving.) So there's not any simple answer except that it's somewhere "in between". It's neither 1st gear nor overdrive, but something in between. You need high speed, but also a somewhat "firm foundation". (A quibble — it will be absolutely impossible for the swing to be moving faster immediately after compared to immediately before. [I'm modeling the club-ball collision as essentially instantaneous.] Would require you to apply an infinite torque or force or whatever applied by the golfer to the club.)

Art Cooper comments:

 This seems an obvious application of the basic principle taught to someone learning how to hit a baseball: follow-through on your swing for a better hit. It must be the case that an accelerating swing in baseball, golf, tennis or anything else will impart more force (for a longer movement of the ball), because the moment of contact is longer than instantaneous. 

Sushil Kedia writes:

You have to make an assumption that the movement of the club is following a harmonic motion as in a pendulum. Highest Kinetic Energy at the point of equilibrium and zero at the extremes. Acceleration will have to be negative from equilibrium onwards.

Case 1:

Velocity of the club after impact > velocity of the club before impact: This will be possible only when the point of impact is reached before the point of equilibrium.

Assume mass of the ball is B and the acceleration it achieves on impact is A1. Then the amount of force transferred in this case is B*(A1)^2. Since there is an equal and opposite force it exerts on the club. The net acceleration of the club at the point of impact will be calculated by adjusting the existing harmonic form of the kinetic energy equation MINUS B*(A1)^2.

If this value is 105 mph it only tells us that without knowing the length of the club AND NOT just the effective weight (Center of gravity adjusted leveraged weight for the length of the club) it would be impossible to know at which angle the impact happened.

So either it is not possible for this to happen of there is inadequate data for comparison since you mention everything else is constant.

Case 2:

Velocity of the club after impact < velocity of the club before impact: Without knowing the acceleration of the ball at the point of impact (which can be estimated by estimating the values of friction, time before which the ball stops and the distance traveled) it is not possible to calculate the net force transferred by the club into the ball at the point of impact. EVEN if one assumed that the impact happened after the equilibrium point was reached on the trajectory of the club swing. It is worth mentioning here that the swing of the club would HAVE TO HAVE A NEGATIVE acceleration beyond the point of equilibrium else it is not the point of equilibrium.

So, in both cases 1 and 2 the assumption of everything else is constant is a situation of inadequate data. If however the question is implying that the club hit both the balls at the same angle, then the question is a trick and does not have a solution.

Stefan Jovanovich writes:

 Here is a link to a fascinating site called batspeed.com — the most comprehensive study of the baseball swing on the web.

Charles Pennington comments:

There's no way to solve this problem theoretically–only experimentally–but there is a good theoretical framework to think about it. You model it as a totally elastic head-on collision between a mass M moving with speed V and a mass m (the golf ball) moving with initial speed 0.

In that case, the final speed of the ball is:

v = V*(2M)/(M+m)

and the final speed Vf of the "club" (*) is

Vf = V*(M-m)/(M+m)

(Note that this is always less than V, and could even be negative, e.g. if a golf club hits a bowling ball.)

The problem is, what do we use for M? Do we use the mass of the club? The mass of the golfer who's connected to the club? The mass of the earth, which provides some friction so that the golfer doesn't slide backwards?

There are some simplifying cases:

If M>>m (sledgehammer hits golf ball), you'll see that the equation reduces to v=2V, i.e. the ball will fly off with twice the initial speed of the club.

If M<<m (feather hits golf ball), then the equation reduces to v~(2M/m)V.

The only way to find out the value of M is to do an experiment: get a real golfer, measure his (pre-collision) swing speed and the speed of the ball, and then use these equations to find the golfer's "effective M". A golfer who braces himself more and has a solid stance might have a bigger effective M than a golfer who uses a more floppy, wristy swing–but he also might have a lower V, so his shot might end up with less speed.



 I do reckon I found a gem of a BBQ place and had to go all the way to Fairfield, CT to find it. A good friend, and fellow spec, took me there to prove the Northeast has BBQ that will stand on its own — and he was right. He was quite apprehensive in trying to score a good fix of BBQ, as I'm known for being very tough to please and rather discerning.

Walking into Wilson's (1850 Post Rd, Fairfield, CT) our senses were immediately assailed with the sounds of good music, the sight of tasty food, a funky atmosphere, and very helpful and cheerful employees. Before the food was even discussed and ordered, I had that sixth sense that told me that this would be good. We stepped up to the counter and each ordered a slab of St. Louis style ribs (dry rubbed), and several sides. My companion had sides of beans and slaw, and I had fries and slaw. Wilson's served a lagniappe of homemade cornbread with each order. They provided three different BBQ sauces, a Chipolte, a Carolina Vinegar, and a Sweet/hot sauce. I wasn't taken by any of the sauces, but my companion enjoyed the Chipolte sauce very much with his initial taste test. Our food came very quickly, and we dove in with gusto. The slabs were extremely meaty, tender, and juicy, no dryness at all. I didn't use any sauce, and really enjoyed my ribs as the bark was to die for, and made the meal 100% enjoyable. Anytime one doesn't need any sauce with his ribs means they hit three sevens and the proverbial jackpot paid off big. The sides were awesome, the fries being A+ in taste and quality. The slaw was rather drab, and I suspect the owners preferred to make a bland slaw as to not overpower the meat when used on the pulled meat sandwiches. Anyway, the slaw was a perfect counterbalance to the wonderful taste of the meat. I looked at the beans my companion ordered, and they looked and smelled delicious, being homemade with several different types of beans. The cornbread was especially notable, made from scratch, moist, and with the right amount of salt to give it that Southern zing. I was pleased that Wilson's offered sweet tea. Their sweet tea was the real deal, and would be home anywhere in the South. They offered unlimited refills, which this sweet tea deprived person took full advantage of. All in all, it was wonderful to eat at a BBQ place where it was obvious that the food was prepared with a lot of love, and the staff takes their BBQ seriously. Additionally, the blues cranked on the Jukebox instantly transported me to Greenville, MS — another place and another time.

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

Charles Pennington weighs in:

I heartily agreed with MOTU about Popeye's, but I dissent on Wilson's. I've been there a couple of times, most recently with my wife. We got indifferent service, prices about three times that of a good Southern place, and mediocre food. Also they won't even give you a fountain coke with ice — they'll only let you buy a 12 ounce can if you're nice. It's also small and has not very good seating. There is a place called Bobby Q's in Westport that is pretty good, and there are plenty of places in Manhattan that are fantastic, though expensive. Bottom line though is that whenever I head down South I'm bowled over by the quality, low prices, and plentitude of the 'cue. Most recently I enjoyed Shane's in Atlanta. It's a chain, but it's great.



think about what you are eatingIt has come to my attention that MOTU has a strong buy on Popeye's fried chicken:

I refuse to do fast food, having given up my Burger King and Wendy’s addiction long ago. The only fast food I will eat is Popeye’s Chicken. They make the best fried chicken, 10 times better than KFC or Publix deli, and their biscuits are world class. Whenever I’m in North Sarasota, I hit the Popeye’s up there; We don’t have one in South County.

I reiterate that strong buy. Gmail chat users will see that my profile picture is the Popeye's logo — that was set up by my colleagues while I was away, but I am not ashamed, so I've kept it.

I think there is some variation in the Popeye's experience depending on location and timing. I'd guess that you'd get the best stuff in New Orleans. There is also a premium on getting your chicken fresh, right out of the frying pan. Offer to wait for a new batch if one is on the way within a few minutes.

There is no reason for anyone to order anything other than spicy. The level of heat is not that high, and it adds to the experience.

I don't want to totally dis' the Colonel, but I agree that Popeye's is 10 times better.

Alston Mabry writes:

As far as fast food fried bird, Popeye's is the best I have ever had. And the biscuits are dangerous, leading to all sorts of crumb debris issues in the car, especially when the biscuits are acquired via the drive-thru window.

Fried chicken is surprisingly variable, with the main drawbacks usually being insufficient flavor and/or overabundant grease.

For you lucky Big Applers and other contiguously situated, the Food Network show "Best Thing I Ever Ate" just aired their "Crunchy" episode which featured fried chicken from Brooklyn Bowl which is, amazingly enough, a bowling alley in Brooklyn.

Charles Pennington adds:

Rating a few Manhattan Popeye's:

Midtown, 26th and Lex: Excellent. In a neighborhood full of Indian restaurants and run by Indians. Good service. Also near Baruch college, so there's a student crowd. (Off topic — supposedly there is a Chick-fil-A somewhere near this spot, the only one in Manhattan, but I haven't found it or tried it.)

Chinatown, Canal/Bowery: The best. Very fresh, good service. Chinese staff. The only problem is it's very, very crowded. Manager wanders around telling loiterers to move along because tables are scarce. Near the bus depot for Fung Wa buses, which can give take you to Boston for a very cheap fare — rumor has it the triads have turf wars over running these bus lines.

Downtown, Chambers/Church: Big footprint site, but very unkempt, with lackadaisical service

Times Square, 40th and 7th: At first I didn't like this one, but I warmed up to it after a while. It's very small. Service was at first indifferent, but it got better after I became a regular.



Andy MurrayIt's frustrating that Andy Murray is one of the top few tennis players in the world right now. There is not much about his strokes or his strategy that's distinctive or interesting. His only distinction is his on-court personality — he scowls and sometimes swears after every error that he makes, as though his expectation is not to make any errors throughout the match. Federer, by contrast, treats his errors as an expected part of the game. His face shows no negative emotions; it looks like granite.

Everybody who gets to number one in tennis has some kind of distinctive flair. They never get there by doing everything like everybody else, just a little better. I hope Federer gets a more interesting opponent in the next three majors.



Below is a graph of the distribution of 52 week price changes for stocks tracked by Google. To me the interesting part is the distinctly bi-modal shape. Some companies are doing well in the last 52 weeks and the mode of the right hand side is about 66%. But others are clearly struggling and the mode on the left hand side is -21% in an otherwise up year.

The valley in the middle is centered around unchanged.


Charles Pennington responds:

I'd think the left-hand peak is just an artifact of the fact that Google used the wrong horizontal axis — they should have used ln(Pf/Pi) (where Pf=final price; Pi=initial price), rather than percent return — which they would have known if they had read "Optimal Portfolio Modeling" by Dr. Philip J. McDonnell.



 A Terrible Splendor by Marshall Jon Fisher.

Picture the all-seeing eye looking down on the crucial third match of the 1937 Davis Cup with the two best players of the world, Don Budge and Baron Gottfried Von Cramm playing, with the greatest of all time, Bill Tilden, in the stands rooting for his beloved German student, along with Barbara Hutton the Woolworth heiress, deeply in love with Gottfried and showing it at every shot as her second husband gets more and more furious, as Europe prepares for war, Germany recovering from hyperinflation, homosexuals and Jews gradually being stripped of their property and lives, and fighting for their lives on and off the court. It's two all in sets, extra games, and Von Cramm has volleyed a sharp angle 10 feet wide to Budge's weak forehand on the Wimbledon grass with the Queen's interlocutor in the royal box trying to restrain his enthusiasm for the German royal's victory, and stock market volume is way down because they're all following the match on the radio with Al Laney from The Tribune broadcasting.

"Take a rest," Tilden had told his very good friend. "I can't," Von Cramm answered. "I'm fighting for my life." As the players walked to the court, Von Cramm had been called back to take a call from the Führer. "We're counting on you to win… or else." Men of homosexuality, like Von Cramm, in those days were being sent to concentration camps and Cramm had been outed by the SS already. In addition his mother was half Jewish and Jews had been forbidden to practice any profession, including finance, as well as having their businesses and money confiscated. (However, they apparently were able to take out 7% of their money upon proper application). Thus Von Cramm really meant it that he was playing for his life.

That's the backdrop for this entertaining and well researched book by a man who loves tennis but doesn't play the game, and weaves the story of the match into the backdrop of the culture of tennis, arts, and economics during the 1930s. Along the way, we learn the true story of Von Cramm's gentlemanly behavior with the linesmen (he liked to thank them for their vigilance in calling his foot faults, and never corrected a linesman, and always called the ball down on himself). The sexual preferences and vices of all the Davis Cup players of the era. "Budge apparently was often three sheets to the wind, but Tilden never drank. "I'll have a Tilden" was the way the French ordered water in those days. The tragic story of all their deaths, the nitty gritty of the home economics of all the players (Tilden was always broke even though he was the highest paid athlete of his day — he insisted, like me, on picking up all checks), and many anecdotes about the tennis players of that era. Very entertaining and revealing. (Part 1).

Charles Pennington adds:

Here is a video of the Don Budge backhand.

This particular backhand looks "flat" to me — not too much topspin.

I think that the reason that the topspin backhand was considered so difficult a few decades ago is that most everyone used a grip that was too "open". It was too much of a wrist-balancing act to keep avoid netting or skying the ball.

Last night I was watching a 1980 US Open Borg-McEnroe match on the Tennis Channel. McEnroe's backhand was very unsteady. Usually he hit weak slices. It is amazing that he could hit topspin at all, since he used the same grip for both backhand and forehand.

Pedja Zdravkovic comments:

Tennis has evolved since that time and the modern day rackets allow you to play with a lot more topspin. However for a recreational player nowadays, it is maybe wise to flatten out the stroke since there is less effort in the shot and strain on the body. But in order to do that you need to have a feel for the ball. It is much more complicated to play with an open grip. Spin is what gives less of a margin for error and also creates bigger problems for the opponent. McEnroe had the best hands in tennis. When I watched him play last year out at the Long Island Tennis club it was amazing. He is able to control each ball and put it within six inches of the line 90% of the time.



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

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

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

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

Mr. Justa Guy replies:

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

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

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

That is a short version of how it works.

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

Jeff Sasmor writes:

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

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

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

Justa Guy adds:

That is where it get more complex.

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

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

Riz Din responds:

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

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

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

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

Here are the links:

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

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

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

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

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

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



 I used to do a lot of business in Japan and I think very highly of Japanese businessmen (unfortunately they rarely include women at high levels). They have an industrious, highly intelligent population, are very interested in business, and a good base as the second largest economy in the world.

It is a great mystery to me why they (and their stock market) have not done better in recent years and I have never seen any good explanation of it. Okay, they had a bubble that burst, government policies that were not great, and they have an aging population. But so what? They had plenty of opportunity to recover on their own in spite of whatever the government has been doing. (BTW their government policies could not be any worse than our current ones, so if government policies are the test, we're in big trouble.)

Has anyone seen or can anyone give a decent explanation of why Japan has lagged?

Ken Drees writes:

1. LDP party out of power after 55 years.

2. Exports and profits slumping via USA trade like others Asian exporters.

3. Big(gest) holder of USD denominated debt.

4. Aging populaton (nothing new), but 81 billion spending package just announced, more internal stimulus to follow?

5. Need to diversify their surplus holdings like others (China, Brazil, Russia, et. al.)?

6. New party administration playing a little differently with USA — recent Obama trip no real results, prior to that some grumblings about USA debt, etc.

7. Japan equities — bottoms in 1998, 2003, 2009 — skewed symetric reverse head & shoulders – or just bumping along the bottom?

8. Will need to strengthen export markets everywhere and keep USA markets open and profitable. Japan's growth lies with its neighbors if USA doesn't fix itself.

9. Yen carry trade over, yen rising — conflicts with strategic direction that exports and export profits need to be robust.

10. Zugszwang-lite Japan — any small move doesn't change game for the better. Are there any good moves available?

How will the new party lead? If they cannot rope in the yen to improve exports can they stimulate spending via QE and weaken yen at same time? Or is this approach too slow and meandering? There seems no real strong moves available unless global imbalances happen first and allow Japan countermove possibilties. Japan seems still to be unable to escape via its own power.

Is Japan getting tired of being tired?

Charles Pennington adds:

A broad-brush explanation is that the Nikkei got way out of line with other world markets and has spent the past 20 years returning to normalcy.

The Japanese price to earnings ratio was "well over 100" in the late 80s, and now it's 33 (reported by today's Financial Times), still higher than the US at 22. Earnings for the S&P are up about 2-3 times over their level in 1989, and perhaps the Nikkei's are as well, but if the P/E fell from, say, 200 down to more normal value of 33, a value much more in-line with other world markets, well, that explains a lot.

The Chair will rightly point out that this is retrospective, descriptive, and not predictive, that Japan's interest rates are (or at least were) lower, that the accounting may be different. Also, Mr. Grossman doubtless already knows all these figures, so he is looking for a better explanation, which I don't have.

Kim Zussman adds:

Country-stock could be like "best company" studies, showing admired firms under-performing the rest. Presumably established/successful companies/economies have less upside than currently dire situations. And more downside? 

Vince Fulco replies:

To the list I would add traditional factors such as:

1. Shareholders — very far down the societal list of all stakeholders in the corporate world. The stock market is generally considered more for gambling (no jokes Dr. Z!)

2. Much heavier reliance on debt financing (too much) due to roots in maibatsu/keiretsu structure whereby a conglomerate's banking branch handles all the financing needs

3. No Carl Icahn or Guy Wyser Pratte influence to shake up entrenched mgmts and unlock under-utilized assets. The quote is 'the nail which sticks up gets pounded down'. A few have tried over the years but are usually labeled degenerates or cowboys and run out of town one way or another.

4. Years of very low ROI, white elephant projects by the government, to keep happy important constituents of the LDP (the old group in power) such as construction and the mob — i.e. the bridge to an island with 50 people on it, which we almost got in Alaska a few years back.

5. Legacy obligations which haven't been addressed but simply kicked down the road as we've emulated so well in the last 12 months.

Ken Drees responds:

Mt FujiVince, Kevin, Kim and Charles have all provided excellent observations as to Japan's inbred entrenched-ness, inabilities to move, and relative over valuations. Also, the idea that is was the once high flyer status albatross, so all these past behaviors are in the rear view mirror, yet they continue to taint the view of Japan as an old has-been power country. But change agents may now be inside this yesterday/today paradigm. So far Palindrome's reflexive reinforcement of trend is still in force. The malaise continues. Will some new change agent surface? Will the reflexive reinforcement finally be breached.

The early elements for a change exist. To bet on a new bullish Japan is a long shot. But how much money can be made betting the field? Tax policy can be repealed, monopoly/hands in hands can be abolished, small investors can be made more ownership level. All the levers to lift the old dead stump and turn it over are at the ready. Or is this a dead end due to lack of will? Is Japan a stunted growth, never ever to leave off-broadway? If a global imbalance rises up, will Japan change tack and ride out on a new wind? I am watching Japan, if only since they since they are shackled to the USD. Maybe the impetus for change is at hand. This new administration in Japan — what do they owe the US? 

Stefan Jovanovich replies:

The Japanese are certainly not hidebound where their Navy is concerned. They are the dominant sea power in their part of the world. From the folks at StrategyPage.com:

"Japan is currently the second largest naval power in the Pacific (after the United States), with a total of 32 destroyers, nine guided-missile destroyers, and nine frigates. The older Tachikaze-class guided-missile destroyers are being replaced by the new Atago-class destroyers. Japan also has 16 modern diesel-electric submarines. The Chinese navy is larger in terms of ships. They have 25 destroyers and 45 frigates. However, of these 25 destroyers, 16 are the much older (than Japanese equivalent) Luda class. Most of the frigates are the obsolete Jianghu class ships. China has 60 diesel-electric submarines, but most of them are elderly Romeo and Ming class boats. China's Han class SSNs (nuclear attack subs) are old and noisy. In terms of modern vessels, China is not only outnumbered, but the Japanese ships spend more time at sea and the crews are better trained. The Chinese are also at a disadvantage when it comes to naval air power. Most of China's naval fighters are old. They have a growing number of modern J-11s (a copy of the Russian Su-27) and the Su-30MKK. Japan is almost at parity in terms of numbers (187 F-15J/DJs and 140 F-2s to 400 Chinese J-11/Su-30MKKs). Japan has better trained pilots, although China is trying to close that gap as well."

Yishen Kuik adds:

 The attention to detail and sense of duty of their workforce is amazing, and the public infrastructure in Tokyo is of a very high quality — certainly better than Boston, DC, New York or the Bay Area. Tokyo is much bigger than all these four areas. It makes New York seem small.

It's not entirely clear to me why their equity markets haven't done better, but the "obvious" explanations of long term multiple contraction and shrinking internal aggregate demand seem to be correct.

I believe GDP per capita in Japan has been rising all along at the same pace as in the US since 1989, so it isn't as if quality of living in Japan has been frozen at 1989 levels. From what I can tell walking around the streets, they still enjoy a comparable standard of living to anywhere in the OECD, and have an unemployment rate (whatever that means in Japan) of 5.0%

Henrik Andersson replies:

Some investors are expressing great fear about the debt given the large amount maturing in the coming 12 months that is held by citizens, as Yishen writes, and given it has "no foreign demand, no domestic savings, structurally declining tax receipts and savings due to demographics, etc." Any views on this?

The top line numbers for the country are stagnant, but the per capita numbers don't look so bad. Japan might have a ton of public debt, but most of it is yen denominated and some 3/4 of it is held domestically by its own citizens.

Dan Grossman writes:

 Two thoughts perhaps follow from the helpful comments of Prof. Pennington and Mr. Kuik:

1. Based on the two-decade decline in average Japanese stock PEs from 200 to 33, why shouldn't average US stock PEs decline further from the current 22 if government policies following bursting of the bubble are equally ineffective in the US as they have been in Japan?

2. If since 1990 the U.S had avoided illegal and legal immigration anywhere near the extent to which Japan has, the US unemployment rate would probably also be 5%.

Vitaliy Katsenelson adds:

Please look at slide 14. Japanese valuations at the of 1989 were incredibly high, add to that a lengthy deleveraging process on the corporate side and leveraging (debt to GDP has tripled) on the government side and you also have anemic economic growth.

Vince Fulco writes:

Here is fascinating article in the WSJ re: a foreigner helping a small japanese village manage the downside of the demographic slowdown. One wonders how much more pervasive this sclerotic 'no change' attitude really is…

Charles Pennington adds:

There's a nice column by Lisa W. Hess in the Dec. 28 Forbes about investing in Japan.

She claims that small cap companies are even more undervalued than large cap, and recommends buying the Topix rather than the Nikkei.



Here is a description of the studies I am doing on Value Line. FVL is an ETF which uses the Value Line timeliness system. Instead of using VL service to pick stocks individually, you can own FVL and obtain VL returns (of course other screens could be applied).

Using daily closes of FVL and SP500 ETF SPY, I did a linear regression:

For each day's change in SPY (X), what is the same day's change in FVL (Y). The actual equation for this line is:

FVL = - 0.000109 + 0.791 SPY  (Y = alpha + beta*X)

The regression does a least-squares fit of a line to the data (minimizing the sum of squares of errors in Y direction), and the slope and Y-intercept of this line describes how FVL's daily change is related to SPY's.

The slope ("beta") of 0.8 means that when SPY goes up 1%, on average FVL went up 0.8%, etc.  The intercept alpha) shows, on average, whether FVL gives higher or lower daily return than SPY, by checking where the line crosses when SPY is zero.

Both slope and intercept are tested for statistical significance (assuming error residuals are normally distributed), that is whether they were likely to have occurred by chance alone.  

(Better descriptions welcomed)

Here is the study:

FVL; Value Line timeliness ETF.

From inception in 2003, regressed daily return of FVL vs SPY:

Regression Analysis: FVL versus SPY

The regression equation is
FVL = - 0.000109 + 0.791 SPY

Predictor        Coef         SE Coef        T      P
Constant   -0.00011       0.00023    -0.48  0.630
SPY          0.79111        0.01640    48.24  0.000

S = 0.00906282   R-Sq = 59.3%   R-Sq(adj) = 59.2%

>> Conclusion: alpha (with respect to SPY) for FVL is negative, though N.S.  Beta is 0.8, and highly significant.

A scatter diagram is also available.

Charles Pennington writes:

For my curiosity, could you (if convenient) try reversing it and regressing SPY vs the VL fund, for comparison?

Kim Zussman replies:

No problem, Charles. Here's what happens when you reverse the independent and dependent:

Regression Analysis: SPY versus FVL

The regression equation is
SPY = 0.000173 + 0.749 FVL

Predictor       Coef    SE Coef               T      P

Constant   0.0001734  0.0002204   0.79  0.432
FVL          0.74920      0.01553       48.24  0.000

S = 0.00881953   R-Sq = 59.3%   R-Sq(adj) = 59.2%

Analysis of Variance

Source            DF       SS       MS        F      P
Regression         1  0.18099  0.18099  2326.84  0.000
Residual Error  1599  0.12438  0.00008
Total           1600  0.30537



A AI was planning to review Agassi's autobiography but he shows himself as such a loathsome character on every page that I don't wish to waste the time before finishing A Terrible Splendor, an excellent book by someone who doesn't know anything about tennis, but does tell some great anecdotes along the way, and evinces the pathos of Tilden and Von Cramm in a heartfelt way. I always thought that Agassi was a terrible sport, and a spoiled good-for-nothing and people would try to dissuade me and say he's changed — but I see my views were correct. I wish I could see as clearly to the bottom line in markets as I can in racket sports.

Charles Pennington responds:

It was an enjoyable book, and I like to watch him play, but it's true that almost everyone who comes up in the book, except for his current inner circle, gets panned in some way or another:

  1. Pete Sampras gives miserable tips to cabbies, luggage handlers, etc, and makes you feel like one of them when he wins.
  2. Michael Chang is sanctimonious, takes God to be on his side in his tennis matches.
  3. Jim Courier, after beating Agassi, went out for a jog to demonstrate that Agassi didn't even tire him out.
  4. Boris Becker blew kisses to Brooke Shields during his match with Agassi in order to tick him off.
  5. Brooke is superficial, talks only about things rather than ideas.
  6. Nick Bolletieri can't be taken seriously as a coach.
  7. Andre's dad tormented him with tennis.
  8. Jimmy Connors is a mean SOB, walks around like Julius Caesar.
  9. Andre's grandmother has a hideous wart on her nose.



AgassiI got the new Agassi book and have now read the first chapter.

The first chapter tells of his match at age 10 with Jeff Tarango (who also later became a touring pro, controversial for his bad temper). With the score tied 4-4 in the third set tiebreaker, Agassi hits a backhand winner that's three feet inside the lines. Tarango "bows his head and seems to cry…" [Tennis Week story]. "Now he stops. All of a sudden, he looks back at where the ball hit. He smiles. 'Out,' he says," writes Agassi. "I stop. 'The ball was out!' Tarango yells. This is the rule in the juniors. Players act as their own linesman… Tarango has decided he'd rather do this than lose and he knows there's nothing anyone can do about it. He raises his hand in victory. Now I start to cry."

Overall, you definitely get your money's worth if you want dirt dished. Again, writing of his childhood, page 39: "My father's mother lives with us. She's a nasty old lady from Tehran with a wart the size of a walnut on the edge of her nose…" I also once read the Tatum O'Neal autobiography, which is tangentially connected to tennis because of her marriage to John McEnroe. Agassi is scoring high on the scandal-meter, but he won't be able to touch that one.



What would a weekend be without my noting that Mr. Dow crosses back and forth over magic 10000 gravitational level six times on Friday, as was guaranteed to happen.

Allan Millhone comments:

I note a different Isaac Newton effect as pump prices rise in the last ten days. I read in morning's paper an inside trader hedgie arrested. I feel as a sheer novice it is scoundrels like him who moved the Market to ten thousand and not a solid economy; as to foreclosures we have yet to see the true picture. This coming Winter will be a very cold one and demands will be made on natural gas and ole Reddy Kilowatt. People will use their cash for food and fuel and home utilities and holiday retailers will suffer.

Alston Mabry takes out pencil and paper:

The Dow first crossed 10,000 on 12 March, 1999. The first open above 10,000 was 19 March, and the first close above was 29 March.

Looking at all Dow days from 29 March, 1999, to present and calculating how far in points each close is to its nearest round thousand, produces the following stats:

Total days: 2657

Mean distance in Dow points from nearest round thousand: 265.46

Histogram (using 25 point bins):


0-25 112 4.22%
50 122 4.59%
75 104 3.91%
100 119 4.48%
125 132 4.97%
150 135 5.08%
175 105 3.95%
200 124 4.67%
225 144 5.42%
250 115 4.33%
275 126 4.74%
300 135 5.08%
325 140 5.27%
350 116 4.37%
375 131 4.93%
400 156 5.87%
425 168 6.32%
450 156 5.87%
475 157 5.91%
500 160 6.02%

Looking again at this histogram, one can total the bin %'s in different ways:

distfromround / %totaldays

.   0-250 45.6%
250-500 54.4%

.   0-125  22.2%
125-250  23.4%
250-375  24.4%
375-500  30.0%

We are honored to receive this communication from Prof. Charles Pennington:

Benford's Law gives expectation frequencies for the first digit of a numerical quantity that's thought to be uniformly distributed logorithmically over several orders of magnitude. The Dow has varied by about 2 orders of magnitude since 1928. Here's its distribution along with the Benford's Law prediction:

first digit / frequency of occurrence in daily Dow 30 prices /
expected frequency from Benford's Law

1 35.0% 30.1%
2 12.5% 17.6%
3 6.3% 12.5%
4 4.7% 9.7%
5 3.7% 7.9%
6 5.5% 6.7%
7 6.1% 5.8%
8 14.2% 5.1%
9 11.9% 4.6%

(There were 20,352 observations.)

So there are "too many" 1s, 8s, and 9s, and not enough 2s, 3s, 4s, and 5s. Because of the serial correlation in the daily prices, it's not obvious (to me) whether this is statistically significant, but over history the Dow has spent some extra time hanging around near the powers of 10.

Victor Niederhoffer bypasses Benford's Law in his evaluation:

Yes, it seems significant. There were 45% within 250 points and the standard error expectation was 25. So the deficiency of 130 is five standard errors from expectation.

Alston Mabry follows up:

I broke the Dow into non-overlapping 250-day segments and counted the number of times within each segment that the Dow had an 8- or 9- handle. Chart of the results (click on All Sizes [magnifying glass] to see large version).

Conclusion: the big skew is there from the mid 1960s into the early 1980s.



Some high quality youtube of Fabrice Santoro vs Julien Benneteau. Benneteau won the match, but he had to win each point three or four times before Santoro would let go.

Santoro might like the new two-handled NaturalTennis racquet promoted by a pro doubles team, the Battistone brothers, who bought the patent for it.

Victor Niederhoffer remarks:

That tennis is among the most beautiful match of racket sports I've ever seen. Reminds me a bit of a fantasy match between Evonne Goolagong and Althea Gibson. Or Vic Herskowitz playing Martie Decatur in handball or Jeff Hunt in squash versus Sharif Khan. amazing that Santoro can hit so well considering he can't move well. And neither has much of a serve or overhead which must have been their undoing.

Murali Mys agrees:

Santoro is a magician. He wields the racquet like a wand. He will be missed — 2009 will be his last year on the ATP tour.

Matt Johnson adds:

Santoro… Amazing touch and feel, plus, he loves the sport. I dig watching him. Actually, a rerun of a 2005 Masters Doubles Championship was just on Tennis Channel. Great tennis; four guys at the net, ping, ping, ping, lob volley, wind sprint, lob, overhead smash for the point. Santoro was a gift to tennis, I hope he comes back in a year or two, heck he's only, what, 36?

Don Chu extends:

Another Magician of the Court was the Moroccan, Hicham Arazi. With his dexterity, body coordination and rubber wrists, his touch and feel has to be amongst the best of any era. He could do so many amazing things with that racquet, admittably some of which had little to do with the game of tennis. Alas, his lack of a robust mental game, temperament and a complete game, was too much to overcome even for a wizard with his kind of body-alchemy; many times the Magician was reduced to Court Jester.



Pennington jerseyEvidence is accumulating that football, at least at the professional level, is causing dementia and other cognitive problems among retired players.

"..the Michigan researchers conducted a phone survey in late 2008 in which 1,063 retired players — those who participated from an original random list of 1,625 — were asked questions on a variety of health topics. Players had to have played at least three or four seasons to qualify. Questions were derived from the standard National Health Interview Survey so that rates could be compared with those previously collected from the general population, the report said.

"The Michigan researchers found that 6.1 percent of players age 50 and above reported that they had received a dementia-related diagnosis, five times higher than the cited national average of 1.2 percent. Men age 30 through 49, for whom the national average is 0.1 percent, showed a rate of 1.9 percent, or 19 times that of the general population.

"The paper itself questioned the reliability of using phone surveys to assess prevalence rates of diagnosed dementia, as did several experts in telephone interviews. For example, some of those affected might not be reachable; then again, N.F.L. players may have greater access to doctors to make the diagnosis, and so on."

The study already seems compelling. There could be some promising ways to test the idea further and learn more, such as measuring the dependence of cognitive problems on:

– years played
– self-reported number of diagnosed concussions over football career
– height and weight at retirement
– "safety" of position played, as rated by some independent source.
(e.g. punter and kicker would probably be rated safest)

Obviously this may cause some worries among high school and college players. One can hope that the problems don't really kick in until the play reaches the weight and speed level of the NFL.

Victor Niederhoffer generalizes:

HeaderThe study the Professor alluded to reinforces my long held belief that soccer is an evil sport, and the body is not meant to be banged up, especially the head, and that this causes early death and dementia. In addition to the heading shot, which must be involved on at least a third of all goals, I find soccer objectionable for my kids because kids with no other means of recreation or occupation play it from the day they are born, and by the time they compete with Americans who have to go to school and develop other interests, they are much too good for the Americans to compete against . Also, I hate that you can't play it without great effort after you graduate from college so it's not a life long source of recreation. My father Artie always said, whatever you do, don't let your kids play football. And I would add soccer and boxing.

Jordan Neuman opines:

I always thought that the rise of soccer in the suburbs over the last generation was just an extension of liberal politics because everybody can play. If someone has no talent they just stick him on defense. (I am speaking of school kids, obviously at higher levels of play this does not apply.)

On the other hand when my kid is pitching, he is on the stage. When he is throwing good strikes it is beautiful. When he gets lit up you have to tip your hat to the hitter (also on his personal stage). I always thought all those volumes expended on "America is baseball" were wasted, and most are. But there is a reason that baseball is a uniquely American game.

