# Maybe Not Obvious Department, from Kim Zussman

What is the relationship between range and return? Using SPY intraday 1/04-present, %range and %return defined as:

day range = ((H/L)-1)*100
return =((close/open)-1)*100

Then regressing return vs (same day) range:

The regression equation is day rt = 0.246 - 0.262 day range.

Predictor      Coef    SE Coef      T      P
Constant    0.24619  0.05315   4.63  0.000
day range  -0.26152  0.05195  -5.03  0.000

S = 0.605558   R-Sq = 3.0%   R-Sq(adj) = 2.9%

Wee! The bigger the range, the more the drop. Seems obvious in that large range implies large variance, and there is contemporaneous negative correlation between variance and return. Logically big range can accompany big gain, big drop, or little change, yet it turns out most often to drop.

Optics trivia: this scatter plot resembles geometric spot-diagram of off-axis star image for system exhibiting the aberration known as coma.

In other regressions, tomorrow's day return had little correlation with yesterday's range or return.

The association of big range with contemporaneous negative returns is also seen if plotting range vs. date since 2006, the broad and (so far) narrow peaks corresponding with summer 2006 and recently, respectfully.

To further Kim's findings, it would be interesting to note that the daily range (as defined above) is strongly partially auto-correlated with a maximum lag of 10 trading days for the sample period since Jan. 2004, whereas intraday returns do not exhibit such a degree of auto-correlation. This would be in sync with findings of volatility clusters.

Day of high volatility or high daily trading ranges are likely to be followed by days of similar wide trading ranges. If one were to expand the sample period back to 2000, the above returns vs. daily range equation no longer holds. Neither the intercept (0.041, p=0.41) nor range (-0.026, p=0.38) is significant.

# On the Coming Commoditization of Hedge Fund Strategies, from Henrik Andersson

I believe hedge fund strategies will be new frontiers in the ETF market. As we are seeing ETFs move into more active strategies, we have already seen the beginning of this trend. The quantitative backdrop for evolution can be found in these articles by hedge fund Bridgewater, on selling beta as alfa and levering betas.

My prediction is that the increased accessibility will make it harder to prosper for hedge funds that are currently selling beta as alpha. In effect I see no reason why it couldn't soon be as easy to access some of these strategies as it is to trade the QQQQ today.

## Gordon Haave writes:

Yes, but the whole point of the ability to replicate these funds is that you don't need the lockup, or at least not as much of one. One can short volatility without a 1-year lockup.

## From Bill Rafter:

The largest portion of hedge fund money is employed in long-short. Long-short is highly liquid and highly scalable, and could easily endure a zero-day lockup. For example, we have a long-only (in theory, less liquid that long-short) large-cap program that has a zero-day lockup. One might ask why. Our answer is "marketing." Investors (particularly pros) are a lot less reluctant to give you money if they can get out on an instant's notice.

Lockups are really only necessary for strategies such as event-driven or distressed assets. The hedge fund industry mostly uses lockups to keep control of its assets. Recall how the recent ('06) Greenwich-based fund went guts-up and tried to manipulate its reports to shareholders to have the latter miss a redemption deadline.

If the funds are algorithmically managed, they are a short. Fixed systems die. If the funds are actively managed, they are a short. They will not attract the talent that 2/20 type arrangements will, and will thus be the mark at the table.

This whole "you can replicate any hedge fund strategy by adding beta and a few formulas" meme is no different from the "You can beat Wall Street at its own game!" type hucksterism so prevalent in the late 90s. It's just marketing crapola. While the base idea may be sound, that you don't have to get involved in hedge funds to receive average returns, so what? The only possible outperformance in products like these is relative to managers with subpar returns. It's all just another way for the industry to sell average performance.

Managers who do add alpha are very happy about this whole development. It's another source of edge. One needs to look no further than the "Goldman roll" in commodities to see an example.

I have been offered structured notes (intended to be re-offered to our customers) that pay interest based on the Tremont hedge fund indices. Depending on the degree of index participation desired, investors have the option to have total return floored at zero percent (principal guaranteed, like a bank note). Naturally, the secondary market for such a thing is limited, but it's still better than a hedge fund lock-up. Moreover, the issuer is generally an AA-rated large European bank.

Need to get more aggressive? Just buy 'em on margin…

Some of these structured products, which are particularly popular in Europe, are selling with a participation rate of 100% and no Asian etc. This is strange since it seems you get the put for free; but in these cases the cost of the option is most likely taken from the fees of the underlying funds.

# Advanta Plug, from Roger Arnold

I recently opened a business line of credit with Advanta and thought I would share with the members here that my experience with them has been far and away superior to any other business lending institution I have ever worked with.

If you are a business owner I highly recommend them. Their people are classy as are their written communications. Moreover, their website for managing the account is superb.

# “In God We Trust,” from Alan Millhone

March 31, 2007 | 1 Comment

I traveled 500 miles today, to Marion, Illinois. I noticed many things crossing 70W and then on to 57S. Some of the Illinois license plates are a blue with white lettering and red and white flowing stripes on the bottom of the plates. To the left of the numbering is "IN GOD WE TRUST." It was nice to see that in today's troubled America.

Traveling alone afforded me plenty of time to reflect and think about many things. Without TV I did not hear all the bad news on the various channels. All of us need to stay positive and believe in our great nation. I don't even have a clue what the Dow did today! There are checker players here this weekend from Louisiana, Missouri, Illinois, Indiana, Kentucky, and Ohio, to name a few. All of us have a common bond; we are Checker players. Checkers will be the sole topic all weekend.

All the players have different skill levels (I am average) but we have a common bond in that we all love to play and be around other players. All Americans need to band together and be supportive of each other and reach out to our neighbors to the north and across the ocean. Negativity serves no useful purpose and undermines confidence. The great Tom Wiswell told me once at my home to "Accentuate the positive and eliminate the negative."

# Themes, from Martin Lindkvist

Theme (music), the initial or principal melody in a musical piece

Theme (literature), the unifying subject or idea of a story

Theme (visual arts), the unifying subject or idea of a visual work

Theme (computing), a custom graphical appearance for certain software, similar to a skin

Theme (linguistics), that part of a sentence which indicates what is being talked about

Theme music, signature music which recurs in a film, television program or performance

Theme (stock market), high at or soon after open, selloff, then strong up move luring in buyers, only to sell off again at or soon after next open….

Thanks to wiki, for the first six, thanks to the mistress for the last one.

# Activist Funds, from Gordon Haave

I used to work for my Dad's hedge fund. At peak we had ~300 million. We never considered ourselves an "activist fund" in the new sense. We were just money managers. Now "activist fund" is the new fad. When I was in college my dad sent me to wage a proxy fight at Ceradyne (CRDN). We frequently owned ~15% of companies, and were involved in this sort of thing.

In the instance of Ceradyne it was somewhat of a surprise attack, but we had ~17% and another guy with ~5% was on board with us. The CEO knew we and the other guy were cheesed off. There was cumulative voting for directors at CRDN. So I show up at the meeting, I nominate the candidate. The vote is called, I show my proxies. The CEO didn't challenge them at all. Why? He knew. He knew how we felt, and he knew how the guy with ~5% felt, and he saw in my hand the proxy from the guy with ~5%. It wasn't that hard for him to know.

So when a hedge fund calls up and says others are with him, what do you do? Say, "I don't believe you unless you tell me who they are." Then you call them and ask them. It's not that tough. When I worked at Devon I knew the IR guys. They knew darned well who owned the stock and what they thought of management. That was their job.

Once, the unions were leading a big proxy fight against Avondale Shipyards (AVDL). The unions claimed big shareholders were on their side. So what did management do? They looked at the 13Fs, talked to the custodians to try to get ownership info, and they called the shareholders. It's not that hard, happens all the time.

# The Onion…or Absolute Return Magazine? From Sam Humbert

Boyz II Men to hedge funds

Dennis Ross, composer and producer of the 1980s multi-platinum R&B group Boyz II Men, is understood to be readying a long/short equity fund for launch this summer. PBGB Fund is expected to begin trading with \$20 million and to focus on US technology and biotech stocks. Ross has worked with the likes of Michael Jackson and Usher…

## George Zachar conjectures:

Par Bonds Got Bling
Paid Boyz Get Booty
Portable Beta? Got Blunts!

Post Bond, Got Busted

# Counting, from Bruno Ombreux

Sometime one doesn't need to count. Here is an example. Once I was considering buying a very illiquid small cap with a huge dividend. I called the CFO and said I was an investor interested in their stock. I asked him why such a dividend? He told me it was a one-off; they were getting rid of cash they didn't need. There was no chance of such a high dividend in the future.

Then I told him his stock was too illiquid anyway. He said they could do something about it. The next morning there were 100,000 shares for sale, instead of the usual 1,000 or 2,000. Needless to say, I never bought this stock. There was no need for counting.

There are plenty of examples like that, but to my knowledge they are always in opaque markets, with few players. I could give similar examples in physical oil or even swaps.

However, when it comes to huge markets like stocks indices, big caps, or WTI (even the oil majors or OPEC don't try to call the price of oil), how can anybody believe that he knows more than the market, that he has an information advantage? In those cases, counting is the only solution.

You could reply that information is not enough; you need to process it. And someone with experience and interest in the markets is able to process information better than the rest of the financial community. This may be true. Still, for the rest of us, with less experience and wits, isn't it safer to do what scientists do when confronted with time series, that is, count?

Besides, nobody can deny the incredible efficiency of the scientific method. Just look at its positive impact on everybody's lives from the Age of Enlightenment. To deprive oneself of such a tool doesn't make sense, even if one is a superior analyst.

I'd like to present my critique of counting. I assume that we wish to predict where the market is heading, be it in an hour's or a year's time. Counting — as exemplified by Vic and Laurel — generally involves regressing the returns or prices of stocks on one or, at most, two explanatory variables and testing for significance. Thus, using daily data, we may ask was has happened to the S&P500 over the past few years if, on Groundhog Day, the little beast saw its shadow.

We may check what happened the next day or daily for the next month or whatever. The problem is that rarely are other explanatory variables added to the regression and this is OK if those missing variables are uncorrelated with shadow viewing. But, if this does tell us about a cold winter remaining, it affects energy prices and these should appear in the regression since the S&P 500 is clearly affected by energy stocks which are known to be related to the weather. But this is not the real problem.

The real problem is that since the variance of stock price returns is relatively large in all models that have ever been built, any exogenous shock can turn ups into downs and vice versa. And it is precisely exogenous shocks (e.g. what will the Iranians do tomorrow, what will Bush do, what will the big boys do?) that counting and its big brother econometrics cannot handle at all! But the world is full of these. How many of the news items in today's newspaper have you predicted?

To be sure, many turn out to be irrelevant, but not all. And once they have happened, it's too late for the model! Now, there are people who evidently know in advance things that are not in the public domain. The Iranians know what they'll do to the sailors tomorrow, but most of us don't.

Suppose they are each given \$1 mil in gold and sent home first class tomorrow after seeing the Iran nuclear sites destroyed tonight. One suspects the market might react and counting will have proven utterly useless. Suppose, on the other hand, the Iranian Navy, having proven that it is superior to the Royal Navy, decides to blockade all oil exports from the Gulf. Hmmmm…

# Talking Whilst Playing, from Nigel Davies

A lot of players get nervous when they play and like to defuse the tension by talking. I tend to sit at the board just to avoid this; it's very distracting.

This reminds me of a story about a somewhat insecure Romanian GM I'll just call George. He used to get up all the time and ask colleagues what they thought about his position.

What do you do if you're asked? One colleague wondered: "You're completely lost! Haven't you seen the latest Informator?" I'm not sure whether or not he actually used this on George.

Trading also needs focus, but in my experience it's not quite as intense as a chess game. There is lots of watching and waiting. Even so, I don't like to talk, but I found that email isn't a problem.

### Mar

#### 30

March 30, 2007 | 1 Comment

The redheaded man (Monte Walsh's boss) chuckled. Later when Monte had finished wiping the table and counter and putting things in place and sweeping up assorted debris, the redheaded man pointed to the three new unused saddles on their racks by the rear wall. "Maybe you could use one of those." (Monte is leaving to join a cattle drive). "Shucks," said Monte, "I can't pay for it." "Don't I know that," said the redheaded man, gruffly, seeming angry. "I ain't dumb. Pay me when you come back through or send it by somebody."

I have been considering the subject of what investors can learn from business. These are preliminary ideas and I would appreciate any augmentations from readers so that I can do justice to this subject and perhaps influence a few youngsters to take this path.

Some thoughts that come quickly to mind:

1. Businesses hire and expand when business is good. When there are more goods, prices tend to come down. Thus, an increase in business, and especially profits, is very good for inflation. Not the reverse, as almost everyone who hasn't been in business thinks.
2. Incentives matter. You have to be rewarded for a task if you're going to perform it well. The incentive that matters to most people is the after-Service income they can spend on their families. Thus, changes in the amount the Service takes are a great influence on business. The reductions in capital gains rates in the 1980s and again in 2003 were a key to vibrant stock markets.
3. Individuals have widely varying talents. The way to elicit them is to show them the goal and then have them use their individual abilities to achieve it. Businesses run from the top down with authoritarian leadership, a la the golf expert from the conglomerate with ever-rising earnings from assets bought hundreds of years ago, are not as successful.
4. Business is amazingly competitive. There are substitutes for every product that a business produces. New entrants wait to rush in at any sign of above average profits. Innovators with new methods of production, and better products, are always in an arms race. When I was trying to sell Tyco Toys to Herb Everts at Consolidated Foods, I remarked that Tyco's model cars were the fastest. He wisely said, 'That's terrible. It won't be long until someone comes up with a faster one." The same is true for processing and production in all fields. The businesses that prosper are those with a complete business operation with proprietary marketing, production and research.
5. It's hard to make a profit on your initial sales. There's too much search cost and marketing cost involved. A company has to make its money from repeat business. That can only come by offering a product at a better quality, price, or delivery. Many mail-order companies lose money for the first 10 years on a customer, but the long tail gives them the edge. The early Internet companies were building up databases and customer lists. It takes time to make a profit. But once they get it, and enjoy repeat business without any marketing cost, they can be golden.
6. Business is a benevolent activity. The customer and the purveyor both gain from each transaction. It builds friendship. When I was young, an insightful businessman told me that more than half my friends when I grew up would be business associates. He was right. The businessman can prosper only if he can voluntarily provide good value to his customers, employees and suppliers. That's why so many businessmen who rise to the top are the finest people you'll ever meet, salt of the earth with nary a bad word for anyone and loyal to a fault to their employees, knowing everyone's name, for example. It's great if you find a business where the employees are really excited about the value of their product. A plan, a purpose, decentralized decision-making, and latitude for the employees to soar create the proper environment for business greatness.
7. The best books I've read on business are Monte Walsh, Atlas Shrugged, and Show Boat. Both Schaeffer and Rand know the subject as well as anyone ever has, and my metal industry friends have told me Rand got everything about the iron and steel business right. Schaeffer is a naturalist and knows his horses and terrain as well as Lamour. I also recommend the Broadway show Jersey Boys as a great business story of struggling to achieve success and wealth in a most challenging and competitive field. Every kid should read these books and see the movies (Fountainhead and We the Living, until Atlas can get by the destroyers) and be ready to travel the path to success in the heroic field of business.

