Vocabulary brings the world to an individual. Without words we are reduced to surviving by non-verbal signs and gestures, primitive. Basic survival.

Some have expressed irritation when I write about incarceration, convictions, and whatever is associated with penal servitude, but any convict can vastly improve his life if while serving time he takes up the task of building his vocabulary.

My grandmother sent me a Webster’s Dictionary and a thesaurus at my request when I entered Walla Walla State Penitentiary without more than a 9th grade education. I took a liking to words and began reading just the dictionary.

In adult life I carried a pocket thesaurus, in my shirt pocket, and whenever a moment was idle I would read it.

A pocket thesaurus, maybe leather bound, would be perfect gift for any occasion, as a birthday for a child with some basic language skills to evolve with.

One word can lead to another, to an association. One association leads to another, until the student has gone into another dimension and left others behind.

I did not however, leave my street vocabulary behind and I cherish the way it can embellish a conversation with exclamatory frills.

Stefan Jovanovich comments:

Ken would have been right at home in 1780. In the 18th century nine out of ten Americans could read and understand the King James Bible, and all who could afford it owned a copy. (Today only an optimist would argue that the number was higher than three out of ten.) The extraordinary exception of the American Revolution and the Federalist Papers comes from the fact that the “average” American of that time had a larger vocabulary than present day college graduates. That fact also explains the lethality of Continental marksmanship that the British Army so justly complained about. The use of rifled barrels has been the conventionally accepted academic explanation, but the far more likely one is the extraordinary literacy of the “ordinary” American soldier, who carried a musket (not a rifle). The ability to read and write and think correlates directly with the ability to shoot, as Scott Brooks’ postings and hunting skills amply demonstrate.

Those of us who hate the draft do so for two simple reasons: it is a reminder of how far we Americans have gone on the road to serfdom, and dumb conscripts make lousy soldiers. The two best memoirs of “ordinary” American soldiers were written by Joseph Plumb Martin and E. B. Sledge. The first was an 18th century farm laborer; the second a 20th century biology professor. Both were volunteers.



Abelson: The O.J. episode happened. A handy chart tracks the number of times the press uses the word “goldilocks”. It is up lately, which might mean people are using that as a reason to stay bullish in the face of bad news. (Of course, a simple look at the chart shows basically zero correlation between the number of times goldilocks is used in the press and later stock market action.) The dollar has gone down, it will go down further, which will hurt the economy. Miracle of miracles, there is some good news: The world is awash in liquidity. In other news, the sky is falling.

Page 18 (follow-up section): We were wrong about B of A. The US Trust purchase was smart, and B of A stock is doing well. Avon stock is up despite lack of improved fundamentals, plus there are a lot of clouds on the horizon. Snap-On Tools has been doing great.

Page 21: One of the reasons there has been so much buyout activity is that corporate managers are risk adverse compared to the LBO guys. With debt financing so readily available, the LBO guys have been willing to load up their targets with debt… something that corporate and/or strategic buyers aren’t willing to do. This has given the LBO guys an upper hand in the buyout game. The Private Equity boom will end badly if the economy weakens.

Page 22: The Schwab Equity Ratings system has been doing great. The guy who designed it doesn’t focus on forecasting earnings, rather he looks for factors that help to predict earnings surprises. Free Cash Flow is the most important factor. He also compares inventories to sales. Profit margins have no correlation with future stock returns.. rather FCF to equity does. Another good indicator is comparing rates of change in sales vs. assets. The higher the capex rate, the lower the return over time, for various reasons. Tracking short selling in a stock also had predictive ability.

Page 25: Lots of people have Hepatitis C, and there is no cure. Wall Street is betting on Vertex to find one. However, the doctors think you should be looking at IDIX, ITMN, ACHN, VPHM, XTLB. You can read the rest of the article to learn about Hep. C, or you can just google it.

M3: For those of you cruising the Gulf of Bothnia last week, there were a lot of big buyout deals, Dell did well, and the dollar declined, resulting in profit-taking by Kirk Kerkorian and insiders in general. It was a good week for copper stocks, and it could get better. The Phelps bid could move higher. KFC has a new logo, and a nice start in China. Large cap stocks are finally outperforming small caps.

M6: Lots of reasons to worry about Google, mostly that we haven’t really seen any sort of big payoff to its non-cores businesses yet. Fred Hickey things consumer spending, which will hurt Google advertising.

M7: There are lots of people in China who don’t have mobile phones yet, so buy China Mobile and China Unicom.

M8: M&A activity is going crazy, and bondholders are taking it on the chin. It used to be you could buy the bonds of big, safe, companies and be ok. Not anymore. Deal sizes are huge, and getting bigger. Bondholders are fighting back, asking for better covenants.

M9: It used to be that options markets predicted takeovers, but that didn’t happen on the big deals last week. The reason is two fold: 1. The prevalence of all cash deals (that makes no sense to me whatsoever, the stock will still go up if the cash is at a premium), and perhaps there is so much option volume it is not as obvious that there are inside traders. The new technique for insiders is selling calls that go out more than a year.

M11: Air France-KLM is silly for even thinking of buying Alitalia. So silly, that people are speculating that there are political reasons behind the deal.

M14: Gasoline futures have been clobbered lately, but they should do well through the winter, better than crude oil.

Page 27: It used to be that philanthropists gave their dough to popular causes like hunger relief. Now people are tailoring their giving in a much more narrow manner where they feel they can have a greater impact and more personal meaning. There are 4 pages of various example of this, if you care.

Page 32: You don’t have to give away cash, you can give away stuff like rare books. You should talk to a lawyer to figure out if you should give them directly, or give them to your family foundation and then sell them, etc.

Page 34: A Mellon activist hedge fund wants ASM International to break up. ASM doesn’t want to. This is ironic because Mellon is having the same problem with its shareholders. Either way, ASMI shareholders should be winners.

Page 35: The Human Genome Organization needs help naming new genes. The CEO of Cyberonics stepped down.

Page 36: There is a pretty cool Wine service called Vintrust. You buy wine, and store it at their facility. Then, you can trade wine back and forth with people, and all it does is require the moving of the barcode on the bottles. They have about 2 million bottles under management.

Page 37: Buying insurance online is pretty cool, but you still want to take your time and know what you are getting. With a lot of these sites, after you enter all your info, etc. you get phone calls from insurance agents, which is a pain.

Page 38: The AMT was designed to snare people who used every trick imaginable to avoid taxes. However for a few reasons, including inflation, it is nailing all kinds of people. It is not fair, and needs to be changed.

Page 39: Hedge fund Roundtable. blah blah blah. Overview of strategy returns. Going forward, M&A activity will continue. A way to hedge against geopolitical events is to go long volatility by buying VIX options. If Volatility goes up, equity markets will sell off, credit spreads will widen, and the dollar will strengthen. Where are we in credit cycle? Defaults low but rising, when will it really head up - who knows? 50% chance credit cycle goes bust next year. Interesting take on Amaranth: Investors were screwed because the creditors were running the show with nobody looking out for the investors.

Page 44: Joe Queenan went to the $99 dollar wealth Expo at the Javits center that Trump spoke at. The two pages can be summed up as: “As you might have expected, it is one big fraud, and the people who pay many for this thing are idiots”.

Page 45: The democratic congress is going to try to force net neutrality, which is the dumb idea of forcing the fiber providers to charge the same thing to everybody, when really they should be able to charge more to access bandwidth clogging sites.

Page 46: Interview with Will Chester of the Westcore Select Fund. It is a midcap growth fund. He oversees $2.8 billion. He thinks midcap growth stocks are great. He likes DOX, CSE, ERTS, STZ, DVA, GHCI, DOV, OSK, TPX, COH. Also, CAL and AMR. He just sold TROW because of valuation. The playstation 3 and Nintendo Wii will help Electronic Arts and Gamestop. He has a positive outlook on health care.

Page 47: Everyone tells you to diversify, but if you want to build wealth you need to concentrate and leverage your investments. You also need to be a hard-core contrarian investor. For example, you should like GM and F better than Toyota or Honda. Sometimes, of course, beaten down companies stay beaten down, like Kmart. Take a look at the Forbes 400, most got there because of large concentrated bets.

Page 48: Silicon breast implants are back on the market, and Mentor and Allergan, who make them, are up, and could go higher.

Page 51 Editorial: Airlines lose lots of money in general, despite there being lots of travelers. They keep buying lots of new planes during the good times, and receiving them in the downturns. The US Air and Delta merge will be bad news, and synergies are never realized. The bankruptcy judge should liquidate Delta.



Dr. Brett Steenbarger has written a new and wonderful book, Enhancing Trader Performance, that has kept me thinking about trading, performance and niches since I got it.

The book starts with four composite traders built up by personality type. It’s just so fascinating to see oneself illuminated that way. Next, the book takes each composite trader through a series of hurdles before he discovers his trading niche. Again, quite illuminating and it sets the stage for the second part of the book which provides sound, proven tools and techniques for performance enhancement.

The book is beautifully written, easy to read and worth orders of magnitude more than the price of admission. A psych book for quants — imagine that!



It is hard to believe that the moves of the Nikkei on Wednesday and Thursday overnight, before the US stocks opened, were not indicative of the imminent break through from below of the round 1400 by the S&P, but this must be tested.

  NIKKEI (NI1) S&P (SP1)
Date Open Close Open Close
1-Nov 16375 16380 1386.1 1372.9
2-Nov 16395 16350 1368.8 1371.3
3-Nov 16350 16330 1375.8 1368.5
6-Nov 16320 16380 1372.8 1383.8
7-Nov 16385 16420 1385.0 1389.0
8-Nov 16420 16235 1382.5 1391.6
9-Nov 16235 16245 1392.5 1384.0
10-Nov 16240 16080 1383.5 1384.8
13-Nov 16085 16020 1384.0 1388.0
14-Nov 16025 16295 1391.3 1397.7
15-Nov 16300 16260 1397.0 1401.5
16-Nov 16270 16170 1405.4 1405.1
17-Nov 16175 16065 1400.2 1404.8
20-Nov 16065 15735 1403.2 1405.3
21-Nov 15740 15720 1404.8 1406.2
22-Nov 15720 15855 1407.0 1408.4
23-Nov #N/A #N/A #N/A #N/A
24-Nov 15800 15725 1401.6 1402.9
27-Nov 15725 15860 1401.9 1383.6
28-Nov 15860 15865 1381.2 1388.6
29-Nov 15855 16080 1392.7 1402.2
30-Nov 16080 16310 1402.5 1402.9

An Earnest Spec replies:

On a related note regarding moves in the East, I was wondering if you might critique this Kindergartner’s effort in the quantitative world. What is worthy? What is worthless? What to add? What to omit?

IF was up 9.5% yesterday, completing a five-day percentage gain of more than three standard deviations above the average five-day percentage change measured over the last 30 trading days. I queried IF’s history for like moves while trading over the 200sma. The table is expressed as percentage change, T+(X) days out from yesterday’s event.

Date t+7 t+8 t+12 t+28 t+30
04/23/1992 -7.1 -7.1 -5.9 -2.4 -1.2
05/28/1993 2.3 0.0 2.3 3.5 3.5
12/27/1993 -11.1 -15.3 -21.7 -22.8 -24.9
05/11/1995 -6.1 -7.1 -6.1 -8.2 -8.2
04/25/1996 -5.7 -3.8 -2.8 -5.7 -6.6
07/08/1997 -11.1 -11.1 -16.2 -29.3 -33.3
01/06/1999 -11.9 -3.0 -14.9 -9.0 -10.4
06/08/1999 -4.5 -3.6 -1.8 -5.4 -11.6
08/23/1999 -8.6 -10.8 -14.0 -8.6 -11.8
04/09/2002 -4.0 0.0 -0.4 -6.0 -5.2
05/09/2003 -6.7 -6.7 -1.8 -0.9 0.9
10/13/2003 -1.3 -2.9 -4.0 -5.1 -6.9
12/26/2003 -14.1 -14.2 -16.8 -23.7 -22.0
11/29/2006 NaN NaN NaN NaN NaN
Avg -6.9 -6.6 -8.0 -9.5 -10.6
AvgPos 2.3 NaN 2.3 3.5 2.2
AvgNeg -7.7 -7.8 -8.9 -10.6 -12.9
PctPos 7.7 0.0 7.7 7.7 15.4
PctNeg 92.3 84.6 92.3 92.3 84.6
Maximum 2.3 0.0 2.3 3.5 3.5
Minimum -14.1 -15.3 -21.7 -29.3 -33.3
StdDev 4.5 5.0 7.7 9.7 10.6
Avg/SD -1.5 -1.3 -1.0 -1.0 -1.0
Date t+7 t+8 t+12 t+28 t+30
01/06/1999 : 1 Obs. Min. :-14.100 Min. :-15.300 Min. :-21.700 Min. :-29.300 Min. :-33.300
04/09/2002 : 1 Obs. 1st Qu.:-11.100 1st Qu.:-10.800 1st Qu.:-14.900 1st Qu.:-9.000 1st Qu.:-11.800
04/23/1992 : 1 Obs. Median : -6.700 Median : -6.700 Median : -5.900 Median : -6.000 Median : -8.200
04/25/1996 : 1 Obs. Mean : -6.915 Mean : -6.585 Mean : -8.008 Mean : -9.508 Mean : -10.59
05/09/2003 : 1 Obs. 3rd Qu.: -4.500 3rd Qu.: -3.000 3rd Qu.: -1.800 3rd Qu.: -5.100 3rd Qu.: -5.200
05/11/1995 : 1 Obs. Max. : 2.300 Max. : 0.000 Max. : 2.300 Max. : 3.500 Max. : 3.500
Other : 7 Observations
t.test(Dataset$t.7, alternative=’two.sided’, mu=0.0, conf.level=.95)
One Sample t-test  data:  Dataset$t.7 t = -5.492, df = 12, p-value = 0.000138
alternative hypothesis:
true mean is not equal to 0 95 percent confidence interval:  -9.658867 -4.171903
sample estimates: mean of x -6.915385  
t.test(Dataset$t.30, alternative=’two.sided’, mu=0.0, conf.level=.95)
One Sample t-test  data:  Dataset$t.30 t = -3.6192, df = 12, p-value = 0.00352
alternative hypothesis:
true mean is not equal to 0 95 percent confidence interval:  -16.969087  -4.215529
sample estimates: mean of x -10.59231



I have a couple thoughts related to your recent writing on the Humor of the Markets … There was an article in The Economist last year on theories of humor:

One description of how laughter is provoked is the incongruity theory … This theory says that all written jokes and many other humorous situations are based on an incongruity — something that is not quite right. In many jokes, the teller sets up the story with this incongruity present and the punch line then resolves it …

With the “incongruity theory” of humor, I’m reminded of something that interest rate analyst James Grant wrote a few years ago in Forbes when he was commenting on how he approaches the markets:

… I look for financial non sequiturs — ideas and prices that apparently make no sense … [The market] is not so efficient that it doesn’t propagate, occasionally, titanic errors and absurdities.

On a separate note, the stadium indicator is being flagged again. A nuclear waste disposer will follow Delta Air Lines as the sponsor of the arena for the Utah Jazz

Gary Rogan adds:

I also believe that success in dealing with the markets and telling jokes is based on the common theme of incongruity. In my opinion though, there are substantial enough differences between the two areas to warrant very different approaches.

Punchline-based jokes rely on the following property of human brain that is becoming better understood with the latest research: people are always predicting the very near future when seeing, hearing, etc. Therefore, perfect timing in telling jokes depends on waiting just long enough for the setup to register and the non-humorous version of the punchline predicted, and then surprising the listener.

Market “jokes” tend to be not jokes at all but fairy tales. They work by suspending disbelief and lulling the “listener” into a false sense of complacency with what starts to seem like a perfectly natural state of affairs. There is no general sense of timing, as the “punchline” is revealed after a fairly unpredictable interval.

While a good sense of incongruity is useful in both areas, dealing with humor involves quick and obvious surprises, and with markets, digging out the non-obvious ones.



The fossil record of life on earth can be read as sequential ecological dominance. It is interesting how formidable species at the top of then-current food chains often become extinct.

Dunkleosteus terrelli is a fish which bit with 11,000 pounds of force (twice that of great white shark), which along with other big-biters (T. Rex) are dodos of other eons.

When this creature terrorized oceans full of big prey, what were eminent forces that would end his reign? Temperature change? Small prey? Disease?

Species success and dominance appears to require risks of commitment and inertia, which pay off competitively but increase vulnerability to unforeseeable environmental shifts.

Dylan Distasio comments:

An interesting creature for sure … This type of fish (Placoderm) was wiped out in one of Earth’s great mass extinctions in the late Devonian period. It is rather startling to look at just how many species died as a % of the total on Earth during any one of the given recorded mass extinctions.



The main point of Towing Icebergs, Falling Dominoes, and Other Adventures in Applied Mathematics by Robert B. Banks, is that mathematics is a language that can describe, measure, and help inform us about everyday points of human activity. The book uses mathematics such as differential equations, integro differential equations, the calculus of variations, and some physics (mainly the laws of motion and free body diagrams) and statistics (least squares regressions). Using these methods Banks explains many events such as; the impact of objects falling from the sky, the shape of a sagging flexi-cable, the shape of a jumping rope, how to throw a curve ball, how strong waves are, oscillations in the records of football teams, how fast one can run and how high and efficiently one can jump, how strong bridges and buildings are, how fast epidemics spread, how far it is possible to tow an iceberg… and how fast dominoes fall.

Like all good books, this one can be read on many levels and many times over. I read it because I want to see how math could better prepare me to understand the physical and market factors that move. I found it very interesting in this context, and particularly liked the many uses of the Logistic equation to explain such as the spread of rumors. I also enjoyed seeing the various estimates of pi that simple geometric diagrams like inscribed circles in a square can generate.

Unfortunately the author is woefully uninformed about statistics. Indeed it does not look like he knows how to compute a standard deviation from individual observations, as he classes observations into groups and intervals and then computes the standard deviation based on the numbers in each group rather than the individual observations. Nor does the author know about the common limitations of regressions, when such factors as multi-co-linearity appear, and why one should hesitate to use squares and cubes in some regressions. The chapters where he applies mathematical methods to deficits and debts contains numerous omissions and errors of analysis. His discussion of predicting the future height of a child based on the child’s percentile height at an early age, which is the kind of thing that market people think about all the time, is terribly naive and misleading. Indeed on all the subjects that I have even a rudimentary knowledge of, such as those that touch on economics, I find the discussions and models painfully inadequate. But they are suggestive.

The author is a professor of fluid mechanics and he is not sheepish about believing that the lay reader has some expertise in that field. Within the first eight pages he develops a mathematical model of a baseball that assumes the reader knows about functional relations between viscosity, roughness, velocity, the Reynolds number, the velocity of sound in a gas, and such things as the Fronde and Weber numbers. Admittedly , my physics knowledge is deficient, having had only a college level course in the field and dabbling in electronics as a hobby, but it would have seemed that the author could have chosen a subject for his introductory chapter that the educated layman who he is writing for, might have had more familiarity. Indeed, most of the chapters suffer from either being much too technical for a reader not familiar with physics and accustomed to using such things as free body diagrams, or, when the author deals with economics, being much too naive and out of date to have much import.

Despite this, the topics covered raise many interesting ideas and tests for the market speculator. Some that sprang to mind after reading the book the second time were: What is the area of a chart that is covered by points, and lines, relative to randomness? How long can one market tow another along for? What is the time to travel a certain distance in a market that is showing parabolic growth? What is the price limit of how much a soybean oil can sell for when it is limited by the size and price of the soybean crop itself — perhaps according to a logistic relation? What is the easiest and most effective path for a price to take from one level to another a’la a pitcher throwing a curve ball to the plate? How high can a stock go, based on its initial ascent during a year or a day?

The author is apparently an old timer who likes to use puns and jokes, and I believe that his persona and style is captured by the following quote:

I decided to be a bit light hearted in the analysis of some of the problems. It just seemed like a good idea to not always be entirely serious about everything.

I recommend this book to all market people who have a reasonable interest and background in physics, and to all others who like to gain insights from other fields and other methods of analysis that might help them to improve their feel for the markets.

Rick Foust adds:

For anyone seeking a practical compilation of engineering formulas and methods, the books engineers use to prepare for Professional Engineer exams are hard to beat. These are available at most university book stores.

Or If you prefer a high tech approach Mathcad is the tool of choice. And then there are various widely accepted topical references, such as Crane Technical Paper 410, Flow of Fluids.

But as in statistics, it is essential to understand the assumptions implicit to the formula.

A standard engineering calculation follows the format: Problem Statement, Data, Assumptions, Formulation, Calculation and Conclusion. Of these sections, “Assumptions” is the most important. Assumptions are the cornerstones for calculations ranging from bridge to nuclear reactor design.

The worst calculations I have seen were generated by engineers having excellent memories yet poor understanding. As an example, such a fellow engineer once asked me to verify his perfectly logical three page calculation that proved a long bolt can take more torque than a short bolt (it can’t, of course). Fortunately, important calculations are typically verified by a second engineer, and engineers like to find things wrong with the works of other engineers.



A very cute 26 year young lady was temping at the office recently and told of her experience at a convalescent home where she had just quit. It seems there is an 87 year old Romeo who, just as she turned around, planted a big wet one right on her lips.

Another lady who works there and is pregnant is telling this guy, who has some Alzheimer’s, that the baby is his.

From a Darwinian view, a man of any age should construe any attention from a woman as an invitation (evolution occurred before lawyers); the goal is maximum projection of genome into the future, and you have to risk refusal to get it there.

In Russia flirting, sexual innuendo, and fondling, which used to be legal here between opposite sexes, is alive and well. Funny thing is, most of it is in jest (a Russian aphorism: “Every joke has some truth to it”) and women crave the attention tremendously. In fact, even married Russian women become quite furious if they cast a furtive glance at a man and he doesn’t respond. Even though they are busy poisoning their enemies, they haven’t yet polluted the soul.



I find that at this time there is no evidence from the Monetary Base numbers suggesting a change in policy. Additionally there is no change in the job growth numbers as evidenced by the payroll tax receipts.

George Zachar adds:

This morning William Poole observed that the MZM and M2 monetary aggregates “are chugging along at pretty steady rates.” Year over year, he noted, MZM is up 4.3%, while M2 is up 4.9%.

Although they have accelerated in more recent months, Poole said those money supply growth rates “are pretty close to the growth rate we’ve got for nominal GDP” and are “consistent with the growth that’s being forecast for next year.”

Since real GDP growth is expected to be “a little below 3%,” he said, “if you take a 2% inflation target that adds up to 4 1/2% to 5%, which is really very close to where money growth is right now.” So he said, “money growth is not telling you that monetary policy is tight or easy, just in line with GDP growth.

Bill replies:

If you think of the Monetary Base as a window on Fed policy, then the data makes the case that there has been no change in policy. Since the beginning of 2005 that policy has been moving from accommodative to restrictive. Thus there is no deviation from a restrictive policy, which at this time is very restrictive (more below).

George Zachar’s comment was more insightful. George pointed out how the Fed’s statements on M2 and MZM growth were contradicted by my data. The boys at the Fed think that they are walking the narrow line between restrictive and accommodative. The data suggests otherwise.

At this time the Monetary Base is in excess of 4 percent below the long-term mathematical fit of that data. This is more restrictive than in 1998. Perhaps our “planners” wanted to be more restrictive in 1998, but had to back off because of (a) Asian contagion, (b), Russian bond default and (c) Long Term Capital Management. In any case, the current data shows the present to be more restrictive, and there is no anxious moment to force a change. The period of 1990-92 had the most restrictive policy. Remember that as the period of “It’s the economy, stupid”.

Monetary Base is an interesting number, consisting of currency and deposits at Federal Reserve Banks. Breaking the Base down into those two components does not give you as complete a picture as the two together. For example, look at the two spikes: the earlier one was the Y2K spike caused by excess currency (the ATMs were all going to fail). The later spike (9-11) was caused by the Fed goosing the bank reserves. Only if you look at the Base data do you see both spikes.

I’m looking forward to Diebold next week.



There was a nice overview of Bernanke’s current thinking on the economy in today’s speech. There were No bombshells, with both the rhetoric and the conclusions between the 40 yard lines of recent Fedspeak and Centralbankese.

