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Boo-yah Jim!

Technorati Tags: cramer,high frequency trading,HFT,flash crash,algorithmic,algo,pe,price earnings

 Jim Cramer is a howling megalomaniac and an internet stock tout, but you can always count on him to speak his mind. This rant, on his June 15 broadcast, perfectly captures the frustration felt by “ordinary” investors who can’t be sure what the rules of the game are anymore. Market moves do not seem to be based on fundamentals and what goes up one day can reverse on a dime. A stop loss order was the traditional way to protect your profits by posting a floor price on a stock that would trade on a market reversal. The May 6 “flash-crash” caused the activation of thousands of stop loss tickets in a twenty minute period as high frequency traders took a coffee break and pulled their orders. The indexes fully recovered in less than an hour, but left a pile of burned out stock positions smouldering on the exchange floor. Traders call this getting “whip-sawed”.

High frequency or algorithmic traders don’t care about the fundamentals of valuing stocks; the price action is all that counts and they are capable of instantly shooting off thousands of buy and sell orders on the instructions from a piece of software that can measure technical changes in the markets in nano seconds. In fact, so important is processing speed to these outfits, that they have negotiated deals with the exchange bosses to co-locate their computers with those of the exchange in order to cut the distance that the electronic market information must travel. It is probably the first time in history that a dollar value has been assigned to the speed of light.

High frequency trading is the mainstay of the proprietary trading desks of the Wall Street merchants JP Morgan and Goldman Sachs, who boasted recently that their “prop” desk was profitable every single day for the last four years. That fact ought to tell you that somebody is losing skin in the game. Trading volumes on the major stock exchanges have exploded in the last several years, but it’s not because the average retail investor has suddenly decided that stocks are the place to be. Now institutional portfolio managers, the men and women who manage our pension funds, are questioning if the “casino” atmosphere of modern stock markets offer a fair playing field on which to execute their fiduciary duty.

Volatility may be here to stay, but long term investors may not be. When stocks fall out of favour, valuations sink as price to earnings multiples drop to single digits – that’s historically where the real bear market bottoms are to be found. It won’t matter one wit to the HFT’s who care not for fundamentals. They’ll trade stocks down to P/E’s of 8 and not lose a day of profitability. Buy, hold and….prosper?

The Sunsets Are Still Nice

 Barak Obama is furious. Tony Hayward, BP’s CEO, is sorry. Both are spinning their stories like mad on TV to cover up their gross negligence in the Gulf drilling disaster. The government is condemned for permitting an oil company with one of the worst records of environmental miscreance to engage in high-risk drilling without verifying that it could cope with a blow-out. BP is a mendacious corporation that advertises its initials as standing for “beyond petroleum” and wraps itself in “green” in well contrived media spots. BP is “beyond propaganda” and this unfolding drama strips away the subterfuge that it ever had a concern for the environment. Hayward’s teary-eyed contrition acted out on a prime time television commercial rings hollow after having stated last week that the amount of oil gushing from Deep Water Horizon was actually insignificant given the total volume of water in the Gulf of Mexico. He has no credibility. Obama will attempt to restore his tomorrow on another trip to Louisiana where he will try to get his oleaginous ducks in a row.

I, myself, have moved beyond the disgust and depression that have weighed on me these last weeks. I am buoyed by the indomitable spirit of capitalism which will assuredly find a business opportunity in this calamity. The beaches on Florida’s Gulf side will no doubt be despoiled of their pristine beauty and property values will plummet, but innovation will prevail to create a brand new good. Welcome to Tarball Beach, Florida’s newest retirement community. Here’s the idea: form up and press down the oil laden sand to form a strip of blacktop right on the beach. Not a highway mind you, but a two-lane road on which the new residents can drive their obesity scooters from their ocean side condos to strategically placed ice cream stands. It’s a winner I tell ya. You’ve gotta think positively!

Still About The Oil

 Next time you are driving to Red Lobster, think about this: the Cajun shrimp won’t be on the menu. Actually. they will be, but the shrimp will be from Thailand, not Louisiana.You will never know the difference. As consumers, we may think that we are hard to please, but generally, we are easily satisfied. Substitutions will be accepted so long as it does not cost us more.