"Letters From A Self-made Merchant To His Son," by Lorimer, was one the Chair recommended earlier on. That book is truly a classic "business" text and one that I appreciate deeply. Not only is it a text that teaches business technique and survival, but it is a book about a father's relationship with his son.

To paraphrase Lorimer, one of my favorite lines is this one: a five-cent shine is as good as a five-dollar lunch. It's amazing how many people will meet you for breakfast, lunch, or dinner if you are buying and not do a lick of business. Not doing so and meeting them in their own environment in a well-dressed manner works ten times better.

That book definitely makes my "must" reads for life, business, and parenthood.

# Zero to Hero, from Kim Zussman

Count this: expectation of (logic=and):

1. weekends which include first of new month
2. down last of month of up month prior, which followed largest 1-day drop in years
3. likely weekend UK/US defrocking of Ayatollah
4. FOMC not inclined to tighten with new chief either buying or selling puts

(hint: N=0)

# Mr. Axe Indicator, from James Tar

Roughly four years ago, Victor and Laurel wrote about a birthday party dinner they attended, where they had the pleasure of sitting with a market neutral fundist who had earned the nickname "Mr. Axe." The Specs bestowed the name on him because the performance of his market neutral fund's performance at that time was summarized as "axe murder."

Small world we live in! Mr. Axe happened to be, and still is, my greatest trading mentor and advisor.

Despite speaking with Mr. Axe over 10 times a day, every day, for the last seven market years of my life, he has used the phrase "we are going to zero" only 15 times. The market has not ever failed to mount a meaningful rally immediately following such musical words. He made the statement at 11:46am today.

# I Would be a Great Fed Chair, from Gordon Haave

I would be a great Fed Chair. I would just leave the money supply alone and never touch it. Now, some say that deflation is a bad thing. Why should it be? Wouldn't you like the prices of the goods and services you buy to go down?

The argument is made, though, that wages are sticky, and wages won't move down, so the net result is economic slowdown because wages are too high. Fine. If the economy is forecast to grow 4% this year, increase the money supply 4%.

# Concert Review: Leon Fleisher & the Stuttgart Chamber Orchestra, from Laurel Kenner

I heard one of the greatest living musicians, Leon Fleisher, conducting and performing tonight with the Stuttgart Chamber Orchestra at the Metropolitan Art Museum. Like my own piano teacher, Aube Tzerko, Fleisher studied with Artur Schnabel in Berlin until they all fled the Nazis. Schnabel was one of the giants of 20th century piano: passionate, humble, humorous, serious, refined, wild, without pretense, never dull. Many of his recordings are now available in a collection, "Maestro Espressivo." Tzerko died in the 1990s and my last lesson with him was 30 years ago and I did not become a pianist by profession, but his spirit is with me. I think of him every day.

Leon could not perform for 30 years after injuring his right hand through over-zealous practice. He began conducting, and his life took a new turn. The only thing more glorious than making music on a piano is having a whole orchestra do it for you; most concert pianists never make it to the podium. (Ashkenazy was an exception. Paderewski got to run a country — better still!) "Suddenly, I realized that the most important thing in my life wasn't playing with my two hands: it was music," Leon wrote in the notes to tonight's concert. "The instrumentation becomes unimportant, and it's the substance and the content that takes over."

Substance, not form, guided tonight's choice of pieces. The program was not one of the grab-bag "surprise" models, invented in the 19th century for enthusiastic but unsophisticated new concertgoers. The typical pastiche consists of three pieces from three different periods: a "warm-up act" of a little harmless something followed by a concerto, intermission, then a big romantic or modern piece. The concertgoer is thereby forced to listen to what he does often not wish to hear, in an earnest, heavy-handed attempt to educate him. Leon's program, by contrast, was sweetly rational:

Boccherini: Symphony Opus 12 No. 4, "The House of the Devil"

Mozart: Piano Concerto in A, K 414

Intermission

Mendelssohn, String Symphony No. 10 in B Minor

Hayden "Farewell" Symphony

I had never heard any one of these pieces performed live although I have been attending concerts in America's two biggest cities for decades. What a pleasure to hear good music and share Hayden's little joke. I won't spoil it for you, as you may be lucky enough to hear it performed live some day.

Leon has regained the use of his right hand after 30 years through a new medical treatment, and performed the piano concerto. Hearing him play is like breathing fresh sea air - I will not be a critic. He is on tour with the amazing young musicians of the Stuttgart; if they come to your town, do not on any account miss them.

# Hand Study of Reverals of Length 1, from Victor Niederhoffer

I have received many ironic comments about my speculations that a quantification of the point and figure approach might be particularly applicable to the Dow Jones. My speculation was prompted by the inordinate tendency of the Dow to bounce around the round numbers during the day. For example, during the last two days the Dow has broken above and below 12,300 by at last five points, 12 times on a intra day basis. I felt that there must be many who look inordinately for such reversals, and that they wouldn't come when the masses expected them. Indeed, it seemed guaranteed that there was a higher form of deception here, akin to what birds, fish, and mammals do all the time.

To get a feel for it, I decided to do a hand study of the Dow from the beginning of the year when the Dow conveniently started on 12 28 06 at 12,501. I decided to count only moves that went through a new round number of 50 or 100 using closing prices.

To quantify it, I decided to go back to my roots. One day, some 45-years ago in Lamont Library I was looking at some old journals, which in those days were bound conveniently for perusal on the second floor. I came across the Monthly Meteorological Review and saw an intriguing article by Jones on calculation of runs. It turned out he worked for Alfred Cowles at the Cowles Foundation. And Cowles divided the price moves into sequences and reversals.

A sequence is a plus followed by a plus or a minus followed by a minus. A reversal is a plus followed by a minus or a minus followed by a plus. I must remark here that Cowles insights into stock price movements circa the 1910s and 1920s seem much superior to any I have come across in the many years since, among academics, except for those of my esteemed friend MFM Osborne.

I decided not only to take into account the sequences and reversals but to quantify them by length. In particularl I have always felt that a series of prices ++++- was quit different in its predictivity than +-+-+-.

Here are some closing prices of the Dow from 1228
Date  Closing       Pos     Pos         Neg      Neg
price        seq     rev          seq     rev
12  28   12501
12  29   12463
01  03   12474
01  04   12480
01  05   12398                             1
01  08   12423
01  09   12416
01  11   12514         1
01  12   12582         2
01  22   12477                                        1
01  24   12621         1
01  25   12502                                           1
01  26   12487                                     1
01  30   12621         1
02  01   12673         2
02  09   12580                                             1
02  13   12654                  1
02  14   12741          1
02  15   12765          2
2  22   12686                                               1
2  23   12647                                         1
2  27   12216                                         10
3  02   12114                                         12
3 05   12050                                         13
3  6   12207            1
3  8   12260            2
3  12  12318            3
3 13   12075                                         3
3 15   12159                      1
3 19   12226             1
3 20   12288             2
3 21   12447             4
3 22   12461             5
03 27  12397                                                    1
03 28  12300                                          1

What does one conclude from a hand study like this? There were many moves in Jan, a stasis in Feb leading up to a negative sequence of length 13, which wouldn't have been able to get into until 10 of them had elapsed and would have led to a slight loss. Since then there have been more frequent moves without much ground being covered. The negative reversals of small length as I had hypothesized were not good to reverse. Doubtless there are a million other ways of analyzing or tabulating this data. Indeed, I wrote a program to do this with the Wiz about 10 years ago, but because there was so much qualitative involved, one has not exhumed it. However, I think it's a good suggesting things for meals for a lifetime.

# Stops at 24, from Jim Sogi

The bears who project great declines and market breakdown on fears of Iran, the nervous longs with the same fears of subprime mortgages and recession, buyers at market at today's gap up open today, those that recalled with trepidation last month's breakdowns, all had their stops at June ES 1424, the prior day low. As GM says, it was too obvious.

# Interesting Bifurcation, from Steve Ellison

While oil goes above 65, agricultural commodities widely viewed as alternative energy sources fall, with corn near a 2-month low and sugar below the round at an 18-month low. What does this apparent schizophrenia portend?

## From Gordon Haave:

As energy goes up, the price of that drill bit, and the price of moving that rig, etc. goes up. Drilling costs are up 100% in the last few years. This causes people to drill less, just as they would if they actually counted all of those inputs.

## From Stefan Jovanovich:

The actual numbers for the rig counts over the past few years are rather different.

It is the spread that matters, not the absolute cost. The increased cost of drilling only cuts back on the rig count if drilling becomes unprofitable at the anticipated revenue from production. The difficulty with alternative fuels - like bike paths and free subways - is that their marginal costs are inflexibly high. None of them has the declining marginal cost curve that coal, oil & gas production still has. The costs (both in dollars and in gross energy consumption) of the fertilizer, water and mechanical energy to produce #X barrel-equivalent of corn or sugar-based energy are not significantly different from those for #X-1. (Neither are they for subway train or bicycle #x vs. #x-1).

For oil & gas and (to a lesser extent coal), the numbers are very, very different. I hate to quarrel yet again with James about transportation history; but he has it backwards. The evil oil companies and their customers built the roads in the United States. Three quarters of the paved roads in the United States were built after 1950, and they were funded almost completely by the taxes paid on gasoline and diesel fuel consumption. It was those same funds that have paid for and continue to pay the subsidies for mass transit as well as all Federal Highway improvements. It may be different in Hawaii, but the state contribution to road building here in California has been funded by state fuel taxes. As usual, the devil is in the counting details.

# Correlation and Probability, from Philip J. McDonnell

Winning percentage = 50 + 32*(correlation)

Because the constant is 50 (~50%) it would appear that the numbers input to this were basic coin flip probabilities. To a good approximation most markets do obey coin flip odds so this is very useful. I would, however, conjecture that if the odds were different, say 20%, then a new approximation might be needed with different parameters.

## Charles Pennington notes:

I'm not sure what Dr. Phil means when he says that "it would appear that the numbers input to this were basic coin flip probabilities."

1. Generate 2 series, A and B, each having 10,000 random numbers from a normal distribution with average 0 and standard deviation 1.
2. To each element of B, add alpha times the corresponding element in A, to generate a new series C. (I will end up trying alpha values ranging from much less than one to much greater than one.)
3. For the first 5,000 elements of A and C, run a regression of C versus A. This gives a correlation, slope, and intercept.
4. For the remaining 5,000 elements of A and C, use the regression, and the A values, to predict the C values.
5. Count the fraction of instances in which the prediction gets the sign right–that's the "winning percentage".
6. Now you have a correlation, and a winning percentage.
7. Repeat for a different values of alpha to generate a table of winning percentage versus correlation. (When alpha is small, much less than one, then alpha and the correlation that emerges are very close. When alpha becomes much greater than one, the correlation approaches 100%.)

For correlations approaching 0, the winning percentage approached 50, as of course it should. For large correlations, it approached 100%, as also it should. For small but non-zero correlations, I found this result, as stated earlier:Winning percentage = 50 + 32*(correlation).

Seems like a reasonable answer for a guy who wanted a rule-of-thumb mapping of correlation onto winning percentage. Obviously if there is a big drift term, or any other number of things are true, it could be significantly wrong.

# My Viking Beard of Sun and Fire, from Gordon Haave

March 30, 2007 | 1 Comment

I haven't shaved for weeks. The result is my manly Viking beard. You see, most men have difficulty growing nice beards — they are spotty on the chin. Not mine. Mine is a mixture of red, blond, and light brown. And it was even better back in 1997-2000, when my beard was soaked with sun, salt from the wind, seawater, and rum.

Most people don't like beards in the business world, maybe because most people can't grow good ones, and their inferiority complex leads them to marginalize beard growers.

W-2? A shave is due.
1099? You look just fine.

# Counting on Chinese Canvas, from Marion Dreyfus

The Asian Art Auction held at Sotheby's in March was notable for several reasons.

As recognized by the art crowd, it is a baby market. As such, the prices are still short of the stratospheric heights attained by the likes of the Impressionists and their kin.

Still, the prices were not the bargains of five years ago, when a few thousand could fetch you a now-prime Huang Yan, whose multiple face images feature handsome young Chinese men with calligraphy, fernery or landscapes "creeping" or growing across their faces, hands or torsos. Still, for his intensely mesmerizing "Face Painting: Plum, Orchid, Bamboo and Chrysanthemum," lot 247, the hammer struck sold for a bargain \$20,000. One can hypothesize a rapidly ascending price trajectory for Huang.

A fellow in the art field, British, living currently in Shanghai, murmured to this reporter that such prices as were common at the auction are "hype." Asked for follow-up clarification on this capsule review, the Brit, call him Trevor, said that hammer prices are not reflective of the actual prices for these paintings. Of the 308 lots auctioned on Wednesday, 21 March, three went to the mat for over \$1 million. Highest price, for lot 21, "Bloodline: Three Comrades," by the stunning Zhang Xiaogang (one of my favorites), sold for \$1.85m. The aggregate sum (commission plus taxes) totaled an impressive \$2.11m. His painting adorned the inside cover of the Sotheby's catalog.

The front of the catalog featured a descending series of four Chinese brushstrokes ideograms. I puzzled over them awhile, trying to discern stroke formations I learnt while I lived there. Finally, after much effort, I realized what they 'said.' Art For The People — in English! — cunningly worked into traditional calligraphic formats. This lot 153, by Xu Bing, "Square Word Calligraphy," drew \$190,000 on the hammer.

"Goldfish," lot 53, by the significant and escalating painter, Yue Minjun, now 45, went for \$1.2m. It is a strong canvas, with a repeating Chinese Kuomintang figure, smiling broadly in profile, receding endlessly into the distance, curving around a balustrade suggestive of the Great Wall. All the identical figures grinned broadly as they peered down into a dark strand of water where a lone goldfish swam, indifferent to his onlookers.

An exceptional formulation of the traditional Chinese five-pointed star was captured in chilling detail, with rivets and nails and metal cobbling together the symbol of the State, in "Five-Pointed Star," by Leng Jun, which went for \$1.05m, minus aggregate fees and commission.

Another of my favorites, Wang Guangyi, sold one of his less-glorious canvasses, "Eternal Halo #1," for a mere \$310,000, lot 170. At 50, Wang is one of the elders of these powerful artists. His canvasses often sport two unrelated series of file numbers "stenciled'' in black over entire canvases in regular intervals, like flocking; his colors are often primary red, yellow and black, and the overall feel is that of ambitious patriotic revolutionary posters of the sort that still abound in the hamlets and byways of the Peoples Republic.