One passage struck me as being modestly noteworthy:

What implications does the pickup in labor costs have for price inflation? One possible outcome is that increases in labor costs will largely be absorbed by a narrowing of firms’ profit margins and not be passed on to consumers in the form of higher prices. The fact that the average markup of prices over unit labor costs is currently high by historical standards suggests some scope for this outcome to occur. If higher labor costs are mostly absorbed by firms and not passed on, then workers will see the gains in their nominal compensation per hour of work translated into greater real compensation per hour; in the process, workers would capture a greater share of the fruits of the high rate of productivity growth seen in recent years. The more worrisome possibility is that tight product markets might allow firms to pass all or part of their higher labor costs through to prices, adding to inflation pressures. The data on costs, margins, and prices in coming months may shed some light on which of these two scenarios is likely to be the better description of events.

Bernanke echoes his predecessor in calling attention to the rise in profit margins, and implying it is business’ slicing of the wage/profit pie that is central to inflation pressures. This plays perfectly in the rhetorical framework of the labor union-backed Democrats who will be holding the gavels on Capitol Hill.



The following is from Gary Becker and Richard Posners' Blog. It is a piece by Becker on Milton Friedman, who sadly passed away this month. [Read the NYTimes Obituary]

I will not dwell here on what a remarkable colleague he was. However, I do want to describe my first exposure to him as a teacher since he enormously changed my approach to economics, and to life itself. After my first class with him a half-century ago, I recognized that I was fortunate to have an extraordinary economist as a teacher. During that class he asked a question, and I shot up my hand and was called on to provide an answer. I still remember what he said, "That is no answer, for you are only restating the question in other words." I sat down humiliated, but I knew he was right. I decided on my way home after a very stimulating class that despite all the economics I had studied at Princeton, and the two economics articles I was in the process of publishing, I had to relearn economics from the ground up. I sat at Friedman's feet for the next six years– three as an Assistant Professor at Chicago– learning economics from a fresh perspective. It was the most exciting intellectual period of my life. Further reflections on Friedman as a teacher can be found in my essay on him in the collection edited by Edward Shils, Remembering the University of Chicago: Teachers, Scientists, and Scholars, 1991, University of Chicago Press……

To conclude on a more personal level, I was most impressed by Milton Friedman's sterling character–he would never soften his views to curry favor–his perennial optimism, his loyalty to those he liked, his love of a good argument without any personal attacks on his opponents, and his courage in the face of prolonged and virulent attacks on him by others. I cannot count the number of times I participated with him in seminars, nor how many visits my wife and I shared with Milton and Rose, his wife of almost 70 years. Rose, a fine economist, would not hesitate to differ with her husband when she believed his arguments were wrong or too loose. When I spoke on the phone with him last Monday, he sounded strong and a bit optimistic about his health, even though he had just returned from a one-week hospital stay with a severe illness, an illness that a few days later took his life. Although his ideas live on stronger than ever, it is hard to believe that he is not here. I can no longer seek his opinions on my papers, but I will continue to ask myself about any ideas I have: would my teacher and dear friend Milton Friedman believe they are any good?

Sam Humbert adds:

I also like these vignettes from Ben Stein:

When I was a Columbia undergrad in the early '60s, Friedman taught there for a year and was a good friend to me. He even used applied statistics to save me from romantic desperation when I was worried about replacing a girlfriend. If there were only one right woman for every right man, he advised, they would never find each other. Another time, he stopped me from crossing against the light on Broadway and 116th Street, telling me, "Why risk your whole life to save 10 seconds?"



I thought there were a couple interesting aspects of Steve Leslie’s Nov. 22nd post. He concludes: “Success in poker is like success in life. It is attainable but not easy and it requires lots of work. That is why so few attain it.” Yet if everyone, or a significant number, were to follow professional advice, the quality of poker play could jump nationwide without any change in levels of success (though perhaps many would gain by feeling less stupid about losing, since bad luck rather than bad play would be responsible).

Similarly with sports. Every NBA or NFL team could raise their quality of play 20% with no change in levels of success.

Except in international competition. NBA teams and players, as well as gamblers, might do better in world competition following a popular U.S. book, lecture tour, or movie that somehow inspires competitors to higher quality play.

Unlike gambling and sports, which are zero-sum games, (apart from the mental or physical pleasure gained through competing), investing is a positive-sum game. Higher quality investing directs funds to higher quality projects. Insight into foolish corporate or commodity projects and positions, provides both returns to winners and instruction to losers. Losers don’t just lose pots or games, if left alone they continue to misdirect and waste capital and labor resources. “Capital” belongs to people and “labor resources” are people. Misdirecting them wastes the time and money of people in production, and deprives consumers of goods and services that could have been produced with better “play” by investors (assisted by speculators).

The question arises whether there might be a similar difference in the quality of play across cultures. If the game is basketball, U.S. beats China. If the game is ping pong, China beats U.S. (for now, at least). I don’t know how good the Chinese are at poker, though I hear gambling is very popular. As hundreds of millions of everyday Chinese gain enough wealth for everyday gambling, there will be some thousands or tens of thousands wealthy enough for big-time gambling as well as big-time investing and speculating.

As these newly minted big-time speculators jump into the game, will they make systematic “newby” mistakes? I don’t know enough about Chinese culture to know what to expect. But with commodity prices jumping up and down in front of tens of millions of gambling-prone newly capable investors what might we expect? (Plus, thousands of local government officials seem able to gamble and speculate illegally with local bond revenue.) Markets will draw in an influx of low-skill, limited-experience players, flush with success from one culture and range-of-experience (wealthy Chinese manufacturers), trying their hand with commodity speculation.



In the office we were talking about the repeated action of the S&P’s move to a certain level, and then it’s falling back from this level, that occurs on a day like today. This repeats until the potential energy of the market is converted to kinetic energy, and the market rises higher. We were looking for analogies for this, such as power lifting where you bounce the weight before extending it to maximum lift, or pole vaulting where you can take up to three tries to get over the bar. In the process of this we were also considering the energy transfer involved in making a child’s swing set go higher with each swing. The following brief explanation was found but I would be interested in any ideas people have on a proper model for the back and forth; the trying to get there but failing, that happens so often in the markets.

Each time the swing moves forward and then returns to its starting position counts as one cycle. Using a stop watch determine the length of time a swing needs to complete say 20 cycles. Divide 20 cycles by the time and you have the swings frequency in cycles per second or Hertz (Hz).

Since a swing is basically a pendulum it’s possible to calculate its resonant or natural frequency using pendulum equations as follows:

Note that the natural frequency of the swing is not influenced by the mass of the person in it. In other words’ it makes no difference whether a swing has a large adult or a small child in it. It will have the about the same natural frequency. Slight differences can be caused by slightly different locations of the person’s center of mass. This is located about two inches below the navel. When people are sitting the center of mass is in about the same place relative to the seat of the swing regardless of whether the person is an adult or a child.

If a forcing function is applied to a swing at the natural frequency of the swing it will resonate. The amplitude of the swing will increase during each back and forth cycle. The forcing function can be provided by a second person pushing on the swing. In this case even a small child can make a large adult swing by pushing in sync with the swing’s back and forth cycle. The forcing function can also be provided by the person in the swing. In this case the person in the swing shifts her center of mass very slightly by changing the position of her legs or torso. This creates a slight pushing force which makes the swing go higher and higher. It takes a very small force but it has to be timed perfectly.

The big question is what keeps the swing from flying apart or spinning over the top of the swing’s frame and subsequently killing its rider? After all, if it is a resonating system then it should be very dangerous to keep applying force in time with the swing’s frequency. The answer is fairly simple. The equation given above is only good for small angles. When the swing goes beyond a certain height it is no longer possible for the person in it to apply the necessary small force in sync with the natural frequency because the natural frequency changes. In other words the motion of the system is naturally limited.

Jim Sogi offers:

The apparent back and forth motion around the round number is a chart artifact, and as with so many chart artifacts is an illusion. The motion is in three dimensions and only appears on the chart in two. The model is a tether ball, like at summer camp. It has circular momentum from whacking it, and tightens, then rebounds off and unwinds. The angle of the wind depends on the angle of the whack. Circular math a’la Newton might work.

The other model is a guitar string. It has harmonics and standing waves along its length as the axis of vibration meet along the string, similar to price action harmonics. The higher harmonics are recreated in the higher and lower price levels.

Gary Rogan comments:

I also view the market gyrations as something similar to a swing, except it’s nothing like a physical, earthly swing because there are two forces involved, and one of them is “unusual” for a physical-world system. In the physical world, there is only gravity (other than a small amount of friction) involved in the dynamics of a swing that results in a simple differential equation describing the motion for small deviations. I see two basic “forces” involved in market motion: “momentum” and “value pricing”. Positive momentum is the force that causes people to buy when the market is moving up (buying interest proportional to market velocity), negative momentum is the force that causes people to sell when the market is moving down. Thus momentum is a force proportional to velocity, sort of like inverse friction that doesn’t exist in the real world. Value pricing is what causes people to buy when prices are “too low” and sell when they are “too high”.

Of course all of this exists in the environment of slow upward drift and real-world-like friction of various trading costs as well as news events and money-supply formations that are not completely dependent on the immediate market dynamics. The relative amplitudes of the two forces also change with time.

Normally the two forces are balanced enough to keep the market gyrating around some sort of a temporary equilibrium that itself is slowly drifting. However, when the momentum force gets too high (as in 2000) it will break the swing.

Jeff Sasmor adds:

Another thing to consider is inertia. There is a nice article on this in Wikipedia and other sources.

The principle of inertia is one of the fundamental laws of classical physics which are used to describe the motion of matter and how it is affected by applied forces. Inertia is the property of an object to resist changes in velocity unless acted upon by an outside force. Inertia is dependent upon the mass and shape of the object. The concept of inertia is today most commonly defined using Sir Isaac Newton’s First Law of Motion, which states:

Every body perseveres in its state of being at rest or of moving uniformly straight ahead, except insofar as it is compelled to change its state by forces impressed. [Cohen & Whitman 1999 translation]

Perhaps this explains the recent upwards moves in stocks in spite of multiple discouraging memes. Humans have a lot of inertia, we’ve probably programmed a lot of it into the machines that do a lot of the trading these days.

It’s odd that this came up today, I was mulling the concept last night before falling asleep. Interesting questions that came up are:

  • What are the mass and shape of the market? How do you define it?
  • What are the forces? First-order ones are probably obvious.
  • What are the second-order forces - those which affect the first-order ones in smaller yet important ways?
  • How do they connect - are they independent or not?
  • At what levels do particular forces become important and others less so?

It is a system with a lot of inputs and time-varying coefficients. Maybe it’s a reverb chamber?

David Wren-Hardin mentions:

Swings and oscillations are found throughout nature where systems on different time courses interact with each other. One obvious relationship is the classic predator-prey population dynamic. As prey animals increase in number, predator numbers rise on a lagging basis. A peak in prey animals is followed by a crash as they consume their resources, dragging the numbers of predators with them. One can cast value investors in the role of rabbits, with their steady grazing on low-calorie fare, and the momentum investor in the role of the coyote, waiting for concentrated packets of dense nutrients. Or one could place the casual investor in the role of rabbit, and the average financial professional in the role of coyote, but I’ll refrain from that comparison so not to risk defaming the coyote.

Animals also use oscillations to find out information about their environment, much like the technical analyst or trading-surfer surveying their charts. The weakly electric fish, Eigenmannia, emits an electric signal as a sort of radar to find objects in its surroundings. The problem arises when another Eigenmannia is nearby, sending out a signal at a frequency near the first fish’s signal. This results in a “beat” frequency equal to the difference of the frequency of the two signals, composed of amplitude and phase modulations. Much like the market, when the agendas of different market participants collide, the result is confusion and little information for anyone. The fish responds by moving the frequency of its signal away from the other, a process known as the Jamming Avoidance Response. The fish doesn’t know if it is higher or lower, and has to solve the problem based on how receptors spaced over its body are receiving the phase information of the two signals. In essence, each receptor “votes” on whether it perceives the signal to be leading the other, i.e., it’s at a higher frequency, or lagging, i.e., a lower frequency. Any one neuron may be wrong, but in the aggregate, the animal arrives at the correct conclusion. In classic research, the late Walter Heiligenberg termed this organization a “neuronal democracy”.

As traders, individual neurons awash in the market’s oscillations, we are faced with the same problem. Are we leading? Are we lagging? It may come as little comfort that the market will eventually get it right, even if we are wrong.

GM Nigel Davies offers:

In chess this would be quite a typical scenario. Often when you inflict some kind of permanent damage (structural or material), there is a temporary release of energy from the other side’s pieces. The ‘trick’ is to balance the gains against the likely reaction, and this is also necessary. To improve a position you often have to allow some temporary (hopefully) counter play, kind of like a wrestler letting go of an opponent temporarily so as to get a better grip.

Dr. Michael Cook adds:

Gary comments that market gyrations are “nothing like a physical, earthly swing” because there are two forces involved. How about the case of a damped oscillation, which has physical analogues? Using this analogy, momentum investors are “damped” by the “restoring force” supplied by value investors.

And what happened in the bubble was the disappearance of effective value investors, which led to an un-damped oscillation, which, when driven at the appropriate frequency, leads to wider and wider oscillations which no physical — or financial — system can sustain.

The collapse of the Tacoma Narrow Bridge is the canonical example, and here is an illustration of the math behind the phenomenon.

Rick Foust contributes:

Imagine a ball rolling down a slight incline that has a crown in the middle and rails on the sides, similar to a highway with guard rails. The ball seeks the nearest rail, bounces repeatedly and eventually stays on the rail as it continuous forward.

Now imagine that the roadway has an irregular surface and rough rails. The ball will once again seek a rail. But this time, it will do so in a careening fashion that depends on the roadway surface. As it encounters a rail, it will briefly run down the rail, bouncing as it goes, until it eventually hits a point of roughness large enough to kick it to the other side. The amount of roughness required to cause a change in state depends on the slope of the underlying surface.

In the market, the rails are accumulations of large and small limit orders. Rail roughness is created by variations in order size and position. The roadway surface is formed by underlying market orders that create a natural drift. The roadway surface may undulate in a rhythmic fashion, similar to the Tacoma bridge, if market participant psychology is undecided. Or it may consistently lean in one direction if there is a prevailing sentiment.

At some point, limit orders at one rail or the other are exhausted, pulled or merely absent. At that point, the ball is free to discover the location of other rails. Stops are now run, creating new market orders. New participants are drawn in. If the new rails encountered are small and scattered, the ball will plow through them and may even gain momentum until it eventually encounters a rail large enough to stop it. Until this rail is reached, the underlying roadway slope will likely increase as sentiment is self-reinforced.



Over the holiday my family and I played a board game we've played many times before named Balderdash. The game is pretty straightforward. A dealer pulls a card containing several categories … a name, a date, an acronym etc. The entries are almost entirely unknown to the players. The goal then of each player is to make up a trivia fact that is believable to the other players. These fake facts are added to the real one and read by the dealer to the table. Points are awarded for picking the truthful fact, as well as getting other players to pick the one you conjured. The dealer scores by convincing the other players not to pick the correct one. This got me to thinking about the markets, life and bluffing specifically. When prices change, people wonder why. The truth is always that the supply/demand relationship has changed, but there are many people willing to fill in the "answers". What are the motives of those supplying the answer. In the game, one of the strategies employed is to pick the answer that you made up in an attempt to convince other players to do so. Do market participants ever do this? Generally, the more believable the fact you make up, the better. But sometimes, a preposterous answer works wonders. People simply can't believe its made up. When several answers have equal believability, the ludicrous answer stands out. The players almost talk themselves into believing it. Do we ever talk ourselves into things we know are bold faced false? When I was the dealer I always read the true answer somewhere near the middle. I know that in any list, the first and last thing a person hears sticks in their mind. Is the first explanation given for a market move the one that will be believed going forward, even when a better truthful answer comes along? I would like to hear more about bluffing from your readers.

Sam Humbert adds:

Santa brought us a game called Blokus last year, and, as mentioned by Tom Ryan, kids are eerily capable at it. Like Checkers and 9-Ball and (circa 1982) Space Invaders, it has a beautiful simplicity that hides much depth. Also, Blokus can easily be 'handicapped' by a simple rule such as 'adults must play their pieces from smallest to largest' (i.e., starting with the 1-square piece). I like to play the kids even-steven, subject to a some such simple constraints or rules-changes, but I find that not all games lend themselves to this. (Though many do: e.g. at Go Fish, I play level with the kids if I enforce on myself 'wait one full turn before asking for a card I just picked up!') Another great game to play with kids is Mille Bornes, though it seems not to be as widely circulated nowadays. They do make a new version, but I bought a 1970s set for a few dollars on eBay. It is self-handicapping because the kids gleefully gang up on Dad, taking delight in fixing my wagon again and again… until they get close to 1,000 miles and need to turn their attention to each other.



Quarter/Quarter Activity Annual Returns 3rd Quarter 2006 2nd Quarter 2006
GDP 2.2% 2.6%
Goods 3.7% 3.6%
Services 3.0% 2.4%
Quarter/Quarter Annualized Prices    
Market based PCE 2.2% 4.2%
PCE Price Index 2.4% 4.0%
Market PCE Core 1.9% 2.7%
PCE Core Prices 2.2% 2.7%
Market based PCE 2.6% 3.2%
PCE Price Index 2.8% 3.3%
Market PCE Core 2.0% 1.9%
PCE Core Prices 2.4% 2.2%

Note: This moderate and modest report will no doubt be seen on Constitution Ave. as validating both the Fed’s pause and the markets’ dampened vol readings.



If you like your movies to twist and turn like switchback roads in Glacier Park, splashed with a twist of love affairs, intrigue and the mystery of Nicholas Telsa, this is a very good movie. Michael Cain, who seems to go from very bad movies to very good ones is in a good ‘un this time.

Steve Leslie comments:

I agree wholeheartedly. I particularly liked the time period, 1897, and the cinematography. very artistically done. Plus it was extraordinarily well written.

There were great set designs and the lighting and costumes should receive plenty of nominations.

Four stars acting for Michael Caine, three stars for David Bowie and Christian Bale, and maybe even the ever present Hugh Jackman. I believe the director is the same person who directed Batman Begins.

One cautionary note. Watch very closely or you will miss some very important clues to the Prestige.



First let me preface my post by emphasizing that I am only posting this model because the analogy presented below ceased to exist within the sector (Canadian Banking Sector) subject of this model. I still believe that the model can provide a meal for lifetime with some modification and/or refinement. In this very simplistic model, I assume that all the Jockeys (CEOs) on top of the horses (Canadian Banking Stocks) are of similar skill set and reputation in the street (which in this case they actually are), I also assume that all the horses are of similar quality (the Bank Stocks are of equal fundamental quality, an assumption I make due to my inability to dig into fundamentals and pick favorites); and I also assume that every month is a different race.

In other words, Jan 1st to Jan 31st is the first race, Feb 1st to Feb 28th second race, etc…

A different model might want to consider Jan 1st to Sept 30th as the 1st race and Oct 1st to Oct 31st as the second since mutual funds report results then and since they own the biggest chunk of the sector under consideration. Another variation might regard the 12 months as one long race and each month as one lap in a 12 lap race and so forth.

For example, in the table below, at the end of January, BMO (Bank of Montreal) was the winner, followed by RY (Royal Bank) and so forth.

CM (Canadian Imperial Bank Of Commerce) was at the bottom of the list. Notice how the slacker for the first 5 races (CM) ended the year taking the lead.

My theory, playing on psychological biases and incentive is that given equal horses of same weight, speed, history, etc, the 2 jockeys with the most incentive to compete in a given race are the second horse that was so close to winning the previous race and the horse that came last since coming last race after race will cut into the jockey’s bonus that’s very highly correlated to where his pony ended in the overall race.

but, that needs to be tested …

This is how my racing form usually looks:

January - February bmo ry td bns na cm
February - March td ry na bmo bns cm
March - April ry td na bmo bns cm
April - May ry td na bns bmo cm
May - June ry na bns td bmo cm
June - July ry bns cm bmo td na
July - August ry bmo bns cm td na
August - September ry bmo td cm bns na
September - October ry bmo cm td bns na
Year to Date cm ry bns td na bmo
1 month na bns ry cm td bmo
3 months cm bns bmo ry td na
6 months bns ry bmo cm td na
1 year ry cm bmo bns td na




I propose One of the biggest problems of trading successfully is the in-built work ethnic, that is instilled in “us” at an early age. This may be something which is regional or religious based, but I believe this certainly works against us when looking to apply discipline to allow for a nice gradual equity curve.

Being from the “west” and school’ed, fed and watered from day one in the pursuit to work hard, thus achieve , reproduce and run a successful family, is I believe not conducive to allow the best characteristics and education to become a trader.

To sit for long periods, and hold the gun, during normal working hours, even though you may of been cleaning the gun and burning the midnight oil looking into research , number crunching and the like, and have done the time, still does not prepare the individual for long periods of holding positions without lifting a finger. These positions also, maybe out of the money, in the money, flat for weeks, before a solid explosion in volatility takes off, where unless risk and money management procedures are solidly adhered to, the human conditioning of work work work, starts to take over, and interferes with correct operating procedures to gain the most out of the position. So in reference to discipline I believe this relevance should be centered on, more so because it is what predominantly disables it.

It could be argued regions, where less importance is placed on routine and normal work practices, could produce interesting results , which of course does nothing to take away from the need for a suitable trading plan and approach to trading.

Tony C. adds:

I have often tried to explain to the young uns’ how I can be wrong most of the time and still make money … and that is a problem with trading.

Typically, you go through 16+ years of schooling, where very early on you quickly come to learn that getting anything less than 9 out of 10 right is a sort of mediocre performance, and getting anything less than 7 out of 10 right is failing … and results in an 80 year old practically blind nun, (who inexplicably possess an arm like Koufax’s), nailing you from across the room with a felt eraser …

Which is to say, you become conditioned.

And then you engage in a profession where getting 6 out of 10 right results in great riches, and even getting 4 out of 10 right results in a more than comfortable living [if you gain 61 cents the 40% of the time you’re correct, and only lose 39 cents the 60% of the time you’re wrong, … and you play often enough.]

So, folks that did reasonably well in their main activity in their formative years are fighting 16+ years of conditioning.

“Geez, I’m right only 4 out of 10 times, I must be stupid to be wrong so often … my success is all luck, I’m a fraud”, etc, etc. If only we could all think like baseball players.



You cannot be grateful and feel like anything is wrong or missing at the same moment in time.

Before the Thanksgiving spirit wanes, I for one, am going to try to hold onto gratitude, because in the Jack Nicholson line from the movie, As Good As It Gets, “It makes me want to be a better man.”

Try it. Think of three people that you are grateful to. Who were those people? What did they specifically do that you feel grateful for? Remember those people and what they did in detail and then try to feel angry, embittered and/or cynical. You will find it difficult to do so (unless by nature you take more pleasure out of being unforgiving).

There are a number of explanations for this, but my favorite involves neuroscience. When you feel angry, embittered and/or cynical, deprived, that something is missing or that something has been taken away from you, you react to that hole in your happiness — and neurophysiology — with resentment and may even feel the impulse to seek revenge.

When however you imagine in your minds eye the people you feel grateful to and envision clearly what they did to cause you to feel that way, the hole in your happiness–and in your brain and mind–spontaneously goes away, and is replaced by satisfaction and gratitude. In most people it even leads to the impulse to express that gratitude or even give back to the world.

If you want even more of an explanation for this, the entire process of remembering these wonderful people and feeling grateful to them is mediated by mirror neurons. These are cells that read minds and enable us to understand and empathize with others. And when in reverse we feel understood and empathized with by others, these are the cells that cause us to feel grateful and to borrow and recast a line from a famous old Beatles song, that is “what fixes a hole where the pain gets in.”



In honor of the Chair I am submitting this post: a short explanation of Le Chatelier Principle and the further development of the principle by Paul Samuelson.

Henry-Louis Le Chatelier — born Oct. 8, 1850, Paris, France and died Sept. 17, 1936, Miribel-les-Échelles.

French chemist who is best known for the principle of Le Chatelier, which makes it possible to predict the effect a change of conditions (temperature, pressure, and concentration of reaction components) will have on a chemical reaction.

What is this principle which is so highly recommended, and who is its author? The nature of the principle itself is as easy to grasp as it is difficult to state succinctly, and the man himself is almost totally eclipsed by the popularity of his most famous observation.

