I'm not quite ready to fall on my sword, but I think about it minute-by-minute during market hours. The DOW has quietly trudged forward going up almost every day in March to a height near 11,000. It cannot defy gravity forever and even if it does break the 11,000 mark, or go even higher, I'd be even more foolish now if I sold my short positions. I need a face-saving turnaround to stem the bleeding and stop hemorrhaging cash from the Ithaca Experiment portfolio. I'm not the only one who has called it wrong. Guy Adami, one of the professional traders on CNBC's Fast Money, has been calling for a top to the market since July and he's a pundit with an impressive resume. That's about when I started my short positions, in July of 2009, but I am taking a long-term perspective on this. I don't know what's going to happen in April. There is usually heavy selling around the middle of the month because investors need to pay their taxes. We are also at the culmination of an end of the quarter short squeeze where mutual fund managers window dress their portfolios. There may not be a single shining moment to stop the market momentum. It just might grind to a halt.
This week I had a chance to read The Road From Ruin by Matthew Bishop and Michael Green. The two coauthored a previous book Philanthrocapitalism and I was drawn to the new book because Bishop is the U.S. Business Editor of The Economist. I thought they could shine some light on the current economic troubles we are facing, or not facing anymore if you believe some in the broadcast media. They even devote one of the chapters in the book to the media and how it tends to inflate bubbles. Here they comment on a study by Alexander Dyck of the Harvard Business School and Luigi Zingales of the Chicago Business School: "The media tend to operate in a pro-cyclical way...helping inflate bubbles on the way up, but sometimes making matters worse on the way down. The bullish bias, they argue, comes from an implicit 'quid pro quo relationship between companies and journalists,' arising from the need for journalists to cultivate informed sources. In a bubble, bad news tends to be disproportionately damaging for a company's share price, as it stands out from the generally rising tide of good news.".
I'm a believer that for the most part, if you stick to the more traditional special-interest media outlets, you're much better off than some of the of the newer, less established forms. After all, if you watch Bloomberg or CNBC, or read the New York Times or Wall Street Journal in print, or Yahoo Finance on the Internet, you will get a fairly biased approach to a story. Getting your main news from Twitter or Facebook or even a blog like this one is a big mistake. As Bishop and Green point out: "The failure of the media during the crisis also speaks to the wider problems of the industry. Traditional print and broadcast media are yielding an even greater share of the market to new forms of digital media where speed is often more important than accuracy.". If you have been reading this blog, you are well aware that speed is not of the essence in my investing style. However, if you trade frequently (which I believe is best left to the pros in the pits), you might get burned by misinformation if you rely on cyberspace for your main media fix.
Wall Street is an insider's game and if you try go toe-to-toe with some of these pros, you'll be left in the dust. Television commercials bestowing the virtues of high-frequency trading platforms make no money except for the companies that advertise them. The Road From Ruin points out that it's still an old boys network no matter how hard you try to game the system: "...much valuable information continues to be transmitted informally, sometimes still in coffeehouses and other watering holes. Despite the promise that technology can make all communications virtual, thereby freeing investors to spend their days on the beach trading via laptop, in reality they and the journalists who report on their activities continue to cluster together in the financial centers, from New York to London to Dubai.". The first 200 pages of the book basically gives a history of past bubbles and how they relate to the 2008 market implosion. It's been done before, but I'm not sure how much better, so you may be able to skip that if you are well versed in financial history. The final 150 pages of The Road From Ruin gives what I consider well balanced ivory tower advice to a very complex problem. It's not a fast read, but it is informative.
Wednesday, March 31, 2010
Sunday, March 21, 2010
The Quants
Like his Wall Street Journal colleague Gregory Zuckerman who wrote The Greatest Trade Ever, Scott Patterson tells a compelling story about the epicenter of the financial crisis in The Quants. The big difference between the two books is that Zuckerman spins a yarn about a man that made billions from the sub-prime implosion while Patterson's tale is about those who lost and lost big time. Young gunslingers at the quantitative hedge funds were unstoppable in the new gilded age racking up huge gains for years on end, but failed to program in the appropriate amount of risk in their complicated financial models. They didn't account for the fat tails of the bell curve which happens more than you'd think in investing. The result is now history of a bygone era with fortunes forever lost.
