The market has moved up impressively like a race horse running a fine long course (narrow volume though). Only the aging Colonel Bob Dixon (the unseen market driver) can jockey the still robust and beautiful steed, Ol Rebel Commander. The shiny black bridal straps mirror the deep beautiful eyes of the well kept race horse. The crowd loves to watch their favorite at the holiday race as the Colonel takes the prize despite his age and the danger associated with racing an older horse who doesn't run regularly.

Wouldn't it be wise for Colonel Dixon to finally sell the horse (market) to this young man (Ben–the public)? Yes, it would be prudent on all accounts for the deal to get done and through the urgings of caring matron and unwitting lass to arrainge a fair market price for the deal. They even throw in the custom bridal as a courtesy since the horse is accustomed to it.

When the public hitches Ol Rebel Commander up to a buggy and drives on home (buys into the recovery story and long the market) its odd how the horse runs right up on the boardwalk instead of stopping in front where the hitching posts are. And isn't it odd how the horse has to be guided through turns in the road, as if it would just run straight into the high grass if left to its own ways?

After the horse is home and properly taken care of, watered and fed, bedded and inspected–the truth of those deep beautiful eyes becomes clear. The eyes are blind, the high buff black leather bridal reflected a shine to them at point of sale and the Colonel was the only one who could jockey the Rebel Commander through a local race track that the horse had run many times before he went blind.

And you can't return the horse now, you are too far away now and it would hurt the girl's feelings and the Colonel's reputation. Somehow you like this horse anyway, so you put the bridal on and walk out of the barn.

The market seems to be guided by a very skilled jockey. This very low volume and technically narrow (local race track with local bettors) year long run has won a first prize (best 12 month move) The trusted and widely loved steed (that ol bull market dow of yesteryear) is loved by all. Now would be a good time, after taking a prize to offload the market onto whomever is left of the public that sold at the lows of March 09. The constant bullish chattering of financial tv (the young lass) and the seemingly "ok" numbers that indicate a recovery to occur(wife's deep concern for the Colonel's welfare) combine to lure the public into the deal. The market looks great, runs great, but there is something about its eyes I am not sure of (M3 heading down).



 It is common sense that the stock market anticipates what will happen in the economy after some time. The invisible hand of the market driven by millions of investors who make decisions according to different quantity and quality of information eventually represent the best way to encapsulate and synthesize the current status and prospects of the world's economy. But is this always true? Or for some reasons markets are resilient to change and slow in timely reading the information available?

If this is the case, what are these reasons and when does this happen? Can markets be manipulated by strong hands or there are simply forces that render decision making viscous and create a breakout friction before markets actually change the course they are following? Like a ship takes some time before reacting after the wheel is turned.

These questions are relevant today as they were before the beginning of the crisis two years ago. As loan underwritings standards deteriorated, the securitized mortgage market developed a bubble in housing prices that continued for quite some time until it finally popped. Even if we now read on several reports that it was clear to many what was about to happen, until the very last moment almost everybody continued to play the same sheet of music. Investors, regulators, government. The markets went on with huge inertia along the tracked lines of unrealistic risk assessments, walking on quants' clouds and careless of gravity. The longer they continue the more violent is the reaction eventually.

It seems to me that currently markets are in a similar situation. After the impressive injection of liquidity in the system (like an adrenalin shot to the heart) aimed to restore confidence and normal functioning of shaken markets, prices of assets have reflated for over a year now. In order to do this, sovereign debt in Europe and the US is increasing to levels that everybody knows are unsustainable. Still, for political reasons nobody wants to take the bitter medicine that would be needed. The show goes on with cheap money poured into assets that go up with a regularity and pace that is almost unprecedented. Regardless of unemployment, housing prices that in some states are going down again, the contracting credit to consumers, some states and cities are very close to bankrupcy, banks continue to be seized by the FDIC, industrial production levels are still 10% lower now than at the pre-recession peak, durable goods orders are almost 20% lower now than they were before the recession began. Finally, equities are up 75% from the lows, but earnings are still almost 40% below their pre-recession levels.

Is this manipulation? When and how is this going to finish? Or actually this time markets are reading correctly what is going on and are simply anticipating a global recovery and the consequent future increase in corporate profits?

Laurel Kenner writes:

The wonder is that the market didn't go up much more, given the trillions of stimulus. Since '07, the market has made short-termers of all of us– at least, of everyone fortunate enough to still possess enough liquidity to trade. We're all dancing in the dark until the tune ends. Meanwhile, the music has changed in the bond market.

Russ Sears writes:

It is my contention that the markets are good at forecasting what is predictable. However, much is not forecastable, like the weather.

I will be presenting a paper Tuesday that Dr. Dorn and I have authored in Chicago Tuesday.

In it we content that faulty risks evaluations can cause neurotic outcomes, in individuals, companies, sectors and even whole economies.

The markets can become, and apparently did become, a mechanism to trade short term gains while coming at the expense of increasing long term risks from over-allocation of resources. The risks of over allocation is often a chaotic system, meaning it is impossible to predict specifically when and how hard it will crash. Statistically, this could be thought of as trying to predict when the correlations will become a self reinforcing mechanism approaching 1 . Or is more practical examples when would over- building of housing in California, Arizona, Nevada etc. lead to deflationary spiral and foreclosures and inability to refinance all across the country and world. Another example would be the over allocation of delta hedging and portfolio insurance in Oct 87.

I am hesitant to make predictions, especially after Bear Stearn then Lehman and AIG and a government run mortgage market in Fannie and Fredie. But I am not as pessimistic as many that this is only a short term bounce. This stems from my belief that while the mortgage markets securities economic value are difficult to predict… the markets are giving at least giving them a more realistic view of their worth given this uncertainty. If this discount for uncertainty is as healthy a discount as I believe; there is still considerable liquidity and value that can return to the markets once these values are realized and known. The markets, at least in my modeling, seems to still give a considerable chance to the deflationary spiral returning.

Mick St. Amour writes:

Paolo, thank you for sharing your thoughts. I like your comments on inertia because that is at work. I see this all the time with retail investors and as of right now that dynamic is at work in that those folks still haven t taken a bullish slant and have been slow to change their minds. most investors are slow to embrace a change in thought when conditions change and they tend to ignore what market prices tell them. They tend to get locked into some ideology and usually only change their belief until after bulk of gains are made. Best trades are made when you can find inertia still at work and market prices begin to shift in different direction opposed to prevailing view. I have found those to be the best low risk trades.



DJIA daily returns (1929-present) were partitioned into non-overlapping 50 day periods. For each period, counted number of days with return greater than 0 (up days). For the recent 50D period ended Friday, there were 33 up-days (66%), which is in the highest 3.6% count of 50D>0 for the series.

The attached chart shows 50D>0 counts for the entire period, and the stem-leaf below covers the tree aspect:

To clarify the stem-leaf, the rows tally (using the "ones" digits) the number of each 50D up-count. The second column of each row is the "tens", the first column is count for that row and all those larger, and each number to the right of tens row represents an individual count.

eg, for the bottom row: 5 3 44455

3 is the tens, and 4445 are ones. Thus there are five observations in this row: 34, 34, 34, 35, 35 (and they are the top 5 observations in the sample).

The row above the bottom counts: 10 X 32's, and 9 X 33's. "24" before this row says there are 19 in this row + 5 larger (in the next row).

Perhaps the ranking is clearer in the following histogram for the same data, with a marker ("o") above the current "33" count.



But wait…there's more!

The probability chart below incorporates a Kolmogorov-Smirnov test of normality for "count of up days within 50D periods". The P-value is N.S., and as shown in the graph, the [statistically non-significant] deviation from normality is due to "heavy tails" (too many high and low counts).



a mcmansion

What the Stocks and Bonds have that the Government does not is a mechanism to maintain the cash flows to the company to a positive present value. Meaning that through the financial markets management is held accountable for their actions. While clearly there can be some robbing the bondholders to enrich the stockholders and vice versa with leverage or without… management decisions still have to make the most long term sense to the business as a whole for Modigliani-Miller theorem to work as Rocky pointed out.

Monetary policy could never exist in a tax free world; what gives money its store of value is the ability to use money to pay  taxes on real taxable assets, be it gold or personal income. Government issued money would be only paper without the government's power to tax. 

Further, a liberal monetary policy debases the purchasing power of money, and therefore is a figurative tax on the past producers of wealth that have stored their value in fiscal assets. This of course drives up demand to store value by holding real assets, like McMansions or Dot.com start-ups, or commodities.

Whereas a tight monetary policy increases purchasing power, and therefore is a real tax on the future producers of wealth. Which erodes demand for real assets to store value and drives a demand for fiscal assets.

Perhaps soon they will see that the swings can be wild rides if they switch between the two quickly.

Finally, emerging markets are full of wealth to develop; like the boomers example competition increases wealth for all and there must be a hundred ways that the increase in wealth from the past 60 years is speeding up rather than declining.



one of the great pattern searchers --leonardo fibonacci

Since the publication of Luca Pacioli's Divina Proportione in 1509, many artists and architects have proportioned their works to approximate the form of the golden rectangle, which has been considered aesthetically pleasing. Wikipedia.

When it became apparent that we would have to move our rented art space to a new location, I used 3D modeling software to draw up a design for a new set of studios. I based each unit on a golden rectangle, and did the same with the entire block. I found a way to maximize the amount of light entering each studio in a scalable multi-floor design, and by the end it looked like a set of holiday apartments.