Any system in stable chemical equilibrium, subjected to the influence of an external cause which tends to change either its temperature or its condensation (pressure, concentration, number of molecules in unit volume), either as a whole or in some of its parts, can only undergo such internal modifications as would, if produced alone, bring about a change of temperature or of condensation of opposite sign to that resulting from the external cause.[2]

This may prove to be a cumbersome description of the principle so a more simpler version can be postulated.

If the conditions of a system, initially at equilibrium, are changed, the equilibrium will shift in such a direction as to tend to restore the original conditions.[4]

This principle which worked well in explaining how changing variables in a chemical reaction affect the equilibrium was expanded upon by the esteemed eonomist Paul Samuelson.

Paul A. Samuelson (born May 15, 1915, in Gary, Indiana) is an American economist known for his work in many fields of economics. He was awarded the John Bates Clark Medal in 1947 and Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 1970.

His Economics: An Introductory Analysis, first published in 1948, has become the best selling economics textbook of all time. The textbook has sold more than a million copies and has been translated into French, German, Italian, Hungarian, Polish, Korean, Portuguese, Spanish and Arabic.

Le Chatelier principle as explained by Samuelson, deals with constraints on maximizing behavior, explaining that short-run demands have lower elasticity than those in the long run since a longer time frame allows new factors and prices to change.

Le Chatelier principle has since been used to explain such events as domestic economic issues to market analysis to its efficacy in outlining a Theory of International trade.

I am sure there are many more and the wise speculator would do well to ponder upon them.



When I was younger and people would try to talk to me about Skinner and operant conditioning; I would always counter that “humans are not rats”. Rats do not have the option of opting out of the cage and finding food elsewhere. Rats are bred so that there is basically only one type of rat, humans are diverse. Traders, speculators, investors … subtypes of each — quants, value, growth, etc. If the market does not give a profit often enough the trader dies, yet the buy and hold investor (so far) eventually thrives. Yet, for short time periods — the buy and hold investor is often subject to ridicule. It seems to be assumed that a buy and holder is so stupid that they never take profits or cut losses on individual stocks, or build cash (from dividends/stock sales) to take advantage of downturns. Buy and holders in turn scoff at traders, assuming they all day trade until they go broke.

I live in an affluent neighborhood in San Francisco. Ten years ago, when walking around doing errands, I would see perhaps one or two baby carriages, pushed by obvious nannies (Hispanic women-blonde children), now the sidewalk is so filled with carriages that it can be difficult to get around them; and they are being attended to by women who actually appear to be the mothers. Is this happening elsewhere? A new baby boom among the affluent seems to me to be a hugely bullish sign and counter to the “everyone is going to sell their stocks when they retire” meme.

Luck is important in any undertaking. Can luck be counted? Is the VIX becoming unreliable as a fear/greed indicator? Is it possible to have equal but ever increasing amounts of both fear and greed?

I know it is time to start selling a speculative position when I start worrying about the tax consequences of taking profits, although I am usually early.



I made some excellent trips to the Seminary Book Store in Chicago and University and Follets book store in Austin, both of which had many good books.

I also found that the roller derby in Austin has many similarities to market moves, with two sparks waiting 20 yards back while the rest of the pack jockies for position, reminding one of the battle that stocks and bonds often play while the other markets jockey around to let their side win. I will relate this to the Texas proverb about ‘never talking big unless you can shoot well’, and Laurel’s two stepping at the Broken Spoke, imminently.

With money unlimited in Texas due to incentives provided by a lack of income and estate tax, museums in Texas are on a par with anywhere. We particularly enjoyed the State History Museum, the Blanton Museum of Art, the Zilker Botanical Garden, the Harry Ransom Center and the North East Texas Childrens Museum, as well as a spectacular visit to the Museum of Science and Industry in Chicago. Austin has many advantages over many other warm cities that I have visited, with its many entrepreneurs and techs, a University, and much culture, diverse landscapes, many young people, the Austin Opera on a par with New York (We caught a fantastic performance of Madame Butterfly), and more live music than anywhere in world. Prices for real estate seem rather modest relative to other warms cities.

It is good to be back with the Specs again. And the market finally scored a down day on Friday, setting one up for a good study of the first 11 months of the year as a predictor of the last. Vic



Bronstein once complained to me about how today’s players lacked the responsibility of his generation. Indeed chess was bound up with ideological considerations during the era of Soviet domination, the leading Soviet GMs being representatives of the state, examples to the masses. Even before this the game was imbued with meaning as Steinitz, Tarrasch and others debated points of strategy on the board, their own struggle reflecting a larger battle in the war of ideas. Players were said to have founded ’schools’ and felt obliged to write books expressing their ideas, something which these days would be laughable.

Now there is no ideological battle, no war of ideas, just the game as a ’sport’. So if a single player tries to perfect his game, without writing books or teaching, is he serving no broader purpose, giving nothing back? Actually I would argue that the act of self improvement will inevitably bring benefits to the world at large as it changes the way we are, how we interact with others and in doing so has a knock-on effect. Perhaps this game is ’smaller’ than in the days of Steinitz or Botvinnik, but it is nonetheless there.

One of my goals is to write a good chess book, for what I believe to be similar reasons that Ken feels compelled to play a bigger game and the chair has written books and founded the speclist. But I wouldn’t call it ’social justice’, it is something else.




I often ask myself what is the purpose of my trading. Yes, I know, I do it for the money, for the intellectual challenge, and all that. I also understand how the markets function by allocating capital and signaling value, etc., and how I am a small, small part of that. But I mean it from a different perspective. Having worked a lot with business planning (mostly with LOTS) in different companies, I often think of how I would characterize my reason for trading if I were to write it in a business plan format. If I sold some gadget for example, I would ask: What is the purpose of the selling of the gadget? Who benefits from it? What is the underlying reason that there will be a value gained from my selling the gadget, from which I can make a profit. I think that the same applies to trading. Furthermore, a good purpose should also function as a day to day rudder and make sure that I do not deviate from my niche. To do that, it should encapsulate what we should do, why and for whom. With a well thought out purpose, we should be guided both in our every day activities as well as our important long term decisions.

During the talk this year in Central Park, Mr. Wiz mentioned something that perhaps is not spelled out as a company or trading purpose, but which I nevertheless think was one of the best fitting purposes I have ever heard, as far as I understand the underlying thinking in the company. He said: “We provide the market with liquidity in fearful situations”. Well, it seems to have worked out quite nicely, and I think there is a lot to be gained by all traders from being very clear with what it is their niche is in the market, and spelling it out in a “trading purpose”.

Scott Brooks adds:

Providing the market with liquidity in fearful situations is tantamount to buying low. The flip side of this coin is providing the markets with liquidity during the great times, which is tantamount to selling high!

This is an investment philosophy that I invented years ago … it is called “Buy Low and Sell High” … (I know, you’re shocked, you did not know I was the inventor of “buy low and sell high”)

But seriously …

This was described to me by a college professor as the “good guy school of investing”. It works like this:

If someone wants to sell you something for far less than it is worth, be a good guy and buy it from them. Conversely, if someone wants to buy something from you for far more than its worth, be a good guy and sell it to them.

The “Good Guy School of Investing” is providing liquidity to the markets during fearful situations (and also providing liquidity when the party the market mistress is throwing is at its crescendo.)

In between, just take advantage of the long term positive drift!

Dr. Kim Zussman comments:

I recall Viktor Frankl’s Man’s Search for Meaning. His conclusion was that we are not in a position to ask life it’s meaning - life will ask you to determine it’s meaning.

Something like ‘what you get out of it is proportional to what you put into it.’ Even if you lose, or under-perform various benchmarks, you get to be ironic.

For some, trading has analogies in most aspects of the universe, and can become self-consuming. To others it is just money; and Buffett, Soros, Ken Smith, etc. all put on their pants one leg at a time and suffer the same frailties we all do.

Laurence Glazier contributes:

This brings to mind the great Armstrong lyrics:

If I never had a cent I’ll be as rich as Rockefeller Gold dust at my feet on the sunny side of the street [More]

So above all let us trade for the love of it! Trading is a two way process and equally important as our purpose is the realization that it shapes us, acting, like other arts, as a mirror.

GM Nigel Davies mentions:

Something I’ve noticed with many very strong chess players is that they don’t need to think about purpose, they are simply at one with the game. And one of the best ways to nobble a tournament leader is to congratulate him on his excellent play and ask what it is that he’s doing right (not that I’d use such a tactic myself).

Accordingly I suggest that one of the goals of mastery is get past the stage of awkward consciousness and discussions such as the present one. For a chess player it should be enough to say ‘I crush, therefore I am’, and the trading version would be ‘I’m profitable, therefore I am’. And the strategies required should be in one’s blood, things that are so well studied and deeply ingrained that one uses them as naturally as breathing.

Jim Sogi adds:

In Trading and Exchanges by Larry Harris of USC discusses why People Trade. People trade to invest, borrow, exchange assets, hedge risks, distribute risks, gamble, speculate, and deal. Understanding the reasons different people trade and the taxonomy of traders, including ourselves, allows understanding the opportunities that arise. Interestingly a smaller percentage of participants are true investors, and even fewer are speculators. Of those even fewer of what he terms informed speculators are the statistical arbitrageurs, of which we compose a small part. Oddly Many do not trade to profit but for other reasons. This is where the speculators purpose in the firmament comes in, and for which we are rewarded, to facilitate the other purposes of the other participants. They pay us for that privilege. Dealers are the ones who sell liquidity, not the speculators. The above does not answer the heart of Mr. Lindkvist’s query, but it does set the framework for the answer which must vary according to each of our purposes and which niche into which we fit in our respective operations.

Larry Williams mentions:

Years ago we did a personality profile at seminars asking traders to list the 3 primary reasons they traded.

None of them listed as the first reason to make money.

Answers were like, “Excitement, Challenge, to show my brother in law I’m smarter than him, etc”

Kim Zussman creates a masochist/self-loathing correlation matrix:

Long Only Bought Hold Sold
Too Soon -$ -$ -$
Too Late -$ -$ -$
Too Long -$ -$ -$
Long/Short Short Flat Long
Market Up Up/Down Down
Short Only
100 Year Return -1,000,000%

Steve Ellison comments:

There is a technique used in ISO certification called SIPOC. In this technique, an organization identifies its suppliers, inputs, processes, outputs, and customers (hence the acronym). The organization divides its processes into those that create value, triggers for value processes, and supporting activities that do not themselves create value for customers but facilitate value creation. This technique can help an organization articulate its value proposition and focus its processes on value creation.

Participating in a SIPOC exercise this week challenged me to consider how I might apply this technique to trading. A trader might create value in any of several ways, including providing liquidity, moving price closer to true value, assuming risk that others wish to avoid, and providing psychological relief by taking other traders’ losing positions off their hands.



The story of the Pilgrims’ first years in America shows how a change from common ownership to private property led to the feasting celebrated today at Thanksgiving. Similar tales of expanding harvests and benevolence are told wherever people can keep the fruits of their labor and trade them as they please.

The story illuminates why eBay and Chicago Mercantile Exchange Holdings, the owner of the Chicago Mercantile Exchange, were among the two best-performing stocks in their class during each of the last two years, and it provides a useful signal that other markets now preparing to go public might be good investments.

After landing at Plymouth in November 1620, the Pilgrims endured a cold, hungry winter during which half of them died. Promised supplies failed to arrive from London. The 1621 harvest wasn’t as big as hoped, nor was the 1622 harvest. More famine seemed inevitable.

And then the colony began to talk through the problem. The London merchants who financed the Pilgrims’ settlement specified “that all such persons as are of this colony are to have their meat, drink, apparel, and all provisions out of the common stock and goods of the said colony.” In 1621, the Pilgrims planted 26 acres, according to Judd W. Patton, an economics professor at Bellevue University in Nebraska. In 1622, they planted 60 acres, but that wasn’t enough to keep hunger away.

People began to steal by night and day, “although many were well whipped,” Gov. William Bradford reported.

The system made no sense to anyone. The hard-working subsidized the slackers. The young and ambitious didn’t want to do work for anyone else and get nothing for their trouble. The wives of some of the men objected to be commanded to wash clothes, dress meat or do other tasks for other men.

As Bradford would later write in “Of Plymouth Plantation 1620-1647,” “At length, after much debate of things, the Governor (with the advice of the chiefest amongst them) gave way that they should set corn every man for his own particular, and in that regard trust to themselves, in all other things to go on in the general way as before.”

In what’s known today as the Land Division of 1623, each family was allotted land at the rate of one acre per family member and told to go out and produce. More than 184 acres were planted that year. And, Bradford reported, “This had very good success, for it made all hands very industrious, so as much more corn was planted than otherwise would have been by any means the Governor or any other could use, and saved him a great deal of trouble, and gave far better content. The women now went willingly into the field, and took their little ones with them to set corn.”

What is apparent from this history is what we all know from our experience: When you can benefit from working hard, you work harder. Under the system of common ownership, there was stealing, shirking and malevolence. Under the incentive system, there was good feeling, hard work and benevolence.

News of the success at Plymouth and other settlements like it attracted more and more immigrants to the New World. And everyone who lives in America today has a personal story that is part of that great continuing tale.

The impulse to improve one’s conditions through greater effort and trade is as natural as breathing, and this has been so since the beginning. New York University economist Haim Ofek, in “Second Nature: Economics Origins of Human Evolution, argues that trade helped spur the growth of the brain.

“Exchange requires certain levels of dexterity in communication, quantification, abstraction, and orientation in time and space, all of which depend on the lingual, mathematical and even artistic faculties of the human mind,” Ofek writes in the introduction to his 2001 book. “Exchange, therefore, is a pervasive human predisposition with obvious evolutionary implications.”

Relatively flexible and acute people had an edge in trading. They survived and prospered, they had bigger, healthier families, and their descendants became dominant.

The success of eBay since its founding in 1995 shares many similarities with the Pilgrim story. Now a public company with a market value of around $75 billion, eBay has created an electronic network of niche markets that takes account of the infinity of human tastes and aptitudes and specializations. The stock is up 72-fold since its September 1998 IPO, from a price-adjusted initial price of $1.50 to $109.42 as of Nov. 15. That is after a 77% drop in the tech crash of 2000.

Like the Pilgrims, eBay gives each of its sellers a piece of land (though in virtual space) to carry out his or her business. A spirit of benevolence is apparent in the company’s feedback system; in almost half the transactions, both buyer and seller rate each other, with almost all them highly favorable. But to us, there is one overriding reason for eBay’s success: It unleashes the desire and provides a forum for buyers and sellers to improve themselves by trade in a million ways every day.

The CME, odd as it sounds, also bears some similarities to Plymouth Colony. Founded in 1897 as a member-owned organization, the Merc started out as a market for the trading of foodstuffs. Its activities and goals were torn between the interests of the members and the interests of the public. A low point was reached in 1989, when a widely publicized sting operation uncovered conflicts of interest and failures to give the public a fair shake.

For years, the Merc had been content to play a sleepy second fiddle to the Chicago Board of Trade both in volume and number of products traded. In 1972, an inspirational governor — in this case, Leo Melamed — decided it was in everyone’s interest to match members’ interests with the growing public interest in financial products such as currencies, Treasury bills, Eurodollars and stock market futures. Growth exploded in 2000 as the CME prepared for the shift to public ownership by converting members’ interests to shares. Since the Merc went public in December 2002 with its shares listed on the New York Stock Exchange, the stock has risen nearly six-fold, and it has stayed in the top 10 of NYSE performers.

In effect, the CME transformed itself from a tradition-bound club with the image of a raucous den where men shouted at each other to get an edge on the public in trading pork bellies. Instead, it became a pioneering company that lets hardly a week go by without introducing a new electronic product designed to give the public more ability to improve and hedge their ownership of stocks and debt.

The table below shows how acreage planted and revenues grew at Plymouth, the CME and eBay.

The Plymouth, Chicago Merc and eBay experiences
Year Plymouth acres planted CME revenue* eBay revenue*
(1621/2000) 26 $226.6 $431.4
(1622/2001) 60 $387.2 $749.8
(1623/2002) 184 $453.2 $1,214.1
(2003)   $526.1 $2,165
(2004)**   $743.8 $3,260
* In millions    **Analysts’ estimates

The Pilgrims originally agreed with the London merchants who financed their settlement to hold their land and its products in common, a sort of forced socialism, much as the communists imposed on Russia after the 1917 revolution.

And the Pilgrims learned, as the Russians would, that the system led to misery and poverty. Whenever trade and its rewards are permitted, well-being and output improve across the board. The principle is so mundane that it’s hard to believe that it could ever be forgotten. But it was. The Soviet economy broke down because people had no incentive to reduce costs, to produce a quality product, to provide the kind of gracious service that an American expects from even a humdrum retailer.

If it weren’t for those who risked death — literally — to start private enterprises on the black market, the Soviet system would have collapsed long before it finally did.

Everyone knows a million examples of how people respond to incentives. It’s no accident that when President Bush won a reduction in taxes on capital gains and stock dividends in May 2003, the S&P 500 ($INX) responded with a 27% rise. Incentives to buy stock increased, so prices rose. The after-tax returns from stocks increased, so the public decided to place more dollars into stocks versus the alternatives.

In Plymouth, thanks to the gift of the Land Division of 1623, trade was created, and it did what it has always done:

  1. It allowed economic freedom. The Pilgrims borrowed the money to start their colony. Their decision to redistribute the land allowed rapid repayment and the freedom to practice their beliefs as they wished.
  2. It financed new enterprises. The Virginia Company of Plymouth served its own interests by lending to farmers, giving the company a chance to increase its agricultural imports.
  3. It increased output. When each Pilgrim family gained the freedom to labor as they wished in exchange for the freedom to keep their crop, yields increased.

We believe the successes of the Pilgrims, the CME and eBay are not anomalies. And we will predict success for any company or country that lets people trade as they are predisposed to do by instinct and common sense. If the International Securities Exchange and Chicago Board of Trade follow through on plans to offer shares to the public and if the New York Stock Exchange ever goes public, we’d recommend buying those stocks.



December is a generally good month averaging about a 1.5% rise in the S&P, and having declined only 7 out of the last 26 years since 1979.

  • The biggest decline during this stretch came in 2002 with a 7% decline, which had been preceded by a 20% decline over the previous 11 months, and the next biggest decline was of 4% coming in 1980, following a 30% rise over the preceding 11 months. The biggest rise came in 1991 which was 11%, and followed a 10% rise over the preceding 11 months. The second biggest rise of 6% came in 1987, which was preceded by a big decline of 4% in the preceding 11 months. Thus, big declines come after big rises and big declines, and big rises came after big rises and big declines — in aggregate there is certainly not a linear relationship. All one can say about the extent to which this is non-random is that about half the moves were approximately 1% rises, and there were a few outliers that followed enormous rises and declines from the preceding 11 months.
  • An attempt to get proper percentage changes, and proper adjustments for a series like this shows the need for careful work. The S&P Index started out at around 108 in year end 1979 and now is at 1400, but the algebraically adjusted futures (the only way to go), started out at approximately 600. Any calculations that do not take into account the influence of dividends and levels on studies like this are woefully inadequate.
  • A look at adjusted S&P futures shows that, from November 1998 when they stood at 1400 to date, a buy and hold strategy would have broken even. It is no wonder that there is so much potential for people who have missed the boat — for the Abelprechflecfals of the world to join the party and create a big move or to catch one up.
  • Some of the changes this year are somewhat inconsistent with the 10% yearly volatility one would compute from extrapolation of daily variations. There is a nice 30% move in the first 11 months of 1980, a rise of 31% in 1995, and four other changes of approximately 25% for the year during the test period. The problem with selling calls and covered writes is clearly indicated by these moves, as is the reason this is all so popular on Wall Street, causing the public to lose much more than they have to lose.
  • The Astronomer Royale, Dr. Kim Zussman, has performed a nice regression with an r2 of 8%, showing that the first 11 months is positively correlated some 30% with the next month. Unfortunately, with small numbers like this, a non-linear relationship and a few 30 percenters contributing to the sum of squares, this is not overly meaningful and certainly not predictive.
  • I am often asked the proper way to learn to count. A good way to do it is to wrestle with monthly adjusted prices and unadjusted prices and do some calculating … In fact, I propose a method. Start with 1979 year end, as 1969 year end or anything else is much too far back to be relevant to anyone but the chronic bears. Consider four hypotheses as to the predictive powers of December:
    1. Compute a regression prediction of December based on all the data available up to that time. For example, in 1982 you would have two observations, 1980 and 1981. In 1983, you would have 1980, 1981 and 1982 to fit.
    2. Compute the average move in the Decembers up to that time and predict that the next month will be the same.
    3. Compute the average move in the last three Decembers, and predict that the next month will be the same as this.
    4. Take the prediction generated by the first three methods each year and find which one has the best forecasting record in the past, and use that method for the next prediction.

    Now you have four methods of prediction. Does any beat just predicting the average change from month to month based on simulation, by a reasonable amount. If you want to make money, or test seasonality properly you have to use your head.

  • Some of the years are amazing in retrospect. There was 1997 where some people, I am told, lost a lot of money in Thailand and elsewhere from the bull side. Yet the market went up 26% in that year. There were the ‘5 years of 1985 and 1995 where the market pushed up 30% on the year. Also the year 1987, where the market was actually making a comeback in December. There was a run of fantastic rises in 1995 to 1999 pushing 20% or more in each one.
  • As we have seen the market went from 100 to 1400 during the 26 year period that I have reviewed. Were there any negatives in any of these years, and were they more or less than the present? Are they counterbalanced by any positives or has this been discounted, and is this more or less bullish than usual?
  • There would seem to be a tendency for the market to do well in December over the years. Is this due to the generally optimistic spirit that most of us have in December and is there more than one way to make a profit from this?
  • Year Adjusted Futures Move for first 11 Months (%) Adjusted Futures Move in December (%) Start of Year S&P Index
    1980 30 -04 108
    1981 -09 -03 136
    1982 13 01 122
    1983 15 -01 141
    1984 -03 01 165
    1985 20 05 167
    1986 20 -03 211
    1987 -04 06 242
    1988 10 01 247
    1989 25 01 278
    1990 -10 01 354
    1991 08 10 330
    1992 03 01 417
    1993 08 01 435
    1994 -02 01 466
    1995 30 01 459
    1996 25 -02 616
    1997 25 01 741
    1998 15 05 971
    1999 12 04 1229
    2000 -10 03 1469
    2001 -15 01 1320
    2002 -20 -07 1148
    2003 15 04 880
    2004 06 03 1112
    2005 05 -0.5 1211
    2006 09   1248

    Dr. Kim Zussman adds:

    Looking further at the same monthly data, December moves seem large compared to the prior 11 months. To check this (and eliminate effects of sign), for each year I looked at the ratio of absolute values:

    |Dec ret|/|J-N ret|

    One would expect each month to contribute something like 1/11 of the return of the prior 11 months. But Decembers are larger, as shown by the data:

    Year Jan-Nov Dec |Dec|/|j-n|
    2005 0.031 -0.001 0.031
    2004 0.056 0.032 0.583
    2003 0.203 0.051 0.250
    2002 -0.184 -0.060 0.327
    2001 -0.137 0.008 0.055
    2000 -0.105 0.004 0.039
    1999 0.130 0.058 0.445
    1998 0.199 0.056 0.283
    1997 0.290 0.016 0.054
    1996 0.229 -0.022 0.094
    1995 0.318 0.017 0.055
    1994 -0.027 0.012 0.450
    1993 0.060 0.010 0.169
    1992 0.034 0.010 0.296
    1991 0.136 0.112 0.819
    1990 -0.088 0.025 0.281
    1989 0.246 0.021 0.087
    1988 0.108 0.015 0.136
    1987 -0.049 0.073 1.487
    1986 0.180 -0.028 0.158
    1985 0.209 0.045 0.216
    1984 -0.008 0.022 2.733
    1983 0.183 -0.009 0.048
    1982 0.130 0.015 0.117
    1981 -0.069 -0.030 0.434
    1980 0.035 -0.034 0.966

    The attached plot depicts |Dec|/|J-N| vs. date, and though variability in this fraction has damped out over time, it still seems high. Even discarding two out-lying years of ‘83 and ‘87, the mean ratio is 0.26; almost 3 times 1/11.

    Rick Foust comments:

    I suppose that there are two major factors (amongst other smaller ones) that cause the December effect.

    The first is money flowing into IRAs prior to the end of the year. Someone on the retail side of the business could confirm or refute this.

