Where to start???

The past 10 days serves as an excellent illustration with regards to the proper selection of significant variables going forward.

As the popular press has stressed, quantitative funds who have modeled the markets based on the historical relationships (be they correlative or factually dependent) between sets of prices have suffered some unsettlingly correlated losses.

These numerical relationships are, to put it mildly, "under stress". There are certain members of the press who see the results and quote some amporphous quality called "trading wisdom" and harken back to open-outcry systems, which by implication must be better during these conditions. But what do they mean by this?

Simple: The ability to utilize a deep-thinking form of educated common sense. It is the ability to "connect the dots" using metaphorical and narrative arguments as opposed to data-driven statistical or combinatory reasoning.

And, giving a nod to Soros, any system with thinking participants will produce self-sustaining bubbles as competition will chase profits and drive down the opportunity costs of prudent restraint..."No covenants on your Sub-prime backed equity tranche mortguage securities?? Who are we to argue?? Nobody else is either!! Give us the fee and see you later."

Quantitative analysis is no different. The investment industry has been flooded with brilliant mathematical minds all employing similar (or worse, functionally indentical) trading algorithms. Many have spectacular historical results which bred competition and duplication, using the same arbitrage arguments, the same financing vehicles to fund the trades and the same amount of leverage to make the crumbs on the floor look like loaves of bread.

And then someone yells "FIRE!!!" in the factory with one emergency exit, and the devil takes the hindmost.

Pre-emptive...

and early.

The capital markets were moving to re-price risk categories. As I stated in the last post, beyond the initial euphoria of today, what will the logical interpretation of the Fed's surprise cut in the discount window rate today be?

I suppose we will have our answer monday, but this observer believes that the move will stoke suspicion that the capital markets (especially the credit markets, with CP rates blowing out today in spite of the cuts) are not as healthy as they appear an that a "calamity" may have arisen...

"Calamity"

A problem with saying that you will not lower rates barring "calamity" is that if you do indeed lower rates, participants will surmise that ragnarok is indeed upon us.

Fed watch...

As I have stated a few times before, the Fed cannot cut now. It is between the rock of inflation expectations (using Headline inflation as opposed to core inflation as criteria) and the obvious point that additional cuts will be calamitous for the dollar due to interest rate differentials with other currencies.

And today we hear from Bill Poole, noted inflation hawk, who squelches hopes for a rate cut barring "calamity" (whatever that is...) The following is from Bloomberg:

``It's premature to say that this upset in the market is changing the course of the economy in any fundamental way,'' he said in an interview in the bank's boardroom. ``Obviously, there could be an impact, but we have to rely on some real evidence.''

Barring a ``calamity,'' there is no need to consider an emergency rate cut, Poole said. His comments were the first by a Fed official since the U.S. central bank joined counterparts in Europe and Asia to inject emergency funds after a surge in money- market rates. The Fed has added $71 billion of reserves in the past five trading days.

Poole, 70, said businesses have maintained their hiring and investment plans and banks have sufficient capital to weather the credit-market turmoil. The St. Louis Fed chief stressed that the best course is for policy makers to assess the latest economic data when they next meet Sept. 18. The comments contrast with the certainty that traders put on a rate cut next month.

``If the data confirm the market's view that the economy is sagging, we'll have to decide whether to share that view,'' said Poole, who votes on the rate-setting Federal Open Market Committee this year. He cited the monthly jobs, retail sales and industrial production reports as key gauges he'll be watching.

Equivocation.

Lots of this today as every asset manager in the known universe has a theory of why the credit crunch has happened and what will happen now that its here.

The problems will continue, and, as in the dot-com bubble, all the excesses will in hindsight found to be egregious and unwholesome..."greed" some will say. "Indictment" will be uttered by the government against selectively chosen transgressors (under the oft-utilized "the more publicly known, the better" criteria).

I expect international (especially emerging market debt) spreads to blow out a bit as well, effecting equity markets further. Credit crunches are sticky.

But. Soon, very soon...it will be time to go the other way.

Savvy.

This is a very astute move. One day before the last day to enter in redemptions, GS announces a cash injection into two of its hedge funds that have lost significant value during the volatility of the last two weeks. This effectively shores up the "run on the bank", and is a wonderful example of an investment bank using readily marketable names (such as Hank Greenberg himself...one THE most savvy and tough businessmen on the planet) to increase confidence among its investors. A wonderful marketing move, and this is the only reason why GS would seek to publicize this bailout (which of course is denied to be a bailout). One has to applaud.

http://biz.yahoo.com/ap/070813/goldman_funds.html?.v=19

The Paper Dragon and the Yuan...

A 67% trade surplus with the US. Over 5% inflation. Chinese are angry about the Blackstone deal, and are somewhat "disappointed" with the Shanghai elites gambling the People's money away...and now appear to be involved with Bear Stearns. Interesting.

In this age of information, it is not good when a communist country displays this kind of arrogance and disregard for its very large proletariat...