This vision remains in Sketchup, but the studio to which we transferred (serendipity!) is a rectangle very close to being Golden — length / width = 1.618.

It feels good to be and work there. I wonder if there is more than psychology to this effect.



General PetreusI am trying to think of some good people for my son Aubrey to model himself after, for a little letter I'm writing to him, on his fourth birthday. I have in mind the General Petraeus. He was a totally admirable guy (see Vanity Fair) and Jack Aubrey. Do you have any thoughts about what was admirable about Aubrey besides how he was so competent and loyal and exuberant?

Laurel Kenner explains:

Jack Aubrey was a great and thorough teacher, merciful, generous to enemies, gentlemanly in war, well versed in deception, capable of silence, a great friend to few, a leader who knew how to keep a happy ship, not petty, paid attention to details without losing sight of his big goals, a fine husband, a fine musician, and enjoyed his success without being a jerk.

James Lackey writes:

I like Cal Ripken Junior's post play as much as his game records. You'll notice "for profit" and G_d bless him and Tony Hawk (skateboards/bmx) that realize giving back means a for profit structure as the Non Prof structures I deal with drive me nuts — their entire focus is how to get grants vs. teach kids to play/race.

Rich Bubb comments:

JeffersonI wish my parents had pointed me at the Greater Philosophers and Intellectual Giants, like Lao-Tzu, Confucius, Ayn Rand, Niederhoffer & Co., Ken Smith, Aristotle, Franklin, Jefferson, and so many others I am still discovering. One must indeed seek to acquire the wisdom of the world-prior-one's-existence, for that is the very foundation upon which our unique and individual intellectual journey/ies depend.Finally, one must not only know the "Who" (i.e., person/s or group/s) to model oneself after, but equally important is the "Why". It is far too easy to emulate the wrong type of person, but that will only push your life in the wrong direction.

Ken Drees adds:

Certain story books a la Grimm's fairy tales were very stimulating to me. The germanic flavor of old crones in candy houses, scary dark forests, and other stimulating fantasy was magical to my mind. I would highlight that older children's books seem much better than newer ones that are PC dipped. And older books usually had nicer illustrations.

My son recently had to do a report on snakes. I gave him a book from the archive's "Wild Animal Pets" from the big golden book series 1959. Needless to say, seeing pictures of kids handling, caring for and interacting with all sorts of animals like kids used to do in the 50s was stimulating for him. Since it is spring, maybe Aubrey could be given a role model that highlights botany, some kind of person who represents learning the diversity of nature. Children like to look at plants, flora and fauna.

Russ Sears writes:

At 4 a bright young mind is connecting to the world of fantasy, imagination and legends. There are myths and Aesop's Fables. There are many great American pioneers, heroic sports figures and rags to riches stories of entrepreneurs. If I recall my childhood correctly, establishing a personal familial connection to those models made all the difference to me. 

Pitt Maner writes:

the sound of musicWith respect to books there was a big push to sell children's encyclopedias back in the 60s. Some of those were visually appealing to youngsters. I remember liking a Cowles Comprehensive Encyclopedia because it was one big thick book, sort of a handheld Internet at the time, and you could look up all sorts of stuff. But before that there were pictorial dictionaries with Albert the Alligator and other such characters. I suppose Sesame Street and Mr. Rogers came later and replaced those learning tools. Encylcopedia Brittanica Jrs. are also interesting to kids.

Frankly at that age cartoons, comic books, Disney movies (Sound of Music, Mary Poppins, Swiss Family Robinsons), and the TV characters Barbara Felden (Get Smart) and Barbara Eden (I Dream of Genie), I Spy (Culp and Cosby), Daniel Boone (Fess Parker), Star Trek (Spock, Capt. Kirk), etc. were my Sesame Street for good or bad. So good TV and movie characters can be useful models too.

Vince Fulco writes:

founder of aikidoMorihei Ueshiba, the founder of Japanese Aikido, is my role model. I regret not having studied enough of his work when I was younger. The messages of keeping grounded through thick and thin and self-reliance while not forgetting the needs of those around you are particularly appealing:

"The Art of Peace begins with you. Work on yourself and your appointed task in the Art of Peace. Everyone has a spirit that can be refined, a body that can be trained in some manner, a suitable path to follow. You are here for no other purpose than to realize your inner divinity and manifest your innate enlightenment. Foster peace in your own life and then apply the Art to all that you encounter."

Stefan Jovanovich comments:

Petraeus is Ulysses Grant; their greatest difference is that Petraeus has only begun to carry the weight of having 40% of the voters in the country hate him.

Alston Mabry replies:

After last night I have become a big fan of the Butler program and its coach, Brad Stevens– and that's coming from somebody who went to the other school in that basketball game. The Butler team believed in themselves, never gave up, played quality basketball all the way through, and it was just a terrific contest.

And I think Coach K has run a great program for a long time. Leadership, commitment, connection, bringing out the best in his players, focusing on his players and their experience. And getting results again and again. I would consider him as a model for many positive qualities. (Here's a story about K.)

The game last night was a great reason to love the NCAA tournament. Butler will be back in a big way next year. I predict they will not be a school that goes to the Final Four only once. (As long as Brad Stevens stays….)The Duke team that won last night has been battling it's way step by step up the tournament ladder each year, and this year to win it all after losing key players early to the NBA and transfer…it's just amazing to see their work and commitment pay off like this.

Jim Sogi writes:

Bruce LeeBruce Lee.  He was a master of martial arts.
Musashi Miyamoto.  He was a master of strategy.

Jeff Watson writes:

I found that when John was that three, I started reading children's biographies of the greats in society. I let him pick and choose the characteristics he wanted to emulate, teaching good from bad, etc. Later, when he was 5-6, he was devouring biographies like crazy. Still, after all the parenting, teaching, lessons, etc, the kids are going to turn out however they want (neuroses and all) and we as parents have little to do with it. All we can really do is teach them right from wrong, a little knowledge, sportsmanship, manners, good citizenship and respect for others. The rest is up to providence.

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

Chris Tucker suggests:

FeynmanAs for Jack Aubrey, I am impressed by his ability to take such pure joy in humor. His guffaw, belly laugh and knee slapping at the dumbest pun always made me laugh more than the joke itself.

I have Richard Feynman in mind as a person to emulate. The man was curious, curious, curious about everything. His curiosity and ability to find joy and humor, his practical jokes. His determination at one point to do nothing but have fun led him to the most incredible discoveries of his career.

Nigel Davies writes:

I think that most of these models mentioned thus far may be more suitable for when he's 12 or 13. For 4 year olds I suggest Thomas the Tank Engine. 

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

John Floyd comments:

I would focus more on the qualities one would wish to have emulated. Use tangible examples that are level appropriate. Then focus on the product of those qualities such as the people, achievements, etc.

The springtime blooms and growth are a reminder of what a strong foundation can bring in terms of fruit and flower. Some words to consider "To Dai Moto Kurashi" or "At the foot of the lighthouse it is dark" and "Setsu Do Motsu" or "Be strong and know when to bend".

George Parkanyi writes:

sir roger moore as ivanhoeEven after having 4 kids I don't feel qualified to dole out parental advice, but I will say that certain books (and by extension characters in those books) do make a major impression on one at different stages of life. I remember relating tremendously to Mika Waltari's The Egyptian. It wasn't until much much later– a few years before he died– that I found out that my mentor and friend Sheriffe was similarly impacted by that book. He was a fiercely independent (never married) and resourceful (never married) man, and half Egyptian himself in fact. He could (and did) recite the opening paragraph from memory. What resonated with me was that regardless of where I lived in the world, I would never be bound to one place– I would never have (or feel the need for) a "home". Even though I've lived in Ottawa most of my life and a little bit in Australia (my early childhood), I still feel that way. I could pick up tomorrow and move anywhere. My family means a lot to me, but my house or this city, absolutely nothing. Couldn't care less about them. The other book that had a strong impact on me was Sir Walter Scott's Ivanhoe. Not sure why; that was a long time ago. And the Jules Verne books of course earlier on.

Craig Mee comments:

tintinIf he goes into Politics… Ted Mack can be no better example. Aussie politics, has been waiting for someone to replace him ever since. He is the only person ever to have been elected and re-elected as an independent to local, state and federal government in Australia. During his term as mayor, Mack sold the mayoral Mercedes-Benz car, buying buses instead and instituting reforms to improve accountability. He retired two days before he was due to qualify for his parliamentary pension entitlements, as a statement against the excesses of public political office.

Sushil Kedia writes:

I would recommend Tintin, since Aubrey is to turn only 4 now. Of all the comic characters, the one that combines the ability to survive, penchant for resolving mystery, ability to befriend professor Calculus, over-come the Simpsons (who would be too many in any case in life ahead) and still make good use of them, varieties of fantasy, imagination all wrapped in an environment of light humor often reaching to shades of satire is the Adventures of Tintin. All of this is set in the backdrop of WWII, and would provide an intro to more serious war readings as Aubrey grows up.

Michael Pingo comments:

faradayI think Michael Faraday is name worthy of mention in your letter. Particularly, because during the peak of his popularity, so I read, he would give lectures on his latest discovery or invention closed off to London's elitist adults and instead would present to school children. The lectures came to be known as simply, "The Christmas Lectures" and the custom continues today.

