Oh chit. The Fed is raising the discount rate for emergency loans (Bloomberg). It's beginning to sound like my 2010 forecasts might be on the right track.
Too soon to call it, son.
Recently in *Investing Category
My three months absence here is inexcusable. I've been trying to shake off a World of Warcraft addiction that has been detrimental to my trading. It created slippage in the neighborhood of about 25% reduction in my expected profits. I kept on playing the game ignoring my end of day signals.
The gaming addiction was that strong! It was akin to the character Sam in the movie Avatar where he was more focused on the "virtual" world than his actual word. All of that is mostly behind me now as I believe I've moved on. I feel like I've already mastered the game and there's not much out of it.
Looking back at my forecasts for 2009, I've been pretty accurate and profitable. The experts at the time, January 2009, mostly predicted our economy will not recover. The prediction markets pegged positive GDP growth for 2009 at about 33% chance.
Buying the Dow at 8500 and even 8000 as I suggested might not have been such a bad move right?
To put it simply, I do not expect the positive returns this year to be as nice as last year. You know how the S&P averages about 10% a year with a whole lot of variance year-by-year? This year feels like a 10% year.
To draw from many sports analogies, we're in a rebuilding year. We're trying to find what works and doesn't work for our team. There are a host of systematic weaknesses that need to be addressed and we need to focus on the positive aspects that grow our economy.
My general economic forecasts are great if you're managing a large sum of money or into that intellectual hot air.
To break it down into a more usable form, I predict the FOMC to set higher interest rates. The Fed doesn't exactly set rates. They have interest rate targets, but you know what I mean. Rates will go up this year. There's very little doubt in my mind about this.
To play off the higher interest rates, US dollars will be an attractive option for 2010. If you don't see the relationship between higher interest rates and currency, then there's not much I can do to help.
What I've discovered in my statistical analysis is that the price of gold is about 60% negatively correlated with the US Dollar. Correlation does not imply causality, but that's the nature of the gold/dollar relationship. Be careful though, because I lost a slight bit of money betting against gold last year, but luckily my stop loss kept me safe.
I'm going to wager this year that the rising interest rates will make the dollar rise and pop the air out of gold.
1 Day - 53%
5 Day - 55%
15 Day - 60%
30 Day - 62%
There are even more voodoo systems for trading in the market.
The noise about fake winning strategies from television, newspapers, and books will make you deaf. The only way to be certain of a winning system is to subject it to valid hypothesis testing (i.e. avoid curve fitting, data mining, and selection bias).
A common misconception for testing systems is to assume the odds of calling the market correctly is 50/50.
50/50 is flat out wrong.
It's been said many times, "the market is a like casino rigged in your favor". If you randomly bought the S&P index on one day and sell it back the next day, you can expect to be in the black about 53% of the time. The chart above very roughly approximates the odds of the market based on the number of days. The average returns from when you're right is a lot less than from the average returns when you're wrong, but in terms of the number of times correctly the percentages above very roughly approximate the odds.
Knowing these odds, it's not surprising to find many long systems promising you the moon. Long systems should already have a built in positive advantage. It's a strong tide that already pushes you towards winning.
Odds are if someone is losing money in the markets after a few years they're doing something wrong.
Tough one.
Arnold Snyder wrote an excellent post about talkative players at the poker table a while back, entitled Shut the Fuck Up. Some poker players just don't realize that educating the fish makes the game harder.People's propensity to talk too much exists in all forms of advantage play and investing. A fine delicate line exists between sharing ideas among private individuals and shutting down the game.
A couple of years back one could have taken simple algebra and made a lot of money gambling online through the various bonuses. The returns on some of these games were equivalent to a ROI of 100% for about 10 minutes worth of work. No kidding. That was precisely how I built my small fortune with a couple of hundred dollars.