    The second is large fund rebalancing. Some funds operate on the basis of maintaining a fixed ratio in various asset classes (percent stocks to percent bonds…). Periodic rebalancing of the ratios forces them to buy the asset class that has done poorly and sell the asset class that has done well. It seems that rebalancing predominantly takes place towards the end of the year. Surely there is someone here that could confirm or refute this.

    Scott Brooks offers:

    IRA fund flow is bigger towards the end of March thru about April 20th or so than it is in December (I say April 20th because the envelope the IRA deposit check is mailed in need only be post marked April 15th).

    One can also look at index reconstitution as issues are dropped and others added to the indexes. However, this has the greatest effect on the smaller issues (smaller in terms of cap weighting). Most larger capitalized stocks are going to stay in the index and could be bought in an effort to rebalance a portfolio fund back into the index weighting.

    As a result, the index funds have to go thru a flurry of rebalancing, selling the issues dropped from the index and buying those that are added….and proportionalizing those stocks that stick (again, mainly the largest capitalized issues).

    Something else to consider (for both money managers and individuals) …

    Stocks that have a loss are often sold to realize capital losses to offset the fact that …

    Stocks that managers or individuals feel have run their course and have a gain are sold.

    Another phenomenon that occurs are RMD’s (Required Minimum Distributions) for those with qualified money that are over 70. This is a forced sale for no other reason than realizing taxable income. What’s interesting is that this now becomes money in motion and as a result, opportunity to invest in other areas. As the baby boomers age, this will become more and more of a factor … especially since such a large number of boomers bought into the myth that they will retire in a lower tax bracket than when they were working.

    I’m sure there are are many other reasons that our resident bond mavens and options experts (as well as anyone smarter about the market than I) could add to this discussion

    An Anonymous Contributor says:

    In his post Kim Zussman wrote that:

    Looking further at the same monthly data, December moves seem large compared to the prior 11 months. To check this (and eliminate effects of sign), for each year I looked at the ratio of absolute values:

    |Dec ret|/|J-N ret|

    One would expect each month to contribute something like 1/11 of the return of the prior 11 months.

    No, one wouldn’t. Since you already have all the data, go ahead and look at every month relative to the other eleven months of the same year (or to the preceding eleven months, it won’t make much of a difference). My own back-of-the-envelope calculations with unadjusted data show a mean of about .22 over all months, with December being somewhat below average.

  • Nov


    Below is the distribution of months between the chronological record of the 100 largest declines in S&P futures from January ‘01 to date. Starting with the January 2, 2001 decline of 27.1 points and ending with today’s, decline of 19.3 points, they range in size from a 57.0 point decline on 9/19/2001 to a 17.3 point decline on 8/28/2001.

    Months Between Consecutive Declines in Top 100
    Number of Months Number of Observations
    0 61
    1 28
    2 03
    3 03
    4 02
    6 01
    14 01

    The average duration between each of the top 100 declines was 1.5 months. A time series of the durations between consecutive large declines however shows that the average duration between them was 1/3 of a month in 2001, 1/4 of a month in 2002, 1 month in 2003, 1 and 3/4 months in 2004 , 14 months in 2005, and 2 months in 2006.

    Kim Zussman adds:

    Since late 2003, big daily moves (up or down more than 1%) look to be less frequent, as well as smaller, which fits with the secular decline in volatility. The frequency change is shown by counting moves per year:

    Year Down Up Up/Down
    2006 13 13 1
    2005 21 16 0.76
    2004 22 23 1.05
    2003 38 42 1.11

    The ratio of up/down is 1 or more for all years, except for 2005 (Which fits with other studies suggesting interval-returns scale contemporaneously to count down days).

    Another observation is that yesterday’s decline is the first in a while, whereas big advances have been more evenly spaced. In fact when ranking gaps between big declines, yesterday’s was the longest hiatus dolor of any since January 2003.



    Tasmania’s land bridge to the Australian sub continent was flooded about 14 thousand years ago, which cut off the isolated island from all outside influence. The land enjoyed a cool but stable climate untouched by ice ages. The relative isolation, the lack of predators and the stable climate and geological environment led to the evolution of relatively docile, primitive and slow moving marsupials which survive today in abundance. The aboriginals were exterminated completely by the Anglo-Saxons. There are now few humans, making Tasmania the least crowded, cleanest first world developed place that I have ever visited. The half a million very friendly, talkative and hospitable people are 99.999% of European descent. They and their children appear to have much less anxiety and stress than Europeans, Americans and Asians from more crowded areas. The cities reminded me of Portland Oregon 40 years ago and San Francisco 100 years ago.

    The primitive marsupials tended to be gentle, docile and slow moving due to the low environmental stresses. This is compared to aggressive placentals such as the fox which was a recently introduced problem in Tasmania. Though there were only a few cars per hour on the roads, road kill was abundant. The hypothesis is that the low environmental stress leads to less aggression and slower moving adaptations. There were impressive predator birds such as Harrier hawks swirling close with sharp eyes for unwary prey hovering close to the road sides. The image of the speculator as the predator hawk and the docile foragers as the prey is apt. The marsupials have interesting adaptations to stresses (such as drought). They can have three embryos, each on a different feed teat, and can retard development of the embryo when conditions are harsh, or speed it up when feed is abundant. Unfortunately the last Tasmanian tiger, a marsupial carnivore, was killed in 1936 and is now extinct. Even high level predators suffer extermination at the hands of even higher level killers, in this case the humans. When a storm blows the rain, all the sheep face in the same direction.

    How can the lessons from Tasmanian ecology help with an understanding of the market ecology? The current remarkable low volatility market reminiscent of the Tasmanian experience leads to the hypothesis that the long periods of low stress and low volatility promotes docile and slower moving participants and slower evolution. Applying this to the current market we observe that there has not been any new 20 day lows for 90 days now, and there has been a steady march upwards with low volatility. There has not been a 20 point open to close drop for almost a year since 2006-01-20.

    As with physics and geology, the study of micro structure allows insights into macro and cosmic structures and function. The same holds true in finance where micro structural elements can explain markets. A descriptive theory for the reason for the low volatility is that the CME futures are causing or contributing to the broader markets low volatility. CME equity index futures hit record high volumes CME E-mini equity index volume set a monthly record of 2.1 million contracts per day, up 70 percent, and a quarterly record of 1.7 million contracts per day. Globex does not have true market orders but limit and modified limit orders only.

    As explained by O’Hara in Market Microstructure Theory and by Osborne in The Stock Market and Finance, it is the interest of the market maker to have only limit orders to avoid the uncontrolled gaps that pure market orders cause in panics, without specialists where the market makers get caught with an inventory imbalance. With only limit orders micro-structural theory predicts the benefits to the exchange and the market makers resulting in the steady clicking up and down in orderly increments of limited price change, allowing maximum profit to the exchanges with maximum volume and steady but small price changes to benefit the market makers. In fact we see the increase of market making type behavior in the predicted market motion of a steady clicking up and down and very structured waves in the market with relatively low volatility and limited ranges. The behavior is characterized by a buy at or near bid and a sell at or just above ask. A steady click up and down in limited ranges allows a steady foraging income to the participants. This explains in part the current low volatility index future type action. As more participants are attracted to this cycle by necessity, the volatility goes down and size and leverage goes up. The tail wags the kangaroo as arbitrage causes the rest of the market to start following the future and further decreasing volatility. If this hypothesis is true, it is not likely for volatility to increase cyclically which is what Professor Ross has been telling us as well. There are periods when the density thins, such as right before an announcement, and the resultant opening up of volatility, but it shuts down right away. When a storm blows the sheep face in the same direction. This type of low volatility foraging allows growth of the population as there is steady and adequate food for these participants, but complacency is dangerous as population grows and the demands on the food stock and competition for resources increases. This is why the fox is so dangerous.

    Evolutionary cycles and the market ecology require adaptation to survive and prosper. This might mean avoiding overcrowding over grazed foraging areas. It means developing better predatory tactics or low effort foraging. Mid level predators such as foxes and harrier hawks need to avoid extinction by higher level market participants even in low volatility environments. The smaller operations are at risk from large farming/hedge fund operations and their need for bigger trend moves or perhaps vice verse. As in nature, in the markets, understanding the cycles and their causes enables survival and prosperity.




     The elections held in The Netherlands on Wednesday have shaken the country. Almost 10 million votes were cast, and statistics show that a full half of those who voted used a popular web-based voter guide. This guide is operated by the independent institute for the public and politics. Advice is given to the visitor upon answering a number of multiple choice questions on some common political topics. Statistically, a number of people ended up scoring in support of populist parties both on the far left and far right. No bias was reported to exist in the test itself. However, these parties have ended up with an unforeseen amount of power as a result of the election. The voter participation was high, and the web-based advisories may have motivated people with little interest in politics to cast a vote anyway. Can politics be simplified to a ten minute test?

    The above thread discusses the impact of a neutral opinion test on the recent Dutch election. The test, English version here, took me less than 5 minutes to take. It is interesting to contemplate the impact this sort of thing might have going forward.



    According to the article S&P fears defaults after merger boom:

    …the value of deals agreed worldwide this year has jumped to $3,230 billion (£1,700 billion), up 40 per cent compared with the same period last year.

    And according to Wikipedia, here are the worlds largest markets (plus a few extras) as of some recent date:

    Ten Largest Stock Exchanges by Market Capitalization (in trillions of US dollars)

    New York Stock Exchange - $22.6
    Tokyo Stock Exchange - $4.5
    NASDAQ - $3.6
    London Stock Exchange - $3.5
    Euronext - $3.3
    Toronto Stock Exchange - $1.83 [3]
    Hong Kong Stock Exchange - $1.55
    Frankfurt Stock Exchange (Deutsche Börse) - $1.4
    Madrid Stock Exchange (BME Spanish Exchanges) - $1.1
    SWX Swiss Exchange - $1.1


    Milan Stock Exchange (Borsa Italiana) - $0.94
    Australian Stock Exchange - $0.73 (June 2005)
    Bombay Stock Exchange - $0.73 (October 2006)
    Shanghai Stock Exchange - $0.64 (November 2006)
    Johannesburg Securities Exchange - $0.58 (September 2006)

    This is a total cap of $48.1T, so YTD buyouts are at $3.23T, or 6.72% of global cap.

    You would think that this would put a little upside pressure on the markets. Not to mention whatever the receivers of that $3.23T in buyout payments plan to do with their money!



    I was eyeballing a Daily Mail article on the Paul McCartney divorce, and came upon this passage:

    I remember him saying that all she thought about was money and that she had asked for £80million. He said something like, ‘She is going to take me for £80million, because we now know it’s for £80million. All she thinks about is dollars’. He even drew dollar signs to emphasise it.

    What struck me was how a UK subject would talk about money and specific amounts denominated in pounds sterling, but when it came to symbolize the wealth, he spoke of dollars, even drawing $ signs.

    Something to contemplate amid the unending litany of dollar doom stories.



    Gold has gone up 23% on the year and 11% since the Fed got a new chairman. By making the actions of the Fed transparent, and hence the cost of money completely predictable, assets are being driven to their maximum valuations because there is no uncertainty to be discounted. This I believe has raised the market’s crash potential should a change in expectations occur. And while I have long believed the Nasdaq could potentially make it back to the lows of its crash at 3042, I also think gains from this point in time will prove to be fleeting a few years hence as yields have a tendency to chase speculative activity.



    Freakonmics author/blogger Steven D. Levitt asked his readers to name the “most trusted” person in America. (He didn’t know that was Walter Cronkite’s nickname.) The results, from among 150 replies:

    Warren Buffett 8 Bill Gates 7 Jon Stewart 7 Oprah Winfrey 6 Alan Greenspan 4 Billy Graham 4 Colin Powell 4 Bill Clinton 4 Tom Hanks 3 Dr. Phil 3 Paul Harvey 3 Mister Rogers 3 George Bush 3 Homer Simpson 3

    The only positive thing I can say about this list is that it is led by two notional capitalists.



    Through my observations playing in many many tournaments and cash games, and through reading of countless books and columns, there are a few points that one needs to always keep in mind.

    Poker is like golf in that one can never master it one can become more skilled at it. There is always something to be learned every time you play. There is no black box that can be manufactured to help one master the game. You can become successful by learning basic skills, but to go to the next level, you must constantly refine the skills and always be willing to adapt. Doyle Brunson said that the problem he had with writing Super System is that everyone read it and whenever he played a game, his opponents played against him using his own strategies as outlined in the book.

    In poker, if one is not studying the cards one needs to study the people. the dynamics of the human spirit is what makes poker fascinating. Therefore poker is much more than statistics. Blackjack is pure statistics. Poker is a microcosm of life. In my view, the best poker players are great students of behavioral psychology, sociology etc. They love to study people. The phenomenon of social interaction combined with money is the engine that powers the train. You can only get so good at poker by playing online. It is a world of difference between playing someone online and looking at them across the table.

    The great poker players are the most consistent. They play their style successfully. They have amazing abilities to focus. To stay in the moment and to play within themselves.

    Poker is generally straightforward. Meaning most of the time one should play the hands that have the highest probability of success. I have heard poker pros state that amateurs always overestimate and overvalue the bluff. In other words, pros bluff rarely. Dan Harrington says that one bluff every hour and a half is usually sufficient to keep others at the table wary and off guard. And they are surprised as to how often they get called down when it is obvious that they have the best hand. If you saw Jamie Gold at the end of the tournament at the 2006 WSOP he would tell players that they were beat and they would call him anyway. Phil Hellmuth states that he has built a career out of getting his money in the pot when he has the better of things. Daniel Negreanu says that he enters every tournament with the same goal in mind: not to do anything stupid. That means calling out of position steaming, overplaying hands, becoming too sophisticated in plays, showing off.

    Pros have great control over their emotions. They know that they have no control over the cards but they do have responsibility over themselves. Chip Reese is a great example of this. Dan Harrington and Dewey Tomko are some others. They are completely unflappable. The emotional wrecks like Mike Matusow have very volatile lives and wide success variances. The great survivors in my view prosper because of their consistency.

    Cash games and tournament games are diametrically opposed. What works in tournaments does not work in cash games. Cash games are infinite. In a sense, they never end. As long as there is money there is a game. Furthermore there is no time limit.

    Tournaments have time limits. Not in the pure sense, but in the sense of blinds. The blinds continue to rise. As a result, there are separate acts to tournaments:

    1. The opening stage of the tournament. This is where one needs to survive and begin to accumulate chips. Straight forward play is rewarded. Reckless play is punished. You want to win the hands you contest and not show up second best very often. You don’t want to get into pots that become chip bleeders. The goal here is to stay in the game.
    2. Later, when positioning begins to play out. This is where the big stacks go after small stacks and knock them out of the tournament. I think of this like Highlander who gained power by vanquishing his opponent and then cutting off his head and collecting his life force and power. You begin to use your chips to your advantage to intimidate. If you have acquired a big stack, you will get to see some more flops. And as the players begin to tighten up. You can therefore loosen up. You are setting yourself up for the end stage.
    3. Toward the end, it’s all about aggression. There is only so much time left and to win or cash aggressive play is rewarded. Showdowns occur all the time. Good hands get beat by better hands, Junk hands are played all in. Bad beats jump up with regularity. Every possible scenario gets played out. Ultimately the champion is declared by outlasting the field through skill, cunning and a great deal of good fortune.

    Success in poker is like success in life. It is attainable but not easy and it requires lots of work. That is why so few attain it.

    Dean Tidwell adds:

    I have played poker since allowed in the room at age 17 … 15 years later I can attest to 1 thing: all good players understand odds and therefore much of your success comes from feel, being around your opponent and understanding that most players have immense EGOS which can be used against them if the right comments are made. I have learned a few tips from an old timer — Mr. Hooks, who was Binion’s “man” in the older days, and even he went on losing streaks that lasted several months and had him questioning himself…



    Looking at a chart of my ratings, January 2000 to October 2006, it shows a dramatic rise from April 2003 followed by a plateau and recent decline.

    So what was I doing prior to the rise? I ‘decided’ that I had to get the International Grandmaster title. The Berlin Wall had come down and International Masters were not making much of a living. Another incentive was that my solitary GM qualifying score (from 1987) was given a new lease of live by an extension of its validity.

    Towards the end of 1992 I devoted myself to improving my game making chess the number one priority. My ‘investment’ into this project was to live off savings, the single payoff was the title. In early 1993 I went to the UK and lived in my parents small caravan during the time I was not at tournaments. My Dad drove it to a remote caravan site from which it was difficult to reach any distractions. I had some chess books I was studying plus Chessbase on the computer. And not much else.

    I set a time-table for my studies which mainly featured two weak spots, openings and endgames. I also took long walks in the country and swam a couple of times a week. The goal was not so much ‘mastery’, I was already a strong IM. The idea was to become a beast of prey, to have an edge.

    My results do not tell the full story — I was also second in Lichtenstein with 7.5/9. My results in 1993 were around 2570, which is not indicated by the rating chart (it takes time to catch up). This was more or less a 100 point jump in a relatively short space of time. I should stress that I was 32 at the time and not a teenager.

    One of my main regrets is that I did not continue and go for a 2600 rating, but the incentive (survival within the way of life I was used to) had gone.



    Sorry I missed last week folks, was traveling quite a bit:

    Abelson: The USDA has gotten rid of all the hungry people in the US by defining them away. Now they have “very low food security”. “Speculative sap” is rising, as indicated in increases in bullish sentiment. Exiting early could be costly, but exiting late could be disastrous. Housing is collapsing, and is going to get worse. Alan Newman suggests that the market is up because of the $34 billion that has gone into ETF’s this year, which must purchase their underlying stocks. He also says that insiders are selling financial stocks on a major scale. The sky is falling.

    Page 18: Barron’s was bullish on airline stocks last month, and we were right. Barron’s has been generally upbeat on Sony, but the stock keeps languishing, will continue to do so until Sony proves that a broad turnaround is underway.

    Page 21: The interests of CCE and KO have diverged, so KO ought to buy CCE back, should be willing to pay $21 per share.

    Page 22: The street thinks that MGIC is great, but the housing bubble collapse is going to hurt them worse than everyone thinks. The troubles facing them are the same things everyone has been talking about for a year, but somehow two pages were written about it.

    Page 24: Dupont has been saying for years that they are going to have to be a science company again, but nothing has really happened. Now, they really, really mean it. They are getting into the kinds of GM seeds that Monsanto does, and they have a new fiber coming out.

    M2: For those of you in Saamiland, stocks were up last week. They might keep going up because even those who are skeptical have to chase the market in order to not lag behind the indices. There could be more mergers happening before the end of the year. Despite a lack of buzz, Verizon’s yellow pages spin-off looks interesting. Consumer stocks have been doing well since oil has been down.

    M4: The Nymex IPO did well, it went up. (”Doing well” obviously refers to those who bought stock, and the bankers who will get paid a good sum despite having totally mispriced the IPO., costing the sellers of stock massive amounts of money. - This is one of the last great Wall Street scams. Such a poor job performance would, in any other industry, be a matter of disgrace and shame. Instead the I-bankers will get nice bonuses this year).

    M5: The socialist candidate from France may be good for investors because she may wipe away the last vestiges of Mitterrand era socialism. On the downside, she is still a socialist. The film Blood Diamond looks to be a winner for TWX. The diamond industry, not surprisingly, isn’t too happy about it since it is about how the diamond trade results in all sorts of misery and death in Africa. On the other hand, its not as simple as that, so don’t get all worked up after seeing the movie.

    Also on M5: Lot’s of stuff happened last week in the credit markets. What is all suggests is a general lack of worries. Volatility is low. It’s time to count our blessings.

    M6: Singaporean stocks are finally doing alright. Ng Guan Mean thinks that this is going to continue. Long term, however, if the US economy goes south it will hurt Singapore. He likes property stocks, and the marine, oil, and gas sectors.

    M7: High wholesale prices mean that supermarkets won’t be offering good deals on Turkeys this year (For what it’s worth, I recommend brining your Turkey as taught by Alton Brown). Turkey production is down. Chicken prices are down, however. Crude-oil and copper were down last week.

    M12: Options on retail stocks are inexpensive, which is surprising because Black Friday is just a few days away. (Another possibility is that the markets are somewhat efficient and there is no reason to assume that known events recurring events should impact the markets a few days out). Retail investors should sell their high priced retail stocks and buy low-priced calls. If they are concerned about taxes, they should buy contracts that expire in January ‘08.

    Page 27: Cover Story, the Death of the Floor: You need a cover story to tell you that technology is destroying the trading floor as more and more trades are being done electronically.

    Page 31: Cardiac device makers, who have been pummeled in the past, may start doing better thanks to some reassuring safety studies. Investors will be watching Medtronic’s earnings report. A new wireless protocol is out.

    Page 32: Gates, Nealy, Doerr, et all are spending a lot of money and knowledge on green technology to try to save the world.

    Page 33: Free trades aren’t free. Not all of the costs of investing are commissions. Execution quality plays an important role, and you should consider the interest paid on your cash balances as well. Some brokers might route your orders to market makers that pay them for the order flow, even if that market maker is not offering the best prices.

    Page 34: Picking the right bonds requires care, but don’t worry, you subscribe to Barron’s. We like Harvard College 6.3% 2037. Dallas, Texas, 4.75 2026. Freddie Mac 4.75 2009, Wal-Mart 6.875 2009, Kraft(Nabisco) 7.55 2015, K. Hovnanian 7.75 2013, GMAC 8.00 2031. Two good places to look for bonds are and Tax free munis can be good.

    Page 35: UAS is a great separate account manager.

    Page 37: After the Blackrock-Merrill deal, everyone thought that there would be a bunch of other huge M&A deals in the mutual fund industry, but that hasn’t happened, although it still might. Basically, the Mutual Fund companies are over-priced.

    Page 38: Everyone keeps saying that the dollar is going to go down, but there is a huge demand for the dollar since it is the main currency used for trade, and global trade keeps increasing. Plus, other countries all have an interest in keeping the dollar strong so that we can buy their stuff. Now is the time to be long the dollar.

    Page 39: Wynn resorts is going to pay a fat dividend. JCI and ADP are boosting their dividends.

    Page 40: The KBR spinout will help Halliburton. HAL is a complicated company, so its energy services business doesn’t trade at the same multiples as SLB and BHI. Without KBR, Halliburton will be “cleaner” and should close the multiples gap with its competitors.

    Page 40: Farewell, Milton Friedman, for all of the reasons that ever other right of center pundit has made clear.

    Page 41: The money fund/Wilshire gauge indicates how much cash is sitting around, waiting to fuel a stock rally. It currently suggests that the rally could continue. (However, looking at the graphs they supplied, there appears to be zero predictable relationship.)

    Page 42: Interview with David and Lyric Hale of Hale Advisors and China Online. This couple gives advice to hedge funds and has an internet site. Their stunning insight is that the election creates risks to trade and tax policy. That the coming report from the bipartisan commission on Iraq will be important, that the US economy is in a slowdown, and that inflation is creeping up. Asked what asset classes are most attractive, they offer that that equities are more attractive than bonds because interest rates are low, but, at the same time, the slowing economy should help bonds. Also, the private equity boom is spinning out of control.

    Page 44: Chinese manufactures are able to undercut their competitors. How come? Is it because of mercantilist policies, or something else? The U of Cal/Irvine China price project is trying to figure that out. They say 39% of the Chinese price advantage. 11% of the advantage is an undervalued currency. Export subsidies count for another 17%. Piracy and counterfeiting are 9%. 5% due to lax environmental and worker safety regulations. Network clustering i.e. supply chain members in close proximity accounts for 16%, and foreign direct investment 3%. What does all this mean? For one thing, US corporations should be careful transmitting technology there. They should also consider the ethics of relocating to where there is slave labor.

    Page 46: The good news: There will be more nuclear power plants built. The Bad News: There is no place to store the spent fuel. The source of the Problem: Jimmie Carter made it illegal to reprocess spent fuel rods. The solution: Recycling.




    Male Chimps Prefer Mature S-x: Study

    Mon Nov 20, 4:02 PM ET

    PARIS (AFP) - Male chimps, unlike their human counterparts, show a distinct s-xual preference for females on the riper side of life, an American anthropologist reported in a paper.. Male chimpanzees consistently sought out the oldest females within a troop for s-xual intercourse..

    Male chimps don’t need ego enhancement. Ripeness counts for more than coquetry backed by ineptitude, perhaps, for the more developed simians.



    I stumbled upon an interesting interview of Prof. Robert F. Engle by Prof. Francis X. Diebold (guest speaker at the December NYC Junto) from 2003. The whole interview is quite readable.