I never saw a Red Lobster restaurant that you could walk to from any normal place of habitation (you could get there on foot if you lived under an overpass). It is one of a dozen corporate eateries that accommodate the masses who have parked their families in the indistinguishable suburban sprawl covering the continent. Civilization does not need sidewalks when you must use a car to get even a loaf of bread and a quart of milk, and it works on cheap oil.

So now we have the tragic consequence of the trade off of the natural environment for life in an automobile. In the quest for more, drillers went boldly where they had never gone before -one mile down to the ocean floor- to poke their diamond bits into the earth’s crust. With two thousand deep-sea oil rigs in the Gulf waters, it was only a matter of time and the law of large numbers for a serious breakdown to occur, and British Petroleum was not prepared. They figured that being forty-eight miles from the shore would give them plenty of time to clean up a spill. Not so. Consider this: one mile either way from the surface of the earth is a place where humans don’t easily operate. When I’m flying, I’m comforted to know that the machine that I have trusted my life to has redundant systems that will keep it in the air in the event of a system failure. Deep Water Horizon was doomed by a faulty blow-out preventer valve and there was no other device to kick in to prevent the ensuing catastrophe. Blame it on weak regulation which in turn is symptomatic of the lack of political will in North America to promote alternate forms of energy production. We are still deluded by the myth of the endless frontier. Do we care that the groundwater in Alberta is being poisoned by the extraction of the tar sands? Not enough it seems to put a halt to that project.

The tide of concern and hand-wringing over the disaster on the Gulf Coast will recede when CNN pulls its cameras from the scene after milking the spectacle for all it is worth in viewership, ratings and advertising revenue. Give it a couple of weeks before the public tires of seeing one more pathetic, bunged-up seabird and turns back to I Love Lucy reruns (life was so much simpler then). The powers that be, political and commercial, prefer to keep the populace high on the real thing: a clean windshield and a full tank of gasoline. Climb into the Vista Cruiser kids and we’ll drive to Disney World where the sea turtles can talk (mind you they only say what they’re told to). The dead ones tell no lies. How long will we remain in suspended animation, inured to the inescapable fact that we are destroying our planet?

Contrast this with the forward looking German Renewable Energy Act which promotes the development of renewable energy through scaled feed-in tariffs which guarantee a higher revenue for producers of renewable energy, from biogas, wind and photovoltaics, than for conventional producers of hydro, nuclear and coal generated electricity. It is a market mechanism that limits bureaucracy and regulatory arbitrage and it lowers the barrier to entry for small producers who have proven to be very innovative in creating new economies  built around renewable energy. Currently 16% of electricity consumption in Germany is sourced from renewable energy, well exceeding the targets initially set out in 1997. They are on track to reach the 30% threshold in less than ten years. According the the architect of this policy initiative, Dr. Hermann Scheer, at this pace Germany could conceivably secure all of its electrical energy needs from renewable sources in twenty years.

  

Chinese Walls

 

 Listen to Jim Chanos in this interview with Charlie Rose. This talk is 30 minutes long where Chanos, famous investment manager who shorted Enron, gives his reasons why he is negative on the Chinese property market. Hang in, though, for the last 10 minutes where he gives his thoughts on the U.S. credit meltdown and the fraud he says has yet to be punished. It is fascinating, informative and a must see:

http://www.charlierose.com/view/interview/10960

Enough Said

I am going to break a self-imposed rule here and use a word that is not in the Pocket Oxford dictionary. The word is “malversation”. It does not describe a discussion you might have with the tax authorities any more than “conversation” defines a talk with Bernie Madoff from which you walk away shirtless. Malversation is misconduct in public office, or corrupt behaviour in a position of trust. When it is evident it is meant to be prosecuted, unless you are too big to fail and too big for jail.