Ryan Carlson digresses to his favorite sport:

One of the many reasons why I find hockey to be such an honorable sport is that cheapshots and any unsportsmanlike conduct is dealt with through "the code" that such behavior has to be answered through fistfights. The code serves as a check and balance for problems to be addressed quickly and so liberties aren't taken when the ref is looking the other way. An entertaining book for those interested is The Code: The Unwritten Rules Of Fighting And Retaliation In The NHL

Scott Brooks continues:

GassoffHaving grown up a big St. Louis Blues fan and overall general hockey fan, I watched more than my fair share of hockey. We had season tickets to the Blues when I was growing up in the 1970s. My dad ate at a restaurant by his work that was frequently attended by Blues players. Dad was on first name basis with such greats as the Plager Brothers, Garry Unger, Bob Gassoff, Noel Picard, Chuck Lefley and many others.

Watching the dynamics of hockey growing up, it was clear that every team needed at least one good enforcer. This was the guy that would go out and beat up whoever on the the other team "breached protocol". If someone smashed into the Garry Unger (the Blues main scorer back in his day), he'd have to deal with one of the Plager Brother or (even worse for him), Bob Gassoff!

My father knew Plagers and Bob Gassoff and would tell me regular stories about what nice guys they were — but on the ice, holy cow! They were animals!

Pound for pound, there was no tougher, meaner group of hockey players ever to step on the ice than those Blues teams in the early/mid 1970s. The Plager Brothers were two of the toughest men ever to play in the NHL. And the best pure fighter to ever step on the ice was Bob Gassoff!

Bob Gassoff was the ultimate enforcer. Even the Plager Brothers — easily in the top 25 best fighters to ever step on the ice in the history of the NHL — would defer fights to their teammate Bob Gassoff.

Of course, there is always the image in my mind of the Blues going up into the stands fighting with the crowd in Philadelphia (a city known for its toughness).

And of course, there is ultimate showdown in the history of the NHL: Bob Gassoff vs. Tiger Williams as to who was the toughest man in the NHL. Both coaches agreed in advance to not let the players on the ice at the same time. But with around three seconds left in the game (and the game already won), there was a dead puck face off. The coaches put Gassoff and Williams on the ice at the same time. They lined up next to each other in the circle, looked directly into each others eyes, nodded to each other and proceeded to drop their gloves and go at it!

What a spectacle! After the fight, Bob Plager grabbed a bloodied Bob Gassoff and skated him around the ice holding his hand up like a referee does for the victorious prize fighter. Gassoff had won the ultimate hockey battle!

I think the markets would be a lot more interesting if we could have enforcers. If someone squeezes you out of your position too many times, you just send over your equivalent of Bob Gassoff to let him know he'd better not do that anymore!

Vinh Tu gets back to the subject of using the head in sports:

HeaderWhen I was between the ages of 8 at 12, my parents signed me up for soccer, and made me go play it, even if it sometimes meant they had to tear me from my Apple II computer. Doing clever things with one's feet was fun, and I'm sure that all the running was beneficial to me, physically. But I also remember heading practice, where a beefy coach would force 10-year-olds to use smack their heads against a flying ball. I remember that I only once, after much trepidation, allowing a ball to hit my head. I immediately knew that the feeling in my head after the impact was not at all good. After that, I could not help but flinch or duck during these heading drills, despite feeling intimidated by the large, angry, frustrated coach. Meanwhile there were a few kids on the team who really took to it and were gleefully smacking their heads against balls launched at them by the coach. It would have been interesting to follow up on my team mates and see if there has been any correlation between being a keen header and intelligence, and a few decades from now, dementia, and also whether there are correlations with other behavioural traits (perhaps lack of caution and restraint, impulsiveness?) and genetic correlations.

Stefan Jovanovich reassures:

BoxingThe most important question to be asked about getting smacked in the head is "where?". The upper forehead and the forward peak of the skull can take a severe impact without any damage; the same blow to the temple will kill a person. There is no question that football players and professional boxers have problems with dementia from the repeated blows to the temple. Vinh Tu's beefy coach was an idiot and bully. The first lesson in learning how to head a ball is teaching the kid to watch the ball into his/her forehead, and the best way to teach that lesson is to have two kids soft-toss the ball back and forth, as if they were playing pepper.

There is very little risk of head injury in amateur boxing; if it is properly worn, the head gear protects the temples and the upper jaw – the two places where you can get hurt.

What is stupid about the design of football head gear are that the helmet is allowed to float; compare the design to military headgear where the webbing and the helmet are cross-braced so they move together.

Tom Marks is skeptical:

InjuryA humble postulate: Nearly all orthopedic and neurological injuries related to professional sports stem from the fact that eons of evolution hardly designed the human body for the unique stresses these activities put on it.

Sports-related head and knee injuries aren't going away anytime soon, especially the latter. Somebody could design a more efficient helmet, but only nature could design a knee that could better withstand the unnatural rigors of playing running back in the NFL. And there's nothing hasty about nature. It tends to deliberate long and hard.



Prof PTennis28.com gives in order the youngest and oldest major tournament winners of the open era — e.g. Michael Chang was the youngest winner at age 17, in 1989, at Roland Garros, and Ken Rosewall the oldest, at age 37, in 1972, at the Australian.

I list the top 25 youngest and top 25 oldest below, along with my assignment of "E" (Eastern) or "W" (Western).

Of the 25 youngest winners, 12, by my count, use a Western grip.

Of the 25 oldest, only four use a Western grip –and all four are Andre Agassi, and I think that's generous, since I would argue that his grip, toward the end of his career, may have been more Eastern than the average player's.

So apart from the borderline case of Agassi, none of the oldest 25 winners used a Western grip, while 12 of the 25 youngest winners did. This supports the Chair's prediction that Nadal doesn't have many more years to go at the highest level.

25 youngest major tournament winners:
1    Michael Chang    1989    Roland Garros    17y 3m 20d E
2    Boris Becker    1985    Wimbledon    17y 7m 15d E
3    Mats Wilander    1982    Roland Garros    17y 9m 15d E
4    Bjorn Borg    1974    Roland Garros    18y 0m 10d W
5    Boris Becker    1986    Wimbledon    18y 7m 14d E
6    Rafael Nadal    2005    Roland Garros    19y 0m 2d W
7    Bjorn Borg    1975    Roland Garros    19y 0m 9d W
8    Pete Sampras    1990    US Open    19y 0m 28d E
9    Mats Wilander    1983    Australian    19y 3m 19d E
10    Stefan Edberg    1985    Australian    19y 10m 19d E
11    Rafael Nadal    2006    Roland Garros    20y 0m 8d W
12    Bjorn Borg    1976    Wimbledon    20y 0m 27d W
13    Mats Wilander    1984    Australian    20y 3m 17d E
14    Lleyton Hewitt    2001    US Open    20y 6m 16d W
15    John McEnroe    1979    US Open    20y 6m 24d E
16    Marat Safin    2000    US Open    20y 7m 14d W
17    Gustavo Kuerten    1997    Roland Garros    20y 8m 29d W
18    Mats Wilander    1985    Roland Garros    20y 9m 18d E
19    Jim Courier    1991    Roland Garros    20y 9m 23d W
20    Stefan Edberg    1987    Australian    21y 0m 6d E
21    Rafael Nadal    2007    Roland Garros    21y 0m 7d W
22    Andy Roddick    2003    US Open    21y 0m 8d W
23    Bjorn Borg    1977    Wimbledon    21y 0m 26d W
24    Jimmy Connors    1974    Australian    21y 3m 30d E
25    Lleyton Hewitt    2002    Wimbledon    21y 4m 13d W

25 oldest major tournament winners
1    Ken Rosewall    1972    Australian    37y 2m 1d E
2    Ken Rosewall    1971    Australian    36y 2m 12d E
3    Ken Rosewall    1970    US Open    35y 10m 11d E
4    Andres Gimeno    1972    Roland Garros    34y 10m 1d E
5    Ken Rosewall    1968    Roland Garros    33y 7m 7d E
6    Andre Agassi    2003    Australian    32y 8m 28d W
7    Arthur Ashe    1975    Wimbledon    31y 11m 25d E
8    Rod Laver    1969    US Open    31y 1m 0d E
9    Pete Sampras    2002    US Open    31y 0m 27d E
10    Jimmy Connors    1983    US Open    31y 0m 9d E
11    Rod Laver    1969    Wimbledon    30y 10m 26d E
12    Rod Laver    1969    Roland Garros    30y 9m 30d E
13    Andre Agassi    2001    Australian    30y 8m 30d W
14    John Newcombe    1975    Australian    30y 7m 9d E
15    Rod Laver    1969    Australian    30y 5m 18d E
16    Andres Gomez    1990    Roland Garros    30y 3m 14d E
17    Jimmy Connors    1982    US Open    30y 0m 10d E
18    Petr Korda    1998    Australian    30y 0m 9d E
19    Rod Laver    1968    Wimbledon    29y 10m 27d E
20    Ivan Lendl    1990    Australian    29y 10m 21d E
21    Jimmy Connors    1982    Wimbledon    29y 10m 2d E
22    Goran Ivanisevic    2001    Wimbledon    29y 9m 26d E
23    Andre Agassi    2000    Australian    29y 9m 1d W
24    Andre Agassi    1999    US Open    29y 4m 14d W
25    John Newcombe    1973    US Open    29y 3m 17d E



TildenHypothesis: The more western your grip, the less longevity in your career.

With a "western" grip, the racquet face is "closed", facing relatively downward, and you have to take a big swing, rotating your body as much or more than 180 degrees, with great racquet speed and top-spin. Nadal is probably the ultimate. Borg was western for his era (though not nearly as much so as Nadal and current players).

With a continental grip, the racquet face is relatively open; you hit flatter, with less spin, and your body rotation is closer to 90 degrees.

One can think of a host of players with eastern or continental grips who had long careers, playing to relatively old age: Laver (one of the world's top players until he retired at 38), McEnroe, Tilden, Navratilova (playing up to age 50!). Federer has a relatively eastern grip by today's standards. Jimmy Connors hit flat, no spin, the ultimate easterner, and he competed well at age 39. Agassi played near the top to a ripe old age, and his grip was a bit western, but not extreme for today's play. Both Federer and Sampras (US Open winner at age 31) were more eastern than most of their competitors.

Here are some of the big westerners:
Borg — Retired at 26
Nadal — Game in apparent decline at age 23
Courier — Retired at age 30, won 6 major tournaments, all before turning 24
Roddick — Still in the mix, but probably peaked at age 21

Going back further in time — Bill Tilden (eastern) and Bill Johnston (extreme western) were born just one year apart. Johnston won the US Open in 1915 and 1919, but then Tilden won it in 1920, 1921, 1922, 1923, 1924, 1925 and 1929.

With age it just becomes too difficult to hit the big, swirling western forehand, and so players that have a relatively economical stroke are the last ones standing.

(Note that most of the "modern" grips and styles are described in Bill Tilden's 1925 book "Match Play and the Spin of the Ball" which I have reviewed before.)



RingI was hoping some one here may be able to help me out. After four years of dating my girlfriend, I have finally decided to ask her to marry me. I am in the early stages of looking for a ring and am obviously wanting to get her the best ring I can. Unfortunately what she deserves and what I can afford are two different things. Therefore my hope is that someone on this list knows someone that would be able to get me some type of deal on an engagement ring. I'm not looking for a hand out by any means, I just want the best value for my money. I'm also looking to get it pretty soon as I believe both of us would like to get married before I leave for Afghanistan next year.  Thank you in advance to anyone who is able to help me out!

Dylan Distasio replies:

Good luck with the proposal! Unfortunately I don't know someone who can give you a deal on a ring. However, I would highly recommend checking out Blue Nile. They have beautiful diamonds at all price levels, quality levels, cuts, etc. at very low prices compared to retail. I am incredibly happy with them from personal experience. I was able to get a very high quality diamond for an engagement ring that my wife is now wearing. They also offer settings if you want to one stop shop. They ship quickly, and the diamond appraised at approximately 50% higher than what I paid. Most importantly though, it is a beautiful stone. My co-worker also had great luck with them. I'm not a Blue Nile shill, just a satisfied customer.

Charles Pennington weighs in:

T BoxBorsheim's is pretty good. With them I don't think you have to worry you're getting ripped off. You can call them on the phone and just talk with them about how much you're thinking about spending, and they'll provide a host of options for you. If you want, they'll even ship one or two out to you so that you can have a look. If they do rip you off, you can go complain to Warren Buffett at the next Berkshire Hathaway shareholders' meeting!

Caution: She may want a ring from Tiffany, even though you both know the extra money is just for the blue box.

Dan Humbert takes an unconventional view:

Don't waste your money on something so ridiculously overpriced as a diamond (especially since you indicate you are short on funds and are off to Afghanistan, meaning you'll have a lot more important things for you and your fiance to spend your limited funds on). If you and your fiance want an engagement ring, cubic zirconiums are nearly as good, and I understand there are now even better man-made diamonds that a jeweler cannot distinguish from natural diamonds — it takes an expert with sophisticated equipment. Exact types and prices are well-covered in the recent book Spent by Geoffrey Miller. No one else will be able to tell, and you and your fiance have no obligation to confess that you were not so wasteful as to buy in to De Beers's monopoly and ridiculous advertising that you should spend 25% (or whatever obscene portion of your year's salary) on the diamond.

Taking it a step further — this being a libertarian-oriented site, why get married at all? You and your love should set the terms of your own wonderful relationship rather than letting the government, courts and lawyers dictate the terms. It's a lot more romantic to voluntarily win each other's love each day, than to be obligated by the government to stay together unless and until expensive and debilitating proceedings involving lawyers and judges allow you to change the terms.

The dissenting view gets support from Kevin Humbert:

Dan offers excellent diamond advice. After losing a number of "real" diamonds to both women and thieves, I decided to look into synthetic diamonds as an alternative some time ago. At the risk of sounding cynical you don't blow through as many ring-requiring ceremonies & occasions as I have without incurring significant financial loss… and that's before the rings are even factored into the equation. Man made diamonds vary wildly in price & quality. Even so, the discount to comparable high quality diamonds is high enough to make something man made a no-brainer for me. As for whether anyone notices if it is real or not, I can't recall having met anyone outside of the jewelry industry who is impressed with a diamond wedding ring one way or the other, either real or synthetic.

But Laurel Kenner interjects:

Gentlemen! A fake gem sends the wrong message. And relationships without marriage usually turn out to be fakes, too. Just ask a wife whether her marriage is real or not.

An anecdote from Chris Cooper:

I once had an employee who had already made a lot of money from stock options owned by her husband and herself as executives at a big tech company. When they got married he told her she could have a one-carat ring now, or for every year she waited he would increase the size by an additional carat. After several years she caved in, and could be seen flaunting a 5-carat flawless solitaire in important business meetings. A stone of that size does tend to attract the eye.

Legacy Daily sends a specific suggestion:

Congratulations! Engagement and marriage are indeed very special life events. I have jewelers in the family who would be happy to help. I just called them to let them know that they might hear from you. Feel free to contact Artinian Jewelry.

John Lamberg looks back:

A word of advice: When your wife to be picks out a wedding ring, no matter what price, run, do not walk, to the counter and purchase it. Do not repeat the mistake I made many years ago and say, “let’s think about it…”. Some mistakes are never forgotten.

Victor Niederhoffer also reminisces:

I bought mine for 25 cents at Woolworth on 86th and Third Avenue. And as the poker player said after he took his real diamond from her the day of the wedding to throw into pot, "she's still wearing it."



J RobinsonWhat can we learn from baseball that is applicable to markets?

In looking at how to hit for Aubrey, I focus on posing and gaining potential energy by moving the back foot back or lifting the right foot up before hitting the ball. Also holding the head directly at pitcher, and the trigger point. Also following through the ball with the bat following it on a line before snapping up. I don't know anything about baseball but all this seems applicable.

Please augment. We have quite a few experts on baseball who read this site and the All-American also.

James Lackey replies:

They don't teach you to lift your foot up anymore when you bat. You use a wide stance, and you pivot your back foot towards the pitcher and snap your hips. Some teach you to pivot your back foot on the ball of the foot, with you front foot on its heel while swinging, and you end the swing with your feet pointing to the pitcher. My son's 11-12 year old hitting coach had a hard time retraining my kid. He cut a 1" piece of PVC pipe the length of his shoulders made him stand over it and do a zillion swings to get his front foot down before he could snap his hips. We were all taught to keep your elbow up, use a narrow stance and step into the pitcher.

J.P Highland comments:

Being able to choose the pitchers we want to face gives us a great advantage over baseball hitters. The Nymex's pitching rotation is my favorite. They like to intimidate batters with lightning fastballs but their stuff suits my swing, as opposed to the tough off-speed pitches ES has mastered that have victimized me so often.

James Lackey adds:

My kid was born with a cannon. I knew it at age four when he threw me a hardball. By 10 he could throw from the fence to the catcher. He was a good pitcher at 12, but his coach would always yell at him over the top when he lost control.

Now what I do not quite get is that his football coach yells at him at practice to quit throwing a baseball. It's how quick you release to give the defenders a chance to attack. My son explained to me how it works, but I still do not get the mechanics.

The only good thing to report is I have never been his football or baseball coach only dirt bikes. So naturally he loves team sports.

Tim Melvin writes:

I'm not a much of a pitcher as I have a noodle for an arm and always have, but in the excellent baseball book featuring John Smoltz and Mike Mussina we learn that speed, location and deception are the keys to successful pitching over time. I am not just talking about power speed either. The Nolan Ryans are the one off Soros and Buffets of the baseball world. The ability to vary speed and move the ball around are the key to long term success.

I shall leave you all to draw you own market conclusions as there are many that leap to my mind.

Scott Brooks comments:

Good pitching isn't about overpowering batters and striking them out, it's about throwing the ball so that the batters make bad contact, and then letting your fielders do their job.

Stefan Jovanovich writes:

 Albert Pujols does both old and new school. He has his right foot turned 45 degrees towards the pitcher, the right knee bent slightly, the hands held back and high (at the top of the strike zone), the right shoulder held above the left, with the bat vertical. When he unloads, the left foot and hips do a quarter turn, the right shoulder drops slightly as he throws the bat at the ball, and the bat stays level to the ground for the full travel across the plate. In 4 days against the Giants he made one bad swing: when Matt Cain threw him a 1-2 slider down and away. He absolutely ate Barry Zito alive even though Zito now has game back and had no trouble at all with the rest of the Cardinal lineup. Theoretically, you could throw him changeups and curves down and away; but, when Lincecum tried it, by the 2nd at-bat, Pujols was hitting doubles down the line in right. It was like watching the Yankees try to pitch Williams inside (with his long arms and height, he should have been vulnerable) and watching him take the ball early and park it in Ruth's pavilion. Yo-Yo Ma with a pine bow.

Pitt T. Maner suggests:

This article which I quote from was interesting in light of an optical illusion I had seen a few days earlier on the internet. Many years ago I had read stories of knuckleballers who had pitches where even they themselves were not sure of the ball's pathway to the catcher's (often oversized) mitt.  This story has a bit of that mysterious, "unhittable" pitch reminiscent of Plimpton's April Fool's hoax:

"DiFelice grips the ball across the seams, like a four-seam fastball, and tilts it so his middle finger rests along the red stitching. He squeezes the ball with his middle finger, raises his index finger and throws it as he would a fastball. The result is confounding: The ball spins like a fastball and moves like a slider, and the optical illusion it plays on hitters allows him to get away with throwing an 82-mph pitch the batter knows is coming."

And here is the optical illusion (best illusion of the year in fact).

How would you learn to hit such things? Would you need to learn to selectively ignore information coming from your eyes?

Phil McDonnell writes:

Lifting the front foot high does not inherently add energy to the swing. If you think about it lifting a foot straight up adds potential energy only in an up and down direction. The point of a baseball swing is to drive the ball in the horizontal direction. Any energy from the foot lift is orthogonal to the intended swing and does not add any power.

The real reason for the foot lift is that it enforces a good weight shift. When the foot is lifted all of your weight is on the back foot by necessity. This allows the weight to start on the back foot and shift to the front foot. The weight shift adds power to the swing by starting the twisting motion of the body and the hips. Fundamentally the power is generated by the centrifugal motion of the bat. The center of that motion is the twisting of the hips and body.

There is another subtle but important aspect to batting. That is the need to have a good follow through. The key is the hands. If you do an imaginary swing with your hands you will see that when you fully extend your left hand in a follow through that your right hand cannot stretch out nearly as far as the left (for righties).

This compels two types of follow through motions. The first kind is simply to break the hands. The follow through continues with only the left hand still holding the bat as the right hand is released. Reverse for lefties.

The other type of follow through involves a roll of the wrist. Basically the right wrist rolls over the left as the bat passes to the left of the body. The object of either finish is to keep the bat moving even after it is in contact with the ball.

The one follow through technique that is bad is to keep both hands on the bat without a roll. If you try it you will see that you get a hitch in your swing just about when the bat handle passes your body.

One little known, but good exercise is to simply swing a light bat 50-100 times with your left hand only. The left hand is an important hand for guiding the bat. The left tricep is the important muscle for this motion. This exercise is best started pre-season because it often leaves the tricep sore after the first few times.

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

Jeff Watson adds:

 With much ado regarding the merits of different pitching styles, and the physics of different type of curves, knuckelballs, fastballs, and sliders, I'm surprised that nobody has brought up the pitches of Gaylord Perry and Joe Niekro. Perry allegedly did wonders with a spitball, and when the heat came to tough for him to bear, he replaced spit with Vaseline. Perry was constantly hounded by umpires his whole career, and had to develop different methods for hiding his illegal substances after the 1968 ruling regarding wiping the mouth before a pitch. The spitball was one of those pitchers that made the ball seemingly disobey the laws of physics, and was hard to hit. Perry and pitchers of his ilk had deceptive moves down to a science, and whether they threw a spitball or not, the batter was never sure. The market has shown similar characteristics in the past and present, where following the rules is winked at. Certain reports are released early by officials to their friends, and nobody really says anything. Naked short selling was allowed until it was apparent that there would be a possibility of the whole financial sector going to zero. The market players just had too much of an advantage over the public and the rules had to change, much like they did in 1968, and much like little things like the height of the hill being modified from time to time. Even after the rules are changed, in baseball and the markets, people still try to cheat. Niekro was caught red-handed by the umpire after he was searched for an emery board, and it flew out of his hand onto the field. That was one of the classic moments of baseball.

Stefan Jovanovich responds:

 Niekro used a piece of emery board to scuff the ball so he could get a better break on his curve. That was what he was throwing away when he was caught. Perry used perspiration from the back of his neck to load the ball so his sinker would have more drop. (He would take off his cap and run his pitching hand over the back of his head and down to adjust the top of his jersey). Baseball, being like the SEC, had and still has elaborate rules that are utterly useless in terms of actual cheating on the mound. For example, the pitcher cannot go to his mouth while standing on the mound (automatic ball to the batter; balk if there are men on base); but he can still walk off the mound and lick his fingers all he wants. However, since saliva doesn't work nearly as well as sweat (which is much heavier because of the salts and dries more slowly), the anti-spit rule itself is pointless. The spit ball was outlawed was the one where the spit the pitchers used was loaded with chewing tobacco.

The idea that pitchers used vaseline is a media urban legend. There is no question that the stuff could be useful; but you would need a towel boy with soap and a basin of water that you could go to between pitches so you could clean off your hands. However, since the batters - who are always looking for an explanation for their inevitable failures - never figured this out (not being particularly concerned about hygiene), Perry and Early Winn and others always made a great pretense of using it. Perry still does; but you can hardly fail to notice the twinkle in his eye whenever he gives his seemingly evasive answer to the latest interviewer.

In my next life I want to hit against the pitchers on Dr. Phil's team. Everything he wrote is wrong. The knuckleball wobbles because it has no gyroscopic balance. It has no gyroscopic balance because it has no spin. The pitch is thrown with the ball held by the nails so that when it leaves the hand there is no friction with the skin. The trick is in holding the ball with the nail of the thumb; that is the part of the grip that defeats most people. (This is why nuckleball pitchers are fussier than manicurists about their nails; they want them trimmed so that they perfectly fit the curve of the ball.) The pitch is called a knuckle ball because when you have the proper grip the knuckles all stick out on the pitcher's hand. That also makes it instantly noticeable so there is no deception whatsoever about what the pitcher is throwing. If the ball has any rotation at all — even the magic reversible one from the "sail effect of the seams" that Dr. Phil has discovered, then the pitcher is in for a world of hurt because the pitch becomes a batting practice fastball (think Tim Wakefield pitching relief against the Yankees in the playoffs). All the other pitches Dr. Phil mentioned — the palm ball, fork ball, split finger — do have spin; they have to because the pitcher has to control their location. The knuckleball and the true 95+ mph fastball are the only two pitches where the pitcher can say "here, hit it" and not worry about where he or she throws it. (Some day some bright woman is going to learn how to throw a knuckler!) What the palm ball, fork ball, split finger all do is change the velocity. By holding the ball against the palm or jamming it down between your fingers, you lose some of the whip from your release. The circle change has the same effect; by holding the ball with all 4 fingers, you lose speed while keeping the same arm action. The cut fastball that Pitt posted about earlier is different; it is like the screwball. You are throwing the pitch with the same speed as a fastball but with a different rotation.

Phil McDonnell remarks:

 Curve balls really do curve. There are many proofs of this but the simplest is the center field TV camera where the resolution is too poor to show the spin, but the curvature is obvious. If the viewer cannot see the spin then it is difficult to explain how it can be an optical illusion.

Basically the curvature comes from the spin of the ball. The easy way to remember is that the direction that the front of the ball is spinning is the direction of curvature. A pitch that is thrown with a right to left spin will curve to the left. A pitch that is thrown with a down and to the left spin will break low and away.

The spin exerts a small orthogonal force on the ball as it speeds toward the plate. This force is governed by Newton's equation:

Force = Mass * Acceleration

Note that the last term is the acceleration not the speed of the sideways movement. The ball actually curves at a faster and faster rate. Thus the most deceptive part of the curve occurs right at the point where the batter swings.

The knuckle ball is a bit different. The idea of a knuckle ball is no spin. What happens is that the seams act as little sails that catch the passing air causing curvature in one direction or another. Naturally the seams also cause a very slight rotation of the ball until the another seam comes around. The effect is that the ball begins to curve one direction and then as the seam changes it actually begins to curve in a new direction. From the batter's perspective the ball can appear to wobble. Other times it can fly off in one direction or another in a strongly curving manner. Even the pitcher does know what it will do. The knuckle ball is not the only grip that results in no spin. Others can be the fork ball AKA split finger fast ball and the palm ball.

Another deceptive use of these no spin pitches is that they can be thrown just like the pitcher's fast ball. If the batter has previously timed the pitcher's fast ball then he will likely start his swing based on that timing only to be fooled by a ball arriving slower than expected. So even if he is not deceived by the wobbles of the ball he may be swinging too early or need to hold up his swing and lose critical power.

In many ways these change up style pitches are reminiscent of the deceptive action of the seemingly dead market last Friday which suddenly exploded to life in the last seven minutes of the trading session.

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

George Parkanyi comments:

In pick-up ball where it's pretty easy to hit, I choose the direction I want to go by adjusting my back foot. If I want to hit to the opposite field because I'm being played to pull the ball, then I'll drop my back foot further away from the plate, which turns my torso to slightly lag my swing and "point" the direction of my "power" through to the opposite field. If I want to hit to center I line up parallel to the plate, and if I want to pull the ball, I move my back foot closer in toward the plate. If you connect well with the ball, it will go in the direction of your set-up. Against a professional pitch, I think I'd be happy just to touch the ball — perhaps even just to see it.

Dean Davis writes:

The most critical thing you can teach Aubrey is to avoid moving your head forward (toward pitcher) in the process of moving from a loaded position to the striking the ball. This is often the result of a hip shift which moves weight to the pitcher side of center (this destroys a hitter's power). The timing of hitting a baseball is difficult enough without ceding an advantage to the pitcher by destroying his stereo-vision by moving your head forward.

If you can get him to solidly place his stride foot slightly closed (closer to the near edge of the plate than the back foot), before he starts his swing (done by merely rotating the back heel low to the ground until pointing away from the pitcher), you will avoid him having to relearn the swing when he gets to a select/traveling/high school team later in life.

The Texas Rangers pitchers are taught to throw the circle change where they are attempting to "throw the O" (the circled index finger & thumb) at the target (pushing the index finger down to close the O at release). This means that their middle three fingers are are pointing at one of the dugouts as the shoulders are square to the target. That exaggerates the screwball spin and drop. Index finger should lay across the seam.

I teach my pitchers (age 11 & up with longer fingers) to have the same grip (floating the the middle finger off the ball if possible, substituting the ring finger for stability), throw it like a fast ball (the hand is more behind the ball when coming over the top) and emphasize the index finger pressure through release. They get the same screw ball action and drop as the major leaguers (to a lesser degree). When thrown by a righty to a righty (or lefty to lefty), it is a devastating "out" pitch (thrown on a X-2 count). My pitchers love to see the hitter "corkscrew" into the ground trying to make any contact.

Here is an interesting interview with Mike Basich (gave up record breaking HR to B Bonds) about how pitchers cheat (he names names!)

Steve Leslie contributes:

A great lesson that one learns from baseball pertaining to the markets is in the area of hitting. There are many different types of hitters those who are contact hitters for example and those who are home run sluggers.

Many consider Ty Cobb the greatest hitter in the game. He had a lifetime batting average of .367 over 24 seasons. This is the highest career batting average in the major leagues. He also had 724 doubles 295 triples and 117 homer runs. Through that whole period of time he had but 357 strikeouts. He also stole 892 bases. With the exception of his first season in the majors he never batted below .300 and his peak performance was in 1911 with 248 hits and a .420 average. He also held the batting title 12 times with 9 in a row. Ty Cobb forcused on what he did best which was hit the ball, put it in play and as a result of this dedication maintained a productive career that lasted a quarter of a century.

After his retirement, Cobb was a very wealthy man having been advised by executives and others in the Detroit area how to properly invest his money. He went on to invest in stocks and was a major stock holder in the Coca Cola company.

The lessons for the investor is that success in the markets is a lifetime pursuit. It is showing up for work every day and dedicating onself to the task at hand and utilizing the particular skills and they have been blessed with. Ty Cobb had a very productive and successful career because he concentrated on what he did best and he did it very well. Year in and year out .

Phil McDonnell admits:

Yes, I did pitch for Cal in the PAC-10. We actually won the conference when I played although only slightly due to my minor contribution. Since that time I coached about 50 kids in Little League. Of those, five players were drafted into the Major Leagues for a total signing bonus of about $5 million. Somehow that does not seem random to me.

The wonderful thing about the markets and baseball is that everyone thinks they know all about it. There are many ways to skin the cat. Perhaps I can arrange some batting practice against one of my ex-players next time they visit the A's or the Giants.

With respect to the back foot weight shift, we can do a simple thought experiment. Lift your back foot into the air and try to swing. Did that swing feel powerful? The fact is the weight shift from back to front occurs whether you are conscious of it or not.

The fingernail ball is something I have never taught. However I have never had to pull my starter for a broken cuticle, nor have I ever needed to smuggle an emery board out to the mound for emergency fingernail repair. I have coached the circle change. It is an excellent and easy to learn off speed pitch. My technique is to circle the two fingers in an OK sign, the the three remaining fingers are used to throw a weak pitch. The spin is the spin characteristic of a screwball (curves to the right). But the pitch does not curve because the spin is too weak and the speed is too slow. It is simply an off speed pitch.

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

Stephan Jovanovich replies:

Heck, Dr. Phil, with my eyesight I couldn't tell you from one of your former prodigies, let alone see the ball. I stopped playing ball at 18, after I went to the Phillies organization pow-wow and met the three catchers they already had in the system and compared the sizes of their hands to mine. The only talented pitcher I ever caught blew out his arm in AA in Odessa; he was from Guatemala, and he had the same stuff Mike Cuellar had. He would have been a marvel. I know enough about the bonus baby mania baseball went through to be unimpressed by the "about $5 million"; it is one of those factoids that is like Clinton's 100,000 new cops - wonderfully round and purposely vague. Hell, even with my puny hands and Molina family footspeed, I was offered $10,000. If you want to post your stats and the stats of your magic kids, I will be more than happy to eat crow and buy you and your camp followers each a bottle of bourbon. Until then, let's call it a draw. You still don't know anything about hitting, but there are few people who do. As for pitching, I would still recommend to the List that they send their kids to Dean's camp, even if his players have never been offered a stick of chewing gum by a scout. He knows far more about this than you or I do, and he lacks your cocoa puffed ego and my bad temper. Neither is a good temperament for teaching people. But - last shot - the most important reason to trust DD (listen up, Lack!) is that he clearly has no interest in any of the kiss-ass rituals that have turned so much of "organized" baseball at the junior level into a game of "my daddy knows your daddy" (out here in the Bay Area it has become even worse than it is in soccer).

Phil McDonnell suggests:

Lifting the front foot high does not inherently add energy to the swing. If you think about it lifting a foot straight up adds potential energy only in an up and down direction. The point of a baseball swing is to drive the ball in the horizontal direction. Any energy from the foot lift is orthogonal to the intended swing and does not add any power.

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

Charles Pennington demurs:

Potential energy does not have a "direction". Why do batters start with the bat held up high? That's potential energy that ends up contributing to the kinetic energy of the swing, when the bat is low.

Let me add that the pitcher lifts his front foot in an effort to throw the ball fast in the horizontal direction.

Stefan Jovanovich notes:

Randy Johnson did it — at age 45. He became only the sixth left-hander in baseball history to win 300 games in a career. And, like Teddy baseball's final game and last home run (at his last at-bat), it happened while the world was looking elsewhere — before a tiny crowd on a rain-sodden field. Pure Brueghel.



PhilAAA rated bonds are the best corporate bonds available. BAA represent a somewhat riskier class of such bonds. So, using St. Louis Fed data monthly (series AAA and BAA) it might be instructive to look at the yield spread between the two bonds versus the monthly returns of the Dow Jones average. The yield spread was calculated as BAA - AAA yield from 1928 to the present. The spread is currently near historically high levels and thus seems especially relevant now. One way to think of the yield spread is as a measure of fear in the bond market or as a measure of the current availability of credit to riskier corporations.

The following correlations are for the yield spread lagged n months ago. Zero lag is the concurrent relationship. To be significant at the 5% level, two tailed with n =1000 the correlations should be above 6.2%.
Lag    correlation
12     0.054331609
11     0.060955747
10     0.05292927
9      0.039778526
8      0.035184767
7      0.01231181
6      0.000377968
5      0.004196862
4      0.008836528
3      0.027029827
2      0.043577867
1      0.030773782
0     -0.03036919

But what is interesting is that they are all positive at the various lags. In other words if there is a credit crunch indicated by a larger yield spread, then stocks subsequently go up. This is not what one would have expected.