Big Iron. That's what it was all about. The quiet hum of mainframe computers churning out eons of high frequency trades with little or no regard to fundamental analysis. As Patterson so aptly puts it: "They used brain-twisting math and super-powered computers to pluck billions in fleeting dollars out of the market...These computer driven investors couldn't care less about a company's 'fundamentals', amorphous qualities such as the morale of its employees or the cut of its chief executives jib...Quants were agnostic on such matters, devoting themselves instead to predicting whether a company's stock would move up or down based on a dizzying array of numerical variables such as how cheap it was relative to the rest of the market, how quickly the stock had risen or declined, or a combination of the two - and much more.". But as the author foreshadowed at the beginning of the book: "Amazingly, not one of the quants, despite their chart-topping IQs, their walls of degrees, their impressive Ph.D.'s, their billions of wealth earned by anticipating every bob and weave the market threw their way, their decades studying every statistical quirk of the market under the sun, saw the train wreck coming.".
They had it made. After setting up their original trading programs which found small inefficiencies in the efficient market hypothesis, they basically sat back and raked it in. The computers did all of the work. It was all based on arbitrage and probabilities and while the market was in a generational bull market, there were no problems except for the bloodbath at Long Term Capital Management in the late 1990's which almost collapsed the market as well as the dot com meltdown on 2000. But they bounced back and even made money during the downturns. Not this time. It was too hot to handle: "As investors tried to unload their positions, the high-frequency funds weren't there to buy them - they were selling, too. The result was a black hole of no liquidity whatsoever. Prices collapsed.". They were trapped: "...in a self-reinforcing feedback loop. More selling caused more volatility, causing more selling, causing more volatility.".
Patterson makes a powerful argument as to why these high rollers were a huge contributing cause to the 'Panic of 2007'. He also points out there were other factors involved such as President Clinton repealing the Glass-Steagall Act in the early 1990's and former Fed Chairman Alan Greenspan keeping the interest rates too low and pumping more and more money into the system. However, Patterson does a terrific job of connecting the dots back to the beginning of the quant movement and takes you step-by-step through all of the hijinks until the market went haywire and plunged just two years ago. He points fingers, and it isn't at all of the hedge funds, only some of the more notorious ones. If you want to get the skinny on where your IRA or 401K plan went down the tubes, look no further than The Quants. It's a very good book.
Big Iron. That's what it was all about. The quiet hum of mainframe computers churning out eons of high frequency trades with little or no regard to fundamental analysis. As Patterson so aptly puts it: "They used brain-twisting math and super-powered computers to pluck billions in fleeting dollars out of the market...These computer driven investors couldn't care less about a company's 'fundamentals', amorphous qualities such as the morale of its employees or the cut of its chief executives jib...Quants were agnostic on such matters, devoting themselves instead to predicting whether a company's stock would move up or down based on a dizzying array of numerical variables such as how cheap it was relative to the rest of the market, how quickly the stock had risen or declined, or a combination of the two - and much more.". But as the author foreshadowed at the beginning of the book: "Amazingly, not one of the quants, despite their chart-topping IQs, their walls of degrees, their impressive Ph.D.'s, their billions of wealth earned by anticipating every bob and weave the market threw their way, their decades studying every statistical quirk of the market under the sun, saw the train wreck coming.".
They had it made. After setting up their original trading programs which found small inefficiencies in the efficient market hypothesis, they basically sat back and raked it in. The computers did all of the work. It was all based on arbitrage and probabilities and while the market was in a generational bull market, there were no problems except for the bloodbath at Long Term Capital Management in the late 1990's which almost collapsed the market as well as the dot com meltdown on 2000. But they bounced back and even made money during the downturns. Not this time. It was too hot to handle: "As investors tried to unload their positions, the high-frequency funds weren't there to buy them - they were selling, too. The result was a black hole of no liquidity whatsoever. Prices collapsed.". They were trapped: "...in a self-reinforcing feedback loop. More selling caused more volatility, causing more selling, causing more volatility.".
Patterson makes a powerful argument as to why these high rollers were a huge contributing cause to the 'Panic of 2007'. He also points out there were other factors involved such as President Clinton repealing the Glass-Steagall Act in the early 1990's and former Fed Chairman Alan Greenspan keeping the interest rates too low and pumping more and more money into the system. However, Patterson does a terrific job of connecting the dots back to the beginning of the quant movement and takes you step-by-step through all of the hijinks until the market went haywire and plunged just two years ago. He points fingers, and it isn't at all of the hedge funds, only some of the more notorious ones. If you want to get the skinny on where your IRA or 401K plan went down the tubes, look no further than The Quants. It's a very good book.
