In the lengthy thread regarding "whether markets decline faster than they rise," I did not see any mention of the put/call skew in S&P. It's well documented that, at least since 1987, during most "normal" periods, out-of-the-money puts are rather more expensive than out-of-the-money calls. There are several ways to explain this phenomenon:

1) Markets fall faster than they rise — and options traders know this. Otherwise, arbitraging this difference would be a meal for a lifetime.

2) Market participants perhaps anticipate that the realized volatility during a bear market is greater than a bull market. However, the problem with this analysis is one might expect to see an upward sloping volatility yield curve in out-of-the-money puts (during bull markets), and yet that does not usually occur based on my tests. Conversely, right now have a downward sloping yield curve in out of the money calls — which confirms the hypothesis that market participants anticipate slower price rises in the future. [Note to quants: I am not confusing delta, gamma and vega. I'm using options to predict terminal price at expiration.]

3) For most humans, fear of loss is a stronger emotion/motivator than the pleasure of gain (greed). This is well documented in the psychology and behavioral finance literature. Hence, ceterus paribus, capital market participants (who have a net long position) will, as a group, pull their rip cord faster — to flee from risk — than they will embrace the possibility of profit.

4) Lastly, my tests show that, in certain commodities, the exact opposite behavior to S&P occurs. For example, and perhaps due to the inelasticity of demand for grains, more-often-than-not one sees a call/put skew on the call side. Every so often, after a quiet "normal" period, one does indeed find an upward acceleration in price change correctly predicted by the put/call skew. Once suppy/demand is normalized, the (inevitable) ensuing bear market is much slower. These are generalizations of course, but I've found them to be true over the years. Bottom line: Market participants anticipate that stocks do indeed decline faster than they rise. The options market is priced for this outcome. And if it were not true, you could arbitrage the put/call skew.



(This is in the literature, but wanted to check it).

Using quarterly-change in (%, 2000 dollar adjusted) GDP, checked stdev
every 16 quarters starting back from Q3 2008, to 1952:

Date        16Q stdev
2008q3    1.75
2004q3    2.02
2000q3    2.05
1996q3    1.80
1992q3    2.36
1988q3    1.57
1984q3    5.21
1980q3    5.19
1976q3    4.70
1972q3    4.13
1968q3    3.48
1964q3    3.50
1960q3    5.87
1956q3    5.47
1952q3    6.65

Noticeable reduction in volatility since the late 1980s, dating with the Greenspan tenure. The attached chart shows the source data, which suggests we have been in much more stable economy in the recent 20 years.

Looking at the quarterly GDP data, checked for the pattern "UDX" (up qtr, down qtr, next=X). Found that 30% of X were negative (2 consecutive down GDP qtr), whereas in the whole series (1947-present) down quarters were 15%. And the means of X and all qtr were not significantly different (test not shown).

Also checked DJIA quarterly returns with respect to QTR GDP changes. Here is test of mean quarterly returns for DJIA for all qtr of the series (DOW QTR), simultaneous with down GDP QTR (DOW SQ), and those qtr following down GDP QTR (DOW NQ):


Test of mu = 0 vs not = 0

Variable       N   Mean   StDev   SE Mean       95% CI            T      P
DOW QTR  243  0.0197  0.0737  0.0047  ( 0.0104, 0.0290)  4.17  0.000
DOW SQ     35  0.0155  0.0858  0.0145  (-0.0139, 0.0450)  1.07  0.292
DOW NQ     34  0.0262  0.0893  0.0153  (-0.0049, 0.0574)  1.71  0.096

Stocks average up during down GDP QTR, and interestingly up even more the following QTRs.



 I note they are having a 50% off sale on all suits and shirts, etc. (gift cards and shoes excluded) this Saturday. So if you need a new set of 'threads' this sounds like quite a sale if you have one of their stores in your area.

Jay Pasch writes:

A nice 50% off sale to go along with an -85% sale price on the stock over time, back to 12/1998 highs by the looks of things…



 Winter surf is starting up. Surf prediction is almost as important, (to me) as stock prediction. One of the tools for surf prediction are polar plots of wind and swell direction from the offshore buoys. A few years back Chair mentioned polar coordinates and plots. These can be done in R. I thought a simple plot of the direction and angle of market price might be helpful in some models to predict. For waves, NOAA uses data from offshore data buoys and says:

Spectra and source term are presented for selected output locations in the form of polar plots. The radial lines in the polar plots depict the directional resolution of the model. The concentric circles are plotted at 0.05 Hz intervals, where the innermost circle corresponds to 0.05 Hz and the outermost circle corresponds to 0.25 Hz. Wave energy plotted in the lower left quadrant travels in SW directions etc. The blue arrow in the center of the plots depicts wind speed and direction. Colors represent wave energy density for spectra and rates of change of energy density for source terms and are plotted at a logarithmic scale where the contours separating the colors increase by a factor of 2.

This application might be good for markets as a different sort of plot on the question, "Is the market going up or down, and how fast?". Surf direction and speed is critical to choose the spot, and equipment. Market direction and intensity is critical, but hard to predict. Surf travels generally from north to south in the winter. Market forces generally tend to travel East to West. Perhaps a polar plot of the prevailing market winds, and the concentrations of energy might be helpful in predicting market direction and intensity.

Jeff Watson writes:

As a serious student of surf prediction, I note and live by the seasonality of the swells. Different seasons bring swells from different directions, and Sogi-San is lucky to live in a place that gets swell from all 360 degrees, ensuring year round surf somewhere in the islands. Surf prediction is easy at my location as we have roughly two primary causes of swell; Cold fronts and hurricanes. We only have a window of roughly 90 degrees where conditions will produce rideable waves I check our weather maps daily and look at all the buoy information from the NOAA, whether it's surf season or not. From my location it is pretty easy to predict when we will get swells, although predicting the size gets rather tricky. To predict the size takes a lot of experience, comparisons of past data, and a firm grasp of current weather conditions…much like looking at the markets. Although it's anecdotal, I find it much easier to predict the possibility of waves than future market action.

One thing of note, sometimes mysto swells will appear out of nowhere, lasting only a very short time, with no apparent cause, disappearing as quickly as they arrive much to the chagrin of the locals. The swells that hit with no warning cause a lot of surfers to miss out on waves, because they aren't positioned to hit the swell. The markets do the same thing with movements that come out of nowhere, surprising the participants who are out of position, causing the players to be frantic while trying to catch the move which is usually missed. All of this, whether with the waves or markets, sometimes comes with no valid explanation. When I talk to groms about the waves and swell, I sometimes resort to using the cliche, "It is what it is." The same thing can be said about market moves.

Vinh Tu adds:

Mathematically, angles are even closer to correlations. Two series of t observations can be represented as two vectors in t-dimensional space. You get the cosine from dividing the dot product of the two series by the volatility of each series.

I'm not sure whether, with more than two instruments, you can still flatten it to a circle and still have it show anything useful. But restricting the plot to two series, we could take one series to be "North" –logical candidates for this might be an interest rate, or a "market portfolio", or a major market index. Then the other series could be examined in relation to North. Samples of the other series could be colour coded and assigned polar positions.

Alternatively, perhaps north could be a straight line representing a desired or hypothesized drift. The result would be somewhat related to the R-squared technical trend indicator.

Alex Castaldo quibbles:

A correlation is exactly like the cosine of an angle, as opposed to an angle.  Because cosine is an even function, there is an ambiguity as to the sign of the angle.  For example if Bonds represent North and Stocks are correlated 0.5 with Bonds, how should that be plotted? As +60 degrees (approx. W-N-W) or -60 degrees (approx E-N-E)?



 Some of the sophisticated media, including the most used ones are subtle in how they bias their news for their own man in the election. They report original studies using their own data that in the last 20 elections the market has moved better under their favored administration than in their least favored one in the first year. With 25 elections, and a starting point, and one of four years, or cumulatives to work with, and leaving out that the main reason the market is down is that the election is in the bag already, they leave it to the reader to overcome their natural aversion to favor the administration that will enable them in their platform to keep more of their after service gains.

The attempt to propagandize using stats in an indirect way, rather subtle compared to their usual attempts to objectively debunk any claims that the other side makes against their favorite,(thereby maintaining their je na sais quoi with their founder and his votaries), elicits an important formula. The variation or standard error of a mean without replacement is considerably lower than its variation with replacement. Thus, a sample of the stats that we all use when searching for regularities in past patterns are based on replacement. The standard error withour replacement is lower than the standard error with replacement by a factor sqrt ( 1 - n/N) where n is the sample size and N the population. Thus with a sample of 10 from a population of 25 where the standard deviation is 25 %, the standard error would not be the usual 25/3 but 8 x 3/4 = 6. 25% of the area of a normal curve is within 0.7e standard dev from the mean. That means that we would expect 1/2 of all means of 10 observations from such a distribution to be greater than 4 away from the grand mean of say 10 percentage points. The average difference between the better performaing group and the worse performing group would be approximately 8 percantage points. When we look for regularities we generally don't choose just one split but 3 or 4 or 10 until we find the best one. That runs into another statistical problem relating to the average difference between succesive samples from a distribution. A short approximation for that is contained in Kendall and Stuart, but looks to be approximately equal to an average difference for a normal distribution of 2/3 of a standard deviation (one must check that). Thus if we take the best of 2 cuts of 10 from a distrition like the above, we could expect the best one to be 8 away( 4 +2/3 x 6 ) from the grand mean a full 80% more than the grand mean approximately 1/2 of the time. This explains why so many of the regularities discovered with many different qualifiers, if's and or buts, stops et al are purely artifices of randomness rather than propaganda as above. It also explains why such programs as artificial interaction detector and cart often give such spurious results. The whole subject cries out the artful simulater.

Steve Ellison replies:

The Political Economist studied this last month:

I've run the numbers myself. Superficially at least, the Democratic claims are true: Since 1948, the Standard & Poor's 500 total return (capital gains plus dividends) has averaged 15.6% when a Democrat was in the White House and only 11.1% when a Republican was in the White House.

You get a similar result if you look at growth in real gross domestic product. Under Democratic presidents, the average since 1948 has been 4.2%. Under Republican presidents it has been only 2.8%.

But it's not so simple when you study that 'study.' … While stocks could be expected to react very quickly to changes and expectations of changes in the political environment, the whole economy doesn't just turn on a dime. So when we compare real GDP growth under Democratic and Republican presidents, maybe we should lag the results by a couple years. That is, we'll assume that the growth in a given year was the result of the president's policies from two years ago.

When we do that … we find that the economy performed pretty much exactly the same regardless of the president's party: 3.5% under Democrats and 3.4% under Republicans.

But then who ever said that the president alone determines the economy or the stock market? It's Congress that makes the laws. The president just signs them. Based on congressional control, the study results look very different. Under Republican Congresses, stocks have averaged a 19% return, while under Democratic Congresses only 11.9%. Real GDP growth, lagged two years, has averaged 3.7% under Republican Congresses, and only 3.2% under Democratic ones.



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

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

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

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

Phil McDonnell writes: 

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

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

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

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

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

Riz Din adds:

A couple of additional thoughts on the carry trade:

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

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

Alston Mabry replies:

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



 There are a number of free internet radio stations, and in honor of the pending savage bear market rally, here is a good site.

I like the Bartok station from Hungary, and of course Zappateers which is on now (that man died too young).

But since this is a trading list, certainly you have read, "Trader know thyself". Which I think means that when you are intimately involved with the market it is difficult to disentangle your interpretations from unbiased signals, because you kind of merge with it. As if it is about you.

Last week while sitting in the kitchen with a mug of Costco coffee (Jose brand), a hapless bird struck the nearby bay window with a loud thud. I went out and found that she had banked off the glass into a waste bin; not dead but disoriented and bleeding. I picked her up –it looked like she could make it, so I set her on the lawn to recuperate.

Half hour later she had flown; but suspecting not far, I put out some bread crumbs and filled the bird-bath. Almost immediately she flitted from a tree into the bath, sipped it, and looked at me in appreciation. It felt good to bridge across inter-species bigotries (I eat her cousins), and being recognized by her felt like how Adam must have before he got poisoned.

When we came back later that night she was perched incautiously on our porch looking quizzically at her savior, and it was hard to resist thoughts of Cult Cargo Science and that she might now worship me.