A striking Chinese red sculpture standing some 10' tall marched strong black dots ascending and descending invisible longitude lines from its topmost twig end on a "pumpkin" of brilliant Styrofoam and acrylic sold for \$220,000 (\$264,000 in aggregate). Created by one of the older artists represented: Yayoi Kusama, at 78, is several decades older than the run of artists at the center of attention. To my eyes, it more resembled a giant red bosque pear than a pumpkin. Other sculptures, in green bronze, rosewood, iron, bronze, painted wood, and, especially, aluminum, were very strong examples of the form. In particular, Sui Jianguo drew plaudits, and \$240,000, for his 5-foot-tall aluminum pompous, empty Mao's jacket, "Legacy Mantle." It spoke voluminously as it stood commandingly — massy, gray, fearsome — at the head of the auction hall.

Two well-received names sold for from half a million to one million. More than 50 works sold for from \$100,000 to half a million. Several, of course, seemed like bargains for under \$10,000, with the biggest bargain three lots that went for a mere \$2,000, with a puny \$400 for fees and taxes.

The morning session, with 125 lots, sold far more expensively than the second session after 2 pm, with another 125 lots. Most of the heavy draws were sold in the morning; all three \$million+ canvasses were auctioned in the early session. One canvas in the afternoon session did top half a million. Wang Yidong's "Yi River," a deceptively 'easy' representational painting with immaculate brushstrokes of a young peasant woman on a round stone in a fabric-seeming river, in front of a sleeping contemporary man on a black rock ledge, went for \$680,000. Aggregated, the total price topped \$800,000. Not bad for a market of such tender years.

Many of favorites were on sale, and some, as one would expect, were to be had at bargain pricings, as well as the obverse. Subject matter that was less conventionally 'pretty,' or that had a deeper subtext that required more time to suss out, such as the agonized self-portrait of a harsh nude, "Dreaming," by Liu Xiaodong, were purchased for well below what should be their correct market rates. Axiomatically, while unconventional paintings might not grab the 'sofa-conscious' buyer, they are often the canvasses that linger in the assessments of the elite and discerning, far down the road. Their value often accretes with successive press and acclaim.

Coming into the picture are questions of living with the artwork –some paint is just easier on the eyes, and living spaces, than others.

The crowd was considerably thinner than last year, despite the strong representatives of exceptional Chinese painting and sculpture, indicating perhaps that the non-gathered were aware that the prices were no bargain. Being at the Sotheby auction is in my opinion one of the iconographic IT experiences one can experience in NYC. The excitement at lifting a bat and having the auctioneer recognize one's bid with a nod, then being overbid by a telephone bidder (a slew of telephone assistants on a raised dais lined both sides of the hall, on the phone constantly taking bids from those stationed elsewhere but unwilling to let a favored art-piece go without a pertinent offer).

My bat was a favorite number: 807. I carefully keep my yawning and waving to friends at a minimum, ever since, some years ago, I mistakenly "purchased" a \$5,000 item at an Israeli auction of memorabilia from Entebbe and other high-notes of Israeli history. Another time, excited by the aura of excitement at a furniture and household auction, I bid on a killim I neither wanted nor needed –and got it. Now, I keep myself in check, do not drink before or during such events, and sit on my paddle. Why go, if that is the case? Endorphinic rush, that's why.

It is a truism that if the current escalation in valuation continues, next year's prices will be at a premium to this year's, so those not sitting in this week may have forgone a buying opportunity, much as the nose-bleed tags seem to belie that possibility. Few storied subprime lenders hang out in these precincts, and fewer still, those who can't shell out the shekel.

My art dealer from Shanghai also voiced the mantra of all art auctions: "Of course, don't buy on the expectation of appreciation. Don't buy unless you love the artwork. There is no guarantee these works will scale upwards in the future." No telling how many of the hundreds of purchases were from ardor and not dancing-dollar dreams.

The artwork, costly or not, was among the most pristine and enjoyable I have seen in years, and especially so when compared to nonpolitically stressed oeuvres. It is obvious that countries where the polity may not voice their opinions overtly often excel in exceptionally vivid and vocal productions in the plastic arts. A gander at Russian work from the war years, as well as at Nazi-era productions, reinforces this postulate to squelched freedom of speech.

Art can do what tongues cannot.

China, though hardly the mirror of the brutal "Thousand Year Reich," manages to blank out some emails, overt public dissent, workers' strikes or protests and the like. It has produced, evidently, a bumper crop of striking and eminently collectible works of canvas and wood, marble and metal, works that speak profoundly to the emerging culture, to the voice of silence, and to the rebirth of expression by another name.

# Childhood Games, from James Sogi

When no friends were around to play, I would spin nickels like little tops. Dimes were harder since they were smaller, and there were fewer of them. Pennies were plentiful. I would try to see how many I could get spinning like a top at one time.

Watching the market paths recently, in line with Chair's study on dimes and nickels, June ES seems roughly like a coin spinning around the dimes and bouncing off the nickels.

## From Steve Ellison:

I have been thinking in terms of quarters since the frightening intraday drop of March 14 that left a low-water mark at 1375.9 and the rally later the same day that breached 1400. The post-Fed exuberance was turned back just above 1450, and today the market rallied from just under 1425.

# Alzheimer’s Vaccine, from Janice Dorn

Alzheimer's Vaccine Works on Mice: Japanese scientist.

March 28, 2007 11:49:28 PM PST

Japanese scientists have developed an oral vaccine for Alzheimer's disease that has proven effective and safe in mice, the director of a research institute behind the project said on Thursday.

The team is preparing to move to small-scale clinical trials in humans, possibly this year, said Takeshi Tabira, director of the National Institute for Longevity Sciences in Aichi, central Japan.

Animals are able to recover their functions after developing symptoms, but humans are less able to do so. It may be that this only works in the early stages of the disease, when symptoms are light"

When administered to mice suffering from the disease, which causes dementia and is currently incurable, the vaccine reduced the amount of amyloid plaques in the brain and improved mental function.

Amyloid plaques are believed to be at the root of Alzheimer's — a growing problem for aging populations around the world. The disease affects five million in the United States alone, the Alzheimer's Association said in a report last week.

The treatment did not cause inflammation or bleeding in the brains of the mice, Tabira said.

The vaccine is made by inserting amyloid-producing genes into a non-harmful virus. When taken orally, the virus stimulates the immune system to attack and break down the amyloid proteins in the brain, Tabira said.

The treatment was tested on 28 mice genetically modified to develop Alzheimer's disease. Half the animals were given a dose of the vaccine at the age of 10 months, while the control group were not treated.

Three months later, tests showed mental function in the treated mice had returned to levels close to those before they developed Alzheimer's symptoms.

# If the Water is Clear, No Fish Will Live There, from Nigel Davies

More from the Hagakore. It's an idea that has been echoed by the chair, and also in Saveilly Tartakover's "obvious therefore dubious, dubious therefore playable." If moves and trades look too good to be true they probably are. The reason being that an unskilled player can also find them.

So the water should be at least a little murky, but then where does this leave our z-scores?

"I hear that some samurai is preaching thrift. He is fussy and fastidious and feminine with his preaching. This is not desirable.

"It sometimes happens that, if the water is too clear, then the fish will no longer dwell there. When there are algae and water plants, fish can safely grow by hiding behind the plants. As long as people overlook matters, then inferiors can, without any fear, lead an easy and pleasant life. You must know this as far as your personal conduct is concerned.

# A Few Studies in Areas of International Relations, from Stefan Jovanovich

No one in "international relations" in 1574 was buying futures on the Dutch Republic, and no poll at the time would have found William the Silent to be more popular than either Philip II or the Othmanli Sultan. And yet, within less than a century after the relief of Leyden by the Dutch fleet, the ever-unpopular, grasping, fat, Jew-tolerating, free-speaking soldiers and sailors of Orange had defeated the Spanish infantry and the British Navy and extended the reach of their tiny, sodden country to the Americas and Asia. The people who went long on the Middle East and traditional Europe (Spain, France, Italy) lost big. Historical parallels are as useless as CBO numbers in predicting what will actually happen, but they are a useful caution against accepting as certain what "everybody" - i.e. those with tenure - knows.

# A Trading Query, from Kevin Bryant

March 29, 2007 | 1 Comment

I live in the UK. I am looking to do a bit of intraday trading and would like recommendations on the best online trading systems — execution speed and accuracy, charting software, price. I am looking to deal primarily in commodities but may also trade equities and currencies.

## Nigel Davies responds:

If you want pictures then one possibility is the software that comes with a Deal4Free account. You can even have live Point & Figure charts there now. It can also do backtesting.

Many UK futures brokerages use J-Trader, which has an intuitive interface and works just fine. I tend to put the resizeable 'Dome' from J-Trader on top of the Deal4Free window, like the way Tuco constructed his gun in The Good, the Bad and the Ugly.

## Vince Andres remarks:

Instead of a product name, I propose a few criteria:

- Controllable, easy to master
- Complete, full-featured
- Proprietary, or open-source
- Cost
- Technical support
- Safety/respectability: tool developed by one person or 100?
- Number of users: 500 or 50,000?
- Independent and objective, or a broker tool
- Customizable
- Confidentiality: can the provider access your algorithms?

This list is far from complete.

# Turtle Trader, from Sushil Kedia

March 29, 2007 | 2 Comments

Surfing the web today, I landed on Turtle Trader and noticed:

1. The significant angst with which the author has latched onto the long-since-lost-its-value device of obtaining cheap popularity by attacking Dr. Niederhoffer's 1997 glitch.
2. No mention of Steve Cohen. Noticeable because the author has compiled a pull-down menu of Top Traders, classifying them as Hall of Fame, Market Wizards, Turtle Traders & Trend Followers, and has SAC nowhere in that list. The author hasn't found a reason to classify this success anywhere?

## Larry Williams replies:

Sushil has scratched a very dark surface here. Long story to this website; mostly negative, vile stuff about people that is not correct, and sets themselves out as the savior. Orignated by a guy who does not trade (so a real Turtle told me — who knows?) but the bitterness expressed towards others is the clue to the soul of these people.

I had a tiff with these guys a few years ago when they were putting me down. Where is their track record? Where is their heart? This is not how good thinking people treat others. There are many ways to make a good cup of market soup.. some like it hot, some like it cold, some like it in the pot, nine days old.

The site lists among its heroes a multi-year loser of clients' funds, and a mystic who (as I understand it) has not traded for years, just holds navel-gazing seminars sprinkled with platitudes. If I am wrong on this… I would sincerely like to know.

# Overnight Volatility, from Craig Mee

On looking at the way some overnight, particularly Asian equity markets trade, and their relationship to the U.S. markets, i.e., Dow or S&P, it would be an interesting experiment to test say the average maximum range move in the Dow. An example would be comparing settlement to extreme high or low, to the corresponding move on the overnight Aussie market in order to gain an average rate of volume between the two. When this varies greatly a meal may be presented.

For example, last night the Dow was off 140 at the extreme, and the Aussie equity futures where only off 33 on the extreme (which on optic observation is a minimal move on average over x range). Subsequently on the day session, today, the market rallied all day from the open. You could throw in a filter such as gold (as the Australian market has a reasonable leaning to resources), with gold being up five dollars overnight (a large sell-off on the index was very much against the resource sector).

# Truth and Time Constraints, from George Zachar

As is now the norm for America's social democrats, Nobel laureate Joseph E. Stiglitz bashes the US in overseas venues. In Thursday's Shanghai Daily, the Clintonite unleashed a lengthy barrage of falsehoods and partial truths in the course of a sloppy wet kiss to celebrate Europe's 50th birthday. The full piece reads like a John Kerry campaign speech before the Young Socialists of Berkeley.

An [American] economy that, year after year, leaves most of its citizens worse off is not a success.

Nowhere in the world do neighbors live together more peacefully, and people move more freely and with greater security, than in Europe…

…only Europe can speak with credibility on the subject of universal human rights.

# Studies With International Implications, from Yossi Ben-Dak

I find these studies of particular meaning and interest to speculators and speculation. Given their forecasting trends that are easily copied. Today's rancorous conflicts have implications for both US behaviors and attitudes, as well as for understanding foreign dynamics.

I am more concerned with the type of information that can allow us to think through antidotes or countervailing strategies [available herein] rather than the gloom that is unfolding now more intensively than in the past five years in Palestine, Thailand, Iraq , and Central Asia, and the truly contaminated post intellectual theatre of Academia.

1. From Nationalist Battle to Religious Conflict: New 12th Grade Palestinian Schoolbooks Present a World WIthout Israel , by Itamar Marcus and Barbara Crook. A report for the Palestinian Media Watch. (February 2007; 35 pages)

2. "It Was Like Suddenly My Son No Longer Existed" - Enforced Disappearances in Thailand's Southern Border Provinces. A report by Human Rights Watch. (March 2007, Vol.19, No.5(C); 72 pages)

3. After the Surge: The Case for U.S. Military Disengagement from Iraq. Steven S. Simon for the Council on Foreign Relations (CFR) (February 2007; 64 pages)

4. U.S. Interests in Central Asia and the Challenges to Them. A monograph by Stephen Blank for the Strategic Studies Institute. (March 2007; 53 pages)

5. Inside the Ivory Tower. A survey of opinions of international relations scholars at 1,199 colleges and universities in the U.S. on foreign policy issues. By Foreign Policy (March/April 2007; 7 pages)

# Design of Everyday Trading, from Tom Ryan

I just recently finished the book The Design of Everyday Things, by Donald Norman and found it a treasure trove of useful advice for designing and maintaining all types of systems. The book contains chapters on feedback, mappings between thoughts and actions, human logic patterns, and the psychology of choice. There are many examples of really bad design and what not to do (what to avoid). But at the end of the book there is a summary of seven basic principles involved in good design. The book is a bit deeper than these seven principles, but I have been mulling these over and will try here to briefly relate these principles to trading.

1. Use both knowledge "in the world" and knowledge "in the head."

Patterns and back testing are fine but they cannot tell you that tomorrow is the unemployment day, or that Bernanke is speaking at 10 today. Therefore, a trader needs both the knowledge contained within the numbers, and knowledge outside of the numbers.

2. Simplify the structure of tasks.

Trade the anticipated move in your market in the most direct way possible with the fewest instruments possible.

3. Make things visible.

Know your position at all times. Have the p/l updating in real time. Know where you are relative to your margin 24/7/365.

4. Get the mappings right.

Keep the rudder steady. If you trade reversals stick with that. If you trade momentum stick with that. Don't go back and forth simply because of recent p/l. Don't flop back and forth during the day between long and short. Don't completely reverse course because of a loss. Nothing is worse than taking a loss in both directions on the same day. Know the 1000% per century drift. Trade with it as much as possible.

5. Exploit the power of constraints.

Know when the big announcements are coming. Know how volatility changes as you get close to the end of the trading day, the trading week, and the fiscal quarter. Know where the shoals are and account for them in your trading and placing of orders

6. Design for error.

We all have placed shorts when we meant to place longs. We all have put in orders for 1000 when we meant 100. Have a system in place to catch these mistakes before they kill you. Set your limits in your trading platform. Check your position frequently. Have a backup source of capital ready for the margin call. Diversify. Train the spouse in methods of dealing with the inevitable "rough day at the terminal."