In the early eighties the American government stepped in to clean up the mess of the Savings and Loan Crisis through a bail-out program called the Resolution Trust Corporation, at a cost of $132 billion to the U.S. taxpayer, but they also exacted pounds of flesh by convicting more than a thousand malefactors who perpetrated mass mortgage fraud from their financial institutions. The experience gained by the Federal Bureau of Investigation during and after the S&L debacle was not lost as evidenced by this headline from  CNN on September 17, 2004:

WASHINGTON (CNN) — Rampant fraud in the mortgage industry has increased so sharply that the FBI warned Friday of an "epidemic" of financial crimes which, if not curtailed, could become "the next S&L crisis."

This time around it was’nt just the bit players from the Peoples Bank of Poughkeepsie who were up to no good. The mega-banks on Wall Street could not pass up on a ready supply of sub-prime loans from crooked mortgage originators, and with the collusion of the rating agencies who had long been in their back pockets, packaged a new form of “security” called a collateralized debt obligation (CDO) and sold them around the world through their sales forces. Supposedly sophisticated pension fund administrators are also prone, it would seem,  to mistaking a $1000 Armani suit for intelligence and integrity. The cost to Joe Public may amount to ten times the expense he incurred in the eighties to bail out the regional banks, and not one indictment has yet to be filed in reference to to the fallout from the financial collapse of 2008. Is the wanton disregard of underwriting standards for easy profits and ludicrously large bonuses an actionable offence, or should it be considered  merely an error in judgement and a cost of doing business as usual? Periodic financial loss used to be the means by which a free market purged itself of excess speculation and imprudent behaviour, but with the readiness of governments to use the public purse to backstop the risk-taking of the giant financial players, how is this cycle of miscreance going to end?

There is a growing realization by taxpayers in the U.S. that the wool is being pulled over their eyes. Former Secretary of Labor in the Clinton administration and now economics professor at Berkley, Robert Reich, raised the alarm last week about the recent revelation of the secret bailout of Bear Stearns by the Federal Reserve Bank months before Congress authorized the government to spend up to $700 billion of taxpayer dollars bailing out the banks, and months before Lehman Brothers collapsed in 2008. You can read his entire post in the Huffington Post here http://www.huffingtonpost.com/robert-reich/the-fed-in-hot-water_b_522059.html, but let me reprint three main points that he makes:

1. First, only Congress is supposed to risk taxpayer dollars. The Fed is not part of the legislative branch. Its secret deals, announced almost two years after they were done, violate the democratic process, if not the Constitution itself. Thomas Jefferson put a stop to Alexander Hamilton’s idea of a powerful central bank out of fear it would be unaccountable to the public. The Fed has just proven Jefferson’s point.
2. Second, if the Fed can secretly bail out big banks, the problem of "moral hazard" – bankers taking irresponsible risks because they know they’ll be rescued – is far greater than anyone assumed after Congress and the Bush and Obama administrations bailed out the banks. Big banks will always be too big to fail because they know the Fed will secretly back them up if they get into trouble, even if Congress won’t do it openly.
3. Third, the announcement throws a monkey wrench into the financial reform bill now on Capitol Hill, which gives the Fed additional authority by, for example, creating a consumer protection bureau inside it. Only yesterday, Sen. Jim DeMint (R-S.C.) blasted the Dodd bill for expanding the Fed’s authority "even as it remains shrouded in secrecy."

Government officials argue that they had no choice but to bail out the banks in the manner which they did, in order to save the financial system from self-destruction, and thereby prevent a global depression. This may be true, though the counter-argument is that, as in the eighties, selective bank failures could have been allowed and losses taken which would have mitigated costs to the taxpayer and applied the appropriate market discipline to forestall a repeat of the speculative fever which is again building momentum. The taxpayer has yet to feel the real pain that is coming. The contingent liabilities of future government entitlements of social security, and now health care, are increasingly looking like impossible targets to meet given current deficits. What happens when the citizenry in the United States realize, that not only have they lost their shirts, but that they are sans-culottes as well? 