The next morning I found her dead there. Clinically, probably internal bleeding, shock, and cardiac arrest. But at least someone was nice to her in her last day.

The next day I saw another bird like her; a kind of "tit".

If you read the description, when you have seen one tit, you have seen them all (which in all species never derails the inquisition). And over the next few days I noticed there were many, and it occurred to me that the bird which hit the window may not have been the one who came to the bath. And it also may not have been the one that was stooped on the patio, and maybe even a different one had died. Maybe this "one bird" was all a self-constructed story, originating at the center of the universe, like the one running in every one of us.

All of which perhaps argues for another conservation law: The more you strive to know yourself, the more self-obsessed you become, and the less accurately you can visualize your unique irrelevance.



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

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



I know to many this is very basic commentary but it may prove helpful to some here: This explains in one paragraph why things go down a lot faster than they go up. Hedgefunds, mutual funds and pension funds must sell on the way down. They have no choice. They must meet margin requirements and other technical requirements. This forced liquidation scenario is the most wicked of wickeds that the unfortunate fundamental investor faces in their education.

Remember near the end of the movie Trading Places where the Duke brothers (Ralph Bellamy and Don Ameche) are approached by the exchange with their margin calls. Their comment was “we don’t have that kind of money!” Same thing there as here. This is the cataclysm when people trade with OPM (other people's money). They are universally more cavalier and reckless than if they have their own capital at risk. LTCM in 1998 suffered the same fate when they had a famous decoupling of their spreads. Their models, suddenly and evidently without warning, [stopped working; the firm faced margin calls and] had to liquidate. Then, the Investment Banks and Commercial banks came to the rescue because they saw ultimate value in the spreads. Otherwise they would have not gotten involved and the Fed would have had to step in and take over the company. At the time, they controlled over a trillion dollars of assets on their books. Whereas with an intangible to go up in price it takes many months to build up a position and to trade ahead of the fundamental estimates.

This scenario is very well described by Dr. Hersh Shefrin in his book Beyond Greed and Fear: Understanding Behavioral Finance. He eloquently describes how it takes a fundamental analyst approximately nine months for their estimates to catch up with a stock price. What we see today especially with the stock market is pure technical trading. It has everything to do with liquidity needs in an environment where credit is non-existent. Until this picture becomes clearer when Investment Banks and Commercial Banks will give up their new found capital and help companies thaw out from this very arctic deep freeze credit crisis, we shall continue to trade in a black hole of confusion. I actually heard a “professional” comment, “It has been three weeks since the Federal Reserve and the Treasury put forth their solutions. How long do you think it will take for these things to start to work?” Summary: It took years for us to get into this mess, we are not going to get out of this one overnight.



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

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



                2008                 1997                                         

Date        S&P close         S&P close                                        

10/23         915                1309                                           

10/24         866                1297                                           

10/27        835                1227                                           

10/28        939                1278                                          

10/29                             1278

1. The Nikkei broke through 7000 at 22:30 GMT, a 26 year low, but closed up 6% at 7621. The last 10 day max in the S&P was Aug 11, a lapse so far of 55 trading days, the longest dry spell in history. Dax was up 10 % at 10:00 GMT today while the S&P was up 2%.

2. 99% of financial news articles have been bearish. Oat futures at a 6 year low at 219 showing horse power is still a bargain for what must be the most basic, and, one believes, the purest agricultural commodity to be. These prices are typical for all other commodities.

3. The odds for the incumbent party in the Presidential race which have almost gone off the board at 1 in 10 are so low that there is no need for the teetotum that Nock described to keep the Dow down any further. And most important of all, with the market down 30 yesterday, normally good for a VIX rise of 8 these days, it was only up 1.

4. What else?



21, from Steve Ellison

October 27, 2008 | 2 Comments

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

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

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

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

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

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

Charles Pennington writes:

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

Chris Cooper says:

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

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

John Floyd observes: 

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

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

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

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



 It's coffee picking season again [here in Hawaii] and the coffee cherry beans are turning red. I hate picking coffee and have just enough trees to call myself a gentleman farmer (emphases on the former). The process starts with waiting for the rows of beans on the tree branches to turn red and pick only the red ones, not the green ones. I pick just enough to drink so go for the quality over quantity, and pick the best and easiest to pick beans. So in my humble opinion my coffee is the best coffee I have ever drunk. The commercial pickers who are paid by the pound include many green and unripe beans to add weight, but not taste or quality. It's easy to see how incentives shape behaviors. What are the incentives are for mortgage holders who have a moratorium on foreclosures, or the incentives to banks who can sell their mortgages to the fed for 90% rather than move them now for 60%.

After the beans are picked, they are run through a pulper, an industrial device made of cast iron in England from a design from the Industrial Revolution. Mine had a hand crank, but a friend in the neighborhood to whom I lent it to pulp his coffee added a small motor bringing it squarely into the modern age. The pulper takes off the fleshing fruit leaving a seed in a wrapper. This is soaked overnight, then dried in the sun to 14% moisture. This is called parchment. Most of the value in the operation is in this simple processing and provides a much higher return than the farmer or picker receives. The sun drying is the key to the flavor. Most commercial coffee is dried in heated machines. This takes away the mellow soft palate to the coffee and gives a harsher bitterness that is often criticized in some Kona coffees. Be sure your gourmet coffee is sun dried. After the parchment is dried, a husker machine takes off the thin skin and leaves the green bean which is shipped to the roaster. These huskers are large and rather expensive so I go across the street where there is a coffee farm and have them do it. I strongly recommend buying just green beans, then using a small roaster such as "I Roast" to roast a weekly batch for drinking to enjoy the best flavor. As soon as the bean is roasted, the gases start to escape and with it the flavor. There is nothing like a fresh roasted cup of coffee hand picked from your own yard.



victorJeff Watson thoughtful post below about the relevance of George Seurat to trading inspired me to think about the many lessons about markets I learned from Sondheim's Sunday in the Park with George, and asked my assistant Linda to send him a copy of it tonight. Two hours later, as I looked through the jacket of my pink coat that I wore to my brother Roy's Halloween party, I found a playbill — Sunday in the Park with George. The 1 in 16 chance of five days' repeating each other like last Friday, makes me think of coincidences and the many times that I have had patterns with 25 of 25 correct predictions at the hand ready for use, only to find the 26th, in real life, totally wrong. The power of probabilities to make truly unlikely events when taken in isolation very probable, a variant of the birthday problem, is astonishing and if one was not a man of lack of faith, it would be eerie.

Michael Cook writes:

This makes me think of Ramsey Theory. The classic version of Ramsey's Theorem: in any collection of six people, either three mutually know each other, or three mutually do not know each other. The philosophy behind Ramsey Theory in general is: "a sufficiently large system, no matter how random, must contain highly organized subsystems."

This is very suggestive for markets.

Steve Humbert replies:

Ramsey Theory is fascinating, but other than as an analogue I'm not sure it has any predictive power in the markets. Note that Ramsey Theory does not reveal which people know each other and which do not (a bit like Ogilvy's famous lament that half of the money spent on advertising was wasted, but that he was never sure which half), and that in its binary, know-don't know, criterion, RT doesn't tell us anything about the strength of the connections. A passing acquaintance is treated the same as a life-long friendship (the market equivalent of treating a 1-tic and a 20-tic up move (or down) as equivalent, and only concerning oneself the binary up-down distinction.



peony seed podI wonder what nature has to teach us about how it recovers from natural disasters vis a vis the current market decline. Does the process of recovery and change after fires and floods and earthquakes and hurricanes have anything to teach? I looked at the methods of seed dispersal at the Botanical Gardens recently and it made me think again that IPOs at times like this must be priced at implicit returns of 100% a year or more. I also wonder whether there are insights from the Stockholm Syndrome here with people who are the source of the disaster being greeted with love and votes and money? How does romance come into the picture? I return to the subject of catalysts in markets. Are there some agents that are sufficient to cause big changes in markets that come ahead of everything, e.g. a big move in oil that precedes a violent move in stocks? When will asset allocators begin to compare the returns of stocks versus bonds and find that their portfolios now have gone up by 20 percentage points from before in terms of their allocation to bonds? That's too much, other things being equal, even if the expected rate of returns were not changed. I can't help but think that Alan Greenspan's confession that his belief in free markets was wrong is an example of the "Old Man Syndrome" a la Cyril Burt's wanting to have the most identical twins in his study, combined with George Zachar's "your own man said you were out." Does the average politician really believe that raising the rate of contribution to the Service will raise revenues or or is just an example of rent seeking and public choice theory at work where they look out for their own personna above all, and to what extent is the likely increase in this contribution under the now 10 to 1 favored new administration a major contributing cause to the current past meltdown? What is the cause of those fantastic moves at the close that are so ephemeral and dysfunctional to all who are not properly capitalized and money-managed? Most of all, I wonder what my mentors at the University of Chicago, Jim Lorie and George Stigler, would say about the current carnage. Would it undermine their faith in markets?

Sam Marx writes:

Something I noticed about market that I tried to avoid when I had traders working for me is that the market rewards and penalizes on a continuous basis, but "employed" traders and executives are usually rewarded on a yearly basis.

Dick Fuld of Lehman, Stanley O'Neil of Merrill, Frank Raines of Fannie, et. al., received yearly bonuses, so their goal was maximizing the yearly profit while neglecting the carry-forward risks. If they had to leave a large portion of their bonuses or profits in escrow, as did my traders, to be carried over from year to year, they wouldn't take excessive risks and the market would be more stable.

Alex Castaldo adds:

The study of how nature recovers from natural disasters such as forest fires or floods is called the theory of succession and was developed by one H. C. Cowles.  Wouldn't it be a strange coincidence if he was related to the Alfred Cowles III who studied stock market forecasting.



 In a recent Bloomberg interview, Roubini says that markets are dysfunctional, there are no natural buyers, markets are in a situation of deleveraging, capitulation and total panic. He says to stay away from the US dollar, which appreciated too much. Stock prices will plunge another 20-30%. Relative economic, political, geostrategic power of the US over time will be eroded and reduced. It is likely we will experience a L shaped recession with long term economic stagnation. Not really an optimistic view I must say. Sen. Obama has a clearer idea of how to solve the crisis. He said a laissez-faire approach at this time cannot work. I was skeptical when I heard him speak at the beginning of this year and then the economy and markets spiraled down as he predicted.

I do not have enough information or the crystal ball to assess whether he is right or not, however, his "predictions" are quite scary. But are we really able to predict how this crisis is going to evolve? Being optimistic may sound silly at this point. The crisis is spreading to East Europe, smaller governments may default, there may be a currency crisis. The speed of this meltdown in the past weeks has been impressive. Are there any positive points? For the moment I do not see many, unless you believe that market forces will start again to price assets orderly and investors will see good value for money at these prices sooner or later. I believe, however, that we may see even a long rebound, but this crisis will have a long term effect. If you look at the charts, e.g. the Nasdaq, you can see that the bear market has actually started in 2000. The uptrend between 2002 and 2007 was only a long rebound. The long term bear trend has now resumed to print a C Elliot wave for the "secular" optimists or a wave 3 for the chronic bears.

Has the ability of creating wealth in our societies become a problem? If technology and innovation are not creating value in our economies, it may the bad sign of the shifting of geostrategic power to other powers of the world. The challenge is intellectual. We need to rethink if we want to tackle this challenge, and how our societies can re-organize and re-assess their life-style, their education, financial and industrial system.

Nigel Davies responds: 

Quite a few people have predicted something like this, though they tend to differ on how it will play out. The big unknown is how we react to this crisis, for example it's a moot point about whether we should have tried to prop the thing up at all.

One very interesting feature to emerge from this is that the World's nations have come to a very sudden understanding that we're all linked economically. So hostile acts vis a vis oil, for example, end up rebounding. I wonder if this will be the great good that emerges from this crisis, an awareness of our shared predicament.

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



hot soupEarlier today I was at Beechwood Presbyterian Church to help with "Souper Saturday" held the last Saturday of each month. The church opens up its kitchen and dining room and volunteers come from various churches in the area on a rotating basis to help serve those who come to dine. The tables were set for 60 and those chairs were all filled with people in the area who walk in for a monthly free meal. I also asked and found that 55 dinners were 'to go' and they ran out of food tonight or more dinners would have been packaged. As last time I helped, I worked the dessert table and it kept me busy serving cookies, cupcakes, and cutting various pies. I was in the back of the room and from my vantage point could tell that those who came were hungry and enjoyed a hot meal. A blessing was given before the meal and after that no other items of any religious nature were invoked. Those who came could come and eat and leave when they were finished. It did me good to help serve tonight and made me thankful for all I have in my life. I also noted that there were many more people tonight than the last time I helped as a volunteer.