The first popular site to discuss these ideas decided to shut down its message board because of the information leaks. Another site popped up to replace it. The leaks weren't as bad as the previous site, but that site shut down too. The current most popular site has a new owner that does not understand the value of silence. Any and all ideas are discussed and talkative bitches have killed the game. Where ROIs of about 30% were common, now the most common ROIs are about 1%. The game is dead after factoring in the risk of having one's funds stolen.
What most people don't realize is that excess returns are proportional to the flow of information. A broad interdisciplinary understanding between information theory as it relates to gambling, investing, and maximization of wealth would clearly illustrate this. If you care to explore this idea further I'd recommend the book Fortunes Formula by William Poundstone.
By writing this very post I am also guilty of contributing to the information leak. I'd like to believe that my contribution is much more minimal. I don't mention too many specifics and have not discussed the strategies or the ideas behind these opportunities, but the very act of mentioning them is a leak. I maintain this blog so that I can crystallize my thoughts into a concrete form. The value from forcing me to organize my thoughts exceed the slight leak it might cause. I apologize for that. If at anytime I feel this site is hurting my profits, I'd shut it in a heartbeat.
Relating this to the investment world, people with high Investor Quotients (IQ) don't discuss their methods. Rather than proving to the world they're right and the Efficient Markets Hypothesis is wrong, they'd rather make millions and billions. If that much money is on the line, they know how to the STFU.
If you spot an investment opportunity, $100 lying on the floor, or a game that can be beaten, don't tell others. STFU and take the money. It sounds simple enough, but people can't keep their mouths closed in real life.
I'll defer twelve very good points to an older article at Seeking Alpha:
If you're a self-professed "Goldbug," feel free to read no further. Or at least spare me your hate mail. Because no matter what I say today, I know you'll cry foul... or something much more colorful.
But for those of you with an open mind - especially after my last three contrarian predictions proved dead accurate - read on.
Because it's time to start shorting gold!
You won't find many, if anyone else, making this case. But as the first reason of 12 below reveals, that's precisely why you should give it more credence.
12 Reasons To Start Shorting Gold
- It's decidedly contrarian. If a contrarian investor is someone who deliberately decides to go against the prevailing wisdom of other investors, shorting gold certainly fits the bill. Right now, everyone else isbuying gold, or at least recommending it. If you have any doubt we've reached such fever pitch levels, consider No. 2.
- The infomercial factor. The best indicator of a turning point for any investment, in my experience, is infomercials. If an investment gets so popular it invades the pre-dawn hours with non-stop but-wait-there's-more offers, it's time to get out. And that's exactly what's happening now. So much so companies like Cash4Gold.com are invading primetime television. They even splurged for a Super Bowl ad spot. And they recruited washed-up celebrities Ed McMahon and M.C. Hammer to boot. In case you forgot, the Hammer filed bankruptcy in 1996. And Eddie boy almost lost his 7,000 square-foot, $6.5 million Beverly Hills pad to foreclosure. No offense, if you take investment cues from these two, you deserve to lose money.
.........
The excellent article just about sums up most of what I want to say. From a more generalist perspective, there appears to be a bit of bubble mentality going on. When cash4gold is a familiar household name, people are having gold parties, and it's being featured on nightly national news program -- talk about non-rational valuation.
For the gamblers, consider selling gold.
Disclosure: I am long on DZZ which is a double leveraged short ETF on gold.
In my last post I looked over the results from my four guesses. I only looked at their returns which were great returns, but I did not consider their applicability for the future. I'd hate to make four new guesses on four very different topics under such a time constraint, but I do want to pull out the "weeds from the garden" as Peter Lynch would call it.
I'll officially stand by guess #1. China in the form of a GXC or FXI will still be a good bet. No further opinion on the greenback, TIPS, and the short term market performance.
The worst of the stock market is over and now is as good of a time as any to get back into the market. I don't like buying into market rallies like what we've experienced recently but if you can get back in at low DJIA 9's, that would be a good price. We've seen some very real signs the economy is recovering and I think they're legitimate.