How cool to master a topic by being able to present to young, curious minds. Not sure on Faraday's super religious bents, but none of us ever get it perfect…

Marion Dreyfus writes:

TinTin was and remains one of my all-time favorites for all the reasons stated, and because it has a richer-than-usual offering in terms of sophisticated vocabulary and story lines.



Here is a cool article about Centenarian Gertrude Matthews and the benefits of music, bridge playing, family and faith:

"She is a fantastic piano player, and she's very involved in our arts and crafts program," Lechiara said. "She's a beautiful, delightful lady — down to earth and very, very elegant." Matthews plays piano during cocktail hour once a week at 264 The Grill and plays bridge regularly in Palm Beach and Cape Cod. "She's a very shrewd bridge player," said Joan Driscoll, who plays bridge with her in Cape Cod. Matthews was a music teacher in Maine and Boston during the Depression. In 1937, she was playing piano at a political rally at Symphony Hall in Boston when a girlfriend introduced Matthews to her brother.



It is always interesting when a market 'takes off' or gets 'clobbered', a measuring percentage above the recent ATR, without any news service's being able to quantify above the usual rhetoric. I have often wondered if we could put a measure in place of a dozen drivers of the market, and if no ticks go in any boxes for the said day, then it would be very possible we should be on the move. Measurable by 2-5-10 day/one month performance after said event.

A gold example. I flew up a few days back, and I saw nothing above the norm, on the push from 1110-1130, now 1156 trading. Big pushes without any good reason, and even without any volume (I believe Larry Williams never found any use in volume), depending on your trading size, and the ability to limit risk in this day and age of instant information may be the leading indicator we need.



 The human body after a certain age (25 - 30 - 35?) doesn't take impact quite so well as it did prior to that age. My desire to jump or tumble or fall is diminishing by the day. Pain seems to hurt more and recovery time is increased. I think this phenomenom is a function of how many blows you took when you were younger/immortal/bullet proof.

What I mean is this: Had I know then what I know now (i.e. how much my knees/ankles/back would hurt today), I probably would have done things differently. But alas, my  athleticism fooled me into thinking that I was destined to play professional sports someday so I played hard and threw my body into every scrum, pile up, oncoming blocker, went across the middle and jumped to my full ability to catch every high pass, blasted through every catcher guarding home plate and took every hard charge to draw the offensive foul that came my way.

Unfortunately, athleticism does not make one aworld class athlete. High jumping for the college track team my freshmen year was the end of the road for me (well, except for church ball, and pick up games here and there).

The Bottom Line is this: The aches in my 46 year old body outweigh the adulations from the former glory days of my youth. Those days are but a memory, but the aches, unfortunately, will likely never go away.

Jeff Watson notes:

Being no stranger to skateboarding, skateboarders, and skateparks, I will note that the helmet issue is a very contentious issue with the skaters. I tried insisting with my son on wearing a helmet, which was a battle I quickly lost. especially for the freestyle casual skating. His excuse was that he never saw me wear a helmet while skating or riding a bicycle, for that matter. Plus, the peer group pressure was just too great for me to overcome. However, almost everyone wears helmets when they are lucky enough to find a pool, bowl, or good concrete drainage ditch to skate in as the danger level is moderately high. Personally, I still skate decently and quite often at the age of 53 and I always wear a helmet, as I learned that from the school of hard knocks. 

Pitt T. Maner III writes:

Having had bad wrist injuries in my family I would worry a little bit about that too. It's a balancing act though with being too overprotective and letting kids learn the risks themselves. My worst accident was falling out of a tree and breaking my arm. A memorable learning moment was shooting a BB gun at the ground and having it richocet right back between the eyes.

At age 8, started thinking about safety after that. You don't forget stupid mistakes like that. Better to learn with a BB gun then with a .22. You wonder though how my dad's generation survived– sending up home-made hydrogen balloons with Roman Candles, playing around with any number of electrical circuits, Windhurst machines, transformers/electrical coils, making thermite "bombs" to burn holes in the asphalt street outside, making home-made wine from Scuppenong grapes with occasional explosion of bottles, shooting at each other with BB guns, shooting guns in general, slingshot accidents, riding unruly ponies, high pressure German steam engine toys, playing with massive M-80s and other potent fireworks from Texas and on and on. Wild Indians and Mad Scientists at work.



Please correct me if I'm wrong, but am I right in thinking that the particular suitability of Markov models to interest rate derivs derives from the term structure of interest rates vis a vis the section of the wiki entry that states:

"Since the system changes randomly, it is generally impossible to predict the exact state of the system in the future. However, the statistical properties of the system at a great many steps in the future can often be described"

Here is an abstract of a paper that might be of interest.

We introduce a general class of interest rate models in which the value of pure discount bonds can be expressed as a functional of some (low-dimensional) Markov process. At the abstract level this class includes all current models of practical importance. By specifying these models in Markov-functional form, we obtain a specification which is efficient to implement. An additional advantage of Markov-functional models is the fact that the specification of the model can be such that the forward rate distribution implied by market option prices can be fitted exactly, which makes these models particularly suited for derivatives pricing. We give examples of Markov-functional models that are fitted to market prices of caps/floors and swaptions.

Bruno Ombreux writes:

I just checked "Analysis of Financial Times Series", by Tsay. It is a relatively recent book so should be almost state of the art. It looks like Markov chains are used in two areas:

- better time series modeling, with regime switching.

- MCMC as a tool for Bayesian inference, whose main financialapplication at this point seems to be stochastic volatility models.

Practically, that would mean applications in "ever changing cycle" detection and option pricing/hedging.

On the first point, I personally toyed with Hidden Markov models. They work well in hindsight and are able to detect transitions between (high volatily / bear) and (low volatility / bull). But:

- this is all in hindsight. "Past performance is no guarantee…"
- this is low frequency data and I am not sure that the fact they could
detect the handful of past secular changes is that much useful. - a simple volatility threshold might do the job just as well without complication. - what you end up with is a probability transition matrix, which is not very helpful given that you are looking at only a few cycles.

… Maybe they could be more interesting in high frequency. I don't know.

On the second point, my opinion about option pricing is that the price of an OTC option is "as high as the buyer is prepared to pay". Models are an excuse. So I am not sure bayesian stochastic volatility models beat "seat of the pants" marketing.

Phil McDonnell adds:

If we look at the Niederhoffer-Osborne data on p. 899 we can see the number of times the market went from a don tick of various sizes to an uptick state. The reverse is also enumerated. I will take just the -1/8 state and +1/8 to illustrate the following. This matrix is the transition matrix by number of times each prior state led to the subsequent state.

            -1/8       +1/8     total
-1/8      231        777      1008
+1/8      709        236       945

From this we can compute the probabilities of being in each state given the prior state in the previous time period (trade).


           -1/8       +1/8      total
-1/8      .23        .77       1.00
+1/8      .75        .25       1.00

For Markov analysis we can make a prediction by multiplying the probability matrix by the vector which describes the current state. The result is a new vector of probabilities of being in the two states given the initial state. To predict two states ahead we multiply that by the probability matrix yet again. Let us take S as our starting state and P as our probability matrix. Then a prediction k steps ahead is given by:

S(k) = S(0) * P ^ k

Note that * is the matrix multiplication operator and ^k means to multiply P by itself k times.

What often happens is these matrices arrive at some steady state equilibrium after k iterations and we get the happy result that the probabilities are unchanged from iteration to iteration.

Russ Sears writes:

the Society of Actuaries has many research articles using the Markov Chain process. To see them all type in "Markov chain" into their home web search. I believe one of the best papers to give and intuitive understanding of its use and power and limits, is Ms. Christiansen's paper in which she gives a brief intro to many different interest rate generators.



Suddenly my "buy" list has a large number of companies which have never graced the list before. They are property and casualty insurers. Although they have sufficient capitalization, their volumes are too small for me to get involved. Does anyone know why they would be in favor?

Dan Grossman writes:

B RVolumes too small for you to get involved… You must be quite a heavy hitter, trading millions of shares.

I don't know what you mean by in favor, but because the insurance companies held mostly bonds, including mortgage bonds no one knew the value of, they were beaten down to very low levels, below book value, PE multiples of four or five. Now bond valuations are normalizing, and I guess the insurance stocks are returning to reasonable levels.

Scott Brooks writes:

I deal a bit in the insurance world and I have to say that this baffles me. Insurance brokerage firms that I deal with are hurting big time. Premiums are down as small businesses (which insurance brokerage firms have as clients) continue to layoff, not hire, and generally decrease payroll.

Maybe their revenues are down, but their margins are looking better, but I find that hard to believe since every P&C guy I know is busting his butt to bring on as many new clients as possible and bidding as low as possible to "buy" the business. The problem is that their competitors are doing the same to them.

Vince Fulco comments:

A few I follow remain at a healthy discount to book value (WTM, CNA) and I've been wondering when the rising tide would lift these ships–  since other industries are being given the benefit of the doubt that conditions are normalizing — and when would some of them get credit for adequate portfolio management and improving pricing and underwriting activity. Loosely speaking, a properly running P&C company can trade from .9-1.3x book and when the punch bowl really overflows, multiples of 1.5-1.8x are possible. Still plenty of room vs. normalized valuations. Why it has taken the crowd until now to really start bidding them up, I remain puzzled particularly vs. underlying corporate performance. It would seem the investors wanted to wait the half life of the bond portfolios to ensure no more problems as most run short duration portfolios.