 Being a bit disappointed with Peter Schiff (in 'Crash Proof' he recommended that Americans borrow on their homes so as to buy 'foreign stocks', so as to emerge with a massive overplus when the US unilaterally collapsed) I've been thinking about the art of the doomster. My pick for being the greatest master of the art is Frazer from the ancient UK TV series, 'Dad's Army', a character who may not be known in the US: excerpt.

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



(Or what the boring do on Saturday morning)

Curious about investor dispositions over time, I used DJIA monthly closes 1928-present (w/o dividends) to calculate a rolling compounded 10 year return. At the end of each month, plotted the product of this and the prior 119 month's return vs date (see attached - dark blue line) defined:

Month return = (this month close) / (prior month close) = "M"

10y compound rolling return = {M * M(t-1) *…… *M(t-120)}

Also plotted in pink is ln(DOW) - 4 (to scale with 10y compound rolling return)

Assuming October ends about where it is now, the 10y compound rolling return is currently just under 1 (0.975), which hasn't happened since 1982. The last time 10y compound rolling return dipped below 1 was 1974, and it hovered around this level for 8 years. The the prior sub-1 regime was in the 1930's, so the wait was about 40 years. There is about the same wait between 10y compound rolling return peaks -from 1959 to the most recent in 2000.

While there are few inferences to be made when N=2 (but how often do we get markets like the current one…), this could be evidence for cycles of over–and under–enthusiasm for stocks on the timescale of human-investable-years.



 Back in my grad school days, I'd stroll down Michigan Avenue to go over to the Art Institute in Chicago whenever I had some free time.. Although I had covered the entire museum about a hundred times, one painting kept me coming back view every visit, without exception. The painting was Georges Seurat's Post-Impressionist "Sunday Afternoon on the Island of la Grand Jatte." Since Seurat was an early adopter of pointillism, his paintings took on an ethereal quality. Pointillism was a technique that used very small dots of primary colors closely arranged, almost overlapping, that would create the illusion of a variety of secondary colors when observed from a distance. Seurat was probably the second painter, after DaVinci, that melded art with science, except that Seurat took his techniques to a level never before seen in art. He combined the science of such scholars as Chevreul, Newton, Helmholtz, and all of the Neoimpressionists, and was able to reproduce their theories on canvas brilliantly. His ideas were that one could use color to create harmony in a painting, much like a composer could use certain devices to create harmony in music. Seurat said that applying colors to a canvas follow the natural laws of science, much like Newton postulated his law of gravitation from the observation of a falling object.

I borrowed this passage from Wikipedia regarding Seurat's theories.

They said, "Seurat's theories can be summarized as follows: The emotion of gaiety can be achieved by the domination of luminous hues, by the predominance of warm colors, and by the use of lines directed upward. Calm is achieved through an equivalence/balance of the use of the light and the dark, by the balance of warm and cold colors, and by lines that are horizontal. Sadness is achieved by using dark and cold colors and by lines pointing downwards"

Looking at a work like Seurat's "Sunday Afternoon" can be an emotionally uplifting, beautiful, moving experience. One can get very close up and see the individual points of color, gently dabbed in a very painstaking way. Looking at the very close level makes one appreciate the sheer genius and talent that went into such a masterpiece. Moving 15 feet from the painting, and one is swept away by the magnificence of the entire drama and is allowed to see the entire picture. The whole painting is an illusion, created by nothing more than dots.

In the markets, we're sometimes hypnotized by watching every movement, tick by tick. The ticks, the inside market, can be compared to Seurats' individual tiny dots of primary color. Taken alone in a small sample, they have little meaning, but observed from a distance, a different time frame perhaps, they begin to show the complete picture. The market always tells you what it is doing at any given time, and sometimes even gives you a hint of what it is going to do. It is up to the speculators to connect the dots…pardon my pun.



Having just wrestled over the weekend with a multi-monitor, multi-graphics card setup in Debian, found a comment posted today on OneUnified to be useful.  hope it saves some folks a few hours.



 I firmly believe that cash flow will be king in the coming decade. Buying companies with a solid cash flow that do well in difficult times will allow the prudent investor to have the capital available to make purchases of other companies (and acquire their talent either thru acquisition or hiring them after they are laid off) during this depressed time.

Cash flow = money in the bank to buy depressed companies…..depressed companies that offer (what I believe to be) the great growth opportunity of the coming decade.

Kim Zussman writes: 

I keep trying to remember why my folks weren't buying stocks in the early 1970's: "cash flow" (used to be called money, like consumers were once citizens) was needed for things like mortgage, cars, food after coupons, and thread for mom to repair our clothes.

Darn socks - damn stocks

Alston Mabry adds:

Given the DS comment on the new cash flow ("I firmly believe that cash flow will be king in the coming decade."), I have the temerity to re-post this link of mine from 2006.



2. A market mystery is that crashes are prone to Fridays and Mondays. A certain Friday opens limit-down, but bobs up a bit during the day. What will traders do at the end of the day? Choose the best answer:

A. Fearing a Monday massacre, they sell heavily to the close. You buy because now there is no "portfolio insurance", and a 1987-type crash cannot happen. Plus it's a good way to get a date on Friday night.

B. Traders are horny, so they run the close up. You short or hedge because the lack of fear makes a Monday crash more likely, plus you already had a date on Thursday (meow).

C. Trader is finally listening to the pleas of radical Islam .



War, from Andrea Ravano

October 24, 2008 | 3 Comments

 I have the privilege of being born in Western Europe in 1958, and I don't know what being shot at means. On a day like this though, I get the feeling of looking at my city being shelled, in ruins. I do remember two days after the Monday October 19 1987 we were waiting for the 14:30 CET Economic data from the US. Not a noise could be heard. Telephones as well as mouths were shut. The figures for the balance of payments came out much better than expected and the market came back to life. Very few of us were aware at that moment that the market had changed direction. The general manager of the bank had started buying the US market the very same day of the crash. Some executions came in by late Friday due to the massive volume traded on the NYSE. Most purchases were already very profitable by the time the booking was done. As I write I relive some of the feelings of those days, fear, hope, dismay and disbelief are running around in my brain (Dillinger "Cocaine" late 70's). The contract futures limit down early on Friday October 24 2008 are a pretty good sign the forced sales are almost over.



ShuiNice time to read The Education of a Speculator.

The Yen is making an explosive move against both the Dollar and the Euro, not because the Japanese economy is doing comparatively better than US nor EU, but it is useful to make money. After all, all of the currency traders and investors want profits in their own currency, i. e Americans eventually want US$, Europeans want Euro and Japanese want yen. Soon as the game is over, the Yen will lose its popularity. There is no reason for Yen to be this popular for so long. My special best wishes to Victor and Laurel for good Yen trading. It is almost time for me to buy US$ and sell my Yen.



What are the odds? A man who excels in the obscure sport of bodybuilding, hails from Austria, can't speak English, moves to America, makes an obscure Hercules movie. Now he starts to make movies about a mythical character named Conan. He becomes the biggest box office draw in the world, marries into one of the most powerful political families in America, is elected Governor of the largest state in America and lives a fantasy that we can usually read about only in fairy tales.

Do you think you could learn something from such a man?



date    level        change               date   level     change

fri      10-10    891   -21                fri     10 17   933 -08                                 

mon   10 13    1017   26                mon  10 20   990   57                                  

tue     10 14    1002  -24               tue    10 21   959  -41                                   

wed    10 15    903   -09                wed   10 22   903  -56                                 

thu     10 16    941    38                thu   10 23   915   12

I dare not put the change for 10 17 up except to say that my two year old played heads with the market, and beat me.

Alex Castaldo updates:

The streak continues.  Friday of this week was again in the same direction as Friday of last week (down).  



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

Victor Niederhoffer asks:

Given that it would be possible to make 10% on senior debt, what would the required return on equities be at this level? That's my point about VIX and the required a priori rate of return.

Tim Melvin replies:

I would humbly suggest two times the level of senior debt rates.

Phil McDonnell ventures:

One reasonable and quantifiable approach might be to assume the market demands comparable Sharpe ratios from various asset classes. Consequently the ratio of the observed or estimated standard deviations of stocks to bonds may be the same as the ratio of the required expected returns.

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



greenspan"Alan Greenspan, the former Federal Reserve chairman once considered the infallible maestro of the financial system, admitted on Thursday that he “made a mistake” in trusting that free markets could regulate themselves without government oversight…. But in a tense exchange with Representative Henry A. Waxman, the California Democrat who is chairman of the committee, Mr. Greenspan conceded a more serious flaw in his own philosophy that unfettered free markets sit at the root of a superior economy."

article from nyt.com

"Citizen judges, I want to tell [you] how a man who spent thirty years in the party and worked a great deal, stumbled [and] fell … I have committed heinous crimes. I realize this. It is hard to live after such crimes . . . But it is terrible to die with such a stigma. Even from behind bars I would like to see the further flour-ishings of the country I betrayed." Genrikh Yagoda

"… I confirm the admission of my monstrous crimes . . . We were preparing for a coup d'etat, we organized kulak insurrections and terrorist groups … I would like those who have not yet been exposed and have not yet laid down their arms to do so immediately . . . Their only salvation lies in helping the party." Alexei Rykov

article from Time

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

Kim Zussman replies: 

I doubt Mr Greenspan has as much at stake as the bolsheviks did, though the interesting parallel does illustrate the easy job inquisitors have.

Given government ownership of assets and increased regulation decrease the risk premium, keeping risky assets at a durably lower price level?



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

Vince Fulco adds:

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

Riz Din replies:

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

Rocky Humbert remarks:

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



See chart showing the relation between 30 yr swap spreads and 5 yr swap spread going back to 1994.

The current situation seems incredibly absurd to me– can any readers offer some insight into the economic/financial implications of this? It seems to me that the 30-yr swap spread is utterly out of whack (the 5-yr swap spread is also pretty darn low considering the distress in the banking sector; see this for more on why I think that. In fact, the 30-yr swap spread recently turned negative! (it's now hovering above zero). Consider for a moment what a negative 30-yr swap spread implies. For one, it is saying that the full faith and credit of the US Treasury isn't as good as an unsecured obligation of some shaky banks. But going beyond that, suppose the 30yr swap spread remains near zero. That would means that, if I had a $1b floating rate loan at say, 50 over libor, someone would be willing to lock me into a fixed rate for 30 years, and the rate I could lock it in at is the yield on the 30 yr treasury bond. Now, as we all know, treasuries are pretty expensive at the moment — flight to quality and all that. This statement is of course more applicable to short maturity Treasuries, but it is still the same underlying credit for the 30 yr. Now, I don't know about you guys, but with the way the fed has been printing money lately (see Federal Reserve release, +$245b in a week, and it's much worse, because as you can see, in that last week they sold a bunch of treasuries and replaced them with… crappy assets from banks), I can easily see Libor getting up to very high single digits over the next 10 years.

So what's going on here? What has caused this dislocation? Let's see what the fixed income mavens have to say about this.

Convergence trade anyone? Would be easy to put on — just pay fixed on a 30 yr interest rate swap, and then receive fixed on a 5 yr swap. You could lever it up pretty ridiculously too, as long as you had some cash put aside so you could stay in the game if this madness got even worse.




1. Risk appetite is to (__________) as (__________) is to (__________)

A. The trader, tunnel of love, cute amusement parks

B. The US capitalist system, egg, matzo-brei

C. Dead generals, never to be written chapters, history books

D. The male black widow, leverage, market liquidity



Normally we try to stick to education and not commerce on this site, but one of our members has insights and asked us to post this for him . As Horatio Bump said of Davey Crockett "I believe that Dr. Goulston is a man of integrity and insight". Vic.