Paul Tudor Jones might disagree with my rosy outlook. In a letter to Tudor investors, Tudor Investments is of the opinion the current market rally is a bear market rally. They have doubts about the sustainability of the current rally. I'd like to think that a billion dollar private equity fund managed by a trading genius would have a better opinion than me. It probably does, but I try to be as honest and as objective as possible. Can the same be said about any company's statements? I don't know.
Good investors try to be grounded in reality and tend to learn more from their mistakes than from "getting it right". I've made some predictions over the past few months and now is as good of a time as any to test their accuracy.
Guess #1: The investor says to invest in China through a broad based indexed ETF like GXC or FXI (April 22)
This has been an unequivocal successful gamble. GXC was going for about $50 a share when I made my guess. It's now worth about $70. In my own personal position I've made an approximate 40% return on this wager in the past 4 months.
Guess #2: For the investors, a good diversified portfolio should contain some bond holdings like TIPS (Treasury Inflation-Protected Securities). (April 24)
This one is a small loss. TIP went from $101 took a nose dive and fluctuated to about $100. A small loss of less than 1% would hardly be considered a loss by many, but the small loss is a fact. TIPS yields are typically very slow and this did not prove to be any exception.
There are a wide ranging universe of possibilities as to why TIP hasn't made me any money. My best guess is the recessionary deflation pressures are slightly stronger than the inflationary pressures from increased government spending.
Guess #3: For the gamblers, USD is not very attractive. (April 25)
This was an unequivocal success. FOREX traders trade on leveraged currencies. I don't trade FOREX and I honestly don't know what leverage ratio I would use, so I can't estimate what my returns would be. Further, my predictions were just a general knock on the US dollar but I did not explicitly mention which currency would be stronger than the USD, so I just picked EURO. Either way, this was a gangbuster correct guess.
Guess #4: I'm starting to think this current rally might have been a bit too much and too soon. (June 11)
Out of all my guesses, this one is one that sticks out the most to me. Not just because the S&P zoomed from 944 to a 1000, but because I took the entire month of July off.
This one is tricky and I'll chalk it up as a 6% loss. The S&P pretty much followed as I predicted until July when it turned around and zoomed up. Unfortunately, I was busy preparing for the Bar Exam (which I never took) and so I haven't paid much attention to the market.
The question that bugs me is, would I have pulled the trigger in July to get out this losing position? On about July 15th, it occurred to me that I did not check the July June ISM numbers. The ISM numbers were surprising for me, because it showed an undeniable decline in shrinkage -- meaning the economy was showing real signs of improvement. Would I have pulled the trigger? This question still bugs me, but I'll chalk it up as a loss. The lesson to be learned is that if I want to trade professionally, I will have to devote full time to the markets. I can't compete against the market on a hobbyist basis when I'm competing against people who live and breathe the market 24/7.
Overall: Not bad guesses. Maybe studying economics wasn't such a bad idea after all.
I've been trying to find a copy of this 1980's PBS documentary on Paul Tudor Jones. The only places that had it were bootlegged copies charging hundreds. Bear in mind this was shown on PBS for free back in the 80's.
The hour long documentary follows the daily grind, mindset, and attitude of the legendary trader Paul Tudor Jones. FYI, Paul Tudor Jones and Edward Thorp (the father of card counting) were in a few investment deals together and it's fair to say they've collaborated on a few trading strategies.
After watching the tape, I (1) have a man crush on PTJ and (2) feel better about gambling with my life.
Update: It's been taken down. If you missed it, it was a great video. Look for it to spread at the torrent sites and other places.