7. When all else fails, standardize.

If you are having trouble initiating positions, buy and sell on a scale. Use limit orders. Be consistent in your scales; don't change them day-to-day. It's hard enough making a judgment whether things are bearish or bullish, where to be placing orders, let alone monkeying around with the structure of the scale. Trade based on the system, not whether you had great romance the night before or too much coffee this morning.

# Tenths, from George Zachar

March 28, 2007 | 1 Comment

I just noticed that on CNBC they have a countdown to Bernanke's testimony incremented in tenths of a second.

Is this a new feature or have I just been unaware?

## Scott Brooks remarks:

In a game situation, especially in basketball, tenths of seconds make a huge difference.

When I was playing we had clocks that measured only full seconds. When we had an inbounds pass with one second on the clock the question was always, "Do we have a long second or a short second?"

The difference between 1.5 seconds and 0.5 seconds was huge. It meant the difference between a rushed shot (almost having to push the ball toward the basket as soon as it hit your hand) and being able to make a quick deceptive move (maybe a fake step left, the fadeaway jumper to the right).

Unfortunately, in the markets, you can't stop the clock.

The clock in NCAA tournament games measures seconds. After it drops below one minute, the clock measures tenths of seconds. There is no difference, but time seems to go by faster because you have numbers spinning away faster than you can read them. It certainly works to increase my excitement, even in a relatively boring game.

# Point and Figure, by Victor Niederhoffer

Today I did a quick hand study to make a point and figure chart. I looked at swings of five or more points, only above an S&P futures level of 1400, and starting on the 15th of March. I defined a sequence as a plus plus (++) or minus minus (- -), a negative reversal as a plus followed by a minus (+-), and a positive reversal as a minus followed by a plus (-+).

There has been a nine long (++++++++++) positive sequence up to the 1450 level, then a negative sequence of three (- - - -) to 1434, and then a positive sequence of one (++) to close again at 1450 . There has since been a negative reversal of length one to bring us to 1439.

I hypotheize that the expectations after negative reversals of length 1 are negative.

## Bill Rafter writes:

Two years ago we wrote some code to test Point and Figure data. Our goal was to quantify some of the anecdotal claims going around. We were predisposed to like the concept of running data through a P&F filter, as the resulting data is non-linear.

It is also asymmetric (it usually takes more points to reverse than to continue) and in the classic version, adaptive. We found that smoothing the data with all varieties of P&F filters did produce better results than obtained by using raw data, by reducing "noise."

However, it was vastly inferior to most other filters, mainly because the P&F process introduced additional lag. So, the dog hunts, but he doesn't hunt as well as the other dogs.

## Sushil Kedia writes:

Dr. Rafter's post has invigorated the ever hungry mind. Without trying to pry any profitable filtering ideas from list members, one is curious to learn how to think of suitable filters.

What properties, in general, should one look for in including a particular filter or filtering system on the list of "need to test further or develop further?" And which attributes would help put the rest on the other list?

The more learned could help neophytes sharpen their thought and creativity tools to focus better. Thanks in advance.

## Bill Rafter replies:

By filters we mean filtering the data, not spam filters for email, although the principle is the same: weeding the wheat from the chaff. By filtering we create a surrogate dataset. The goal is to create a dataset with all of the good attributes of your original and minus a few of the bad features of the original. We are of two opinions that are not necessarily mutually exclusive, but approaching it:

1. It is not a question of separating the short-term noise from a long-term signal, which is the general consensus. According to our research, the true signal is in what most refer to as the noise. That is the counter-intuitive point of view. A good example of this is illustrated where we break down the put-call ratio by wavelet de-noising, and then reassemble the shortest time frame components.

2. Opposing that is the fact that we have found that some minor smoothing universally improves our results. I suggest that you look at 3-period medians and 2-period exponentials for a start. Medians have some great advantages. I definitely recommend against midranges (daily or otherwise), although that's what many "experts" tout.

The consensus refers to filtering as smoothing. That's not always the case. Some filtering will result in data that seems to be more erratic or discontinuous. A fairly inclusive "course" on this can be found at one of our sites.

# Freedom: Serfdom as Austrian Economics? from George Zachar

Yesterday the Financial Times showcased Harvard ex-President Larry Summers calling for easy money as the cure for what ails us. Today it has Harvard Prof. Dani Rodrik telling us that markets are at risk from insufficient political meddling. "We cannot leave national governments powerless," he warns.

Aggressive regulation and easy money - I guess the antonym for "Austrian Economics" would be "Harvard Economics."

# Mentoring, According to the Hagakure, from Nigel Davies

There is an interesting piece on mentoring from the Hagakure (The Book of the Samurai). I must admit to having great gratitude for those who have shown such patience with me over the years.

To give a person one's opinion and correct his faults is an important thing. It is compassionate and comes first in matters of service. But the way of doing this is extremely difficult. To discover the good and bad points of a person is an easy thing, and to give an opinion concerning tbem is easy, too. For the most part, people think that they are being kind by saying the things that others find distasteful or difficult to say. But if it is not received well, they think that there is nothing more to be done. This is completely worthless. It is the same as bringing shame to a person by slandering him. It is nothing more than getting it off one's chest.

To give a person an opinion one must first judge well whether that person is of the disposition to receive it or not. One must become close with him and make sure that he continually trusts one's word. Approaching subjects that are dear to him, seek the best way to speak and to be well understood.

Judge the occasion, and determine whether it is better by letter or at the time of leave-taking. Praise his good points and use every device to encourage him, perhaps by talking about one's own faults without touching on his, but so that they will occur to him. Have him receive this in the way that a man would drink water when his throat is dry, and it will be an opinion that will correct faults.

This is extremely difficult. If a person's fault is a habit of some years prior, by and large it won't be remedied. I have had this experience myself. To be intimate with all one's comrades, correcting each other's faults, and being of one mind to be of use to the master is the great compassion of a retainer. By bringing shame to a person, how could one expect to make him a better man?

# A Quote, from George Zachar

What follows is from a Mightily Loquacious economist, amid calls for bond rallies and Fed easings:

"Our proprietary measure of 'cyclically sensitive' inflation - what the central bank can actually influence - is running around a 1% annual rate."

Markets should therefore:

1) Rejoice because inflation has been vanquished.

2) Tremble because clearly the Fed has lost control over things if there's such a spread between experienced inflation and "what the central bank can actually influence."

3) Seek out this seer to learn the details of this "proprietary measure."

4) Announce the closing of this quarter's competition for Chutzpah Economist, and award the coveted lead bagel.

# How Prenuptial Agreements Kill Romance, from Mark Goulston

Mark Goulston writes about how prenups kill romance. An ounce of distrust is worth a pound of romance and a week of sleeping in the den.

# More on the Signs of Subprime, from Stefan Jonanovich

March 27, 2007 | 1 Comment

My partner and I recently listed the names of every entrepreneur we had worked with in three decades of doing business in California and then tried to decide whether or not any had provided income documentation for a business, auto, or home loan with "stated income" that varied significantly from what we knew their actual income was. The answer was that less than a quarter of our law clients and business associates had been "completely honest" when it came to filling out lenders' paperwork. That may be a damning commentary on our choice of associates, but there is an alternate explanation.

Credit scoring and credit documentation, at least as we have directly experienced it here in California, is based on the assumption that people work for government, the educational-industrial complex (by far the State's largest employer group), or a large corporation. Failures such as losing a job, having a business go under, or surrendering assets in a divorce can be excused, but only if one has reformed, i.e., worked for at least five years as a W-2 employee for a bureaucracy or company that cannot possibly go out of business. Having substantial assets but no current income, the common fate of entrepreneurs, is not seen not as the natural result of making one's living from deals. On the contrary, it is taken as a clear sign of having a questionable character.

People who work for themselves repeatedly go through these inquisitions. Being nothing if not resourceful, they soon learn how to "pass" as upstanding citizens. They form corporations that can "verify" their own personal incomes as employees. They learn how to provide copies of tax returns that "restated" their income appropriately. We do not know but strongly suspect that the decision of the Sandlers and CFC and WM (each of which we bought last week) to offer "no income verification" loans in California was a sensible response to the fact that income verification had become a bigger genre of show business than either CSI spinoffs or reality shows.

It has been a number of years since we have been involved with a start-up, and the entrepreneurs on our list and we are now all respectably successful. A few people we know have done time - one for drug dealing, another for securities fraud, but none has defaulted on their mortgages. We know nothing about the credit market other than the little we have gleaned from George Zachar's considerable wisdom. But the recent "discovery" of dishonesty on the part of sub-prime borrowers and their mortgage brokers seems to have at least some echoes of Claude Raines' expression of "shock" at discovering that there was gambling going on at Rick's.

I concur with the assessment concerning the sensible response to an irrational marketplace by World, WAMU, and the other original members of the 11th district of federal home loan bank system (before most of them were bought by WAMU) to offer no income verification loans to self employed borrowers in California and then spreading that same offer throughout the US. They exploited a massive irrationality in the system.

Previously, it was incredibly difficult for these people to get loans. For some bizarre reason the banking system always looked at them with suspicion and underwrote their loans to much more strenuous standards than wage earners with far less assets. So, underwriting to two of the three c's of credit, character, and collateral, and negating the necessity to prove the 3rd c, capacity, with tax returns, and financial statements, was brilliant. But, then to extend that offer to wage earners in an attempt to maintain their own growth rates was imprudent, especially for World and the Sandlers.

If it had stayed that way it probably would have been OK too; but it didn't. The Sandlers and WAMU began to cannibalize their own track records. They began to monetize their good will and trade on their historical track record of prudence in underwriting by gaming the system they created. As they increasingly went out on the risk curve by offering no income verification loans to increasingly dubious borrowers they simply increased the margins on their loans to make up for it.

And then countrywide, in conjunction with the MBS, packagers created similar loan products and sold the idea and the bonds to investors using the historical track record of performance established by World and WAMU. The problem is that that track record was based on borrowers that are no longer reflective of the profiles of the borrowers that the track record was based on.

From 1990 to 2000 or so, World was ranked by Fortune and Forbes magazines as the best financial firm in the US. In the last five years or so, they gamed that reputation and WAMU and Countrywide did too by extension. Their balance sheets ballooned along with their earnings and last year the Sandlers cashed out at the top by selling World to Wachovia for 25 billion dollars.

But now, the traditional clientele World had, the high-end self-employed borrower, has left them because World abandoned them by raising rates to what are today close to subprime. Today, world savings is where borrowers needing no income verification loans go to get loans they can't get from WAMU or Countrywide. And if they fail to get a loan at World the next step is subprime.

That's a long way down from the prudent underwriting that the Sandlers grew World with. Just as GM had to put one billion into rescap don't be surprised if before too long Wachovia is asking the Sandlers for some money back, too.

## George Zachar writes:

Everything I know about "liar loans" and the real-life history of no docs I learned on this list from Roger Arnold.

There's a huge discontinuity in knowledge between the ground troops originating loans, and the Air Force strategic forces playing with highly abstract tranched securities. At the latter level, it's all (pseudo?) quantified risk profiles and lots of comparative history on the trajectories of various securities under "Monte Carlo-ed" simulations.

The securities geeks don't believe they need to know, let alone care, about such origination details as W2s, FICO scores, etc. Once the tranches emerge from the sausage machine, it's just a matter of getting the AAA pieces to favored accounts, seducing options kids to assume convexity, and finding the dummies to take the dreck. The marketing material will map out how (supposedly) each slice "should" behave along various rate and default paths. Then it's old fashioned caveat emptor.

As I understand it the fatalities thus far have been among folks holding the hot potato raw products before they could pass through the Street's cuisinart.

Yes, the down-credit tranches and related derivatives have widened out, but nothing like parallel historic events. And the rest of the capital structure has hung in so well that even the cynical pros are scratching their heads.

There's an interesting pattern to how sophisticated folks are reading all this. Those close to the ground, watching the paperwork and hearing the horror stories, understandably fret about an economic disaster. Folks who pass their days in front of screens watching the relationships between securities, see a speed bump. Politicians and lawyers see the next three years of legislation and litigation.

A Rashomon economy.

# It’s the Rush, from Steve Ellison

March 27, 2007 | 1 Comment

My wife had a friend visit from out of town. Since the friend and her husband liked gambling, we took them to a casino for the evening. I did not last long at the craps table, losing the first six points (it reminded me of my trading, all from the long side, on February 27). I wandered over to the sports book and bet on a hockey game. At least I could watch my favorite sport and at worst take several hours to lose a small amount of money.

The sports book was nearly deserted by the time the game went into overtime at 9:30 pm. Two other men who had bet on the same team as I sat down nearby. One was quite talkative, saying he had won all his bets that day, all on hockey games.

Nobody scored in overtime, and the game went to a shootout. As the first player lined up for the series of shots that would win or lose the game, the talkative man said, "This is it. This is why we bet–it's the rush."

I wonder how many people trade for the rush. No doubt there are some, and I would guess there is money to be made in taking the other sides of their trades.

# The Bust is Boom in One Region, from Eric Ross

March 27, 2007 | 2 Comments

I'm not sure where the numbers truly are when it comes to the housing bust of the recent bubble. However, I can tell you it has had a very small affect on this area and our absorption rate is healthy. Homes in the ranges of 1.2 to 4.5 are moving along in a normal pattern of sales. They are projected to jump by 12% and we are on track. One of our projects, 2100 acres of land (956 unimproved), is looking at a fair market value of 158 million. We have 14 buyers who are currently in the running for our property and expect bids to come in shortly.

The sub-prime situation has hit the lower income and mainly ethnic groups in San Antonio. Yet, I do not see a slowdown in midsize to high end homes any time soon. In fact, both West Coast and East Cost monies are flowing in to purchase homes and land.

Of course, I expect somewhat of a bump eventually, due to many sellers not going being able to unload their homes in the up and coming market. I also figure that sellers will not want to write checks, at closing, to buyers, and will sit and ride whatever storm is brewing.

Not only is the bust bringing boom to the home sales market in the South West Region of Texas, many corporations are moving into and around the city of San Antonio for the economic reasons such as inexpensive and abundant land, cheaper labor, and weather.

I came to this region two years ago to capitalize on the next recession, the next long and harsh bear market that will hurt the east and west coasts job market and real estate market, and cause individuals to migrate to less expensive areas. I think my timing was early but I know I am on the proper track.

Nonetheless, the bust is nothing but boom in the southwest region. In fact, the proposed 14-lane highway called, the Texas Trans Corridor is looking to bring in more real estate money. I will find out more in two weeks when we have a lunch with Congressman Gonzales to discuss the NAFTA and commerce.

Certainly in greater Sydney (Aus), where the housing market broke down earlier than the States, middle to high-priced houses on the coast have had a relatively solid floor bid. The poorer areas (and last into the "bubble") are coping with the worst of it.