Of Elephants and Barn Doors

A wife rarely misses a chance to tell you how wrong you are. I’m not being sarcastic: a good confidant should question your assumptions and tell you if they think you’ve strayed down the wrong path. It does not mean you have necessarily erred, but it’s a good idea to check your bearings. Lately my wife has been questioning my reluctance to put more of our retirement money into stocks. She is right, that I have been dead wrong in saying that North American stock markets would be good for perhaps a fifty per cent rebound off the post-crash lows hit last year, but would likely roll over at that point and possibly slide to new lows as the gravity of the credit collapse sapped the animal spirits of investors. The markets blew holes in that prediction and are currently ahead by a little over seventy per cent. The public demands to know, “what’s next?”

Financial markets are fraught with uncertainty and the smart players know that any predictions they make are provisional and are probably better not made at all.  When asked what he thought the stock markets would do, John Pierpont Morgan replied, “They are going to fluctuate.”  Experts in any field know that the esteem in which they are held by their clients and peers  is fortified by bold prognostication – it comes with the territory. Dithering and ambivalence are seen as proof that you really don’t know your stuff. Experts though, suffer from a failing that plagues all humans, which is a tendency to overestimate our competence to make correct decisions. This is the stuff of behavioural economics which has risen to the fore lately, as real-world events have undone the assumptions of classical economists whose theories are predicated on the belief that we always act rationally, at least where money is concerned. Pity former Federal Reserve Chairman Alan Greenspan, who now shuffles down the road to contrition, forced to admit that much of what he thought he knew of the workings of the economy and financial markets was wrong. And to think he was married twice.

I’m not deaf to the practicality of J.P. Morgan’s words, and this is what I have always said, and will continue to say, when asked about how holding equities in a portfolio: Stocks are not guaranteed and are therefore a risky asset, and the stock markets can do crazy things at just about any time.They also happen to reward their owners with returns which exceed other asset classes over the very long term and this makes them attractive. The ideal percentage of equities in a retirement portfolio should be conditional on the amount of risk you need to take to assure yourself of an income for the rest of your life. Consideration is given to how many years you will be saving and investing and how many years you will be withdrawing from this savings pool in retirement. An heuristic (rule of thumb) that financial planners can use to at least start this discussion is, that in the absence of an annuity like a defined benefit pension plan, you should hold a percentage of equities equivalent to one hundred minus your age. A fifty year-old would have half of his retirement portfolio in guaranteed fixed income and the other half in stocks.

Pundits are proclaiming lately that the “coast is clear” and “the worst is behind us”, and people are emboldened to take on more risk in their portfolios. The idea that the stock markets could experience another fifty per cent collapse any time in the foreseeable future is simply not in the cards for most market commentators. I say, “never say never”. The stress test that needs to be applied to your retirement strategy is to calculate the impact of a worst-case scenario drop of fifty percent in your stocks tomorrow. That’s not a prediction, its simply an acceptance of a measurable hazard that has always hung over the stock markets from day one. The better part of surviving calamity is being prudent about discounting what you think is improbable.

John Sedgwick was a Major-General in the Union Army who was shot dead in the Civil War battle of Spotsylvania Courthouse. From horseback he inveighed against his troops who were ducking from  bullets being fired by Confederate sharpshooters from (for then), an incredible 800 hundred yards. His last words were, “They could’nt hit an elephant at this dist-“

Here’s Looking At You Kid

   The headline on page four of Saturday’s Globe and Mail, Canada’s “national” newspaper, states, “The face of Quebec revealed in niqab debate – English-speaking Canada assails province’s opposition to headwear…”  I appreciate the editor’s cleverness of juxtaposing  a metaphor for Quebecer’s supposed social attitudes with the function of the muslim headress which serves to cache the presentation of self in everyday life, but I think he and the rest of Canada have got it wrong. The move to remove the niqab from civic life in Quebec is not about an intolerance to Islam, but rather is a practical “tweaking” of rules of behaviour on the part of a society that has always concerned itself with the social solidarity of the group. This contrasts with the Anglo-American ideal of the sovereignty of the individual and the attendant protection of personal liberty at all costs. The author of the piece rightly points out that this is not a particularly recent debate in Quebec and it is one that has engaged all Quebecers from every social milieu. The consensus that has arisen is resolute: the hijab–yes, the niqab-no.

