Musings of a Speculator

I Was Wrong

2008-01-19T11:14:00.000-05:00

The financial markets are tough. They are hard to predict. When they prove someone wrong, they do it in the harshest way possible. My forecasting record so far is 0 for 3.

I put together a forecast based on seasonal patterns for which I could establish some statistical significance. However, the markets decided to head into the opposite direction. The Fed Model I frequently wrote about was hardly ever more bullish, yet the markets went down like a stone in deep water. The Dow Theory whose validity I questioned more than once, has in fact given a very timely sell signal this time around.

I could retreat from here and nurse my bruised ego, and then come back and try to rationalize away the 0 to 3 defeat. That would not do me or anybody else any good. So instead I ask the question: What can be learned from all of this?

A few things are obvious to me. For instance, statistical significance is not synonymous with inevitability. Forecasts are a double edged sword. It is great when you are right, but when you are wrong you look like a fool.

Even a model based a verified principles can produce the wrong results some of the time. And a random dart throw will inevitably be right some of the time.

In the meantime the financial markets are grinding along. It appears that the bullish trench line has been cut wide open. The bullish forces launch a massive counter-offensive yesterday. It was well prepared with a massive artillery bombardment (S&P futures 20+ points above fair value). Yet after a huge initial success, it quickly turned into a rout and ended with another loss of territory for the bullish forces.

At this point in time the conversation around the lunch table at work turns inevitably to the recent losses in the stock market. The gainfully employed are bemoaning the losses their portfolios sustained in the last few weeks. They invariably recount the joy they felt when the recognized that their mutual funds had doubled at some time in the past. They talk about their visions of a retirement in luxury on Barbados, which have now been shattered by the markets.

I listen in silence and take it all in. I am going to watch out for sightings of the Wall and Bay Street operators of yore. They will leave their comfortable mansions and visit their brokers when they sense blood in the street. Then they will purchase high quality shares for 20 cents on the dollar. And after their purchases are made, they will once again retire to their mansions until the next time...

This time around I am going to join them!

Goldilocks Trades on Monday

2008-01-27T13:43:00.000-05:00

We had quite a roller-coaster ride in the financial markets so far this year. Our heroin Goldilocks has fallen into the grubby paws of the bear. The bear had his way with her in a bad way. Goldilocks' portfolio is some 23% lighter as a result of it. By comparison the S&P 500 cash index lost 13% over the same period.

Goldilocks is currently holding three ETFs:

PowerShares WilderHill Clean Energy – PBW
iShares FTSE/Xinhua China 25 – FXI
iShares MSCI Brazil Index – EWZ

Goldilocks reviews her portfolio every 20 trading days and ensures that she is holding the three strongest ETFs in her watch list of 60 ETFs. The three strongest ETFs currently are:

Market Vectors Gold Miners – GDX
iShares Silver Trust – SLV
iShares MSCI Brazil Index – EWZ

So Goldilocks will dump PWB and FXI at the open on Monday. At the same time she will buy Gold and Silver in the form of GDX and SLV. It is her way of expressing her distrust in the central bankers of the world.

Goldilocks Update

2008-01-28T21:19:00.000-05:00

Goldilocks executed hypothetical trades today as follows:

Sold FXI @ $147.79
Sold PWB @ $21.34
Bought GDX @ $50.83
Bought SLV @ $163.82

Goldilocks Struggles

2008-02-17T12:42:00.002-05:00

At times It happens that things are not going as planned. This is especially true for trading operations in the financial markets. In spite of well intentioned efforts to start paper trading the Goldilocks system, we entered the market at the worst possible time. Trading commenced a few weeks before the recent relatively steep decline in the global stock markets.

Now this would have been real bad, had we put real money on the table to trade. But as it stands, we only made hypothetical trades. Viewed in that light the market decline is beneficial. It provides the opportunity to examine your intestinal fortitude. Are you able to manage 20% to 40% draw downs of your trading capital?

At any rate as of Friday, February 15, 2008 the Goldilocks statistics look as follows:

	GDX	SLV	EWZ	S&P 500
Entry	$50.83	$163.82	$72.86	1527.29
Last	47.75	169.52	78.70	1349.99
Profit/Loss	-6.06%	3.48%	8.02%
Portfolio	-20.99%			-11.61%

The first row in table shows the three ETFs that Goldilocks holds currently, followed by the respective entry price and the last (Friday's) closing price. Next comes the current profit or loss for each of the three ETFs in Goldilocks' portfolio. The last row shows the profit or loss of the Goldilocks system since the beginning of trading. For comparison, the last column in the table shows the S&P 500 statistics for the same period.

Stay tuned for further updates...