    Most professionals would frown upon such a piece of software as WealthLab, but it is very cheap with good backtest functionality. This is my own opinion, but I think that backtests are useful, even if no substitute for rigorous statistical analysis.

    What’s nice is that they have a utility for using R inside WealthLab, and someone on their R forum posted code to communicate the other way, from WealthLab to R. All these efforts are yielding a decent low cost exploratory analysis and backtest solution for the small guy.



    In a land far, far away, almost thirty years ago, I worked on a mainframe with hundreds of terminals, and it occurred to me that I could write an OS script to enable users at different screens to have text conversations with each other. As perhaps the only person in the building with any interest in so doing, when the script was finished I had to test it by informing colleagues that I had written an AI program. When they typed the appropriate command at the prompt (on teletype printers I think rather than screens) they would be presented with two options — Psychology or Polite Conversation. By this time I had disappeared to my own console ready to don my Freudian or friendly hat. Not everyone guessed immediately what was going on and some polite conversations or analyses were able to develop — I was eventually quizzed by my boss who I suspect was not entirely unamused. Ten years later, it was the birth pangs of the Web and bulletin boards were already popular with techies and those with access to equipment at work or school. I set up a math group on one of the UK boards and set a programming puzzle that seemed of technical as well as philosophical interest — to write some code (in any language) whose output is the same as the code which drives it. I think someone solved it by using a print file command where the said file was suitably set up first — if I ever set this poser again I must be sure to exclude printing files. Thankfully the web came along and now one has to be truly original to be original. I love the way we all act as synapses and what used to take years can now happen in a day.

    Sam Humbert comments:

    "To write some code (in any language) whose output is the same as the code which drives it" is a well-known idea, at least nowadays. This is called a Quine, after the philosopher W. V. Quine.



    A new patent index was recently launched by Ocean Tomo:

    The Ocean Tomo 300(TM) Patent Index, which is priced and published by the American Stock Exchange(R) (Amex(R)), is a diversified market-weighted index of 300 companies that own the most valuable patents relative to their book value. The 300 member companies have an average market capitalization of $21 billion and a median market capitalization of $7 billion. The Index is split equally between small cap, mid cap, and large cap stocks. The smallest member company has a market capitalization of $400 million.

    According to the site, over the last 10 years it outperformed the S&P by 3.10% annually.

    However, I have the following observations of this:

    1. Though this is one “value” index, a growth guy may embrace it as a measure of “growth” potential. I wonder if it suffers from the common value survivorship bias problem — especially when one considers that 2000 seems to account for its outperformance.
    2. Though it attempts to “measure” patents, I am not sure I endorse their measurement method. It would prove much more useful if it was somehow weighted by this measure, instead of simply market weight.
    3. Eyeing the comparison chart to S&P over last 10 years, it appears that it tracked closely until 2000 when it outperformed before underperforming through the 9/11 drop and then it outperformed again since late 2002. But this is hard to say without numbers.
    4. Considering the notion that stopping to tie your shoelaces hurts you only if you are going intellectually fast, (i.e. laying off people) I wonder if the outperformance in 2000 is due to employee job security in these companies and how the individual components are ranked on this basis. Though I suspect the stock and the index lead the lay-offs.
    5. It seems to be best of both worlds — it tracks the S&P when it dominated with growth stocks, and it outperforms the index when it dominated by “value”.

    It seems a good idea, but hard to perfect, to try to measure a patents worth.

    Allen Gillespie replies:

    This is something we have been trying to understand for awhile, because I once read an article about the development of the steam engine. The idea was developed and patented in 1818 but not commercialized until 1831. There is a difference between having a patent and successfully monetizing a patent.

    In short, I believe there are lags in the value of patents. Some patents turn out to be valuable, some do not. Sometimes managements reward shareholders, sometimes they do not. During the internet bubble (’99) we conducted a study of biotech stocks from the early 1990s. In our study we found purchasing a basket at the top eventually yielded a return over 7 years roughly equal to the risk free rate and closer to the market rate over 10 years, however, your results were completely driven by the success of a few ideas like Amgen and Biogen which developed multi-billion dollar products. Buying the same basket at the lows, when the market had sorted out what was valuable and what was not, produced returns in excess of 40%/year. Even the successful stocks like Amgen experienced 70+% drops.

    Our study of Biotech and subsequently Internet stocks shows a similar pattern. An initial flurry in the stocks based on concept, followed by capital raises by investment bankers, a fall due to lack of profits, taming of euphoria by the increased supply of stocks, and finally recovery as the ideas begin to bear profits and managements are forced to show profits as opposed to developments.

    One of the things we have noticed in our momentum studies is the tendency for certain stocks to reappear after a number of years on a much sounder financial basis (though it frequently doesn’t look like it at the time). For example, energy trading companies were high momentum stocks during the bubble period, collapsed, but then reappeared in 2003 as high momentum stocks as distressed recovery names.

    Another company which illustrates the concept is SEPR. The company for years as been run more like a research company than a business, as they have maintained a very high plowback ratio into new ideas, now however management is beginning to run it like a business for the shareholders rather than the lab. Here are the earnings and stock price:

    Year EPS High Low

    1999 -2.77 70 29

    2000 -2.80 140 45

    2001 -3.19 81 23

    2002 -3.11 59 3

    2003 -1.33 32 9

    2004 -2.05 59 23

    2005 -0.11 66 48

    2006 1.31 2007 2.18

    Important times in the life of a stock are inflection points like when earnings can be anticipated to begin recovery or decline (because this creates an earnings slope) - at year end 2002 you had inflection from 2001, crossovers into profitability, and eventually new highs in profitability matter because the valuations get more compressed if the stocks do nothing or go down. Companies with new highs in earnings power can recover quickly from some fantastic declines.

    Steve Ellison adds:

    Patents are a one-dimensional view of intellectual property. Intellectual property also includes trade secrets, processes, and expertise. Pepsi has enormous intellectual property, none of it patented. Dell and Southwest Airlines became successful by perfecting processes that their competitors could not imitate because of constraints imposed by the ways of doing business that had made the competitors successful.

    A patent measure can be gamed.

    An ex-CEO trumpeted increased patents while cutting research.



    I think I have a solution, something I ‘knew’ about before but the memory of which got buried beneath the rust. The problem with achieving mere ‘expertise’ is that it doesn’t necessarily give you an edge, an area of your game or field where you are a world leader. Some ‘experts’ got their reputations by being a leader at one time, but didn’t maintain this edge. Others got their reputations by being reputed to be leaders, but in fact they just talked a good game. I liked Larsen’s honesty in ‘How to Open a Chess Game’ that he was never the ‘expert’ he was reputed to be in openings like Alekhine’s Defence. But he was the only GM who was playing them, so relatively speaking he was the best.

    This is not my idea, in fact I know of three sources in the chess world and one in investment. Tony Miles once advised me that it didn’t matter too much what someone played as long as they knew more than anyone else. This echoed Lev Alburt’s advice in ‘Test and Improve Your Chess’ in which he advised studying a few positions in great depth. It’s even there in Kotov’s ‘Think Like a Grandmaster’ in which we are advised to know ’something about everything and everything about one thing’ in the openings.

    In the field of investment Jim Slater’s ‘Zulu Principle’ was based around knowing more than anyone else about a particular company, but there’s no reason it should be restricted just to that. There are plenty of niche areas and approaches in markets, but the ‘trick’ is to know one of them better than anybody rather than be able to do nothing more than be able to hold a conversation about them. Of course if you do know them better than anyone then it’s probably wise to keep your mouth shut. Knowledge shared can mean an edge gone, unless of course you share with those who will help you to maintain and improve your edge.

    So now I realize my mistake, I’m an ‘expert’ without an edge on a gradually descending plateau. How can I get off? Well to be a leader it’s not enough to read books.

    Tom Ryan counters:

    With all due respect I suggest you are confusing expertise with competitiveness. Last night for example while swimming, despite the fact that it doesn’t really matter -I am just swimming for my health, but you know how these things go - I did notice this guy two lanes over who was lapping me while I was chopping away for 2000m. Subconsciously you always wind up trying to synchronize yourself with the faster swimmer in those situations but I couldn’t keep up with him. When I got up out of the water at the end of my workout I found that I was swimming mentally against a 22 year old. Now I may be an “expert” in freestyle after 30 years but that doesn’t mean I can compete with a 22 year old who is in great shape. I could do two sessions a day in the pool for six months and still never out swim that guy, I am in my mid-40s for pete’s sake! FOC Ming Vandenberg tried to get me to race her in the pool two years ago and I just laughed, as if I could stuff myself silly at Tony’s place, then eat like a horse at Vic and Susan’s for two days and go out with FOC Tim Melvin and Wiz on Saturday night then the next day jump in the pool and race someone 25 years my junior. How would we handicap that one? But compared to you, in the pool I am the “expert”.

    On the other side of the equation, we have all experienced people who are competitive, but yet, are not experts. For example in martial arts it is possible, and I have seen, people who perform well in competition, at least in the initial rounds, because they have honed a small “bag of tricks”. But of course once the trick is observed and they run up against someone who has more knowledge and skill they lose, because they have nothing to fall back on.

    Not being a chess GM, I can’t comment on aging and competitiveness in chess. However the problem with the analogies between chess and trading is that chess is a head-to-head competition, whereas trading is a statistical game against a huge field of players where you have to be better than a certain % of the field, not every single other person. And in trading you can walk away when you are one piece up, whereas in chess the only way out is to withdraw or win. 0 or 1. There is a lot of money in trading between the 0 and the 1. Trading is not a single elimination tournament, well it needn’t be anyway unless you get carried away with margin. Good discussion!

    GM Davies clarifies:

    Maybe I am ‘confusing’ or ‘melding’ the two, but are you very sure I’m wrong to do so in fields such as chess and short term futures trading? The number of people who are ’successful’ (i.e. win money overall) is so small that most experts, by your broader definition, will be losers. I also disagree with your definition of chess success being defined as a simple win/loss - it is similar to trading in that there are a certain number of prizes and you need to finish in the top few places to get one of them. Then deduct the frictional costs of getting to the tournament and you need to be really good to have a chance to make money overall.

    How does one get really good? This is where I maintain that the goal must be to do ’something’ better than anyone else as a way of bootstrapping oneself above the mere ‘experts’.

    Tom Ryan adds:

    I think the more relevant point which you have already alluded to is that in a competitive environment you have to find, and constantly be searching for ways (plural) of staying sharp and developing your ‘edge’ or your ‘focus’ or your ’shape’. That’s a tough one although I think there is certainly value in practice, practice and more practice. But that’s not exactly the same as being knowledgeable above and beyond others in a subject. For example, we have all manner of really bright, smart, engineers and geologists on the Spec List who are experts on various facets of the work, statistical analysis of data, 3-d modeling etc., but who can’t pull it all together to make a decision about where to drill or what slope angle to use or how far apart the pillars should be.

    In the posts between you, me and Spec List member Scott that didn’t make it to the this website, I was trying to make a distinction between ‘expertise’ and ‘mastery’…sure its syntax but it’s a subtle and I think important difference. Expert is sort of a relational context whereas mastery goes beyond and supersedes that. Really, anyone who knows more than me in a certain field and who can impart that wisdom to me so that my game improves, that person is an expert to me…even if they are not to you. But that doesn’t mean they have mastered anything. To me mastery is where something gets to the point where the art/skill just simply becomes a part of you - there is no longer any notion of doing/not doing, achieve/not achieve, as there is no peak to stand on top of. You just walk the path and keep walking and keep walking and keep … It just simply internalizes to the point that it’s part of who you are.



    The National Book Award winners were announced yesterday:




    CHICAGO A police watchdog group is calling Tuesday on the FBI to review whether the Chicago Police Department is hiding crimes to lower the murder rate and make the city seem safer.

    We have anecdotal but first hand evidence that they are massaging the data so that reports indicate a rosier scenario in more crimes than just murders. It’s been an ongoing bone of contention that property damage crimes are not being reported, that shootings that don’t result in murder get reported as “assaults,” and similar sorts of schemes are taking place. Frankly, I don’t think that the CPD is driving the data distortion but that commands to do such are coming straight out of city hall, happily aided and abetted by our Rocky Horror Show cast of a city council. God love an oligarchy.



    Inspired by breaks of round at 1,400 in SPU and 1,800 in NDX and Google moving to 498, one is tempted to make some numerical, gravitational, uneconomic predictions for end of year.

    • S&P futures: 1400 or 1410 (either the spot or futures at round)
    • Google: 500
    • Dax: 6,500
    • US long term bond futures: 114 or 115
    • Crude: 60
    • Nasdaq spot: 1,800
    • Dow: 12,250
    • Bund: 118.00

    Joyce Shulman observes:

    A completely uneconomic prediction for the end of the year is that trouble might be brewing. Some months ago Victor asked what do you notice that you do when you are possibly making emotional mistakes in the market when the market is rising. It took me a while to realize what I do. I begin to make reservations and plan expensive trips. I am doing it again.

    Steve Ellison invokes some quantitative techniques:

    Using the arc-sine distribution, I predict the S&P will make its high for 2006 on December 29.

    The ratio of the earnings yield on the S&P 500 index to the yield of the 10-year bond was 1.17 at yesterday’s close (using trailing earnings, not yet adjusted for the September quarter). The 2006 high to date is 1.23 on September 25, and the 2006 low is 1.03 on May 9.

    Jay Pasch guesses:

    Nasdaq futures, open gap @ 1807.25 from 1/17/06…



    I have been considering areas in which I am supposed to be an expert. And it’s sobering to realise how many flaws there are and how I haven’t improved my knowledge at all during the last few years.

    Could it be that the thought that one is an ‘expert’ starts to close the mind to new developments and counter-arguments whilst fostering stultification. I suspect that many great players have had this thought, and they counter it by changing their game as soon as they know what they’re doing.

    Scott Brooks agrees:

    Interestingly, I have felt the same way for some time about deer hunting. I am confident that I know what I’m doing, but in the last few years, I have found it difficult to improve my “game”. I used to like to read all the deer hunting magazines. I got bored of them. It’s the “same ‘ole…same ‘ole” in every magazine story. Nothing new.

    I then got into the Quality Deer Management Association. It’s a scientific organization that gets into the real nitty gritty of deer managment (with the emphasis on hunting). Good stuff and more detailed. But still, it is becoming a more detailed version of the “same ‘ole…same ‘ole”.

    It makes me wonder:

    1. Is there really anymore to learn about deer hunting (chess, trading) or is just a different rehash of the “same ‘ole…same ‘ole”
    2. What am I missing? There has to be more, and I’m just not seeing what the next level really is…of course, no one else is either…but that’s no excuse….just because others aren’t seeing the “next level” is no excuse for me to not see it.
    3. Maybe the “Peter Principle” is real and I’ve risen to the level where I’m no longer competent (I reject that, of course. Which means that I’ll break thru to the next level. Or its further proof of the principle in action).

    So maybe it’s my complacency in what I “think” is competence in an area that I “think” I have expertise. I have been feeling this way for sometime about many areas of my life. Deer hunting, trading, and my businesses. There is either more or there isn’t. If there isn’t more, do I have the intellectual capacity to see my limitations and find happiness with “my level of competence”? If there is more, how do I tap into my intellectual capacity to find it?

    J. T. Holley offers a suggestion:

    “If there isn’t more, do I have the intellectual capacity to see my limitations and find happiness with ‘my level of competence’? If there is more, how do I tap into my intellectual capacity to find it?”

    Don’t necessarily forget everything that you’ve read, watched or seen; but wipe the slate clean. I personally feel that a lot of those “hunting” and “fishing” magazine are just like the “financial pornography” that exists on Wall Street via papers, TV, and radio programs.

    Go out and get nothing more than a .99 cent composition notebook and pencil and start writing down everything that comes to your mind. Approach hunting as if it were a “science experiment” and don’t limit anything that comes to your mind.

    My Papa did this back in the early 1900’s and kept many a journal. He has one on trapping minks and muskrats that I cherish and feel honored to have read due to the fact that only a handful of people have done so. The other journal comes from hunting deer in Picco Gap of the Blue Ridge Mountains. It gives insights that nothing today would give or come close to.

    Persistently writing and keeping notes and reviewing will allow you to see things that you’d have never before paid attention to or might have been distracted over “other’s experience”. Once you have enough of this data and writings then you’ll be able to form hypothesis and see that certain things are or aren’t predictable when it comes to hunting. Sure beats taking David Petzl’s or Bill Dance’s word for it.

    The approach above is one of the main parts of Vic’s two books that I cherish. If you read  Education of a Speculator he didn’t promise a “get rich quick” but a way of thinking that will apply to everything you do. The joke is that nobody wants to take the time to do the work to get the results. They would rather cheat themselves and farm it out or not do it at all and rely on others.

    I am not a single expert on anything. Maybe the outdoors in general but that’s about it! That comes from Cub Scouts, Hunting, Fishing, Rafting, Hiking, Climbing, Skiing, Camping, and going places and experiencing things that other people simply wouldn’t do.



    I recently stumbled upon Ehrenfest Urns. The results from their simulations look like tick charts with no drift.

    And I am wondering if things like advances-declines, ticky, basically anything in the market that is based on a sum of binary states, could not be modeled as an Ehrenfest process.

    Going further, an Orstein-Uhlenbeck process seems better suited to a market drifting up against a wall of fear (fear is the viscosity), than a standard random walk. Why don’t people use these?

    I know this sounds like a lot of name-dropping, but this is merely to point out that the science of finance seems very backward. There is still a lot of progress to be made.




    Ignorance is preferable to error and he is less remote from the truth who believes nothing than he who believes what is wrong. — Thomas Jefferson (Notes On Virginia)

    During my ongoing Bayesian spelunking, I have run across the idea of “complete ignorance” and “stated truth”.

    Reading probability theory shows background to things we know.

    1. The differences between people who both claim to know nothing about a situation must be tested anyhow.
    2. The similarities in answers between people do not differentiate the volume of perspective.

    Complete Ignorance:

    One might think that such a thing is an important part of Probability Theory, alot like zero-ness.

    But it seems nailing down what you do not know results in discovering things one does know. Discovering if a problem is location or scale or rotationally invariant provides an idea of what one does not know: that is, the problem itself encodes what you do not know.

    And that complete ignorance may only be relative to the problem and not the observer (being dumb does not count in this exercise).

    A full blown modeling of “complete ignorance” would create a starting point for building knowledge, but that is off in another realm of thinking.

    Stated Truth:

    As an experiment, one can play with meta-distributions of probabilities: Ap

    P(A | Ap, X) = p

    Ap means regardless of anything else you might have been told, the probability of A IS p

    The net effect of this “rule” is: for new information to update the meta-distribution Ap, the probability of P(New | Ap) must have some slope effect to either narrow the distribution or provide some focus to the uniform.

    The integrals are fun to play with, the regular case of arguing with someone who has an Ap distribution in his head we all know, his receptiveness to new ideas is mathematically predetermined, if the new information creates unwanted redefinition, there is no need to reprocess the meta-distribution. Dogma about Ap is different than knowing why Ap is relevant.



    Religion is good for most people. Others with logic on their mind do not take to it well. Philosophers and big brain people scoff. Let ‘em. It’s not for them so why do they make an issue of it?

    Religion is for people who need it. And why deprive people of a valuable resource, both spiritually and materially since life is so, so short and happiness is so so difficult to come by?

    If Randians praise happiness and are atheists they surely ought to understand why others also seek happiness. What difference does it make how one comes to happiness?

    Philosophy is nonsense. Leave people alone in their happiness. I recommend this book: The Power of Kindness by Piero Ferrucci. Be kind to fools and thinkers alike. It won’t hurt a bit.

    Gary Rogan replies:

    Religion does bring happiness to many people, that’s undeniable. Studies in behavioral psychology have indicated that human beings are genetically predisposed towards religious beliefs. Evil ideologies have in the past tried to control religious thought because it interfered with their attempts at mind control, therefore one always has to be suspicious at such attempts. Religious freedom is a litmus test of free societies.

    Nevertheless, by definition religious beliefs are not rational. People are trained from childhood not to exercise the same level of skepticims towards “facts” associated with religions as they would towards most other subjects. Therefore, when a significant number of people acquire similar religious beliefs, religion often stops being just a force for personal fulfillment and becomes an organization force to achieve some real-world ends. Since religious beliefs cannot be argued with on a rational basis, if they happen to contain elements of intolerance or imposition of one’s will on others, they can and have led to great injustices imposed on those who don’t profess them. Even today, it’s a real possibility for whole cities and contries to be blown up in the name of religion.

    The shifting lines between rationality and “magical” thinking patterns is something that has been with us since the dawn of our species. There are obviously no easy answers. People should be left alone in their happiness, but any attempts to impose their “happiness” on others need to be stopped.



    I found a fun and educational Equity Curve Random Generator where you can enter values of win/loss ratios and win probabilities and see their effect on returns over time. Note that increasing the number of lines (third blank) will overlay multiple runs on the chart. Playing with this revealed rather quickly that ratcheting up the win/loss ratio in tenths only gradually improves the curve, but ratcheting up the win probability in tenths rapidly improves the curve. Even hundredths are important. Try ratcheting the probability .55, .56, .57, .58, .59, .60 and you will see. Improving odds even a tiny amount can dramatically improve returns.

    Dr. Phil McDonnell comments:

    I would caution all that the author of the web site mentioned by Mr. Foust uses the Average Win/Loss ratio as his characteristic criteria. As Rick found the criteria did not seem to be the most helpful. Part of my caution comes from the author’s apparent use of the Average Win/Loss ratio in conjunction with the Kelly Criterion. The Kelly Criterion applies only to gambling games with binomial outcomes.

    Some people have tried to extend it to multinomial outcomes such as we have in investments. They try to use the average win and the average loss as though they were binomial outcomes. In so doing they commit a basic arithmetic mistake. Implicitly they are assuming that the distributive law applies to logarithms. It does not and that is where they go wrong.

    This error has been repeated to the point of being a meme. Many books espouse it, much software is written to calculate it and articles proclaim it to the unwary. The simple fact is that the incorrect formula invariably leads to over trading and will CAUSE the ruin which it ostensibly promises to prevent.



    I was in my garage late last night changing oil in my car and I came across an old beat up paperback of Moby Dick that was stashed in a box next to the oil filter wrench. One thing led to another and I was 30 chapters deep. I came to the realization that chapter 24 titled “The Advocate” could easily be retitled “The Speculator” and have the word/words “speculator” “wall street” substituted. I will share some samples with the ya’ll:

    In the first place, it may be deemed almost superfluous to establish the fact, that among people at large, the business of “speculating” is not accounted on a level with what are called the liberal professions. If a stranger were introduced into any miscellaneous metropolitan society, it would but slightly advance the general opinion of his merits, were he presented to the company as a “speculator”, say; and if in emulation of the “Corporate Presidents (C.E.O.’s)” he should append the initials “C.S (Chief Speculator)” to his visiting card, such a procedure would be deemed pre-eminently presuming and ridiculous. Doubtless one leading reason why the world declines honoring us “speculators”, is this: they think that, at best, our vocation amounts to a butchering sort of business; and that when actively engaged therein, we are surrounded by all manner of defilements. Butchers we are, that is true. But butchers, also, and butchers of the bloodiest badge have been all “CEO’s” whom the world invariably delights to honor. And as for the matter of the alleged uncleanliness of our business, ye shall soon be initiated into certain facts hitherto pretty generally unknown, and which, upon the whole, will triumphantly plant the “speculators chambers” at least among the cleanliest things of this tidy earth. But even granting the charge in question to be true; what disordered “trading desk” of a “speculators chamber” are comparable to the unspeakable carrion of those “cherry desks” from which so many “corporate presidents” return to drink in all ladies’ plaudits? And if the idea of peril so much enhances the popular conceit of the “corporate president’s” profession; let me assure ye that many a “CEO” who has freely “signed quarterly earnings”, would quickly recoil at the apparition of the “Market Mistress’s hand”, “fluctuating his capital up and down with reckless abandon”. For what are the comprehensible terrors of “being a corporate officer” compared with the interlinked terrors and wonders of “Speculation”! But, though the world scouts at us “speculators”, yet does it unwittingly pay us the profoundest homage; yea , an all-abounding adoration! For almost all the “TV shows”, “Daily Papers”, “Radio Programs” that spread “market wisdom” around the globe, “shout our language”, as before so many “pulpits”, to our glory!