# Bank of International Settlements, from Ryan Carlson

March 26, 2007 | 1 Comment

I'm really enjoying Supermoney by Adam Smith, republished by Wiley. I question, however, some mention of the Bank of International Settlements.

Smith wrote,

"The stock of the bank is held by the member governments: the United States, Germany, France, Japan, Italy, and so on. Every once in a while there seem to be a few stray shares floating around, and so there was this day. For something like \$1,100, I bought one share. Then the stockholders were the United States, Germany, France, Britain, Japan, Italy, and Adam Smith."

Upon reading that passage, I scrambled to see if I could buy some shares. But I read on the Internet that the public shares were forcibly bought back from private hands. Can anyone provide color on the performance of the BIS shares whilst held by the public? Were they a home run, just a steady performer, or a slow mover? More important, are there any similar organizations with small and obscure share offerings?

# “When Bubbles Burst” Study, Redux, from Nigel Davies

This "Bubbles" study was posted some time back. It is difficult to know if it is predictive in the current climate.

In the past housing 'busts' have had longer lasting and more extensive GDP effects than stock market busts. To qualify as a bust the housing market has to lose more than 14% of its peak 'boom' value. So I understand that the US is now there.

## From Laurence Glazier:

I am sure that the human spirit will drive the market ever forward, along with the entropic force that requires participants to have at least a minimum incentive. But the use of what seems to the uninitiated (like me), like complex credit derivatives, along with wide acceptance of multiple mortgages, leads me to images of bubbles and pins (quite apart from finely balanced domino structures).

# 200D MA System Buys Lower Variance, from Kim Zussman

For the following evaluation, I used SP500 daily index returns from 3/57-3/07, partitioned into decades. The signal was to be long the SP500 any days when the past five have been above the 200d moving average, and to be "cash" otherwise (without interest).

No adjustments were made for transaction costs or taxes (not that the SP500 index would have been difficult to own until the 1980s). Returns and variances were compared for MA vs. B/H (buy and hold) for the five decades. The following table summarizes results, with "ret T" being t-score for difference in daily mean returns for the strategies, F the F-statistic for difference in variance, (p) the probability associated with F:

Decade MA v B/H MA v B/H
ret T        F (p)
97-07       -0.1      1.5(0.0)
87-97       -0.1      1.7(0.0)
77-87        0.6      1.0(0.7)
67-77        0.6      1.8(0.0)
57-67        0.8      1.7(0.0)

The mean daily returns in all periods are not significantly different. However, in 4/5 decades the variance of MA strategy was significantly lower than B/H.

# Sudoku, from James Sogi

March 26, 2007 | 2 Comments

This weekend my daughter taught me how to do the Sudoku puzzles that I have seen others doing. They say it is good to keep the brain in good working order and to prevent brain atrophy, and it's fun. It involves a process of elimination, narrowing down the possibilities across different variables in order to have a better chance of recognizing the patterns. It is similar to the SAT aptitude test technique of narrowing choices to one or two, to increase your chances of arriving at the correct answer.

Perhaps such a process of elimination might be fruitful in market analysis, where one does not need to be exactly right all the time, but in order to achieve some level of success one needs to avoid being totally wrong all the time. Eliminate the possibilities that have a poor chance of occurring and it reduces being totally wrong.

The tendency for the news and the public seems to be to assume that whatever trajectory the market is on it will continue on in that direction. After a big bounce and big up, is it likely for the market to continue up forever? After a big drop, like earlier in March, will the market, as the news seems to assume, continue down forever? What scenarios might we want to eliminate from consideration?

Let's say the market is caught in a tight range for days on end after a move. The process of elimination might make pattern selection a bit less error prone. And though it might not make you right all the time, at least you might not be wrong all the time, which is a start. If you are at least not going in the completely wrong direction, that is about 68 percent of the battle.

# An Epidemic Scholar’s Query, from Victor Niederhoffer

March 26, 2007 | 1 Comment

I have been wrestling with an idea over the last week. It is that the best model for the dynamics of epidemics of bearish propaganda about the stock market, that we are periodically visited with, comes from Zombie Movies. In particular, I've found that the Night of the Living Dead, is a great model for the typical sequence of events. The plot here, which most know much better than I, since it's the most released Internet Archive film, is that the dead come to life and eat the living. The humans become helpless; they fight among themselves; they kill each other, and eventually the hero, a Black man, is killed by his own men. The movie is generally seen as in indictment of everything American - the capitalist system itself with the dead eating the living, sexism, racism, and of course , militarism.

I find the uprising of the dead, to feed on the living, perfectly apt for mainstream events that seems to come up when a meme like subprime losses, or declining profit margins, or weakness in the economy. The same applies when Chinese problems are floated as a trial balloon to see if the living can provide food for the dead. Previously dead and buried humans, like the shorts during the past five years, slowly come out of their graves. They enlist ghosts, like our friends, to come out from a cemetery not in rural Penn, but from Trinity Church, to try to get the attention of the living members of the system. They are joined by old zombies exhumed who, if there is a nice decline, can be seen on the television stations with headlines like, Every Bear Has a Day.

The bond maven, who has previously tried to feast on the living, is called out from his yoga sessions to appear again, to predict Dow 5000. The former big speculator who lost 99%, and his ilk, are deputized to fan the flames with talks about biological viruses, natural disasters, or weakness in this or that rural area or sector. There is always a forum for some centenarian in the weekly financial newspaper, and ever more fanciful reasons for being bearish are given. Other examples are the various Presidential hopefuls who are going to do much more legislation than usual, or that there is just not enough bad news to worry about. The sage is always bearish for everyone but him, as is the Palindrome, and they can be called upon for interviews at the height of the carnage, especially if there are some declines to help their positions along.

Those who resist the decline can expect to find themselves suffering the same fate as Ben, and perhaps Abbey from Goldman, who is always bullish after a big decline, and presumably an opportunity for the bear traders who opened the cemetery gates to get out of their positions.

I don't know enough about films or epidemics or the sequence of events in these periodic visitations of horror in markets and film to provide all the technical details. And I would appreciate help from my colleagues and readers to flesh out the gory and destructive sequence.

# Some Thoughts on the Back and Forth, from Victor Niederhoffer

March 26, 2007 | 1 Comment

We've had three weekly reversals in a row recently:

Friday        S&P futures

2 23          1467
3 02          1398
3 09          1417
3 16          1399
3 23          1447

… what I would call a positive reversal of a length of three. The weekly moves have been big, approxmately twice as large in absolute value as those of the previous year. What does this portend? It is not above the old highs, and it has gone in a w rather than a v. It has been to Hades once, and then visited it again. Is this a underworldish pattern? Does it continue more after a reversal of length three than a reversal of length one? The two least helpful forecasters I know, one being the columnist who is always bearish, and the other, the ghost who has never yet admitted to an inaccurate prediction, nor made a falsifiable one, are both bearish (of course). How does this change the normal expected distributions? All these ideas have to be tested.

Pulling out "minimal path" again (min of abs[C_prev-O-H-L-C] or abs[C_prev-O-L-H-C], as % of C_prev) and applying to weeks, to maybe capture more of the intraweek volatility, and then computing z score for each week relative to previous 25 weeks, one does a quick back-of-the-spreadsheet calculation to determine the highest-z weeks since 1990 for the S&P. A recent week comes in at #2:

week of z
27-Oct-97    7.97
26-Feb-07    6.40
28-Mar-94   5.46
19-Aug-91   5.16
15-Jul-96     5.02
30-Jul-90     4.79
22-Jul-02     4.13
21-Nov-94   3.95
10-Sep-01   3.85
31-Aug-98   3.78
3-Oct-05      3.71
3-Jan-00      3.51
15-May-06   3.51
24-Aug-98   3.49
17-Apr-06    3.43
19-Mar-01   3.43
16-Oct-00    3.39
12-Jun-06    3.39
20-Aug-90   3.38
17-Jul-95     3.35
4-Mar-96     3.28
6-Apr-92     3.26
10-Jun-02    3.19
5-Jun-06     3.19
16-Feb-93   3.15
1-Jul-02      3.11
13-Aug-90   3.07
24-Jun-02   3.02

(This list is all weeks with z of 3 or greater)

Where was the S&P six weeks later? Can't know that yet for Feb 07, but here are the z scores (relative to previous 25 weeks) for the S&P's moves six weeks later for the other weeks from the list above:

week of z
27-Oct-97     +0.39
28-Mar-94    +0.21
19-Aug-91     -2.46
15-Jul-96      +0.59
30-Jul-90      +0.84
22-Jul-02      +1.46
21-Nov-94    +0.67
10-Sep-01    +2.02
31-Aug-98    +1.85
3-Oct-05      +1.42
3-Jan-00      -1.51
15-May-06   +0.09
24-Aug-98    -0.43
17-Apr-06    -1.77
19-Mar-01   +2.76
16-Oct-00    -1.28
12-Jun-06    +1.12
20-Aug-90   +3.19
17-Jul-95     -1.24
4-Mar-96     -0.21
6-Apr-92    +0.18
10-Jun-02   -2.03
5-Jun-06     -0.29
16-Feb-93   +0.01
1-Jul-02      -0.17
13-Aug-90  +1.05
24-Jun-02   -0.53

Average: +0.22
Count:     27
Positive:  16, or 59.3%

This doesn't look much different from LT positive drift.

# Easy Money is the Answer, from George Zachar

Towards the end of a verbose survey of contemporary doomology in today's Financial Times, Larry Summers offers his policy nostrum.

If, as may prove the case, the dominant economic concern becomes a shortage of demand, it is incumbent on the Fed to provide stimulus so as to maintain conditions for growth and financial stability.

The recent spate of Larry Summers' economic/market pronouncements is probably an attempt to burnish his image as a prestigious consultant to hedge funds and financial firms. Moreover, it might be to signal his interest in leaving the Harvard that denigrated him in favor of a leading cabinet post in a future Democrat administration.

It appears one can talk one's personal availability book as effectively as one's investment book.

# Tax Statistics, from Yishen Kuik

It is the season for looking at tax statistics.

In the year 2004 and 4,488,654 filers reported short term capital gains ("ST gain") and 5,506,046 reported short term capital losses ("ST loss"). The IRS has thoughtfully binned all filers into 19 income categories ranging from AGIs of zero to \$10mm plus

Every bin showed more filers reporting an ST loss than an ST gain except the last two bins of \$5mm-\$10mm and \$10mm plus. Every bin also showed the total dollar amount of ST losses suffered by filers exceeded same for ST gains, save for the last two bins.

If we take the total dollar amount of ST losses divided by the same for ST gains in each bin, naturally we get a ratio greater than one for all bins except the last two. If we then plot this, we get a nice slightly kinked line starting from an incredible high of 20 [AGI \$5,000 to \$10,000] to 7.76 [AGI \$25,000 to \$30,000] before rising again to 9.21 at [AGI \$40,000 to \$50,000] and falling gently thereafter to hit 1.25 at [AGI \$2mm to \$5mm], before going into sub-1 territory.

The aggregate ratio for all returns is 3.65, i.e., ST losses for all US filers were 3.65 times ST gains in 2004.

# C.D. Biscuits, from Scott Reeves

A coworker's girlfriend's cousin's late father had cleared out shelters in the 60s or 70s and stocked up a barn with biscuits, candy, shovels, 1967 medical gloves, and portable toilets. He has been eating the biscuits and candy since the 60s, and gave me two boxes, which contained two, 12 1/2 lb cans containing 1112 biscuits.

I opened one from Jan 1963 this morning; i have the same opinion as my coworker, yuck. They don't taste too good. Maybe one from the center will taste better. But now I can say I know what a 44-year-old biscuit tastes like. These look like the saltine crackers I remember as a kid that were four squares that would be broken into quarters. I should be getting some of the candy soon. I was told it tasted great. If I like it, it will be great with my 57 Chevy at the shows to say, "Hey, want to try a piece of candy almost as old as my car?" It may be funnier with my 67 Mustang, "want to try a piece of candy older then my car?"

I suggested they try putting some on eBay. It would be nice to see pictures of inside the mine. The Geiger counters often sell at ham fests for between \$40 and \$100. I have one with the original box and also some dosimeters; if you find them they should sell well.

# Leonard Cohen, from Craig Mee

I was lucky enough to view the film, "I'm Your Man." It is about Leonard Cohen and billed as "an intimate look at the songs, poetry and life of one of music's most celebrated and influential troubadours."

What an amazing intriguing and humble character he is, representing all the traits needed to push beyond imaginary boundaries into the next level of introspection. The amazing performances of featured muso's is mind-blowing.

# Dr Mishkin, Meet O’Brien, from George Zachar

It's hard not to be impressed by Fed Gov. Fred Mishkin's Friday night speech. He comes across as a humble, clear, knowledgeable technocrat with a sense of history, and a command of arcane monetary matters. But reading his text in the context of where we are on the timeline of monetary mysticism is a chilling experience.

First, in keeping with this cycle's fashion, he put the public's inflation expectations front and center as an analytic deus ex machina:

"What is particularly attractive about highlighting a better anchoring of inflation expectations as probably the primary factor driving the changes in inflation dynamics is that this one explanation covers so many of the stylized facts–an application of Occam's razor. Indeed, I have always become more confident in a theory if it can explain a number of very different facts. This is why I am so attracted to the view that inflation expectations are a key driving factor in the inflation process…"

Then, he reintroduces the comic book analysis of commodity forward prices:

"…from the mid-1980s through the first years of this decade, energy price movements were smaller and more transitory. We see this in futures markets, in which oil prices in far-dated futures contracts moved much less than spot prices over this period, suggesting that people expected a quick reversal in any rise in oil prices. Such transitory shocks to energy price would presumably have a smaller effect on inflation than the more-persistent oil price shocks of the 1970s and early 1980s…."

Since we can dismiss the notion that Dr. Mishkin is unaware of the no arbitrage rule, we are left to puzzle over what seems like a willful misreading of these tealeaves. There's a reaffirmation of rhetorical oneness with the ECB:

"…we remain vigilant about developments in the economy that could lead to persistent departures of inflation from levels that are consistent with price stability…"

And here is some Winston Smith material.

"Although solidly anchored inflation expectations are indeed highly desirable, they could pose a bit of a problem for monetary policy if they were at a level somewhat above or below the rate preferred by policymakers. Under such circumstances, the central bank would likely be interested in shifting the public's expectations in a more favorable direction. Whether such adjustment would be easy or difficult is, unfortunately, quite uncertain because we do not understand the expectations-formation process very well…"

So, the Fed likes well-anchored public inflation expectations. Really. But they have to be the right expectations, Goldilocks expectations, not "above or below the rate preferred" by the Fed. You see, the public, well, they just might not know what inflation is:

"…long-term inflation expectations from the Reuters/Michigan survey have been running much higher for a number of years, at around 3 percent. However, this figure seems overstated in light of the persistent bias found in the short-term inflation expectations reported by this survey. Correcting for the bias, these survey results are probably more in line with PCE inflation closer to 2 percent.