Mark Goulston announces:

Sadly there is much more brightness (how to turn nothing into something) and smartness (how to turn something into everything) in this world than wisdom (knowing what is important and worth fighting for and what's not). If you want to bathe yourself in the wisdom of one of the wisest people you will ever listen to, you and your teams should attend the live webinar:

Move from Managing to Leading, with Warren Bennis

Warren Bennis, the foremost authority on leadership in the world, will be interviewed by Dr. Mark Goulston, one of our Daily Speculations contributors on Oct. 28 from 9:30-11 AM PST/11:30-2 PM EST. The forementioned link will enable you to receive a discount on this [$] event.



sushilAndrew McCauley says, "Volatility itself can be a decision: Long or short volatility."

That is stretching the point which then can be elucidated by the fact that the cost of (in)decision question would then address the volatility of volatility as the relevant metric.

Stephen Knipe says, "If people were totally indecisive and no trading decisions were made then volatility would equal 0."

Well that's one specific situation in which volatility could be zero. The other situations could be where there is a linear or otherwise perfectly predictable price curve. Could it not be said that since there is uncertainty and / or volatility people trade and not vice versa? In the absence of any trading activity the reading of volatility will keep dropping closer and closer to zero.

Perhaps my own original question suffers from the limitations of language at expressing. I may be able to convey my query better hopefully by paraphrasing that should one lean onto trading strategies / practises / ideas/ habits/ programs whatever anyone follows that tend to increase the frequency of trading as the PRICE of volatility goes up?

We have discussed this before on the lists and I have written that the price of volatility is what is observed in the markets whereas the value of volatility is unique and different for each unique participant in the same was that the price of the underlying security is same for everyone but the value of the underlying is different for each unique participant.

There is a another possible way to visualize the response mechanism of each participant as to what is volatile and what is not volatile that when a price series spends more time within the boundaries of moves around the mean change over the relevant (for each participant) time span that trigger the sense of pain and gain for each participant it gets increasingly volatile. The less time a security price series spends within the pain and gain definition bounds of a trader / trading system the more number of profitable or loss making trades it generates. I conclude that as each individual's value assessment of volatility increases each individual is induced to trade more. Another twist exists that the law of diminishing marginal utility might not be ruled out here. As the individual sense of volatility goes past a certain optimal threshold for each the desired frequency of trading does come down. In such a context, when the commonly accepted and agreed upon price (not value) of volatility is going up (option implied volatilities or the vix index) the actual prices of the security are jumping around the mean path more widely triggering crossovers of pain and gain thresh-holds with a larger frequency. However the paradox then arises that options writers (volatility sellers) are providing to the options buyers (getting more uncertain about market in the coming future) a protection from the perils (expected by the option buyers) of taking decisions. By such an argument is it then not true that at any given point in time the buyers of options or protection are those whose optimal point for increasing the number of decisions with rising volatility has already been reached while the writers of options have an optimal point on the volatility vs trading frequency curve further ahead?

Volume, I would like to submit to Mr. Knipe, according to me is the struggle for the discovery of price. Volume itself can be erratic or steadily rising or falling. Perhaps, akin to the kind of insight the volatility of volatility could provide about the state of markets the volatility of volume may aide in understanding the market's willingness in contesting or not contesting the discovery of price. Volume I do not agree is the "decisiveness to trade" but it perhaps is the anti-thesis of the prevailing price meme in that a rising volume provides a rising chance / facility to trade rather than a rising willingness to trade.

If the volatility-frequency of trading relationship can be tested to the applicability of the law of diminishing marginal returns of volatility in inducing trading then it may be possible to demonstrate that strategies that are pegged on buying large packets of insurance with an aim to living under long periods of non-achievement to gain some day on the unpredictability of dooming uncertainty arising at some point are rather than getting fooled aiming to fool the rest on the concept of randomness.



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

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



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

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



Looking on the, er, bright side, we shouldn't get 6% daily declines for the next two weeks. Stocks should be worth something no matter who wins the election.

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



bootsWhen in college towns the pawn shops are full of class rings, band instruments. Here in cowboy country you'll find guns, saddles and power tools. Cash is king when you have to pay the bills. It matters not that what the price is you sell, hock everything, gold, the family silver everything. Money coming in next week does you no good. It would seem to this simple minded investor that much of the "too big to fail" problem and CDS problems are really too big to fail quickly problem, due to cash and liquidity constrains. Perhaps some enterprising financial engineer/ legal team could develop a more orderly process, by developing a queue process for payoffs within counterparty risk and CDSs written in the future.



T o t OThere is a tremendous preponderance of negative news. 14 of 16 headlines on my monitor are negative.

Credit defaults are up.
Unemployment is up.
A forecaster predicts Dow 5000.
Recessions are likely.

Yes. As I write this with S&P down 20, is this good or bad? Is the economy in a recession as of March '08 good or bad when it is announced nine months late? it's due to oil prices that we were not in one so far, but it will almost definitely put us in as of 9 30 2008 GDP, and later, because oil prices are added back to GDP and the previous adjustment was way up, and this one way down.

Does this override the 10 P/E and the resilience and the Triumph of the Optimists? One can give up principles or try to manage money properly and take account of laws of economics and the required return that investors demand, let's say 60% a year when VIX is this high.

Dan Grossman adds:

To quantify, the 30 to 1 leveraged assets referred to by Vic that have been/are being reduced or liquidated to create the current environment, at the beginning of 2008 the five largest investment firms (don't know exact definition) held $4.3 trillion of assets.



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

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

To gain perspective, I looked at weekly prices:

date       sp     nikkei    bonds    euro   crude gold   wheat vix

0919     1246    1192       118 5   14466   10254  834   718   32

0926     1216    1189       117 1   14609   10618  879   716   35

1003     1108    1094       11920   13772    9301  835   640   45

1010      891    8276       11620   13408    7799  849   563   56

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

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

Anatoly Veltman adds:

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

Kim Zussman wonders:

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

Charles Pennington comments:

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

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

J.T Holley writes:

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

Stefan Jovanovich replies:

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

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

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

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



A VeltmanFor the week 10/7-> 10/14, during which SP futures traveled 1006-> 837 and back 837-> 1002, the Net change was Long in Commercial category, while Short in Small Spec. We don't get any direct signal, as market entered consolidation and is no longer short-term stretched out. However, we note marked change in sentiment:

1. Small Specs now tend toward Short
2. VIX has risen substantially
3. Futures do not maintain premium at US close.

So, as opposed to early October, when we could find little sign of short-term capitulation at 1100+ pricing, we can see plenty of that now, at almost 200 points lower pricing! There were few strong signals elsewhere. Of note only firming EUR, Gold and energy Commercial support.

Eht Yob asks:

Why do you refuse to test these data? It is so easy and you will find that small speculators' positions have almost zero predictive power to future movements of the S&P 500. Is it because you are too lazy or is it because you are a salesman and really don't care about the future outcome? Or is there another reason?

Anatoly Veltman explains:

1. A quality test is not as easy or cheap as you portray.
2. I don't believe COT will test profitable anyway.
3. COT can be extremely useful to a competent discretionary trader.
4. Useful exactly "because" it should not be used as primary, but only as a filter to original solid ideas.

Isam Laroui adds:

Why so much hatred, Mr. Yob? I, for one, find Anatoly's COT notes very instructive. As he says it's just one tool in a trader's toolbox. Just the fact that most traders look at it is reason enough to stay informed. No one is telling you or anybody else to blindly follow some kind of mechanical trading rule using COT data.

Eht Yob replies:

What you don't understand is that I do blindly follow a mechanical trading rule using the COT, and what I'm pointing out is that the data are very useful, when analyzed correctly.



 In the context of markets, a cost is a reduction in equity or a forgone opportunity of enhancing equity. A decision, in the context of markets, is a new trade. A rise in the price of volatility is, in general, accompanied by a fall in the price of the underlying and vice versa.

A rise in the price of volatility is a reflections of the higher cost of protection market participants are willing to pay for their indecisiveness.

Hence, volatility is the cost of unwillingness to decide. Should one then, being a contrarian, not be keen to take a larger number of decisions during periods of higher volatility? How may one be able to study and understand if volatility is the cost of decisions or the cost of not making the decisions?

Matt Johnson comments:

Volatility is an expression of uncertainty (risk), not an ‘unwillingness to decide.’ For me, an unwillingness to decide is the lack of a clear trading plan. I make most of my money in periods of higher vol, but I’m in at the beginning, when I’m most uncertain — not at the end.



tbMy daughter, PhD candidate, coauthored this paper. At my level of understanding how this might relate to markets is that TB deceives its host through a signaling process on a micro scale that affects its virulence. This study on a micro level shows that the answer to the question, how does news affect the market, and how might it be approached from the micro level. It is interesting how the scientists look at spectometry charts to see some of the effects and how some of the chart are simlar to stock return charts or charts of micro structure. In a different vein, Vic and Laurel wondered how mixtures and or enzymes in chemical reactions might be a good model for markets.

The news is some sort of signaling process, as is price itself. The virulence of the reaction is certainly described in the market microstructural property or in broader quantitative characteristics. . Micro study lends itself to shorter terms predictions, but I see no reason why it cannot be aggregated to higher time levels. Recent market news has allowed a virulent government meme to invade and virtually take over our banking and market systems and allowed government ownership of our banks. Perhaps takeover of the markets themselves is next. The hypothesis is that government is the disease not the cure and its growth is like that of TB or cancer.



Update on 10d non-overlapping daily stdev of DJIA: The recent 10d daily (cls-cls) stdev is 5.7%, which was only exceeded in 1987 and during the depression (see attachment).

Here are the other cases with 10d sdev > 4%, the dates of which seem to make it hard to argue that the mechanisms of modern finance reduce volatility:

Date    STDEV10    nxt 10 ret
10/27/87    0.089     0.017
11/14/29    0.075     0.112
10/14/31    0.071     0.033
03/21/33    0.060    -0.026
10/29/29    0.052    -0.056
08/16/32    0.051     0.078
02/25/32    0.047     0.051
09/28/32    0.045    -0.187
07/28/33    0.045     0.031
06/22/31    0.042     0.048
12/28/31    0.042     0.075
01/12/32    0.041     0.005
09/29/31    0.041    -0.025
06/20/32    0.041    -0.091



pic"W." shows him to be a man of principle and caring, though a bit hijinks-committed as a stripling, OK–but now deeply faithful–surprising from a man like director Oliver Stone, maker of big, entertaining films about significant people, but often not reliable histories of the eponymous films created.

Another guilty pleasure, in a way, these Oliver Stone films:

as works of art, they are above-average entertainment, although don’t mistake them for documentaries. “JFK,” for instance, was a terrific movie, but anyone who bases his or her understanding of the assassination on Stone's movie will be severely misinformed. Likewise, the darker biopic, “Nixon,” which while very involving was not the valentine to the former president that “W.” appears to be. Stone is not Michael Moore. Watching this enjoyable though not heavily ground-breaking Texas through White house trawl, I feel Stone disappoints the Bush Derangement syndrome avatars, and went out of his way not to do the kind of over-the-top ‘coverage’ that Moore certainly shaves his name into.

One has to wonder at the timing of the release. Since the election is so close, surely he meant to piggyback on the possible frisson factor of getting the goods on the sitting president as he enjoys his last months in the nation’s Capitol. But since one emerges from the film liking this George more than one went in with, and it certainly does not affirm any of the distortions that have been bruited about the reasons for our entry into the Iraqi and Afghani military enterprises, one again is put to the question: Why make the movie?

The casting of many of the strategic roles is itself a hoot, and you see how deliciously Richard Dreyfuss (not my namesake) licks his chops at being the brilliant though carefully cloaked Dick Cheney. Likewise, Scott Glenn does one of his few wrong turns in the industry with his obdurate, snarky Don Rumsfeld. Condoleezza Rice is done a disservice, it seems to this reviewer, by the usually lovely Thandie Newton; she is nasal, whiny, servile, and wound even tighter than the original, but she comes off , as written here, as an insignificant twerpy entity nipping at the heels of the President. Elizabeth Banks does a gorgeous Laura, and I too fell in love with her (she’s lovely, supportive, kind, literate, kind of what the ideal wife should be in the best of all bests). Barbara Bush is brought to vivid life by a tough Ellen Burstyn, matched by Bush 41, reserved, careful and patrician, as evoked by the dependable player of presidents and senators, James Cromwell.

The image of Truman Capote dithering beatifically over the proceedings was distracting, because someone (mistakenly) cast Toby Jones in the role of ‘the Architect,” Karl Rove. Jones is a good actor, and he bears a surface resemblance on some level to Rove, but he just played diminutive gay scribe Truman Capote, and he still looks too much like him in the mind’s recent imprint. Rove has a different valence than Jones and this impression was erroneous. Jeffrey Wright bore the necessary gravitas for Colin Powell.