    I will save the last of the chapter for you to read. It is an impressive homage to the whaler or “speculator” as I have taken the liberty to implant. It discusses the heritage forgotten, the lineage of the men, the importance of the risk taken and the rewards reaped by those of the type. I got goose bumps from the reading. It was something I must have forgotten or hadn’t thought of the first few times I’ve read Melville’s masterpiece.

    Gibbons Burke replies:

    Interesting that you should run across ‘Moby Dick’ yesterday as November 14th was the 155th anniversary of the great novel’s publication.

    My favorite chapter is The Castaway, about Pip, who jumps from a whale boat on a sleigh ride and is abandoned to the solitude of the ocean alone:

    He is treated to a vision of God, and returns and is adjudged to have gone stark raving mad. Of course, he is also given the gift of prophesy, and like Cassandra, can see what the future holds for the barky.



    I wrote on Nov 9 about a most unsettling day in the market with all commodity futures up 2% right after the election. It was followed by a most healthy day with commodities down an average of 3% and some down much more.

    It brings up the immediate thought that after cardinal events like elections there is a tendency to back and fill, trying to get you to get on the wrong foot like a good competitor in any game including the favorites here of chess and checkers, martial arts, and racket sports ( the defunct game of hard ball squash being the only thing I am expert about ).

    The general question of healthy and unhealthy days in the market is a very pungent one that deserves study. Today, bonds are at a new 10 month high, and the dollar is low, and the Saudi Arabian market is pushing 8,000 again — down 60% for the year. How should healthy days be defined and what predictive properties do they have?

    Along those lines, another aspect of wellness is the health of the market for the big players — the ability of the market to survive, recirculate the energy, carry away the wastes, providing food and hope for all the niches in its community — is the movement in markets during the day. It must be sufficient to get the public to do the wrong thing and to create frictional costs to cover the costs of the infrastructure and the profits of the larger feeders in the chain. Tuesday’s 16-point range in S&P futures (high 1399, low 1383) is the biggest since the 04 Oct 19-point range (high 1359, low 1340). It was very nice because it went down 9 points from the open at the low and up 7 points from the open at the high — enough to get everybody leaning the wrong way, selling at the bottom and buying at the top, with a thousand other emotional trigger and chart points to do the wrong thing also. A most healthy day for the market for sure. But what does it portend for the future? Slightly bearish in the large, but in particular slightly bullish is a reasonable counting answer, but how can one generalize such health for the infrastructure days. One might suggest studying days of running maximum ranges as to their predictive properties. One believes that some meals for a lifetime are contained within the above lines of inquiry that might be used to answer such questions of strength.

    P.S. Try graphing the consecutive points (a, b) on the S&P chart of Nov 13th and draw the points (a,-b) for a hypothetical chart of Nov 14th, and then query whether the degree of overlap between the hypothetical Nov. 14th chart and the actual Nov. 14th chart is random, and if you conclude it isn’t, under what conditions is such a non-randomness predictive and/or useful? Alternately, flip the 13 Nov chart upside down and enjoy the Adam Theoretic aspects.



    Hedge Manager Is Almost Famous
    Published: November 14, 2006

    Managers of billion-dollar hedge funds do not usually drive Hondas — except at Goldman Sachs, that is. Traders at Wall Street investment banks are now priming themselves for another big bonus haul this year. And Raanan A. Agus, the manager of one of Goldman's largest internal hedge funds, and the owner of a Honda minivan, will be in line for one of the richer paydays.

    This puffpiece on a Goldman trader in today's New York Times lacks a discernable "news peg". Anyone have a theory as to why the agenda-driven broadsheet would run a story like this?

    Gregory van Kipnis replies:

    NYT does human interest stories, usually about the downtrodden. However, perhaps the angle is that there have been so many stories about hedgefund types who live rich, conspicuous (and sometimes dishonest) lives they (Goldman Sachs) felt it is time to show a counterexample to minimize public backlash.

    Eliza Bethan adds:

    There is a new TV soap-opera/series that will stereotype hedgefund managers. Among the images to be broadcast are self-praising or youthful managers with advanced degrees, arrogance in winning at all costs, overcoming defeats and obstacles, and of course media stardom, all with a lack of humility and humor…



    The Hawaiian polymath James Sogi recommends Coercive Family Processes by Gerald R. Patterson. The book discusses how to measure and study aggressive behavior, and has already lead to great controversy in my family, as it recommends an authoritarian approach to raising children by removing what kids value, e.g. attention, when they are bad. Don't give them attention when they cry. Removing the attention is called negative reinforcement. The whole subject of how we behave when faced with stimuli of various kinds, with selling and buying being the behavior, and the environment, e.g. an economic announcement, a vivid change in a related market, or a backdrop of staged conditioning by the Fed Commissioners, would seem to call out for study and testing. This introduction to operant conditioning provides a nice summary of the kinds of things that behavioral psychologists study and might open up some fruitful lines of inquiry. A good reference to Patterson's work can be found here. In examining the diverse bodies of stimulus and response schedules covered by behavioral psychologists, one comes away with the impression that the grass is always greener on the other side and that if instead of following the promiscuous theories of cognitive psychology, that have a hypothesis for any seemingly irrational behavior, (albeit most of them are completely rational and based on rules of thumb that people in real life as opposed to college students for a buck an hour would choose), the often validated and completely specified studies of operant conditioning would be a much more fruitful line of inquiry for market people. One feels he is one the right track here as "Operant Conditioning" and "Stock Market " is almost a Google whack at 337 mentions but "Operant Conditioning" "Cognitive Psychology" has a promiscuous 38,700 mentions. It would be good to take the basic two by two table of operant conditioning and classify it by fixed ratio, fixed interval, variable ratio, variable interval, and see how these relate to predictive patterns. For example: bonds up/ stocks down, a positive reinforcer when it occurs at a steady rate with little variation (fixed interval) versus when it occurs with great variability (variable ratio). But bonds up/ stocks down, if it occurs at an unsteady state, it is an example of a positive punishment variable ratio. All the predictions of operant conditioning could be tested in the real world of humans with prices in markets, instead of on rats.

    Reinforcement (behavior increases) Punishment (behavior decreases)
    Positive (something added) Positive Reinforcement: Something added increases behavior Positive Punishment: Something added decreases behavior
    Negative (something removed) Negative Reinforcement: Something removed increases behavior Negative Punishment: Something removed decreases behavior

    Source: "An Animal Trainer's Introduction To Operant and Classical Conditioning"

    Alston Mabry Replies:

    As I understand it, in animal learning trials, if you put the rat in the cage with the little lever, eventually, in the process of exploring the cage, the rat pushes on the lever, and there is some possibility that a bit of food plops out. The process repeats, and the rat learns to associate pushing the lever with getting food. Interestingly, if what you want is for the rat to push the lever a lot, you provide the food reward only intermittently and randomly. If the food is provided each time the rat pushes the lever, the rat will push the lever only when it is hungry. However, if the food appears only occasionally when the lever is pressed, the rat will press the lever over and over, brimming with anticipation. Now let's assume the Mistress is a master trainer, to her own benefit. She places the rat (trader) in it's cage (home office with high-speed internet access, TradeStation account, etc.) and waits until the rat discovers the plastic keys on the keyboard and starts tapping them. Then she provides the rat with a food pellet (profitable trade). If the Mistress wants the trader/rat to trade as often as possible, she will reward the trader/rat with a profit (food pellet) only intermittently and randomly. If the trader/rat could get profit/food any time it pleased just by tapping the keys on the keyboard, then it would tap the keys only when it needed money. But because it is actually the Mistress who is in control, and she wants to maximize trading behavior from each rat, she keeps the rewards as random and unexpected as possible. In fact, "unexpectedness" is one of her most important tools. By the Rescorla-Wagner model of conditioning, the greater the unexpectedness of the reward, the higher the associative strength of the learning. This is why it is so effective for the Mistress, after a rat has tapped the keys many, many times with no reward at all and become convinced in bleak despair that no further reward is possible, to toss a nice food pellet into the cage and provoke the rat to even greater efforts.

    Russell Sears responds:

    This is of course the opposite of what is recommended for a baby totally dependent on the parent. I find this one of the greatest challenges of parenting, determining when to use negative reinforcement to cut off the dependency. And looking around to family and friends, especially with young adults, it seems many have never truthfully acknowledged this.

    Steve Leslie adds:

    This is exactly the foundation of slot machines. Intermittent rewards promote more activity on behalf of the participant. The theory is that if one gets rewarded on equal installments the activity is seen as work, whereas if one receives an intermittent reward then it is seen more as recreation. This is also how companies motivate their salesmen and saleswomen. They conduct sales contests but they do it randomly. It is one way that the company keeps the salespersons attention. Brokerage firms were famous for offering sales contests during the summer months, typically the slowest months for commissions to keep the brokers working and keep the revenue flowing. Here is a sidebar to this discussion. In Las Vegas, if a casino advertises that they give a 99% payout on their slots, then they must pay out on average the machines that they have posted to pay out that amount. This does not mean that every slot machine in the casino pays out 99%. It applies only to the bank of machines that are listed as paying out this amount and the patron has to look long and hard inside the facility to find those. What this does mean is that if you took a large enough sample size for example a $1 slot machine and played this machine forever and each individual were to put $100 in and no more, taken collectively they would receive back $99 on average. Now statisticians will tell you that everyone who plays slots will eventually go broke. The reason for this is that people continually take their reward and plow it back into the machine until eventually they have spent their full bankroll. Therefore the machine will collect everything, it just takes longer if the payouts are higher. This applies to all other games as well including roulette baccarat and dice. Even though you can approach almost even money odds such as betting the color on a roulette wheel, the player only on the baccarat table, and the line on the craps table, if you keep playing them long enough you will lose your entire bankroll.

    Jay Pasch replies:

    Markets are authoritarian, nature is authoritarian, society is authoritarian, the world they're going to live in is authoritarian, "ya gotta serve somebody" as Dylan would say. Of course there is great benefit to self and others in going against at times, i.e. Thoreau's Civil Disobedience, the rebel call, et al. But on the battlefield of child-rearing, relieving one's self of authority is like dropping one's arms on the field, and pants, and waiting to take one between the… eyes. What works best for the young warriors is that they have 'contracted' to decency and respect with all of the ensuing benefits and luxuries given their meritorious behavior; but break the contract and it is they that surrender their benefits, rather than the mindset that some sort of entitlement has been 'taken away'. Under this arrangement the kids have buy-in, they feel important, creative, their ideas beneficial, because they were asked to help create their world in the first place. They see clearly the reality of their own behavior, understanding it was they that surrendered their privileges rather than the big bad general removing their stripes…

    Daniel Flam replies:

    It would seem to me that all education revolves around pain. So you say we can't "flik" the kids? Ok let's give them a mental pain Like take away something they like, put them in the corner, its like the way the intelligence interrogators in the western world operate under the democratic laws, we just find a better way of inflicting pain in confines of the law… I find the same with the market… which bring an old adage… "No pain, no gain" How would we go about studying pain in the market?

    Steve Leslie replies:

    First let me say that "No Pain No Gain" is a very dangerous statement. Physical pain while training is an indication that one is approaching a physical limit. By going too far, one can instill permanent damage. Only a fool would feel a muscle tearing during a set of lifting weights and continue to lift weights. Now there are minor aches and pains that an athlete must endure however there are limits that the body can withstand. An athlete who is in touch with their body is well aware of the difference. I am sure my good friends Dr. Goulston and Dr. Dorn are much more qualified than myself to comment on this subject matter and I hope that they do weigh in. However, there are three distinct subjects here.

    • Positive reinforcement
    • Negative reinforcement
    • Punishment

    Giving a child an iPod for excellent grades is positive reinforcement. Withholding a reward from a child or taking away privileges would be negative reinforcement. Yelling and/or corporal punishment would be forms of punishment They are very different. The problem with punishment is that it has a very short term result. And repeated punishment eventually will result in no positive result whatsoever. Please forgive me for probably misrepresenting this study but here goes: There was a famous study performed where an electric grid was installed in an enclosed box. Mice were placed in the box and half of the box was shocked. The mice went over to the other side away from the pain. Then a barrier was installed so they could not move from one side of the box to the other. Then the mice were shocked. They initially tried to escape to the other side. However the barrier would not allow them to move over. After repeated shocking, the barrier was removed. The mice were shocked yet they did not move over to the safe side. In effect, they were conditioned to just sit and take the pain. Think about this: When your dog runs away and you beat it. That is punishment. If the dog runs away and you beat it again it will be trained to stay away. If you beat a dog long enough eventually it will just lie there and allow itself to be beaten. This is shown dramatically in abused wives. They become beaten physically and/or mentally and that if this occurs long enough that eventually they just sit there and continue to be beaten. And should someone come along and offer them sanctuary, the abused wife will chose to stay with the abuser. Someone once said you train animals but you teach children. If you really want to go into deeper understanding of this, I recommend an exceptional person Dr. James Dobson either in his numerous books on this subject most notably Love Must Be Tough. He also hosts an extremely informative radio show entitled Focus on the Family. My church radio station broadcasts this as do many Christian radio stations around the corner. He is seen very regularly on Fox shows such as Hannity and Colmes.

    Daniel Flam adds:

    Having spoiled brats that everyone in the room hates to be around because you don't want to put them in their spot, Will just delay the point in time where someone that is not a family member will put him in place in a most unpleasant way. Bringing up Children is like painting a work of art. You must use all the colors of the spectrum, although some colors should be used a very small dose, or you might get an ugly result. I see additional factors to the one suggested:

    • Fourth: Randomness. We also act randomly, the fact is that we need to be *taught* to be consistent parents. (it is referred as a mood and there is a theory that most people have moods).
    • Fifth: The Counter. Kids also press our buttons in order to understand how to live in a society. As James Sogi mentioned kids training their parents.

    Today we find names for anyone who doesn't behave like a sedated rabbit. This reminds me of that shirt "I hate it when people think I have ADD! Oh look, a chicken!"

    James Sogi replies:

    Rather than 'greed' and 'fear', counting, like behaviorism, is more scientific. Quantify to predict. The market trains everyone to do the wrong thing. When one is trained to go long, the market goes south. When one is trained to play the range, it breaks out. Of course it trains one in the just the most intermittent and thus most powerful manner, like slots, to go the wrong way. It is called variable reinforcement. Counting gives the clue that the training is in play and not to follow the masses and to stay a step ahead of the market. Be the trainer not the trainee. Who is in control here after all. Little babies train their parents. It is the brat in public that has the haggard parent running around like a chicken. Both are miserable. Proper training involves the use of love attention and affection. It is not the rats-in-a-box syndrome. The natural reaction is to run to the crying baby. That merely reinforces the crying. The natural crying pattern has variations. When there is a break in the first few moments of crying, use that moment variation to sooth the child. The reinforces the calm not the cry. Inconsistent parents give mixed signals can cause confused children, unhappiness. Consistency give certainty and clearness to the child. I tried to see how many days we could et my kids without crying. How many times per day would they cry? Why did they cry, what were the operant conditions? Quantify the responses. Forget the mumbo cognitive jive. In the market, the public rushes to the upsurge, but is this the correct response? When the market tanks, the public trained panics. Again, scientists, is this the right response? Quantify one's own responses to get an idea of what works, what doesn't. consistency brings profit.

    J. T. Holley reminisces:

    My PaPa would espouse to me "the grass might be greener on the other side but someone has to mow and rake it too" whenever I would act like those cognitive psychologists! I think the operant conditioning like B. F. Skinner is appropriate for those dealing with the markets. The classic philosophy (shortened and brief) is that Plato felt to "know the good was to do the good", whereas Aristotle had a more operant conditioning belief in that "to do the good was to know the good".

    Russell Sears suggests exercise:

    What the kid needs is an outlet for his energy. Have the kid run a few lapse, go a few miles on his bike, or even shoot some hoops. I would suggest, that what Lackey encourages his kids to do has more to do with his kids well adjusted behavior . Lackey little league, and coaching wouldn't see these kids. Kids with no competitive outlet, takes it out on the adults. Exercise generally works better than any drug for mild depression. But what Doctor will prescribe 2-3 miles run everyday for 2 months to a single Mom for her kid. Its called "child abuse". But giving him mind altering drugs, to a developing growing brain, is called "therapeutic care."

    Pamela Van Giessen laments:

    This seems to be part of a larger issue where every single moment of childrens' days are being structured and moderated by adults. There is school, soccer practice, swim lessons, judo, music lessons, play dates, etc. It's kind of like jail. Even worse because at every turn there are adults loitering, supervising, and otherwise keeping a watchful eye. I call them helicopter parents. They mean well, but I can't help but be eternally grateful for my parent's lack of vigilance. I read an excerpt from John Dickerson's book about his mother, Nancy (first female TV news star), where he noted how absent his parents were and that he and his siblings were often left to their own devices, and how, in the long run, that turned out to not be an entirely bad thing. My American nephews are supervised 24/7 and while they are smart and adorable children, I notice that they are more prone to temper tantrums and the like. My Dutch nephews roam free; they rarely have a baby spell. And, honestly, the Dutch kids seem more creative and amusingly naughty. I like children who stick carrots up their nose at the dinner table, provided they are stealthy and quiet about it. Kids don't put up with other kid's temper tantrums and so children who hang out with children stop behaving like brats — at least if they want to have friends. At the age of seven, I was biking a mile to go get candy. I rarely see children about my 'hood without adults. Can't they even go to the bodega without Mom? At what point will they not be supervised and watched over? I've also noticed that the young women (oh, how I hate saying that) that work for me seem to approach their jobs, careers, and even daily to-do list like a school exam that they must ace. They miss the larger point about spontaneity, about creating, about doing as you go and it all becomes about getting an A and moving on to the next "test." They also seem to structure their lives accordingly. From x-time to y-time is work time, from z-time to a-time is not work time. One hopes that romance isn't scheduled so rigidly. When I think of all the wonderful experiences and successes (and even some failures) I've had by being spontaneous, by looking in rooms I wasn't due to be in, by not scheduling my life with much structure it makes me sad to see us creating a society of automatons.

    Nat Stewart adds:

    One of the most worrisome trends in my view is the "bans" on student organized, spontaneous recess games, which for me were always the highlight of the day in the early grades. The spontaneity and sense of it being "ours" and not a teacher/instructor lead activity also increased the value and fun of these activities. I think for many kids this type of vigorous exercise is almost a need or requirement, It certainly was for me. Kids who are naturally curious, such as this kid in the article who is a "gifted reader" need independent outlets to exercise their own curiosity, and opportunities for individual study and thought. I think many of these kids are just bored stiff! The extreme bureaucratic environment is not a good learning environment for many children. Kid can use logic, and I believe many start to rebel and have trouble when they are repeatedly asked to do things that they do not find logical. "Johnny has a problem…" Well, maybe he is mad that so much of his day is wasted in useless, pointless, mind numbing activities? Maybe he would rather be off on his own, reading a book. Kids can be sensitive to injustice, and little things over time poison can poison ones attitude to the entire process or system, which is unfortunate. All kids are different. Labeling children with 1000 different Disorders is only a smokescreen that hides our severely dysfunctional system.

    Professor Gordon Haave replies:

    I would suggest that what is wrong with the children is nothing… except a total lack of discipline and their learning at 5 when taken to a psychiatrist that being crazy is normal and they can do whatever they want because they are not being bad, they are "sick". Another good thing about Oklahoma: I don't know anyone who sends their kid to a psychiatrist. Kids get discipline, hard work, and an ass-whupping if they do something particularly egregious.

    November 11, 2006 Troubled Children What's Wrong With a Child? Psychiatrists Often Disagree By Benedict Carey

    Paul Williams, 13, has had almost as many psychiatric diagnoses as birthdays.

    The first psychiatrist he saw, at age 7, decided after a 20-minute visit that the boy was suffering from depression.

    A grave looking child, quiet and instinctively suspicious of others, he looked depressed, said his mother, Kasan Williams. Yet it soon became clear that the boy was too restless, too explosive, to be suffering from chronic depression.

    Paul was a gifted reader, curious, independent. But in fourth grade, after a screaming match with a school counselor, he walked out of the building and disappeared, riding the F train for most of the night through Brooklyn, alone, while his family searched frantically.

    It was the second time in two years that he had disappeared for the night, and his mother was determined to find some answers, some guidance.

    Sam Humbert responds:

    The long-time sense of the word "discipline" was to instruct, educate, train. It somehow became twisted (as has the word "liberal") to mean, in common usage, Prof. H's "ass-whupping." What does an "ass-whupping" instruct or educate? Well, it teaches that if you're frustrated, angry, tired or stressed, and have the advantage of being bigger and stronger than the other guy, then it's OK to indicate your frustration with verbal or physical violence. Is this the what a parent wants to teach? "Discipline", in the bastardized sense of the word, means the parent has failed. Failed to authentically instruct, educate, train. And is now lashing out, motivated by frustration, not by a desire to educate or improve the child. The parent's reptile brain is in charge. And what becomes of kids who are beaten into submission for 12, 14 years.. But then become teenagers? How will they conduct themselves "out of eyeshot" of their parents, when their parents are around to "control" them with "discipline"? What actually does work in parenting — since "discipline" doesn't — is spending time with kids, and most especially, meeting them at their level, not at your own. Becoming engaged in their lives, their interests, their hopes, fears, dreams. Really hearing them, rather than lecturing them. My kids have never been "disciplined", and many parents in our town have commented to us that there are — far from being "undisciplined" — among the kindest, most thoughtful little boys they've met. The proof is in the pudding.

    Professor Gordon Haave replies:

    Although, as I have said, I don't believe in Ass whupping, I don't think what you are stating is correct. In its simplest form, it is the most crude way of stating "actions have consequences". Most of this on this list know that there are better ways of teaching that then ass-whupping, therefore they don't do it. Around here in Oklahoma, it is probably not very common, but was even just 15 or 20 years ago. Now, what goes on in NYC is simply the opposite message, that actions don't have consequences, that nothing is your fault, that if you look out the window during class or talk back to your mother you have a problem that needs to be medicated. Mr. Wiz suggests that those who receive an ass-whupping grow up having learned the wrong lessons, etc. I submit that it is better than the weirdos who grow up thinking that actions don't have consequences. They are more prone to destroying families and societies, in my opinion. So, I will restate: Ass-whupping is preferable to the NYC psychobabble approach, even if it is crude in its own right.

    Stefan Jovanovich responds:

    The "ass-whupping" meme seems to me more than a bit overdone. Striking a small child is like beating a cat. Children are small creatures compared to us adults, and they spend most of the years up to the age of puberty navigating around us comparative giants. Simply restraining them physically - holding them still - is enough physical punishment for "acting out". What was notable in the article about poor Paul Williams is that his father - the person most likely to have the physical strength to be able to hold him still - is nowhere mentioned. You can step on a cat's tail, and she will instantly forgive you even though the pain was excruciating. Intentionally strike the same animal with one-tenth the same force, and she will view you as an enemy until the day one of you dies. I agree with Gordon's skepticism about psychiatric diagnoses. Since they almost always have no clinical basis in blood chemistry or any other quantifiable physical symptom, they are usually like visits before the parole board. The patient - i.e. prisoner - has to reassure everyone that he is "sorry" and will make a sincere effort towards "rehabilitation" - i.e. sitting still in school. My Dad's theory was that compulsory education was invented so that the adults could find somewhere to warehouse the children during working hours. In his darker moments he also speculated that it was an expression of society's underlying belief that poverty was a crime. Since almost all children were destitute, society was simply doing what it did with other criminals - locking them up and then pretending that incarceration had some useful purpose.

    GM Nigel Davies responds:

    I agree. And given that one of the tenets of libertarianism is to remove physical force and coercion from human affairs, this seems to be given quite the wrong message. I strongly suspect that kids who get beaten will tend towards an authoritarian attitude to life. There are more creative ways to instill discipline, such as gaining a child's attention by showing them something that actualky interests them and using a system of reward and punishment based on what they like to do. If good behaviour is rewarded it represents a trade and fosters an attitude to life based on exchange rather than force.

    The President of the Old Speculators Club:

    I recently read an article with a darker view — suggesting that Americans who send their children to public schools are allowing the "state" to "kidnap" their children for 8 hours a day. Hours in which they are taught what it is believed they should be taught, and shielded from those things that might make them less than docile, cooperative citizens. The goal is to produce individuals who will view governments the provider of all solutions.

