Tuesday, May 30, 2006

Hark! The cause of all our volatility!

I am always amused by financial columnists who ascribe such iron-clad causality to up or down markets. Today the market (a conglomeration of millions of participants each with variate wants, desires, needs for hedging, etc.) according to the AP was:

"Higher oil prices and sliding consumer confidence sent stocks plunging Tuesday as a weak sales report from Wal-Mart Stores Inc. raised concerns about discretionary spending. The Dow Jones industrial skidded almost 185 points."

"Ex post hoc, ergo propter hoc" can only be repeated so many times...

Anyway, the volatility continues. Hank Paulson today was appointed in what appears to be a blatant attempt to increase "brand U.S.A." and the good old american $. The dollar has been "declining" (against the Euro anyway) which reflects just how bad some think the prospects for U.S. stocks are...but again, it only takes one global scare for the herd to pile into U.S. $ denominated assets...

This "correction" (the dumbest term in finance...do declining prices "correct" a "wrong" market? that would imply knowledge of "true" asset values, which is what the market does continuously anyway. Stupid choice of word.) will last for a bit then I expect the S&P to rebound for the remainder of the year.

Wednesday, May 24, 2006

The short version of Beta...

...being the worst way to measure "risk".

Beta is the standard deviation of returns. Standard deviation requires a distribution to be meaningful. A normal distribution is used. Capital market probability distributions are no-where near "normal" (i.e., mean, mode, median are equal). The crash of 87 was more than 13 standard deviations away from the mean of a normal distribution. The probability of a NINE standard deviation move is .0000000000000000000001049. A 13 standard deviation is three times that size, and I don't want to type in any more zeros. Add to that the fact that volatility is volatile and you have to be VERY careful about making any conclusion or decision based on "beta".

Speaking of volatility, there are academic bubbles right along with market bubbles. The two often develop in parallel. The market goes up for awhile, and the risk managers all start high-fiveing each other while counting their bonuses from their superior performance. They give lectures at Universities to MBA students and give the impression that they have built an iron-clad way to shield themselves (but never their clients!) from any adverse exposure.

It will be interesting to see who are the losers here. I don't anticipate the largest players being hurt...they are too close to the information flow (Goldman Saches fired its technical analysts some time ago...why employ people who analyze price movements ex post when you know the biggest trades ex ante???). I expect some long/short and global macro hedge funds to suffer, along with all the fools who came late to the party.

Saturday, May 20, 2006


...volatility this week. Commodites were thoroughly trounced, stocks plummeted, and it appears most of the players have re-established their appetities in bonds.

This was the primary reason for my belief that the U.S. $ is not going to substantially depreciate. When volatility increases (as measured by the VIX) by 50% in one week, people sailing those turbulent seas seek a safe harbor. The safe harbor is government debt denominated in U.S. $.

As I stated in the previous post, I thought the markets would decrease significantly in the summer from an unanticipated rate hike or some other catalyst. Still, I think that now is the time to buy stocks, fully informed of the performance of stocks in an evironment of increasing interest rates.

Of course, the probablity I will be wrong in this assesessment is currently very high and asymptotically increasing to 1...

Wednesday, May 17, 2006


...are all over the place today.

1972, 1987, 1997, (curious how the most recent is always the best remembered) etc. All of these periods have taught us a thing or two about global volatility and and risk management...haven't they? We go back to the cyclical/linear dichotomy described previously.

For my part, this down period is coming much sooner than I had anticipated. In addition, although the dollar is getting hit hard, it is increasingly obvious to the recapitulator that any more tremors will fuel the usual flight to quality. Volatility is up 50% and rising...is this the time when one would like to be long Emerging Markets?

The next few days will be interesting indeed.

On the reinsurance front, analaysts are now stating that the physical hurricane risks have been overstated. Owning insurance companies at this point appears to be analogous to a long call with a strike price a few points above the current book to market value and an expiration date a month after the end of the hurricane season when the holder figures out if he is ITM or OTM.

These themes ("we can control risk...unpon further reflection, maybe we cannot") are cascading down from the financial markets to other markets. Its interesting when the most important element of any function based on risk shows up, Luck, to annoint the winners and losers.

Wednesday, May 10, 2006

The FED has spoken...

…and they have no idea what is going on. A strange couple of days. Its as if human emotion and human nature is making a big comeback throughout the capital markets.