The film intercuts the past and present, omitting the campaigning process for Bush 43, omitting various crises, but showing the various Cabinet trials and Middle East challenges, showing the younger Bush through his Yale-Harvard years, as a good ol’ fratboy with a huge round of friends, his oil days, highly telegenic Americana and keggers…but also as the baseball team owner, and as the successful campaign manager for his father’s huge 1988 trouncing of Dukakis.

Overwhelming experience as the film unspooled: surprise: If Stone wanted us to dislike or distrust the man, we don’t. Instead, we watch a strongly principled man who means well, is devout (too-long absent Stacy Keach inhabits his pastor-evangelist, Earl Hudd, with delicate unctuousness and presence), loves his country, his deft and delightful wife, and his daily 3-mile runs.

Drudge carried a small item from Jeb Bush, right after the former Florida governor saw the film, that called the spine of the film, George’s strident Oedipal rivalry with their dad, “Hooey.” But the film can be enjoyed for its own sake, if one can put aside cherished misconceptions and petty rage. For the unhysterical, this is a not-unpleasurable viewing experience. If you’re fair (it probably won’t cure Bush Derangement Syndrome, unfortunately), you’ll enjoy this well-crafted biopic.

Will it have any impact on the election? TBD.



 One wonders if similar techniques are not used to shake investors out of their positions…

From The London Times:

Dr Ken Catania, of Vanderbilt University in the US, found that the vibrations created in the soil by rubbing steel on the stake mimicked those made by moles digging through the soil. Fishermen had happily made use of the practice, known variously as worm grunting, tickling, snoring or charming depending on where it is done, but didn’t know why it worked. His conclusion, reached after a series of experiments in the Apalachicola National Forest, in Florida, confirmed a remark made by Charles Darwin in his 1881 book The Formation of Vegetable Mould.

I will have to remember this the next time I go fishing–it certainly beats looking under rocks for suitable bait. And to brings back a childhood memory of going with my father in rural Alabama to buy a carton of worms at a backwoods bait shop. When we arrived at the finishing pond there was only one worm in the carton — which had been kept in a cooler — caveat emptor was the lesson for that day!




BooksThe other night I went shopping for books. I hit the three major book stores in our area, Barnes&Noble, Borders, and Books a Million. Since I enjoy browsing through book stores, I usually walk the entire stores. I noticed a few things such as the inventory levels being very low, and the labor was very tight, despite many customers. All three stores had one thing in common that was of great interest to me; The business/investing/trading section of books has recently shrunk by an average of three vertical feet of shelf space, being replaced by books on how to survive the coming recession/depression/hard times. I found many investing books in the remainder displays with a heavy markdown. Two of the stores had a separate display of the new book by the Palindrome, and also a couple of other displays of books on how to handle the coming recession/depression. A quick scan through some of those recession books showed no mention of buying good stocks on the cheap as a way to handle the rough times. I also noticed a decrease in the periodical section of business related magazines, with just the major ones represented. I've never seen such a shift in a business section inventory since the malaise of the late 70's. Later, going home and browsing through Amazon.com, I noticed heavy markdowns of all investment books. I can't say whether my small sample of the major bookstores in my area constitutes any kind of national trend. However, I wouldn't mind if the public loses interest in investing for awhile, licking their wounds. That will indicate a great buying opportunity for stocks. One positive note about the three stores: all had "Education of a Speculator" in stock, and it wasn't on markdown.

Steve Ellison writes:

At the public library today, I saw a display on the stock market "crisis." I was surprised because usually the displays feature topics related to multiculturalism. Included in the display was the Senator's book "The Right Stock at the Right Time". There were also two books about stock market strategies by the American Association of Individual Investors and two books about 1929.



vicAn interesting question is to what extent news is news. Oct 16 at 3:00 pm, news of a rescue plan for the insurers came out with the market down 1%. It immediately rallied 4%. The question is would it have done it without the "news"? And to what extent was the news in the market? Looking at Israel one notes it was down only 2%, catching up with a 12% decline in the US. The extent of the decline at 11:00 was similar to yesterday, and last week, and the path similar to last Thursday. Would it have repeated without the news, and was the news elicited, as I have often said, without quantifying for Thursday, to be the last gasp? It would be interesting to generalize this question. For example, gold rallied a few percent the day before a Libyan jet was downed in 1983, and it turned out that the downing of the plane was already planned as a shot across the bow to our friend Muammar.

George Parkanyi adds:

This whole crisis has very much been managed with strategically released "news." Every time the market has started to turn ugly, the Fed, Treasury, central banks, larger institutions take some action and make some kind of announcement designed to reassure the markets and the public.

Today for example, Warren Buffett announces he's buying (probably already has bought [chuckle!]) equities. The announcement had great timing, as everyone hangs on every word of his [except on this web site], this is a Friday, also a volatile options expiry day, and there's been a little bit of recent upward momentum. I'm sure (well my guess anyway is that) the Feds asked Buffett that if and when he did start buying, to let them know so they could time the announcement to maximum effect.

Steve Leslie writes:

Interesting philosophical question "When is news news". Answer: All news is news. I suppose your question truly is when is some news more important than other news. Obvious answer: news that is unexpected is important news and news that the consensus is keying on or deems relevant at that particular moment in time.

For example if one were to study the movie Trading Places with Eddie Murphy and Dan Ackroyd we see that by having information that was not available to the general public ahead of time, it gave them a great advantage to trade ahead of the news and make a great deal of money in Orange Juice futures.

We also see in the movie Wall Street which is based on the life of Ivan Boesky and his corrupt methods, Gordon Gekko makes huge fortunes trading ahead of public informations but is driven under by manipulation of information by Charlie Sheen into the marketplace. Boesky was written of more thoroughly in Den of Thieves by Stewart

Years back there was a scandal at the Wall Street Journal where one of their writers for the Heard on the Street column was secretly sharing his column with a few people before it was published. This was back when a mention of a stock in the "column" was worth a few points. This landed him a jail term as I recall.

Dr. Doom Henry Kaufman of Salomon Bros fame, used to have profound impact on the markets esp the bond market with his prediction on interest rates. This was when interest rates were very sensitive.

Farther back, Joe Granville market maven could move markets with a special call on stocks.

Dan Lundberg could move the oil markets with his release of data on the oil industry back during the oil crisis of the 79's and 80's. We see this to an extent today with Pickins when he decides to publicly discuss oil.

Efficient Market theorists will explain that the market adjusts to all available news in the world eventually. I suppose the psychology and sensitivity (volatility) will determine to some extent how profound that impact will be immediately and blended out over time. Thus from this perspective all news should have only an ephemeral quality to it.

A pure technical analyst like Stan Weinstein author of Secrets of Profits in Bull and Bear Markets will state that the charts tell all. It is just a matter of being able to read them correctly. Bob Prechter became famous by his trading in the 80's using Elliot Wave Theory then fell out of favor by "losing his touch" and making a series of bearish calls during the greatest run in the equity markets in history.

Back in 1942 with the World War still very much in doubt the US stock market performed very well. Was this due to the massive ramping up of the US military machine or was the market anticipating a victory by the allies a full 2 years before victory in May of 1945.

Perhaps the real answer lies in blending of thought. Similar to Einsteins Theory of Relativity and Quantum mechanics. Neither fully explains the universe but a unified theory gives a much better heuristic.

I hope these comments are helpful.



laborMy surgical assistant often asks for updates on the stock market, especially lately with what's happened to her 201K (used to be 401).

"Big dip after the open, with a huge rally to the close. We're nowhere near the bottom because there is still too much speculative buying, and we won't get there until normal people stop talking about the market."

(Read it somewhere and wanted to impress her.)

A lady overheard this, and related a similar story about childbirth: She was exhausted after laboring for a few hours, and the doctor came in to check. He asked her to rate the labor pains on a scale of 1-10. "Eight or nine!" she said. "It hurts a lot!"

"You're nowhere near delivery" he said, "because when you get close you won't be able to answer my questions, or even hear them."



philThe volatility of the market has dramatically increased in the last few weeks. It is often said that the correlations between various markets increase at such times due to forced margin selling. Certainly such a suggestion is plausible on its face but like everything else must be tested.

One can look at the same-day correlations between various macro variables and the S&P. For this purpose the relevant ETFs were chosen. The correlations with SPY are as follows:

Oil                81%
Gold            -32
Tbonds        -53
Tbill             -53
Yen             -64
UK stocks     93
Japan stocks    93
VIX               -86

The most striking is the strong positive correlation with oil. One interpretation is that oil is driven by recession fears just as stocks are. Another explanation may be that oil is being liquidated to finance stock margin accounts just as the pundits claim. Clearly holding oil is not now a hedge against a stock portfolio.

But when we look at gold the correlation is negative. This would tend to serve as evidence against a wholesale correlation of assets being sold. To some extent gold is still a hedge against a stock portfolio. The same goes for treasury paper and the yen. But we do see UK and Japanese stocks being strongly positively correlated. So it appears that many world markets are strongly correlated with each other. Again this may be a sign of coordinated margin liquidation. The strong negative VIX correlation can be interpreted as the markets are now being strongly driven by fear. None of this is predictive but is an interesting descriptive look at where we are now.

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



As someone who has become very tired of my investment peers whining, I thought to restate some points we have made to clients recently:

* At what point do you add risk? At some point, traders will have to decide between a "Hail Mary trade" and unemployment. History shows late October, early November is their last chance.

* The public has seen a large number of people in the investment business lie and panic (in that order). The likely follow-on effect will be for those managers/asset classes to lose large numbers of clients once the market stabilizes; Debt is out, equity is in. God help private equity or anything else that relies on cheap debt and easy access to it. Cash is king. This is how we are positioned.

* The auction of the Washington Mutual credit default swaps is next week. That should be the last "whale" liquidity need for this year.

* Details are not forthcoming yet on many of the government support actions, both here and abroad. It appears safe to say the US was embarrassed into following the UK's lead. Whether from malice or incompetence, these details should be available after Election Day.

* As the size of the government increases in the economy, volatility in markets should drop. In reality, there are lots of assets sitting "off market" on the government balance sheets. They will be there a while, and more are being added. The pool of sellers is shrinking.

* Overseas economies/markets should lead the US out of this panic, as they have been far more proactive in addressing systematic liquidity (except for Europe). We are positioned with companies that have lots of overseas revenue sources. Additionally, platform companies - those who have intellectual property but shift the locations of their plants around the world frequently - are very attractive. This is the most adaptable company structure here and is essentially big cap. Very small cap should also hold up if they have narrow protected niches. We are concerned the middle cap sector is where alpha will be lost. The loss of the middle seems to be a recurring investing and economic theme.

* Who the hell knows what the "real" risk free rate is when gov'ts yield 4%, agencies 5% and bank loans 6% all with gov't guarantees? This throws all quantitative models to hell, but lead to the biggest (in all senses) convergence trade in my lifetime. All assets are reverting toward that new risk free rate, and the move will likely be finished post election (once the DC types decide to release the details). I'd suggest this is the equivalent of at least a 200 bp parallel shift in the yield curve upwards over a 10 day period. Most financial institution asset/liability models were not set up for this as a probability. Consider the possibility/probability that this move can be reversed. If this is not immediately clear, please call and I'll explain the math.

* Looking behind the 9% sell-off in the S&P 500, it seems that "quality" names suffered less than "lower quality" names. The data shows investors have been moving towards quality and "fortress" names. For instance, stocks whose debt is rated "investment grade" outperformed "high-yield" by 300bp. Larger cap names (>$50b) outperformed smaller caps (<$2b) by 300bp. Those stocks with lower short interest have outperformed those more heavily shorted by 600bp over the past five days.

* Even with a reduction of 20% from existing earnings estimates, earnings yields on many stocks are greater than their own corporate bonds. This is not a stable situation historically, and one that should reverse. As our high yield default probabilities are still rising, we'd expect that debt prices will adjust, again favoring equities. Another way to look at it: with dividend yields at these levels, you have an equity "bond" - with an equity call option included for free.