Secondarily, there had been concerns within the industry about six months back that the Obama administration would go after the Bermuda-domiciled ones doing biz in the US for a bigger tax bite. That seems to have fallen by the wayside for now. Talking my book as I've owned WTM off and on for the last seven years.

Ken Drees adds:

The big question is since these insurance companies were screwed by their debt holdings, took writeoffs and have muddled through — some with Tarp but most P&C did not get Tarp — where do these companies park their cash now? They used to make money in the derivative leverage through the bond kingdom — outside of normal operational gains through underwriting. What is the risk of their holdings now? I don't see many stock buy backs from these guys and I don't see dividend rates that have gone up — both factors here would show that companies would rather pay out earnings or reinvest in themselves. Will they be able to ring the registers as normal through the bond markets? 

Kim Zussman replies:

At a recent lecture by a business law attorney, the take-away message was "everyone needs business practices liability insurance." He went through a litany of litigations; violations of overtime laws, rest-breaks, bonuses not being factored into overtime calculations, performance reviews, extensive paper-trailing, s_xual harassment (including a married doctor who had relations with a woman six times before hiring her, then continuing to pursue her on the job).

In an environment of increasing regulation/litigation, empowerment of little old ladies in lieu of rich guys, and increasing taxes, the deductible expense of increasing insurance coverage could make sense — even though lining pockets of bureaucrats and their legal co-conspirators.

Phil McDonnell asks:

Vince, I have a question. For CNA the ratio of receivables to revenue is about 100%, for wtm it is about 75% (by eye). That would correspond to 12 and 9 months worth of receivables they are owed by their customers. Are their customers really the slowest payers in the world or am I missing something? 

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

Vince Fulco responds:

Not sure where you are looking but the largest receivables on the balance sheet from the last few years relates to business they've reinsured with others. WTM management is generally more risk averse than their peers and is inclined to cede segments of their business to better define their upside/downside. These arrangements have truing up terms, conditions and times which make the receivables ratio more lumpy than an ordinary industrial concern. The mix of biz between them and CNA is probably another factor.

If you are speaking specifically to 'insurance and reinsurance premiums receivable', they've been 21-22ish% of revenues for the last few years. I have no specific answer for that but it doesn't seem out of line if we think of the balance sheet as a point in time.



Tiger wood's apologyI'd like to hear from readers of this site on the subject of apologies. We seem to be inundated by them from the sporting world to Wall Street and beyond.

Here's my question. If you're the one who has felt injured, then the other person simply saying, "I'm sorry" does not seem to ease your pain as much as, "I'm sorry, I was wrong." However, many attorneys will advise their clients to perhaps say you're sorry, but never admit wrongdoing, because that only invites the other party to seek damages from you.

Maybe the distinction is between disappointing people in your behavior who believed in your character where admitting you were wrong will not set you up for legal or other retaliation, whereas in instances where you actually did harm to or cheated others, admitting you did wrong might not be a good idea.

Here's my question. If you committed wrong either intentionally or unintentionally, when should and shouldn't you admit it?

My initial answer is that if you committed something intentionally and/or with malfeasance you really do owe it to the other person to admit you were wrong. If however you didn't do it intentionally or with harm in mind you can say, it was wrong (as Clinton admitted during the Monica Lewinsky situation).

in matters of the heart a formula I have discovered that works concerns the 4 H's and the 4 R's. What do you think?



the asset side of the economy
I think we have a problem that stems from a confusion between the asset side of the economy and the liability side of the economy. The assets are land, plants, people. They produce something. They create wealth. Sometimes this is called "the real economy."

The liabilities are financing the asset side, but they don't create wealth by themselves, or only at the margin (via tax arbitrage mainly). They are: stocks, bonds, etc… They are the oil in the engine, not the engine itself. The Fed is part of the liabilities.

What macroecomics is sorely lacking is a Modigliani-Miller theorem. As you know, the Modigiani-Miller theorem is a corporate finance finding that what matters is the asset side of the balance sheet, not the liabilities. The way it is financed doesn't change the value of a firm. It needs to be extended from corporate finance to macroeconomics, and I am happily providing it here as a conjecture, because at this stage it is not a theorem yet: "In a tax-free world, finance is irrelevant to the real economy." That means monetary policy is irrelevant, the Fed is irrelevant. What matters for wealth creation and growth are people, plants, and land.

Things were going well until the late 1990s because of the asset side:

1. reconstruction after WWII
2. baby boom
3. cheap oil
4. wave of innovation
5. no competition from emerging countries– they were communist, and, in hindsight, communism was great for Western Europe and the USA, because it meant less international competition

All these positive factors meant the asset side of the economy created huge value. It would have done so with or without monetary policy, with or without central banks, with or without banks actually. Now the positive factors are gone. The real economy is doing poorly and it will do so no matter what is done in terms of monetary policy, which is I repeat, irrelevant.

That's why we can have huge unemployment, that's the assets world, and a booming stock market, that's the liabilities world. They really operate independently.

Alston Mabry writes:

I'll bite.

The last few years appear to have been a story of how much finance does matter, unless one argues that the global downturn was a purely secular matter coincident with a financial collapse. Now, I have felt that the importance of the cyclical downturn in real demand got less credit than it should have, but it would be tough to argue that finance doesn't matter.

At any given point, there is some interplay between the finance side and the real asset side. The nature of that interplay changes over different regimes. There are times when lax monetary policy is just "pushing on a string" because there is no demand waiting to be unleashed by loose money. There are other times when changes in policy can have a much larger effect. And monetary policy is just one vector of finance. Finance can matter a lot, in different ways, at different times.

The asset world and the liabilities world certainly can operate independently, but we may also be seeing the markets work as predictors of what is going to happen in the "real" world.

Rocky Humbert disagrees:

I disagree that what macroeconomics is sorely lacking is a Modigliani-Miller theorem.

The practical interpretation of Modigliani-Miller is that leverage doesn't matter (to an enterprise) and while it has limited merit in structuring an enterprise during normal times, any sensible executive (or hedge fund manager) who has lived through a severe business contraction or credit squeeze will laugh at the notion that leverage doesn't matter. M-M correctly observes that a lousy business with 2% ROE is still a lousy business with 20% ROE (after 10:1 leverage). However, M-M doesn't say that a decent business with 7% ROE can be turned into a lousy business with 70% ROE (after 10:1 leverage). That is, leverage can't turn a lousy business into a great business, but it can turn a great business into a lousy business. After after that cyclical downturn, the company with less leverage will have less competition, more market share and greater unleveraged ROE. Lastly, if debt doesn't matter, why does anyone care about a rising national debt? Given the choice, I'd prefer a restoration of the Papal Vix Pervenit to a M-M in macroeconomics.



 Amazingly, no one has asked me who Aubrey was. Here is a beautiful heroic tribute to him from the heroic Chris Tucker.



Starting Monday the Earth was hit by a series of Coronal Mass Emissions which were the strongest in over three years. The CMEs produced a spectacular multi colored aurora show at both the North and South poles and lower latitudes. According to an Atlanta Fed study the CMEs are also associated with temporary weakness in stock prices in affected countries. The usual lag is about 3-4 days. The Fed paper gave no reason for the hysteresis.

The paper by Robotti and Krivelyova is here.

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



 One has always hypothesized that holidays are inordinately associated with major turning points. One hypothesizes that the correlation between the extent of bailout and subsequent economic recovery between countries is not zero. One notes the story from The Book of 5 Rings where a group of wealthy samurai were traveling in Kyoto and were met by a vanguard of vassals telling them that a group of noblemen were behind them and they should bow down on floor in prostration. It turned out the noblemen were robbers and stripped them of their clothes and honor and the samurai had no recourse but to renounce their profession out of shame. What lessons does this have for markets, market people, and others? One believes that the early leads in basketball games and other games tend to be increased in subsequent parts of the game. One hypothesizes that the expected change from the time that the NBER announces that a recession is over or started are opposite in direction from the economy's current announced state — i.e., after they announce a recession the market goes up more than after they announce an expansion.

Rocky Humbert writes:

The continuous surfeit of negativity over the past year (and now hints of protectionism) makes one ponder whether one fell asleep during the housing bubble and awoke in Bizarro World (the mirror-image of Superman's world)… A successful investor doesn't need to either celebrate unemployment (Dr. Rehmke) nor declare millions are out of work forever (Dr. Dreyfus). Both statements are simply provocative– it's much less dramatic to simply observe that employment is a lagging indicator. (Yawn.) Perhaps it would be good medicine for all– if the Chair resumed his slights toward Alan Abelson (last mention July 20, 2007), and prior to that more than once/month. Most importantly, for those who are looking for a "major turning point," I share the words of Bruce Kovner, with whom I had the honor of briefly working: "Listen to the market."

Put simply: for the past year, the optimists saw a monetary/fiscal cyclical recovery with the yield curve predicting growth and inflation. During the same time, the pessimists saw a false stimulus/inventory uptick with the yield curve predicting troubling deficit/supply overhang. (No one expects the job market to recover meaningfully before 2011+.)

By any standard, the pessimists have been horribly wrong. But instead of acknowledging that things are improving, they are being Alan Abelsons, digging in their heels, and predicting that the next huge downturn is just around the corner.