    Roger Arnold replies:

    When I was a boy, getting a butt tannin from time to time was a part of growing up, as it was for everyone else I knew. I can still hear the sound of my father's belt as it is pulled through his belt loops. My mother would send me and my brother to our room with a pronouncement of "wait til your father gets home", and we would sit in there laughing and joking until we heard the front door open — and oh my god that's when the terror began. Nowadays we joke about it at family get togethers and, although I have never raised a hand to my own child, I can understand the utility of the spanking as a tool of nurturing.

    Jim Sogi adds:

    The characterization as 'authoritarian' places the wrong emphasis. The reason is that firstly operant conditioning is not necessarily controlled by parents as the authoritarian and that secondly rewards are more powerful than punishments. Everyone is subject to operant conditioning regimes, some of which they may be aware, but also by many others of which they are not aware. There are in fact random conditioning regimes that wreak havoc on the unsuspecting. The result is superstitious behavior and the development of personal "issues" and psychotic behavior due to the various random influences at work creating random patterns in people without their knowledge. We see this in the markets daily. When one is not aware of the theories of social learning, feedback loops can be created that are destructive and create bad habits. When one is aware of feedback patterns in social situations one can control the bad influences and foster the good. A human cannot opt out of conditioning regimes. They exist everywhere in the family, in society, at work, and also as random elements in daily life. The question is not whether social learning takes place, the question is which regime is going to dominate your development? The random crying of a baby? The whims of a teenager? The random flow of traffic? Or the structured goal oriented regime of successful adults in the pursuit of happiness. To believe one is not conditioned every minute is denial. The question is who is doing the conditioning and to what ends? In the delightful and hilarious book, Taxonomy of Barnacles by Galt Niederhoffer, read during the last vacation, the issue posed by the author was whether nature or nurture were the determining factors in the success of a person. This issue has been a great debate in our family and I agree with the author that nature is the predominant influence, and that we in fact are subject to many of the same traits our grandfather's displayed to a remarkable degree, and that conditioning might try to guild refined gold or paint the lily, but the mold is cast genetically to a much greater degree than most are willing to admit.

    Steve Leslie offers:

    Jim, you have nailed what I find one of the most difficult aspects of trading. If I open a trade and the price goes the direction I want, I feel rewarded; if it goes the other way, I feel punished, but these feelings have little to do with actual success. Success is trading when, and only when, one has an edge. Individual trades may not be profitable because of variance or because the hypothesized edge is illusory or has fallen prey to changing cycles. Success is managing risk so that, after the inevitable setbacks, one lives to fight another day.



    I was watching CNBC over a bowl of cereal a short while ago and Pisani said something along the following lines: “The S&P cash hit 1388 or 1389 again this morning and backed off. This is about the seventh time this has happened.” I don’t generally follow information like this but have seen lengthy List conversations about various indicies at various levels (including “the round”). First, is Pisani’s information accurate (or at least close)? Secondly, is it indicative of anything important? I’ve heard much of “levels of support and resistance” but am not sure that they, or double and triple tops, are significant (it wasn’t that long ago that Dow 11350 was being watched as an area of resistance - obviously it has been overcome).

    John Bollinger replies:

    I find repeated visits to a level, line, band, etc… useful as ‘logical places’ to take decisions. This is the sort of thing that is hard to ‘count’, but relatively easy to trade. Some of you may know Fred Wynia, it was he that taught me the importance of making decisions at ‘logical places’. I put ‘logical places’ in quotes as it is Fred’s term.

    Dr. Phil McDonnell replies:

    Pisani is accurate. The previous 6 dates and highs are:

    11/13  1387.61
    11/8   1388.92
    11/8   1388.61
    11/7   1388.19
    10/27  1388.89
    10/26  1389.45

    So this morning’s high made the 7th such high in the 1387-1389 range.

    Under the category of knowing one’s adversary I would note that there has been a long term up channel which one can draw on a chart over the last few years. The tops of significant rallies appear to be collinear, so drawing a line through them gives an upper limit to the channel for chartists. We hit that line on 10/26 at 1389 (or so) on the SnP.

    Note that the line is an up sloping line but it has a much more gradual slope than the recent advance from the June-July lows. I would put this in the same category as round numbers and other such things which cannot possibly work but do. Human beings are superstitious and those who look at charts may sell at such junctions ‘just to be safe’.



    Snub at AT&T.
    Metioric rise at Lucent.
    Trust first impressions.

    She may take a stab
    At politics after her stab at business.
    And Lucent stock price.

    She still has so much to offer.
    550 local business leaders
    Can’t all be wrong.



    I recently returned from a month in the Philippines and Vietnam, and one of the highlights of the trip was learning how to drive competently in such alien conditions. For example, I spent a lot of time in General Santos, a city of about 500,000 on the island of Mindanao. GenSan has only one traffic light, and it doesn’t work, anyway. The roads are packed with bicycles, tricycles, motorbikes, “cyclos”, cars, and trucks, and the widely varying speeds mean that you are passing somebody, or being passed, every few seconds. And of course, there are people, dogs, kids, pigs, and buffalo wandering onto the road at random. You have to drive with one hand on the wheel and one on the horn, as the horn is used to warn pedestrians and slow traffic that you are about to hit them if they don’t move over. The concept of traffic lanes is a very fluid one, but at least the slower traffic tends to stay to the right. I also did a lot of motorcycle riding on dirt roads in the country.

    In Vietnam, you cannot yet rent a car, which would probably be a very bad idea, anyway. But you can rent a motor-scooter if you are brave. The traffic, especially in Saigon, is incredible. What used to be a human flood of bicycles is now the same, but faster, on scooters. If you go too slow, you die. If you are hesitant and unpredictable, you die. If you don’t react quickly when cars and trucks try to squeeze you out of the way, you die. For me, driving in Vietnam was exhilarating, but for my partner riding on the back it was terrifying. Crossing the street on foot is also a mind-expanding experience. Since there are few traffic lights, and no crosswalks, there is only one way to do it. You have to just step out into the middle of the flowing traffic and trust that you won’t be hit. Just keep walking slowly and predictably, and amazingly the traffic flows around you. It reminds me of smoke flowing around a wing being tested in a wind tunnel. I did see some accidents, though. Usually they were motorcycle riders, and since helmets are rarely used, accidents can be traumatic. I don’t know if the lack of traffic lights, laws, and cops makes people better drivers. Maybe it is just survival of the fittest. It is a fun adventure, but I must admit that modern traffic engineering leads to faster, and probably safer, travel.



    I received a book recommendation from Stefan Jovanovich who, like Jim Sogi, utters something of profundity whenever he speaks. He recommends historical books by Peter Green and J. S. Holliday as models of good scholarship. I call on him and others for some good historical books that I can read and augment my library with and share with my children, who are studying history in school, and regrettably have been brainwashed by politically correct curricula, starting with Squanto as the archetypical American hero.

    I recommend the book Lessons of History by Will Durant as well worth reading for its lessons on markets as well as a honest attempt to review the lessons from a life long study of the sweep of history in conjunction with this request.

    Alston Mabry replies:

    Inventing America is a textbook that has an interesting approach and might be an alternative for homeschoolers:

    Book Description; W. W. Norton presents Inventing America, a balanced new survey of American history by four outstanding historians. The text uses the theme of innovation–the impulse in American history to “make it new”–to integrate the political, economic, social, and cultural dimensions of the American story. From the creation of a new nation and the invention of the corporation in the eighteenth century, through the vast changes wrought by early industry and the rise of cities in the nineteenth century, to the culture of jazz and the new nation-state of the twentieth century, the text draws together the many ways in which innovation-and its limits-have marked American history.

    Check out the TOC or get the second edition here or get a used copy of the first edition for a nominal amount.

    Some other longtime favorites are The Making of the Atomic Bomb by Richard Rhodes, The Devil’s Horsemen: The Mongol Invasion of Europe by James Chambers, and King Harald’s Saga: Harald Hardradi of Norway: From Snorri Sturluson’s Heimskringla by Snorri Sturluson. You can get the wiki overview here, but the saga itself is a quick read and an amazing story.

    Another audio book I have thoroughly enjoyed listening to on cross-country drives is Simon Schama’s A History of Britain. The audio book is in 3 volumes. Schama, a professor at Columbia, is such an excellent storyteller that I would pick up anything he has written. The television series of the same name is also available on DVD and is outstanding.

    Schama’s most recent work, Rough Crossings, is about the British and slavery during the Revolutionary War: You can hear Schama talk about Rough Crossings on Book TV.

    Stefan Jovanovich replies:

    Simon Schama has the gift of charisma. When you watch his narration of the video documentary of the History of Britain, you are instantly aware of it. The trouble is that his histories are not to be trusted. At their worst they are little more than royalist propaganda. Too often he writes the story that the Queen would like to read, not the one that happened. Even though Cromwell was the first head of the United Kingdom to allow Jews to openly practice their religion, Schama finds the Great Protector to be a far greater villain than any of the crowned heads who so routinely persecuted the children of Israel. He is equally severe in his criticisms of those greedy speculators of the Dutch Republic who left Spinoza free to grind his lenses; in Schama’s eyes, those Dutch Reform bigots were guilty not only of inventing capital markets but also of buying too much stuff. The common thread in Schama’s works is the notion that sectarian Christians, with their notions of free markets, are to be feared as dangerous, greedy fanatics who will upset the natural order of the world. The meme continues with Rough Crossings. Schama makes a great deal of the fact that the British offered freedom to slaves who would join the Royalist forces in fighting Washington’s Army while failing to note that the Confederates ended their struggle with the same concession to the dire necessities of war. In general, Schama finds the Christian deism of the slave owning signers of the Declaration of Independence proof of their hypocrisy and, by extension, that of the American nation as a whole. The fact that, for another half century, neither the Archbishops of Canterbury nor the Kings of England had any problem with sanctioning and enforcing slavery in their remaining territories is somehow put aside. So are the origins of the anti-slavery movement in both England and America (those dreadful Methodists). The nearly two centuries old Anglo-American naval alliance (the longest-lived military confederation between democracies in recorded history) had its origins in the anti-slavery patrols off West Africa by both fleets that began in the 1820s. Those were initiated as a political concession in both countries to those same cross-bearing nutballs who thought that the “common” people should have the right to vote even if they did not own a carriage. Ain’t history grand?

    Tom Ryan suggests:

    Daniel Boorstin’s three books, The Americans, written before 1973, provide a refreshing take on American history in my opinion. I recommend the third in the series, “The Democratic Experience”, which covers the 1870-1970 period in American History. It is unconventional in the sense that it focuses on the stories of the individuals who built, invented, and created this country, the untold stories of the individuals as it were, rather than the typical history of Washington political leadership that is regularly fed to children in grades 4-12.

    Steve Ellison adds:

    I highly recommend British historian Paul Johnson’s A History of the American People, which goes into detail on many topics, including the relentless economic growth that occurred almost from the outset. A small sample:

    By the third quarter of the 18th century America already had a society which was predominantly middle class. The shortage of labor meant artisans did not need to form guilds to protect jobs. It was rare to find restriction on entry to any trade. Few skilled men remained hired employees beyond the age of twenty-five. If they did not acquire their own farm they ran their own business.

    Rodger Bastien responds:

    I just completed Rubicon: The Last Years of the Roman Empire by Tom Holland. I highly recommend this historical narrative of the final days of the Republic which deals with primarily the years 100 B.C. to 14 A.D. For me, the book brought to life this period which I knew little about but was arguably as important to subsequent civilizations as any period before or since. Caesar, Marc Antony and Cleopatra may have existed centuries ago, but to me those centuries somehow feel a little shorter.

    Gibbons Burke replies:

    I am finding I am enjoying first-person narrative accounts of historical events and times, so, with that in mind:

    and one that’s not a first person, but which is fascinating and has many meals:

    John O’Sullivan replies:

    I recommend two books by Anthony Beevor: Stalingrad and The Fall of Berlin 1945. Both mesh grand strategy with individual detail and amazing narrative momentum. I also like three Middle & Far Eastern travelogue/history/biographies by William Dalrymple : Xanadu, From the Holy Mountain and White Mughals. Dalrymple has created his own genre and its a rich mix.

    MacNeil Curry replies:

    I would have to recommend Bury My Heart at Wounded Knee: An Indian History of the American West. Not only is it a fascinating account of the West from a different perspective, but it highlights quite well that there are two sides to every story and that both must be carefully studied before one can truly come to there own conclusion.

    Tyler McClellan replies:

    Speaking of John Wesley Powell, Beyond the Hundredth Meridian: John Wesley Powell and the Second Opening of the West by Wallace Stegner is a book with many practical lessons for investing and life that used to be required reading for the history of the American West.

    Craig Cuyler replies:

    My favourite historical novels are without doubt the three part trilogy by Neil Stevenson called the Baroque Cycle. This body of work, over 2500 pages long, covers life in 17th-century in England, Europe, Russia with special reference to natural philosophy & science. Stevenson weaves in his ideas about currency, calculus in speculation which took place around the central characters like Isaac Newton, Huygens, Hook, Leibniz. The courts of Louis XIV in the battle for the monarchy in England feature strongly. The Baroque Cycle is to science what the Lord of the Rings is to fantasy. Fantastic read!



    A simple explanation of herding can be found in this week’s Economist, with obvious parallels to the stock market.



    As an undergrad at Yale I entertained two passions-Ivy League athletics (particularly basketball) and markets. The former drew me to nearly every contest in New Haven and its vicinity while the latter compelled me to keep a close eye on game lines and eventually pursue a career in investing. After following Ivy League Basketball for nearly two years and always being cognizant of each game’s spread, I began to find wild inefficiencies in certain contests. My thesis was that because Ivy League Athletics, particularly basketball, were not televised or particularly well covered in the press, the market was relatively inefficient. Having followed the teams for nearly two years and watching each team play in New Haven, I believed that I had a fair amount of differential insight and could take advantage of the inefficiencies offered. For the next two years I played specific contests where I thought the spread to be wildly inaccurate and was successful to the point that I was able to pay for my textbooks in both my Junior and Senior years with my winnings.

    After graduation, I decided to revisit my thesis, with the belief that I would continue to bet on contests. However, I noticed that during the 2005-2006 season, spreads seemed to be relatively fair and I was having trouble finding those ridiculous spreads that screamed of opportunity. I attributed this to increasing media coverage of Ivy League contests-particularly television coverage on YES and ESPNU of many Ivy League games. In an effort to test my thesis, I compiled empirical data. Unfortunately, I had a rather limited data set (the last 20 contests of each Ivy League team) and so could not look at the relative efficiency of the market pre-coverage and post-coverage; interestingly, however, the data suggested another opportunity. Eliminating overlapping contests and including contests outside the league, I have 104 observations. Collectively, Ivy League teams won 48.1% of games vs. the spread, roughly in-line with the 50% you would expect in an efficient market. Yet, in — of the observations, the collective score of the game exceeded the Over/Under line (estimate of total number of points to be scored in the game) published prior to the game. This is an important observation, one that leads me to believe that deep-seated biases, particularly the belief that Ivy League affairs are always low-scoring defensive battles, are manifesting themselves in the spread makers over/under decision.

    Markets will always evolve, but it is important to remember that the demise of the status quo does not portend a similar fate for opportunity.




    “The fund will be people of limited income, employees, and others, this groups matters most to me . If they win then this is their luck, with God’s will, and if they lose, then their capital is preserved with us” — Saudi King Abdullah in commenting on his implemented plan to allow 3 Million investors, out of their 10 million population, to invest risk free in the face of a 50% drop in marriages this summer in Saudi due to the 60% decline in the stock market in which 50% of the population plays.

    J. T. Holley replies:

    A Google search of the words “Saudi Arabia Market Crash” produces 969,000 hits. If you read any of the articles and also look at the headlines scrolling down you’ll see the same “editorial propaganda” as if it was here in the States. The Body Snatchers have no borders!



    I like reading Kenneth Fisher’s columns in Forbes and Bloomberg Money (also available on Fisher’s own site), and I liked his books Super Stocks and Wall Street Waltz (I have not read his 100 Minds That Made the Market). In early December he is due out with a new book The Only Three Questions That Count (excerpt here). Apart from some inspiration for testing, it seems hilarious.

    One of the reasons why I like his writing is that he dares to be different and stick his neck out. It also seems that he does a lot of testing of different hypotheses about the market. His works are full of ideas and inspiration for further testing. But — the million dollar question — I have no idea about what his returns have been like. And he has been in the business since 1972 with his own fund from I think the late 70s. He is currently managing $30 billion, so there has to be a long track record somewhere. Can anyone enlighten me?

    Steve Ellison replies:

    The Political Economist reviewed his book.

    “First, what do you believe that is actually false? You may be preventing yourself from making smart investment moves because you’re blinded by falsehoods - ones that you get suckered into believing just because everyone else believes them.

    Fisher comes up with some good examples of such falsehoods. You probably believe that stocks perform better starting at times when price/earnings multiples are low - and that they perform worse starting when multiples are high. Haven’t you heard that a million times? Isn’t it the core tenet of ‘value investing?’

    According to Fisher’s research, it simply isn’t true. He’s crunched the numbers. Over history, it turns out to just not make much difference whether market multiples are high or low.”

    “The second question is, what can I fathom that others find unfathomable? If you’re investing based on ideas that everyone else can grasp, those ideas are probably too stale to make you any money. Go for the things that you think are true - but that everyone else thinks are crazy.”

    “The third question is, what the heck is my brain doing to blindside me now? Here Fisher walks us carefully through a minefield of cognitive dysfunctions that trick even smart investors into doing very dumb things.

    Fisher points out that two emotions rule most investors’ souls — pride and regret.

    We seek to build up our self-image by successful investing, rather then treating success as an end in itself. When we do succeed, we swell up with the pride of it and start believing we can do no wrong. At the same time, we will do nearly anything to avoid the shame of regret - that horrible sinking feeling we get when an investment goes bad, and you have to accept the fact that we really blew it.

    Fisher says to turn these emotions inside out. Seek regret - that is, embrace your mistakes and learn from them. Shun pride — invest to make money, not to pump yourself up, and never, ever imagine you are invincible.”

    J. T. Holley replies:

    Vic and Laurel in Practical Speculations (chapter 2) did a wonderful job of illustrating and showing the reader with the added education of Scatter Plots the “Propaganda of Earnings”. A fish for a lifetime more importantly was the 7 techniques that came from the book “Fine Art of Propaganda”. Since reading the book the two that have come up the most in my observations is Plain-Folking and Bandwagoning. When I read an Ezine or online paper dealing with Finance those two seem to be the most frequent to me or the ones that I find easier to identify.




    SEC Plans to Raise Hedge-Fund Investing Requirements

    Nov. 10 (Bloomberg) — U.S. Securities and Exchange Commission Chairman Christopher Cox said the agency will propose rules next month making it harder to invest in hedge funds. “We’re going to make it very clear that hedge funds are risky investments that are not for mom and pop by fencing it off with higher standards to accrediting investors,” Cox said in an interview today.

    Nice meme imagery, “We’re going to make it very clear that hedge funds are risky investments…”

    What does that mean? Leverage? Commodities? Long/short? Short only? Unlevered equity? Fixed income subordinated leverage? Not important. They’re all the same!



    Fed chair Bernanke’s speech, “Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective” is simply a litany of failures by the central bank to understand its own core product: money.

    Kudos to Bernanke for his clear-eyed ability to acknowledge failure… but would you take your car to a mechanic who said that despite decades of study, he still didn’t understand engines?



    Rafe Furst of FullTiltPoker states that each chip in a short stack is worth more than same amount in big stack and should be played more carefully (e.g. you might fold a 50/50 shot with short stack whereas you’d call with big stack). I wonder if there is analogy to money management. Should a certain amount of risk or certain trades not be taken when fund is short stack vs. big stack?




    Fiorina’s Winding Road Points to an Uncertain Future

    Monday, November 13, 2006; Page D02

    Carly Fiorina knows what it’s like to be an outsider. The law school dropout started her career as a secretary in a male- dominated business world. She was initially rejected by the University of Maryland’s business school, was once referred to as the “token bimbo” at her job selling telephone service for AT&T, and later became the chief executive of Hewlett-Packard.

    Medievalist Carly,
    Georgetown part-timer,
    tries "pity me" tack.
    She works the lecture circuit.
    Oh, she's lonely too.



    When you start out in a game, a fight, a competition or a trade and right off the bat make a mistake or two, it puts you “on the wrong foot”. It’s a stumble coming out of the gate. You are in bad frame of mind because of making errors. You are fighting to catch up. These two factors set you off balance, not on the right foot, not leaning forward into the trade, off balance slightly, unable to attack strongly at the prime opportune time to attack when the opponent is weak and also off balance. These problems are compounded by distance and time. In longer term events this balance issue is critical in maintaining the correct mental attitude. Then at the end of the trade, you are so glad to be past the trouble caused by the original errors, you end badly as well. Champs don’t make mistakes right off the bat, or if they do, can overcome them and put them behind, make the extra effort and come from behind. That’s what makes them champs. How do you fight back, when you are weak, and behind?

    In everyday endeavors, a regular discipline can help avoid the occasional errors. Errors are going to be part of every human endeavor, so it is important to be able to work with the situation and come out productively in the end, especially in areas that require judgment calls. Perfection is not possible. Admission of the error is important. Denial can cause further, irreparable damage.

    Peter Earle responds:

    With respect to preparation, and since you mention fighting — an apt field, indeed, for cultivating trading metaphors — I am reminded of an old boxing truism revolving around coming in dry: part of the informal intelligence casually gathered by cornermen (and sometimes fighters themselves) on the way to the ring and while waiting for a fight to start is whether the man across the ring is perspiring or not. This can sometimes give a clue as to how seriously he is taking the match/his opponent, how adequately he has warmed up, and even his level of anxiety.

    If one’s opponent appears to be dry, sometimes — depending upon how he is known to perform under pressure — the game plan can suddenly shift; not, as may have been planned, to engage in a multi-round chess game, applying increasing pressure, but instead to come in with guns blazing at the open.

    Though examples are numerous, I’m reminded of the mid-1990s undercard fight between John Ruiz, who would eventually become WBA heavyweight champ, and David Tua. Tua’s corner, noting Ruiz’s stiffness and lack of perspiration, urged Tua to jump on Ruiz right at the open… with resounding success.

    David Lamb replies:

    Frederick the Great started off on the wrong foot, but he never thought so. He just retreated for a few weeks, came back after doing some readjustment at home in Berlin, and accomplished what he first set out to do.

    During his first campaign (at the ripe old age of 29) he led (very literally) a part of a two-columned Prussian army toward Neisse, the strongest Austrian fortress in Silesia. I now quote from the book on Frederick the Great I am reading (written by David Fraser):

    “Both wings of the Prussian army ultimately converged on Neisse, where they found an Austrian garrison prepared to resist. There could be no question of exposing the troops to methodical siege operations in the conditions of winter and after trying, without success, intimidation by a ferocious ten-day bombardment, Frederick decided to leave Neisse… to return to Berlin, which he reached on 26 January. He had lost only twenty men in all.”

    While back in Berlin he acted as if all was going as planned. In other words, he seemed not to worry too much about momentary setbacks. He acted as if they were the undesirable fatty parts of a great T-bone steak: He wouldn’t eat it, but regularly expected it upon ordering a steak. He even wrote all the neighboring Kings and Emperors that everything was going great and they could back him up or not. He acted alone, acted first, and never hesitated. But he never gave up once all his homework was done and all the data was aligned his way.

    Furthermore, perhaps Frederick never felt he was fighting back, or on the wrong foot, or playing catch up. Perhaps the feeling of vulnerability and weakness and initial loss is what places the competitor at a disadvantage, not necessarily his actual numeric disadvantage.

    Stefan Jovanovich responds:

    Christopher Duffy, an exceptional scholar, wrote a fine book on Frederick the Great. I have not yet read Duffy’s new book on the Somme, but the people I trust think it is the most important book on WW I in decades.



    Last weekend I went to play in a tournament in Tenerife. On the Sunday I was not quite as careful with my luggage as usual (it was Spain and I was relaxed), leaving it in the luggage compartment of the bus that would take us to the airport. It was going to be locked, but still… When they heard what I’d done some GM colleagues enjoyed recounting various luggage horror stories, adding to the torture with looks of mock concern. And Bojan Kurajica told me about how he’d lost his luggage once in Germany, apparently the victim of a perfect crime.

    He left it in a locker at a railway station, taking the key and setting off for some tourism. When he came back his luggage was gone with no sign of a forced entry. He complained to the authorities who were as dumbfounded as he was - they even asked him if he had the right locker. Eventually he figured out what had happened.