The hijab is the headscarf worn by devout muslim women, and it is ubiquitous in Montreal. I have never met anybody who has ever expressed distaste for this symbol of religiosity, unlike in France where anything which deviates from an expression of the secular is verboten. The niqab, however, raises the ire of everyone here, but not, I believe, for the reasons most often cited in the press. Feminists disparage the wearing of the niqab as an example of the subjugation of women, but I can only presume that a muslim woman who puts on the headcover does so willingly. Nor do I buy into the Globe’s conjecture that Quebecers suffer from some post-traumatic disorder caused by a history of intrusion into everyday affairs by Roman Catholic priests, the symptoms of which are an extreme allergic reaction to religion. Practical reasons for condemning the niqab, such as the original complaint which led to the quasi-judicial prohibition – that a language teacher could not see the movement of her student’s lips and therefore could not properly teach her – hold little water: the Globe article points out that there are probably no more than sixteen women in Montreal who wear the niqab, and I, myself, have seen the niqab on only several occasions in the last few years. 

Quebec society’s universal disapproval of the niqab stems from a simple human desire and need to see our neighbour’s face. In a culture that has a history of trying to overcome language barriers (English and French), the ability to read emotional response in faces is an important tool. I may not be sure if I adequately communicated with my customer in his language, but I can tell from his facial expression if I am on the right track or not. In this linguistically split society, the need to promote social cohesion has always been apparent and this is generally manifest in Quebec by its tolerant and mostly liberal attitude towards immigrants whose cultural differences are usually overlooked. In societies where there is a concentration on individual rights and liberties, there is a tendency, I would argue, for cultural differences to be magnified as exemplified by the policy of multiculturalism in the ROC (Rest of Canada). If I were an immigrant, which culture would I choose to live in? It’s an open question with many variables to consider, but if I was to look at at least one statistic, I might make up my mind more quickly. The following chart is taken from Statistics Canada from data collected in 2006, showing the incidence of reported crimes due to racial hatred per 100,000 of population. Montreal stands below the national average, and so far below the numbers posted by four major Ontario cities that I would dispute any argument which says that differences in the way the data was compiled could explain the disparity.

 

Another Sports Metaphor for High Finance

I like to curl. It is a sport that keeps me physically fit and sociable through the long Canadian winter. Curling requires strategy which is made good by perfect shot making. Perfection, of course, is impossible to achieve every time, and this is what makes the game so interesting. A team’s fortune can change dramatically in a game and outcomes are never guaranteed.  Before making the shot the shooter has to consider the possibility of failure and its consequence.  If the rock is thrown with too narrow a trajectory or is too light, is there a benefit to be gained that is greater than throwing it too wide or heavy?  What can be redeemed from a failed shot depends on how you fail. This is called the “pro-side miss” and is something that the good players consider every time they are in the hack.

Central bankers in developed economies are at a cross roads. To save their banking systems and economies, they had to do a deal with the devil. Plans to reign in government deficits were thrown out the window and the public purse was opened up to bail out indigent investment banks. For now the call is to overlook the trillions in toxic debt which still remain on the books of the banks with the tacit belief that new sovereign debt added to the old will allay investors’ fears of massive default and systemic collapse. If we can just keep growing the economy however slowly, so goes the reasoning, we will pay our way out of this mess, even if it takes twenty years. The stock markets like the plan so far and have bid up the indexes seventy per cent from the lows a year ago. If stock markets are indeed the leading indicator many believe them to be, then they are clearly portending the salubrious shade of full grown trees from the green shoots of economic expansion being touted in the financial media today.