"…expectations from the companion one-year-ahead expectations have come in about 75 basis points higher than actual PCE inflation since 1990, suggesting that there may be a systematic bias in the responses to the Reuters/Michigan survey…"

Who'd have guessed the public would intuitively grok positive yield curves, risk premia, and the potential for perfidy on Constitution Ave.? Not the Fed! The public's rational expectation for the annual decline in their currency's purchasing power is defined away as a "systematic bias" subject to "correcting."

Naturally, this calls to mind the scene from 1984 where the thought policeman O'Brien holds four fingers up before Winston Smith, demanding that Smith say there are five fingers aloft. That didn't turn out too well for Smith.

Back to our monetary dystopia, Mishkin clearly signals the markets that he expects core-core inflation to fade toward 2% once the energy price spike finishes working its way through the economy:

"I think that we can be reasonably optimistic that core PCE inflation will gradually drift down from its latest twelve-month reading of 2-1/4 percent. This process may take a while in light of the recent rebound in prices for gasoline and other petroleum products. These price increases have boosted the cost of producing many non-energy goods and services, and as firms gradually pass on these higher costs to their customers, monthly readings on the change in core prices are likely to be higher than they otherwise would be. Once this process is completed, however, we might expect consumer price inflation to move into better alignment with long-run expectations and thus settle in around 2 percent…."

Finally, we learn that the FOMC's iteration of Minitru is very sensitive to where public perceptions rest relative to the Fed's favorite measures, and perhaps more subtly, just how much inertia the Fed sees in those perceptions:

"Looking to the medium term, I am less optimistic about the prospects for core PCE inflation to move much below 2 percent in the absence of a determined effort by monetary policy. For the most part, this assessment–which I should stress is subject to considerable uncertainty–flows from my view that long-term expectations appear to be well anchored at a level not very far below the current rate of inflation. If so, a substantial further decline in inflation would require a shift in expectations, and such a shift could be difficult and time consuming to bring about…"

Yes, the suits on Constitution Avenue run a cost/benefit analysis on the efficacy of manipulating the public's understanding of its own money.

It's not Orwell, but Nora Ephron who best sums it up: "No matter how cynical I get, I just can't keep up."

# Stamps, Wine, and Seahorses, from Yishen Kuik

March 25, 2007 | 1 Comment

I was recently alerted to the bull market in dried seahorses. A value-oriented friend on vacation in Hong Kong told me merchants in traditional Chinese medicines have found their inventory of dried seahorses enjoyed rates of return in the teens.Since this is not exactly a market with a well-reported price time series, a bit of Googling shows:

Ten years ago, the kilo-price for dried Sea horse in Hong Kong ranged between 250 U.S. dollars for "inferior" small, brown species and 850 U.S. dollars for large, bleached species.

Punching the numbers into my 17B, I get 10.94% return over 10 years.

# Musings on James Cramer and CNBC, from Steve Leslie

My view on James Cramer is to take him strictly as entertainment along with his show Mad Money. His discussions are very topical and he has on occasion gotten himself in hot water with regulators with his off-the-cuff remarks both on his show and his website, The Street.com. He has also incurred the wrath of regulators for allegations of front running which ultimately led to the demise of his predecessor in this field and CNBC's Mr. Dan Dorfman.

Yet he can be helpful and harmful to a neophyte investor, which appears to be his audience. He is helpful from the perspective he is very animated and theatrical and thus keeps his young audience's attention. Moreover, he gets them interested in stocks, the markets, and investing at a young age. This is a good thing.

However, and this is my opinion, he is harmful because of his very cavalier Lightning Round and his lack of accountability and follow-up. In addition, he offers opinions on many stocks with witty quips and seemingly little analysis. This can be construed as damaging because it gives the impression that investing is a carnival act rather than a very sober and difficult venture. Still, I must say I do like him in small doses.

For stock ideas and market perspective I much prefer Fast Money hosted by Dylan Ratigan on CNBC at 8:00pm eastern time. His original after-hours show was replaced with Mad Money and now he is back with his new show and new format. His guest lists are actual people who make actual money.

For after-hours economic views and market perspective I appreciate Kudlow and Co. for the guest list if nothing more. Here you can get views from Arthur Laffer, Wayne Angell, and others.

As always, these shows should be taken with a grain of salt. Caveat emptor information that is free is usually worth what you pay for it. I am sure there are varied opinions on this but as they say, "That is what makes markets." These opinions happen to be mine.

# Trend Following Study, from Kim Zussman

Here is a fixed-system signal using a 10 month moving average. It is a bonus quantification of risk using Ulcer index, which was not clearly diagnosed with endoscopy.

## Philip J. McDonnell writes:

Looking at exhibit two, it should be noted that the greatest differential between the 200-day moving average timing strategy and buy and hold was achieved in 1932. Since that time buy and hold has out performed. The trend following strategy appeared to do better mainly in the 1929 crash, 1973-4, and 2000-2002 bear market years. Given that it is 30 to 40 years between such events one wonders how soon the next one will be.

# Jack Tierney on “Kid Turns 70″

Frequently I place particularly long emails in a "to be read later file." I received Joseph Epstein's "Kid Turns 70" almost two weeks ago. I just read it this morning and find some of the thoughts not unlike those expressed by the Chair regarding the "Old Lions." This is a very long article. Here are a few excerpts:

W.H. Auden, who pegged out at 66, said that while praying we ought quickly to get over the begging part and get on to the gratitude part. "Let all your thinks," he wrote, "be thanks."

I have never attempted to calculate the collective age of my readers. When I am out flogging a new book, or giving a talk, the audience who come to hear me are generally quite as old as I, and some a bit older. Perhaps the young do not spend much time attending such non-events. Perhaps they feel I haven't much to say to them.

But how long can a writer commenting on the culture be expected really to know the culture? In fact, there can even be something a little unseemly about writers beyond a certain age claiming to share the pleasures of the young.

Chateaubriand (1768-1848), whose dates show that he lived through the ancien régime, the French Revolution, Napoleon, the Restoration, the Second Republic, and died just before the Revolution of 1848, wrote: "Nowadays one who lingers on in this world has witnessed not only the death of men, but also the death of ideas: principles, customs, tastes, pleasures, pains, feelings–nothing resembles what he used to know. He is of a different race from the human species in whose midst he is ending his days." In my youth one could go into a drugstore and confidently ask for a package of Luckies and nervously whisper one's request for condoms. Now things are precisely reversed.

Another diminution I begin to notice is in the realm of tact. I have less of it. I feel readier than ever before to express my perturbation, impatience, boredom. Why, with less time remaining, hold back? "I wonder," I find myself wanting to say to a fairly large number of people, "if you haven't greatly overestimated your charm?

# Housing Anecdotes, from George Zachar

The press pity-party on housing is taking the form of a steady drip-drip-drip of tear jerking anecdotes. These stories fit the press consultants' mantra of emotionally engaging readers, while at the same time providing a steady stream of material for agrarian reformist pundits, legislators, and regulators.

The New York Times provides, as it so often does, a classic of the genre:

In the last two years more than 600 houses in Euclid [Ohio] have gone through foreclosure or started the process, many of them the homes of elderly people who refinanced with low two-year teaser rates, then saw their payments grow by 50 percent or more.

Playing the elderly exploitation card is always a winning meme for the agrarians. That said, I do feel that anyone who pushed clearly inappropriate obligations on folks who neither needed nor comprehended the contracts should be spending some quality time face-down in the day room at Leavenworth.

I pulled up the demographic and economic footprint of the town chosen by the Times for their implicit lesson in the evils of capitalism. It's a part of the Cleveland metro area, north and east along the lakefront. The link above features slightly dated histograms of income and property values there. Hint: It ain't New Canaan, CT.

My point? The folks whose purchasing power seems most at risk are precisely the folks who didn't have much purchasing power to start with. While, again, this is a tragedy at the micro level, it really doesn't strike me, green eye shades and all, as something that is likely to crater the overall economy.

Modest folks on fixed incomes who thought they were going to turn their homes into cash cows will now have to live yet more modestly than their starting point.

Another way to think of this: Folks playing this mortgage game were engaging in amateur financial engineering, with scant ability to model the downside. It's like granny watching a few cablecasts of Texas Hold'em and then taking her life savings to a table in Vegas.

# TwiEngine, from Sam Humbert

Here is a handy utility worth a look: TwiEngine. It fetches both Google & Yahoo! search results and presents them in a split-screen format. It is in the spirit of DogPile and the other old-school metasearch tools, but confined to the two engines currently in widespread use.

However, it's a shoestring operation (he uses he uses no-ip.com — presumably to save \$50 or so) so it will probably fail under traffic as word gets around in the weeks to come.

I'm trying out TwiEngine, and noticed that Yahoo search produces lots of cheesy websites that were set up just to capture web search attempts and then hit you with advertising. Some of them even automatically redirect you to specific sites.

Google filters these out, but in the process also filters out some valid links. Having not used Yahoo in a long time, I did not know about the endless supply of sites returned on any given search.

# You Cannot Blame the Bull, from Martin Lindkvist

March 23, 2007 | 1 Comment

Stephen Maturin and Jack Aubrey, in "The Mauritius Command," by Patrick O'Brian:

Stephen … looked at Jack with his pale, expressionless eyes, looking objectively at his friend, tall, sanguine, almost beefy, full of health, rich, and under his kindly though moderate concern happy and even triumphant. He thought, 'You cannot blame the bull because the frog burst: the bull has no comprehension of the affair…'

This week the shorts must have felt just like the frog when the bull burst it. But what happens afterwards? Well, it seems the bull has no comprehension of the affair and just races on.

Since the beginning of 2003, there have been five instances of an up week of more than three percent (S&P Futures). The next week the market was up five out of five for an average of another one percent.

# A Sign of the Sub Prime Situation, from Scott Brooks

One of the problems with living in St. Louis is we only have one local paper, The St. Louis Post Dispatch, which is one of the most left leaning papers in the country.

Yesterday's left wing editorial cartoon showed a sinking boat named "Sub Prime." In the boat was a shark (sitting up like a man of course) and the shark's chest was a label, "Predatory Lenders."

"Fly over country" is full on board with the solving of problems thru the savior of all humans: Big Government!

"Personal responsibility? We don't need no stinkin' personal responsibility."

# Inflation Premium Grinding Wider, from George Zachar

Here is a link to a graph of the spread between generic treasury five-year nominal yields, and generic treasury five-year inflation protected note yields.

This gap is typically referred to as the "break even yield" or the "market's forecast for inflation" over the next five years.

It seems counterintuitive that amid the subprime fiasco and the (not entirely meritless) forecasts of economic deterioration, one would see market-based inflation premia expand.

It's something to contemplate as I pack for spring break (with the kids) in the Rockies.

# Some Stock Market History, from Victor Niederhoffer

Imagine if you will a very bad year in the stock market with a substantial rise in interest rates. Imagine, too, the elders of the stock market having to go to the Palindrome en masse to beg him to buy back his tremendous line of shorts stock, and begging the bearish insurance company, conglomerate hard landing guy, or media forensic accountant, to say a few bullish things to prevent stock from falling to zero.

That situation sounds somewhat similar to the present except it was 1907 not 2007. In 1907 the S&P fell 40%, from ten to six, and the elders went to Boy Wonder, Jesse Livermore to buy back his shorts. Also, interest rates went to 200% rather than the five percent inversion of today.

I felt that a study of the backdrop and concerns and intricacies of how investors tried to make money in the aftermath of that environment might teach us some lessons about how to navigate 2007. It also might provide some food for thought on what we've learned in 100 years. I turned for guidance, therefore, to the Ticker Magazine of 1908. It was a 50-page monthly edited by Richard Wyckoff, similar in its concerns, articles, and advertisers to many we have today, like Stocks and Commodities, Active Trader, or Futures.

The first issue could have been written today. Except that like most things written 100 years ago, it seems to be focused on a much higher common denominator, i.e., the literate investor population of their day. I find all their articles just as timely today as when they were written, and often their insights seem much more useful than comparable journals of today.

The first issue starts out with an excellent article, Mistakes of Investors. The mistakes are divided into excusable mistakes and inexcusable ones. The excusable ones are what we would call those that occur from the vagaries of change, where the investor has taken all precautions and done his due diligence. "If his reasoning has been wrong, or if unforeseen events bring disaster, it is a misfortune. Not so, however, with "willful mistakes."

Here's Cushing's classification of of willful mistakes to avoid.

1. Avoid inside information.
2. Never make an investment on enthusiasm or excitement.
5. Consider earning value and market value. The man who buys real estate looks to the enhancement of value more than to earnings.
6. Don't lose confidence. The investor hears rumors of impending disaster, which, if he would reflect upon, he would see would have no effect on his security. This applies to bank runs.
7. Stay away from names. (Even then there were touts and promoters.) No high sounding titles can make it a success if it lacks the true qualities of success itself.
9. The losses through mining investments (not tech) are greatest. Beware of promoters who have no reputation to lose.
10. The greatest mistake is one of pessimism and doubt. Never let your mind fall into that chasm. Do not think because you have lost money in one investment that all are unsafe.

The most interesting article to me in the first issue was by our old friend Roger Babson, written in 1908 about bank loans. He says that when the proportion of loans to investments gets too high it's bearish and when it's too low, it's bullish, but on a time series basis for all banks, and cross-sectionally between banks within a year. He gives yearly figures from 1860 to 1906 to verify his point and then shows how the panics of 1873, 1894, 1890, 1893, 1898, and 1903, were accurately forecast by the ratio.

The key ratio he uses is 50% loans to assets, which was "In 1873, the ratio of loans to resources first exceeded 50%. Consequently a panic occurred by the spring. Another panic occurred in 1903. Again the western farmer came to the rescue and owing to bountiful crops, the recovery continued until 1897 when interest rates exceeded 2200% a year."

Thus, Babson preceded Boltan Tremblay, Colonel Ayres, the bank credit analyst, the fake doctor, and many other greats in relying upon these credit ratios more than 100 years ago. It's overdue for a test again today.

A final article in the first issue is archetypical of articles of today. A retired engineer has a mathematical way of predicting swings in markets, and shows with a chart how his method caught "the immediate trend of each market, and the beginning and end of the longer price movements, and whether stocks are being accumulated or distributed based on a balance between the volume of price movements and volume of transactions."

He catches the full movement by "eschewing selling on strong rally, and bucking an upward trend, but instead waits until the rally has run its course and the downward movement has actually begun." In that modality, let your profits run. He seems to have captured in 1907, exactly the essence of the main methods of trading futures of today, including the methods used by most CTAs and most of the books written about trading.

In addition to these articles, an excellent article on bucket shops, the harms of short selling restrictions, how a floor trader makes money, and ticker talk rounds out the issue.

I'll augment this with further insights from the subsequent issues, as they're too good to miss.