Suppose one were able to obtain a newspaper for the yield spread over the next 12 months (in the future). Well the correlations between the Dow and the future yield spreads were as follows:

Lag   Correlation
1    -0.112798121
2    -0.126495119
3    -0.124710641
4    -0.096857777
5    -0.107535598
6    -0.112776958
7    -0.117648043
8    -0.10364356
9    -0.117856956
10    -0.134941986
11    -0.137242692
12    -0.148479036

They are all negative and statistically significant. Again not what was expected.

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

Charles Pennington asks:

Is this summary correct:

1) High (or rising?) yield spread predicts excess positive returns for stocks in the future, though not statistically significant and 2) Rising stocks predicts narrower than average yield spreads in the future?

If so, then why would you find item 2 to be "not what was expected"? I would have expected that rising stock prices would lead to lower yield spreads, as you observe.

Also, it sounds like you've used "levels" rather than "moves" for the yield spread. I would think that the yield spread is something that moves around on a fairly slow time scale, and that there would be a lot of serial correlation in its level from month to month. That would explain why the second set of 12 numbers are all about the same.

Phil McDonnell responds:

Your first and second points are correct.

It has long been held as common wisdom on Wall St. that yield spreads indicate credit conditions, and that widening spreads predict stock market problems. In this case stocks seem to predict yield spreads. As always you make a good point. I did use levels in the yield spread only, percent changes in the Dow. It is probably worth looking at the changes as well.

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

Bill Rafter adds:

This number was down to a -349 and has now risen to -259. Above -270 it took out the post-LEH, post-TARP periods, meaning that the credit problems associated with those events have been rendered old-news by recent behavior. It's nice corroborative information but not actionable, in my opinion.

More important than this is that the "dumb" money is still short, and still shorting the rally.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy



 Below are data for the various iShares country funds. Columns are country, ticker, economic freedom index (from Heritage Foundation), and percent return (dollar denominated) from the end of 2008 through May 4, 2009.

There are 24 funds available. The bottom 12 in terms of economic freedom returned an average of 17.6%, while the top 12 averaged 8.3%. So yes, the least free countries did best this time.

The biggest winner was Taiwan, up 47%, but near the median in terms of economic freedom. The least free country, Brazil, was up 42%, well above the 13% overall average return for the 24 countries. The biggest loser was Switzerland, down 8%, and near the top in terms of economic freedom.



 On February 1st, Cassandra picks up the Wall Street Journal outside her door and discovers that it is the paper for March 1st, one month in the future. She does not know what to do with it, and no one believes her story, so she simply saves the paper. The next day, February 2nd, the paper dated March 2nd appears. This continues unabated. Come March 1st Cassandra checks the actual stock prices and sure enough they all match the prices in her originally-delivered paper. Likewise with all of the subsequent newspapers.

Soon Cassandra puts a PC to use and starts ranking stocks on their average 1-month growth rates based on this perfect knowledge. She then partitions her available capital into 21 tranches and each day purchases in equal values the 200 stocks of the Russell 3000 expected (actually "guaranteed") to do the best over the next 21 market days (1 calendar month). This partitioning eliminates any start-date bias. The returns she achieves are the best possible for a buy-and-hold strategy over that time frame. After all, it is the result of perfect look-ahead bias. Returns for this, the control group from 2001 through 2008, are a not-surprising 25.53 times her capital per year.

John B says, if you give a trader any system, no matter how good, in half an hour he will have modified it in an attempt to improve it. This is true even when perfect foresight is present, and Cassandra succumbs to her curiosity. You see, Cassandra is uncomfortable with the decision to buy-and-ignore. And she is correct to be uncomfortable. She has this constant stream of excellent information, albeit for later periods. It has to be worth something, according to information theory. And Cassandra's intuition is legendary.

Cassandra alters her trading in that she will now only hold her positions for 15 days instead of 21 days. She does this without knowing in advance what the prices will be 15 days after her purchases. When Cassie sells the portfolio on day 15, she will then purchase another 200 stocks based on their next 21-day forecast. Now of course, she is investing with sub-perfect knowledge, because she does not know the price of those stocks on day 15. She is using knowledge farther in the future to trade for a date shorter in the future. Intuitively it would seem unlikely that she could tinker her way to a better return than the perfect portfolio. But she can, and does so repeatedly. Strategy A beats Strategy B, where Strategy A consists of more-frequent forecasting and trading with sub-perfect knowledge, and Strategy B consists of less-frequent activity with perfect knowledge. The 15-day recast produces 39.52 times her capital per annum, about half-again better than the control.

Encouraged by the success of active investment management over a seemingly-unbeatable investment, Cassandra shortens up even more. She still forecasts 21 days ahead on the basis of the newspapers, but she only holds 10 days, or half the forecast period. This produces a whopping 138.53 times her capital per year. Recasting every 5 days produces 56.62 times her capital annually, less than 10 days, but greater than 15 days or the control period of 21 days.

Additionally, these experiences were not limited to monthly forecasting. Trying to further game the system, Cassandra subscribed to Investor's Business Daily, which arrived always a calendar quarter ahead. Her control group 63-day (quarterly) returns were 5 times capital each year. But reducing the holding period to 2 months increased it to 12 times, and reducing it to one month produced returns of 10 times. From 5 days out to the forecasted time in both the monthly and quarterly scenarios, the improvements were universal. Furthermore, extending the holding periods beyond the forecast period was universally worse. This is also true for different rate of return ranking processes. That is, it works identically whether one uses exact rates of change or regression rates of change.


There are two possible explanations for the increased profitability. The least obvious factor would be portfolio rebalancing of an entire portfolio every time new positions are taken. Indeed, rebalancing tremendously adds profitability and the more frequent the better. However in this study rebalancing was excluded for any unchanged holdings. In this study new positions would have had an equal value allocation, and existing positions were left alone to grow or decline in value, unchanged in size until liquidated. Thus with rebalancing absent, there can only be one explanation - that more frequent forecasting is more profitable, even better than some forms of perfect knowledge.

What About Risk?

Increasing profits without consideration of risk is foolhardy. It is worth noting as an aside that perfect knowledge does not always produce profits in every period. This is a long-only strategy in which Cassandra is purchasing the top-200 ranked stocks. There are some periods when virtually all stocks decline, or at least when the average return of the top-200 is negative. Thus we must consider the dark side of investing.

One of the distinct advantages of more frequent analysis and forecasting is that losses get cut earlier, providing damage control. Given the inclusion of risk into the equation, shortened time horizons become exceedingly obvious in the role of risk reduction. Recasting our 21-day forecast every 15 days produced an annual return of 39 times one's money, but at the risk of a 30 percent decline in capital. At 10 days the returns were 138 times, but with a 47 percent drawdown. At 5 days, the returns were 56 times, but the maximum drawdown was only 14 percent. Thus 5 days had a reward-to-risk ratio of 391, compared to 292 for 10 days and 127 for 15 days. The monotone progression makes the point. And it is confirmed in the quarterly data as well; the risk-adjusted rewards are improved by ever shorter forecasting periods.

What Are the Practical Applications?

Here we see a situation in which our investor has perfect future knowledge and yet she is absolutely advantaged by re-evaluating her decisions with increasing frequency. This is essentially a conflict of two mutually-exclusive ideas. On the one hand, perfect knowledge has to win, and indeed it will over that exact period. However it is also intuitive that more-frequent information would be beneficial, if one is willing to shorten the trading period. And here we have evidence of the latter's success over a perfectly-chosen portfolio. If active management can improve a portfolio chosen with perfect foresight, surely logic dictates its value on a sub-perfect portfolio. That would have to be proven, but any of those results would be dependent upon a particular investment or trading program. The beauty of this particular study is that it is program-independent. The clear lesson from this is that any financial advisor who tells you to buy an investment and ignore interim news or market action is repeating some time-honored advice that is clearly and profoundly wrong. The buy-and-ignore strategy only works if you or the advice provider is unable or unwilling to devote more time to your investment analysis. Clearly lack of perpetual investment diligence applies to many investors and advice providers, but the costs of that ignorance or intransigence are generally dismissed.

The purpose here is not to suggest a specific trading frequency, but only to suggest that the trading frequency should be a shorter number of days than the forecasting horizon. Over time there will certainly be sweet spots, and one should not assume those to be constant. Some traders will argue that they trade without making any forecasts. However, every trading decision is at least an implied forecast.

Technicians of course practice their craft with increasing analysis frequency, and they should gain comfort with these results. But some technicians also look at less frequent data, and this work should provoke caution in that regard.

Some fundamental analysts would argue that it is not possible to increase the frequency of analysis. Assuming the fundamental variable of Earnings (released quarterly), that would be true. However the Price/Earnings ratio is available daily, albeit based partly on a quarterly number. Greenblatt ("The Little Book That Beats the Market") uses only two ratios as inputs: Return on Capital and Earnings Yield, and produces daily recommendations. Likewise Haugen ("The Inefficient Stock Market") uses approximately 70 inputs (several of which are technical) very frequently despite the fact of some of their precursor variables are only available quarterly.

Furthermore, the rationale for frequent use of fundamental information is abetted by the blurring of the definitions as to what constitutes technical versus fundamental information. Something we have learned as a result of the recent market declines is that at least one of the major credit rating agencies (S & P) reevaluates its company ratings partly on the basis of a company's stock price performance. A big drop in the stock price might earn that company a downgraded rating. Thus daily priced-based activities (a technical factor) become part of the fundamentals of that stock.

What Prompted This Research?

With so many things to be studied, why spend time on such a seemingly esoteric idea? Well, it's not so esoteric. In our research we had attempted to look at longer time horizons, as we wanted to hold our positions longer. The investment community has sold its customers on the concept that more frequent analysis/increased trading must be bad for the investor. The government effectively limits more frequent trading for IRA accounts, although it is allowed for qualified pension plans. Consequently we started crippling our research to make it equal to "industry practice". Every time we did that we experienced declining results. That of course suggested that targeting separate time frames for forecasting and trading could be advantageous to any trading program.

Research Notes

To eliminate survivor bias our list of the Russell 3000 stocks from 2001 through 2008 consists of about 4200 stocks, the difference being those deceased, merged or otherwise eliminated. The constituents were obtained directly from Russell.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy

Jim Sogi comments:

Absolutely fascinating. The reduction of risk seems to be a main factor as the rate of variance goes down faster than the decline in profits. Is there a sweet spot for maximum risk/reward, or would it go down to the vig as the timeframe shortens? An exercise for the reader?

Charles Pennington comments:

I know it's problematic to use the word "obvious" in mathematics, but isn't this obvious? The un-updated predictions are partly about the past, not the future, and to that extent they don't help you as much as the updated predictions would.

Bill Rafter responds:

Bill RLots of things are obvious and still ignored. And sometimes seasoned professional traders do the exact opposite of what is obvious.

We learned quite a lot from that research and altered our trading process –with definite benefits. Specifically what we did was to have different time periods for our forecasts and trading, and that was not obvious to us at first.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy

George Parkanyi writes:

I did a lot of research on re-balancing fixed names packaged into groups of six, trading on the relative price movement against each other over fixed time intervals. I settled on 4 months as "pretty good". The other major variable you need to consider besides the time frame is the volatility. The wider and faster the swings, the more you can compact your re-balancing time frame. The challenge is try to catch as many smaller interim fluctuations as possible but not to sell your winners too soon or to average down on your losers too soon when the stocks are in big moves.

In my research I ran a large batch of tests keeping the time frame constant but varying the volatility range of the randomly seeded stock simulator I developed. I ran a whole bunch of tests using my simple re-allocation algorithm at different volatility bands within which I allowed my "stocks" to fluctuate. These tests generated an average annual compounding increment over buy-and-hold, that, as you might expect, increased with volatility.

What was encouraging, is that the outperformance generated by the simulated data used in the periodic reallocations matched testing I did on real stock data. Theory was confirmed by reality. You can seriously beat indexing (over the long run) with this type of active re-allocation methodology. The trick is to re-allocate individual securities (index components) against each other, not whole asset classes or indices, which are already smoothed out and much less volatile because they are, by definition, averages.

I've published the re-balancing methodology on my blog if anyone's interested — it's not a long read, and easy to digest, but too long for an email or single blog post. The links to the 3 segments are the first three in the blogroll column under the My Portfolio heading.



 Actually this is a tricky question: Even after defining a bear market, could a given decline have occurred by chance — given a random arrangement of returns? One aspect of a bear market could be down weeks clustering more than would be expected by chance, giving rise either to more frequent or deeper declines.

4194 DJIA weekly closes were partitioned into non-overlapping 40 week periods. At the end of every such period, calculated the maximum decline as:

min(this 40) / max (last 40)

Done this way the maximal decline could have been as long as 80 weeks or as short as 2 weeks; the idea was to capture large drops over various periods of interest to investors.

A simulation was used for comparison: The same 4194 DJIA weekly returns were resampled 100,000 times, and multiplied ("compounded", without dividends) out to produce a 100,000 week series. Like the actual market history, the series was partitioned into non-overlapping 40 week periods, and every 40 weeks min/max was calculated for the current and prior period.

One definition of a bear market is "a decline more than 20%". In the actual series, such declines occurred in (a surprisingly high) 26% of 40 week intervals (27 out of 104 40 week pairs). If this were more often than random, it would have occurred more often than in the simulated series. However in the simulation declines more than 20% actually occurred 32% of the time.

So if anything, declines of 20% or more occurred less often historically than by chance along.

But what if 20% is too arbitrary to capture a bear? In the actual series, here are the 40 week pair declines above the 95th percentile (ie, declines worse than 94.2% of the rest):

Date    40 min/max
06/20/32    -0.751
04/03/33    -0.642
09/14/31    -0.564
12/08/30    -0.542
03/02/09    -0.499
08/15/38    -0.469

The mean of these 6 40 week pairs is -58% (all but 5 from the depression). In the 100,000 week simulation, the 95th percentile is -34%. The actual 95th percentile and above mean of -58% is lower than even the worst simlated 40 week pair decline of -56%, which was the bottom of 2496 pairs (99.96 percentile, like the Obama cabinet SATs).

The worst 5% of actual 40 week pair declines dropped much more than would be expected by chance arrangement of down weeks. This is consistent with "fat tails" (at least on the downside), but you have to go out further than -20% to see it.

Alston Mabry comments:

Great study, Dr. Z. One thing I would want to explore would be whether in the simulation process, one intermixed different volatility regimes. That is, in the actual 4194 weeks, you may have periods of high volatility and periods of low. High volatility periods would have larger moves in absolute terms than would low volatility periods, and if the simulation mixed them together, the simulation might tend to produce lower volatility overall - this might account both for more 20% moves but fewer +50% moves. If this were a problem, one solution might be to normalize all the weeks against some preceding period, say 52 weeks.

Kim Zussman replies:

 Knowing that volatility clusters, if one is resampling a long data series this gets shuffled up. So you'll get 4% days near a bunch of 0.2% days (though the stdev of the whole series should be the same -shuffled or not). But if the question is whether the market has structure which is not random, does it make sense to stipulate whether you are in a volatile regime or not? Relatedly, maybe sticky volatile regimes translate to down markets, which is kind of the point.

Alston Mabry responds:

Exactly. To be precise, what I'm saying is that the fact that the simulated distribution produces more +20% moves but fewer +50% moves is simply an artifact of the shuffling process, especially when you shuffle individual weeks and then use 40-week stretches for calculating results. I'm thinking that the shuffling takes the actual distribution of % moves and increases the kurtosis and pulls in the tails.

This is not arguing against the hypothesis, just questioning that meaningfulness of the % comparisons.

Charles Pennington adds:

Prof POne uncontroversial hypothesis that might unify and explain many of these studies is that "markets get more volatile after they've gone down".

If you compute the skewness of the weekly or monthly returns of the Dow since 1929, it's quite negative. However if you take those same returns and divide them by some measure of the volatility over the following week(s)(*), then you'll find that both the skew and the kurtosis are close to zero, i.e. it's similar to a normal distribution of returns. That means that someone trading backwards in time, i.e. he has next week's newspaper but not last week's, would experience safe, non-Black Swannish returns if he just adjusted his position size for the volatility that he had experienced in his recent future.

* for example, one might use the following week's high/low range, 100*(h/l-1), or the average of that quantity over the following N weeks, where N is "a few".

To illustrate, here is a model.

First, create a series of random normal numbers with standard deviation 1, with one number for each trading day.

Now, use the following rule: "If the average of the last three days' numbers is negative, then today's return is 2 times today's number. Otherwise today's return is 1 times today's number."

I ran 2500 simulated trading days using that rule, and it gave 715 5-day maxes and 622 5-day mins. That's similar to what the Chair reported for the market.

More generally, I suggest that whenever you see one of these apparent anomalies of "market falls faster than it rises", try to see if it can be distinguished from the uncontroversial hypothesis that "volatility rises following down moves".

By the way, over the past 10 years, the standard deviations of daily returns of SPY under two scenarios:

all days 1.39% after up three-day move only: 1.17% after down three-day move only: 1.61%

Kim Zussman replies:

The simulation made the skew and kurtosis go away.  Here for the 40 day min/max both from actual series and simulation:
Descriptive Statistics: min/max, sim

Variable   Mean     StDev      Min    Median   Max       Skew
Kurtosis         N
min/max  -0.1435  0.1463  -0.7506  -0.1134  0.0313    -1.70      3.66
sim         -0.1604  0.1008  -0.5576  -0.1504  0.0654     -0.53
-0.04         2496

Even accepting there could be non-randomly down markets, this is a different question than whether they can be predicted.  So a small decline results in higher volatility, and trading smaller long positions can be on average profitable.  But some of the small declines go on to become big ones, and its hard to tell one from another.  Using stops (physical or otherwise) is tuchass saving, but it's hard to know whether "cutting your losses and let profits run" is worse in theory or execution. Which doesn't preclude that others can discriminate good from bad dips, or that they found work-arounds using opportunities independent of short term decline-reversal.

Phil McDonnell writes:

It may be helpful to look at the underlying hypothesis a little more closely. When we randomize by individual time periods we are deliberately randomizing any period to period dependencies. I presume that this was Dr. Zussman's point. Thus we are implicitly testing a null and alternate hypothesis something like:

Null: The original distribution or returns is similar to the distribution of a randomly ordered sequence of returns.

Alternate: The original distribution is not similar to a randomly reordered sequence of returns.

One good test of the difference between distributions is the non-parametric Kolmogorov-Smirnov test. Also one can use the more powerful D'Agostino test.

Another way to preserve the known autocorrelation in variance is to perform block resampling. From memory I believe the autocorrelation fades after about 35 days or so. Block resampling of 40 days should keep something like 97% of the variance autocorrelation and even other unknown dependencies even non-linear effects in that range. Comparing the distribution of the original returns to the 40 day resequence might tell us if there is something non-random even beyond the 40 day block level.

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



One way to see if cycles occur is to rank closing prices and see if the distribution of ranks is consistent with independence.

take 5 prices          800, 801, 799, 804, 803,                                 

let's rank them         2      3        1    5     4                                from lowest to highest.                                                               

The distribution of actual ranks for the last 10years, 1, 1 99 to present in S&P adjusted futures prices is as follows:                              

rank    number of times                                                         

1       637                                                                    

2       418                                                                    

3       338                                                                    

4       404                                                                    

5       733                                                           

Queries: Is this consistent with independence? What does this show about the shape of the distribution? How can this be generalized? How does it compare to other markets? Is there any predictive value to such studies? 

Victor Niederhoffer adds:

mkt rank   S&P   Bonds   Bund  Yen  Gold Crude

1                  637  612      624  672  395      430                                       

2                  418  328      354  409  277      294                                       

3                  338  382      352  405  265      257                                       

4                  404  406      404  431  318      295                                       

5                   733  781      789  709  596      529                                    

drift             -03   01       02   00   03       00        per day
Sd                154  69       37   27   81       142                                     

The starting point is 1/1/1999 to present daily for all except gold and crude. Note unusal number of rank 2 for bonds. The surprises are the number of rank 5 for stocks which exceed the rank 1 even though there was a drift of -03 a day. This is consistent with larger big declines than big rises.

Charles Pennington comments:

Prof PYou got 733 "fives" and 637 "ones", a difference of 96.

I looked at ten simulations of a 2500 step random walk, using numbers drawn from a normal distribution. In only one of the ten was there a difference between the number of "fives" and "ones" that exceeded 96. In that one instance, the difference is 137. The standard deviation of the 10 differences was 42.

So an effect this big should show up randomness alone on the order of 1 in 10 times. It's probably a non-random effect.

Victor Niederhoffer asks:

Excuse me, Professor, but did you use the drift of -03 a day and given standard deviation of 137?

Charles Pennington replies:

That seems like false precision to me, with the market's own real-time estimate of volatility having varied by a factor of ten over the period, and with the drift flattish until the last year of the ten year period. If the point is that "the market has gone down rapidly over the past six months", then count me in. Even over that period, though, four of the top ten 1-day magnitude moves have been in the positive direction, including the biggest and the second biggest. And even from 1929-1939, the biggest 1-year magnitude move was the UP year of 1933 with the market up 78%. I think if you or I had lived through that, then..*, **

My friend, you would not tell with such high zest; To children ardent for short selling glory, "Teres quod tardus est, ut venalicium oriri".

* mangled version of poem "Dulce et decorum est", 

** Online English-to-Latin translation of "Smooth and slow it is, when markets rise". I have no idea if the translation is right, but it looks nice.

Victor Niederhoffer requests:

I'd appreciate it if someone would test whether the distribution of ranks for S&P for the 5 day periods is consistent with independence with actual changes since 1/1/1999.

An Artful Simulator writes in:

Using 1000 randomly resampled (w/replacement) data series, I get

obs = observed distribution of ranks
exp = expected number of ranks from simulations
exp = 95% empirical confidence interval from the simulations

rk   obs   exp  95% conf
1    658   702  [644,767]
2    434   417  [382,454]
3    349   366  [332,397]
4    419   396  [360,432]
5    741   720  [656,782]

(i added some random noise to break ties)

doesn't look that non random to me.  Also, the chi squared statistic
for observed as a function of expected is 6.28 with p val of 18%

Victor Niederhoffer comments:

The Professor was right.



Closing prices:

April 21, 1982 (inception) 670.45
Oct. 19, 1987 712.1
today             686.1

A remarkably quiet market.

George Parkanyi writes:

I'm just workin' the drift. man, workin' the drift…



 Why are not more people empathizing with those who lost their nest eggs and retirement plans to the Madoff scheme and instead placing the harm on charities and fate?

Charles Pennington observes:

It is an interesting story, but the $50B apparently lost is less than 1% of the $5-10 Trillion lost in worldwide equity markets over the past year.  People lost $100B on GOOG alone, and one can name scores of other stocks that dropped more than $50B in market cap. Furthermore a large but unknowable fraction of Madoff investors suspected that their gains came from front-running.  They will never admit that now.



The 94 point up move from 1pm to 4pm yesterday was the biggest magnitude 3 hour move of either sign, by a long shot, since the start of 2008 (and probably further back; I didn't check).

The second, third, fifth, and tenth biggest magnitude 3-hour moves were also up, not down moves. The biggest 3 hour down move was only 67 points, on October 9.

But these big up moves don't sit as prominently in our memories, and I hear no one rushing to say that markets rise faster than they fall!

Top 10 magnitude 3-hour moves in ES:

move        date              time (end of move)
73.75    10/28/2008      1600
94.25    11/132008       1600
72.75    9/18/2008         1550
-67.5    10/9/2008         1615
64.75    1/23/2008         1550
54.75    10/10/2008       1540
-52.75   10/15/2008       1610
-51       10/23/2008        1420
-50.25   9/29/2008         1530
49.5      10/13/2008       1615



Mexican FlagOne might guess that the top-rated countries in terms of economic freedom would have the best performing markets going forward. To test the idea I took a look at the returns of all the iShares MSCI country funds from 12/31/1997 through today to see if there was any correlation between those returns and the Heritage Foundation Index of Economic Freedom scores as of 1997.The data are given below: the country, the economic freedom score, and the value today of $1 invested 12/31/1997. There is a correlation (-16%), but it goes the wrong way. The biggest winners were the not-so-free countries Mexico and Malaysia; in fact, Mexico was both the least free of all and the best performer of all. The most free countries, Hong Kong and Singapore, were near the middle of the pack.

FUND                                      EconFreedom  $1 grew to:

ISHARES INC MSCI BELG INVEST     64.6               $0.66
ISHARES INC MSCI NETHR INVES    70.4                $0.68
ISHARES INC MSCI ITALY              58.1                $0.91
ISHARES INC MSCI UTD KINGD      76.4                $0.92
ISHARES INC MSCI JAPAN             70.3                $0.94
ISHARES INC MSCI GERMAN          67.5                $1.08
ISHARES INC MSCI FRANCE           59.1                $1.15
ISHARES INC MSCI SWITZERLD    78.6                 $1.19
ISHARES INC MSCI SWEDEN          63.3                $1.20
ISHARES INC MSCI HONG KONG    88.6                $1.36
ISHARES INC MSCI SPAIN             59.6               $1.43
ISHARES INC MSCI SINGAPORE     87.3               $1.48
ISHARES INC MSCI AUSTRIA INV    65.2              $1.62
ISHARES INC MSCI AUSTRALIA      75.5              $2.12
ISHARES INC MSCI MALAYSIA        66.8               $2.55
ISHARES INC MSCI MEX INVEST     57.1               $3.55



21, from Steve Ellison

October 27, 2008 | 2 Comments

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

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

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

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

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

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

Charles Pennington writes:

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

Chris Cooper says:

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

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

John Floyd observes: 

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

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

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

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



VNThere are many unprecedented events that we are witnessing these days. To me, the most amazing is that on 12 31 1982 the Nikkei closed at 8500, by no means a local high as it was 9000 a year later.. On 10 15 2008 it closed at 8458 thereby marking a 26 year period where a major enterprise stock market moved without a rise. The S&P stood at 800 to 900 in mid 1997 and reached 1000 in early 1998. Thus, 11 years without a gain in the US. Is there a single overriding reason?

To me, the key aberration occurred in the two weeks of 9 26 2008 to 10 10 2008 when the S&P moved from 1218 to 891 and the Nikkei plummeted from 11920 to 82760.

To gain perspective, I looked at weekly prices:

date       sp     nikkei    bonds    euro   crude gold   wheat vix

0919     1246    1192       118 5   14466   10254  834   718   32

0926     1216    1189       117 1   14609   10618  879   716   35

1003     1108    1094       11920   13772    9301  835   640   45

1010      891    8276       11620   13408    7799  849   563   56

A preliminary insight is that vix and the dollar rise and crude were the major harbingers of the unprecedented decline the week of 10 10.

I always believe that markets and prices are the key and that interrelation and the web is always there. The problem is they're always changing. But at least we've got a description.

Anatoly Veltman adds:

My hypothesis at this hour is that the currency markets are destined to wash-out first, with world equity markets grudgingly following. The reason, obviously, is that margin liquidation in FX takes plays instantly - while generating and then instituting collection on stock margin calls takes time, not to mention timezones.

Kim Zussman wonders:

Couldn't help wondering when/if backbone financial theories (such as high allocation to equities for long term investors) will become so unpopular that demand for courses in financial markets will dry up. Y@le had a guest lecture from David Swensen earlier this year, will he be invited back next year?

Charles Pennington comments:

For any remaining fans of the Fed Model, here are some numbers from the Financial Times (page 23, "Market Data"):

country      earnings yield %      10-year gov't bond yield %
                         8%                3.7%
Germany               10%               3.9%
UK                        13%               4.6%
Japan                    9%                1.6%

J.T Holley writes:

body snatchersThe web now includes for me the Vix trading higher than a barrell of oil at one point, and for me a first, the cash trading more than the Dec mini S*P contract. What is next– dawgs n catz sleepin' together? Be very very careful, brainwashin' is in effect and bodies are being snatched!

Stefan Jovanovich replies:

Starting the Index of home prices at 1995 overstates the run-up of home prices. It would be like starting a stock market Index at 1982. Kim may disagree, but house prices here in California in 1995 were still recovering from a boom-bust cycle that was almost as dramatic as the current one. The current boom didn't really get going until after the dot.com bust; 2002 was really the first full year when housing prices only went up no matter where they were.

Time for Oscar Hammerstein and Carousel (first sung on Broadway by Jan Clayton aka Lassie's Mom):

"When you walk through a storm,
Hold your head up high,
And don't be afraid of the dark,
At the end of the storm is a golden sky.
And the sweet silver song of a lark.
Walk on through the wind,
Walk on through the rain,
Tho' your dreams be tossed and blown,
Walk on, walk on, with hope in your heart,
And you'll never walk alone.
You'll never walk alone :| "

Time to buy because it is way too late to sell, and all the canes have been swapped for walkers.



S&P continuous adjusted futures:

03/10/1993 911.0
10/09/2008 912.5



?Mark Cuban was on one of the business channels last night promoting the idea that all the toxic mortgage backed securities be rolled up into a giant publicly traded ETF. I'd have to guess that with so much forced selling, the most distressed mortgage backed securities must be good buys, yet there doesn't seem to be any vehicle for regular folks to participate. Is there something out there that I'm missing?

Rocky Humbert offers:

I like these two closed-end funds: HSM (Hyperion Strategic Mortgage) and HTR (Hyperion Total Return). They are both at steep discounts to their NAV, they are managed by Lew Ranieri (the father of mortgage backed securities… Liar's Poker, etc.), and they have quality assets which have been dragged down by the sector collapse. If you are looking for true toxic waste, then consider RMA, RHY, RSF and RMH. These closed-end funds were previously managed by Morgan Keegan, and Lew Ranieri agreed to manage them after the meltdown (and lawsuits).

George Parkanyi adds:

UYG on the Amex — the ProShares 2x Financials ETF. It is loaded with US financial companies, which in turn are arrayed with every imaginable kind of toxic debt to suit your fancy. It’s not a toxic debt pure-play but if you can move past the token deposit-taking and convential-lending distractions, these guys have simply astonishing toxic debt franchises.



Since 2001 Morningstar has been rating stocks based on a Buffett-esque philosophy, including the usual Buffettisms like "moat" and "margin of safety".

In February they published a report card on how their ratings have been doing:

Here are the reported returns for their top ranked stocks*, along with the returns for the equal-weight S&P:

Mstar *The percentage returns for Morningstar are based on buying when a stock gets the highest rating, 5, and then selling when it falls to an "average" rating of 3.

A regression of Morningstar returns vs S&P Equal Weight returns gives:

(Morningstar return)=(-5.6%)+1.35*(S&P Equal Weight return)

In short, Morningstar was beaten by the S&P Equal Weight index in terms of both absolute return and risk-adjusted return.

I do like Morningstar. Their product is a really convenient and cheap way to get snapshot information on both stocks and mutual funds. I'm also impressed that they were honest and didn't try to bury this report, and that they compared upfront their returns with the S&P Equal Weight (rather than Cap-Weighted) Index. That is the appropriate benchmark for them because when they calculate their own performance, they weight their own picks equally, rather than by capitalization.

Still, it's yet another proof both that stockpicking is not easy, and that chanting Buffettisms (or even trying to apply them using a team of professional analysts) doesn't necessarily help.

Steve Leslie writes:

As I recall, Morningstar's 5 star rating system for mutual funds is backward-looking. They take the last three year returns and then break it into a quintile rating system. You are correct in that poorly performing funds can be victims of the style they employ rather than a reflection of their management skills and prospects going forward. Back in the 90s the 5 star funds were Van Waggoner, Aim, Janus and some of the really highly charged mutual funds everybody wanted these because of their raw numbers. Nobody wanted anything to do with value funds. The tables soon flipped and the high fliers fared very poorly in the bear market crash through 2003. Value funds took over, and then international funds. Interesting fact is that 80% of funds purchased are through a brokerage firm. Most likely due to the work involved in finding a mutual fund, evaluating it, and purchasing it. When I was a broker, we used Thomson Financial research as our database to evaluate funds. Schwab and Ibbotson have some pretty good mutualfund programs and tools as does Lipper. Kiplinger's Magazine is a good source to find quality mutual funds.

Sam Marx offers:

I like Morningstar because in all of their stock reviews they include a calculation of the stock's intrinsic value and indicate what type of moat the stock has.

Morningstar, however, is still in the last century when it comes to downloading their lists, such as screened items, portfolios, ranked stocks, etc., to Excel. Except for one very limited item no downloading to Excel is available.

Morningstar's attempt to cover options is very sparse.

Meanwhile their main competitor, Value Line, is excellent when it comes to covering options and downloading their lists to Excel. Value Line, however, needs an upgrade of the contents of their screen lists.



MikeHad a Karaoke session last Saturday that included two other DailySpec contributors, whose names I shall graciously not disclose.

The singular fact of karaoke that all will acknowledge is that a song's suitability for karaoke has no relationship to the song's merit in general. So in karaoke, the names that rise to the top include Bon Jovi, Wham, Bread, Bolton, Manilow…

Duran Duran is one of the best. Not only is the pitch usually a little too high for card carrying males, but the lyrics also pose a challenge. Consider these:

"The Reflex is an only child he's waiting in the park."

"Two of a billion stars, it means so much to me–like a birthday or a pretty view."

"I sold the Renoir and the T.V. set–don't want to be around when this gets out"

"Telegram force and ready–I knew this was a big mistake."

The Bee Gees are another fine choice, whether one goes with the Beatles-era Bee Gees, something like "How Can You Mend a Broken Heart", or with the disco Bee Gees. For the latter, "Tragedy" is the default choice, but also consider "Fanny be Tender" if you really want to test your falsetto. For early Bee Gees, the emotions brought out on the karaoke stage can be overwhelming. Consider this:

"I started a joke, which started the whole world crying. Oh but I didn't see that the joke was on me."

Or to really liven the evening, you might try their "I've Got to Get a Message to You", apparently about a murderer awaiting the Chair.

I also recommend the early 70s stadium bands, Three Dog Night, Blood Sweat and Tears, and Grand Funk Railroad. For Three Dog Night, go with "Eli's Coming", or perhaps "Liar". I would never think to recommend "And When I Die" by Blood Sweat and Tears, which has way too many key changes and syncopations, but on Saturday one of my anonymous associates pulled it off very credibly.

You should test yourself with a 70s soul number, like an Al Wilson "Show and Tell", or relatedly, a beach music number like "Give Me Just a Little More Time" by the Chairmen of the Board. The latter is at the very top of my range, and the struggle to stay up there adds to the drama of the moment.