From Graham's and Dodd's 1940's edition of Security Analysis, p.685:
Can the analyst exploit successfully the repeated exaggerations of the general market? Experience suggest that a procedure somewhat like the following should turn out to be reasonably satisfactory:
- Select a diversified list of leading common stocks, e.g. those in the DJIA
- Determine an indicated "normal" value for this group by applying a suitable multiplier to average earnings. The multiplier might be equivalent to capitalizing the earnings at, say, twice the current interest rate on highest grade industrial bonds. The period for averaging earnings would ordinarily be seven to ten years, but exceptional conditions such as occurred in 1931-1933 might suggest a different method, e.g., basing the average on the period beginning in 1934, when operating in 1939 or later.
- Make composite purchased of the list when the shares can be bought at a substantial discount from normal value, say, at 2/3 such value. Or purchases may be made on a scale downwards, beginning say, at 80% of normal value.
- Sell out such purchases when a price is reached substantially above normal value, say 1/3 higher, or from 20% to 50% higher on a scale basis.
Exactly two months from today. I said on April 24, 2009
It's possible that I'm picking the one article in the universe that supports my position. Am I guilty again of selection bias?
Back in January 12, 2009 I wrote this:
The big take home for 2009 is the death of free markets. We weren't truly free markets to begin with, but government spending will be the biggest game in 2009. Our markets are going to start looking like the "Chinese Markets" with its government involvement. I can't say with absolute certainty what the next administration will focus it's capital on, but I feel confident in saying they will spend/spend/spend because we are fighting a Depression....
I received some flak with people calling into the whole philosophical definition of words. There's not much value in arguments (outside of legal arguments) when people raise definitional issues to an argument. It usually means they've ran out of counter-arguments.
Anyway, Businessweek has a nice article about the "Campaign for Free Enterprise". Some businesses are fed up with government control. They're even comparing the government control to communist Russia and that we're no longer in free markets.
I'd say that's pretty close to the above prediction. I might be guilty of picking the one article out of the universe that supports my point, but it's pretty spot on.
One of the best ideas to take from Caro's Book of Poker Tells is the notion of players trying to mask their strength by acting the complete opposite. Players with weak hands tend to act too strong. Players with strong hands act too weak. The instinct is to use deception to win as much money as possible. Weak players just don't realize that better players are one game step ahead and use weak players' deceptions to their advantage.
The market sometimes operate on this similar contrarian principle. Widely read newspapers and magazines can be the ultimate contrarian indicators. When the newspapers are forecasting the Golden Age of wealth, it's time to sell. When newspapers are reporting the apocalypse, it's time to buy.
The current market rally from March is giving me some cause for concern. The economy is operating very much like I predicted since January. The transition from bad news to "not so bad" news is the likely driving reason for the current market rally.
The problem with this current market rally is the sudden and explosive gains. The returns are so strong and so soon, some newspapers are reporting a quick V shaped recovery.
My economist hat tells me this recovery won't be as soon and as quick as the newspapers report. While the US is moving out of negative growth towards 0% growth, the move from 0% to +% growth is much more uncertain.
I just don't see much in the way of increased consumer spending (slight increases but not that great) or more business spending to drive positive growth, at least not yet.
For people to start heralding a quick V shape recovery when the current economic feel is much more uncertain signals to me a disconnect with the reality. I'm starting to think this current rally might have been a bit too much and too soon.
Yesterday I wrote about some of the analytical framework that goes on in setting the sports line. I might as well tie together this analytical framework in setting point spreads to investing, and economics.
Sports Gambling
- Point Spread = Home Court + Team Stats + Popularity +.......
Economics
- GDP = Consumer Spending + Business Investments + Government Spending + Net Trade
Investing
- Stock Price = Earnings Per Share + Book Value + Market Cap +.....
In the three examples, an outcome can be estimated through regression analysis. How we determine the ultimate value of something is based on the parts that make up the thing. Using regression analysis can be one of the most powerful ways of finding the truth in gambling, investing, and economics.