Pitt T. Maner III comments:

Trying to be more in the optimistic camp it looks like the US unemployment fits a hysteresis model. Sort of like TW at Augusta and at home–it could take awhile and that's if there are no more more shocks along the way! :

1. According to Caporale and Alana , two well-known facts about the unemployment rate are

(i) the high persistence of shocks, or hysteresis (see Blanchard and Summers, 1987), which is a feature, among others, of "insider" models (see Lindbeck and Snower, 1988), or of models in which fixed and sunk costs make current unemployment a function of past labour demand (see Cross, 1994, 1995), and

(ii) its asymmetric behaviour, namely the fact that unemployment appears to rise faster in recessions than it falls during recoveries.

2. The next survey of Professional Forecasters will be May 14th, but most see an improving jobs situation. Slow at first but accelerating by end of current POTUS term.

3. Interesting chart of GDP fall vs. unemployment rise (Okun ratio). Less regulations in US (and Canada) would seem to be a long term positive, but the US and Canada sensitivities to GDP fall are higher because workers can be let go faster.

Kim Zussman adds:

Here is an update on P/E type-forecast, with a caveat about markets remaining irrational…if they feel like it.

Pitt T. Maner III comments:

What about the case where you may be moving quickly from high P/Es to lower estimated 12-month forward P/Es? (i.e. S&P 500 going from 31 one year ago to 23 now to possible 15 in 12 months time). So if you have a high rate of change in the P/E downward (if numerators continue to grow) that might make the positive portion of the bars more likely?

It seems with the P/E in the 15-17 range you have more variability in range of returns but the forward dividend yield would still indicate lower returns given yield of 3.4 (one year ago) to about 1.8 today.

Jordan Low replies:

I think that the 10 year data mines the worst case as it includes both the dotcom and subprime busts. The peak of the dotcom was almost exactly 10 years ago, and investors in 2000 weren't looking for E. (They preferred g.)

I understand that the long window is supposed to average the business cycle. Well then, the window should be variable. As of right now, we are getting bad earnings from two crashes and many of those companies don't exist anymore. Perhaps it says something about the unfortunate timing of two bad periods and growth of the Internet being captured by late comers (e.g. Google and Facebook) rather than early adopters (AOL and Yahoo). Being an investor in today's market, not yesterday's, may still be attractive.



Using Fed data, I calculated corp bond spreads: BAA yield - 10Y treasuries, weekly from 1990. (Data = "Market yield on U.S. Treasury securities at 10-year constant maturity, quoted on investment basis", "MOODY'S YIELD ON SEASONED CORPORATE BONDS - ALL INDUSTRIES, BAA").

The graph shows fairly close correlation with VIX, with the eyeball suggesting closer correlation since 9/11/01. Verified by correlation post and pre 911:

pre 9/11:   0.038

post 9/11:  0.218

David Aronson comments:

John Wolberg and I have done some work to derive a normalized version on VIX in order to produce a more accurate timing signal. However we only used various measured derived from price data as normalizing variables (price velocity, acceleration and volatility). We were able to obtain some improvement. However it appears that including the default spread might improve things even more. Anyone interested in a copy of the paper email me, aronson[at]mindspring[dot]com.



Reviewing some stats I noticed that the top four first quarter sectors of the S&P 500 index were in order: industrial, financials, consumer discretionary and consumer staples. Likewise manufacturing, financial, and retail all had large percentage decreases in workers over the last 12 months according to FRED. While definition of sectors on the S&P and government statistics are not aligned., it would appear that the lower number of workers are highly correlated. But I suspect that this has more to do with where we are in the creative destructive cycle.



One notes the following 100-day volatilities on Aug 4, 2007 and April 6, 2010:

Instrument    8/4/2007      4/6/2010

SPX             13%              13%
CrudeOil       27%              27%
Copper         28%              28%

US Bonds(1)  6%               10%

US Bonds(2)  4.4%             6.1%

Bunds          4.0%             4.7%

Dollar Index   6.0%             8%

It appears volatility in so-called "risk assets" has uniformly reverted to 2007 levels. However, volatility in so-called "riskless assets" has actually increased versus that earlier snapshot. Some of the bond volatility can be attributed to the  futures "roll" (due to a steep yield curve), however, the divergence is still noticeable.

One wonders if this anomaly is significant or predictive?

[Footnote: Crude, Copper, Bonds and Bunds use the first nearby futures contract. (1)=Ten Year Bond Contract. (2)=30 Year Bond Contract. SPX and and the Dollar Index are the cash indices. All data are from Bloomberg using their "Classical" vol model]



 Our daughter Eddy who is in medical school thinks the predictions of ever increasing medical costs — like David Dodge's – fail to take into account two likely changes:

(1) the breaking down of the medical cartel's current structure of required licenses and

(2) further advances in medical micro technology, both in drugs and in physical surgeries.

A nurse-practitioner with access to computer tools can now do as good a job of diagnosing patients as any Internist; and, just as many patients who once would have been candidates for open-heart surgery are now treated by angioplasty, so will other now expensive surgeries give way to cheaper, less invasive procedures. The medical future may not be as expensive as is feared.

If Christie's catalogs are any indicator, the really good stuff among collectibles seems destined to continue its century-long ascent to the financial heavens. Assuming that the non-profitistas and the life insurers keep the envy-the-dead tax in place, that trend seems destined to continue. However, other, less genuinely precious objects may find themselves becoming less pricy even as currencies become rivals to replace the Yugo (fiat joke!).

That seems to be happening now in our the niche of the economic environment with equipment rentals. In this part of the pond even the biggest fish are finding it hard to eat. Volvo Rents, which is at the top of the food chain, is now offering a $15,000 fee to "the referrers of franchise candidates who become Volvo Rents franchisees and open a store". Coke and ore contract prices out of Australia have certainly proven George right about the worth of tangible vs. paper assets, but there are few, if any, new takers for backhoes and the other stuff actually made out of iron and steel.

George Parkanyi writes:

I don't know what the answers are either– it doesn't look very promising given the social, political, and economic status quo– none of which can be easily changed from the inside, if at all. If you want to play the decline both here and elsewhere, I think you have to look at the eventual effect of these unsolvable problems. Governments are not only bankrupt financially, but also for ideas and simply just in the ability to execute. The knee-jerk response to each crisis du-jour is and will be to borrow and spend out of it. When they can no longer borrow, they'll just print. This can only mean continuous and accelerating currency debasement around the world, so I think tangible (vs paper) assets will remain a very persistent investment theme. Governments are going to default, and currencies are going to fail with new ones issued in their place. It's just a question of which ones and when. In that environment tangible assets (the more liquid the better) would have to do well I would think– precious metals, commodities, real estate, perhaps some collectibles, and equities that represent these things. It's not going to happen overnight, and no given trade will be a slam-dunk, but that's where I think the heart of the drift will remain. 

Ken Drees comments:

5 years ago the highways were choked with landscaper trucks and their stuffed trailers with ubiquitous mowers, weed whippers and gas cans. Getting gasoline in the morning on the way to work, one would always see a few landscapers fueling up the tanks and the cans for the day.

I am lucky to see one landscaper a day now. There are many pieces of equipment for sale now–if things don't pick up this summer, you should see these items go for 20 cents on the dollar (used of course) in the fall.

Justa Guy respectfully disagrees:

Many of you do not know me, but I am a physician who has practiced in both Canada as well as in the US. In my opinion there are two issues that are a threat to health care in both the US, as well as in Canada, as follows:

(i) Increasing technology. Over the two decades that I have been practicing medicine there have been innumerable new gadgets which have allowed physicians to more precisely define where problems exist ( we used to diagnose stroke with CT scans, then it was MRI, then it was supersensitive 3 Tessla MRI, now there are some unbelievably sensitive 15 Tessla MRI machines being produced). These incremental advances in technology of course come with increasing costs. Unfortunately these advances rarely improve either clinical outcome, or survival. For reasons of medicolegal protectionism, and customer expectation, we are in a culture in which the biggest, best and latest technology is the norm in our healthcare, however the use of these technologies does nothing to affect the outcome of patients.

(ii) Unreasonable expectations. There are two facts in healthcare which are undenyable: Every one of us will die, and we spend >60% of total healthcare expenditure on people within the last month of their lives. In order to curb healthcare expenditure, we must begin to recognise futile situations, and limit the resources spent in these situations. Do not beleive that is the same as Palins "death panels", rather it is a first step in healthcare fiscal responsibility.

(iii) There is a need to transition to more mid level providers as a means of primary health care delivery. Those midlevel providers will be equipped with algorithms for how to treat certain conditions in a medically proven and fiscally responsible manner. Only if those initial steps are unsuccessful will patients be seen by internists and then specialists.