Finally, my other anonymous associate tested the low end of the range with "Ol' Man River". Whenever I hear it, I can't help but want to correct him in the fashion of "Elderly Man River", who "must know something, but he doesn't say anything".



Sets that I have and like:

"The World at War," >15 volumes, Laurence Olivier narrating, fantastic
"History of England," 5 volumes, Simon Schama, interesting and fun
"The First World War," 4 volumes, Ian Kershaw

I have a preference for history or science.

I find that DVDs with the History Channel label are usually not as good as those from BBC. History Channel seems so disappointing these days — always shows like "Modern Marvels" and shows about infantry weapons in war. Would be a lot more interesting to see something about history!



HGHGiven the remarkable performance of older players like Clemens and Pettitt, has anyone pointed out that perhaps one of the main thrusts of investigation should be whether there would be a beneficial effect for all of us in using moderate replacement quantities of substances like steroids and HGH that decline significantly with age?

I for one would like to know more and would appreciate article citations, book recommendations, and information on physicians specializing in the field.

Chris Cooper replies:

Such beneficial effects are apparent to anybody with an open mind. Nevertheless, the idea that a performance-enhancing drug might actually make you healthier is the kind of message that is not acceptable to the mainstream.  Aging is not "normal", it is a disease, and should be attacked like any other disease, with an eye to minimizing the deleterious effects.

What you are referring to is often called hormone replacement therapy (HRT).  The approach is to use drugs and nutrients to bring the body's hormonal balance back to what it was when you were a young man.  Is it surprising that if you achieve this, you actually feel much more like a young man?  Why does our culture consider this to be undesirable?  My goal is not simply to be healthy as it is commonly defined, but to strive for optimal health, a very different concept.

A good book to start with was written by my doctor Philip Lee Miller, called Life Extension Revolution: The New Science of Growing Older without Aging. Dr. Miller is in the SF Bay area. Also I've heard good things about the Kronos Centre in Phoenix.

Janice Dorn writes:

One of the contributors to my just-released book is a world-renowned authority on optimal health.  I took nine years of my life, and traveled 1.5 million miles outside of the United States to every country in the world (some many times) in search of life extension and radical wellness methods. Needless to say, it was an incredible journey, and it continues to this day.

Caveat Emptor. There are many charlatans out there, and we are in largely-uncharted waters. It is a passion for me, and I believe that the goal in this area of life is to delay, avoid and eventually reverse death.

Jim Sogi suggests:

SurfPerhaps a better way is hard effort. I still get out and surf 20 foot waves last week and take time to surf at least four times a week and train when there is no surf. No pill will keep you in shape without effort. Just the thought of a pill is enough to kill the will to motivate effort required to maintain and build strength, flexibility and stamina. It's like technical analysis, it offers an easy way without the work, and will lead to more harm than good. I see many men really going downhill. They don't stay active. Laird Hamilton says, "Keep Moving!" That is the best way to stay fit. I compete with the young guys everyday in a competitive lineup in the water for waves. I can't outperform them, but have other strengths which give advantage.  It's hard work. It takes hours everyday to stay moderately fit, and more to build strength. That's the problem, most don't and won't take the time and effort to maintain and build strength and gradually lose it. Strength from a pill won't help without the agility, flexibility and stamina that are the other components of fitness. Don't worry about the pill, just get out and spend the hours everyday to stay fit.

Chris Cooper responds:

BodybuilderYes, a better way is hard effort. I have gotten more benefit from the sports that I train for than I have from the drugs that I take. The drugs are an incremental benefit, though, and I am certain that I am better off with them than without them. And you may find, as I do, that instead of being de-motivating, they actually increase one's desire to participate.As an example, suppose you are taking testosterone. If you are not exercising, it will do little to build muscle. You still get the other benefits, such as general feeling of wellbeing, increased libido, increased optimism. It enables you to build muscle faster, because that only happens if you put in the effort. It's not magic, you still have to do the work — but testosterone also makes it possible for older men to train as hard as they did when they were younger, because your body will recover more like it used to. 

Larry Williams opines:

The flap about HGH in baseball is pure propaganda, based on my personal extensive testing of it. I concluded it was expensive and of little, if any help, in waging the war against old man age — a view that is now also backed up by science.

Ken Smith responds:

Studies are studies and not reports from individuals. I am an individual. The studies cited older people. I am an older people. My individual report differs from the studies as reported.

I can tell you resistence exercise will promote better body tissue and that the same exercise will tear tendons, ligiments, induce on-going pain. There came a time when the benefits diminished and the pain increased.

I am reminded of a story told by an author about his last visit with his grandmother. She was quite old, in her 90s As they conversed during her feeble days, on one of those days, her last it turned out, she asked him for a small glass of wine, told him there was a time for everything, sipped the wine, closed her eyes and passed on to the next dimension.

Russ Humbert remarks:

I would not be so quick to rule it out Growth Hormone for enhancement. The Chinese women seemed to have had much success with using it for distance running in the mid 90s. Several of the women were running times better than the men. However, they also ran extreme high mileage and were practically starved while setting several women's world records before their coaches where caught transporting drugs through customs before an international competition. Several of the stars went insane under such a regiment. 

Charles Pennington enquires:

Dr AliI'm open-minded about this, and I went as far as to buy the book written by Chris's physician, who seems like a reasonable guy. But the Life Extension directory of doctors isn't re-assuring. There is just one doctor listed in Manhattan, Dr. Majid Ali, whose website is Fatigue.net. Featured there are "Hydrogen Peroxide Baths and Foot Soaks" "The Oxygen View of Pain Management," "Bowel Detox," "Water Therapy," and "Dr. Ali's Castor-cise."

I also checked for a practitioner nearby in Connecticut. Doctor Warren Levin, in Wilton CT, is at Medical-Library.net. The general garishness of the site, the endless list of specialties — "Magnetic Field Therapy," "Juice Fasting Therapy," "Auriculotherapy" — and even the Ron Paul promotion (Ron Paul == more permissive environment for quacktitioners [which is fine]) all leave me skeptical.

I wonder if Chris's physician could recommend someone in Manhattan who has a more rigorous, scientific approach than these guys.

Chris Cooper replies:

Perhaps these links will be more productive:

American Academy of Anti-Aging Medicine

The American College for Advancement in Medicine

Steve Leslie extends:

Philip MorrisI think back to the 1960s when the medical profession and the tobacco industry discounted the evidentiary link between lung cancer and smoking as anecdotal. And for 40 years after that the tobacco industry still fights in courts as to smoking and COPD, lung disease, heart disease and emphysema — long after they have paid billions of dollars to settle various class action lawsuits and agreements with attorneys generals throughout the country and have watched 450,000 American citizens die every year from smoking related illnesses.

I watched my father wither away and die as a result of a lifetime of smoking cigarettes.

Now some want to debate that the beneficial effects of steriods and HGH in adults outweigh the anecdotal risk. And I think of those in professional wrestling such as Chris Benoitk who committed multiple murders of his family and then suicide, professional footballers such as Lyle Alzado, dead from brain cancer, professional baseball players such as Ken Caminiti, dead and an avowed steroid abuser, high school boys by the tens of thousands who experiment and take steroids and commit ‘roid rage and suicide, and the untold thousands of recreational users who develop enlarged hearts and forms of cancer such as prostate cancer while juicing just to get bigger muscles.

Chris Cooper clarifies:

Chris BenoitThere is no medically documented connection between suicide and anabolic steroids. The medical data also say, "Supraphysiological doses of testosterone, when administered to normal men in a controlled setting, do not increase angry behavior." 'Roid rage is a convenient media myth. Steroids may very well cause changes in feelings, but that is far from causing major behavioral changes like those suggested above.

Take Chris Benoit as an example. When doctors examined his brain they found that it resembled the brain of an 85 year-old Alzheimer's patient. It had suffered so much trauma and had so much dead tissue that normal function was not a possibility — while dangerous personality, behavior, and temperament changes were more than probable. During his time as a professional wrestler with the WWE, Benoit had subjected his body to head trauma hundreds of times, most notably with his signature "Flying Head Butt" as well as dozens of other highly flashy (and dangerous) moves.

Steroids are being unjustly demonized, just as marijuana was in Reefer Madness, followed by equivalent media behaviour regarding LSD, Ecstasy, and many other drugs. Certainly steroids have their downside, and just as with recreational drugs, should certainly not be used by minors. But perspective is not allowed in times like these, where fear is inflamed to further the objectives of those who will benefit. 

Steve Leslie continues: 

Taylor HootenI dispute Mr. Cooper’s assertion that the is no medical documentation connecting steroids and suicide or rage. That is ridiculous. At a Senate Caucus hearing Don Hooten testified that his son Taylor, while in high school, began using and abusing steroids and committed suicide.

Mr. Cooper furthermore claims that Chris Benoit murdered his family and then committed suicide because of years of suffering numerous concussions and possible dementia. Did he personally perform an autopsy on Mr. Benoit? Has he examined the autopsy report? Where does he draw his conclusions from? In short, what specific research does he quote? Furthermore, what are Mr. Cooper's qualifications in forensic pathology and/or psychiatry?

Mr. Cooper further argues that it is some sort of a myth, steroid usage and its association with massive mood swings and subsequent rage. He then compares steroids to marijuana and says that it is being demonized by an uninformed public. Not to stop there he equates such unfair demonizations with LSD and ecstacy and “other drugs.”

He diminishes the risks to an absurd level and I am severely shocked and alarmed.

Chris Cooper responds:

Don Hooten runs the Taylor Hooten Foundation, established after his son committed suicide. Now Mr. Hooten runs around the country telling everybody that it was because of steroids, when there is no evidence pointing to that. According to Steriod.com,

There had been no active anabolic steroids in Taylor's body for two months prior to his suicide (according to a report on the THF website) At 17, when he killed himself, his hormone levels had likely returned to completely normal, and only metabolites of nandrolone (not active compound) were still detectable.

And no, I didn't personally perform the autopsy. But here is a quote from the doctors who did, via SportsLegacy.org,

SLI's tests showed that Chris Benoit's brain had large amounts of abnormal Tau protein in the form of Neurofibrillary Tangles (NFTs) and Neuropil Threads (NTs). Multiple NFTs and NTs were distributed in all regions of the brain including the neocortex, the limbic cortex, subcortical ganglia and brainstem ganglia, and were accompanied by loss of brain cells, a condition for which no other neuropathological evidence for any chronic or acute disorder could be found.

Gordon Haave adds:

QuoteIt is silly to say that one can't quote the work of someone else. That is, one can't comment on an autopsy unless one performed it himself. If we took such an approach all of the time, there would be nothing to write about.

Furthermore, in the interest of scientific inquiry, providing anecdotal stories to a statement about a lack of research does not prove anything. I have no dog in this fight, but I admire people who challenge orthodoxy.



RazorCan anyone suggested a friendly, old-time style barber shop in midtown Manhattan or the Wall Street area?  As my hairline slowly recedes, my focus on what constitutes a good haircut experience no longer centers on the coiffure, but rather the dexterity and consistency of the barber, as well as the opportunity to get a close shave with the straight razor. Valuing such qualities as skill, cost, and character/setting (in a Damon Runyan-esque sense), I'd love to hear if anyone has a favorite place to get groomed in New York.

Charles Pennington replies:

I like the shop on 52nd St and 2nd Avenue. The $16 charge includes a haircut, a shave of the neck with a straight razor, and a hot towel. Usually they have "Ultimate Fighting Championship" DVDs playing in the background. They're all Israeli immigrants. Magazines are things like Men's Health ("Get rock hard abs!") and Maxim. With the $16 price, you can just hand them a $20, and that conveniently leaves a >20% tip.

Craig Bowles suggests:

Damian between 2-3rd Place on Court St in Brooklyn is tops and costs $10. Preferable to speak Italian as the oldtimers still play bocce ball up the hill. I used to go to 87th or 88th just west of Lex. Guy close to window is the best and cost was $7 but probably a bit more now. Great barbers and cheap prices leaves more for a good tip.

Scott Brooks writes:

Pattern BaldnessAs one whose hairline has stopped receding, I'll throw in my two cents: If you want consistency and a good experience, get a buzz cut. I get a cut every three weeks and can tell any barber/stylist exactly what to do:  

1. Use a 1/2 blade on the sides
2. Use no guard on the top (cut it right down to the skin)
3. Blend the hair on the sides into the "no-hair" on top (don't want a "ridge-line" where the skin and hair meet)
4. Square or round the back — I don't care which — and blend it
I don't know if you have a Sport Clips in Manhattan or not, but I've come to like them. Sports on all the TVs in the place. At your cut station, you have a private TV to watch whatever's on ESPN and the stylists seemed to be trained to do one of two things:
1. Talk about guy stuff (sports, hunting, fishing, etc.)
2. Figure out quickly if you aren't interested in talking
I hate going into a place to get a haircut (Great Clips is my second choice for a haircut and I run into this problem there too often) and having to listen to a stylist talk about her boyfriend or kids/grandkids, or whatever inane subject is on her mind. Most guys just aren't interested in that kind of stuff. Plus, at Sport Clips, I get a cut, massaging shampoo, hot towel/facial massage, and then a vibrating back massage, all for $20 plus tip while watching Sport Center or some game.
But they don't give shaves, and if you've ever seen that picture of Albert Anastasia lying on the floor of a barber shop, gunned down during his shave, you might consider shaving yourself at home! 

Ken Smith extends:

Wild Irish RoseWhen I was about 18 years old, some 60 years ago, the price of a haircut was 50 cents at the Barber College down on Seattle's skid row, a shop nested between flop houses and cheap taverns where alcoholics roamed the street looking for another cheap bottle of wine. Winos, they called them.

People did not have money and jobs as they do now, so a trip to skid row for a haircut was in the economic order of things. The local indigents could also get a bed for the night for the same price, 50 cents. Called flop houses, they were dormitory floors, like in an army barracks or concentration camp.

Rod Fitzsimmons Frey responds:

If you had taken that $0.50 and invested it at 6% interest, Ken, you'd have had $17.36 today. About the price of a haircut. Or a dorm room. Difference is you'd not have to go down to skid row to get either, unless you wanted to.



Sen. Carter GlassHistory says deregulation created instability. Glass-Steagall was implemented to correct market excesses in speculation with gimmicks. In recent times this Act was rescinded. We will have to live with the consequences.

Phil McDonnell counters:

Rarely is increased regulation good for the economy or the markets. Ordinarily we would be tempted to ask if our friend Ken has any source or statistics to put on the table to support the statement that deregulation causes instability. The converse of that proposition is that more regulation decreases stability.

The two Glass-Steagall acts were passed in the first half of 1932. So that year is the focal point. Here are the weekly standard deviations for the Dow industrials for 1931 and 1932.

year std
1931 5.6%
1932 7.1%

It looks to me as though the Dow volatility increased during passage of the bills and immediately thereafter. Certainly 1931 enjoyed lower volatility.

Charles Pennington replies:

I'm anti-regulation, in general, but I'm surprised Dr. McDonnell would put these stats up to make the case that regulation increases market volatility. Isn't it plausible that Glass-Steagall was passed in response to the higher market volatility, rather than the other way around, that the market volatility resulted from Glass-Steagall?
Anyway, here are root-mean-square monthly moves for 1931, 1932, and 1933:

1930 8.1
1931 14.1
1932 16.8
1933 14.1
1934 4.8

Ken would surely say that after volatility soared from 8.1 to 16.8 from 1930-32, the benevolent government officials took action, and their efforts resulted in the steep decline in volatility from 16.8 to 4.8 that occurred from 1932-34.



OpenOfficeA few of my PCs don't have Microsoft's Powerpoint installed. I looked at buying it, but it's not particularly cheap, so I tried downloading OpenOffice , which is an open-source office suite.

In short, OpenOffice, and specifically "Impress", the OpenOffice alternative to Powerpoint, is great. A Powerpoint user will have no problems using it without any special instructions. I can't think of any useful feature that it doesn't have. It also has one big advantage over Powerpoint: you have the option of exporting your presentation to pdf, even if you don't own Adobe Acrobat. You can also export and open files in .ppt format, so a Powerpoint user can open and edit your files. I wonder why everyone doesn't just totally switch over to OpenOffice.

Troy Torrison adds:

Another presentation alternative is Apple's Keynote . If you’ve ever seen Steve Jobs give one of his presentations, you’ve seen Keynote in action. It’s reasonably priced (comes bundled with the Apple iWork suite) and quite powerful. Best of all, its built-in templates sport tasteful typography.



I'm experimenting with Gmail and find a few apparent weaknesses. Oddly, they are mostly in the area of "search":

–Can't sort by size of attachments, or search for only large attachments, or even see size of attachments. (These things would be good for getting rid of the largest attachments in order to cut back on memory usage.)

–Search only displays 20 items at a time, and I don't see any immediate way to change this. Suppose I have 500 items from Aunt Betty that I want to delete. How do I do this? Search for "Aunt Betty" in "from", go through page by page, 25 pages, each time hitting "select all", then "delete".

It's possible that there are ways to do these things and I just haven't found them.

Outside of these issues with search, I find the Google spam filter is a little bit overzealous, filtering out a significant number of non-spam messages. Maybe it will get better with training.



HumilityFrom the Autobiography of Ben Franklin:

…I added Humility to my list, giving an extensive meaning to the word.

I cannot boast of much success in acquiring the reality of this virtue, but I had a good deal with regard to the appearance of it. I made it a rule to forbear all direct contradiction to the sentiments of others, and all positive assertion of my own. I even forbid myself, agreeably to the old laws of our Junto, the use of every word or expression in the language that imported a fix'd opinion, such as certainly, undoubtedly, etc., and I adopted, instead of them, I conceive, I apprehend, or I imagine a thing to be so or so; or it so appears to me at present. When another asserted something that I thought an error, I deny'd myself the pleasure of contradicting him abruptly, and of showing immediately some absurdity in his proposition; and in answering I began by observing that in certain cases or circumstances his opinion would be right, but in the present case there appear'd or seem'd to me some difference, etc. I soon found the advantage of this change in my manner; the conversations I engag'd in went on more pleasantly. The modest way in which I propos'd my opinions procur'd them a readier reception and less contradiction; I had less mortification when I was found to be in the wrong, and I more easily prevail'd with others to give up their mistakes and join with me when I happened to be in the right.



 A couple of years back I advised aspiring investment book authors how to best load up their manuscripts with Buffettisms in order to get published (see my previous comment here). I can find few more exemplary books in this regard than The Dhandho Investor by Mohnish Pabrai. There are endless "margin of safety"'s, scores of "circle of competence"'s, and the "moat"'s number more than the stars in the heavens.

There is a good three page treatment of the momentous story of the American Express Salad Oil Crisis of 1963, which led Warren to invest $7 million. This story must be told and re-told until the end of time, or until American Express has another salad oil scandal, at which point I will be ready. (Remember, investing is like batting in baseball, except that you get an unlimited number of pitches.)

Most of the standard value investing humor is there, including the great "Rule No. 1: Never lose money; Rule No. 2: Never forget rule No. 1". My only quibble is that his presentation of this old chestnut is uninspiring–he simply sets it off in block text, with no special table or appendix. Ideally, it should have been in the title.

Here is a passage from the book that illustrates Pabrai's facility with the language:

"The Dhandho investor only invests in simple, well-understood businesses…we must be down to only reading up on simple, well-understood businesses. We must remain squarely in our circle of competence [sic] and not even be aware of all the noise outside the circle…Every once in a while something about a business will jump out at you. If there appears to be some meat on the bone and you sense that the business might be underpriced compared to its intrinsic value, it is time to hone in…Drill down and see if it truly is an exceptional investment opportunity…Most times it won't be as cheap as you'd like or something will bother you and you'll take a pass. In that case, go back to scanning the radar within your narrow circle…Do not make the fatal mistake of looking at five businesses at once." [Editor's note: Shouldn't the last sentence read "Put all you eggs in one basket and WATCH THAT BASKET"?]

Pabrai's only major blunder is that the title itself is not a Buffettism, but certainly he does very well on chapter titles, which include: "Invest in Businesses with Durable Moats", and "Margin of Safety–Always!". There are a few other weaknesses and oversights. He presents an interesting and inspiring history of how Indian-Americans, and mostly those having the surname Patel, have become the leading proprietors of our nation's motels. That's fine as far as it goes, but that chapter contained zero "margin of safety"'s and no mention of the fact that the only good use for a computer is to play online bridge. There were no mentions of Katherine, or (preferred) Kate, Gorat's Steakhouse, or Cherry Coke. Perhaps these oversights will be covered in "The Dhando Investor Part II".

Despite these quibbles, Pabrai's book is a book that I understand, that is within my circle of competence, with an intrinsic value that exceeds its price with a sure margin of safety. I say buy it and hold, with my favorite holding period, forever.



Passing the TorchBritney's MTV performance has been universally skewered, to the extent that the latest mega-viral video on YouTube is an androgynous figure in tears about the injustice.

My take on all this:

1. The song itself, "Gimme More", is very catchy. If Britney had released it before her meltdown, it would be viewed as a Britney tour-de-force. It's got a propulsive beat, and it's sexy. The appropriate foil for Britney is Justin Timberlake, her old flame. The universal wisdom is that Justin is 'da man, and Britney is history. To me, Justin's stuff seems terrible, a laughable, transparent attempt to run away from his heritage as the leader of a boy band, and to project himself as an honorary gangsta. I think Justin should be seen as Vanilla Ice part II. Britney has none of that phoniness. She's just building on the image that she developed for herself–a girl coming of age and progressively transgressing more boundaries, which in a larger picture, have already been transgressed by everyone from Madonna to Pat Boone. In this song, she dares to use the "b" word.

2. She is said to be too fat, and she is indeed a little too plump for my taste. But cut her a break–she's had kids! Also realize that if she were a little too thin, the tabloids would say she has an eating disorder. This is not a fair criticism. Perhaps it's fair to say that she should have gone with a less revealing outfit, which had stripper overtones.

3. Her dancing is said to be lackluster. This is probably a fair criticism. Her moves could have been a bit more crisp. But she was one of about 40 dancers up there, including several provocative pole dancers. I thought the show overall was not too bad, certainly not an embarrassment, by the standards of these things.

The overwhelming negative reaction to Britney's performance is a collective phenomenon, initiated by a few well-placed opinion makers and then repeated everywhere.

James Wisdom writes:

Keep in mind that this performance was presold to the public as her “comeback” appearance after a series of smaller shows this past year. While I appreciate the author’s apologia, let us not forget that Britney’s career is built on sex appeal alone since we all know she’s not writing the songs, performing any of the music or singing. Therefore, with such a narrow offering to begin with, it is appropriate for us to criticize what little she does do — look good, dance, and lip-synch. In this example, none were passable, especially in the context of her “comeback” performance — where she was supposed to provoke the sheeple to keep buying her records and merch.

The media have merely expressed the collective schadenfreude of the millions who look at Britney’s brand of mass-produced “music” with utter disdain. Perhaps if she had offered the world something of more depth and value the wolves may have paused before feasting on her flabby, glassy-eyed, bungling performance.



 I'll give you my foreigner's viewpoint on the best place in the USA. It is always interesting to have a fresh and candid opinion from an outsider. This is one of the reasons why companies hire management consultants.

My credentials as a European expert on the USA are: I was married with a girl from Boston MA, then I had a girlfriend from Santa Barbara CA for eight years, then a girlfriend from New Fairfield CT for three years. And I traveled for business to places like Los Angeles, Houston, Cleveland. The only really famous American town I don't know is New York, which is odd because that's the city Europeans usually visit first.

In my expert opinion, the best place in the USA is Jacksonville FL. My friends in Boston say that my friends in Jacksonville are trash and I am not associating with the best America has to offer, but I don't agree. The people I know there are marvelous. They are simple, honest, welcoming people. They are not intellectuals like the Bostonians, but who needs intellectuals to barbecue and have a keg party? The Saint John's River is a great river and a sight to behold. Climate is great. Never too warm, never too cold. Food is of the utmost quality.

Charles Pennington adds:

Good things about Jacksonville:

I love Jacksonville.



 It is with great sadness that I report the death of one of our own, John Kuhn, of a heart attack. He was beloved by all who met him. He was a great family man, a great scholar, a great athlete, a great writer, and a creative person who was loved by everyone who met him. I had the pleasure of giving him some happiness from time to time with instructions in tennis.

He was a good man, always optimistic, totally busy with a hundred interests, always learning new things and always striving.

Charles Pennington writes: 

I was very fond of John. I knew him mostly from limited visits, however, even in that amount of time it became clear that he was a very good man, just as you describe, and curious to learn new things. He would chat with me about programming. Mr. Kuhn had a good tennis game as well, and he always got out on the court and gave everyone an enjoyable game. It's very disappointing to hear of the loss. I hope we can convey to his family our appreciation for him. 

Laurel Kenner recalls:

John Kuhn was wise and funny. I only met him in person once, but he went out on a limb for me in a personal medical matter, treating me like a family member. It happened in 2005 and I was scared. John heard about it, and arranged for me to go up to Harvard, where his niece Lisa is an important physician who specializes in the pertinent field. I went up to see her, and she was wonderfully kind and superbly efficient. She was so good that I went back to her for a follow-up just two weeks ago. She squeezed me in. No problem in either case, but a lesser doctor might well have messed things up. 

Here are some of John's posts that show what a great storyteller he was, what a smart guy, and what an individualist. I'm sorry for this loss.

At: 1/29/05 14:18

"I trade for myself," I say if asked, as it helps me not touch client portfolios of common stock which can often do better if left alone. Another thing I no longer mess with is home financing. After much diddling in the past, I’ve converted and would recommend a fixed mortgage. When things go awry, the last unpleasantness one wishes to heap on current troubles is a rising monthly mortgage outlay.

Increasing costs happen anyway. Heat, water, electricity, etc. Where I live, real estate taxes compound at over 5% per annum (since I installed my first computer tracker about 11 years ago) despite prop 2 1/2. Communities roll with the economic times and when times are good, the town managers are ingenious at coming up with vital "extras", new fire house, new high school, etc., which the town approves in haste. These become part of the compounding base. Your real estate taxes will go up each year and if your experience is like mine, always by more than you expected.

The only thing that has grown faster than real estate taxes is home value. Again a vindication of a good principle: if you are young, get the biggest house you can handle.

In the past few years the most consistent mis-estimate has been expectation of increasing interest rates. Again now the sentiment is heavily tilted against duration by the bond gurus. Perhaps they will be wrong again. But all this tells me, after living in all kinds of unpredicted rate environments, is that consistent accurate prediction constantly confounds the experts.

It is very hard to move to a fixed rate at say 6 3/8 having passed on a 5 3/8. But if you have a fixed at 5 3/8 that is not several years old, it's easy enough to roll it to a lower fixed.

At: 4/25/05 10:14

Times have changed: I worked in Paris (Banque Morgan as it was then called, Place Vendome) in 1960. In those days the extreme strength of the dollar combined with very cheap prices to make even the best meal equivalent of half a dozen Big Macs. Perfectly potable wine $.20 the bottle. At the bank you were fed free lunch, usually outstanding quality. And you could get a bottle of wine for an extra 30 cents.

We lived at the time 50 km south of Rome on a nice hunk of land with a beautiful farmhouse acquired for $12k. Good governance was seldom discussed. Even there the food was too distracting as was the stunning beauty of the Italian countryside.

Buffet was already buying stocks for the long haul. Our villa would have been a good spot to park some money as well. We put 10k in and due to dad's death in '85, had to sell for $300,000. 1985 was a while ago. Dad was always a bit lucky and his time to depart this mortal coil was one more example, as thence the cost of living in Europe, with dollars or even local currency, began a very earnest escalation, and the quality of his life, physically, socially, and financially was beginning to decay. And contemporaneously with his death the idyllic period when in Rome one could live like a king with relatively little died too.

I'm not sure if one can't point to overall degradation of currency worldwide combined with prosperity of a more real sort creating a far more intense competition for just about everything. Locally this year, to provide the creature comforts our students deserve along with paving the cracks in the road, it's another $500/year from this taxpayer. Real estate taxes here have compounded at 5.5% under prop 2 1/2 over the past dozen years. To insure myself and wife with good health plan, $16,000 a year. Data I have read recently on the lack of advance of most of the workforce in terms of real wages for many many years suggests that the challenge for all of us is to stay at the top 5% of the wage earner universe, or learn to appreciate less worldly pleasures — and shop at Wal-Mart.

Secrets and Lies

For the biggest of the older bucks, it's the stock market front and center now and forever. And the biggest of the bigs not only own stocks, they own investment management companies, venture capital companies, and now LBO companies. The maximally moneyed types have been doing VC investing at least since I was in my teens, 40 years ago. That's in the US. Also I had a wealthy Swiss client 20 years ago who kept a rolling stable of a dozen money managers around the globe, weighting the contributions on performance and strength of the local currency.

When I was sacked, the agent comforted me with, "Well, you outlasted all but three of the of the dozen on board when you started." They paid the highest fees, found the best managers and those that did not keep up, "aufwiederluege." Hundreds of millions in the old days, when that amount could really spend.

Still, one of the best way to make big money is to print it. That's VC with other people's money, ownership participation and performance fees. If you can hit a really long ball, it can become a gift that keeps on giving. I just Googled the first WASPy VC name I ever came across, Greylock Partners, and up popped a list of three of its best competitors, and on top of that list was the second VC name that had come to mind, Accel Partners, much younger but of similar lineage. I think too of Bessemer and Morgan Stanley. Even J. P. Morgan. It may not take money to make money, but it sure helps. When William Weld ran for the governorship of my fine state of Massachusetts, he was asked by a reporter, "Where are you going to get the money to finance your campaign?" Weld, displaying his intuitive grasp of the common touch, replied, "We don't get money, young lady. We have money!"

The old rich get blasted for a variety of reasons, not all without merit. But whatever their faults, they endure, as they've long known the basic secrets in plain sight about the stock market, not only about the long-term upward compounding of the market, but also the huge benefits available with leveraged compounding that redounds from the judicious application of huge chunks of other people's money.

When I was about 40 I started to wonder, "If the market mostly always goes up, why aren't there more management companies out there owning stocks and claiming the pleasing increases in clients' portfolios were the result of the intense sweat of their own brows?" And collecting the ever-increasing fees the market mistress hands out with pleasing generosity irrespective, within tolerable limits, of whether one's relative heap had been "naughty or nice." Now that there are more mutual funds than stocks and the hedge fund population is at all time high, what was in my youth a mysterious and seemingly almost private realm is now the province of all.

It reminds me of professional golf. We see the names of a handful of top players, and are ignorant of the others in the top 150 beavering away in the sun, making from one to several million a year.

In the money management game, there are thousands of me-too companies, nowhere near the top 150, providing tens of thousands of portfolio managers and analysts and support staff with very nice lifestyles despite the well-broadcast reality that investing directly in the S&P is available almost for free and does better than most of the money managers. The market supports so many. I'm most amazed by the crumb feeders: remora getting paid for their variations on the books.

Jeff Beckwith adds:

I am very sorry to hear that John is no longer with us. I too was a recipient of his counsel. About this time last year I asked for advice on a particular situation my family was facing and John responded. He sought out a couple of his long-time friends from college to help with answers and in the end provided my wife and me with some very cogent and valuable information that helped clarify our decision on the matter. The world lost a very good man. 



If there really were a Plunge Protection team why didn't they come save the world this week? Could it be there isn't one, as certainly this week they were needed?

Charles Pennington comments:

Government likes plunges because they provide an excuse to seize new powers and enlarge the government footprint. It certainly worked out that way during the plunge of the 1930s.

If there were a government Plunge Protection Team, the government would heavily publicize it and its heroic role in stopping plunges. The Hong Kong government openly stepped in to buy stocks in the midst of the 1998 Asian market collapse — the intervention was announced in August 1998 — and to my surprise, the announcement just about coincided with the market low.

My theory, then, is that governments relish plunges and would only intervene if done with great fanfare to take credit. 

Kevin Eilian writes: 

Sometimes "plunge protection" can take the form of a wink and a nod, like the 1998 Russian meltdown/LTC deal. The knight gathered together the biggies from all participating banks (so I understand) and "asked" them to "coordinate" a de facto bailout. Now with huge consolidation among world financials, this type of pp (reminds of me of JP's role in the 1900s) should be easier.

The government will use plunges to assume new power - if it lasts (i.e., the 30s or the late 60s/70s for example). Since most of the world's politicians do not really understand economics (growth causes inflation, static budget analysis, cap gains balance the budget, etc.) the attempt to gather more power in light of a prolonged plunge is worrisome ("double whammy" potential).

I think most politicians dislike the uncertainty and potential shorter term election implications of a typical plunge and/or dislocation, so they'll do what they can to bring in a plunger. To me, whether it’s explicit (like r*bin), informal (like the knight in 98) or just day to day (central bank coordination) they are around. We just need to be careful what we wish for! 

David Wren-Hardin writes:

We're in just the first episode of a multi-episode drama. It's like in the comic books or cartoons where the evil overlord rises up, and a second tier superhero team from another country like Alpha-Flight or Justice League Europe tries to take him on, only to be crushed. Then the real superheroes come in.

We saw Plunge-Protection Team Europe take a swing. Bernanke is still ensconced in his Fortress of Solitude, waiting to call on the rest of PPT-USA. 



 I have heard discussion lately about the market shaking out weak positions on a decline, but I think that the whole concept of "shaking out" weak longs is, on its face, silly.

Let's say, for the sake of argument, the DOW is at 1500. That 1500 is made up of the shares outstanding of the Dow, times the prices per share.

So, the Dow falls to, say 1490. What has happened at an underlying basis is that net money has been pulled out of Dow component stocks.

Then, say it quickly bounces up to 1500. What does that represent? Net money flowing into Dow stocks.

The pundits will say that there was a "shakeout of the weak longs" on the drop, which somehow makes the market go up under some sort "a chain is only as strong as its weakest link" theory.

But what really happened? The same amount of money that flowed out flowed back in.

How can we possibly interpret what that means? Was the money that flowed out weak money, with the money that flowed back in "strong"? How is a guy that wouldn't buy at 1501 a "strong" sort of bull if he buys at 1499?

I don't buy it.

Charles Pennington replies: 

The only rigorous thing we can say about a 10-point down move followed by a 10-point recovery is that the magnitudes of the two changes in market capitalization are equal.

That doesn't preclude the idea that the down move might have been from something like forced selling due to margin concerns, or as one might put it, the sellout of the "weak longs". It's not silly to talk about weak longs; their selling could be different. It would be by definition hurried, and not reflecting the sellers' opinion of the market.