## Peter Earle writes:

After a couple of years (1907 - 1911 or so), Richard Wyckoff's Ticker became the Magazine of Wall Street, which was published until 1970. In all fairness, and perhaps unsurprisingly, in its last 20 or 30 years it was but a shadow of its former self.

Wyckoff lost control of the Magazine of Wall Street in the midst of a messy divorce from his former secretary (and by that time editor of the MoWS), Cecelia, in the late 1920s. After moping about and writing for a few years, he started a small bi-monthly magazine called Stock Market Technique which ran for the last three years of his life, ending in 1935.

They are extremely rare in their original unbound format.

## Bruno Ombreux writes:

The inventory at Global Investor Bookshop offers a good flavor of the market in the early 20th century, and it's true it has not changed. Some articles and some books have been reprinted.

# Big Sister, from East Sider

I assume someone in Cambridge has already re-worked the re-worked 1984 Apple/Hillary ad, with Drew Gilpin Faust's face on the screen as Big Sister.

# Old Rules, from Andrea Ravano

March 23, 2007 | 1 Comment

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

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

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

## Victor Niederhoffer writes:

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

# The US Dollar, from John Floyd

On the day, the U.S. dollar is trading generally better versus the majority of currencies after the initial weakness posted by the FOMC. I am wondering whether the expected return profile augurs for a more significant strengthening in the U.S. dollar in the days and weeks going forward.

While not significant on its own, it is interesting to note that there are several examples in the past six years where the Euro has made a new high or very close to it, failed, and then had a period of notable weakness. See below for a rough outline. In combination with other factors such as: what seems like a universal bearish U.S. dollar sentiment; likely improving U.S. balance of payments as the trade account improves with the slowing U.S. economy and the capital account remaining strong; and future interest rate expectations in the respective countries already pricing a wide divergence in rate paths.

One clear major risk is an all out liquidation of U.S. assets. And with that the capital account would deteriorate more than the improvement in the current account, leading to a weakening in the U.S. dollar.

High                  Low

July 19 2002              1.0199

September 20 2002                            .9613

March 14 2003           1.1083

March 21 2003                                   1.0504

May 30 2003              1.1933

September 5 2003                              1.0764

October 10 2003         1.1860

November 7 2003                               1.1377

February 20 2004       1.2926

April 30 2005                                      1.1761

December 31 2004      1.3666

Februay 11 2005                                 1.2732

March 11 2004           1.3482

July 8 2005                                         1.1868

September 2 2           1.2589

November 8 2005                               1.1640

June 9 200                 1.2979

July 21 2006                                       1.2458

December 8 2006      1.3367

January 12 2007                                 1.2868

# Where’s The Beef? from Alan Millhone

I note just now that McDonalds is testing the Angus beef sandwich in selected markets.

Nothing will ever replace the time-tested Big Mac, but more choices at McDonalds is good for attracting even more customers. They have done a dramatic turn around with upward sales and stock performance. McDonalds does a tremendous amount of good with their Ronald McDonald houses. I always drop my change into the under the window collection box at their drive-through.

# I Think You Will Like This, from Jason Shapiro

The lesson finally being learned by participants in the financial markets is that even though there may be short-term problems, in the end everything will be OK. We constantly hear talk of recession, depression, inflation, deflation, and stagflation, but in the end none of them really happen and everything ends up OK. Then there are the Asian crisis, LTCM blow up, Internet bubble, terrorist attacks in New York City, and oil prices rising seven fold. In the end everything ends up OK. As for the current favorite crisis of pundits, that there is a housing bubble that was fueled by sub prime loans, I can really only say one thing. Don't worry. In the end everything will end up OK.

I think there are a few reasons for this, outside of the easy argument that America is the freest land in the world and therefore the spirit of the free human being will rise up to conquer all problems put in front of it.

First is central banking. This is a relatively new phenomenon in the world, and took 70 or so years to figure out. But since Mr. Volker stepped up the Federal Reserve has basically come to understand what needs to be done to keep the financial peace in times of crises. The '87 crash, the S&L crash, the devaluation of the dollar, a huge deficit, and an Internet bubble are just a few of the things the central bank has seen come and go and yet managed to help make sure in the end everything was OK.

Despite all this, I constantly am reading research from highly paid economic consultants criticizing the Fed and laying out how the latest Fed plan is doomed to send us all back to a farming economy. This has been a main theme since I started in this business 18 years ago. But over that time there has really only been one constant, that the Fed didn't mess up and in the end everything was really OK. The most contrarian trade you could have made over that entire time was to say, no, I think the Fed knows what it's doing and I'm going to stay long the United States of America and buy any dip I can get my hands on. This trade has worked pretty well.

My second argument has to do with the hero aspect. Nobody makes a name for himself in Wall St or any other street by claiming the status quo is OK. One must make an outlier claim and have it come true in order to move up in the mass respect line and increase one's bonus. For the S&P trader, there is nothing like making money on the short side since you get to strut around happy that you made a lot of money on a day the headlines are riddled with how much wealth was erased from the market that day. I've yet to hear anyone proclaim that they were so long here that it's coming out of their ears, yet it seems I hear that about being short on a weekly basis.

This is one of the reasons the markets do not follow through on the downside very long. Everybody wants to be the hero and as soon as there is any break in the market, they are all very short very quickly. There is a reason Dr. Mark Faber's Boom Doom and Gloom report still has subscribers and its writer is invited to every investing conference and is included in the annual Barrons round table discussion despite the fact that he has been bearish on the Hang Send Index since about the 6000 level in 1993. People love the hero mode, even if it doesn't work.

Now, let's think about the implications of this theory for the stock market. If the stock market is a current valuation of the discounted cash flows going out to just about infinity, then why would anyone ever sell? Certainly there will be blips along the way in terms of economic growth and the like, but if all is going to be OK in the end, then aren't these future cash flows on a constantly upward path? And if it's these total cash flows and not just some short term ones that are being discounted, then why ever sell?

The market has learned this over the past 25 or so years now, which helps explain why the stock market goes on record tears of X straight up months without an X% correction. The world has come to understand the reality.

For those contrarians out there, this writing should be the best thing you have ever read. You can now conclude that if the world has discounted the fact that everything will always be OK and therefore the market will never go down, then there is a lot of danger ahead. If no long term risk is being discounted into the market, then certainly there is a huge risk/reward in the favor of betting on that very downside. To this I say yes, be short S&P. I know I am. Because I can see very clearly that the credit bubble the Fed engineered in order to combat the undoing of the late 90s stock market bubble is now going to come back to haunt them as housing prices fall 50%. And the Fed will have to cut rates to sustain growth despite the fact that inflation is picking up (See CRB RIND Index). Also, let's not forget that Niederhoffer and the rest of the greedy vol sellers need to see the vix go to 40 so they can all blow up again. On top of that the USA is losing its dominance in the world as China is emerging with cheaper, better, and hungrier capitalists to replace us. The question remains however, will my P&L be OK?

# Rhythms in Markets, by Laurel Kenner

The market's repertoire of rhythms extends past human grasp. Sometimes it seems to make no sense at all, at least to me.

Sometimes, things seem to become clear. Just as in Afro-Cuban music, a strong voice - the "mother drum" in bata - dominates the counter rhythms of the smaller drums, sometimes the Fed's announcements dominate the backdrop of lesser voices — Chinese monetary authorities, fixed-systems followers, and what have you.

Earnings season has a peculiar rhythm. But it's ever-changing, based on which companies are strongest at the time.

One quality the market shares with music, good music, anyway, is "always the surprise." Bach, Mozart, Beethoven were all masters of deception and expert at weaving rhythms across bars. Beethoven's sforzandi, unexpected sharp accents, and sudden pianissimos, will be appreciated by all traders.

Back in the '90s, when I was the editor for the stock coverage, a humorous bond reporter at Bloomberg had a saying when stocks had yet another amazing jump: "Stocks ONLY GO UP," he would say, rolling his eyes knowingly, meaning just the opposite. No good musician plays loud all the time.

## Victor writes:

I am thinking of ways to quantify the rhythms of markets. Instead of looking at what others do, critiquing it, and then augmenting, I thought I'd just take a crack at thinking of it my own way.

Music rhythms would seem to be a good starting point. The rhythms that kids are taught are those they can step or clap or slap to. They can be fast or slow to start with. And I would look to see if the number of moves in a minute is fast or slow and how this changes. The slapping would involve moves from separate markets occurring in the same time period. When we step, the first step is the accented one and that's a good way to look at moves within a period. Is it the first step that's always the biggest, and what happens when the second or third step in a period is the biggest?

I would look next at the rhythms of big moves. They obviously are reversing now, with some big Tuesdays: February 27, -58; March 8, +22; March 13, -28; and March 20, +8. Naturally this kind of stuff isn't predictive in general or else it would come out in the standard time series programs. But on occasion, it comes back and forth to an inordinate degree and the question becomes how to find it.

Animals often migrate at the same time of year to the same places even when transported geographically. One wonders if the migrations of markets after big moves have a fixed place in the price firmament that they go back to. Or is it just in time, like the conventional seasonal stuff that one can expect from the migration? Last year, prices went way down in May and migrated back the last part of the year. This year the migration started in February. The month ended with the three old bags ("a woman her age would never show her posterior to a camera") acting in concert with the rhythmic release of the perennially bearish message from the Sage.

The rhythms of political announcements always seem to follow a circular path. They start with a loose cannon doing something that hits into something else. Then others join the act. One typical sequence involves worry about inflation, based of course on a preview of an upcoming release, then the release of the number, then the big bond fund guy saying he's bearish, then the perma-bears finding other inflationary things, then the opportunistic movement in certain nations that benefit from this or that energy price, and finally the rhythm ending with the release of the next number, or the quieting influence of an open market meeting.

Hoaglin
has some great diagrams of rhythms in the body. And the body has different rhythms that it responds to as molecules bounce into each other and create disturbances throughout other more complex molecules, thus upsetting the usual homeostatic methods. One market makes a big move, perhaps silver, and it spills over into others in a rhythmic sequence, perhaps an up in energy, and then a decline in stocks. It's not over until the initiating market has its move back down as was the actual case with the recent bloodbath and recovery, which seemed to have the elements of rhythm of all the ones I mentioned.

Of course, the rhythms have to be combined with the melodies. The speed of the moves has to be counted with the steps between those moves, sometimes big and sometimes small. And I like the way they quantify melodies in the Joy of Music and in the statistical studies of music intervals that have so much resonance with markets.

A more humdrum approach to rhythms, which I take, is to look at the rhythms of patterns. How often do the 3-day moves with their eight possible directions: —, –+, -+-, -++, +++, ++-, +-+, + — repeat? Is it a first order Markov process vis-a-vis these eight patterns, and what is the correlation between the closeness of each of the last three moves to these three patterns, and future moves? I recently ran some rhythm stuff with open, open to close, and open, and found some ministerial randomness with t's all below one, but enough evidence of non-randomness to get me thinking about rhythms on the whole.

I know enough about rhythms to know that they feel like the basic rhythms come from within the body, like the beating of the heart, and they can model it with rhythms based on the mathematics of African rhythms. Whatever quantifications they are making in bringing African rhymes and Latin rhythms into the heart beat problem would seem to be a natural for extension into the market.

I am fortunate to know someone with perfect rhythm and she is the coeditor of this column and I am going to ask her how she would try to trade in the market if she knew nothing else but markets. Perhaps other musicians with perfect rhythm might have similar expert opinions as to where market moves would be going based on their knowledge and oneness with rhythms in markets. Certainly these experts would be more prone to give good calls than the eminent people who have passed the tests of the mystical societies of America that are licensed to forecast the market.

The market's open now, and I haven't read any of the dozens of books I have on rhythms lately, but after I do and study it on the Net, perhaps I'll have some other ideas. For sure, my colleagues will be able to augment my preliminary fast ideas on this and guide others and me in proper directions.

Perhaps other musicians with perfect rhythm might have similar expert opinions as to where market moves would be going based on their knowledge and oneness with rhythms in markets. Certainly these experts would be more prone to give good calls…

An interesting way to test this would be to submit representations of various tradeables in various time increments to musical prodigies who are naive about markets. I am thinking particularly of junior and senior high school students, who could have sufficient musical training and experience, without having been exposed to what passes for financial and economic wisdom in the popular press.

## Ken Smith writes:

In harmony with Victor's piece on music, rhythm, I attempted to write a melody with three notes. I am having difficulty conveying this little ditty because the note symbols for music are not available in email text messages.

I've tried before to get symbols to end up as they were written when they appear after I've sent them. Somewhere in the Internet circle symbols sent in email get warped, become hijra. Meanings are thus distorted.

So maybe someone can help here. The musical symbols for this simple melody would be symbols for the Dollar, Mark, and Yen, just three notes.

Create a melody using these notes - they are real notes, after all. Then choreograph a dance for the melody. Add lyrics. Create permutations and program computers to trade dollar, mark, yen - according to the melody.

"A salient feature of markets is temptation." (Syncreticus)

## Todd Tracy writes:

Everyday I am inspired by the list and become more humble. In the business of music I had done well being rather sure of myself. That confidence came about from having practiced hours daily for 20 years. And even then I had much to learn. Afro-Cuban percussion was one of those things I knew nothing about until the day that my roommate brought home four percussionists. I didn't know at the time that they would be living and practicing in my living room for two years. And yes, they had many percussionist friends. The neighbors didn't seem to mind. They played all day, ten drummers strong, and then went on to their gigs at night.

One guy, Jacques, studied African rhythms. His guru was Babinga. Another guy, Blake, studied Cuban fusion. His guru was Giovanni Hidalgo. Davey was into Indian drums, Egyptian bells, and all sorts of experimental world music. Josh was a well-rounded guy who did it all. Their friends were mostly jazz funk kit players.

At any rate, I was doing 80 hours a week at the record company but on occasion they would let me sit in with them during rehearsals. When it came to the Congolese and Senegalese rhythms I had to learn to play the pattern given to me and not concentrate on the patterns the other guys were playing. The African stuff doesn't resolve like western music. Each part is simple; the complexity comes from the layering. Euro rhythms resolve every measure. Four beats to a measure at tempos ranging from 60-130 beats per minute. The African stuff would resolve many measures out, like ten equivalent western measures. It felt as though it was random until, with incredible anticipation, the resolution was at hand.

The Latin stuff was different in that the Cubans, Haitians, and Puerto Ricans had fused the African rhythms with western melodies. The most important part to the rhythm was the clave (wooden sticks that ring out when struck). The clave would be a simplified version of the rhythm. Then came the congas. They would play a rhythm called a Tumbao. Again, you had to concentrate on your part but synchronicity was achieved and resolved after just a couple of measures.

I was completely humbled by all that I did not know. But soon, through repetition, I found I had a whole new arsenal. These guys would play until their hands bled every day as they developed the incredible muscle memory needed to counter western rhythmic intuition.

Now the straight up rap beats are simple in that they are looped (kind of like rock music). But it is the anticipation of that resolution that concerns us with the market rhythms. In hip-hop the kick is on the one and the three; the snare is on the Two and the Four. The snares are played late to increase the anticipation. This lateness is the most important part, in fact, so important that rap artists actually consider the two and the four as the one and the three.