    The locker keys could be duplicated for just a few DM, so the thief would deposit some money to get the key, have it duplicated and then wait. As soon as he saw someone deposit valuable looking luggage he’d use his duplicate key to open the locker and make off with the luggage. A theft in broad daylight at a crowded station and with very little risk. The perfect crime?



    The New York Cost of Living Calculator is a Flash-based question tree that is roughly accurate. Bear in mind what you’re up against



    Victor and Laurel note: A heated debate regarding Joel Greenblatt’s “The Little Book That Beats the Market” recently cropped up among our colleagues. Below is some detailed follow-up work from one of our eminent researchers who is as adroit at analysis of single crystal NMR of high temperature superconductors as he is at uncorking the seemingly suggestive system work of hedge fund managers with putative 40% returns. Please note our response, which follows, as well as earlier intriguing commentary which began in early November and is found further down on the site.I’ll report here the results of a study that I did that addresses the results in Joel Greenblatt’s book. This study focuses on the large cap stocks that make up the S&P 500 index. Just as in Greenblatt’s work, I used the Compustat Point-in-Time database, in which the fundamental data are listed as they were at the time, and not restated.

    Greenblatt’s ranking method involved both “earnings to price” ratio and “return on capital”. For “earnings to price”, he actually uses “EBIT” (earnings before interest and taxes) divided by “enterprise value” (market cap + debt + preferred stock), and for “return on capital” (”ROC”) he uses EBIT/(working capital + property, plant, and equipment). All these items can be specified using Compustat Point-in-Time.

    After ranking stocks separately by E/P and ROC, he then takes these two ranking numbers and literally adds them together, and then finally ranks again based on that sum. He finds that the stocks that have both high E/P and high ROC tend to do well.

    Here are the ground rules for my study. Stocks are ranked and then purchased at the end of each quarter, and held in that decile until the next quarter, when stocks are re-ranked. The most recent trailing four quarters of EBIT are summed to find the trailing yearly EBIT. In order to be purchased, stocks must have been components of the S&P 500 as of the start of the calendar year under consideration. As of the purchase dates, their share price must be greater than $2.

    I checked and found that yes, the study did include Enron and WorldCom. Enron was bought on 9/28/2001 at $27.23 and sold at $0.60 for a loss of 97%. It was not re-purchased the next quarter because its share price had fallen below $2. At the time of purchase, Enron was near the middle of the rankings in terms of both E/P and ROC.

    For each stock the “total return” was calculated, including dividends, using data from what we believe to be a reputable commercial vendor. However, I confess that I need to check on what the exact algorithm is for computing total return when there is something complicated, such as a merger or a spinoff.

    At the start of each quarter the stocks were sorted into deciles according to Greenblatt’s ranking method. For each decile, the average of the forward 1-quarter fractional total returns for the approximately 50 stocks was calculated. Calling that number “R”, we then calculated 100*ln(1+R) for that decile and that quarter, and I’ll let Dr. Phil McDonnell (a frequent site contributor, trader and academic) explain why we did that. (As long as that number is not too big or small, it’s going to be pretty close to the percentage change in the portfolio.)

    Our study covers 1992 to present, 59 quarters of data. The reason that we went back to 1992 was simply that we happen to already have had a convenient file listing the S&P components year-by-year back to 1992.

    For each decile there are 59 quarterly returns. Below we give the results of our study, the average and standard deviation of those 59 numbers for each decile.

    Decile 1 is the one with high E/P and high ROC; decile 10 is the one with low E/P and low ROC. The last column is the average divided by the standard deviation. Multiply that number by two and you have the annualized “Sharpe ratio” for that decile, if I understand the definitions correctly.

    1    3.84    7.89     49%
    2    3.33    8.57     39%
    3    3.07    8.23     37%
    4    3.69    7.46     49%
    5    3.34    6.79     49%
    6    3.04    7.40     41%
    7    2.44    7.32     33%
    8    2.47    7.46     33%
    9    2.35    9.98     24%
    10  2.51   13.27     19%

    The Greenblatt “favorites” portfolio averages 3.84% per quarter with a standard deviation of 7.89%, with an average/standard deviation of 49%. The Greenblatt “bad guys” decile, decile 10, averages 2.51% with a standard deviation of 13.27%. So this confirms that the Greenblatt strategy has worked reasonably well since 1992 on the kinds of large-cap stocks that make up the S&P 500.

    An investment of $1 in decile 1 stocks grew to $9.63; $1 invested in decile 10 stocks grew $4.39, and it was more volatile along the way.

    Greenblatt’s data end at the end of year 2004, so below I will show you how this S&P 500 version of Greenblatt has performed since then. However, first, I will show you how some other strategies fared during the same 59 quarter period since 1992.

    First, here are the results for a ranking based solely on E/P:

    Avg      SD     Avg/SD
    3.54    8.91     40%
    3.88    8.20     47%
    3.50    8.55     41%
    3.01    7.00     43%
    3.04    6.62     46%
    2.77    6.78     41%
    2.65    6.97     38%
    2.40    7.76     31%
    2.88   10.05     29%
    2.36   13.78     17%

    (First row: Highest E/P, Last row: Lowest E/P)

    The results are similar to Greenblatt’s, though perhaps not quite as good. All that’s not surprising (if you believe Greenblatt’s thesis), since E/P is one of Greenblatt’s two ranking factors.

    ROC is Greenblatt’s other ranking factor, and below is the performance of deciles sorted based on ROC alone:

    Avg      SD    Avg/SD
    3.72    8.03       46%
    3.65    7.92       46%
    3.08    6.69       46%
    2.97    7.68       39%
    2.68    7.81       34%
    2.77    7.72       36%
    2.72    8.25       33%
    3.09    8.16       38%
    2.85    8.76       33%
    2.62   13.02       20%

    (First row: Highest ROC; Last row: Lowest ROC)

    Again, the highest ranked ROC deciles performed better than the lowest ROC deciles.

    So it seems that both E/P and ROC each have some independent value as ranking criteria (though we haven’t examined the extent to which E/P are correlated or anti-correlated).

    Finally, here are a few other ranking methods.

    First, here’s another “value” ranking method. Many value investors claim that it’s bullish if a company has a high ratio of cash-and-equivalent on hand to market-value-plus-debt. Below is the performance according to that ranking:

    Avg      SD   Avg/SD
    3.96   10.40      38%
    3.42   11.43      30%
    3.14    9.68      32%
    2.73    8.95      31%
    3.44    7.72      45%
    2.81    7.47      38%
    2.91    6.73      43%
    2.81    6.79      41%
    2.49    6.26      40%
    2.57    6.05      42%

    First row: Highest cash/(market value plus debt); Last row: Lowest..

    Here the firms with the highest cash had the highest average return, but they also had a relatively high standard deviation, and there is no clear trend in the Sharpe ratio vs. decile number. I would argue therefore that this “cash” ranking did not have much value.

    Others have suggested that the Greenblatt effect might be some artifact of share price and/or market capitalization. So here are studies of those factors.

    First, share price:

    3.04   14.94    20%
    3.14   10.12    31%
    3.39    9.11    37%
    2.62    7.43    35%
    3.35    7.58    44%
    3.19    7.14    45%
    2.76    7.75    36%
    2.75    6.37    43%
    2.71    6.74    40%
    3.03    6.76    45%

    First row: Lowest share price; Last row: Highest share price

    This table shows no trend in return vs. share price. The lower share prices, however, do have higher standard deviations in their returns, so arguably one should focus on higher share priced stocks for a smoother ride.

    Next here are the results for a decile ranking based on market capitalization:

    3.33   12.14    27%
    3.52    9.94    35%
    2.89    9.36    31%
    3.35    8.21    41%
    3.46    7.48    46%
    3.36    6.49    52%
    2.62    7.71    34%
    2.45    7.19    34%
    2.57    7.22    36%
    2.66    7.67    35%

    First row: Lowest market cap; Last row: Highest market cap

    The lowest market caps did outperform the highest market caps by a small amount. However, their volatility was much higher, and their Sharpe ratios were about the same or lower. So it is not plausible to think that the Greenblatt effect, as observed in this study, is an artifact of small market capitalization.

    Victor and Laurel compliment and caution:

    We would just add that the “Minister’s” study leaves out the performance since the retrospective data ran out and it ain’t pretty. The Minister is complimented on the perfect study for DailySpec: totally good methodology suggesting fruitful lines of inquiry, but nothing that violates his mandate as “Minister of Non-Predictive Studies”.

    Professor Pennington returns with updated figures:

    Here is an update of the recent performance of the Greenblatt ranking system applied to S&P stocks. Greenblatt’s book gives data through the end of 2004. Shown below is data since 2004.

    10      9        8        7        6        5        4       3        2       1
    12/31/2000  -7.6   -3.4    -0.9    -5.3    -2.0     0.8    -0.7    -0.1    -2.2   -1.5
    03/31/2005   5.6    0.9     4.7     1.1     3.0     2.6     3.1     0.9    -0.2    5.3
    06/30/2005   7.1    7.8     3.9     6.3     3.7     0.8     4.8     4.0     4.7    3.5
    09/30/2005  -2.9    2.1     1.6     2.4     1.6     3.6     3.2     4.8     1.9    5.9
    12/31/2005  10.2    6.6     7.8     4.4     7.3     6.7     5.9     4.9     5.9    1.8
    03/31/2006  -7.9   -4.5     1.4    -1.8    -0.1    -0.9    -1.2    -1.8     0.4   -1.4
    06/30/2006   0.9    3.3     2.7     4.8     3.9     7.9     1.6     5.7     3.2    4.9
    09/30/2006   3.5    3.8     3.6     4.5     2.6     4.3     4.4     3.6     3.6    1.4
    Avg                1.1    2.1     3.1     2.0     2.5     3.2     2.7     2.7     2.2    2.5
    SD                 6.7    4.3     2.6     3.9     2.8     3.0     2.5     2.7     2.7    2.9
    Avg/SD           17%  48%   120%  52%   89%   106%  104%  101%  80%  85%

    Short story is that the high ranked decile, decile 1 (high E/P, high ROC), gained an average 2.5% per quarter since 2005 with standard deviation 2.9%, and the least favored decile, decile 10 (low E/P, low ROC) returned an average 1.1% per quarter with standard deviation 6.7%.

    In such a short time frame, this one’s probably a coin toss, but it looks like it did go in Greenblatt’s favor.

    Dr. Phil McDonnell lauds and extends:

    Kudos to Prof. Pennington for his thorough review of the Greenblatt study. His use of the log of the price relative is exactly the right way to go to take into account compounding.

    In my opinion the best time period to study is the out of sample post publication time frame from 12/2004 to the present. Using this period eliminates most of the concerns and biases which I feared including the post publication bias.

    Based upon that period I looked at the Spearman rank correlation coefficient for the mean and the Sharpe Ratio(*). The basic idea is to see if there is an overall correlation beyond just a differential between the top decile and the bottom. In this case we would expect a negative correlation simply because of the arbitrary ordering of the deciles by Dr. Pennington. The following R code gives us our answer:

    # Test the Pennington-Greenblatt data using robust Spearman rank correlation
    cor.test( av,n,method="spearman" )
    cor.test( sr,n,method="spearman" )

    With respect to the average we get:

    Spearman's rank correlation rho

    data: avg and n S = 226.3731, p-value = 0.2899 alternative hypothesis: true rho is not equal to 0 sample estimates: rho -0.3719581

    Here the rho is -37% and has an insignificant p value of 29%

    With respect to the Sharpe Ratio(*) we get:

    Spearman's rank correlation rho

    data: sr and n S = 218, p-value = 0.3677 alternative hypothesis: true rho is not equal to 0 sample estimates: rho -0.3212121

    Here rho is 32% and the p value is 37% also non-significant.

    (*) Minor quibble on the Sharpe Ratio: The usual formula for the Sharpe Ratio is:

    SR = (average - tBillRate) / stdev

    The idea is that it purports to measure excess return over and above the riskless tbill rate. It is thus the excess return one received for taking on risk. However in the present case making this adjustment would not change the ranking of the deciles at all since each average is being adjusted by the same thing. Thus the Spearman rank correlation test is robust even to this factor.

    Victor and Laurel rejoin:

    We suspect, as does Russell Sears, who ran a four minute mile and is always on target, that Greenblatt isn’t as careful with his data as he would lead us to believe, and that a student did it for him, and that there are millions of multiple comparisons involved in his original work. it doesn’t make sense that you could make a profit without a forward earnings estimate, and that you would be paid just for assuming things so close to cost, with little risk.

    Robert Pinchuk adds:

    I concur with the essence of your doubts (What!, no expectations!?) even with Prof. Pennington’s detailed validation. Haugen also re-did Greenblatt’s work verbatim on his (cleaner? better?) database (written up in Barron’s some time ago) and derived some different numbers — but not wildly different. But then Haugen is touting advice-for-profit of nearly the same kind, so there are caveats. But, Haugen is not dishonest, and the advice he sells also does carry expectational measures that help him squeeze more alpha with less variance (so he says), as we would both expect.

    I am hesitant to disagree with you that the market rarely offers “freebies” for naively assuming risk, but I cannot help but ruminate upon the question: “Do the results make sense?” Bogus data, future information, dredging and questionable strategy heuristics aside, “loss-aversion” and “disposition effects” are powerful anomaly creators, especially in combination with feedback trading. I will grant you that “The Price Is (rather often) Right”, especially when conflicted with sparse non-price time-series data. Maybe elevated short-interest levels will soon make these disappear too, or at least delay gratification for a sufficiently demoralizing period of time.

    One nagging thought: Is there really, as you suggest, such “little risk” in the undertaking? I think one might be surprised by the qualitative “risk”, when anecdotally assessed over time. Someone like Lakonishok might answer: “How can they be riskier if they produce more return?” But this seems insufficient. Risk, like HIV, can hide or remain dormant for extended periods (e.g. inflation in the 90s). I posit that there is risk being shouldered, but perhaps it’s different (i.e., a different array of factor risks) in each epoch, so it’s hard if not impossible to systematically isolate, let alone forecast. How can one measure the risk of buying a Chapter 11 candidate concurrent to potential deflation? It’s binary. Perhaps it’s just this embedded tail risk for which, like a reinsurance company, is good business to write if properly priced (The Reversion Trader?). And perhaps one day, the inherent risk will manifest itself and thereafter, disabuse anyone from naively pursuing The Magic Formula. Then again, maybe there are just a preponderance of traders with differing forms of myopia.

    By the way, Prof. Pennington’s high/low return spread numbers for RoC seem elevated. The E/P spreads look about right, but it remains the inferior value proxy. “Quality” in general seems more efficiently priced.



    One of the most common phenomena that those of us who trade every day face is the delayed reaction to an event. Nothing happens when you expect it. For example the positive Employment number, seemingly so bullish, was greeted with a 1% decline from open to close on Friday. and now the election, which on the surface seems to create so much uncertainty among investors, especially vis a vis discredit of the Administration through impeachment forays and propaganda.

    These delays in electric circuits are called hysteresis and I’ve discussed the various negative feedback loops and components that ordinarily are used to create same for practical purposes, e.g. in the Schmidt Trigger, which is very succinctly reviewed in the excellent book by Michael Merchant, Exploring Electronics Techniques and Troubleshooting.

    I wonder what the general concomitants or preconditions for a delayed reaction are, whether they are predictable, and whether the seemingly fantastic positive response to the recent Democratic sweep, which was 16-1 on TradeSports from 9:45 am on Wed, Nov 7, and continuously higher at all times subsequent until the current finalization as of 11:00 pm, Nov 7, will be an example of the beaten-favorite/hysteretic reaction, and whether such delays can be predicted with similar events regarding individual stocks and or economic announcements.

    Gary Rogan observes:

    I don’t know how to quantify it but this has been my observation: often if a person or a group of people are acting out of negative emotions, such as anger, frustration, irritation, or boredom after a forced delay, they will go further than a rational observer will expect. Thus delayed action based on negative emotions seems related to hysteresis by overshooting the rational point. The voters have acted out of delayed frustration, so there is hysteresis involved in how that carried over to the markets to the extent that some of the voters are also investors. However when the realization sets in that Nancy and Chuckie will be acting out of a bit of their own frustration, and their “rational” point is a bit displaced from Adam Smith’s to begin with, I predict there will be a bit of a chill in the equity markets and it will last for a while. On a separate note, the more “bi-partisan” Bush acts, the lower the markets will go.

    Jay Pasch adds:

    This election day reaction is reminiscent of FOMC report days but with a wider timeframe; it so often ’seems’ on FOMC announcement days there is an immediate reaction, then a brief counter move, followed by the real deal, a trending move in the direction of the initial reaction. Admittedly descriptive and uncounted…

    Rick Foust replies:

    Years ago, when I watched tick by tick, I noticed the same pattern on FOMC days. A quick knee jerk, then a larger head fake, and then an extended run in the direction of the knee jerk. I suspect it also happens in longer time frames for larger events (such as elections).

    The knee jerk could be up or down. It usually lasted only moments and could sometimes only be seen on a tick chart. The head fake was a longer movement in the opposite direction and lasted a few minutes. The final move typically finished out the day. The duration and magnitude of the moves varied from time to time. These were days when the the market treaded water waiting for the the Fed to announce the next interest rate move.

    This three step process reminds me of a simple but effective Judo technique. First comes a quick and subtle jerk to freeze the uke (throwee). Then a push to get the uke to instinctively lean against the push and into the throw. Lastly, a long pull to guide the uke through his flight.

    A 16 year old Japanese girl appeared at our dujo one day. I had worked with girls before, and I had learned to go easy on them. She was a foot shorter and a 100 pounds lighter. As a warm up, we were to alternate practice throwing each other. Being of the highest rank, she went first. Even though she was a blackbelt, I expected to have to help her throw me (that is, jump). Suddenly, and without warning, I found myself doing an airborne somersault. A split second after that I was lying on my back looking up at her with an astonished look. Her execution had been so skillful that all I had felt was a bump and then weightlessness.

    The key to most Judo throws is to stiffen and off balance the uke, fix one part of their body in place and then rotate the rest of the body about the fixed point. A well-executed Judo throw relies more on finesse than strength.

    Scott Brooks replies:

    I believe the question that Victor is asking is “how do we know how the masses are going to react to news or an event that is possibly a surprise, or at least, not known in advance.

    I’ll let those who are better counters than me handle the quant side of this. I’d like to explore the personal side of it.

    How do I (or you) choose to react to an unexpected event or news. As investment professionals, or as speculators running our own money, I believe that one of the things that is incumbent upon all of us is to be prepared for the unexpected. One of the ways we can do that is to know the numbers….to calculate in advance what are the odds of “X” happening, and if it does, what are the most likely resulting reactions to follow….then….

    What do we do from there? There is nothing worse than not being prepared.

    My secretary (excuse me, she prefers to be called my “executive assistant”) has asked me on more than one occasion if I’m going to be doing any work that day. She’ll walk into my office and catch me staring up at the ceiling, or just passing around my conference table, making hand gestures at invisible people.

    I tell her, “I am working”. I’m role playing in my mind scenario’s. I’m trying to cover every possible path the scenario may take. I’m trying to see problems before they occur, and then figure out how to solve them…but solve them in my mind before they actually happen so I don’t have to deal with the unexpected later….and if I can’t find a solution, I ditch that course of action and move on.

    Since I’m up at the farm deer hunting this month, I’ll use a deer hunting analogy.

    One of the biggest problems that many hunters have is buck fever. When they see a big buck, they come unglued. They can’t stabilize the gun, they can’t concentrate or hold the crosshairs on the vitals, and in some cases, get so nervous that they can’t even raise their gun. In some cases their knee’s shake so bad that they can’t even stand.

    I have never had that problem. Oh sure, when I see a deer, I get excited. If its the buck that I’m looking for, my heart may skip a beat and leap up into my throat.

    But then I go into the zone. My mind focuses in on the task at hand. I begin to assess the situation. I wait for the right moment and BAM. I do what I came out to do.

    Why is this so seemingly easy for me to do? Because I’ve killed that buck thousands of times in my mind before the moment of truth came. I’ve visualized him coming from that exact direction hundreds of times. I know every possible path he could take before moving into a killing position. I’ve falsified hundreds of situations in my mind and role played them to figure out how to overcome the obstacles (i.e. is the buck alone, or is there another deer with him? What is the wind….blowing to or away from him? etc.).

    I practice in my mind slowly squeezing the release on my bow and watching the arrow leap forward at 300 fps right toward his vitals, or slowly squeezing the trigger while staring at the crosshairs right on the bucks shoulder and actually seeing the bullet (thru the scope) hit the deer at the exact spot where I was aiming.

    You see, just like I don’t know exactly where the deer is going to come from, or exactly what the conditions are going to be when he shows up, market events and news comes at us from unexpected directions and brings unexpected ramifications.

    We simply don’t know what to expect….but we can role play what to do, have a playbook (that we’ve thoroughly memorized) ready to tell us what to do, and then execute the appropriate play to give us the highest probability of harvesting the big bucks!

    Steve Bal replies:

    This would suggest that the news makes the markets. I would suggest that the news is in fact talking points - just as some individuals believed that Kerry’s mix up of words would hurt the democratic vote (which we now know did not happen).

    I do not trade every day but for some reason watch the business news regarding this number or that coming out. Further, it now appears that revisions happen more often than not (even if not true I believe it) and thus I may act upon it.

    Individuals have different trading time frames, along with different strategies. It is times when multiple time frames for individuals coincide that markets can move. This is not support for cycle trading but a recognition of different trading motives. As new news comes into the market, traders then attempt to mesh with older news to reinforce their views of future market direction.

    As Vic had previously pointed out when a big pharma increased their dividend (mostly dividend collectors noticed) a few days later they announced a big jump in earnings and the stock promptly moved. Everyone needs some form of extra comfort.

    The collective consequences of many traders (individuals) often defy intuition.



    One can hardly fail to trip over mantraic forecasts that a Democratic majority is bad for the valuations and fortunes of hydrocarbon-producing/using companies. Contrarily speaking, what if such forecasts are memes fanned by deft teal-tinted uber-investor/advisors seeking to increase their overplusses by playing against public herd movements?



    Talk of a new stadium for the Oakland A’s:

    “In what could evolve into a high-profile branding and technology testing ground for Cisco Systems, the networking giant is reportedly close to handing the Oakland Athletics almost 150 acres of undeveloped land for a new stadium.

    …The Chronicle reports that Cisco will likely be a major sponsor and could have its name on the proposed $300 million stadium.

    Corporate sponsorship of sporting venues is nothing new, but Cisco seems to be especially keen on leveraging a relationship with the A’s to go beyond simply attaching its name to a building.”

    Flashback: “The Wall Street Journal recently documented the inordinate tendency of companies that bought the rights to name stadiums after themselves to fall into bankruptcy, financial difficulties or drastic declines in market value.

    …After completing a comprehensive study of every company that named a stadium after itself, beginning with RCA in 1984, we can confirm the gist of the Journal’s article.”



    Tremendous inflation in the air today with gold and silver up 5%, grains having just risen 50% in the last three months, Sage at a new high at 108,400 a share, crude oil up 3% in a week, GSCI commodity futures at a several month high, copper up 2% and natgas up 15% in the last week or so.



    I got to ride in a Combine last night for the first time in my life. Neat  experience. My farmer and I were talking as we watched coons run out of the corn. One of the things he said that this is a very unusual year. Corn  prices are rising nicely going into harvest….according to him, not a  normal occurrence.

    Michael Ott replies:

    Prices usually go down around harvest time because farmers are forced to increase supply because they simply can’t store any more corn. Most farmers have decent storage capability on their farms and sell throughout the year when they get a good price or need money. Obviously at harvest time storage is at a premium, so overflow goes immediately to market.

    The huge demand for local corn due to ethanol has dramatically shifted the use, storage, and transportation of billions of bushels of corn. We’re seeing a lot of interest in building grain elevators, railheads and other fixed installations. I think this is the next wave of biofuels spending, because investing in new grain ethanol plants is nearly dead.

    J.T. Holley Replies:

    My buddy has a Deere 9660 with a satellite equipped system that literally drives the combine for ya “hands-free”. It also has A/C and XMFM built in. He could literally utilize wireless internet connection w/ a laptop, trade, harvest crop, and have lunch/dinner in that bad boy! Once seeing and riding in that fine piece of machinery you know why Mr. Simon won his bet.

    keep looking »


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