One could also speculate that once these margined-up traders have sold, they won't be selling again, and that that's bullish.

That may or not be correct, but it's not a silly idea.

James Sogi comments:

The market can drop like the breathtaking morning and midday airdrops Wednesday when buyers pull bids reducing liquidity. An example is when price skips over a price tick down when all the bids are pulled or the spread becomes .5. Here is a situation where no money is changing hands but price drops not due to selling pressure, but due to lack of a bid and Globex moving the inside market.

There is no "money flow", rather there is drying up of liquidity. This can be quantified rigorously in microstructure. This is the third and fourth dimensions behind most screens. The afternoon runs back up were even more violent and sudden than the drops, which had a measured quality to them except as it culminated.

It is ironic and a consummation of recent moves that after all the fireworks today we are just above where we were last night. 

Adam Robinson writes:

I understand the point Prof. Pennington is making about weak and strong longs, and while it may be useful as an explanatory or thinking construct for interpreting market action — I use it myself to distinguish the "strength" of conviction" (largely a function of capitalization, of course), I don't see how this notion has any predictive value.

More fundamentally, on reflection, the entire notion of weak vs. strong (as well as the notion of "smart money") seems suspect even as a construct.

Let's agree, arguendo, that a weak long is a trader less able or less willing (than a strong long) to tolerate adverse movements or adverse "noise" (i.e., random fluctuations against his position). (By the way, the notion of "noise" itself in trading is problematic since the analog, carried over from information theory, assumes the existence of a "true signal". That is to say, you can't have noise without having communication, just as you can't have dirt without having an underlying system in which the matter is considered dirt.) To return, let's say that the market moves against our "weak long" and he sells. He is forehead-slapping "weak" only if the market moves up shortly after he sells.

But if the market continues down, our bull was lucky he was weak. Had he been stronger and the market decline more protracted or precipitous, he'd have endured more pain before ultimately abandoning his position.

But even more fundamentally, these distinctions also confound process and outcome by ignoring the impact of random fluctuations (i.e., luck).

A speculator can analyze the market as "correctly" as his insights and statistics allow, put on a position, and yet the trade can be a loss.

More simply put, a "correct process" does not always guarantee a favorable outcome, owing to the intervention of luck — at least in the short run. In the long run, the correct process should prevail (although even that may be tautology).

As Damon Runyon said, "The race is not always to the swift, nor battle to the strong — but that's the way to bet." 

Ronald Weber adds:

Why don't we just call them margin-long and cash-long instead of weak/strong long, then everyone would be happy!

The fact that many names ended well off their lows could indicate that the shorts are "weak" (or "timid") and eager to close their positions, or that the margin-longs have been taken on a ride! We'll see…



 Publishers reject classic titles

Only one out of 18 publishers managed to spot plagiarized versions of Jane Austen novels, a writer says.

David Lassman, 43, from Bath, had his own attempt at a novel rejected by a string of publishers.

So he retyped parts of Pride and Prejudice, Northanger Abbey and Persuasion, before sending them to publishers and agents.

Not only did most of the literary experts fail to spot the trick -none offered him a book contract. [Read More …]

In defense of the publishers, if someone composed "Beethoven's 10th Symphony", i.e., totally captured Beethoven's genius but wrote music from the point of view that existed during Beethoven's lifetime, it just wouldn't work.

If someone painted a new Sistine Chapel, it would succeed nowhere but in Las Vegas.

Publishers don't have time to thoroughly read everything that lands on their desks. Many may have immediately reacted with a rejection after concluding that the author was a hack trying to imitate the style of Jane Austen. Others may have realized the plagiarism but felt they had nothing to gain in mentioning it.

Marion Dreyfus remarks:

I briefly dated Jerzy Kosinski. I was quite privileged that he spent time with me. He was a fascinating man, not for a second boring, full of ideas and a river of intriguing hypotheses, intense and involving.

He laughed that when grad students retyped his prize-winning PEN-winning novels, they too were not recognized, and rejected forthwith. His books are hot, quite recent, relatively, and famed — immortal modern classics.

Ken Smith adds:

I can always bring The Painted Bird to mind. Kosinski put prejudice, discrimination, scapegoating in a perfect setting. It couldn't be done better. If only his material were mandatory reading before kids get out of high school.



Randy NewmanWhen Ulysses Grant said he knew two songs — one was Yankee Doodle Dandy and the other wasn't — he was being his usual wry self. The journalist he spoke to, a gentleman from the New York papers (who else?), took it as further proof of Grant's cultural inadequacies (the fact that Grant could read French and German somehow was ignored). What the President was saying was that, in matters of taste, there is ultimately only what you enjoy and what you don't, and disapproving of other peoples' tastes is a bit like cursing the darkness because you can't find a match.

One of the reasons that I love Randy Newman is that he writes the kind of songs that can clear a room of sanctimony. For lefties "Rednecks" always does the trick, and for everyone else "Short People" is usually enough. "Political Science" remains the ultimate test.

Charles Pennington replies:

I'm disappointed! Randy Newman's MO is this: a rant by a fat-target narrator (e.g. one who hates short people or foreigners) coupled with a sappy whispered or implied corrective ("Short people are just the same as you and I." Well, thank you very much.)

What am I missing?

Stefan Jovanovich responds:

For some of us the politics of smart people can be very, very funny. Who else could complain with a straight face that "I left Harvard with no real awareness of the awful inequities in the world" but Bill Gates? I don't think Mr. Newman is targeting the narrators of his songs nearly as much as you hope, Professor, and he really is satirizing the PC notion of "one big community" in offering his "correctives."

If you have spent as much time among the millionaire leftists of Beverly Hills and their children and grandchildren as the son of Alfred Newman (film composer, not MAD magazine icon) has, laughter becomes the primary defense against the undying hypocrisy that goes with so much "elite" (sic) opinion. It is the only way to wash away the anger.

Gordon Haave extends:

Having moved from Greenwich, CT to Oklahoma, I've noticed just how elitist the rest of the country's view of country music is. Here, walking into someone's home or business, one is more likely to hear country (or "contemporary Christian") than to hear "pop".

Country singer Dwight Yoakam created perhaps the only cover song ever that is better than the original.



From Point and Figure Charting by Thomas Dorsey:

Page 5: "A long time ago when I was a stockbroker at a major firm on Wall Street, I learned there is no Holy Grail."

Page 367: "It wasn't until 1978 that I came across the Point and Figure method of analysis purely by accident. When I learned it, I realized I had found the Holy Grail of investing."

Ken Smith remarks:

I still have a booklet published by Chartcraft in 1990, written by Michael L. Burke: Point & Figure Construction and Formations. I believe very little has changed in the basic approach since the first use of this method.

What Dorsey has done is market the method. His marketing includes seminars and workshops. He's been giving them for years and has a large following. His book is just a starter. His total program for subscribers is the meat of the method.

What makes it successful is the great number of subscribers. Chart constructions are simple to evaluate. But when an unknown large number of subscribers jump on a pattern the predictions in the pattern become self-fulfilling.



VitaliyIn the long run, the performance of a stock in isolation (ignoring the external environment, i.e. interest rates, risk, inflation) is the product of fundamentals (i.e. earnings and cash flow growth) and valuation ( i.e. P/E, P/CF).

Google and Apple may have great fundamentals: their innovation has led and may continue to lead to high earnings and cash flow growth. But are they good stocks? They may or may not be. But, more importantly, will they be good stocks at any price? No! If I were to follow the above conclusion, that since Google and Apple are great companies they are great stocks at any price, at any valuation – at 50, 500, 5000 times earnings, then I'd walk into an overvaluation trap.

Take a look at eBay in the late 90s: it was a great company (it still is), but it was grossly overvalued. So, if you bought it in the late 90s and held it until today, despite its earnings going up 100-fold, the stock is roughly at the same level it was then. I'd argue few would have the patience and conviction to hold it through the downturn the stock took in the early '00s. Most investing in the stock in the late 90s lost money on it.

One of the biggest mistakes investors make in investing is failing to separate a good company and a good stock. A great company's (fundamental) performance is wiped out by valuation compression. This is the battle of two winds: the tailwind of earnings growth and the headwind of P/E compression.

Also, with a high growth priced appropriately (even to perfection) there is no room for even a small mistake (no margin of safety) left in the valuation - a small disappointment (it doesn't have to be much) will lead to a substantial decline in price. The latest performance of Starbucks and Whole Foods stocks is a great example of being priced for perfection and delivering slightly less-than-perfect results.

This myopia in differentiating between good companies and good stocks is not just limited to wonderful, exciting, larger-than-life (Google comes to mind here), fast-growing internet companies. The bluest of the blue chip stocks, like GE, Coca Cola, Home Depot, Amgen, Johnson and Johnson (and the list goes on) were all great companies that one "had to own" but were terrible (overvalued) stocks in the late 90s. Their earnings have doubled or tripled since but the stocks have not gone anywhere.

I think it was Benjamin Graham who said that "price is what you pay, value is what you get."

Kim Zussman adds:

What are the parameters which make a good company or stock? Here are some good stock categories from the literature:

1. Large five year decline in price (DeBondt and Thaler)
2. Large one year price gain (-large 1 year price decline.) Momentum (Jegadeesh)
3. Small cap stocks (Lakonishok and others)
4. Valuation: Low P/E, P/B, P/cash flow, high dividend yield, and
various concatenations thereof
5. High (low?) short interest
6. Put/call ratio (especially when options orders are placed by grandmas in Serbia)
7. Value line timliness (used to be more timely)
8. Double tops and wiggle bottoms above and below 10 minute panting average

The problem is that they all work sometimes; actually, just often enough to keep people interested in them.

Vitaliy Katsenelson adds:

I spent a good portion of my soon to be published book called, Active Value Investing: Making Money in Range Bound Markets, discussing what constitutes a good company and a good stock. I created the QVG framework (Quality, Valuation, and Growth).

A good company should get high scores on Quality and Growth dimensions. For instance a high quality company will have high return on capital, strong balance sheet, a sustainable competitive advantage, competent, shareholder friendly management, significant free cash flows. A Growth dimension encompasses predictable (high recurring) revenue growth, multiple sources of growth, a nice dividend, etc.

If a company received high scores on Quality and Growth dimensions, for it to be a good a good stock it should pass get a passing grade on Valuation dimension - be undervalued (have a appropriate margin of safety).

As anything in investing this analysis is very subjective, but I find this framework is very beneficial to maintaining a rational head and helps me to stick to an analytical process. 

Steve Leslie comments: 

On June 28th (post number ?p=1834) I mentioned that one year ago, when Google was $350, Vic and Laurel went all-in on the search engine provider. I also remarked that Apple and Garmin were both $50 then. Today GOOG is $550, AAPL $137, GRMN $80.

When one finds a great company with a great product line and great prospects, selling at a reasonable price, it is time to buy. Strike when the iron is hot! And eschew the short-term gain for the much larger pot o' gold that lies at the end of the rainbow.

Charles Pennington responds:

I can find nothing in the original post of Mr. Leslie stating any requirement that the stock be bought at a reasonable price (let alone any definition of what a "reasonable price" would be). The concluding quote was:

".. most importantly the speculator should be willing to hold onto the companies eschewing the quick buck in search of the really big gains that can be achieved through diligence and patience."

I'm sure it was an oversight not to have included some kind of requirement of "reasonable price" in the original message. The vehemence of the reaction is because, I think, the post's assertions were untested, apart from anecdote, and Daily Speculations is supposed to be reserved for ideas that are tested.

An example among many of the way the assertions could be tested is to go back to old issues of magazines, newspapers, etc., and find the companies that were rated at the time as highly admired, and then look at their performance afterwards. If you do this exercise, you might find that highly admired companies do well.

However, it is not at all obvious. Many companies which were once highly admired are not so highly admired now, and their stocks have not done well. Enron, for example, was once highly admired.

Barry Gitarts comments:

Haven’t many value experts said Google has been overvalued since its IPO, and Apple for several years now, however both stocks have significantly outperformed the market.

Driving looking out the rearview vs. the windshield could also be the difference between over and under valued perception.



 I take the subway to work daily. While not the most prestigious means of transportation, it is definitely in my case the most practical, economical, and time saving. I happen to live three subway stops from the beginning of the line.

By the time I catch the subway, it is usually full with no seats available. Sometimes, I am in dire need for a seat to get a little nap, especially if I am caught trading overnight. An hour nap can do wonders in my case.

Out of this need I become more creative about finding this precious vacant seat. Knowing that the previous two subway stops to my own have only two sets of stairs closer to the front end of the train, I started walking all the way to the opposite end in hope that most people will go for the closer compartments. This is in fact the case except oddly enough that the farthest compartment is always packed.

My reasoning in this case is that most people play the same game I do hoping for the precious nap and seat. However, three cars away from the far end seems to be day after day the optimum solution to this game. Now that I choose the optimum car successfully, sometimes I still am not lucky enough to get a seat unless one of the passengers gets off the train.

I start analyzing the passengers’ profiles trying to figure out which ones are likely to get off the train first to sit in his or her place. This is not an easy task but some knowledge of the city and behavior can do the trick. For instance, I stay away from all people over 30 in business suits as chances are that they are headed to my same destination. Once this category is eliminated, I try to eliminate all university students by guesstimating their ages simply because four out of five universities are located downtown (at the end of the line) so the odds are clearly not in my favor there either. I try to spot two age groups. High school students and under since parents most likely prefer to send their kids to nearby schools so it is unlikely that this group will travel all the way downtown for schools. Also, the elderly group is most likely not traveling far either. This whole process usually takes few seconds since I usually get lucky enough to get a seat before we reach the next stop.

This process is very similar to gaming the mistress although I admit it's never this straight forward with her. Incentive, incentive and incentive. I play the market for monetary profits and only profits. I don't care what philosophical reasoning a speculator would give you a la George Soros; the bottom line is that it is all about the monetary reward. It is all about the nap in the case of my subway trip.

I always try to figure the line of least resistance in speculation, the car with the fewest passengers. This is usually the road least followed by the public. In search for prosperity, I have to copper the public play at all times (by going to the opposite end in the case of the subway), but sometimes the simple contrary play is not good enough to win the game. A little tweaking is often needed. In the subway example I had to go to the third car from the opposite end and not the last since some smart passengers figured out the "simple" contrary play by going straight to the last car.

Timing is also a very critical factor and can make all the difference between a win and a loss. In the case of the subway one has to process some information and position oneself accordingly in a few seconds before reaching the following stop. Flexibility is also a key to successful speculation as no fixed system will beat the market forever. In the subway example, my game plan is different on the way back home since a different crowd is taking the subway at that time.

Ever-changing cycles also plays a great role in this game. The last car was full as the public got wiser and I am sure the third will be one day and a new game plan and system will have to be developed.

Knowing who you are playing against is critical to any speculative game as is the case of the passengers' profiles of this subway. An extensive knowledge of the markets you participate in is essential to your success as is a knowledge of the different subway stops and what they represent to different passengers.

I will end this post here as I reached my subway stop and have to vacate my seat for the next player.

Sam Humbert comments:

In my Manhattan years, I'd often give up my seat to a person of gender or age. For me, the psychic pain of sitting whilst a pregnant woman or pensioner is standing outweighs the benefit of sitting down. Often I'd get the fish-eye from my fellow New Yorkers — they were silently thinking "he must be mentally ill." I'd sometimes make eye contact and explain "I'm not originally from New York," and this would calm them.

Craig Mee adds:

Watching commuters pile into the tubes in London, there is sheer brawn! Doors open at the station and boom, some people are fixed on the destination, i.e., empty seats and God help anyone getting in there road. Funnily enough this is usually concentrated to a certain gender. Some people like to try and muscle markets around too!

Chad Humbert adds:

 1. Watch for mothers with small children. Sometimes a child will scurry, and the mother will have to leave her seat to retrieve him. Voila! Open seat!

2. The elderly are often slow. I've found I can often simply beat them to the open seat by walking somewhat faster. If I'm careful, I can make it appear that I passed them inadvertently. "Oh, were you going to sit here? I'm sorry! Do I need to move?" Most of them want to be polite, and they insist that I keep the seat. Copper the elderly.

3. I've found that the handicapped seating rules are rarely enforced, and when they are, it's just a small fine. I pay that fine many times over with the extra trading profits I generate from feeling refreshed after a nice nap.

Yishen Kuik offers:

Mr Saad's comment on how the farthest caboose is not the optimal choice because of gamesmanship, but rather some not so inconvenient caboose reminds me of a well known behavioral finance game.

Ask 100 people in the audience to pick a number between zero and 100. The winner is the one whose number is closest to two thirds of the average.

Eggheads will zero in on zero, but that answer merely demonstrates deductive abilities without canniness.

People with a more limited appreciation of convergent series might pick 33 instead, based on the assumption that the average will be 50. People able to think one more step ahead might pick eleven. People able to think one more step in the convergence series might pick nine, and so on.

The real challenge of the game is to guess the distribution of this gradient of deductive powers among the audience and weight one's answer accordingly.

e.g. If you think half the people in the room will guess 33 and the other half are extremely bright but guileless and will guess zero, you should guess eleven.

So perhaps if the challenge is given in a lecture room at MIT, guess one (zero is pointless because of the likely pot split). If the challenge is given to the general public, guess between ten and fifteen.

Philip Tetlock, whom I'm reading currently, reports that the most common winning answer is thirteen.

Barry Gitarts contributes: 

 Here are a few of my subway gaming experiences as they relate to the market.

Gain an edge by counting - I use the grip mats markers to note where the train doors open when the train stops, so next time I will be standing there well in advance of the train arriving. This prevents others from being the first in the door. This takes several observations, because the train never stops in exactly the same spot, but it’s remarkable how close to the doors you can be. Standing on different parts of the platform to observe which cars are the emptiest helps in figuring out which car you would want to focus on.

Work harder then the next guy and be prepared in advance - Even if you are the first in at your door, there will be others coming into the same car through other doors, competing for the same seats as you, this is why you must start looking for empty seats through the windows as the train is still pulling in so you know exactly which seat you need to go for, instead of walking in, looking around and then going for a seat. Those two seconds are the difference between sitting and standing.

Know the relationships between markets - I find that sometimes, especially during rush hour, it makes sense to take a different train one stop away from your destination so one can catch the transfer one stop before the mob boards.

Capitalize on the public fears long after the threat is gone - Unlike Mr. Saad, in my case the last two cars are the emptiest, because the train I take starts in a more unfriendly part of the city where people wouldn't want to be caught sleeping in the last car, so when the train gets to midtown, every car is packed like sardines except the last two which are near empty.

George Zachar strategizes:  

As someone who sits most of the day in front of screens, my subway priority is not getting a seat but minimizing total transit time. I have a mental map of where the stairs are at my destination, and maneuver to get closest to the doors that will open nearest to my exit route.

Market lesson? Different players have different goals. Absolute or relative return? Style box restriction? etc. 

John Floyd adds: 

 I spent one of my school day summers as a messenger in Manhattan. To increase efficiency I learned the exact subways, waiting positions on platforms for door openings, and the correct cars to place me near an exit that would easiest to get me to my destination. I did this for as many of the routes I traveled as possible.

The numbers of possible routes in terms of subways, exits, etc. are myriad. The proper choice allowed me to be the first off the car and up the stairs, oftentimes placing me right inside the building I needed to reach. This was an added benefit as I avoided the often hot, humid, and crowded streets. I would estimate that this on average increased my efficiency by 20-30% at least. Conversely when I rode my motorcycle across the country I looked at the map once in the morning to get a general idea on the direction I wanted to head and roads I might want to take and then just drove. My efficiency of time probably dropped by 50% but my efficiency of pleasure went up by equal.

When traveling now I try to use the time to read, listen to books on tape, or use the time as a period of thoughtful reflection. I do this mostly because I find it most productive for me given I do not find the sleep comfortable or useful to me in modes of transport. I can understand others find it as a useful battery charger that allows them to be productive later.

So I would extend the logic and say that while the goals –profits, learning, etc., may be the same, the path and methods to getting there may be very different. I think another important point is that one needs to decide and focus on what works best for them, as it may not be the same as what works best for others. 

James Sogi comments:

 We don't have subways here in Hawaii, but I try to find the best time to find uncrowded waves for surfing. The best bet is to take my boat to spots such as the nearby national park that has nice waves, but only with a long walk and even longer paddle which weeds most out. The boat takes me to the front row spot and a short paddle, with refreshments waiting.

The other method is to go right after lunch, but before school is out and before workers get out. That seems to be the old guys’ slot, and usually only one or two old guys like me are left still surfing.

The other odd thing, is that even if its crowded, many in water can't see where and when the wave will form and break. If you calmly paddle to the spot where the wave will form as you see it coming over the horizon before anyone else realizes where or when it will come, you will be right at the right spot as it breaks without paddling and catch the perfect wave with a single stroke without effort at the perfect spot while all the crowd is scrambling around trying to catch the wave in the wrong spot.

This of course takes about 40 years water experience and have obvious market application as well. Study of the bottom, which many in water don't bother looking at, triangulation of shore navigation aids, like palm tree lined up with volcano peak and far point, and timing of the waves and sets all help find the ideal entry point. I guess it’s like standing at the right spot on the subway platform.

Another method if the waves are small, or really big, is to use a big board. All the kids ride short boards and only have one board, so if the waves are mushy they can't catch rides, or if the waves are big, they can't catch rides, and with 12 different boards for each micro category of waves it’s easier to catch the nice ones. So really good equipment helps.

Another method is to exercise and train even when the waves suck, so when the waves come, you are in great shape and can charge while the kooks are gasping for breath. Of course pros like Shane Dorian exercise all day long lifting weights, and after surfing five hours, swim around Tavarua Island twice. Geeze.

There are a million ways to beat the crowd. The last one is move a million miles away. The market still reaches here in about 89 milliseconds. 

Victor Niederhoffer extends:

These posts on how to get a good subway seat are a fine pyrotechnic display of native ingenuity. Presumably many of our readers, in their days as poor shavers, also had to apply these techniques to finding parking spaces, especially if they lived in urban areas and didn't want to pay $50 a day for a garage. What I'd like to ask, however, is how these ingenious delectations could be applied to getting a seat in the market. When someone is forced to get out at an unfavorable price, how do you know it's coming, like on the subway, and how can you take his place at a very favorable position to you? One hint is to study Michael Covel and his gurus.

Allen Gillespie replies:

In my experience, a sign of an open seat in the markets frequently presents itself when everyone sells a stock from news on a single company. A recent example is the retail selloff following SHLD's news — only to have WMT, HD, and retails sales numbers lead the market higher a few days later.

Questions I always try to ask myself in those situations:

1) Is the news company-specific or general?
2) Is the bad news the result of good play by a competitor?
3) Did the valuation make the news appear more important than it really is?
4) Which companies have future catalysts? 

Hany Saad contributes:

A fund manager using a trading system that has been losing for more than three consecutive reporting periods is usually a good bet, especially if the majority of fund managers trading the system fall into the switch trap by moving to a different system (usually a very thorough read of the fund prospectus is necessary in this case). They usually give up on the first system at the exact wrong time when it is on the verge of a big win, falling into what Rob Bacon warned against in his wise words "beware of the switches", leaving a seat wide open for the wise observant player.

The same reason I wager that trend following will make a killing next year with the only reservation being that it should be on the long side. 

Barry Gitarts adds:

I have tried to predict who would get up on the train, but such efforts have usually been futile. Instead I stand ready, knowing that anyone could be the next person to get up and I'll be ready to run for the seat. Of course this works better standing in the part of the car where there are fewer people, since there will be less competition for that seat when someone does get up.

In the market, this is like predicting the next big selloff. I can't predict when it will come, but I can be sure I have sufficient reserves for when the opportunity presents itself. As in the subway, this may work better where it is less crowded, and in stocks/markets with less media/analyst coverage. 



 There is a kind of trap that is implicit in maintaining a constant leverage ratio. Note that when the market falls one must sell to rebalance the ratio. After the market has risen one must buy more to rebalance. In a negative daily autocorrelation environment, this is exactly the wrong thing to do from a trading perspective.

An example: Suppose a stock is $100 and we buy 2x for $200. The stock drops to $90 we have lost $10 x 2 = $20. We now have equity of only $80. So we rebalance to own only $160 worth of stock or 1.778 shares. The stock recovers to $100. We profit by 17.78 so our equity is now $177.78. We have lost $22.22.

In contrast, if we had bought for cash and the stock recovered to $100 we would break even. If we do not rebalance we also break even. But by not rebalancing we run the added risk that during a decline we are implicitly taking on a higher leverage ratio than the 2x originally intended.

Rebalancing frequency at higher leverage ratios such as 5x is fraught with danger. The best way to calculate the ratio at any given time is to find the leverage ratio and rebalance frequency which will optimize the log of the expected relative portfolio returns. Ideally one should use the empirical distribution of returns as the basis for this calculation.

Charles Pennington writes:

I've tried to answer this question using daily total return data for SPY since 2/1/1993. I tried a series of leverage ratios from 100% to 1400%.

I assume that you pay margin interest of 6% annually (0.024% per day) on your borrowings. Of course one could do a little better on the calculation by including the time dependence of the margin interest rate.

Column labels (in order):
leverage ratio
$1 grew to
compound annual % return

100%, $4.45, 10.8%
150%, $5.20, 12.0%
200%, $5.50, 12.4%
250%, $5.24, 12.0%
300%, $4.51, 10.9%
400%, $2.44,  6.3%
500%, $0.87, -1.0%
600%, $0.20,-10.5%
700%, $0.03,-21.5%
800%, $0.003, -33.3%
900%, $0.00015, -45.3%
1000%, $(5*10^-6), -56%
1400%, wipeout (lose more than everything)


– 200% leverage had the highest total return, but it was not much higher than the return for 100% or 150% leverage, and of course the risk and volatility was much higher.

– Wipeout occurred at 1400% leverage. However, this assumes that one rebalanced daily. If you only rebalanced once per year, then 500% leverage would have more than wiped you out during the 2002 S&P decline of 22.2%.

These are sobering findings that suggest you should not have steady-state S&P exposure exceeding about 150%. Possibly higher leverage ratios can be occasionally useful if you have some reason to think that the expectation is higher than average in the near future, but it doesn't look good to go above, say, 400% unless you have a real live crystal ball. 



 There is always much debate whether to equal weight or cap weight indices. If there are 30 securities (country ETFs or stocks) in a portfolio, given that they have similar though different return distributions, what is a good way to estimate how frequently one would expect a cap weighted portfolio to outperform an equal weighted portfolio?

Scott Brooks writes:

It really comes down to what do you see doing better, the larger companies or the smaller companies (large or small in reference to that index/ETF that you are looking at).

If you expect the larger stocks in an index to do better, then go with the cap weighted. If you expect the smaller stocks to do better, then go with the equal weighted. For instance, RSP the SPEWI ETF has nicely outperformed the SPY SP cap weighted ETF for quite a few years now.

Alex Castaldo adds:

I would suggest a bootstrapping approach. Imagine the actual data arranged in a four column table:

Period Ticker  CapWgt  Return
1         GE        0.4     1.05%
1         IBM       0.2    -0.85%
1         …
1         XYZ       0.01   0.97%
2         …

From this table the cap weighted and equal weighted returns can be easily computed. Now generate artificial data by scrambling (i.e permuting) the entries in the return column while leaving the other columns unchanged; compute the cap weighted and equal weighted returns for the artificial table.

Repeat the process 10,000 times and see how the real-life returns stack up compared to the 10,000 artificially generated cases. Some details need to be filled in, but you get the general idea.

Charles Pennington adds:

Alex is sending you on a snipe hunt. It is obvious by symmetry that the required probability is 50%. 



 …a proposal for streamlining addresses, wire destinations, etc.

The average person probably spends about a year of his life filling out forms with his address, filling out change of address forms, filling out wire instructions, etc., etc.

My proposed system:

Every geographic living space or business location applies for and is assigned a unique number, the "geo-number". The mapping between number and location is kept on a public database.

Every individual or corporation’s address is assigned a unique number, the "res-number". At any point in time, all the res-numbers map onto a unique geo-number. The user's res-number typically stays a constant, but he can change its mapping onto a new geo-number when he moves. Your mailing address would be your res-number and would never change. Instead of filling out 50 change of address postcards when you move, you would just go to the database and change the mapping of your res-number to a new geo-number.

Every bank account, brokerage account, etc., would have a unique "acc-number". Instead of filling out complicated wiring instructions, you'd just request a wire to your acc-number. The database would have a mapping of acc-numbers onto specific wiring instructions. The instructions could change with time (e.g. if Schwab starts using Citibank instead of Bank of NY), but your acc-number would remain a constant.

While I'm at it, I'd also ban pennies, nickels, and quarters, and just keep dimes and perhaps 50-cent pieces.

If I Ruled the World, words by Leslie Bricusse and music by Cyril Ornadel:

If I ruled the world, ev'ry day would be the first day of spring
Every heart would have a new song to sing
And we'd sing of the joy every morning would bring… 



NEW YORK (AP) — Stocks wilted Wednesday as comments from former Federal Reserve Chairman Alan Greenspan and worries about upcoming economic data deflated a rally fed by takeover activity.

Those who have been around as long as I have seen these ephemeral events played out many times before after comments were attributed to the hot hand with an esteemed reputation.

There was a time when Dr. Doom Henry Kaufman was known to dramatically impact the markets, especially the bond market, with his interest rate predictions. This was while he was with Salomon Brothers in the 70s and 80s.

There have been others who had limited success with predictions and moving the markets, such as Elaine Garzarelli of Shearson, Abby Joseph Cohen of Goldman, Bob Farrel of Merrill Lynch, Bob Prechter of Elliott Wave, Bill Gross of Pimco, and Joe Granville in the 70s. Even Alan Abelson could comment on a stock in his weekly column for Barron's and have a big effect on its opening on Monday. A comment on a stock in the Heard on the Street column could also be worth a point or two. There have been others over the years.

From John Tierney: 

Here are some examples of Greenspan's forcasting history. 

From Stefan Jovanovich:

I believe Mr. Leslie was referring to the total increase in market valuations, not the percentage gains alone. By that standard the late 90s were qualitatively and quantitatively different from the other periods Professor Pennington noted.

The recovery in the ticker from 1932 was hardly viewed by the public as a "rise"; Americans remained hostile or, at best, indifferent to securities investing for another generation. It would be equally hard to see the post-Spanish-American war boomlet as comparable since the U.S. was not yet considered a financial center equal to Berlin, let alone London.

While the 1926-28 Wall Street boom may have outperformed the late 90s by a slight margin, the level of public participation was not comparable. As a percentage of the total adult population, fewer Americans had checking accounts in the 1920s than had securities holdings in the 1990s.

Charles Pennington adds: 

3-year moves following:
12/31/1932: 139%
12/31/1925: 92%
12/31/1903: 92%
12/31/1994: 106% *
12/31/1995: 79% *

(*Partially overlaps the 3-year period after 12/31/1996)

It is true that the market went up a lot after December 1996, but I don't see any basis for saying that post-December 1996 was the "greatest rise in the history of the United States."

Why make such sweeping statements without checking them first? It is like saying, "Nobody hit more homeruns than Willie Mays."

Sam Marx adds: 

Back in the early 50s or maybe the late 40s, Walter Winchell would end his heavily listened to Sunday program with a stock tip that would create a buying binge for that stock on Monday morning. The Stock's Specialist would open the stock substantially higher and buy back at lower prices as the institutions would come in selling their holdings.

When someone asked Winchell where he kept his money, he quipped, "In rubber bands".

From Sam Marx:

 Michael Milkin should be given a pardon.

He created the junk bond market, was influential in financing many of today's largest businesses including CNN, and building the modern Las Vegas. Now he is using his funds for prostate cancer research.

I believe that with all his capital and important character witnesses he could've stalled and defeated the charges against him which were mainly "stock parking" charges. He pleaded guilty to save his brother from going to jail.

He was a threat to some of the moribund corporate boards because he was able to raise the capital, through junk bonds, to enable the takeover artists (Ivan Boesky was not a takeover artist, he was an arbitrager) to gain control of these companies and remove those moribund boards and revitalize those companies. I've heard that the word came from the highest office in the government to get Milken because he was a threat to the entrenched country club set.

Ironically, although he is credited with it, the idea of using junk bonds to take over companies was not Milken's idea. A superior at his firm suggested it to him.

Some such as Ben Stein consider Milken a charlatan. I do not know the exact details of Stein's reasons but I do know that Milken used a Harvard study that showed that a portfolio of high yield bonds would over a period of time outperform higher quality bonds. This may have been valid at first when he was selling existing high yield bonds as a bond salesman but the type of bonds that Milken later created did not fit the properties of the high-yield bonds in the Harvard study.

Before he moved to California, Milken worked in Philadelphia and then N.Y.C. and lived in Cherry Hill N.J., two blocks from my house. When he was commuting to N.Y.C. he would take the bus very early in the morning wearing a coal miner's helmet to read company reports in a dark bus.



 It is time we get our heads out of the sand and stop subtracting out food and energy and admit we have an inflation problem. Energy prices are up and are going to stay up. It has been going on for two years and we (the Fed) must stop fooling ourselves into thinking there is only transient inflation which will likely reverse itself and that there is no core inflation. The transient is now permanent, though volatile. We really have an inflation problem.

Michael Cook writes:

I disagree that we necessarily have an inflation problem just because energy prices are up and are going to stay up. The fact that they are up is sending a legitimate economic signal that supply and demand are not in balance, similar for food. Were the Fed to choke off this "inflation" by throwing us into a recession, these price signals would not be able to do their work of drawing out competitive supply in the form of nuclear, solar, biofuels, fuel cells, etc. - whatever the creativity of entrepreneurs comes up with.

Jim Sogi writes:

The other unidentified variables are the global currency/capital flows that render the "island model" obsolete. There are a number of well-tested empirical theories and studies. But early into the floating currency regime the dynamics are not well understood. There are various theories.

Productivity, things like hours per week are one measure. Other tested theories include comparisons of monetary conditions, fiscal policies, economic growth, central bank policies, portfolio balance, purchasing parity (McDonald's indicator) that seek to predict currency flows. The size of these capital flows are so significant as to render traditional measures of domestic economic conditions no longer reliable or as predictive as they were. Ignoring these variables is a mistake.

Charles Pennington adds:

This argument has been made repeatedly, but is there any empirical basis for it, or any rigorous theoretical basis?

Can it be stated in a falsifiable way, such as the following:

"If money supply measure X (M1? M2? M3? something else?) increases by Y percent, then price index Z (CPI? PPI? sum market caps of stocks, bonds, real estate?) will also change by Y percent."?