* If you are not long here, when would you be long? Many statistical risk/return relationships have become extremely asymmetric. This has become more pronounced after the recent financial slaughter of statistical arbitrage firms. I've been asking many of the consulting firms we speak with: "How many standard deviations do things have to get out of whack before you re-balance assets?" This needs to be discussed and addressed. It's time to pull up our britches and make these calls. Friends help friends invest rationally. Salesman tell clients to invest emotionally. Stay the course isn't enough to tell clients. Show them the darn map. Show them the math. Give them facts!

* The enemy is out of bullets, and is changing magazines. It is time to move OUR position forward. This is when you press the advantage. Call out the troops. Advance the agenda.

* Semper Fidelis! This is not the time to give up, it is time to earn our fees.

This is a thoughtful piece sent to friends by one of our esteemed contributors, a former partner of the late John Kuhn, ever exuberant, creative and poignant. — Vic and Laurel.



There is an ETF that invests in buyback companies. It is PowerShares Buyback Achievers Portfolio (PKW )

The following are regression stats for daily change PKW vs daily change SPY, from PKW inception 12/2006:

.                 Intercept SPY change

Coefficients      -0.0002    0.8596

Standard Error     0.0003    0.0169

t Stat            -0.8081    50.7573

Conclusion: Alpha slightly negative (N.S) with beta of 0.85.

Either the buyback anomaly has been arbed away, or the market is playing one of its dirty tricks.




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

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

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



lamaAlbert Jay Nock wrote of the regular recurrences of panic, of unreasonable and debilitating fear that takes over a society. Henry Clews wrote of the regularity of panics with the regularity of the seasons. In fact, on a recent visit to New York I actually saw the very same wealthy old codgers hobbling on canes on Thursday night in the splendor of their private clubs. I don't think I will ever forget them despite my own state of panic. It happened in Orson Welles's reading of the Martian invasion, it happened in ancient Greece.

I have seen panic in the water and the unreasoning behavior it creates. In our discussions of survival, I see how panic leads to mistakes, and then the mistakes can compound and lead to death. We're in a panic, no questions. I've felt it. Everyone has. It's an unreasoning blind fear that takes control of your mind.

But as empiricists, we need to take a look at what is happening and what will happen after, and what has happened after and avoid the series of mistakes that leads to death. Rather follow the path to survival. And like in Forrest Gump, mere survival might be success.

The Dalai Lama said that compassion is the key. I might modify that to say that compassion is the key to investing. By acknowledging that other peoples feelings are the same as your own, you understand their needs. In a panic their need is to stop the pain, stop the uncertainty, and have some cash. Your job as a compassionate investor is to give them what they want, despite your own similar feelings. You should be rewarded for such altruism and compassion.

Michael Cook agrees:

I like this point of view. It suggests investing from an "enlightened" point of view, which might also include: not being obsessively attached to outcomes, rather enjoying the process; being relaxed, maintaining an expansive, embracing view of things grounded in acceptance; being mindful; and relaxing and quieting the mind thus allowing spontaneous insight to manifest itself.

This does not necessarily mean assuming the demeanor of a Zen monk, or a Bodhidharma in a cave (although that might work); I think one can be "enlightened" and also be a man (person) of action. See Chogyam Trungpa's "Meditation in Action," for instance. But the best athletes are the most relaxed, aren't they?

The idea of compassionate investing has many more suggestive connotations — thanks.

Jeff Watson remarks:

SpockWith all of the volatility in the markets of late, my protege gets very excited every time he has a trade on. His knees swing, he chews through pencils, and he has to use the bathroom a lot. He develops nervous tics, and talks just a little too fast, a result of his brain going 900 mph. Contrast that with me: I approach the screens in a slow, languid motion, sit down and relax. I look at my positions and don’t panic because of the bad ones, I eliminate them quickly without vocalization. My good positions cause me to absent-mindedly ask questions to myself and ask him about arcane scenarios that might have some value. Since I’m rather dispassionate about the whole deal, he gave me the nickname “Spock.” Whether that’s good or not, I’ll let you know after this storm blows over. He can’t ever find out if I’m mad or glad after a trade, because I do the same thing after every trade. Take a breath, and drink from a glass of water, and change whatever song is playing. I still maintain a cheerful disposition whatever the outcome, the same disposition I had when played ”Chutes and Ladders” in first grade.

Nigel Davies writes:

I'd need some convincing that balanced emotional gearing is an essential for the pursuit of excellence; I think a lot of champs just learn to channel their emotions into doing the right thing at the right time.

Thus it was OK to vent one's frustrations on the cat on Friday as long as one didn't sell.

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

Larry Williams comments:

The Dalai Lama is not a trader. There can be no compassion in trading; compassion does not make a wrong call any better.

The enlightenment is making the correct decisions, understanding and compassion are for marriage counselors, not investors. There are absolutes here; rocks are hard, water is wet, margin calls must be met.

Dr Williams is the author of How I Made One Million Dollars.. Last Year, Windsor, 1998

James Sogi adds:

I'm talking about the philosophical definition of compassion, i.e. awareness of others' emotional states, rather than the softer emotional state of kindness or pity with which the definition is mostly associated. The idea is to understand them in order to take their money, and hence some irony in the definition and its utility in speculative life. Sometimes they are willing to pay for the solace of giving up the position. Tends to be at the worst time. I know — I've done it.



magWould it be wise to speculate a little now consciously in the investment account in which bankers were speculating so unconsciously and so unwisely in 1929?

That's from the May 12, 1933 issue of "American Banker". I guess most bankers answered a resounding NO back in 1933 just like they are answering today. That quote reminds me of a little anecdote from a few years back . A Japanese fund manager was greeted with resounding ridicule when he talked about the Japanese approach to buy stocks only when prices are rising aggressively rather than waiting for a market drop. His reasoning was that buying stocks with rising prices will insulate the portfolio manager from criticism if he should fall. The portfolio manager could easily justify his buy decision by stating that everyone was buying and he was just part of the herd. If the manager bought a depressed stock that fell further, he would be accused of individualism and subject to scorn. It always amazes me how circular the world is. Today's chumps are tomorrow's heroes. Be humble or prepare to be humbled, as the saying goes.



veltSP ideal downside target of the entire Elliott Flat Correction from 2007 record of 1587 lies near 2002 low of 768. My feeling is that lack of clear technical indications and overall regulatory uncertainty will combine to reduce trader activity and directional movement. Subsequent chart action will likely become more grinding, thus eating into implied volatility. In the interim, one should take count of the entire crashing wave as it developed since the "mother of all short-squeezes" on Sep18-19.

Intraday chart of E-mini dissects the waves of the ensuing three-week fall: we have entered wave 4 consolidation, which should retrace toward 966 or max.1006 rally objective. Note previous four rally attempts: each squashed by size offers in Globex order books at precise 38.2% retracement levels. By the way, most of those "timely size orders" came in similar suspicious pattern: "insider" short-covering commenced off of 9/24, 9/29, 10/6, 10/8 lows; followed by bullish announcements of unprecedented government actions - and then stonewalled by the 38.2%-retracement size offer! Following tremendous short term oversold, the pattern was tellingly modified this Friday: to offer only 50% bounce after US pit open, and then a 61.8% bounce near pit close!



bearConsider the reversals off the July and Oct '02 lows and thereafter. Things were pretty bad then as well. If you'll recall, a president had been killed, another president resigned, a lost war, race riots, bankrupt cities. It's not as bad now. A quick Google shows many are studying the '74 and '31 & '37 bottoms as well. Well worth looking in to. What happens after a big bear market?



V N1. Of the 100 biggest markets around the world, almost all are down 40- 60% in dollar terms with the exceptions' being Tunisia and Botswana. The impact of the decline this week, unless rapidly reversed, is going to be very severe on purchases. The previous 20% caused great angst; imagine what this decline will do to those who rely on retirements. The positive feedback of the decline in a negative direction also impacts the election results with every market decline making it more likely the Republicans will be blamed for the situation.

2. The worst aspect of the decline this week from a health point of view was that fixed income around the world cratered, thereby reducing world wealth by a good 15% as opposed to the normal situation where the equities go down 10% and the fixed incomes go up 8% leaving total wealth down only a little. And the people that talked about how bearish it was for stocks because commodities were up would never say that it's bullish now because commodities are down 40% over the past four months.

3. A new word should enter the market vocabulary, a waterboarding decline, being a decline that seems to have a breath of life at the open before going into a death spiral.

4. Because of the decline in all sectors, the wealth/price ratio has stayed relatively constant with corn, copper, soybeans, wheat and oil down 40- 50% since June 30, thereby keeping the number of bushels and barrels we can buy with one DJIA relatively constant, making the number of ounces of gold you can buy with the Dow less than 10 for the first time in a googol, and looking like a bargain for the Dow.

Paolo Pezzutti writes:

In other crises you could see the flow of money from bear markets to more promising assets. From equities to bonds, from equities to housing, from technology to defensive, and so forth. You could see investors moving away from the "bad" returns toward the "new" vein of expected future returns. This time it is a simultaneous meltdown and loss of money everywhere. Only cash has been a safe haven in each country. At least until some of the currencies initiate a fast devaluation path on lack of trust not only of the banking system but also of a country's ability to navigate these stormy waters. Only a few months ago I was confident to see the financial system, at least in the US, finding a good base and start recovering. After all the financial system of the US could not simply collapse! I was not expecting this could go so far. There were many predicting a financial armageddon but I did not pay too much attention. Catastrophists have always been around. The fact that money is simply being burned actually makes it quite difficult to have a complete recovery. I am afraid it will take many years. Because in this case, simply, the flow of investments cannot return to equities. This time there is not enough money to move away from some other asset. What I am really afraid of, and I go back to a previous post I wrote about the end of the US dominance era, is the following: this crisis signals the transition to a new balance of power in the world. I learned at my expense that systems and large organizations continue to act ignoring that they are moving at the edge of an abyss. Factors for a change of balance accumulate but they are ignored. Suddenly they ignite rapid and impressive changes with an avalanche effect (black swans?). It seems that these transitions cannot occur smoothly or gradually. Awareness does not grow gradually. People live in a dream until they are brought abruptly to reality. The reality is that the US and Europe have lived a number of years spending and consuming more than they could afford. Continuously growing current account deficit and immense flows of money out of our countries did not ring the bell. Now, whatever the specific cause that started the crisis we are brought to reality. More regulations vs less regulations, more government vs less government are the discussions we hear in order to try and find a solution. The problem lies in the fact that our societies consume and spend more than they earn accumulating debts that eventually nobody will be able to pay. This has to be changed somehow. And hopefully not through increased presence of the governments in the economy or, even worse, through protectionism. Of course emerging markets are suffering a lot in this crisis. We are the main source of income for them and we finance their surpluses. Moreover, we will not be able to go back soon to previous levels of demand. However, the relative weight of some of these countries will increase as their internal demand will pick up to fuel their growth while we lick our wounds. And demography explains the dynamics of aging western societies. We need to be aware that this historical shift is developing and accelerating. I do not think we will be able to go back to "business as usual". This will have effects in the long term, in my opinion, also in the strategic posture of the US and Europe and in their role in the world governance. There are already signs of increased weakness from the military and political perspective. More in general, we need to understand the possible answers to this crisis. And the implications. This phase, however, if my analysis is correct, could be an opportunity to invest in those emerging markets that will grow faster than we will be able to do (provided that one still has the liquidity to do it).

Steve Leslie remarks:

If it were not enough for ACORN to help destroy the housing market in Florida by being the pointpersons for loans to unqualified buyers, now it seems they wish to start another stain on the Sunshine State with voter fraud. It seems that Mickey Mouse tried to register to vote in the state of Florida at the behest of the political action group. They are currently under investingation in 13 states for voter fraud. My one question would be how in the world did Mickey fill out the application and sign it with those huge hands? And if Mickey Mouse is registered will the other Disney characters soon follow?



Anyone that has run a marathon recognizes the symptoms. Wall Street has "hit the Wall."

You start to run out of glucose/carbohydrates fuel about 90 minutes into a run at a good pace, at which point your body slowly converts to burning fat and protein. If you train right you can extend the glycogen oxygenation process until about two hours into a run. After that you simply run out of fuel and any new sugars that enter through digestion are burned quicker than they can be produced.

At this point your body's fuel is supplied mostly by cannibalizing itself. The proteins come from the muscles, this creates a debilitating loop; making each step harder than the last.