(iv) About 30% of health care spending occurs under catastrophic circumstances. These include bone marrow or solid organ transplants, trauma and accidents. In many of these circumstances, the chances of survival are minimal at best. In the US ( and to a lesser extent) in the Canadian systems, there is no good mechanism by which to limit care in such catastrophic circumstances. A poignant personal example: Several years ago, my aunt (age 70) who lived in the UK was diagnosed with an incurable ultimately fatal lung disease; her physicians told her ( with out presenting options) that her care would be designed to minimize symptoms and discomfort. She died about 2 years later. Around the same time, I was involved in the care of a wealthy businessman age 75 with the same diagnosis in the US. He was offered and ultimately received a lung transplant (even though outcomes are poor for lung transplants in patients with that condition). He died within the year. We need to learn that no matter what insurance company is paying for such cases, it is financially irresponsible to offer such extraordinary care in hopeless situations

(v) The way physicians are compensated needs to change. In most health care settings, Physicians are paid in the same way that lawyers are: the more they do, the more money they make. Example, a cardiac surgeon who does five bypass surgeries in a week makes more that the cardiac surgeon who does three bypasses, and puts two patients on aspirin rather than operating. That system of having a disincentive for choosing cheaper care is dangerous and expensive. Example: many obstetricians believe that the optimum C section rate is between 5-10% of births. In the 60's in the US it approached that number. By 2007 the rate was >30% of live births, although it remains unclear why the rates have grown so remarkably. If physicians were paid by salary, any potential for conflict of interest is removed.

In my humble opinion, without addressing these issues health care costs will continue to rise, and as David Dodge succinctly puts it, heath care will bankrupt which ever countries fail to tackle the issues.

Kim Zussman responds to Dr. Guy:

Dr Guy:

As markets amply demonstrate, there are many discontinuities and irresolvable problems inherent to the human condition. eg, be kind to animals while eating them, love thy neighbor while profiting at other's expense, woman should be faithful but with men its optional, government for the people and for the government, ration health care to others but not your loved ones.

I would likely pay for a lung transplant for one of my daughters, if there was some hope the operation could save her. And if the insurance company making billions will pay some of this, I'll take it.

Outcome, "evidence based treatment", should always be the driver but ultimately humans are driving. Doctors may earn more (earn) by doing more, Kaiser and other HMO's get to keep more by doing less. Both systems have moral hazard problems, as do all the in-between solutions brokered by governments. 

Stefan Jovanovich replies:

Eddy has the fortune/misfortune to have Dr. Zussman's head for statistics. It is a blessing to have that knowledge, but it can be a curse once people in research labs discover that they have someone can actually make sense of the data Pearl Diver spits up AND, if she can't do it herself, she knows some really bright people from Cal who work at JPL who can make sense of the outputs. As a result, in her fledgling career, she has already done a full year and more of full-time lab work collating price and outcomes data for both an ophthalmology and an orthopedics lab. From that limited and completely skewed base of knowledge, she has come to these tentative conclusions about medical costs:

(1) price competition works - in those areas of care that are open to active price competition (Lasik, elective plastic surgeries), where the patients pay for at least half the ultimate bill, prices have gone DOWN each year, not UP,

(2) universal insurance is absolutely the worst possible financial model to use for financing general health care- "imagine an energy/transportation system where people were issued monthly, fixed-price gasoline insurance cards; even the most responsible, self-reliant people would find themselves thinking why not take a Sunday drive, it's free and the energy producers do everything they could to abandon market pricing and go to a cost-plus, government contracting model just as the hospitals have",

(3) the Big Lie in medicine is that there is no scarcity of skills, that, if we can only get the costs down, there are enough skilled people like Dr. Guy available to treat all the patients who need care. The rationing that the medical education system imposes does not help; but, even if the libertarian dream of open, unlicensed competition arrived tomorrow, there would still be a shortage of first-rate care. That is a truth that no one can profit from telling. On the issue of lung transplants, Eddy and her Dad are hopelessly biased; her uncle, my brother, had both lungs switched out 6 years ago so our family interest would outweigh our principles even if we believed in rationing by medico-political authority rather than price.



It seems like

1) naive people think the market will go higher as the momentum is that way

2) the smart people think the market will go lower because the VIX is at a low level, and they want to look smart being contrarian. They also know that you always sound smarter if you are bearish, being too afraid of being thought to be naive, and only Buffett is allowed to be bullish

3) the super smart think the market is going higher since the IPO market hasn't taken off, M&A hasn't taken off, and there are still people who have missed the rally, i.e., money on the sidelines. They also would rather talk about the rho than the vega.

Category 3 often overthinks the market, in my opinion, and some of the worst stock pickers are found in that category.

Phil McDonnell writes:

Mr. Andersson's point about rho's being important is noteworthy. The normalization of the yield curve will be the biggest macro event over the next 12 months. It is not a question of if, but when. Selling options when that happens could be hazardous to your wealth because increasing rho will cause them to rise.

Jim Sogi comments:

It seems from the depth there is some big money bidding up here. Brokers? There was also big money bidding the '07 highs as well, so not sure if that means much, but the size sure is squashing the market. No one is hitting the market, all limits, at big numbers. 



the Turkana BasinA lecture last night by Dr. John Shea of SUNY Stony Brook Dept. of Anthropology at a local favorite resaurant included a demonstration of flintknapping , he made several tools for us in thirty minutes including a spear head, arrow head and hand axe. Delightful and impressive. He talked about the ongoing research in the Turkana Basin in northern Kenya and some of the progress/discoveries being made there on the origins of Homo Sapiens. See the recent NOVA program on evolution here. The food and conversation were wonderful and by the end of the meal I was being recruitted to teach air traffic control at Dowling College by the Dean of Arts and Sciences.



I had a certain successful 20 day holding period trade last month. I had two targets for the move in the stock. My plan was to take the trade off at the first target, redeploy funds on a pullback or buy back if the stock moved up and through the target–since I have another higher ultimate target price in mind.

On the day last week when the stock kissed the first target price to the penny (also happened to be a round number) I was sitting with my hand on the sell button–the stock churned and loitered around acting odd, some flash bids came in and for an instant I thought that the stock could blow right through the target and up towards the ultimate goal–a whiff of greed entered in. As soon as I felt that greedy impulse to not follow my plan –I sold.

20 minutes later the sellers came in and down it went.

Know those triggers of destruction and use them to your advantage.



The Dailyspeculations.com calendar has been updated to no longer show the month of March 2010. Those wanting to see the old page can look at the archive .

As a reminder, the calendar shows the daily moves in S&P futures and US Bond futures (expressed in points and 1/32's of a point) for each trading day. The color scheme is as follows: green (stocks and  bonds up), red (stocks and bonds down), orange (stocks up, bonds down) or blue (stocks down, bonds up). 



 I will be interested to see how the employment news is digested so to speak as the futures markets had 45 minutes on Friday and now some 12 plus hours since Sunday open to react. While the cash market has not traded. Is it "old news" and already absorbed as efficient markets would have dictated or does the cash market have something to say about it?

I have a small wager on the answer.



aberdeen bullThe bull move by many measures is the greatest in history. Birinyi looks for big 10% turning points in markets and found that by some measures this one is the greatest in history going up 1/5 of a % a day versus 1/6 % a day in the 10 others of comparable rise to this. And we're right in the midst of another such surge with exactly 20 days of consecutive 4% or more moves, an event that's only occured 6 times in last 15 years, with previous dates 5/28/1997, 4/06/1998, 11/24/1998, 4/12/2000, 5/15/2001, and 1/27/2004.

One notes also that we haven't had a a month minimum since Feb 8th, 2010. Since Feb 8, 2010, the median S&P 500 stocks is up 13%, and the top 10 are each up more than 40%. An opposite scenario is working itself out in the world of fixed income. How can we make sense of what is happening?

To what should we turn in conjunction with the bearish feedbak that counting gives. I have been considering the fields of economics, martial arts or romance. What fields would you suggest?

Vince Fulco comments:

The thought of a pendulum with too much transitory force being applied to one side comes to mind. 

Russ Sears writes:

In my opinion to understand the crisis and the resulting recovery, you must understand that most of the crash stemmed from "model risks". People had bought these wonderfully complex AAA structured products that suddenly you had to be able to model the expected losses. In the past this was considered only a remote possibility with no need to model. Once it became clear that much of this "structure" was mush, it was equally clear that these things really could not be modeled well. A slight change of the breeze from the butterfly caused wild swings in the heavens.

Models with even a slight downward trend in the housing markets quickly turned into a death spiral in housing. AAA suddenly were worth pennies. And those that bought them were those least able to absorb the losses or downgrades, further cascading the price due to illiquidity.

One must wonder if this recent reversal similarly has the "all clear" signal being given, and people are coming out of their bunkers to see some rays of sun. In other words which came first for the pendulum, the crash or the recovery?

Ken Drees writes:

Some recent puffy white contrary clouds that have passed my eyes:

advertising aimed at gold straddles

advertising oil calls and bull spreads

themes of money market money needing to go to stock market to earn advertising mailers about apple type clone micro caps–a ground floor opportunity advertising for homeowners to lock in natural gas now–don't wait for summer since rates NG rates can't go lower best 12 months in recent stock market history and the recovery isn't even rolling yet at full steam.

Bond bears are simply frothy–they can't wait to feed! The fed is in a box and its locked and its under water.

Lots of interesting hooks in the water in many markets. I am not surprised since trends have been running themselves quite far without pause, and thats the action that creates the hooks–the unarguable facts of self reinforcing trend. Voila!

Kim Zussman suggests we look at the big picture:

The attached plots log [base 10] (SP500 close) every March from 1871-2010, using data from Prof. Shiller's website.

In the context of history, the recent decline and bounce don't really stand out. However stock returns of the recent decade are noticeably different than the prior two, and rather resemble the pre-WWII period.