My understanding is that history shows that there are times when the value of "everything" drops or increases, without any change of comparable magnitude in the various measures of money supply.

The market cap of the U.S. stock and bond markets add up to about $30 trillion. For just residential real estate, I find numbers that are a few $10s of trillion. Meanwhile the most liberal definition of money supply has it on the order of $10 trillion.

From say 1995 to 2000 the stock market more than doubled, and real estate went up, too. Just the changes in value of stocks and real estate over that period clearly add up to more than the entire money supply. Prices of other things, in general (as measured for example by the CPI and PPI), certainly did not go down over the period. So it appears to me that there can be massive repricing of things in general, of magnitude that dwarfs not just the change in money supply (about $2 trillion over that period), but the money supply itself.

This tells me that pricing of things in general has pretty wide latitude to move around. The value of "everything" dwarfs all measures of money supply, and makes moves of magnitudes that dwarf changes in the money supply. One should never think of there being some kind of grand conservation law, though I'm sure there are useful correlations. 



 There is a point of view out there that the best performance comes when you're having fun. In my lifetime I have played in more than 10,000 refereed squash matches, and won at least 50 national tournaments, and I never had fun in any of my matches. When I tried to have fun, it was disastrous, and I shudder at what a horse's ass I was on those occasions.

To someone who's a serious competitor, the idea of having fun in a tournament is ridiculous. There's so much work, and so many better athletes that you have to beat. So many officials working to do you in, and so much equipment to properly deploy. So much practice and preparation before and during the event. You might think that this is a matter of individual differences or different sports, and I grant that there are some so great that they can soar so high and so much better that it's possible for them to have fun.

I believe that Sharif Khan and Hashim Khan had fun when they beat me, but they didn't have that much fun when I beat them, on those much too rare occasions.

I do know it's totally wrong to try to have fun in the market — it's much too hard, and there are no naturals. The cycles are always changing.

One of the best things I've done in my operation is to make sure that no one has fun in my office. Every now and then, I catch someone who doesn't get the joke, and I upbraid them. 

I try to suppress all exuberance, and when I hear of some former trader who loves to have fun by trading I know he's a straw man waiting to be exposed, and I only wish I could short his fund. Normally I wouldn't comment on a subject like this but I am sure that all frivolity should forever be knoced out of the speculative arena, especially when even an iota of other people's money is involved. They should have their own fun with money you make for them through serious and scholarly discipline and improvement, with no fun whatsover.

Charles Pennington adds: 

I don't know whether he considered himself to be having fun, but I remember a quote from Rod Laver in which he said that he would just swing for his big shots until they started landing in. If they didn't, then he would lose. I guess he knew that losing when you're having a bad day was inevitable when you're playing at the top of the game.

Regardless, I remember that he was my favorite player to watch when I was a kid. It's difficult to find footage of those old matches now, except for a few minutes of a match with Borg in 1977. Laver is past his prime, but he's definitely holding his own with Borg. His modest height of 5'8'' makes the court look like a football field. Notice the beautiful drop shots he makes, even from near the baseline, which are so startling when mixed among his blasting drives. 

From Alan Millhone:

Your remarks carry over into competitive checkers with ease and are sound advice. When you play in a competitive tournament you had better be focused 100% or get crushed by your opponent. I have not had the proper time to devote to serious study for some time and my game has suffered accordingly. You have to spend time preparing for any tournament. The better players have obviously prepared with diligence.

Our World's 3-Move Champion, Mr. Alexander Moiseyev has often said that he is wary when making a move as his opponent (regardless of their strength) can make any reply move, and their reply may be a very good move. He is watchful in every game regardless if he is playing one of the top players or an average player as myself. You might play 'skittle' checkers at a party for fun on occasion, but in a tournament leave the fun outside of the playing room or suffer the consequences .

" Knowledge is power" in the market, checkers, chess, or any athletic event.

From Russell Sears:

At least in marathoning nobody comes to the line and expects to "have fun." The fans don't say, "look at how much fun he is having out there." The best they used to say of me was "he doesn't even look like he is trying." But believe me I was "trying." It's funny now that I am older, and much slower, they don't say that any more.

It's good to hear from Vic, that it's only the weekend warriors that think it's all about fun even for the serious competitor. The fun is left for after the finish. Or as the old country song goes, "time enough for counting, when the dealings done."

Nigel Davies writes: 

I think there must be a difference between how a games player or sportsman defines 'fun' and how the average person on the street does so.

Steve Leslie adds: 

Here is a profound clarification of fun that is so on the mark from my perspective.

I heard tournament poker pro Amir Fahidi say "If you are not willing to die you cannot live."

George Patton said, "Compared to war, all acts of human endeavor pale in comparison." In the movie Patton there is a dialogue between Omar Bradley played by Karl Malden and George C. Scott as Patton.

Bradley: "You know the difference between you and me George? I do this because it is my job. You do it because you love it."

Upon reflection Patton remarks: "God help me I do love it so."

From Alfonso Sammassimo:

Playing a tournament match with the aim of having fun has only occasionally entered my mind since junior days, simply because it has always been such a costly attitude to take onto the court. In particular I recall matches where I subtly tried to imitate players whose styles I admired and envied, especially when I had only recently watched them, and how badly it affected the score for me, cost me more matches than I can count.

I recently had my first competitive match (our annual club championships) in a while after a shoulder injury, meeting up in the second round against an older fellow who used to tour our satellite circuit and played a for a few years as a pro. He had been playing club matches for months and was in sharp form, typical Australian grass style player. I was very fit going into the match but hadn't played much, and my plan was to just enjoy myself. But after realizing my range was way out and seeing that the guy couldn't hit three high forehands in a row I decided to turn the match into a hack-fest, the only game plan I was capable of executing well on the day.

Fortunately fitness and concentration won the day for me, and as ugly as the game was it satisfying to win knowing that I managed to change plan, use my available strengths to make him push himself to hurt me - no fun involved until shaking hands.

The tournament player walks onto the court to win, and it's no fun losing no matter how fancy you looked - the fun is in the prize. With so many things that need to be done in consecutive matches to win a tournament and the concentration that is required, there is no room to think of enjoying it. My P&L tends to suffer the same fate when I trade for fun or try to get fancy, not playing the game that feels most natural to me. And I have more recently been prone to some imitation of market players, but that hasn't hurt me much.

From Stefan Jovanovich:

What poker has to do with either running or baseball, I have no idea. I do know that Don Schlitz wrote "The Gambler" in 1976, and Kenny Rogers' recording of it was a hit in 1978. As "old" wisdom, that is bit on the short side even for the more synthetic products of Nashville. I will defer to one of the many poker experts like SL to comment on whether players at the table count. My amateur observation tells me that they can tell you the history of every chip they have in the stacks in front of them.

Those of us whose sporting careers were limited to the John Kruk school of athletics ("M'am, I'm not an athlete; I am a ball player") have no way of understanding what Russell Sears knows as a marathon runner. We are even more puzzled by why he is so moved to anger when told that fun is a necessary part of baseball. Baseball is a game that you can only play well after 10 years of daily practice, study and good teaching. The first time a player gets to the major leagues he fails - either mostly or completely. (Tim Lincecum's debut yesterday with the Giants was a "mostly" so he may, in fact, be the next "pheenom".)

If, thereafter, you are hard working and talented and lucky enough to stick at the major league level, you get to fail only 3 out of every 4 tries. If you are that 1 in a million player whom God has truly blessed, you fail only 2 out of 3 tries instead. Precisely because it mostly about failure, baseball has one cardinal rule: you never "show the other guy up". If you do, the guy standing 60 feet 6 inches away holding a rock-hard ball has the right to aim it for your ribs instead of the inside corner; and even the players on your own team will think you had it coming. What almost all baseball players share, whatever their degree of success, is the capacity to find joy in its daily grind of failure and humor even in its worst moments of humiliation.

Rodger Bastien writes:

Have fun all of the time? Ha!! I think the struggle to excel is universal, in any sport. The idea that it's more "fun" in baseball or that the struggle is less is to me absurd. However, I would give anything to be able to enjoy that struggle again! 

Russell Sears adds: 

Perhaps there is an element of frustration, in what I wrote. The original reply was not meant in anger, but from a Spartan spirit. Nigel said it much better.

Age has forced me to run marathons for "fun" and feel many of the same sentiments Nigel expressed. However, unlike Nigel, my game suffers no matter the discipline I bring to it. But discipline can be exhilarating, even in defeat. Discipline can make the game fun.

Nigel Davies adds:

After some further thought I think I know exactly what the fun is in competitive sports (and trading) if you play for blood. It's the intensity of the experience which is completely off the spectrum of those we have in 'normal life'.

A chess game in which one puts everything in can lead one to feel either great highs or great lows, but always the feeling that one is more intensely alive because of the rich tapestry of emotions. Strong players will also tend to have feelings of pride and self-worth linked to good performance, and not necessarily to favorable outcomes, though the two tend to run side by side.

Those who can't bring themselves to play with much intensity are those I'd describe as dabblers. And they'll never be much good because they won't be able to fire on all cylinders.

Rodger Bastien adds:

My intent wasn't to diminish Mr. Jovanovich's knowledge or opinion pertaining to baseball as much as to respectfully disagree with the idea there are absolutes unique to baseball, especially regarding that difficult period at the beginning of a major league career.

I suspect that the first year in any sport at the major league level is especially daunting. The NBA is a prime example where the first or second year is often a year of learning. I'm convinced that these elite athletes do such a good job of making it look easy that we mere mortals can't begin to understand how gifted they are. When we relate our experience playing the game to the game they play at that level it is truly comparing apples to oranges, their game being that much more difficult.

That all said, I have always enjoyed Mr. J.'s musings and am partial to anyone who loves baseball and respectful to their opinions of it as it certainly is expressed from the viewpoint of greatest affection. Now Vic, I am still trying to figure out how you achieved such great success in the racquet sports without indulging yourself in a modicum of fun! Is it that to label it as fun is to infer a lack of seriousness? I know that at the moment of my most outstanding athletic achievement the almost orgiastic release would be defined in many ways, fun being nearing the top of the list.

Stefan Jovanovich replies:

Rodger: I think you are right. I was going to offer pitcher's WHIP stats as an example of baseball's uniquely absolute level of failure and compare that to the number of unforced errors in a tennis match. But, when I looked at the statistics for matches between professional players at the same level of excellence as the best major league hitters and pitchers (the top 25), their ratios of points won on service games vs. double-faults, unforced errors and winners by their opponents were roughly the same - 1 in 3 or 4. I am afraid that I got mesmerized by my memories of looking at the game through a mask and the joys of doing something well, at least at the orange level. 



There is an idea that's pervasive, that has become conventional wisdom in much of the academic and hedgefund community — it is that there is a tendency for the stocks that have been outperforming over the past 3-12 months to persist for the near future in their outperformance. A main source of the idea is the academic papers of Jegadeesh and Titman, published in the mid 90s (Rev. Fin. 1995, Vol 8, 973-993).

This idea, or at least the simple interpretation of it that I test here, has not been working well in recent years among large cap stocks.

For the years 1997-2006, I considered S&P 500 component stocks at year end, requiring a share price (the price as it stood at the time, unadjusted for splits) greater than $10. I calculated the median trailing 1-year return for the qualifying stocks, then separated them into two portfolios, the "Leaders", an equal-weighted portfolio of stocks that had a trailing 1-year return exceeding the median, and the "Laggards", with 1-year returns less than the median. Then I looked at the forward 1-year returns for these portfolios, and for "Hedge", which is "Leaders -Laggards". Here are the portfolio returns by year:

Year  Leaders    Laggards   Hedge
1997     33         26           7
1998     21          7          14
1999     17         12           5
2000      2         25         -23
2001     -5         10         -15
2002     -9        -15           5
2003     30         51         -21
2004     20         16           4
2005     15          6           9
2006     16         18          -2
avg      14         16          -2
stdev    14         17          13
t-score   3.1        2.9        -0.4

So the Laggards actually won by a narrow margin.

Maybe there are other circumstances where the Leaders beat the Laggards. Perhaps they do so for small cap stocks, which I haven't tested here. Don't fall prey, though, to the idea that they win pervasively, consistently, or by a wide margin.

Kim Zussman adds:

Prof. Pennington's results fit with the recent literature, including the new article The Disappearance of Momentum by Hwang and Rubesam, that suggest rumors of the death of momentum are not exaggerated, notwithstanding that Jegadeesh's construction was high-low deciles, not halves.

Over the past 10 years, buying stocks based either on momentum or reversion worked equally well. Now, where are those darts?



Here's a technical question for experts on the operation of the NYSE and Amex markets.

For listed stocks with large volume, there is a daily "open" and "close" print at which a large number of shares usually trade. Ideally one can trade with a market-on-open and market-on-close order and avoid paying the bid/ask spread.
However, it seems to me that the open and close crosses have much smaller volumes for ETFs.

I'll compare Newmont Mining (NEM) and a gold stock ETF (GLD). Both are listed on NYSE. Both average about 5 or 6 million shares traded per day.

This morning 101,000 shares of NEM traded at the opening print, and 130,000 traded at yesterday's closing print. GLD, however, had a lot of volume this morning, including pre-market, but there was no obvious opening print. The largest single trade between 9:30am and 9:40am was only a few thousand shares, and that was by no means the first trade.

Are there different rules for ETFs in terms of the open and closing crosses? Is there a way to participate in some kind of crossing trade for ETFs?

David Wren-Hardin explains:

The short answer is, yes, there are opening crosses. The issue as to why a lot of them aren't seemingly efficient as stock crosses is that a lot of ETFs are traded as an arb. If there's a large buy imbalance in the QQQQs, the marketmakers and specialist will simply skew the market to where they can get their futures off to offset the trade and lock in their profit.

Unlike a stock, where the open and closing imbalance can be seen as the market's arriving at a conclusion as to the value of the stock, with an ETF, either the market knows what the value is because of an electronically traded future, or it doesn't, because the value is determined by a basket of stocks. In the first case, someone sending resting opening orders knows he will get a fill away from true value almost by definition. In the second case, the marketmakers and specialists can't figure out what something is worth until the basket of stocks is open, which all have their own opening imbalance games going on.

So in the case of something like GLD, which includes illiquid names with all sorts of late opens, the marketmakers would be fools to lay any sort of tight market. Anyone who traded against them would be doing so because he had a much better idea of where the underlying stocks are going to open.

Charles Pennington responds:

I don't understand the argument. The GLD ETF, as you note, would be the second of your two scenarios. That means there is much uncertainty about where it should open. I add that that's also the case for a regular stock. So what's the difference between an ETF and a stock in this regard?

David Wren-Hardin clarifies:

I was thinking of something like OIH. If there are 500,000 shares to go on the open, how are the marketmakers going to get their hedges off? Typically, they will wait until all the stocks are open, so they know what the value is. Of course, by this point, the world knows what the value is, and there's no longer need for price-discovery, and the customer will get arb'ed against. So if a customer is willing to do that, then he is essentially saying he know more about the opening or the post-opening than is obvious, and the trade will only be a loser for the marketmakers. Maybe he is leaning on the open prints in the underlyings in order to pick off the marketmakers.

The difference is who trades stocks, versus ETFs, or the perception of who trades them. ETFs are driven to a large degree by speculation. People trying to get in and out, people trying to capture an arb. They are often seen by marketmakers as smart money. Stocks, on the other hand, can often be driven by a different type of customer, such as a mutual fund. Their opening or closing order is just seen as a block of stock moving at some easy to mark price where the mutual fund is assured of some level of price-discovery giving them a fair price. Therefore, marketmakers, or even other customers, are more willing to step up and offset the balance.

Charles Pennington replies:

OIH is another example of a very liquid ETF which has very little volume on its open and close. Both OIH (the ETF) and SLB (Schlumberger) trade on average about 10 million in volume per day.

This morning, SLB traded 69,000 on the open, and OIH traded only 10,500. Yesterday SLB traded 36,500 on the close. My source of time and sales doesn't show any obvious large closing trade for OIH.

So there seems to be a big systematic difference.

Another Spec asked me what I meant by "closing cross". Here's my understanding:

One type of order that can be entered for NYSE stocks is a "limit on close". (There are also "market on close" orders.) These orders must be entered before 3:40pm EST, 20 minutes before the closing bell.

All such orders are held until the close. Then the specialist determines at what price the maximum number of orders can be crossed. If I have a limit order to buy at 50, and someone else has a limit order to sell at 49, then our orders might be "crossed" at 49.50. The specialist determines the price at which the cross can take place. Ideally there will be a price such that the buys and sells balance each other, and the specialist doesn't have to get involved in buying/selling. If not, then there is an "order imbalance".

However, NASDAQ over the past few years has added a closing and opening cross for its stocks, and they call it the "closing cross". I've been very satisfied when I've used it.

J.T. Holley notes:

From the AMEX webpage,

Rule 131A-AEMI. Market on Close Policy and Expiration Procedures. The following procedures apply to stocks and closed end funds and do not apply to options or to any security the pricing of which is based on another security or an index (e.g., Exchange Traded Funds or Trust Issued Receipts, securities listed under Section 107 of the Exchange Company Guide, warrants and convertible securities).

Looks like ETFs don't have the applicable MOC trade.

And it seems that they trade till 4:15pm in "broad index" cases.

David Wren-Hardin remarks:

That might be the case for products still listed on the AMEX, but doesn't help you if you're worried about things like the iShares.

There's an informal 4:00 closing price in the SPY for brokers/customers who want to mark their SPY against the 4:00 broad market close, then a formal closing rotation at 4:15.

Kevin Depew adds:

From the iShares Web site:

iShares ETFs are traded like stocks on an exchange where investors buy and sell them just as they would any other publicly traded security. And because iShares ETFs trade like a stock, investors can benefit from features like intraday pricing and trading, the ability to place stop and/or limit orders, and the opportunity to sell iShares ETFs short.

Like other exchange-traded securities, iShares ETFs will trade subject to a bid-ask spread. Spreads may fluctuate in response to supply and demand forces, overall market volatility, and other factors ? in other words, the same factors that influence the prices and spreads of stocks. But unlike stocks, the ETF's creation and redemption process not only helps to minimize the bid-ask spreads, but may also reduce the premiums and discounts that can develop between the iShares ETF market price and the Net Asset Value (NAV).

ETFs are very different from closed-end funds. A closed-end fund's shares are fixed, which is why they frequently trade at a premium or discount to NAV. Although they both trade on an exchange, the ETF shares can be created and redeemed throughout the day.

Also, it's important to get a handle on the composition of ETFs. The Biotech HLDR, with fewer than 20 members, is two-thirds weighted in AMGN and DNA. On the other hand, IBB, with more than 150 members, is only about 12% weighted in AMGN, has no exposure to DNA. That's a significant difference for two funds labeled Biotech.

David Wren-Hardin replies:

Kevin makes a great point. HOLDRS were invented by Merrill Lynch, and unlike other ETFs from the Spyder family (SPY, DIA, XLE, et al.), they never rebalance, and their composition does not change unless a company is taken over or goes bankrupt. That's why AMGN and DNA have taken over the BBH, as opposed to IBB, which is rebalanced from time to time.

In addition, it's more costly to create/redeem out of a HOLDR than a SPY, It costs $10.00 per 100 HOLDRS to create or redeem, That works out to a dime a HOLDR share, a pretty hefty premium. SPY, on the other hand, is a flat $3000.00 charge. The minimum creation unit is 50,000 shares, so that's only six cents, 40% cheaper already. But its $3000,00 for 50,000 or 5,000,000, and at that level the fee becomes a much smaller cost.

Also, HOLDRs pay their dividends straight through. If INTC goes ex-dividend, the owner of the SMH gets the dividend the same day as a regular INTC owner, minus a touch since fees are taken out of the dividend stream. Spyder products and their ilk accumulate the dividends over time, and pay it out quarterly. 

Art Cooper remarks:

An excellent resource is Russell Wild's Exchange Traded Funds for Dummies.  



 Winning percentage = 50 + 32*(correlation)

Because the constant is 50 (~50%) it would appear that the numbers input to this were basic coin flip probabilities. To a good approximation most markets do obey coin flip odds so this is very useful. I would, however, conjecture that if the odds were different, say 20%, then a new approximation might be needed with different parameters.

Charles Pennington notes:

I'm not sure what Dr. Phil means when he says that "it would appear that the numbers input to this were basic coin flip probabilities."

The procedure was this:

  1. Generate 2 series, A and B, each having 10,000 random numbers from a normal distribution with average 0 and standard deviation 1.
  2. To each element of B, add alpha times the corresponding element in A, to generate a new series C. (I will end up trying alpha values ranging from much less than one to much greater than one.)
  3. For the first 5,000 elements of A and C, run a regression of C versus A. This gives a correlation, slope, and intercept.
  4. For the remaining 5,000 elements of A and C, use the regression, and the A values, to predict the C values.
  5. Count the fraction of instances in which the prediction gets the sign right–that's the "winning percentage".
  6. Now you have a correlation, and a winning percentage.
  7. Repeat for a different values of alpha to generate a table of winning percentage versus correlation. (When alpha is small, much less than one, then alpha and the correlation that emerges are very close. When alpha becomes much greater than one, the correlation approaches 100%.)

For correlations approaching 0, the winning percentage approached 50, as of course it should. For large correlations, it approached 100%, as also it should. For small but non-zero correlations, I found this result, as stated earlier:Winning percentage = 50 + 32*(correlation).

Seems like a reasonable answer for a guy who wanted a rule-of-thumb mapping of correlation onto winning percentage. Obviously if there is a big drift term, or any other number of things are true, it could be significantly wrong.



 I cannot fail to remind all of the benefits of Spirulina, especially the well grown varieties — not all algae ponds are equal. It is a superfood that simply is more useful to the body than other volumes of food, and the brain gets the message by being less hungry. I find Atkins in addition to Spirulina beats the cravings while simply using the proteins and fats to turn the dials on the metabolism.

Charles Pennington writes:

The last thing that I did in my academic life, or rather the last thing that a very, very talented student in my lab, Luisa Ciobanu, did while I watched, was to obtain a magnetic resonance image (MRI) of a single cell of the algae Spirogyra, which is very similar to Spirulina. It's a plant cell shaped like a cylinder, with a diameter of about 40 micrometers. The "spiro" in the name is there because the cell has green chloroplasts that align in a spiral pathway along the inner cell wall. Dr. Ciobanu was able to resolve these chloroplasts (each just a few micrometers in diameter) piercing in and out of the image planes. The MRI images are on page 75 of our review article, and Dr. Peter Sengbusch has also made some pretty pictures using a regular optical microscope. It never occurred to me that it would be a good idea to eat these things!



 It's all about balance and eating healthy red meat. If you want to eat great red meat, here's how to get pure, organic, lean meat and some exercise in the process. This works for turkey too, and you get just as much exercise!

I get up in the morning, get dressed carefull, go out into the woods with my bow and arrows (walking is good exercise), climb a tree and sit in the freezing temperatures (toughens me up and burns some serious calories), keep my mind and senses alert for "the" deer to come by, wait for the perfect moment, draw, aim and release.

Zip! Razor sharp death zipping along at 300 feet per second through the chest cavity of a deer. Watch carefully where he runs, listen for him to fall, wait 30 minutes, pick up the blood trail, find him, drag him out of the woods (if you want some exercise, try dragging 250 of dead weight up and down a half mile of hills).

Field dress the buck after weighing it and taking measurements (the 'possums, 'coons, coyotes, buzzards, and crows will thank you!).

Hang him up the barn, skin him (20 minutes), cut off his flanks (20 minutes), debone the meat (20 minutes), wrap it up tight and freeze it!

Grind some into burgers and BBQ some that day. Nothing better than fresh back straps (tenderloins) BBQed that day. Get some fresh corn, some green beans, some potatoes and slow cook it all…

Do some situps and pushups while flipping the meat. Grab a low-hanging tree branch to do some pullups on your way in to check on the vittles on the stove, and on your way back out, do 25 deep knee bends.

Put dinner on table while it's piping hot (too hot to eat).

Dash to the shower and take a three-minute refreshing shower, get dressed and get back to the table within five minutes, just in time for the food to be the perfect temperature.

Eat to your heart's content!

Then go outside, stare up at the stars, and take it all in! Life is so beautiful! And it's ours for the taking!

Charles Pennington extends:

 If and when I need to lose weight, I go on the more extreme version of Atkins diet until the mission is accomplished. Then I return to a steady-state diet in which I avoid bread, rice, potatoes, and most sugar, though I do cheat regularly with things like ice cream and chocolate. Avoiding the bread, rice, and potatoes usually pushes me to substitute real vegetables. Don't be afraid of Atkins's almost no-limits approach to meat. Meat is very filling. I, at least, have no craving to overeat meat, although I could easily overeat french fries, sodas, and biscuits.

It is a pet peeve of mine that there is such an anti-meat and anti-fat-in-food bias out there that is not supported by real science. The Atkins/anti-Atkins divide corresponds roughly with the political right/left divide. The left doesn't like Atkins because it involves eating meat, and they're loath to admit its merits. The major studies that have been emerging (such as a massive study of the diet and health of tens of thousands of nurses) have been showing pretty uniformly that the fear of fat is unfounded, that low-fat diets don't work, and that the extreme Atkins-type diets are effective for losing large amounts of weight.

Hany Saad adds:

I have to agree with Prof. Pennington on this. I have yet to find any scientific proof that red meat is harmful for the human body. Colon cancer patients are automatically advised to stop meat consumption, as are patients with kidney and liver diseases. I looked everywhere for scientific proof but failed to find any. 

Marion Dreyfus writes:

In Mongolia you eat lean meat from the vast tracts. On the mountains in Peru, same thing — lean, absent any hormones or commercial shelf-life preservatives. These people live longer, on average, than city folk, even with reddest of the red meats.

The difference is consuming them fresh, without additives, and eating them from the slopes or the veldt, without hormones or padding from artificial feed. I ate wild game when I worked for a hunting magazine, and that game too had little to contest.

The stomach does work harder to digest the meat, true, but if it is of high quality, it is not the cancer-agent suspect the society implicates so easily. I agree, too, that the research with suitable controls is utterly (utterly?) absent, thus far.

Bruno Ombreux adds:

There are also the Okinawan diet and the Cretan diet. Lots of fruits, vegetables and fish. Little meat. And the French Paradox. Lots of wine, goose fat…

Scott Brooks explains:

Exercise and moderation in diet: that is the key, my dear Professors! That is how I've managed my chiseled physique. You don't get this body by accident!

David Hillman writes:

 Ingesting high amounts of certain carbohydrates causes insulin spikes, often resulting in fat synthesis and deposition. So, bread, rice, pasta, potatoes, sugar and greasy three-pound breakfast biscuits from Hardee's not eaten in moderation are common culprits in weight gain. Red meat, or meat of any sort, and fats, have not been shown to cause the creation of excess insulin and glucose and fat. These scientifically proven concepts are the basis of the Atkins diet.

The best advice is to eat what you want, when you want, in moderate proportions, 4-5 meals per day, exercise regularly, screen preventively for common ailments, drink clean water often, good coffee more often, and great bourbon occasionally, smoke a Cuban cigar a couple times a year, get a hobby, steer clear of the press, wear sunscreen and loose underwear, have frequent sex, and always wear your seatbelt. If you want more complete information about insulin spikes, ask a registered dietician or a professional 'natural' body builder. My experience is they know more about this than the average medical doctor.

Dr. Atkins was generally correct, but that's not to say there aren't myriad ways to eat well, stay healthy, keep excess weight off and enjoy life, or that other plans can't also be a kick start. Many enjoy success with Weight Watchers' point counting system. Or, for $300, NutriSystem will sell you enough food for a month's worth of five-a-day MREs (well, not exactly — they sell you the entrees and in the fine print you're told you have to add your own fresh fruits and vegetables, dairy, etc). The truth is, eating to excess can cause weight gain, not eating enough can contribute to weight gain and not everything works for everyone. You have to determine what works for you and develop smart lifestyle and eating habits.

But the misinformation often foisted upon the public as healthful dietary advice by gurus, government and even reputable sources ranges from misleading to deplorable. Years back I stopped sending checks to the American Heart Association after seeing its logo and 'Heart Healthy' endorsement on a box of breakfast cereal known to have 50% sugar content. "No Fat" proudly displayed. Oh, really? The AHA endorses a product that causes insulin spikes, which in turn promotes excess fat production and deposition?

Excess fat builds up around organs (including the heart, and if you're fat outside, you're really fat inside), hampering proper function. Excess weight that wears at joints promoting osteoarthritis and inflammation. Good thinking. Instead, I now support the American Cattleman's Association through regular contributions made at the butcher shop of the local Piggly Wiggly. Ever seen an obese cowboy? Neither had Dr. Atkins. At least not since Andy Devine.



 There has been entirely too little thought given to the mechanism, pathways and reasons that negative feedback works in markets. Perhaps the main reason is that the feeding web is based on a reasonable stability in what and how much is being eaten and recycled.

The people who consume and redistribute must maintain a ready and stable supply of those who produce. They develop mechanisms to keep everything going. One of them is the specialization and great efficiency in their activities. If markets deviate too much from the areas and levels within which the specialization has developed, then much waste and new effort and mechanisms will be necessary.

Aside from the grind that trend following causes (i.e. the losses in execution), and the negative feedback system of movements in the supply and demand schedules that equilibrate, which Marshall pioneered and are now standard in economics, and the numerous other reasons I've set forth (e.g. the fixed nature of the system and the flexibility to profit from it), this appears to me to be the main reason that trend following doesn't work.

Here are a few interesting articles on the subject:

How Great Traders Make Millions in Up or Down Markets 

Does Trend Following Work On Stocks?

Interviews At RealWorld Trading

Why I Don't Believe in Trends

Briefly Speaking . . . 

Bill Rafter writes: 

Dr. Bruno had posed the idea of beating an index by deleting the worst performers. This is an area in which we have done considerable work. Please note that we do not consider this trend-following. The assets are not charted, just ranked.

Let us imagine an investor who is savvy enough to identify what is strong about an economy and invest in sectors representative of those areas, while avoiding sectors representing the weaker areas of the economy. Note that we are not requiring our investor to be prescient. He does not need to see what will be strong tomorrow, just what is strong and weak now, measured by performance over a recent period.

What is a market sector? The S&P does that work for us, and breaks down the overall market (that is, the S&P 500) into 10 Sectors. They further break it down into 24 Industry Groups, and further still into 60-plus Industries and 140-plus Sub-Industries. The number of the various groups and their constituents changes from time to time as the economy evolves, but essentially the 500 stocks can be grouped in a variety of ways, depending on the degree of focus desired. Some of the groupings are so narrow that only one company represents that group.

Our investor starts out looking at the 10 Sectors and ranks them according to their performance (such as their quarterly rate of change). He then invests in those ranked first through fourth (25 percent in each), and maintains those holdings until the rankings change. How does he do? Not bad, it turns out.


From 1990 through 2006, which encompasses several types of market conditions, the overall market managed an 8 percent compound annual rate of return. Our savvy investor achieved 10.77%. A less savvy investor who had the bad fortune to pick the worst six groups would have earned 7.23%. Those results are below. (Note, for comparison purposes, all results excluded dividends.)


How can our savvy investor do better? By simply sharpening one's focus, major improvements can be achieved. If instead of ranking the top 4 of10 Sectors, our savvy investor invests in a similar number (say the top 4, 5 or 6) of the 24 Industry Groups, he achieves a 13.12% compoundedannual rate of return over the same period. Note that the same stocks are represented in the 10 Sectors and the 24 Industry Groups. At no time did he have to be prescient.


One thing you will notice from the graphs above is that the equity curves of our savvy and unlucky investors mimic the rises and declines of the market index itself. Being savvy makes money but it does not insulate one from overall bad markets because the Sectors and even the Industry Groups are not significantly diversified from the overall market.

Why not keep going further out and rank all stocks individually? That clearly results in superior returns, but the volume of trading is such that it can only be accomplished effectively in a fund structure - not by the individual. And even ranking thousands of stocks will not insulate an investor from an overall market decline, if he is only invested in equities. The answer of course is diversification.

It is possible to rank debt and alternative investment sectors alongside equities, in the hope of letting their performances dictate what the investor should own. However the debt and commodities markets have different volatilities than the equities markets. Anyone ranking them must make adjustments for their inherent differences. That is, when ranking really diverse assets, one must rank them on a risk-adjusted basis for it to be a true comparison. However if we make those adjustments and rank treasury bonds (debt) against our 24 Industry Groups (equity) we can avoid some of the overall equity declines. We refer to this as a Strategic Overlay:


Adding this Strategic Overlay increases the returns slightly, but more important, diversifies the investor away from some periods of total equity market decline. We are not talking of a policy of running for cover every time the equities markets stall. In the long run, the investor must be in equities.

Invariably in ranking diverse assets such as equities, debt and commodities, our investor will be faced with a decision that he should be completely out of equities. It is likely that will occur during a period of high volatility for equities, but one that has also experienced great returns. Thus, our investor would be abandoning equities when his recent experience would suggest otherwise. And since timing can never be perfect, it is further likely that the equities he abandons will continue to outperform for some period. On an absolute basis, equities may rank best, but on a risk-adjusted basis, they may not. It is not uncommon for investors to ignore risk in such a situation, to their subsequent regret.

Ranking is not without its problems. For example, if you are selecting the top 4 groups of whatever category, there is a fair chance that at some time the assets ranked 4 and 5 will change places back and forth on a daily basis. This "flutter" can be easily solved by providing those who make the cut with a subsequent incumbency advantage. For a newcomer to replace a list member, it then must outrank the current assets on the selected list by the incumbency advantage. This is very similar to the manner in which thermostats work. We have found adding an incumbency advantage to be a profitable improvement without considering transactions costs. When one also considers the reduced transaction costs, the benefits increase even more.

Another important consideration is the "lookback" period. Above we used the example of our savvy investor ranking assets on the basis of their quarterly growth. Not surprisingly, the choice of a lookback period can have an effect on profitability. Since markets tend to fall more abruptly than they rise, lookback periods that perform best during rising markets are markedly different from those that perform best during falling markets. Determining whether a market is rising or falling can be problematic, as it can only be done with certainty in retrospect. However, another key factor influencing the choice of a lookback period is volatility, which can be determined concurrently. Thus an optimal lookback period can be automatically determined based on volatility.