But what is most debilitating is the effects on the mind. Without the glucose your brain also goes into a depressed state. It is this temporary depression that makes the marathon such a challenge. Each step not only takes more effort, it becomes harder and harder to will your body to continue. Most first time marathoner, upon finishing promise themselves never to do that again.

Once you hit the wall almost anything can happen. This far into a race, many of your systems have already been overextended. With such stress on the body, continuing on can cause many other things to break down due to anything from poor form to internal chemistry. People weave like a drunk, faint from exhaustion, and start crying like a baby.

Personally, I have been diagnosed as gone into shock at 21 miles medical tent only to snap out before the ambulance arrived to jog to the finish. I had several cases of hypothermia, almost always severe cramps, countless blisters some bleeding so bad my socks were ruined, several toe nails completely ripped off. For me it is normal to be so dehydrated that I can't keep fluids down and must get some salt in me before it will start to be absorbed. Also I have had several IV's immediately after a race. For most ultra-marathoners (beyond 42 k or 26.2 miles) keeping hydrated and good electrolyte balances are critical to finishing the race

The recovery from a marathon is different than it is from most other races. While the depression generally is temporary and the spirits lift once digestion or IV's replace the liquids and sugars: it takes awhile before you can start to function normally. Like post-birthing blues, many people take awhile to fully recover mentally. I have even heard of Ultra-marathoners, who done more than 100 miles never quite recovering, falling into a real depression. Those that over indulge their rest, tend to take much longer to recover. The best medicine is to get out there an do something.

For this reason I try to run or if injured, cross train every day at about 2/3rds reduced time, effort and distance. After about 7 days I'll try a more normal run after 2 weeks try to go back to normal training. However, my hard days I expect to be slower. If no complications occur after about the 3rd week I will often get a bounce from the blood volume increasing. For instance to qualify for the 96 USA Olympic Trials, I ran a marathon in Huntsville Al Dec.9 when they had record lows an howling winds. I completed the race without qualifying. So I ran the Last Chance Marathon on Dec. 30 in Tampa where I won and qualified with a 2:20:26.,( the cut off date was Dec. 31 1995 for the trials with max time of 2:22:00 and also last date to qualify for the 100Th Boston )

But many great runners never learned how to run a marathon. Mark Curp for instance held the half marathon record for awhile, fell apart the few times he tried.

What does this all mean for Wall Street? Will they fall apart and go on a death march? Will they bounce roaring back?

I'll leave up to the reader to decide, because as I said anything can happen. But when I bounced back, I was near the best shape ever in my life. I was getting great advice from a former Olympian.

And the best advice for overcoming the Wall, forget the past and the future live in the moment. If you've done well, the worst mistake is to think you can back off the effort. Or think this time it will be different, I'm immune from the Wall. Always expect It to flip you on your back. If you are been hurt, having a bad day and slowed, always keep trying to shore up the pace. Forget the finish line on the horizon, and concentrate on doing your best the next yard.



Martin LBaron Rothschild allegedly said that one should buy "when there is blood in the streets." With the current situation's being what it is, clearly we have reached that point, and the only questions that remain are: How much further — and what will happen then? What strikes me is that people that usually are positive have turned very negative, and no wonder with all the alarming news that keeps hitting the market and the unrelenting selling. But there is a deeper angst that keeps creeping up: "It is different this time", meaning that the market will not stage a rebound, or that any rebound will be short lived. With the exception of the list, it seems that sentiment is very dark. You hear things like "all markets have fallen so there is no where money will flow from", or "we are heading into a deep recession that will further depress markets", or "sell now, we will fall 20% more in a matter of days". While any of these statements may be true, when they come after a 40% fall they seem to me bear the earmark of capitulation underway, and a strong rise to follow.



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

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

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

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

Here are a few quotes and notes from the pieces:

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

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

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

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

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

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

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

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

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

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

UBS Broken Lighthouse report starts off with:

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

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

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

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

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

Phil McDonnell replies:

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

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

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

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



bookWhat is most troubling to me about the current situation in the financial markets is the global backlash against the "free" market and what is perceived as capitalism in general. Your average person is so angry right now, and it seems almost inevitable that anything related to the financial markets is going to be torn down and rebuilt in a nationalized or internationalized shell of its former self. Forget the amount of damage that has been done in dollar terms during this decline (easier said then done for some including myself); the real damage is that the image of America's version of market based economies may have been tarnished beyond repair. I hope this is an overly pessimistic view of where we are headed. I have a six month old that I would like to see prosper as she grows; I just can't help but wonder what damage will be wrought by the powers that be with the backing of an angry mob.

I found the below passage from The Road to Serfdom particularly relevant to the $700 billion package handed to Paulson and the Treasury Dept:

What is promised to us as the Road to Freedom is in fact the Highroad to Servitude. For it is not difficult to see what must be the consequences when democracy embarks upon a course of planning. The goal of the planning will be described by some such vague term as "the general welfare." There will be no real agreement as to the ends to be attained, and the effect of the people's agreeing that there must be central planning, without agreeing on the ends, will be rather as if a group of people were to commit themselves to take a journey together without agreeing where they want to go: with the result that they may all have to make a journey which most of them do not want at all.

Democratic assemblies cannot function as planning agencies. They cannot produce agreement on everything — the whole direction of the resources of the nation-for the number of possible courses of action will be legion. Even if a congress could, by proceeding step by step and compromising at each point, agree on some scheme, it would certainly in the end satisfy nobody.

To draw up an economic plan in this fashion is even less possible than, for instance, successfully to plan a military campaign by democratic procedure. As in strategy it would become inevitable to delegate the task to experts. And even if, by this expedient, a democracy should succeed in planning every sector of economic activity, it would still have to face the problem of integrating these separate plans into a unitary whole. There will be a stronger and stronger demand that some board or some single individual should be given power to act on their own responsibility. The cry for an economic dictator is a characteristic stage in the movement toward planning. Thus the legislative body will be reduced to choosing the persons who are to have practically absolute power. The whole system will tend toward that kind of dictatorship in which the head of the government is position by popular vote, but where he has all the powers at his command to make certain that the vote will go in the direction he desires. Planning leads to dictatorship because dictatorship is the most effective instrument of coercion and, as such, essential if central planning on a large scale is to be possible. There is no justification for the widespread belief that, so long as power is conferred by democratic procedure, it cannot be arbitrary; it is not the source of power which prevents it from being arbitrary; to be free from dictatorial qualities, the power must also be limited. A true "dictatorship of the proletariat," even if democratic in form, if it undertook centrally to direct the economic system, would probably destroy personal freedom as completely as any autocracy has ever done.

Source: Illustrated Road to Serfdom.

Bill Rafter adds:

"I see the Fed, the Treasury, the SEC, long ranks of the new oppressors who have risen on the destruction of the old, perishing by this retributive instrument, before it shall cease out of its present use. I see a beautiful city and a brilliant people rising from this abyss, and, in their struggles to be truly free, in their triumphs and defeats, through long years to come, I see the evil of this time and of the previous time of which this is the natural birth, gradually making expiation for itself and wearing out."

My apologies to Charles Dickens (Tale of Two Cities, last chapter, spoken by Sidney Carton)



holidaysWhy do you hypothesize the Tel Aviv market rose before the holiday? Yom Kippur prayer, as Prof. Schnytzer suggested? What else do they know?

Adi Schnytzer comments: 

I simply couldn't come up with a better hypothesis. I guess you get so low that up is the only feasible direction left, right?

Nigel Davies responds: 

I think there's a flaw in this logic. The concern here is 'system failure,' which if it happens can mean that the profits from being short may be worthless anyway. Who knows, under some kind of post system martial law, short-sellers might even be rooted out and put on trial…

In my view there are two long bets; long the system's surviving and long personal/familial survival in some post-apocolyptic nightmare. So the most reasonable hedge is to buy survival items like freeze-dried food, blankets, medicine, weapons, a horse, some chickens and a couple of goats.

Anatoly Veltman adds:

A VeltmanYou are thinking of V-shaped bottom. Of course, other shapes of bottoms have occurred in history of every contract.

V-shaped bottom's dilemma is that environment created in course of a rout doesn't facilitate one's large reversal position - even if one correctly times reversal. The entire ecosystem deflates; so due pay-off will not be mathematically possible in favor of the bottom picker.

Theoretically, this should not be the case vis-a-vis a trendfollower, who correctly stays short all the way down, possibly even pyramiding. Except in 2008 — when shorting became restricted.

Sam Marx adds:

I agree regarding Cramer but in this downdraft we don't know how far it will go even if stocks are undervalued now. But stocks have a tendency to overshoot at opposite ends.

In '87 when there was a one day sell off of approx. 23% I was clearing through a firm that had its start in commodities and the head of the firm was almost in tears claiming that the stock market was vicious compared to commodities. He gave up clearing and bought a bank in Chicago.

I saw Mike Huckabee on Cavuto's Saturday program say that a "knowledgeable" friend of his suspects "economic terrorism" is behind this sell off.

In the end, undervalued stocks with growth potential will come back in price. That's the basis of Buffett's large purchase of KO (Coke) in '87. The stock was driven down by being part of an index where arbs bought the index future and sold a stock basket that included KO.

In '87 on the floor after that big one day down, I sold overpriced far month out of the money calls and bought an equal number of shorter month calls at the same strike price. Both were grossly overpriced. The plan was when the volatility dropped because of time the spread decreased and I unwound them. As a saving grace if the stock started to move up the volatility would've dropped and I could also unwind at a profit.



Everyone knows last week's 18% drop was the worst in DJIA history (10/28-present). Here are the stats excluding that week (but including Great Depression weeks):

Descriptive Statistics: week ret

Variable     Mean    SE Mean   StDev     Minimum  Median Maximum
week ret   0.0012  0.00038  0.02442  -0.1554    0.0025  0.1821

So last week's return (return?) of -0.18 was about 7.4 STDEV below the mean.

Not only not normal, but where to look for example periods to model quant strategies? We now see it was a mistake to exclude 00-02. Even 29-40. What about the KT boundary?

In honor of this occasion, one will ditch the clever-as-if-it-was-known tone of this web site, and offer an opinion:

There are periods when markets behave well and are amenable to characterization (quantitative or otherwise). And there are periods when they are not. If you could know this with any precision, you would be extremely wealthy; which by design makes it about impossible to know.

Markets wouldn't trade actively if there weren't opportunities, or if it were easy to tell genius from luck.

There are periods when markets behave well and are amenable to characterization (quantitative or otherwise). And there are periods when they are not. If you could know this with any precision, you would be extremely wealthy; which by design makes it about impossible to know.

Markets wouldn't trade actively if there weren't opportunities, or if it were easy to tell genius from luck.

Rich Bubb responds:

So this "characterization" could be a 3×3 cube plotted representation (albeit this might be a little simplistic for most of the SPEC-Listers), with axes listed, in no particular order:

x aka a bubble exists in sector/commodity, scale might read: "no chance" at far left end; hysteresis happening and/or lobagola should happen or just did happen being in the mid-zone/s; and price/cost up n% in m-time meaning "here there be the bubble monster" and tread lightly or get out as fast as feasible.

y aka the interest rate du jour… scale trending down means economy &/or mkt trending down; scale trending up means economy &/or mkt trending up… but the scale would be visually represented by an upside down bell curve. So, for example, if fed rate is trending down, then the might be converted to a z-scale transformed scale with 0 in the mid of the scale, +3 on high end of scale, and -3 (std devs) at the low end.

z aka axis might be volatility or put-call ratio, or money supply, or OBOS%, or your indicator of choice.

With enough data points one might be able to observe the rate of change in 3D as things (x, y, z) move about.

I think this could be done with the charting tools in Excel…

Phil McDonnell observes:

The analysis Rich Bubb has described is essentially a 3D scatter plot. There are many examples of 2D scatter plots in Education of a Speculator and Practical Speculation as well as any introductory stat book that covers regression. The 2D plots relate to regression of one variable in an attempt to explain or predict another. The 3D case would relate to the case of using 2 variables to explain a third one. The regression would be of the form:

Z = a * X + b * Y

The usual caution is to avoid variables which are serially correlated. Usually price CHANGE variables are not correlated because an efficient market will remove any such correlation. By the same token price LEVELS are always highly correlated. One notes in passing that interest rates are a kind of reciprocal of the price level of the underlying debt instrument. Thus interest rates would be expected to be highly correlated but CHANGES in interest rates or prices would not be correlated.