Next, Kim Zussman looks through a magnifying glass:

Using Shiller's SP500 monthly data, here is comparison of mean monthly returns by decade 1900-2000


Note that the 2000 decade was one of only 3 (1910, 1930) with negative mean monthly returns. The two prior decades, 1980's and 1990's, both had the largest mean monthly return since the 1950's, and the 50's, 80's, and 90's - the top 3 - all occurred in the last half of the century.

I also plotted log(sp500) within each decade. Drift is noticeable in some of the decades, and noticeably absent in others.



Word of the Day, for Victor:

aibohphobia (pronounced eye-bow-phobia)

Irrational fear of palindromes

The origin should be obvious…



Maybe I'm being a tad negative, but I have been listening and am hearing from a number of sectors that when the actual (vs. artificially enhanced numbered) job market does improve many baby boomers will not be rehired and find themselves jobless for the remainder of their lives. That may induce many of them to try starting a business on their own, consulting (not that the Gen Xers of Gen Yers will be eager to hire them) or just hunker down so they can make it to the finish line of life without being impoverished.

What are any of you hearing?



Steven Strogatz has a great column in today's NYT (looks like the first in a series) about the foundations and intuition of calculus.

Bruno Ombreux writes:

In the same vein, I read a nice book about the history of mathematics: Taming the Infinite. The link is to the hardcover edition, because it is such a beautiful book that it is better to buy it in hardcover.

I think it would be great if mathematics were taught together with their history. Before introducing a subject, the teacher would first explain the real world questions that led to its discovery, and talk about the people behind it. Some mathematicians led very interesting lives! This way, some maths would stop looking like they were pulled out of a hat and the kids would get interested.

Pitt T. Maner III notes:

Note that Strogatz has received good reviews for his book The Calculus of Friendship. Interview with Alan Alda may be of interest too (aside–Alda should play Dr. Feynman in a movie before he gets too old, he has done it on stage in QED, it's an amazing resemblance especially his voice pattern).Dr. Strogatz discusses how his wonderful high school teacher reversed the roles and inspired him to "teach the teacher". The reverance and sincere praise for higher learning was an inspiration. Interesting overlap of life, emotions, and cold, hard math.

Strogatz discusses "balance theory" in a recent paper and wondered if it might have market implications? The plus and minus sign usage somewhat like Chair's. It also mentions Markov processes and different states:

The shifting of alliances and rivalries in a social group can be viewed as arising from an energy minimization process. For example, suppose you have two friends who happen to detest each other. The resulting awkwardness often resolves itself in one of two ways: either you drop one of your friends, or they find a way to reconcile. In such scenarios, the overall social stress corresponds to a kind of energy that relaxes over time as relationships switch from hostility to friendship or vice versa. This view, now known as balance theory, was first articulated by Heider [ fields ranging from anthropology to political science [1,2] and has since been applied in3,4].



Unemployment Map of U.S-2007 TO 2010

Scary and Real!

Please review this Unemployment map of the United States. This is hard to believe, but TRUE! I had to review this map a couple of times to grasp the enormity of it. Watch the map automatically update from 2007 to 2010… WOW!

Nigel Davies comments:

The scary part may be the symbolic use of colors. Having black (death, nothingness, annihilation) for anything from 10-100% seems almost deliberately misleading and the map looks like a rotting piece of meat. There's probably a similar effect in chess, with players playing White often tending towards optimism whilst Black positions can have a look of doom about them. And you can deliberately magnify the effect by playing cramped looking defenses and even placing the pieces slightly towards the back of the squares. BTW, you get a similar psychological effect with candlesticks, the mind being subtly influenced to see down days (black candles) as being doom-laden whilst white ones appear to offer hope. A good practice may be to use green for down and a neutral gray for up, and maybe do something similar with one's Bollinger bands (black as the upper band, pink or something for the lower one). 

John Lamberg writes:

Many years ago, a wise professor taught me the visual power of choice of scale when preparing a X versus Y graph. 



 From the Life Science & Exploration Society an Epicurean Event:

The Origins of "Modern" Humans in East Africa: New Research in the Turkana Basin, Kenya

part of the Distinguished Lecture Series this one by Dr. John Shea, held this Monday at Mirabelle Restaurant at Three Village Inn, 150 Main St., Stony Brook, New York.Monday, April 5, 2010 Five Course Dinner, $115.00 per person

Mirabelle is our favorite restaurant, and I can recommend Chef Guy Reuge's French cuisine to the most discerning palettes. Here is a pdf of the brochure at Mirabelle Restaurant at Three Village Inn.



Mike D'Antoni
"The Knicks never lead, falling behind 4-0 in a sign of things to come" in losing
118-90 to Portland on March 31. What can we learn from that?

Pitt T. Maner III writes:

If the Knicks were a portfolio of stocks it might be best to start trading them for younger players who put forth effort and play defense. It's a bad sign when statements are issued that accept this type of poor play as a natural event. One can imagine what Maurice Lucas or Bill Laimbeer would have done to players trying to dunk over them or drive down the lane for easy layups. If you are putting a team together it is best to get players who hate to lose and know how to box out and play defense and basically intimidate the opposition. "We had no energy at both ends of the floor," D'Antoni said. "When you do that against a really good team that is trying to solidify everything they do in the playoffs, there are going to be nights like this. We didn't switch [on defense], we didn't talk, we kind of just looked around. There were balls we didn't go after. It wasn't a good effort."

When you think of the Knicks in better times you think of Willis Reed playing on terrible knees to win the 1970 NBA championship — there you had it: sacrifice, teamwork, team defense, accountability, professionalism, precision passing and a hunger to win. And very good announcers to add to the drama and excitement. A quote attributed to the late Red Holzman, the coach of the Champion Knicks: "On a good team there are no superstars. There are great players who show they are great players by being able to play with others as a team. They have the ability to be superstars, but if they fit into a good team, they make sacrifices, they do things necessary to help the team win. What the numbers are in salaries or statistics don't matter; how they play together does."

Well, it could be worse — look at the Nets. Interesting though that they are moving to Brooklyn and may have a billionaire Russian industrialist as an owner.

Jeff Watson adds a corollary:

In 1969, the Chicago Cubs were in first place all season long. The beginning of Sept, they had a 84-52 record and were a solid five games ahead of the NY Mets. By mid-season, the Cubs were already getting ready for the series, and they even wrote many songs about them. The Cubs choked and lost 17 of their final 23 games while the Mets went on a tear with a 23-7 record, overtaking the Cubs and ultimately finishing eight games ahead. The Mets ultimately went on to win the World Series, while the Cubs quickly regained their status in the cellar. Still, Chicagoans love the Cubs, win or lose, as there's nothing like a good day at Wrigley eating hot dogs, peanuts, Cracker Jack, and plenty of beer to wash it down.

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



 By the time the NCAA Men's Division I basketball tournament gets down to four teams, is it a toss-up as to which team wins? In other words, does each team have a 1 in 4 chance of winning?

Steve Ellison responds:

This is an excellent situation to apply the binomial theorem. In E****, you can write a formula: =BINOMDIST(s,t,p,c), where s is the number of successes, t is the number of trials, p is the probability of success, and c indicates whether to calculate the cumulative result (1=yes, 0=no)

Our null hypothesis is that the probability of success (winning the Final Four) is 0.25.

For example, for the teams that have made only one trip to the Final Four, the formula is =BINOMDIST(1,20,0.25,1), resulting in a p value of 0.024. This result appears to be statistically significant, but the significance is questionable given that we are doing multiple comparisons.

Teams that have made at least four trips to the Final Four have won more than a quarter of the time, so we can check the probability of winning 21 times or less and subtract it from 1, using the formula =1-BINOMDIST(21,65,0.25,1), which results in a p value of 0.070.

Russ Sears comments:

This is retrospective, and has "survivorship bias" or winner's bias.

This would be true if the championship wins and returning to the Final Four where independent. But they are not. If you win one year, the record most likely show you have a better chance of repeating in the final four.

You need stats that show winner only in their first appearance or second appearance, etc.

Here are the Final Four champs by appearance order:

appearance  count champs  binomdist

1st                  97     13          0.4%
2nd                 55     15         71.3%
3rd                 32      8          59.4%
4th                 24      9          94.5%
5th or more      80     25         92.0%
4th or more     104    34         97.0%

Alston Mabry adds:

Looks like an opportunity to run a quick sim. The sim sets up the Final Four participants for each year 1979-2009, randomly assigns the National Championship to one of the schools, and then records whether that school was one of the schools that actually went to the Final Four just once, twice, three times, or four or more times. Results of 1000 runs:

schools that went to the Final Four just once
count: 20
actual championships: 1
mean # of championships in 1000 sim runs: 5.00
sd of this distribution: 1.68
z score of actual # of championships compared to sim distribution: -2.38

schools that went to the Final Four exactly twice
count: 9
actual championships: 2
mean # of championships in 1000 sim runs: 4.49
sd of this distribution: 1.73
z score of actual # of championships compared to sim distribution: -1.44

schools that went to the Final Four exactly three times
count: 7
actual championships: 6
mean # of championships in 1000 sim runs: 5.33
sd of this distribution: 1.92
z score of actual # of championships compared to sim distribution: +0.35

schools that went to the Final Four four times or more
count: 11
actual championships: 22
mean # of championships in 1000 sim runs: 16.19
sd of this distribution: 2.53
z score of actual # of championships compared to sim distribution: +2.30



A rare inverted jenny stamp that turned out to be a fake
Just read an update in my morning's paper on thousands of homes infested with defective Chinese drywall (sheetrock). These homes need to be stripped to the bare studs or beyond to get rid of the problems of mold, corrosion, breathing issues, etc. Should be a boon to drywall suppliers, but likely will drive upward drywall costs and create shortages.