Note: I've dumbed things down considerably to make this as accessible as possible. There's also usually a coefficient value in front of each factor, but adding coefficients would make it look more confusing. There's also the assortment of problems from data mining, multicollinearity, bad models, etc., etc. But the three example is its simplest form
Political prediction markets like Intrade.com tend to be more accurate than most Gallup polls. They reflect a "wisdom of the crowd" because of monetary incentives to be accurate.What's confusing is how the wisdom of the crowd is defined. While markets are very public, they don't reflect the majority opinion. Markets are public by definition, but I'd posit that the decision that the crowd makes in the stock market is more heavily weighted by sophisticated investors. The resulting outcome isn't the product of a majority opinion. The average American could be stripped from the equation and the crowd accuracy of stock markets, sports betting markets, and political prediction markets, would probably be just as accurate.
That's why some of the justifications from behavioral financial economics are inaccurate. Some traders claim that trading patterns can be exploited, because of the irrational nature of human beings. Individuals are very irrational, but any such profitable patterns are likely gamed away by sophisticated investors. They make up much more of the action than irrational investors. That's what makes the investing game even more difficult. To make a billion, I'd have to outsmart these sophisticated investors and that requires a lot of brains--the kind of brains that I don't currently possess.
Calendar effects are interesting because they're market inefficiencies that shouldn't exist in efficient markets. Some would say there are no seasonal effects and that the results are just from data mining.The Monday effect pictured here is a very significant result that's not likely caused by data mining. Companies, as well as politicians, do regularly release bad news on Fridays when the markets are closed. When markets are re-opened on Monday, the markets negatively react to these news. This relationship makes a lot of sense.
What doesn't really help is the edge from the Monday effect is only about .1%. Trading fees vary generally with accounts, but it's safe to say that most people will have fees between .1% to 1.0%. It's unlikely that anybody can make a fortune off of this pattern and it might not even apply anymore. The trick is to combine multiple seasonal effects, plus any other 'edge', and not to focus on large efficient markets like the DJIA. Perhaps I've said too much.
Nothing really. He's made over billions in the market and I've made tens of dollars (maybe a lil more). Buffett's respected and I'm unknown. Nobody listens to me. Everyone listens to him.
Okay, we do have one thing in common, we both think this increasing government expenditure is going to drive up inflation.
I wrote about this as recently as last week. I even wrote about this earlier on December 16, 2008 in response to the last FOMC cut:
The Rate Reminds Me of One of those Horror Movies...
Where a cop fires all six shots at an approaching monster.
With no bullets left, he desperately Proceeds to throw his gun at the monster. The Fed has already spent all of its bullets and has now thrown their gun at the approaching Recession Monster". Today's rate cut is the absolute last resort in what rate cuts can do.
Unfortunately, it doesn't seem like it will have much effect in stopping the Recession Monster. It's quickly growing into a full blown Depression Monster. In modern horror movies, this is when the authoritarian government officials decide to use their most powerful weapons like the A-bomb.
The Fed will be using the most powerful weapon at their disposal, the printing press. If this monster does not die by itself, the government will start printing a massive amount of cash and inflation. Due to the elimination of the gold standard, the flow of the printing press is now decided by "rational" government officials instead of a set certainty. This desperate solution might work. It appears there's a deflationary spiral going on right now, and if the Fed pumps just the right amount of inflation through its press, it can potentially offset each other.
That requires a lot of trust in our leaders. I like to believe that our leaders are much smarter now than they were during the last Depression. I'll give them the benefit of the doubt. Maybe the use of the A bomb will destroy the monster, without destroying our own cities. 80/20 that our officials wont fuck it up.
This is what the Oracle was talking about during this weekend's shareholder meeting:
Reflecting on the near implosion of the financial system last fall, Buffett said officials should be judged more leniently when facing "as close to a total meltdown as you can imagine."