All of the rhythms resolve. There are problems in programming the beats in that there is a finite number of places to put each beat within a measure (460 ticks per beat) and the velocity of each beat is set at a value 1-127. We can, however, increase the resolution by doubling the BPM and by fine-tuning these anticipations and resolutions. I am studying the Quantlet Booklets so that I could one day break down the market rhythms as is being shown to me by the list members through the graciousness of Victor and Laurel's benevolence.

As far as what I think the S&P index will do from a musician's perspective is resolving to 1450 after channeling a bit more.

## Laurence Glazier writes:

It is very tempting to apply my knowledge of music in selecting trades, though I like to follow grounded mathematical principles at this stage. I would note that much of what we consider the theory of music was derived by the posthumous analysis of the works of the one and only JS Bach (the Moses of music?), which like much technical analysis is seductive but not necessarily predictive. I work on the principle that part of this analysis represents laws of musical reality empirically testable, but not in the normal way. As Leschetitsky said, "Where words end, music begins."

Of the technical analysts of music, Schenker is particularly interesting, while those who have enjoyed "The Glen Miller Story" may have observed the appearance of another significant analyst, Schillinger.

Having said that, I believe the analogies with market rhythms, while not necessarily predictive, would be very valuable as part of a real-time virtual reality program reflecting the current state of play in the markets, and pose the question whether users of such a system would do better if they were more musical.

There is something rhythmic in the moves of bonds and stocks together, over and above the comparative rates of return that the Duo and Dodger have quantified. And it's like the monkey rope that Melville describes, where when one goes down and the other has to follow. But there is much thrashing around as the turbulence from the whales temporarily overrides the inextricable bond.

And in that context the bonds, after setting a 19-day low at 11,202, are still up 2/3 of a point or about 1/2% on the year. And the stocks, after setting a 19-day high at 1445, are up about 1/2% on the year. Regardless of that it's what I used to call an ugly day and the rhythm is very bad for both when a big decline in one occurs in conjunction with a big rise in the other. Something has to give, and as Berlioz would say in reviewing Beethoven, you know it's going to return.

## George Criparocos writes:

The two days preceding the big note (02.27, the resonant, memorable one) had the bonds making a rhythmic intro analogous to what is expected when the largest instrument of all, the bass, announces a change in melody.

Since then, the contrabass, cellos, and violas (10s, 5s, 2s) are keeping the resonance, while the bass returns. The clarinet (Yen) is hanging around its 200MA set like a rope, refusing to let go of the anticipation and the piano (stocks) are all over the pentagram, in 1/16th intervals: four days low, four days high, four days flat, four days high.

The rhythm seems to be analogous to a symphony, lets say in F major. The allegro is in progress and I anticipate that the andante should follow in a molto mosso way.

Todd's analysis of African rhythms resolving over eight or 12 bars or multiples rather than the simplistic four beat 16 bar square "rock" structure is right on the beat.

One of the most basic rhythms popular in the blues is called the shuffle. It is a short-long, short-long, short-long, similar to the heartbeat or train on the track, da-dum, da-dum, da-dum. This basic rhythm underlies many more complex patterns.

Applied to the market after a small beat, there the long bar, the "shuffle." The count often does not capture the rhythm, just as European musical notation does not carry information relative to rhythm. That is an odd omission. A shuffle might be notated as straight quarter notes, but played as doted quarter and eighth note sequence and designated as a shuffle, all the musicians know right away what it means.

The rhythm can get behind the pocket, giving a laid back feeling, like the end of last week. Or the rhythm can get ahead of the beat, like disco, like last month's drop.

The middle of the pocket of the beat is the march's oom-pah, oom-pah, even beats. The rhythms will swing from behind the "pocket" and give the music different feels. This is very difficult to quantify because the interaction of the multiple players is complex and the "feel" is a subtle thing to capture. Musicians know this.

To capture this in the market is a difficult matter. The main difficulty is the time structure. A structure stretched out over weeks is difficult to feel for human rhythmic sense as our rhythm is based on the heart and walking, and resides in the feet and heart and head motions. So it's hard to feel the market rhythm without condensing the time and looking at the numbers or speeding it up on a replay as an interesting exercise.

## Russ Sears writes:

To Be With Me
by Russ Sears

Chic chic ca dee!
The Bluebird on our clothes line sings to me.
Come home, come home,
To be, to be,
to be with me.

Kar Reeee! Kar Reeee!
The Bluejay mocks the hawk in perfect key
Go! Clear! Go! Clear!
Not free, not free,
No meal is free!

Tit tit ra lee!
The glorious Lark boost for all to see
Stay back, Stay back,
Match me, match me
You cant match me.

## From Vincent Andres:

I am thinking of ways to "quantify" the rhythms of markets.

I didn't test it yet (will probably do so sooner or later) but the already known track of Hurst/Hölder/ exponents seem to me to be a possibly good piece of measurement.

Another possible tool could be wavelets.

Also, I recently came across a paper melting wavelets + Hölder curves : L'analyse par ondelettes, in Science, Vol.119 Sept. 1987. Yves Meyer, S. Jaffard, Olivier Rioul. The paper is in French. Very certainly progress have been made since this paper was published.

# Carry Trade, from John Floyd

It is interesting to note that the Yen is stronger overnight with JGB yields higher. There have been some marginally better Japanese data of late (land prices, etc.). Predictively, I wonder if this portends some consolidation/correction in carry/assets after recent runups.

# Information on Stamp Collecting as a Hobby, from Alan Millhone

My parent's gave me my first stamp album (Coronet) for Christmas when I was seven. An old friend used to work for the Nestle Company and that same Christmas gave me a Nestle album and a selection of stamps. I still have both albums and over the years have added to those with a few other odds and ends.

Stamps are little pieces of paper and each one has a little bit of history printed on it. I never collected stamps with the idea of investment. I enjoy the hobby of collecting and fool with them more in the winter months. Many people took a 'bath' in the 70s, as prices crashed on many overpriced stamps, like the C 13-15 Zep set.

In stamps as in the stock market you have to do your own research and look for items that you feel will appreciate over time. To be clear though, I am not advocating stamps as an investment, but as a pleasurable hobby.

I collected stamps as a kid, then dropped it when I started chasing girls and feared that my peers might think stamp collecting was uncool. But I still have all of my stamp stuff 45 years later. In a way, the stock market has replaced the stamps. I am not talking about the trading part. I am talking about the collecting of all the market books and paraphrenalia (OK, junk).

By the way, one of the biggest stamp collectors is bond billionaire Bill Gross.

That was a most interesting article on Mr. Gross. Donald Sundman of Mystic Stamp Company owned the "Z" grill and it was on exhibition in Cleveland, Ohio a few years back at the APS Convention. I got to see it close up, along with several C3a's (famous inverted Jenny's). It would be nice to be able to purchase any stamp you wanted at any time. But some of the thrill of the chase would be lost due to a person having unlimited funds to spend on one's hobby (not a bad thing!).

My best friend is Greek and we collect the early Hermes heads of Greece. We both have DAVO hingless albums to house our meager collections. The #8 is a scarce Hermes and I have a couple of them. The #10 Hermes is really rare and I hope to have one in my collection some day.

In the US, FDR will be remembered as one of the most famous stamp collectors. During his terms as President he personally approved or reviewed every stamp that was printed. The Postmaster General at that time was a Mr. Farley and a set of stamps was printed at one time solely for FDR. The public got wind of this and demanded mass production of that series. This mini scandal became known as Farley's Follies.

When FDR died his collection was sold over several auctions by Harmer Rooke and brought a very large sum. Greg Manning Auctions is a publicly traded firm on the NASDAQ. Stamps are big business and the APS has a worldwide membership of around 55,000.

# New York Note, from George Zachar

…many Upper West Side residents who will soon be escaping to the beach say they feel overlooked by Hampton Jitney, which stops only on the Upper East Side and will expand its service to Brooklyn this summer.

# Stone Skimming, from Nigel Davies

Looking at stocks since 2003 brought to mind a stone skimming across water. I see five major bounces on the inclined lake.

The world record for stone skimming is an amazing 38. Speed and spin are both important.

# SKICOD, from Paolo Pezzutti

March 22, 2007 | 1 Comment

This acronym stands for Skill, Commitment, and Discipline.

I like to refer to SKICOD when analyzing my approach to markets and assessing whether I will ever succeed as an investor and a trader.

The first element is skill. Proper and detailed knowledge of the market structure and the related products is a fundamental requirement. Having an edge is also the basis. If you buy and hold for 25 years, as it was proposed recently on the SPEC list, you do not need an edge. But if you want to be active on the markets, not having an edge will bring you sooner or later to a loss (it depends on how lucky you are if it is later than sooner). An edge you have today may also disappear. A market inefficiency you identify in now could fade away with time, reducing margins. Continuous research is therefore necessary to keep you competitive in the markets.

The second requirement is commitment. Passion (and obsession) for trading is necessary if you want to obtain above average results. Only with sacrifice and determination you can get the knowledge, the experience, and the hunger for results that is typical only of ultra motivated and committed people. Time is an important component of commitment. Unfortunately, time is a scarce resource. As a part-time trader, I suffer from the lack of time. Family and work may absorb an enormous quantity of energy from you. And if you want to be healthy also some hobbies and cultural activities are necessary. The rest has to be dedicated to trading with great sacrifice.

Discipline is the last but not least requirement. This is probably the most difficult part. Building proper procedures and implementing them consistently is a complex challenge. One must also consider the psychological and behavioral aspects of trading. Being able too build a map of your decision making processes, defining your trading "decision tree," and sticking to it are the keys for success.

I am still struggling to improve myself from a technical and mental perspective in a continuous iterative process, that eventually would lead me to make my meal for a life time, be a better trader, and a better man.

I enjoyed your fine article. Your three areas have a direct carry over to my game of checkers.

Number one is skill. In the scientific study of checkers skill is important and has to be developed with study of the game and over the board play with better players. In the market one must associate with the top traders who have paid their dues and have learned a great deal about the market over years of trading.

Number two is commitment and in checkers you have to devote yourself to study the books on the game and do so on a regular basis in order to understand and improve one's game. Rome was not built in a day and neither will one improve in checkers overnight. I am not a trader, but have learned much from this list of experts and seasoned traders. Your article and many others carry over to the board and thus have helped my game improve. The main thing in checkers and the market is keeping your mind open and to think outside of the box.

Number three is discipline, and in a game you have to set a course to follow once the opening moves of a game have been played. When you arrive at a critical juncture and decide to do something else, you usually encounter trouble. Discipline to 'stay the course' in the market is just as important and many times you do your own research and chart your own course to pursue.

# Those Austere Governors, from Victor Niederhoffer

March 22, 2007 | 4 Comments

It is interesting to note the two up days that preceded yesterday's meeting of Governors (FOMC):

 Friday 3/16 Monday 3/19 Tuesday 3/20 Wednesday 3/21 S&P futures 1399 1416 1423 1445 DAX futures 6580 6671 6700 6880 Nikkei 16730 17115 17220 17475 VIX 16.8 14.6 13.3 12.2

There is a certain symmetry with the following build up to a recent 'event':

 Wednesday 2/21 Thursday 2/22 Friday 2/23 Monday 2/26 Tuesday 2/27 S&P futures 1474 1472 1467 1465 1408 VIX 10.2 10.2 10.6 11.2 18.3

Similarly, two ups and soar have occured on nine consecutive Fed meetings.

Is it a crime to start each day
With a laugh, and a smile, and a song?
And is it a crime to end each day
With a laugh, and a smile, and a song?
Is it wrong, is it a crime
To call the world your valentine?
Is it a crime to grab a lamp-post
Is it a crime to save a wee
Baby bird when it falls from its nest?
That little bird should have a chance
To fly like all the rest.
So if it's a crime to help old ladies cross the
street,
Then put me in jail
Without bail,
Bread and water from an old tin pail,
If that's, if that's a crime.

[Read the rest of the lyrics to Bells Are Ringing

# The Big Dry, from Craig Mee

Last Friday I caught a train that went through 1000 kms, inland, south of Sydney to Melbourne (in Victoria, Australia's southern state).

I couldn't believe the state of the land, it was as dry as a bone through the entire distance, with everything a yellowish brown. Although we may get the odd downpour in the major cities, drought is a persistent problem.

# A Hilarious Touch With Market Applications, from Victor Niederhoffer

March 22, 2007 | 2 Comments

In one of Patrick O'Brian's typically hilarious touches, in HMS Surprise, Maturin is on a rock collecting boobies with Nichols, before he is eaten by sharks due to despondency over his wife's infidelities and the typhoon. He tells Nichols about an Urdu English phrase book he is reading. "I believe it must have been compiled by a disappointed man." Here are some phrases:

My horse has been eaten by a tiger/leopard/bear.

All my money has been stolen.

I wish to speak to the collector.

I have been beaten by evil men.

I wish to hire a palanquin. There are no palanquins in this town sir.

Yet salacious too

Woman, wilt thou lie with me?

I immediately thought, what would a comparable phrase book be like for a trader entering the speculative arena? Perhaps it would include the following examples:

I have no money left. I lost everything when my stops were elected right before it turned.

The margin clerk is off duty sir, so it is not possible to delay getting your money.

The locals have given me a beating in the market.

I wish to enter a market order to sell. — There are no market orders possible sir. It's limit down.

There is 5000 bid ahead of you.

You are filled at your price, and I'm afraid it has continued down.

Yes, it went through your limit, but we're going to get them to take that price down.

Goldman against you on the offer 10000 to go.

It traded at that price, sir but there was a fat finger error and they're canceling all the trades at your price and below.

The Fed just acted and I'm afraid the market is very much against you.

I suggest you use stops next time on your orders, sir and that way your losses will be limited.

It did trade at that price, but your order was canceled at 5:30 due to computer bookkeeping.

Price hit a pivot point and immediately gapped 2% against you.

A domino effect was triggered and it went against you.

Sorry, that fill was for your brother not you.

They revised the previous months number against you, and I guess that 's considered more important now.

Your order was rejected by the compliance department.

You can't take money from your account until you get back to initial.

It was too late to cancel sir.

I am open to other appropriate items for such a phrase book.

We listened to the tape and it went against you.

## Craig Mee writes:

Only in trading the Mib (Italian index futures) "yes sir, it opened higher than your sell level, but due to the mathematics of the opening print, nothing done"

I haven't quite worked that one out.

It's a fast market. Nothing done.

Markets went subject just before your order. Nothing done.

That printed on globex. Your order went to the pit. Nothing done.

We don't show that expiry on our system.

That account is closeouts only.

Fed funds options? The local is in the toilet.

There is no market in that spread, sir.

# The Big Picture, from Brett Steenbarger

March 22, 2007 | 2 Comments

I thought this might be of interest. I wrote it after receiving the umpteenth dire warning of things to come in the wake of the housing market situation.

keep looking »