Friday, March 19, 2010
The Cusp of Doom
Not counting today's action, the DOW has moved about 850 points in 5 weeks. Earlier this week Matt Nesto on CNBC reported that 88% of S&P 500 stocks were trading above their 50 day moving average so we can infer that investors are too far out on the risk curve chasing performance, but the market can still go higher. I'm not going to give you another hard-luck story, but I am getting hammered mercilessly in my short positions. The Ithaca Experiment Portfolio is on autopilot right now and will remain so for the foreseeable future despite the disappointing performance. Saying I am unfazed would be misleading, but the market tends to revert to its mean and there are plenty of problems looming on the horizon that could diffuse the bomb. Most financial planners will tell you it is best to check your portfolio on a monthly or quarterly basis and reallocate your positions once a year. This July will be the end of my fiscal year and a lot can happen by then.
Today is quadruple witching day when options expire and you should expect the market to rally, plus pick up some volume. Anybody who tells you you can't make or lose much money in a low volume market is out of their minds. This rally that started over a year ago has been very low volume. It just keeps slowly grinding skyward. According to the Stock Trader's Almanac 2010, the last week and a half of March tends to be historically weak, so maybe I'll catch a break by the end of the month. Sovereign debt default in Europe, the health care bill here domestically or some sort of terrorist attack could send this full throttle market to a screeching halt, but I doubt it. Both Meredith Whitney and Nouriel Roubini came out with statements on Tuesday saying they still see trouble for the markets in the second half of the year, especially when the Fed takes away the punch bowl and the markets kept moving higher. I'm not sure what impact Roubini has on moving the market anymore, but the prevailing theory on Whitney is that she called the sub-prime crisis and still sees another double dip in housing prices.
The majority of our GDP in the USA is comprised of consumer spending and a lot of consumer spending is dependent on housing prices. If housing prices decline, then our GDP will sink like a rock and if history is correct, so will stock prices. But this is a simplistic scenario here. It is a multi-faceted problem with many factors contributing to the market's decline like employment figures and credit card limits, both of which have been shrinking. Without money or credit, people just can't buy things. In the April issue of Kiplinger's Personal Finance, Jeremy Siegel wrote his monthly column about how stock returns were better than bonds and he may be right, but where I disagree with him is his projection of a 14.2 P/E ratio for the S&P 500 for 2010. Right now the current P/E ratio of the S&P 500 is roughly 20-21 without splitting hairs. For the P/E ratio to reach 14.2, we would have to grow profits by about 30% for 2010 and I just don't see that. I believe it is going to take many years before our economy is back up to speed. That doesn't mean the market can't rally. It has and it will, but eventually it has to prove that the fundamentals are sustainable and I don't see that happening for quite some time.
Today is quadruple witching day when options expire and you should expect the market to rally, plus pick up some volume. Anybody who tells you you can't make or lose much money in a low volume market is out of their minds. This rally that started over a year ago has been very low volume. It just keeps slowly grinding skyward. According to the Stock Trader's Almanac 2010, the last week and a half of March tends to be historically weak, so maybe I'll catch a break by the end of the month. Sovereign debt default in Europe, the health care bill here domestically or some sort of terrorist attack could send this full throttle market to a screeching halt, but I doubt it. Both Meredith Whitney and Nouriel Roubini came out with statements on Tuesday saying they still see trouble for the markets in the second half of the year, especially when the Fed takes away the punch bowl and the markets kept moving higher. I'm not sure what impact Roubini has on moving the market anymore, but the prevailing theory on Whitney is that she called the sub-prime crisis and still sees another double dip in housing prices.
The majority of our GDP in the USA is comprised of consumer spending and a lot of consumer spending is dependent on housing prices. If housing prices decline, then our GDP will sink like a rock and if history is correct, so will stock prices. But this is a simplistic scenario here. It is a multi-faceted problem with many factors contributing to the market's decline like employment figures and credit card limits, both of which have been shrinking. Without money or credit, people just can't buy things. In the April issue of Kiplinger's Personal Finance, Jeremy Siegel wrote his monthly column about how stock returns were better than bonds and he may be right, but where I disagree with him is his projection of a 14.2 P/E ratio for the S&P 500 for 2010. Right now the current P/E ratio of the S&P 500 is roughly 20-21 without splitting hairs. For the P/E ratio to reach 14.2, we would have to grow profits by about 30% for 2010 and I just don't see that. I believe it is going to take many years before our economy is back up to speed. That doesn't mean the market can't rally. It has and it will, but eventually it has to prove that the fundamentals are sustainable and I don't see that happening for quite some time.