Volatility is a more interesting animal. Volatility and therefore Vix levels are highly correlated. Again it is probably better to use changes in Vix than levels.

A final note is that one can perform a two variable regression of the above form even in Exc3l. To do that you need to have the Analysis Tools Add-In loaded. The data columns should be right next to each other (vertically). Then the regression analysis can be performed by clicking 'Tools/DataAnalysis/Regression'. 



Brian, the H@rvard Club chef, made Aubrey a hat just like his. Aubrey poses with Helman, our waiter:



A VeltmanThe three-day latency wreaks havoc for those who try and use Commitment Of Traders report for forecast, rather than just for objective description of preceding market composition. SP slide 1169-> 1006 (down 13%), included in five-session move ending 10/7: uncovered Bearish C.O.T. divergence of unprecedented degree! To sum up regular+miniSP: Commercial Net Short rose 64,000 regular SP contracts; while Funds Net Long rose 30,000 and Small Spec Net Long 34,000! Also unprecedented was Small Spec desertion of commitment overall: their "Net Long hike" resulted from halving of their entire futures Short interest! All this certainly explains subsequent past-10/7 rout, which brought SP further down 1006-> 891 (another 11%), since the period of report capture. Who knows how commitments might have changed over the past three days…

Throughout the panicky activity of the past month, there was un-paralleled number of attempts and methods to account for past and predict future. One can't hold oracle status in all areas of fundamental, technical, historical, philosophical, social and political analysis. What piqued my curiosity — and I must admit, it was not for the first time in my 22 years of 24-hour vigil (i.e. some 200,000 hours of real-time markets): the Commitment of Traders, heavily flawed and latent by definition — did filter out Stock crash, Currency crash and Gold/Treasury "non safe-haven."



caneOver the years, I've enjoyed and preferred the company of working people. The people I'm referring to are fishermen, lawn guys, lifeguards, surfers, and other blue collar types. These people live without credit, loans, real estate, bank accounts, or any other financial instrument, save for their eventual social security benefits. In the past couple of days, I've had five people come over to my house wanting to buy common stock. Without exception, they weren't able to open accounts at brokers, and want to buy good stocks because they heard that stocks are cheap, and they believe in America. They all came over, cash in hand, asking if I would get down the trades for them. They wanted me to buy the stocks and sign over the certificates to them. I wonder what kind of indicator this is, as I've never seen anything like it.

The Fifth Amendment allows me to decline to answer whether I accommodated their requests.

Stefan Jovanovich adds:

Canes come in all shapes and sizes and styles. My paternal grandmother, who remained illiterate in her native tongue of Polish as well as in English for her entire life (probably because of undiagnosed dyslexia), took grandfather's stash of double eagles saved from digging ditches and bought a 3-story rooming house in Denver after the 1919-20 crash for 12 cents on the dollar. Even in the Depression it generated enough free cash flow for her to send all 3 children to the University of Colorado. The money from the sale of the property after her death sent 1 grandchild to the same school in the 1980s, which may signify more about the relative value and price of education in the 1930s versus the 1980s than anything else.

Vinh Tu responds:

Suppose one is operating on the premise that a recovery will occur, but one has no idea how long it will take, or how low the market will go before recovering. What is the optimal trading strategy? I think it should be some kind of optimal Kelly fraction. If one maintains a constant fraction of cash and equity, as stocks approach zero, one's number of shares approaches infinity, which is nice once they recover. If the stocks actually REACH zero, then hopefully one has also stocked some canned food, ammo, etc and learning the art of shoemaking.

So what is the optimal ratio of cash and stocks? What assumptions do we need?



horseAs disorienting as the financial panic is, it is interesting that the U.S. economy is generally strong, apart from finance and housing industries, and unionized automakers. Home prices fell the most where they were some distance from job centers. The long commute to the Bay Area from Stockton and Modesto allowed those locked-out of Bay Area housing by local government home-building restrictions to commute from distant but reasonably-priced homes to well-paying jobs.

Easy money and and Congressionally-promoted bad lending practices inflated the price of new homes in Stockton, Modesto, and other distant suburbs, but high gas prices made them much less attractive. Gas over $4 a gallon made it harder to pay mortgages, and the demand for these homes fell.

High gas prices stalled SUV and truck sales, both profit-centers for US automakers (and slashed boat and RV sales). And high oil prices raised transportation costs across the US economy, reducing the economic advantage of America's integrated production and distribution inside the world's largest free-trade zone. And high prices hurt airlines and all those who operations depend on inexpensive business and tourist travel.

So now we have oil prices crashing down as demand falls and production in Asia and elsewhere has risen in response to higher oil prices. The media likes to emphasize the slowing economy as the cause. But though the housing and financial industries are down, the rest of the economy has continued to grow. Miles driven dropped dramatically as prices rose, but American industry expanded quarter by quarter.

Newspapers report that oil production rose unexpectedly in Asia this year. Production increases in response to high prices are unexpected only to reporters. In the U.S., increased oil production is banned by regulations on exploration and development in western US, and offshore, where state and federal socialism prevails. And environmentalists stand ready with litigation and lobbying as exploration and drilling bans are relaxed. But in Brazil, Africa, China, and the Middle East, energy enterprises enjoy more freedom to explore, drill, and produce, and both oil reserves and output are rising.

With oil prices down to $84 today, transportation costs fall dramatically across the U.S. economy from July highs, and leave consumers with more disposable income. Consumers will have more money to spend, and businesses will see energy costs drop. Housing in the far suburbs will become more attractive to workers willing to commute. Should we look this energy gift horse in the mouth and once-again fear dependence on foreign oil? I would argue that the only thing we have to fear is government itself.

Congress stands ready to protect consumers from lower energy prices with "renewable" windmill and solar mandates, and managed to stuff 100 pages of new alternative energy regulations, subsidies and carbon audit decrees (preparing the way for the coming carbon tax) into the financial bailout bill. Now that the bill has passed, Congressmen and the rest of us will have time to read through this new tangle of wishful thinking and special interests that has become the law of the land.

So, the U.S. economy has a few months to recover with lower oil and natural gas prices, until the next Congress slaps on a massive Carbon Tax to fund the vast array of government programs they were unable to slip into the recent bailout bill.



skullI note with a certain degree of gallows humour that today's villains are highly regulated institutions like commercial banks, insurance companies and broker dealers. Ten years ago, the LTCM debacle had the wolves crying for greater regulation and transparency of fast money. Now the hedgefund community is relatively healthy and will attract huge inflows once the dust settles. The key is that most are not publicly traded (though some are) and have reasonabe lockup periods and few disclosure requirements. In short, they are nimble. The big boys lke GS, MS, JP etc… insist on being global banks and hence require massive amounts of capital accessed via the capital markets. I wonder what Mr. Market will think is the most appropriate market intermediation model 10 years from now?

Philip McDonnell adds:

Regulation is a dirty word to most free market fans. It always entails cost, both to the operating businesses and to the tax payer. After all running a regulator involves an expenditure of public dollars. Having said that some sort of independent oversight is necessary so that the con men and charlatans do not dominate the market place.

However a large part of the responsibility for the current financial crisis can also be attributed to the current regulatory environment. In particular FASB, the Financial Standards Accounting Board changed the rules in the middle of the game. FASB promulgated that the banks had to revalue their sub-prime assets this past summer. Particularly hard hit were the securities which had to active markets. The net result is that banks which were caught 'holding' found huge swaths cut out of their portfolios. This was true whether or not the underlying mortgages were performing or not.

Strictly speaking FASB is not a government entity but it is as least partly government funded. The directors include people from government and the private sector. Mainly they are accountants.

What is needed in the current environment is less restrictive regulation not more. If anything we need to undo the draconian measures which are killing bank asset valuations. To be fair FASB is now quietly revising its earlier directive of only 90 days ago. The original directive was undoubtedly intended to strengthen the banking system. Yet the proximate result was to topple the House of Morgan and WAMU and to bring the entire banking system to the precipice within 90 days. What were they thinking?

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

Stefan Jovanovich responds:

The House of Morgan" would, by Morgan Sr. and Jr. and Mr. Peabody's calculation, be J.P. Morgan Chase, not Morgan Stanley. The idea of looking elsewhere for the funds to support your positions in the market would have seemed to them incredible; even as a market maker you always had to be in a net cash position. (The reason Ron Chernow's book on Morgan is good only for pulping, in spite of the author's extraordinary industry, is that he can only see the Morgan Bank with modern eyes. Whatever Morgan, Peabody and J.P. Morgan & Co. were, they were not a 19th century Bear Stearns with the added advantage of being Episcopalians.) The Morgans and their original partner would have found the Treasury's current rescue plans to be fundamentally wrong-headed. They would have wanted the Federal Reserve and the solvent member banks to buy the failing and failed banks' non-speculative liabilities - the savings and transaction deposits - and left the shareholders, derivative claimants and creditors to liquidate the assets on their own, with or without the help of the bankruptcy court. M Sr.,M Jr. & P would have scoffed at the idea that governments should, would or could reset asset prices in the midst of a panic by writing checks based on their ability to issue sovereign debt. That fantasy is one that only the 20th and 21st centuries have accepted as wisdom.



I don't know about the US, but over here in the UK REITs are now trading at a huge discount to presumed asset value. Looking at some charts, they also seem to be leveling off. Any views on REITs as an investment right now?

Al Humbert writes:

Just happen to be following hospitality REITs, and they are getting pretty cheap by any measure. Many are priced such that if the dividend is reduced by 50%, they will still yield double digits or more. Also, most if not all have market caps below net equity, some as much as 50% below. Equity is mostly the value of the properties, but even if that is reduced substantially, there is still a lot of value. A big concern is refinancing existing debt, but many REITs have debt structures that do not significantly re-fi until 2010 or even later.



You may want to whip yourselves up one of these. I am making my wife and myself one for the first time tonight. My arteries are begging for mercy just looking at the pics. Someone has come up with the idea of using grilled cheese sandwiches as buns for a hamburger. I will be adding bacon, of course.



xmasNext to the Belpre Post Office is one of my favorite stores, Dollar General. They sell a little bit of everything and sell at a fair price. They have a nicely stocked rack of various greeting cards for all occasions for two for $1.00. I noticed today they have in place a nicely stocked rack of Christmas cards! Likely the upcoming Christmas shopping season will be terrible for retailers.

Anyone have any figures on the TV home shopping networks?



S&P continuous adjusted futures:

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



CramerMany signals abound that selling may soon be exhausted. Add to the growing list the TV channel selection list in my local gym. I'm told that two years ago many patrons complained about the lack of CNBC or Bloomberg News on the large flatscreens at my Park Slope gym. Now, those channels and other business channels are being banned. It seems the aerobic hipsters prefer ESPN and Seinfeld reruns to the daily blight offered up Cramer and Co.

I, like everyone else, am dumbfounded by the violence of the selloff and the near universal Armageddon sentiment. Stocks are proving to be one of the few examples of positive price elasticity of demand. Prices fall and demand collapses whilst rising prices lead to higher demand. I'm sure it has to do with some sophisticated utility theory. I wonder if the universe's greatest certainities are calamities (war, poverty, famine etc…) or can we still hope to overcome the odds? I'm banking with the optimists but is really tough going.



Seven down days in a row in DJIA total about -21%. Looking for past cases with exactly seven in-a-row down (ie, UDDDDDDD) 1928-present, the current run appears to be lowest. Here are UDDDDDDD down more than -7%:

Date            UD7          next 10d
10/09/08    -0.209    ?
04/08/32    -0.185    -0.064
09/20/01    -0.165     0.082
10/18/37    -0.146     0.081
05/19/31    -0.101    -0.124
09/30/74    -0.098     0.108
07/16/02    -0.097     0.024
04/02/31    -0.087    -0.057
08/16/74    -0.083    -0.072
05/27/38    -0.077     0.036
10/16/79    -0.076    -0.007
11/06/73    -0.075    -0.075
06/26/62    -0.073     0.099
03/26/29    -0.073     0.014

Stats (not shown — don't matter) for next 10 days are only significant for huge variance.

Q: Doesn't govenment takeover of financial firms worsen stocks, since it either dilutes or destroys shareholder equity? Is the tongue-in-cheek talk about socialism "be careful what you joke about or…"?

keep looking »


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