But he warned that efforts such as the Treasury's $700 billion Troubled Asset Relief Program and the $787 billion fiscal stimulus plan passed this year by Congress will have to be paid for, one way or another
And with political leaders showing little inclination to raise taxes, one sure way to pay for excess spending is to inflate the value of the currency, Buffett said. The biggest losers in a surge of inflation, he added, would include holders of bonds and other fixed-income assets.
"I haven't had my taxes raised," said Buffett, who has run Berkshire for more than four decades. "My guess is the ultimate price will be paid by a shrinkage of the value of the dollar."
From my previous prediction (posted elsewhere earlier), I forecasted that the Obama inauguration point was a good possible turning point. I was wrong about that point being the turning point, but I'd say my prediction of good vibes from the Obama adminstration seems spot on.
Arguably the greatest fear that system traders and professional sports bettors face is the fear their system is no longer profitable. Rather than making positive expected value bets, they're actually gambling into losing situations. There might have been profitable patterns during the tested time period, but there are no guarantees that the pattern will repeat itself in the future. The patterns might even be random, and we're just drawing non-existent connections.
The future is uncertain, and that's what sports bettors and system traders have to face. This uncertainty is why most people can't gamble or trade for a living. The professionals are wagering that any loss from using a negative system will be offset from the wins from a positive system.
Zerohedge just linked an article from Innovative Quant Systems and sums up some of the uncertainty about using a system based on momentum, value, balance sheet, improving financials, and sentiment:
Observations:
- One-Week factor persistence for very few factors in the past, but persistence is now realized for all 5 factor categories!
- Four-Week and Eight-Week factor persistence was positive in the past, but now they are negative!
- Improving Financials is expected to have longer-period persistence, which it consistently had at four-week and eight-week, but not recently.
- Momentum does not have persistence over long periods, and wouldn't expect it to.
- Value is expected to have persistence over long periods, and did so in the past, but not recently.
Conclusions:
Quantitative weighting schemes need to look back at the past to help forecast the future, with the assumption that persistence exists. With negative persistence recently, the better plan is to weight factors opposite what has performed well by incorporating the persistence information above into the process. Based on the results above, shorter-term trading models would have performed well since June 2007, while longer-term models would have performed better previously.
*Yesterday the Dow plunged 290 as investors worry. (Associated Press)
*Dow's biggest decline in 7 weeks. (CNN Money)
Some of the previous headlines before yesterday's drop were, the "Dow Climbs 20%", "Experts see signs of recovery", "Glimmers of Hope", etc. etc. The financial media is manic for the same reason people are manic. People don't think in terms of long run averages. They see the variance, the short term movements and cry or celebrate accordingly. Practically all people can't see beyond today's results and focus on the yearly or decade results. Benjamin Graham, Warren Buffett's crush, associated this behavior with "Mr. Market".
Mr. Market is a bit of an older gentlemen's term. The manic behavior reminds me more of a wannabe Blackjack Card Counter. The book Bringing Down the House and the movie 21 has brought in a younger generation of gamblers allured by the adventure and fantasies of quick money. They read the book and learn how to count (the counting is the easy part). One of two things can happen:
1. They go out to the tables and end up losing money, even though they had an edge. They get mad and blame the system. They blame everything but themselves and quit.
2. They get real lucky and win some money. They're thinking, "This is easy. I'm going to be quitting my job soon, so I can gamble full time." They go back to the casino the next day, next week, or the next month and then get hit with a normal loss and then quit.
That's the sad fate of most Blackjack Card Counters. They don't realize that to make about $10 an hour card counting, they could end up anywhere being -$390 or +$410. The amount of luck possible is 'confined' within a range of possibilities.
These wannabe card counters are almost always the same type of people that work in the financial services industry. They're drawn to the allure of of adventure, quick money, and lavish lifestyles. They panic when the market drops and celebrate when the market rallies. In the end, these people can never beat the market averages.
These guys just never learn that most movement in the market is random, even if they had an edge. They need to chill out. If they planned well, these movements should have no major effect on their investment decisions.