There is certainly no question that a diligent investor can outperform the market. By outperforming the market we mean that he will achieve a greater average rate of return than the market, while limiting the maximum drawdown (or percentage equity decline) to less than that experienced by the market. But the average investor is generally not up to the diligence or persistence required.

In the research work illustrated above, all transactions were executed on the close of the day following a decision being made. Thus the strategy illustrated is certainly executable. Nothing required a forecast; all that was required was for the investor to recognize concurrently which assets have performed well over a recent period. It is not difficult, but requires daily monitoring.


Charles Pennington writes:

Referring to the MathInvestor's plot:

www.mathinvestdecisions.com/Worst_6_of_10.gif :

At first glance it appears that the "Best" have been beating the "Worst" consistently.

In fact, however, all of the outperformance was from 1990 through 1995. From 1996 to present, it was approximately a tie.

Reading from the plot, I see that the "Best" portfolio was at about 2.1 at the start of 1996. It grew to about 5.5 at the end of the chart for a gain of about 160%. Over the same period, the "Worst" grew from 1.3 to 3.2, a gain of about 150%, essentially the same.

So for the past 11 years, this system had negligible outperformance.

One should also consider that the "Best" portfolio benefits in the study from stale pricing, which one could not capture in real trading. Furthermore, dividends were not included in the study. My guess is that the "Worst" portfolio would have had a higher dividend yield.

In order to improve this kind of study, I would recommend:

1.) Use instruments that can actually be traded, rather than S&P sectors, in order to eliminate the stale pricing concern.

2.) Plot the results on a semilog graph. That would have made it clear that all the outperformance happened before 1996.

3.) Finally, include dividends. The reported difference in compound annual returns (10.8% vs 8.0%) would be completely negated if the "Worst" portfolio had a yield 2.8% higher than the "Best".

Bill Rafter replies:

Gentlemen, please! The previously sent illustration of asset ranking is not a proposed "system," but simply an illustration that tilting one's portfolio away from dogs and toward previous performers can have a beneficial effect on the portfolio. The comparison between the 10 Sectors and the 24 Industry Groups illustrates the benefits of focus. That is, (1) don't buy previous dogs, and (2) sharpen your investment focus. Ignore these points and you will be leaving money on the table.

We have done this work with many different assets such as ETFs and even Fidelity funds (which require a 30-day holding period), both of which can be realistically traded. They are successful, but not overwhelmingly so. Strangely, one of the best asset groups to trade in this manner would be proprietarily-traded small-cap funds.

Unfortunately if you try trading those, your broker will disown you. I mention that example only to suggest that some assets truly do have "legs," or "tails" if you prefer. I think their success is attributed to the fact that some prop traders are better than others, and ranking them works. An asset group with which we have had no success is high-yield debt funds. I have no idea why.

A comment from Jerry Parker:

 I wrote an initial comment to you via your website [can be found under the comments link by the title of this post], disputing your point of view, which a friend of mine read, and sent me the following:

I read your comment on Niederhoffer's Daily Spec in response to his arguments against trend following. Personally, I don't think it boils down to intelligence, but rather to ego. Giving up control to an ego-less computer is not an easy task for someone who believes so strongly in the ability of the human mind. I have great respect for his work and his passion for self study, but of course disagree with his thoughts on trend following. On each trade, he is only able to profit if it "trends" in a favorable direction, whether the holding period is 1 minute or 1 year. Call it what you will, but he trades trends all day.

He's right. I was wrong. Trend following is THE enemy of the 'genius'. You and your friends can't even see how stupid your website is. You are blinded by your superior intelligence and arrogance.

Victor Niederhoffer responds:

Thanks much for your contributions to the debate. I will try to improve my understanding of this subject and my performance in the future so as not to be such an easy target for your critiques.

Ronald Weber writes: 

 When you think about it, most players in the financial industry are nothing but trend followers (or momentum-players). This includes analysts, advisors, relationship managers, and most fund or money managers. If there is any doubt, check the EE I function on Bloomberg, or the money flow/price functions of mutual funds.

The main reason may have more to do with career risk and the clients themselves. If you're on the right side while everyone is wrong, you will be rewarded; if you're on the wrong side like most of your peers you will be ok; and if you're wrong while everyone is right then you're in trouble!

In addition, most normal human beings (daily specs not included!) don't like ideas that deviate too much from the consensus. You are considered a total heretic if you try to explain why, for example, there is no link between the weak USD and the twin deficits. This is true, too, if you would have told anyone in 2002 that the Japanese banks will experience a dramatic rebound like the Scandinavian banks in the early '90s, and so on, or if you currently express any doubt on any commodity.

So go with the flow, and give them what they want! It makes life easier for everyone! If you can deal with your conscience of course!

The worse is that you tend to get marginalized when you express doubt on contagious thoughts. You force most people to think. You're the boring party spoiler! It's probably one reason why the most successful money managers or most creative research houses happen to be small organizations.

Jeremy Smith offers:

 Not arguing one way or the other here, but for any market or any stock that is making all time highs (measured for sake of argument in years) do we properly say about such markets and stocks that there is no trend?

Vincent Andres contributes: 

I would distinguish/disambiguate drift and trend.

"Drift": Plentifully discussed here. "Trend": See arcsine, law of series, etc.

In 2D, the French author Jean-Paul Delahaye speaks about "effet rateau" (rake effect), here and here .

Basically, our tendency is to believe that random equals equiprobability everywhere (2D) or random equals equiprobability everytime (1D), and thus that nonequiprobability everywhere/everytime equals non random

In 1D, non equiprobability everytime means that the sequence -1 +1 -1 +1 -1 +1 -1 +1 is in fact the rare and a very non random sequence, while the sequences -1 +1 +1 +1 +1 +1 -1 +1 with a "trend" are in fact the truly random ones. By the way, this arcsine effect does certainly not explain 100% of all the observed trends. There may also be true ones. Mistress would be too simple. True drift may certainly produce some true trends, but certainly far less than believed by many.

Dylan Distasio adds:

 For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter? Their system consists of a fairly simple relative strength mutual fund (and increasingly ETF) model where funds are held until they weaken enough in relative strength to swap out with new ones.

The results have been audited by Hulbert and consistently outperform the S&P 500 over a relatively long time frame (1980 onwards). I think their results make a trend following approach worth investigating…

Jerry Parker comments again: 

All you are saying is that you're not smart enough to develop a trend following system that works. What do you say about the billions of dollars traded by trend following CTAs and their long term track records?

Steve Leslie writes:

 If the Chair is not smart enough to figure out trend following, what does that bode for the rest of us?

There is a very old yet wise statement: Do not confuse brains with a bull market.

Case in point: prior to 2000 the great tech market run was being fueled by the hysteria surrounding Y2K. Remember that term? It is not around today but it was the cause for the greatest bull market seen in stocks ever. Dot.com stocks and new issues were being bought with reckless abandon.

New issues were priced overnight and would open 40-50 points higher the next trading day. Money managers had standing orders to buy any new issues. There was no need for dog-and-pony or road shows. It was an absolute classic and chaotic case of extraordinary delusion and crowd madness.
Due diligence was put on hold, or perhaps abandoned. A colleague of mine once owned enough stock in a dot.com that had he sold it at a propitious time, he would have had enough money to purchase a small Hatteras yacht. Today, like many contemporary dot.coms, that stock is essentially worthless. It would not buy a Mad magazine.

Corporations once had a virtual open-ended budget to upgrade their hardware and software to prepare for the upcoming potential disaster. This liquidity allowed service companies to cash in by charging exorbitant fees. Quarter to quarter earnings comparisons were beyond belief and companies did not just meet the numbers, they blew by them like rocket ships. What made it so easy to make money was that when one sold a stock, all they had to do was purchase another similar stock that also was accelerating. The thought processes where so limited. Forget value investing; nobody on the planet wanted to talk to those guys. The value managers had to scrape by for years while they saw their redemptions flow into tech, momentum, and micro cap funds. It became a Ponzi scheme, a game of musical chairs. The problem was timing.

The music stopped in March of 2000 when CIO's need for new technology dried up coincident with the free money, and the stock market went into the greatest decline since the great depression. The NASDAQ peaked around 5000. Today it hovers around 2500, roughly half what it was 7 years ago.

It was not as if there were no warning signs. Beginning in late 1999, the tech market began to thin out and leadership became concentrated in a few issues. Chief among the group were Cisco, Oracle, Qwest, and a handful of others. Every tech, momentum, and growth fund had those stocks in their portfolio. This was coincident with the smart money selling into the sectors. The money managers were showing their hands if only one could read between the lines. Their remarks were "these stocks are being priced to perfection." They could not find compelling reasons not to own any of these stocks. And so on and on it went.

After 9/11 markets and industries began to collapse. The travel industry became almost nonexistent. Even Las Vegas went on life support. People absolutely refused to fly. Furthermore, business in and around New York City was in deep peril. This forced the Fed to begin dramatically reducing interest rates to reignite the economy. It worked, as corporations began to refinance their debt and restructure loans, etc.

The coincident effect began to show up in the housing industry. Homeowners refinanced their mortgages (yours truly included) and took equity out of their homes. Home-buyers were thirsty for real estate and bought homes as if they would disappear off the earth. For $2000 one could buy an option on a new construction home that would not be finished for a year. "Flipping" became the term du jour. Buy a home in a hot market such as Florida for nothing down and sell it six months later at a much higher price. Real estate was white hot. Closing on real estate was set back weeks and weeks. Sellers had multiple offers on their homes many times in the same day. This came to a screeching halt recently with the gradual rise in interest rates and the mass overbuilding of homes, and the housing industry has slowed dramatically.

Houses for sale now sit on the blocks for nine months or more. Builders such as Toll, KB, and Centex have commented that this is the worst real estate market they have seen in decades. Expansion plans have all but stopped and individuals are walking away from their deposits rather than be upside down in their new home.

Now we have an ebullient stock market that has gone nearly 1000 days without so much as a 2% correction in a day. The longest such stretch in history. What does this portend? Time will tell. Margin debt is now at near all-time highs and confidence indicators are skewed. Yet we hear about trend followers and momentum traders and their success. I find this more than curious. One thing that they ever fail to mention is that momentum trading and trend following does not work very well in a trendless market. I never heard much about trend followers from June 2000 to October 2002. I am certain that this game of musical chairs will end, or at least be temporarily interrupted.

As always, it is the diligent speculator who will be prepared for the inevitable and capitalize upon this event. Santayana once said, "Those who cannot remember the past are condemned to repeat it."

From "A Student:"

 Capitalism is the most successful economic system in the history of the world. Too often we put technology up as the main driving force behind capitalism. Although it is true that it has much to offer, there is another overlooked hero of capitalism. The cornerstone of capitalism is good marketing.

The trend following (TF) group of fund managers is a perfect example of good marketing. As most know, the group as a whole has managed to amass billions of investor money. The fund operators have managed to become wealthy through high fees. The key to this success is good marketing not performance. It is a tribute to capitalism.

The sports loving fund manger is a perfect example. All of his funds were negative for 2006 and all but one was negative over the last 3 years! So whether one looks at it from a short-term one year stand point or a three year perspective his investors have not made money. Despite this the manager still made money by the truckload during this period. Chalk it up to good marketing, it certainly was not performance.

The secret to this marketing success is intriguing. Normally hedge funds and CTAs cannot solicit investors nor even publicly tout their wares on an Internet site. The TF funds have found a way around this. There may be a web site which openly markets the 'concept' of TF but ostensibly not the funds. On this site the names of the high priests of TF are repeatedly uttered with near religious reverence. Thus this concept site surreptitiously drives the investors to the TF funds.

One of the brilliant marketing tactics used on the site is the continuous repetition of the open question, "Why are they (TF managers) so rich?" The question is offered as a sophist's response to the real world question as to whether TF makes money. The marketing brilliance lies in the fact that there is never a need to provide factual support or performance records. Thus the inconvenient poor performance of the TF funds over the last few years is swept under the carpet.

Also swept under the rug are the performance figures for once-great trend followers who no longer are among the great, i.e., those who didn't survive. Ditto for the non-surviving funds in this or that market from the surviving trend followers.

Another smart technique is how the group drives investor traffic to its concept site. Every few years a hagiographic book is written which idolizes the TF high priests. It ostensibly offers to reveal the hidden secrets of TF.

Yet after reading the book the investor is left with no usable information, merely a constant repetition of the marketing slogan: How come these guys are so rich? Obviously the answer is good marketing but the the book is moot on the subject. Presumably, the books are meant to be helpful and the authors are true believers without a tie-in in mind. But the invisible hand of self-interest often works in mysterious ways.

In the latest incarnation of the TF book the author is presented as an independent researcher and observer. Yet a few days after publication he assumes the role of Director of Marketing for the concept site. Even the least savvy observer must admit that it is extraordinary marketing when one can persuade the prospect to pay $30 to buy a copy of the marketing literature.

Jason Ruspini adds:

 "I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods."

I humbly corroborate this point. If one eliminates long equity, long fixed income (and fx carry) positions, most trend-following returns evaporate.

Metals and energies have helped recently, after years of paying floor traders.

Victor replies:

 I don't agree with all the points above. For example, the beauty of capitalism is not its puffery, but the efficiency of its marketing and distribution system as well as the information and incentives that the prices provide so as to fulfill the pitiless desires of the consumers. Also beautiful is in the mechanism that it provides for those with savings making low returns to invest in the projects of entrepreneurs with much higher returns in fields that are urgently desired by customers.

I have been the butt of abuse and scorn from the trend followers for many years. One such abusive letter apparently sparked the writer's note. Aside from my other limitations, the trend following followers apparently find my refusal to believe in the value of any fixed systems a negative. They also apparently don't like the serial correlation coefficients I periodically report that test the basic tenets of the trend following canon.

I believe that if there are trends, then the standard statistical methods for detecting same, i.e., correlograms, regressions, runs and turning point tests, arima estimates, variance ratio tests, and non-linear extensions of same will show them.

Such tests as I have run do not reveal any systematic departures from randomness. Nor if they did would I believe they were predictive, especially in the light of the principle of ever changing cycles about which I have written extensively.

Doubtless there is a drift in the overall level of stock prices. And certain fund managers who are biased in that direction should certainly be able to capture some of that drift to the extent that the times they are short or out of the market don't override it. However, this is not supportive of trend following in my book.

Similarly, there certainly has been over the last 30 years a strong upward movement in fixed income prices. To the extent that a person was long during this period, especially if on leverage, there is very good reason to believe that they would have made money, especially if they limited their shorts to a moiete.

Many of the criticisms of my views on trend following point to the great big boys who say they follow trends. To the extent that those big boys are not counterbalanced by others bigs who have lost, I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods.

I have no firm belief as to whether such things as trends in individual stocks exist. The statistical problem is too complex for me because of a paucity of independent data points, and the difficulties of maintaining an operational prospective file.

Neither do I have much conviction as to whether trends exist in commodities or foreign exchange. The overall negative returns to the public in such fields seem to be of so vast a magnitude that it would not be a fruitful line of inquiry.

If I found such trends through the normal statistical methods, I would suspect them as a lure of the invisible evil hand to bring in big money to follow trends after a little money has been made by following them, the same way human imposters work in other fields. I believe that such a tendency for trend followers to lose with relatively big money after making with smaller amounts is a feature of all fixed systems. And it's guaranteed to happen by the law of ever-changing cycles.

The main substantive objection to my views that I have found in the past, other than that trend followers know many people who make money following trends (a view which is self-reported and selective and non-systematic, and thus open to some of the objections of those of the letter-writer), is that they themselves follow trends and charts and make much money doing it. What is not seen by these in my views is what they would have made with their natural instincts if they did not use trend following as one of their planks. This is a difficult argument for them to understand or to confirm or deny.

My views on trend following are always open to new evidence, and new ways of looking at the subject. I solicit and will publish all views on this subject in the spirit of free inquiry and mutual education.

 Jeff Sasmor writes:

 Would you really call what FUNDX does trend following? Well, whatever they do works.

I used their system successfully in my retirement accounts and my kids' college UTMA's and am happy enough with it that I dumped about 25% of that money in their company's Mutual Funds which do the same process as the newsletter. The MFs are like an FOF approach. The added expense charges are worth it. IMO, anyway. Their fund universe is quite small compared to the totality of funds that exist, and they create classes of funds based on their measure of risk.

This is what they say is their process. When friends ask me what to buy I tell them to buy the FUNDX mutual fund if their time scale is long. No one has complained yet!

It ain't perfect (And what is? unless your aim is to prove that you're right) but it's better than me fumfering around trying to pick MFs from recommendations in Money Magazine, Forbes, or Morningstar.

I'm really not convinced that what they do is trend following though.

Dylan Distasio Adds:

 For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter?

Michael Marchese writes: 

In a recent post, Mr. Leslie finished his essay with, "I never heard much about trend followers from June 2000 to October 2002." This link shows the month-to-month performance of 13 trend followers during that period of time. It seems they did OK.

Hanny Saad writes:

 Not only is trend following invalid statistically but, looking at the bigger picture, it has to be invalid logically without even running your unusual tests.

If wealth distribution is to remain in the range of 20 to 80, trend following cannot exist. In other words, if the majority followed the trend (hence the concept of trends), and if trend following is in fact profitable, the majority will become rich and the 20-80 distribution will collapse. This defeats logic and history. That said, there is the well-covered (by the Chair) general market upward drift that should also come as no surprise to the macro thinkers. The increase in the general population, wealth, and the entrepreneurial spirit over the long term will inevitably contribute to the upward drift of the general market indices as is very well demonstrated by the triumphal trio.

While all world markets did well over the last 100 yrs, you notice upon closer examination that the markets that outperformed were the US, Canada, Australia, and New Zealand. The one common denominator that these countries have is that they are all immigration countries. They attract people.

Contrary to what one hears about the negative effects of immigration, and how immigrants cause recessions, the people who leave their homelands looking for a better life generally have quite developed entrepreneurial spirits. As a result, they contribute to the steeper upward curve of the markets of these countries. When immigrants are allowed into these countries, with their life savings, home purchases, land development, saving and borrowing, immigration becomes a rudder against recession, or at least helps with soft landings. Immigration countries have that extra weapon called LAND.

So in brief, no - trends do not exists and can not exist either statistically or logically, with the exception of the forever upward drift of population and general markets with some curves steeper than others, those of the countries with the extra weapon called land and immigration.

A rereading of The Wealth And Poverty Of Nations, by Landes, and the triumph of the optimist may be in order.

Steve Ellison adds:

 So Mr. Parker's real objective was simply to insult the Chair, not to provide any evidence of the merits of trend following that would enlighten us (anecdotes and tautologies that all traders can only profit from favorable trends prove nothing). I too lack the intelligence to develop a trend following system that works. When I test conditions that I naively believe to be indicative of trends, such as crossovers of moving averages, X-day highs and lows, and the direction of the most recent Y percent move, I usually find negative returns going forward.

Bacon summarized his entire book in a single sentence: "Always copper the public play!" My more detailed summary was, "When the public embraces a particular betting strategy, payoffs fall, and incentives (for favored horsemen) to win are diminished."

Trend Following — Cause, from James Sogi: 

Generate a Brownian motion time series with drift in R

WN <-rnorm(1024);RW<-cumsum(WN);DELTAT<-1/252;

MU<-.15*DELTAT;SIG<-.2*sqrt(DELTAT);TIME<-(1:1024)/252 stock<-exp(SIG*RW+MU*TIME) ts.plot(stock)

Run it a few times. Shows lots of trends. Pick one. You might get lucky.

Trend Following v. Buy and Hold, from Yishen Kuik 

The real price of pork bellies and wheat should fall over time as innovation drives down costs of production. Theoretically, however, the nominal price might still show drift if the inflation is high enough to overcome the falling real costs of production.

I've looked at the number of oranges, bacon, and tea a blue collar worker's weekly wages could have purchased in New York in 2000 versus London in the 1700s. All quantities showed a significant increase (i.e., become relatively cheaper), lending support to the idea that real costs of production for most basic foodstuffs fall over time.

Then again, according to Keynes, one should be able to earn a risk premium from speculating in commodity futures by normal backwardation, since one is providing an insurance service to commercial hedgers. So one doesn't necessarily need rising spot prices to earn this premium, according to Keynes.

Not All Deer are Five-Pointers, from Larry Williams

 What's frustrating to me about trading is having a view, as I sometimes do, that a market should be close to a short term sell, yet I have no entry. This betwixt and between is frustrating, wanting to sell but not seeing the precise entry point, and knowing I may miss the entry and then see the market decline.

So I wait. It's hard to learn not to pull the trigger at every deer you see. Not all are five-pointers… and some will be bagged by better hunters than I.

From Gregory van Kipnis:

 Back in the 70s a long-term study was done by the economic consulting firm of Townsend Greenspan (yes, Alan's firm) on a variety of raw material price indexes. It included the Journal of Commerce index, a government index of the geometric mean of raw materials and a few others. The study concluded that despite population growth and rapid industrialization since the Revolutionary War era, that supply, with a lag, kept up with demand, or substitutions (kerosene for whale blubber) would emerge, which net-net led to raw material prices being a zero sum game. Periods of specific commodity price rises were followed by periods of offsetting declining prices. That is, raw materials were not a systematic source of inflation independent of monetary phenomena.

It was important to the study to construct the indexes correctly and broadly, because there were always some commodities that had longer-term rising trends and would bias an index that gave them too much weight. Other commodities went into long-term decline and would get dropped by the commodity exchanges or the popular press. Just as in indexes of fund performance there can be survivor bias, so too with government measures of economic activity and inflation.

However, this is not to say there are no trends at the individual commodity level of detail. Trends are set up by changes in the supply/demand balance. If the supply/demand balance changes for a stock or a commodity, its price will break out. If it is a highly efficient market, the breakout will be swift and leave little opportunity for mechanical methods of exploitation. If it is not an efficient market (for example, you have a lock on information, the new reality is not fully understood, the spread of awareness is slow, or there is heavy disagreement, someone big has to protect a position against an adverse move) the adjustment may be slower to unfold and look like a classic trend. This more often is the case in commodities.

Conversely, if you find a breakout, look for supporting reasons in the supply/demand data before jumping in. But, you need to be fast. In today's more highly efficient markets the problem is best summarized by the paradox: "look before you leap; but he who hesitates is lost!"

Larry Williams adds:

I would posit there is no long-term drift to commodities and thus we have a huge difference in these vehicles.

The commodity index basket guys have a mantra that commodities will go higher - drift - but I can find no evidence that this is anything but a dream, piquant words of promotion that ring true but are not.

I anxiously stand to be corrected.

Marlowe Cassetti writes:

 "Along a similar vein, why would anybody pay Powershares to do this kind of work when the tools to do it yourself are so readily available?"

The simple answer is if someone wishes to prescribe to P&F methodology investing, then an ETF is a convenient investment vehicle.

With that said, this would be an interesting experiment. Will the DWA ETF be another Value Line Mutual Fund that routinely fails to beat the market while their newsletter routinely scores high marks? There are other such examples, such as IBD's William O'Neal's aborted mutual fund that was suppose to beat the market with the fabulous CANSLIM system. We have talked about the great track record of No-Load Fund-X newsletter, and their mutual fund, FUNDX, has done quite well in both up and down markets (an exception to the above mentioned cases).

For full disclosure I have recently added three of their mutual funds to my portfolio FUNDX, HOTFX, and RELAX. Hey, I'm retired and have better things to do than do-it-yourself mutual fund building. With 35 acres, I have a lot of dead wood to convert into firewood. Did you know that on old, dead juniper tree turns into cast iron that dulls a chain saw in minutes? But it will splinter like glass when whacked with a sledgehammer.

Kim Zussman writes:

…about the great track record of No-Load Fund-X newsletter and their mutual fund FUNDX has done quite well in both up and down markets… (MC)

Curious about FUNDX, checked its daily returns against ETF SPY (essentially large stock benchmark).

Regression Analysis of FUNDX versus SPY since inception, 6/02 (the regression equation is FUNDX = 0.00039 + 0.158 SPY):

Predictor    Coef         SE Coef           T             P
Constant    0.00039    0.000264        1.48        0.14
SPY            0.15780    0.026720        5.91        0.00

S = 0.00901468    R-Sq = 2.9%   R-Sq (adj) = 2.8%

The constant (alpha) is not quite significant, but it is positive, so FUNDX did out-perform SPY. Slope is significant and the coefficient is about 0.16, which means FUNDX was less volatile than SPY.

This is also shown by F-test for variance:

Test for Equal Variances: SPY, FUNDX

F-Test (normal distribution) Test statistic = 1.17, p-value = 0.009 (FUNDX<SPY)

But t-test for difference between daily returns shows no difference:

Two-sample T for SPY vs FUNDX

            N          Mean      St Dev       SE Mean
SPY      1169     0.00041  0.0099       0.00029
FUNDX 1169     0.00045  0.0091       0.00027   T=0.12        

So it looks like FUNDX has been giving slight/insignificant out-performance with significantly less volatility; which makes sense since it is a fund of mutual funds and ETFs.

Even better is Dr Bruno's idea of beating the index by deleting the worst (or few worst) stocks (new additions?).

How about an equal-weighted SP500 (which out-performs when small stocks do), without the worst 50 and double-weighting the best 50.

Call it FUN-EX, in honor of the fun you had with your X that was all mooted in the end.

Alex Castaldo writes:

The results provided by Dr. Zussman are fascinating:

The fund has a Beta of only 0.157, incredibly low for a stock fund (unless they hold a lot of cash). Yet the standard deviation of 0.91468% per day is broadly consistent with stock investing (S&P has a standard deviation of 1%). How can we reconcile this? What would Scholes-Williams, Dimson, and Andy Lo think when they see such a low beta? Must be some kind of bias.

I regressed the FUNDX returns on current and lagged S&P returns a la Dimson (1979) with the following results:

Regression Statistics
Multiple R                0.6816
R Square                 0.4646
Adjusted R Square   0.4627
Standard Error        0.0066
Observations           0.1166

                    df         SS          MS         F            Significance F
Regression       4      0.0444    0.0111   251.89    8.2E-156
Residual      1161      0.0511    4.4E-05
Total           1165      0.0955

                Coefficients  Standard Error  t-Stat        P-value
Intercept  8.17E-05     0.000194           0.4194        0.6749
SPX          0.18122      0.019696           9.2007        1.6E-19
SPX[-1]    0.60257      0.019719         30.5566        6E-151 SPX[-2]    0.08519      0.019692           4.3260        1.648E-05 SPX[-3]    0.04524      0.019656           2.3017        0.0215

Note the following:

(1) All four S&P coefficients are highly significant.

(2) The Dimson Beta is 0.914 (the sum of the 4 SPX coefficients). The mystery of the low beta has been solved.

(3) The evidence of price staleness, price smoothing, non-trading, whatever you want to call it is clear. Prof. Pennington touched on this the other day; an "efficiently priced" asset should not respond to past S&P price moves. Apparently though, FUNDX holds plenty of such assets (or else the prices of FUNDX itself, which I got from Yahoo, are stale).

S. Les writes:

Have to investigate the Fund X phenomenon. And look to see how it has done in last several years since it was post selected as good. Someone has to win a contest, but the beaten favorites are always my a priori choice except when so many others use that as a system the way they do in sports eye at the harness races, in which case waiting for two races or two days seems more apt a priori. VN 

 I went to the Fund X website to read up, and the information is quite sparse. It is a very attenuated website. I called the toll free number and chatted with the person on the other line. Information was OK, but, in my view, I had to ask the proper questions. One has several options here. One is to purchase the service and do the fund switching themselves based on the advice of their experts. The advisory service tracks funds that have the best relative strength performance and makes their recommendations from there, www.fundx.com.

Another is to purchase one of four funds available. They have varying levels of aggressiveness. Fund 3 appears to be the recommended one.

If one purchases the style 3 one will get a very broad based fund of funds. I went to yahoo to look up the holdings at www.finance.yahoo.com/q/hl?s=FUNDX.

Top ten holdings are 47.5% of the portfolio, apparently concentrated in emerging markets and international funds at this time.

In summary, if money were to be placed into the Fund X 3 portfolio, I believe it would be so broad based and diversified that returns would be very watered down. Along with risk you would certainly be getting a lot of funds. You won't set the world on fire with this concept, but you won't get blown up, either.

Larry Williams adds:

My 2002 book, Right Stock at the Right Time, explains such an approach in the Dow 30. The losers were the overvalued stocks in the Dow.It is a simple and elegant idea…forget looking for winners…just don't buy overvalued stocks and you beat the idex.

This notion was developed in 1997, when i began actually doing it, and written about in the book. This approach has continued to outperform the Dow, it is fully revealed.

Craig Cuyler writes:

Larry's comment on right stock right time is correct and can be used to shed a little bit of light on trend following. This argument is at the heart of fundamental indexation, which amongst other points argues that cap weighting systematically over-weights overvalued stocks and under-weights undervalued stocks in a portfolio.

Only 29% of the top 10 stocks outperformed the market average over a 10yr period (1964-2004) according to Research Affiliates (this is another subject). The concept of "right stock right time" might be expressed another way, as "right market right time." The point is that constant analysis needs to take place for insuring investment in the products that are most likely to give one a return.

The big error that the trend followers make, in my mind, is they apply a homogeneous methodology to a number of markets and these are usually the ones that are "hot" at the time that the funds are applied. The system is then left to its own devices and inevitably breaks down. Most funds will be invested at exactly the time when the commodity, currencies, etc., are at their most overvalued.

Some worthwhile questions are: How does one identify a trend? Why is it important that one identifies a trend? How is it that security trends allow me to make money? In what time frame must the trend take place and why? What exactly is a trend and how long must it last to be so labeled?

I think it is important to differentiate between speculation using leverage and investing in equities because, as Vic (and most specs on the list) point out, there is a drift factor in equities which, when using sound valuation principles, can make it easier to identify equities that have a high probability of trending. Trend followers don't wait for a security to be overvalued before taking profits. They wait for the trend to change before then trying to profit from the reversal.

Jeff Sasmor adds:

As a user of both the newsletter and the FUNDX mutual fund I'd like to comment that using the mutual fund removes the emotional component of me reading the newsletter and having to make the buys and sells. Perhaps not an issue for others, but I found myself not really able to follow the recommendations exactly - I tend to have an itchy trigger finger to sell things. This is not surprising since I do mostly short-term and day trades. That's my bias; I'm risk averse. So the mutual fund puts that all on autopilot. It more closely matches the performance of their model portfolio.

I don't know how to comment on the comparisons to Value Line Arithmetic Index (VAY). Does anyone follow that exactly as a portfolio?

My aim is to achieve reasonable returns and not perfection. I assume I don't know what's going to happen and that most likely any market opinion that I have is going to be wrong. Like Mentor of Arisia, I know that complete knowledge requires infinite time. That and beta blockers helps to remove the shame aspect of being wrong. But there's always an emotional component.

As someone who is not a financial professional, but who is asked what to buy by friends and acquaintances who know I trade daily (in my small and parasitical fashion), I have found that this whole subject of investing is opaque to most people. Sort of like how in the early days of computing almost no one knew anything about computers. Those who did were the gatekeepers, the high priests of the temple in a way. Most people nowadays still don't know what goes on inside the computer that they use every day. It's a black box - opaque. They rely on the Geek Squad and other professionals to help them out. It makes sense. Can't really expect most people to take the time to learn the subject or even want to. Should they care whether their SW runs on C++ or Python, or what the internal object-oriented class structure of Microsoft Excel is, or whether the website they are looking at is XHTML compliant? Heck no!

Similarly, most people don't know anything about markets; don't want to learn, don't want to take the time, don't have the interest. And maybe they shouldn't. But they are told they need to invest for retirement. As so-called retail investors they depend on financial consultants, fee-based planners, and such to tell them what to do. Often they get self-serving or become too loaded with fees (spec-listers who provide these services excepted).

So I think that the simple advice that I give, of buying broad-based index ETFs like SPY and IWM and something like FUNDX, while certainly less than perfect, and certainly less profitable than managing your own investments full-time, is really suitable for many people who don't really have the inclination, time, or ability to investigate the significant issues for themselves or sort out the multitudes of conflicting opinions put forth by the financial media.

You may not achieve the theoretical maximum returns (no one does), but you will benefit from the upward drift in prices and your blended costs will be reasonable. And it's better than the cash and CDs that a lot of people still have in their retirement accounts.

BTW: FOMA = Foma are harmless untruths, intended to comfort simple souls.
An example : "Prosperity is just around the corner."

I'm not out to defend FUNDX, I have nothing to do with them. I'm just happy with it. 

Steve Ellison writes: 

One might ask what the purpose of trends is in the market ecosystem. In the old days, trends occurred because information disseminated slowly from insiders to Wall Streeters to the general public, thus ensuring that the public lost more than it had a right to. Memes that capture the public imagination, such as Nasdaq in the 1990s, take years to work through the population, and introduce many opportunities for selling new investment products to the public.

Perhaps some amount of trending is needed from time to time in every market to keep the public interested and tossing chips into the market. I saw this statement at the FX Money Trends website on September 21, 2005: "[T]he head of institutional sales at one of the largest FX dealing rooms in the US … lamented that for the past 2 months trading volume had dried up for his firm dramatically because of the 'lack of trend' and that many 'system traders' had simply shut down to preserve capital."

I saw a similar dynamic recently at a craps table when shooters lost four or five consecutive points, triggering my stop loss so that I quit playing. About half the other players left the table at the same time. "The table's cold," said one.

To test whether a market might trend out of necessity to attract money, I used point and figure methodology with 1% boxes and one-box reversals on the S&P 500 futures. I found five instances in the past 18 months in which four consecutive reversals had occurred and tabulated the next four points after each of these instances (the last of which has only had three subsequent points so far). The results were highly non-predictive.

Starting        Next 4 points
Date      Continuations  Reversals
01/03/06        3            1
05/23/06        1            3
06/29/06        2            2
08/15/06        2            2
01/12/07        1            2
             —–        —–
               9           10

Anthony Tadlock writes:

I had intended to write a post or two on my recent two week trip to Cairo, Aswan, and Alexandria. There is nothing salient to trading but Egypt seems to have more Tourist Police and other guards armed with machine guns than tourists. It is a service economy with very few tourists or middle/upper classes to service. Virtually no westerners walk on the streets of Cairo or Alexandria. I did my best to ignore my investments and had closed all my highly speculative short-term trades before leaving for the trip.