There are those who think we still stand naked in the midday sun. One of the most talked about books in the investment blogosphere is This Time Is Different: Eight Centuries of Economic Folly, by Harvard economist Kenneth Rogoff and co-author Carmen Reinhart of the University of Maryland. It is a comprehensive survey of past financial crises around the world. Anybody with a minimum of formal education is sensitive to the admonition that he who has not learned from mistakes made in the past is doomed to repeat them. Rogoff and Reinhart’s conclusion is that a banking crisis often leads a country into default because the government’s response is to prop up the failed financial system with more debt. When a government’s debt is equal to annual GDP (the total market value of goods and services produced by workers and capital within a nation’s borders), the game is essentially over. The U.S. is nearly there. Other nations are already over the line. Government officials may be close to having to choose how best to fail on their next shot at policy making, either by defaulting on their debt and possibly triggering a worldwide depression of epic proportions or inflating their way out and risking a hyper-inflationary event that would effectively destroy the life savings of the population. What is the pro-side miss?

By the way, last night was the final game of the Brier, the penultimate men’s curling competition in Canada. Kevin Koe, a rookie skip from Alberta and his team, faced off with the rink from Ontario skipped by three-time Brier winner Glenn Howard. The game was tied after ten ends, forcing a sudden death extra end. Alberta had last rock. Koe had no pro-side miss to consider. Either he makes a perfect shot to the button or he loses the game. Here’s how it turned out:

 

 

 

 

 

 

 

 

 

 

 

 

2010 Brier.wmv

 

 

 

 

 

 

 

 

 

 

 

 

 

 

What Does “The Great Recession” Look Like?

I just returned from a four day trip to New York City with my wife and son. New York is a great city for walking, and you do not see the incidence of morbid obesity among New Yorkers that you can’t help but notice among Americans congregating at Disney World, for instance. Driving a car is a nightmare. The city’s rectilinear plan of streets and avenues is a magnet for grid-lock. Humans will normally evolve informal rules of behaviour so that the group can cope with a pervasive problem caused by the physical circumstances of their environment. A good driving habit is to not enter an intersection if you don’t think you can clear it before the light changes. In New York the rule is to pile into the intersection no-matter-what. Noisy protest ensues  and is not abated one bit by the signs posted on every street corner threatening a $350 fine for honking. At least the cops have turned down their sirens to a low growl which suggests a requisite official insistence rather than hysterical emergency. It seems to be enough. Unlike in the seventies and eighties, Manhattan looks and feels to be secure and well ordered and this has played to the city’s advantage making it a top destination in the global tourist trade. At least until the recent economic downturn.

The laid-off commuters who now stay at home in Queens and Brooklyn, are hardly conspicuous by their absence and the buzz in the office canyon-land downtown seems as frenetic as ever, but where are the tourists? You will still collide with the odd stationary pedestrian in Times Square aiming his digital point-and-shoot skyward, but here is the real indicator of the decline of tourism in NYC: visits to the Empire State Building. In 2007 we made a winter trip to New York and passed on the obligatory visit to the iconic edifice; the line-up to get in snaked around the building for a block and a half. Last Saturday we blew off the shill at the entrance trying to sell us premium tickets on the claim of a forty minute wait and were on the eightieth floor observation deck in no time at all, save for the inevitable security check.

The euro has melted against the greenback as the U.S. dollar is believed to be the best paper to own in the midst of economic uncertainty (and belief is the only thing which sustains fiat currency). Pounds for Gucci and francs for Fendi are no longer driving the bottom line for New York retailers, and the cascading economy of suppliers and workers who feed off the tourist trade are not hesitant to point out the pertubations of the “new normal”. The pursuit of money is as relentless as it is necessary, but if you can’t get your fingers around it you may be  forced to go offline. The budding comedian in Times Square who sold me tickets to that evening’s show at the Broadway Comedy Club (at a deep discount I will add), told me, without a hint of self pity, of surviving by dumpster-diving at a local food store. He had recently secured a stock of still sealed packages of cranberries that now lay in his freezer. I suggested he needed a turkey with which to enjoy his store and that one could be had for cheap in Albany. My attempt at a joke did’nt make the grade, but the show that night sure did, proving that New York is still the epicentre of stand-up comedy. We were assured that the five comedians who shared the bill were all professional and in every instance I could convince myself that indeed I had seen them, maybe, in that bit part listed in their filmography. The story telling had us howling for nearly two hours. Things are not so bad yet in the city that New Yorkers can’t laugh about it. A testimony to human resilience that will pull them through whatever comes down the economic turnpike.