Helicopter Ben, fresh from his public humiliation at the hands of a very feisty media personality, raised rates to a nice, even 5% today. The press release stated that future rate increases will depend on the data coming in.

Of course, Ben is a smart guy, and this kind thinking reminds me of an old George Soros quote (paraphrasing): “Shooting an arrow at a target when the act of shooting moves the target.” Lags, leads, and other nasty little inconveniences lie within data.

It is comforting to note, at least, that an institution with access to the best, most, and constant, data has as much clue as the rest of us regarding the future state of the economy.

More regression to humanity…

Meanwhile, Buffet wants to appoint his son as his heir…wow…that’s a new one. A sentarian/octogenarian business owner wants to hand over control to the single entity that can ensure his immortality.

And of course, I must mention the hysteria that is gold. When Fortune, Forbes, and Business Week start singing the praises of gold as an excellent investment, its time to re-evaluate your position…however, I do note that the Chinese central bank may diversify into Gold?

“Qin said the government should increase its gold reserves
by any possible means even though global prices have
skyrocketed over the past few months. "Over the longer
term, the yellow metal is a rare commodity, and its price
tends to rise further," said Qin, indicating the price of
gold shouldn't be a factor holding back the government.
On Tuesday, Comex gold hit $700 an ounce, its highest
level since 1980, amid strong oil prices, a weak dollar and
ongoing geopolitical concerns.”

Now that is news…if you believe that China has not been floating trial balloons over its monetary policy for the last 3 years...just in time for the United States to "stop short of calling China a currency manipulator".


Tuesday, May 02, 2006

A strange morphology...

...from Bear to Bull.


Stephen Roach has been among the most bearish commentators regarding U.S. markets during the past few years. He has, of course, been completely wrong (which is nothing to be ashamed about given the ephemeral nature of the captial markets.), but the fact that he is now covinced that it is smooth running ahead is about as good a sell indicator as one might get. I continue to subsribe to the "there will be a major correction in June/July/August camp.

I completely disagree with his dollar stance. Yes, the dollar has weakened somewhat. But there are only two currencies in the world that approach the depth and liquidity of the dollar. That would the the Yen and the Euro. If the dollar depreciates, these currencies will have to appreciate. Do you really thing that either of these countries wants their export-driven growth to be choked off by a strong currency?

No, of course not. The BOJ is a grandmaster at playing the currency angles and toasting traders who dare think that Japan has finally achieved the domestic-driven demand they need to sustain its recovery.

The Euro is less adept at playing the game, but Trichet will continue to keep rates low to ensure the engine room of Germany and France get moving again.

Monday, May 01, 2006

The benefits of a large chip stack.

The conclusion that you, the guy at the table with the short-medium stack of chips, is supposed to garner from this PIMCO letter can be summarized as "I raise you all-in...you are foolish to bet against the chip leader, even with pocket aces." Basically, Pimco invites a bunch of people to an economic forum, the contents of which will doubtlessely reinforce the "correct" long term implications of the myriad causes that effect long-term price dynamics. Pimco then hopes these participants take the wise and sage advice of the world's largest and obviously most generous firm (wow...giving away their investment secrets...how magnanimous) and toe the line. Its the old pro telling the rookies that he, as the largest stack, dictates the terms of the game.

I am always amused at the "secular/cyclical" dichotomy...as if, ex ante, we can differentiate and categorize the causalities into mutually exclusive terms. PIMCO will simply give their version of the world, and this version will be over-weighted by participants who look at PIMCO's enviable stack of chips. Soros called this "reflexivity", but poker guys might call this a "semi-bluff".

"Secular vs. Cyclical Forces
Secular forces determine market direction over the long term, but
there are clearly times when cyclical forces dominate, either
reinforcing or contradicting the secular trend. For this reason, PIMCO
supplements our secular views with quarterly Economic Forums that
examine cyclical factors and help to fine-tune our strategy over
shorter time periods. The Secular Forum establishes our outlook for
the global economy and the broad direction of bond markets over the
next several years. The Economic Forums provide forecasts for economic
growth, inflation and interest rates over the next several quarters.

PIMCO's portfolios and strategies are rooted within our secular views,
with the flexibility to fine tune our strategies based on the
shorter-term views developed at our cyclical forums. We would not
reverse course or alter our secular views without the full examination
of long-term structural forces that our Secular Forum provides. For
example, we may trim exposure to a bond market sector that we believe
to be temporarily overvalued, such as mortgage-backed bonds, even
though we take a strongly favorable view of that sector for the long