Another problem with the Chinese is in the area of collectibles — stamps and coins, most notably. eBay et. al. are full of fakes of better stamps and scarce coins. You need to establish a good relationship with a reputable and established dealer in today's collecting world. The Chinese have taken over the US with massive loans to us. Thus we cannot say too much to them about pirated goods and fakes that flood the internet and the open market here in America.



If you have not read Life and Fate by Vasily Grossman do so ASAP. Available on Amazon. the book was banned in the Soviet Inion and is as powerful as Ayn Rand. Fantastic novel with many life lessons.



The quarter just ended gained 7.4% in the DJIA, after two prior qtr which gained 15% and 11%. Long ago (March 2009) there was a down quarter. Looked for other instances with quarterly return pattern DUUU, also stipulating that the up-qtrs gained more than 5%. Here are the dates, along with the return for the following quarter:

Date        DUUUX qtr
06/01/99    -0.058
09/01/95     0.068
03/01/83     0.081
03/01/71    -0.015
06/01/54     0.081
12/01/38    -0.146
12/02/35     0.085

avg             0.014
stdev          0.090

t                0.408

As a wakeful friend pointed out, we are now up 4 consecutive quarters after the down Q1 2009(or DUUUU). Here are the subsequent qtr assuming all 4 were up >4%:

Date          DUUUUX
09/01/87    -0.253
03/02/36     0.009
06/01/83     0.009
12/01/95     0.092
09/01/54     0.122

avg            -0.004



 Robert McTeer had an interesting post on StreetTalk. He responded to a TV commentator who claimed the recent BLS employment numbers showed: "Not a single new job has been created." McTeer called the claim misleading because it implied "a stagnant economy dead in the water." McTeer notes that though jobs have been lost on net over the last two years, "The gross jobs numbers behind the negative tell a far different story." Though 8 million jobs were lost in the second quarter of 2009, McTeer notes that "6.4 million were created (674,000 more than in the first quarter)."

A gain of 6.4 million new jobs in a quarter shows a dynamic economy. But I sent an email to Mr. McTeer suggesting there is more to the story. The 8 million jobs lost, I argued, are in some ways as good for the economy as the 6.4 million new jobs.

Eight million people losing jobs means eight million in the market for "better for the economy" jobs, if not at first higher-paying jobs. If these workers were destroying wealth at their old jobs (though no fault of their own), just stopping is good for the economy.

The huge number of union jobs lost in the auto industry is good news for U.S. economy as well as car buyers. Overpaid and badly organized auto industry workers are disruptive for a free society, apart from the problems of high labor costs and uneven auto quality. All these jobs were privilege jobs gained by connections and legal protections. Auto companies could have hired and trained workers at 1/2 or 1/3rd the pay, but were prevented by various labor law interventions from doing so.

The economy has to continue the adjustment out of industries like housing construction and related goods and services, and those resources and workers have to be redeployed into more productive industries and professions. Figuring out and coordinating redeployment to wealth-producing occupations has to be a complex and time-consuming process.

Though a great many job losses could be blamed on taxes and regulations of various kinds, and on uncertainty created by state and federal policies, the lion's share of unemployment was caused by adjusting to new realities after the real estate and financial bubble. What the new realities and opportunities are isn't immediately clear. That is what has to be figured out by millions of entrepreneurial employers and job searchers.

Losing a job creates trade-offs and potential benefits. People for a time lose productivity from established skills and business networks. But as they look for new jobs, the searching process, though labeled unemployment, is actually work collecting information and developing search and self-knowledge skills.

Think how many millions were likely underemployed or by accident in the wrong industries for their personal preferences and skill sets. Most wouldn't leave a secure job, even if they strongly suspected it was somehow not right for them. Though most would prefer underemployment to unemployment, most have probably also been surrounded by employment or entrepreneurship opportunities they lacked adequate incentives to investigate.

If an unemployed worker hired someone else to spend 30-40 hours a week searching for new employment, and to evaluate job-retraining opportunities, that would cost money and likely generate value. Those who lose jobs become self-employed in this informal home-based employment search industry.

Some of the unemployed are not working at job searching (or at "off-the-books" work), so they are taking advantage of opportunities for leisure that a wealthy society like ours affords. This can also have long-term benefits.

Losing my job at the Foundation for Economic Education in 2003 was one part difficult and disorienting, but nine parts a great opportunity to innovate and launch new economic education projects and programs.

Paolo Pezzuti comments:

I agree on the assumption that the economy has to continuously adjust to redeploy workers into more productive industries and professions. Old, low productivity and low added value industries have to be abandoned to move into more remunerative sectors. I do not dispute this because this is the tenet of growing economies and capitalism. This process may be painful for many workers laid off that have to retrain to find better or equal pays in their new jobs, but it brings progress and growth for the individual and the society.

However, I am starting to have doubts that this can be applied to the present situation of western economies, where jobs are simply cancelled to be created somewhere else in the world. This process is negative and is developing in parallel to the healthy process of adjustment I was referring. Jobs are transferred very quickly to areas of the world where labor is less expensive. Our economies cannot adjust adjust timely and fast enough to create enough jobs in the new sectors because the speed at which this transfer of wealth and jobs is occurring is unprecedented. This requires an impressive education system to adapt the professionality and retrain millions of workers very fast. This requires huge investments in high tech and higher value added areas. This takes time, capital, new infrastructures, a government that favors entrepreneurship.

How to manage this transition is the main issues and all elements of the society should be involved in this debate. I am convinced that the governement in the economy is inefficient and should be limited as much as possible. At the same time, without government support, the situation could be disruptive for millions of families while the process of adaptation develops.

Finally our competitors are not looking at us wihout doing anything. They are also moving quickly to acquire the technologies and move their production up the scale toward higher returns industries. They are working to put us out of the market and not be competitive.

Flexible and adaptable economies will be advantaged, but the process is going to be very painful. The transitory will be very long in any case because of unprecedented scale of what is happening. The challenges are huge and success is not ensured even for the most dynamic countries. The outcome, if we are not able to adapt, could be to see our economies and standard of living decline sharply in favor of others. We could simply see unemployment and poverty increase structurally.

Paolo Pezzutti is the author of Trading The U.S. Markets, Harriman House, 2008

Pitt T Maner III adds:

Touring around in Europe in the early 80s you couldn't help noticing the number of young Australians and New Zealanders. Many of them apparently just decided to do a "walkabout" and wait out the bad unemployment situations back home. If you are willing to rough it there are many cheap places to live outside the US. Hanging out for a couple of years in the right "socialist" country with good food, beer, healthcare, law-abiding citizens, low cost education, history and culture would seem to be an option–at least you would get an opportunity to see the pluses and minuses of other systems. No its not the American way. Are citizens of other countries more flexible with respect to moving around the globe to where there are opportunities?

Do today's youthful short-term free riders outside their native country that avoid permanent bumdom become tomorrow's long-term tourists and multilingual global investors?

Russ Sears writes:

While simply based on anecdotal evidence from those I know, I think you will find that "funemployment" is almost exclusively the domain of the youth, still riding on Mom and Dad's pocketbook. It seems to me to be the result of being taught: "you can be any thing you want","you are the star at everything" and most important parents never letting their kids fail– meeting the reality of this job market.



An article in Business Insider suggests that after a 40% run up in stock prices the market will suffer a correction. Sadly this conclusion is based on close reading of a 90 chart of the Dow. Thus one is suspicious.

Putting this to a test one finds that the market gains .024 per day in all days since Oct 1929. But after a 40% gain in the previous 252 days the return nearly doubles to .043 per day. During days without the prior 40% return the average day only gains .023%. Full summary results:

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

Rocky Humbert comments:

That article demonstrates many flaws, including the way the question was posed and the fuzziness of the outcomes.

Here's a different spin: What would happen if you bought the Dow Jones only after a 40% annualized gain, and held the position for the next 90 days? The results:
1933: +18%
1935: +10.9%
1943: +4.9%
1954: +6.7%
1983: +8.1%
1986: +4.0%
1987: -23%
1996: +3.2%
1997: +3.5
1999: +0.4%
[Data do not include dividends]

(There are 14 data points in the article versus 10 above. The difference is due to my having an open position and not double-counting a re-entry.)

Conclusion: Buying after a 40% rally provides returns that are better than long-term drift unless you get caught in a market crash. Hence, if history is predictive, it's actually a fine time to go long and pay 1% premium to buy some out-of-the-money puts to attenuate the tail risk. Applying a T-test is above my pay grade.

I interpreted the article as arguing that an initial move over a 40% ROC had bearish predictive value — and history suggests that it does not. Re-entries were not mentioned…One should also consider the source of the article: Business Insider picked it up from a website aptly called FinancialArmageddon.com whose author (Michael Panzner) wrote the eponymous book, Financial Armageddon (2008) and more recently, When Giants Fail (2009). I have not read either book, but I'm told that his most recent tome doesn't mention Eli Manning. 

Rocky Humbert, quantitative analyst, speculator and master chef, blogs as OneHonestMan.

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