Friday, March 12, 2010
Déjà Vu
Yesterday the S&P 500 closed at 1150 which matched the January 19th year-to-date high. This is also the high for the rally that has been forging ahead since March of 2009. If I were a trader, I'd be long the market, but I'm not a trader so I will remain in my short positions even though I could be suffering considerable pain for the foreseeable future. I'm not rattled yet although the paper losses I've experienced make me second guess myself on a daily basis. It takes a leap of faith to remain leveraged and short during a 12 month run to the upside. Now, you might think I've been taken to the cleaners, but that doesn't happen until I sell for a loss. The odds are in my favor that we will see a significant correction in the months ahead, especially since the market is overvalued and we really haven't backed and filled for a significant amount since a year ago. The bulls do tell a compelling story, but I'm just not buying it. I thought bad financial news would redefine the current investing landscape and we'd be in for a white knuckle ride to the downside, but I've been proven wrong again. This market is off the charts.
People I respect tell me if a stock or your portfolio is down 50%, it takes a 100% increase to get back to even. I am well aware of this and still am not gun shy and consider myself battle tested. As I've stated before, leveraged portfolios tend to rise and fall at lights out speed. You just have to get used to the volatility. Let's see how bold I am when the S&P 500 reaches 1200. I may have to snap out of it and crawl away with my tail between my legs, but I don't think so. I felt this gnawing in my stomach two months ago when the market reached its high the last time and it turned around and headed south. With a dearth of economic news being released the next few weeks and earnings season almost a month away, we very well could drift higher now. I am prepared for that and will counter punch by doing nothing. A rope-a-dope situation, if you will.
People I respect tell me if a stock or your portfolio is down 50%, it takes a 100% increase to get back to even. I am well aware of this and still am not gun shy and consider myself battle tested. As I've stated before, leveraged portfolios tend to rise and fall at lights out speed. You just have to get used to the volatility. Let's see how bold I am when the S&P 500 reaches 1200. I may have to snap out of it and crawl away with my tail between my legs, but I don't think so. I felt this gnawing in my stomach two months ago when the market reached its high the last time and it turned around and headed south. With a dearth of economic news being released the next few weeks and earnings season almost a month away, we very well could drift higher now. I am prepared for that and will counter punch by doing nothing. A rope-a-dope situation, if you will.
Monday, March 8, 2010
Running on Empty
Last week the Ithaca Experiment portfolio got crushed. Most of the damage was in the the Direxion Small Cap Bear 3X Shares (TZA) because of the major move in the Russell 2000, but the ProShares Ultra Short S&P 500 (SDS) also went down significantly. Remember these are leveraged and short positions, so if the market goes up, my holdings go down - big time. This week is the one year anniversary of the market hitting it's March, 2009 low and because it's climbed a wall of worry for 12 months, I took some time to reflect on my investments this weekend and have decided to stay the course even though I've considerable paper losses on a percentage basis. I still firmly believe we are due for a major correction. If I had a magic wand or a genie in a lamp, I'd start the correction immediately because this market is trading on inertia, but I'll just have to be patient for the time being. As I've stated before and I'll say again, I'm taking big risks here, so following my portfolio advice is not recommended for most retail accounts.
Because David Walker's Comeback America was praised by Paul Volker, I took a flier on it last week and have decided not to review it even though it is an economics book. Mr. Walker is the former comptroller general of the United States and although he has written a good book, there isn't very much investing information in it. He seems to keep repeating the same themes over and over and as he states: "By now you recognize my mantra. The expansion of the government over time, excessive spending, and the continuing cry for tax relief have been driving us towards bankruptcy.". This is quite evident to most Americans except for those on the far left and to go into detail about Mr. Walker's views would be sidestepping the main focus of this blog which is to track the Ithaca Experiment portfolio and to discuss my reasons for being short the market (for the time being). Because of that, this will be a very small installment this time. However, on the docket is The Quants by Scott Patterson and from the first few chapters I can already tell there will be plenty of fodder for my next posting.
Because David Walker's Comeback America was praised by Paul Volker, I took a flier on it last week and have decided not to review it even though it is an economics book. Mr. Walker is the former comptroller general of the United States and although he has written a good book, there isn't very much investing information in it. He seems to keep repeating the same themes over and over and as he states: "By now you recognize my mantra. The expansion of the government over time, excessive spending, and the continuing cry for tax relief have been driving us towards bankruptcy.". This is quite evident to most Americans except for those on the far left and to go into detail about Mr. Walker's views would be sidestepping the main focus of this blog which is to track the Ithaca Experiment portfolio and to discuss my reasons for being short the market (for the time being). Because of that, this will be a very small installment this time. However, on the docket is The Quants by Scott Patterson and from the first few chapters I can already tell there will be plenty of fodder for my next posting.
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