While preparing for taxes I was looking over some of my trades for last year. Absolute worst trade was going long CVS and WAG too soon after WalMart announced $2 generic pricing. I had friends in town and wasn't able to spend my usual time watching and studying the market. I just watched them fall for two days and without looking at a chart, studying historical prices and determining how far they might fall, decided the market was being stupid and went long. Couldn't wait to tell my visitors how "smart" a trader I was and my expected profit. It was fun, until announcement after announcement by WalMart kept causing the stocks to keep falling. The result was panic selling near the bottom, even though I had told myself before the trade that I could happily buy and hold both. Basically, I followed all of Vic's rules on "How to Lose."

Trends: If only following a trend meant being able to draw a straight line or buy a system and buy green and sell red. The trend I wrote about several months ago about more babies being born of affluent parents still seems to be intact. I have recently seen pregnant moms pushing strollers again. Planes to Europe have been at capacity my last two trips and on both trips several crying toddlers made sleep difficult, in both directions. Are people with young children using their home as an ATM to fund a European trip? Are they racking up credit card debt that they can't afford? Depleting their savings? (Oh wait - Americans don't save anything.) If they are, then something fundamental has changed about how humans behave.

From James Sogi:

My daughter the PhD candidate at Berkeley in bio-chem is involved in some mind-boggling work. It's all very confidential, but she tried to explain to me some of her undergrad research in words less than 29 letters long. Molecules have shapes and fit together like keys. The right shape needs to fit in for a lock. Double helices of the DNA strand are a popular example, but it works with different shapes. There is competition to fit the missing piece. They talk to each other somehow. One of her favorite stories as a child was Shel Silverstein's Missing Piece. Maybe that's where her chemical background arose. Silverstein's imagery is how I picture it at my low level. 

Looking at this past few months chart patterns it is impossible not to see the similarity in how the strands might try fit together missing pieces in Wykoffian functionality. The math and methods must be complicated, but might supply some ideas for how the ranges and strands in the market might fit together, and provide some predictive methods along the lines of biochemical probability theory. I'll need some assistance from the bio-chem section of the Spec-list to articulate this better.

From Kim Zussman: 

Doing same as Alex Castaldo, using SPY daily change (cl-cl) as independent and FUNDX as dependent gave different resluts:

Regression Analysis: FUNDX versus SPY ret, SPY-1, SPY-2

The regression equation is FUNDX = 0.000383 + 0.188 SPY ret - 0.0502 SPY-1 - 0.0313 SPY-2

Predictor     Coef           SE Coef       T        P
Constant     0.000383    0.00029      1.35    0.179
SPY ret       0.187620    0.03120      6.01    0.000*            SPY-1        -0.050180    0.03136     -1.60   0.110           SPY-2        -0.031250    0.03121     -1.00   0.317 *(contemporaneous)

S = 0.00970927   R-Sq = 3.2%   R-Sq (adj) = 3.0%

Perhaps FUNDX vs a tradeable index is the explanation.




On 2/5/07, Andrea Ravano wrote:

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

That pain of loss is 2.5 greater than pleasure of gain, in absolute terms, has been bandied about in literature for a while. What is the nature of a trader's state of mind as a function of trading (or more specifically, position checking) frequency?

One check on this is to look at the effect of multiplying losses by 2, and comparing with gains scaled at 1. Using SPY returns since 1993, checked average returns for daily, weekly, and monthly intervals:

           Daily       Weekly    Monthly

Ave:   -0.003      -0.005     -0.002

Pos:    1855          411       411

Tot:    3529          730        169

%Pos:    52            56          65

When the "effect" of losses on your soul is double that of gains, you are suffering, on average, in all intervals. Therefore, it is no coincidence there are so many psychologists/psychiatrists involved in trading. Percentage of the positive, however, scales up with longer intervals, so you feel bad less often.

Philip McDonnell adds:

Consider what happens when you lose: How much is required to break even? 

Loss       Required Gain          Ratio
-20%           25%                    1.25
-25              33.3%                 1.33
-50              100                     2.00
-75              300                     4.00

Average Ratio                       2.15

The ratio of how much is required to break even rises rapidly as the losses increase. Although the above unscientific data points appear to be in the ball park of the putative 2.5 ratio, the underlying ratios are clearly non-linear and NOT well described by a simple number. In fact any simple ratio is far too simplistic to be a good measure.

I would argue that a log linear utility function is what an investor, and any rational individual, would want. In their famous paper on Prospect Theory, Kahnemann and Tversky identified what appeared to be irrational behavior on the part of university students and some faculty when presented with hypothetical bets. The Nobel Prize winning professors concluded that the students chose irrationally as compared to the Gold standard of statistical expectations based on an arithmetic utility of money.

But if money compounds, one would want a log utility of money. When the examples cited in the study were recalculated with a log utility based on the relative net worth of typical students the results showed that the student subjects were invariably quite consistent with a log utility function. This re-opens the question: Were the subjects or the professors the irrational ones?

If one expresses the gains and losses in the above table as the natural log of the price relative, then the negative logs of the losses exactly cancel the logs of the gains.

Charles Pennington adds:

These experiments that psychology professors run on students invariably involve the students' winning or losing maybe $100 or less. That's a small amount by any reasonable metric.
$100 is very small, for example, compared with their first year's salary out of school. So it's quite reasonable for the professors to assume that the amount is in the limit of a "small" amount, in the sense that it (1+x) is approximately x if x is "small."

Any reasonable person, offered the opportunity to bet with a 50% chance of winning $250 and a 50% chance of losing $100, should take the bet. That's true even if he only has $250 to his name, because he also has prospects for future earnings.

In this case, the professors are more rational than the monkeys.

J. T. Holley wrote: 

"Could it be that all the bruised and battered hold-outs from '00 - '03 will finally join in, and we resume the incessant trek toward the summit of market-based capitalism?" kz

How about this simple fact: For the first time in recent years that I can remember, the Dow and S&P indexes (headline purposes) outperformed the price appreciation, across America, of houses or real estate. This is roughly a two to one ratio. Now for the sake of simplicity, how many of the '00 - '03 bruised and battered people are going to scratch their heads and say, "twice as much, huh?"

I think the "Confidence Index" mentioned by Carret has a ways to go fellas; but this must obviously be tested.

 Philip McDonnell adds:

"Any reasonable person, offered the opportunity to bet with a 50% chance of winning $250 and a 50% chance of losing $100, should take the bet, and that's true even if he only has $250 to his name, because he also has prospects for FUTURE earnings." 

I would agree that future earnings can be and perhaps should be factored in. But to a freshman with $100 (not $250) the 50% chance of no beer, pizza, and dating for four years might seem an unacceptable risk. Losing it all results in a utility of Ln (zero), the way I look at things. Ln asymptotically approaches negative infinity.

A few points:

1. KT did include some bets in the thousands of dollars.

2. Most of the KT bets were fairly close calls even viewed from an expected arithmetic value as opposed to a log utility.

3. KT never concluded that the indifference ratio was 2.5 or any other number in their ground-breaking paper.



A few weeks back, Spec Dean posted a link to some nice BBQ reviews. That got me thinking about travel plans, and then it made me want to make myself a little map of BBQ festivals and competitions and what not. Then that kind of grew as I did more research, and it expanded beyond BBQ at times, and it's still a work in progress, but it may provide some use and inspiration to others wanting to hit the BBQ trail in 2007.

Alan Millhone comments:

In my state of Ohio, I don't know of any barbecue gatherings. Let me know if Ohio is added to your excellent map. I noticed recently along route 33 from my home to Columbus a new barbecue restaurant at an exit for Logan, Ohio. It has been built with a green metal roof. I also noticed a large stack of wood ricked up at the back of the restaurant. My daughter for some years lived in Charlotte, N.C. and I visited "Smokey Bones" and "Sonny's Pit Barbecue" on a couple of occasions. Your map is excellent and I enjoyed looking at it. I saw a segment on TV a few days ago interviewing the creator of "KC Masterpiece" barbecue sauce (# 1 in America) and he now has a restaurant to serve up ribs, etc. coated with his secret recipe sauce — only in America.

Russ Herrold adds:

In my state of Ohio, I don't know of any barbecue gatherings.

There is the annual Jazz and Ribfest at Columbus along the Scioto River.

Finalists over the years based in Columbus include: City BBQ (started at a location in the 2000 block of W. Henderson Rd.) is my personal favorite and it's in an easy driving distance. Others include: the Damon's chain (started here by some folks who also ran a local financial recovery collections firm); the locally started Hoggy's chain (their third location at the corner of Fifth and Grandview Ave. is about 1/2 mile from my office); and the Knotty Pine (one location on West Third, near Ashland), which was a long time favorite, but as noted in a review:

The Knotty Pine originally opened in 1935, and was taken over by new ownership five years ago.

The change was not for the better as they lost their fire for barbecue.

One of my children lives in Memphis (ask for Eric at Bar-B-Q Shop), but he is married to a St. Louisian, and there are regular wet vs. dry rub debates.

The location down on Rt. 33 near Logan is just one of many in southeastern Ohio — go down Fairfield Co. Rd. 86, and a couple others are waiting to be sampled.

Charles Pennington offers:

I lived in Columbus for 12 years, so I wanted to chime in on a few barbecue topics covered by Russ Herold.

City BBQ on Henderson Road is a wonderful place. I stalked the restaurant before it opened, rejoicing that good barbecue might be arriving. I thought I was their first customer, but the owner, Rick Malir, denies it. I went through long streaks of eating there almost every day, either for lunch or dinner. I like the chicken, but really the brisket is probably what they do most distinctly. Credit me for their offering of green beans and Brunswick stew. I lobbied for these intensely. They also have good macaroni and cheese.

Damon's is a chain, and I don't think it's as good as the best non-chains, but still it's very good, and much better than the option of eating something that's not barbecue.

Hoggy's is also good, but not as much to my taste as City or even Damon's. It places more of an emphasis on a mustard-based sauce that isn't to my liking. Often it's a little too loud in there too. The barbecue restaurant should be more like a sanctuary for contemplation in my opinion.

Some recommended Columbus non-barbecue restaurants, if you must: La Chateleine on Lane Avenue (ask to meet Gigi as part of the experience, and listen to the sounds of Salvatore Adamo, Gigi's favorite, in the background), Katzinger's deli (I prefer it over New York delis.), Schmidt's Sausage Haus, the Gyro Shoppe.

A note on New York barbecue: Really the best in New York is Dinosaur Barbecue, which is way west of Harlem (646 W. 131st St. New York, NY 10027). It has very, very good food and surprisingly low prices for Manhattan. Before I got reading glasses, I once misread the check as $83, and started to fill in a tip and sign the Visa receipt, until my dining companion alerted me that the bill was actually $33. $83 seemed very plausible for the amount of food we had eaten and also taking into consideration the Manhattan location. However, this place is not really a sanctuary — it's a bit boisterous. It's a spinoff of the original location at Syracuse University, a loud campus hangout.

Scott Brooks adds:

On the theme of BBQ, I would like to throw into the mix a small midwestern BBQ chain of restaurants, Bandana's Bar-B-Q. I know we usually don't go for the chain stores, but I believe this one is unique

It started locally in St. Louis and became so popular that they began to expand. They are now in several cities throughout Missouri and Illinois.

They serve BBQ as part of a lunch or dinner platter and you can get either at any time of the day. I always get the lunch pork platter. It is more than adequate to fill you up … I usually can't eat it all. The lunch platter comes with a lot of BBQ, two side dishes, and two big pieces of garlic bread. With the dinner plates, you get a third side dish.

The food is consistently good at all stores. They smoke the meat and let you add sauces to your taste (which is what I prefer). All their sauces are good, however, I prefer to mix a few sauces together as follows:

About eight parts "Sweet and Smokey" sauce with one part each of "Spicy" sauce and "Hot" sauce, ending up with a tasty sweet mixture that has just a little bite to it.

The original sauce that they are famous for is mustard based and has a unique flavor … but I'm not fond of that one (although many people are).

I like to go eat at the Bandana's in Columbia MO, where they know my name, or the one in Arnold MO (a suburb of St. Louis) right at highways 55 and 141 where my best friend's wife is a server. I always sit in her section … she is a great server. If there were a spec list for servers, she would be the Chairman … she's that good!

If you get a chance to eat at the Bandana's at 55 and 141 in St. Louis, ask to sit in Sharon C.'s section. Tell her Scott sent you!



A few weeks back, Prof. Marion Dreyfus presented a poem about a soldier who dove onto a grenade to save the lives of his buddies. Our list's best historian had some technical objections about the plausibility of this story, which I'm sure were true. Nevertheless, occasionally something like this happens. Jason Dunham (1981-2004), on January 11, was posthumously awarded the Medal of Honor after he dove onto a live grenade and covered it with his kevlar helmet, saving the lives of two of his men.

In April 2004, during an attack near Iraq's Syrian border, Corporal Dunham was assaulted by an insurgent who jumped out of a vehicle that was about to be searched. As Corporal Dunham wrestled the man to the ground, the insurgent rolled out a grenade he had been hiding. Corporal Dunham did not hesitate. He jumped on the grenade, using his helmet and body to absorb the blast. Although he survived the initial explosion, he did not survive his wounds. But by his selflessness, Corporal Dunham saved the lives of two of his men, and showed the world what it means to be a Marine. [Read more here]

Stefan Jovanovich comments:

My objection was about the physical impossibility of diving on an IED, not the implausibility of any story of heroism. I have been blessed to know three WW II veterans who were truly heroic. My uncle George was a paratrooper with the 82nd Airborne at the Battle of the Bulge, and he spent three days of the battle with a carbine bullet in his right foot. The Army Medical Corps was able to save his leg, but for the rest of his too short life he walked like the Elephant Man and had one shoe twice the size of the other. He never once mentioned any awards he received; to this day I don't even know if he received any. My father-in-law, Buster Turner, was on a minesweeper at Saipan and Okinawa. That may not sound particularly heroic until you consider that the mine sweepers went in before the landing craft and worked their way parallel to the beaches (which tends to simple any problem the enemy has about ranging its target). In the 40+ years I knew him, Buster never talked about what he had done or seen. I think he put up with me in large measure because I had the good sense never to ask him. My CO at the Fleet Sonar School was a cruiser sailor in WW II at Ironbottom Sound and a survivor of two sinkings. The first time anyone on the base knew what he had done was at his retirement ceremony after 30 years. Watching him sitting on the podium squirming in his chair as the speaker recited his awards is the only time I ever saw him flustered. Marion may well know WW II veterans who "bragged about their spit shines to their children" but the only ones I have ever met were right out of the movies - they had shoveled shit in Louisiana and lied about it ever since. It might interest the List members to know that, measured against the total number of combat days (# of men and women being shot at x number of days), there have been fewer MOH awards granted in this war than there were in the first Gulf War and far, far fewer (less than a third as many) than there were in Viet-Nam. The record for MOH awards relative to combat days remains the Spanish-American War. That does not make those Spanish-American War MOH awards gedunk ribbons, but it does confirm what any thinking person should already know: the truth is always in the "technical" details.



Daniel Boorstin's 1961 book The Image described the illusions, contrivances, simulations, and unreality — what he calls pseudo events — in news, travel, heroic ideas, books, celebrity worship, desire for prestige, advertising, business practises, etc.. He shows how one pseudo event can lead to another, and can become a self-fulfilling prophecy in which more falsity must follow. He attributes the growth of pseudo events to a chain started by the graphics revolution, which began with faster newspaper printing and telegraphs in the early 1800's. Boorstin characterises a pseudo event as one that is not spontaneous, and is planned primarily for the purpose of being communicated and replicated. It is ambiguously relative to reality, and designed to become self fulfilling. The news leak and the press interview are often prime recurring examples of pseudo events. He distinguishes pseudo events from propaganda by pointing out that the former is ambiguous whilst the latter is an appealing falsehood.

One finds that many pseudo events occur in the market, such as all the events that are leaked by actors in the fray, with a view to eliciting behavior that will help them in their jobs, happiness and wealth. The best example of this would be leaks by the various powerful boards and agencies related to the markets which support their favored news reporters and former or prospective brokerages. Other examples could be a leak of earnings or sales numbers to a reporter, the expansive modality that a high official takes when trying to show importance to a reporter of the opposite sex, the interview of a fund-manager or some great like the Palindrome or the Sage to describe his feelings concerning the dollar, gold, the market, or the likelihood of a crisis. Also the appearance at an investors conference of some elite system seller, the article written by an academic describing various anomalies he has discovered in a major retrospective file, the speech at an industry conference by the promoter of one technology or the other, the report of a hedge fund manager that he sees a 30% chance of a disaster to rival 1929, the theoretical mathematico-econometric arguments boiled down for the public of this or that academic showing that the solution to our problems would be less inequality, the prohibitions against cut throat competition or freedom of entry in all its forms so that no economic agent will be induced to offer anything but a Cadillac product, the protection of the public from using a product that is unsafe without regard to the benefits, the rules of thumb concerning following the trend, the buy and sell recommendations provided by star financial news people. The list of pseudo events in the markets is greater than the list that Boorstin elicits in our cultural life! I propose that a classification scheme for market events be developed in terms of their pseudo or actual occurrence, and that this should take into account whether each event has a definite time of occurrence and magnitude, as well as the information value of any ambiguous messages making up or relating to its content. I would be interested in other ideas as to how to navigate the minefield of pseudo-ness we are exposed to, with a view to precluding the public from losing so much more than they have to, as well as going about life as puppets beset by false strings.

George Zachar comments:

When I taught a course called "The Politics of Communication" in a remote town in upstate New York, that book and the concept of "pseudo events" were literally at the top my syllabus.

It is a crucial concept, and must be central to anyone's use of any information that is subject to prior filtration.

The types of infomercials enumerated by the chair should be transparent to market professionals. The dangerous ones are those that appear to be untainted, leaving specs with their mental guards down.

One useful test is to google the board members of any research outfit one is unfamiliar with. Within seconds, the agendas and motives become clear.

To pick an obvious example from today, I poked around the background of a Yale professor whose anti-inequality schtick is the meme-du-jour. In about a minute I traced him to a think tank chock-a-block with Clintonites.

George Zachar further adds:

Following up on the chair's discussion of pseudo events and the need to categorize them, I would like to suggest a related game.

This link goes to a program that generates bingo cards using buzz-phrases related to Apple media events.

Why not have Doomster Bingo(tm)? Each card needs 24 phrases or concepts, and the first player getting five in a row wins.

Now, what should go in the boxes on the cards?

Options Scandal
Executive Compensation
Consumer debt
Savings rate
The dollar
Inverted yield curve
Housing prices
Peak oil
Carbon tax

…no doubt there are dozens of other better, candidate phrases.

Perhaps we can have a party game where one reads a random Abelson column aloud as folks check their cards…

Professor Charles Pennington offers:

This is just a start, but I predict that at least six will be found in next week's Abelson column.

"Those who don't remember history …"
bubble (extra points for "South Sea")
tulip mania
dead cat bounce
rising dollar
falling dollar
overheated economy
March 2000
"predicted 1987 crash"
stock tips from shoe-shine boys
"sentiment well off the lows"
"the smart money"
"This time it's different." (this is used in an ironic sense to mean "this time it's not different; it's going down just like in 1929.")
a double negative, as in "One might not be uninclined to take profits."
"October is a bad month to buy stocks … others are November, December, January …"
"more concerned about return of capital than return on capital"
"Rule Number 1: Don't Lose Money; Rule Number 2: Don't Forget Rule Number 1"
margin of safety
Keep some powder dry.
Look out below.
"an esteemed economist/stockpicker/broker/proprietor at X, but we won't hold that against him"



 A few quick thoughts on George Gilder's talk on Thursday …

Gilder's comments on the randomness/unpredictability of the creative process (and its resistance to central planning) reminded me of The Fountainhead because of the obvious intrinsic motivation of Howard Roark.

From a conversational exchange between Ellsworth Toohey and Peter Keating:

Does he like money? No. Does he like to be admired? No.

Gilder discussed the impossibility of modeling creativity. But there are some guesses at the distributional arrangement of total output:

Lotka, Price, Pareto and, most recently, in his wonderful book, Human Accomplishment, Charles Murray have studied the extremes of human accomplishment in literature, science, and the arts. Murray also developed some of the statistics of sports accomplishment. The models of these authors are power law statistical distributions of the form … [Read more here]

 There's also some indication of predictabilities in the individual timing and cross-sectional clustering of creative acts [Read article here]

Claude Shannon was a protagonist of Gilder's talk. Here's an excerpt about him that I just read in Fortune's Formula:

Shannon was the not the first great scientific mind to suppose that his talents extended to the stock market. Carl Friedrich Gauss, often rated the greatest mathematician of all time, played the market. On a salary of 1,000 thalers a year, Euler left an estate of 170,587 thalers in cash and securities. Nothing is known of Gauss's investment methods.

Gilder's remarks about how supposed "deflation" harmed the telecom sector were parallel to an economic theme Bill Gross considers in his Investment Outlook this month:

Since almost all yields reflect a real plus an inflationary component, it stands to reason that the ability to pay debts expressed in nominal terms should be viewed in a similar fashion when analyzing growth. By so doing one can understand, for instance, why a deflationary environment can be so deadly to a modern-day, debt-ladened economy … the U.S. economy has gravitated to an average nominal growth rate of 5% or so as disinflation has taken hold. Because 5% has become so 'standardized,' government, mortgage, and corporate bond yields have centered around that level as well - the Lehman Aggregate index now yielding approximately 5.30%. 5% is how fast we grow and 5% is what we owe; the two rates are thus symbiotic, one feeding off the other when the economy is in balance. Problems arise however when nominal growth rises …too far below 5% - usually indicative of declining real growth … [Read more here]

Professor Charles Pennington comments:

My comments on George Gilder and his talk at the Junto on Jan 4:

He was very forthright and abject about the many subscribers who started buying his stocks in early 2000. He had lost 94% from peak to trough. He also showed (using data from a third party provider, Mr. Dick Sears) that his stocks had actually outperformed the S&P and Nasdaq from 1996 to present, even including the gigantic decline.

His big idea is kind of paradoxical. He believes that in order to earn big returns, returns much higher than you'd make from bonds, you've got to be in companies that have intrinsically unpredictable future profit streams. The paradox is that he must think that he can at least partially predict them. His aim is to have a few of the companies he owns go up by 100-fold or even 1000 fold, and by doing so, they will make up for the ones that failed. He may be correct, but let there be no confusion–this is not in sync with conventional "efficient market theory," which states that you don't get paid for the "idiosyncratic" component of your risk, the component that can be diversified away.

He does not believe in "reductionism" or "materialism," which is the prevalent idea in science that states that everything is all ultimately explained by the deterministic laws governing microscopic physics. He believes in "emergence" in which new laws emerge as one goes to a larger scale; that quantum electrodynamics is not the relevant thing to think of when approaching something like child psychology. His belief could be either very obvious or very controversial, depending on how it's interpreted. He mentioned an essay that he wrote for the National Review on intelligent design, which unfortunately requires a subscription.

In my opinion, his understanding of science and engineering does not deserve the criticism that he sometimes gets. No one can understand all of science and technology. His thoughts and studies are very wide ranging. He takes in a lot, and he thinks about it clearly and often originally.

Will his strategy be successful over the long term? I don't know. As discussed above, it's been fairly successful since 1996, though few could stomach the volatility. It may be more successful going forward. It might be more orthogonal from the growth/value axis than you might think at first glance. For example, he might do well going forward even if "growth," defined in other ways, does not.

I agree with the Chair that adding a new guy just to monitor PE's or something like that is not promising. That looks like a very rear-view-mirror kind of move. The guy does seem like a bright guy, but individuals can also appear to be misleading themselves about how easy it is to predict things in advance.

Personally, Mr. Gilder is quite a nice guy, very humble and optimistic. He was very gracious and patient with all the questions from the Junto members.



Recently I read an article somewhere describing a study showing that stocks with novel tickers outperformed those with humdrum tickers. One thinks, for example, of Southwest Airlines, with ticker "LUV." This is based on the name of Love Field, which was the first airport from which they ever flew. Southwest, of course, has done very, very well over the past few decades (I'm finding that it appreciated by 2900% since 1982, which corresponds to 14% compounded. This is actually less than I expected, but it is still nothing to sneeze at). This may lead someone to ask if stocks with clever tickers in general tend to do well. Unfortunately I've forgotten where I saw the original article on this topic, so I have decided to try a homemade version.

A difficulty arises in assessing without bias which tickers are "clever," but I did the best I could.

I took the members of the Russell 1000 as of 1997 and listed their names and tickers as of that date. A good starting point for finding clever tickers is to look for tickers which have a first character that does not match that of the company name. For example, the "L" in "LUV" doesn't match the "S" in "Southwest Airlines," and the "X" in "XRAY" doesn't match the "D" in "Dentsply." There were, however, some tickers that were obviously clever but didn't obey this rule. For example, the ticker for "Outback Steakhouse" is "OSSI," and I definitely thought that qualified. You can see an obvious problem–I recognized "OSSI" as significant only because I'm familiar with the Aussie theme of the steakhouse. I'm familiar with that only because it's a successful company. If it had fallen apart soon after 1996, I could have forgotten all about the chain and the "Bloomin' Onion" and all that. (As an aside, I've tried to visit the Outback in Norwalk, Connecticut about ten times, and the wait was always too long. It's not that good, is it?)

So here is the list of companies in the Russell 1000 as of 1/1/1997 that had clever tickers, as assessed by me, today.

Column 1: company name as of 1997
Column 2: company ticker as of 1997
Column 3: total return from 1997 to present (*) in percent

Franklin Resources        ben   445
Anheuser Busch            bud   197
Nextel                         call    410
Brinker                         eat   321
Callaway Golf                ely    -39
Sprint                          fon    28
NICOR                         gas   106
Santa Fe Pacific Gold     gld    0
Coca Cola                    ko     9
Southwest Airlines         luv    261
Philip Morris                 mo    279
Quaker Oats                oat    192
Bank One                    one   62
Outback                      ossi   132
Everest Reinsurance      re     264
Transocean Resources   rig    152
Panamsat                    spot  7
Lone Star Steakhouse   star   28
Toys R Us                    toy   -10
Dentsply                      xray  303

avg 157%    stdev 148%

Stats for all 1000 Russell 1000 companies:

avg 132%    stdev 200%

(*) I need to investigate the exact algorithm that my expensive software uses for calculating total return. That is especially important when there are mergers, spinoffs, etc. It is crucial that whatever it does for the novel-ticker companies, it also does for all the other Russell 1000 companies, so that our comparison is unbiased.

Results: The novel ticker companies on average made 157% and the average Russell 1000 stock made 132%. The standard deviation for the novel ticker returns was 148%, and there were 20 novel tickers. The standard statistical error then from taking 20 novel ticker companies is 148%/square root(20), or 33%. So the average novel ticker return of 157% is not significantly different from that of the average Russell 1000 stock, 132%.

The bias factor discussed earlier–which one would guess would make me prone to pick currently successful companies as having novel tickers–would tend to make the novel tickers appear to perform better. Even with that presumed bias they don't seem to perform much better.

Net result: I don't believe the idea that novel tickers tend to outperform.



Prior to Spring 2004 I lived in Columbus, OH, and I enjoyed dining often at Katzinger’s deli. My special sandwich was their “#34″, a hot brisket sandwich on rye with Russian dressing and coleslaw. I omitted the coleslaw. This is a great sandwich, and Katzinger’s is a great deli. I’ve been to most of the highly rated delis in Manhattan–Katz’s, Carnegie, and others — and I haven’t found a sandwich that can match this one. The Katzinger’s people told me that they were a knockoff of the Manhattan delis, but in my opinion they outdo their model.

On Dec. 26 I found myself in Ann Arbor, Michigan, and now I don’t know what to think. Zingerman’s deli is incredibly similar to Katzinger’s. Even the #34 sandwich is basically the same thing–hot brisket on rye with coleslaw and Russian dressing. (Katzinger’s actually also has some non-brisket roast beef mixed in.) Furthermore the format of these two delis is exactly the same, as are the signage, fonts, and lettering. Yet apparently there is no business connection between them. Zingerman’s has been around since 1982, and I suspect it’s the original and Katzinger’s the imitator. The imitation though is so profound that I can’t believe there are not lawsuits flying everywhere.

Zingerman’s #34 was outstanding, and I think it had a slight edge over Katzinger’s. Nevertheless they are both fantastic, and it’s one experience that I can’t seem to re-create in Manhattan.



Thanks to Victor and Laurel for introducing me to this major work on the history of tennis, two volumes with a total of more than 1000 pages, including many gorgeous photographs.

It will take me some time to make a dent in this book, but as I thumb through it I find that it’s the kind of book that I like–one that you can pick up, turn to any page, and start reading something interesting.

Page 310, Volume 1:

“There were no doubt definite rules in England long before Mr. Lukin’s time, and it is possible that there was a printed code, for our attention has been drawn to an interesting passage in a book entitled “The Academy of Armory”, 1688, by Randle Holme… The passage is so interesting as showing how far the game had progressed in those days that we give it in full. It is as follows:

‘The Game at Tennis is a most Princely Exercise; having its first Original (as I have been informed) or brought over to us from the French Court; it is Gentile, Cleanly, Active and most ingenious Recreation, exercising all the parts of the Body; therefore for its Excellency is much approved of, and played by most Nations in Europe, especially by our great Gallants of England, where such Tennis Courts are Built…

The manner of the Play is so intricate that it is hard to describe, which I suppose is the reason none (as ever I could hear) have written concerning it, as of other Games; there being so many turnings, windings and motions of the Body; as also the several ways of striking the Ball both backwards, forwards, under and over hand, and from the rebounds, that they were endless to set down…

Laws of the Tennis Court

  1. They that serve upon the Pent-house, are to serve behind the Blew on the Hazard side, else it is a loss.
  2. If the Receiver miss two stroaks at his Serving, which is two Faults, it is a loss, which is 15.
  3. They that get the first four stroaks, get the first Game of the Set, which may be as many games as the Players order to be in the Set.
  4. All Standers in the Galleries are not to speak a word in the Games except they be asked; if they do they lie liable to play the Game that they (the players) plaid for.’”

The last rule seems to be saying that if the spectators are too noisy, they’re liable to be dragged down on the court to play the game themselves!

Another fine passage (remember, the book was written in 1924.), from p. 360,

“The change in racquets has been perhaps the most marked of all. Mr. Marshall writing in 1878 says, in comparing the racquet of that time with that of earlier generations, that the implement of his day was as perfect as could be conceived. Now, if we look at a racquet of the seventies and compare it with a present day racquet it looks a wretched thing, and perhaps again fifty years hence, the implement in use will be as far ahead of ours as is ours of one Mr. Marshall’s time.”

Around 1974, the steel Wilson T2000 and the aluminum Spalding Smasher were popular, and I remember my own brother saving all his summer’s lawn mowing wages to buy a Head Arthur Ashe Composite racquet, which cost $60 then, which was an astronomical figure at the time. Certainly the wood racquets available then were also much, much better than those of 1924.

Vincent Andres comments:

An interesting fact is that Le serment du jeu de paume, the Tennis Court Oath,
was a harbinger of the French Revolution



I have written extensively about my belief that growth beats value, because my experience with many hundreds of companies shows that you get paid for finding areas where capital has a high rate of return, and for doing innovative things. You don't get paid for using capital with low rates of return and imitative enterprises. I like to give the anecdotal example of Joe McNay, who took part of Yale's endowment from a few million to over $125 million in 20 years, as unobtrusive evidence supporting my view. Also, since 1960, Value Line has tried to find groups of low P/E and low P/B stocks that would beat their composite, but found that a dollar invested in their composite or their Group 1, rebalanced each month, grew at least 10 times faster than a dollar invested in value over the period.

There are some problems in this, in that the Value Line composite, is an equally weighted geometric average, (the return on portfolio at time t is equal to the nth root of the cumulative product of the relative returns P[t]/P[t-] of the n stocks), and the portfolio may be arithmetically averaged. In this case the average would always be greater for the arithmetic workings over the geometric workings for the same data.

Anyhow, I based my empirical conclusions on the Value Line findings, and pay no attention to the results of Fama-French and their followers, which are fatally flawed by data problems, retrospection, non-operational results, and data ending in 1999. Almost seven years have passed since 1999 and it is now time to update the prospective Value Line results.

% Returns

Year    Value Line Low    Market Low Price     Low Price     Low Price    Comp Cap Earnings Book Sales

2000            -9                         -24                    -47                -33                        -26

2001            -5                          32                    -19                 10                          22

2002           -29                        -32                    -50                -39                        -29

2003            37                         62                      54                 71                         59

2004            12                          6                        4                  14                         16

2005             2                         -9                       -7                   -7                         -2

2006/Sep       3                         30                      14                 26                           3

Total            -1                         40                     -63                  4                           38

We have in this data the unfortunate feature of a theory meeting a fact. The results show clearly that during this period low P/S was best and low P/E was worst. Low Market Cap was best of all by a thin margin, but because these stocks would have suffered from transaction and liquidity costs, they are only slightly more meaningful than the seriously flawed studies of my former colleagues alluded to above.

Professor Pennington offers:

This is correct about the method used by Value Line to calculate the daily returns of their composite index. However, that's a very bizarre quantity to calculate, and it has no relation to a real portfolio that anyone could hold. Here are the problems:

Here is text from the Value Line site.

Larry Williams replies:

I was always perplexed by Vic and Laurel's comments on growth vs. value, as my studies suggest that in the large blue chip stocks, DJIA, value outperforms growth hands down. The studies are backed up with actual performance from 1999 forward that beat the S&P and Dow.

Finally I reconciled it, in that Vic and Laurel are not looking at blue chippies, which have been my focus. There, growth is more difficult to come by, I suspect, so value leads the way. And I'm still learning about all of this.

Dr. Kim Zussman adds:

Out-of-sample testing should be powerful. However there are still fog issues with:

Russell Sears mentions:

If the companies are reacting to incentive, it would make sense that they buy market share at the expense of profits, when growth is being rewarded in the markets, and do the opposite when value is being rewarded. Which comes first, and hence is predictive?

Steve Ellison adds:

Most companies are growth companies first and value companies later, after their industries mature and products become commoditized, or as a result of company-specific difficulties. Buying market share at the expense of profit actually heralds the end of growth, as it indicates the company is having difficulty differentiating its products from competitors' products.

From management's perspective, simply being in the value stock category is a slap that conveys an urgent need to improve profitability. One incentive is the possibility that management might be ousted in a takeover if the share price is low enough to attract a buyer. The generally high profit margins of growth companies provide incentives for competitors to enter the market.

Russ replies:

While this explains it on an individual company basis, I don't think it explains it on a total basis, as the graph Gordon sent suggest. What are the signs that this is happening at a macro level?

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