Goldilocks Trades Today

2008-02-26T05:59:00.002-05:00

Well, she would, if changes in her current portfolio were necessary. As of the end of yesterdays trading the 3 strongest ETFs in her watch list of 60 are SLV, EWZ and GDX. Yet those same three funds are currently in her portfolio. That means she will simply continue to hold those funds and review the ranking 20 trading days from now.

Goldilocks portfolio is currently down by 15.4% since paper trading began last year. The S&P 500 is down 10.2% over the same time period.

Will the Empire's Money Become Worthless?

2008-03-15T21:44:00.002-04:00

There is no definitive answer to this question of course. But it is not much of an intellectual challenge to determine that the Empire's money – the US Dollar – has been loosing value at an accelerating rate. Finding the most likely reasons behind this decline is a bit more difficult to ferret out. You will usually not find the answer in the ubiquitous propaganda machine known as the mainstream media.

Occasionally, there is a priceless nugget like this Jim Roger's clip on CNBC. Is really advocating to abolish the Federal Reserve? Yes, indeed he said it. The CNBC interviewers cannot fathom that he may be serious. It is utterly unthinkable, that we could exist without the Federal Reserve. Is it?

Yet, the machinations of the Federal Reserve is precisely where one has to look to find answers. I have written about central banks in general and about the Federal Reserve in particular in this blog. It is interesting to go back over the record and see what predictions and conclusions turned out right and what turned out wrong. If you want to see for yourself, just pull the articles about the Federal Reserve or pull up the articles with the Currencies tag.

Yet, the Federal Reserve is only instrument to the will of the Empire. The doctrine proclaimed by the Emperor himself reserves the right to wage pre-emptive war, if he (the Emperor and his inner circle) perceive that a potential threat to the Empire's interests is developing anywhere. You are either with us or you are with the terrorists was his dire warning to the rest of the world...

All of this is not new. What is relatively new is the public acknowledgement of this aggressive strategy. The Empire has been drastically extending its military presence around the globe since the end of World War II. And when the Empire perceives its interests are threatens it lashes out viciously and mercilessly – in Vietnam – in Chile – in Argentina...

I digress into politics. This blog is to be about financial markets and issues. So, the astronomical cost of sustaining the Empire's military around the globe is beyond comprehension for mere mortals. The 2 billion + dollars it costs per week to fund the wars in Iraq and Afghanistan is just the tip of the iceberg. If you think that much of this is funded from tax revenues think again.

The bulk of the expenditures is funded through the printing press. Or in other words it is funded through inflation. This is why the dollar has been declining against all other major currencies. This is why Gold is around $1,000. This is why commodities prices are rising. Well, may be commodities represent a stable value and while the perceived value of paper money is declining.

Goldilocks Portfolio Review

2008-03-26T05:57:00.001-04:00

Another 20 trading days have passed and Goldilocks needs to review her portfolio. As of the end of yesterdays trading the 3 strongest ETFs in her watch list of 60 are EWZ, GDX and SLV. They are the very funds in Goldilocks' portfolio. That means she will simply continue to hold those funds and review the ranking again 20 trading days from now.

Goldilocks Substitutions

2008-04-23T21:06:00.001-04:00

The markets have been see-sawing back and forth for a while. I have been taking an extended brake from writing comments in these pages that few have been reading. I like to go back over older entries. It is quite illuminating to see how much different things are from I thought they would be.

Be that as it may, I still believe that the Goldilocks trading system is fundamentally valid. I am planning to keep updating it. On that note, Goldilocks will replace Gold (GDX) with Metals and Mining (XME) at the open tomorrow. Further updates to follow...

Goldilocks Update

2008-05-22T06:12:00.001-04:00

Goldilocks maintains her portfolio unchanged for another 20 trading days!

Goldilocks Bets on Commodities

2008-06-22T16:34:00.001-04:00

It is trading time again for Goldilocks. She will ditch Brazil (EWZ) and silver (SLV) on Monday. She will pick up oil (OIH) and energy (XLE) as replacements. She will continue to hold on to the metals (XME).

Goldilocks' Next Trade

2008-07-20T20:57:00.004-04:00

It is time again for Goldilocks to update her portfolio. She will sell the Energy Select SPDR ETF at the open on Monday, July 21, 2008. At the same time she will purchase SLV (Silver ETF).

Goldilocks Substitutes...

2008-08-17T19:59:00.002-04:00

Goldilocks does not like the recent performance of its commodity dominated portfolio. She will sell her current holdings, XME, SLV and OIH at the open on Moday, August 18, 2008.

At the same time she will buy equal shares of BBH, IYT and PHO.

Goldilocks Bets on Biotech...

2008-09-14T21:11:00.003-04:00

The time for a portfolio adjustments has come again. Goldilocks will switch water PHO for biotechnology IBB. With that switch Goldilocks is completely out of commodities. She now has two biotechnology holdings - BBH and IBB.

Goldilocks RIP

2008-10-12T07:38:00.001-04:00

Again, it is time for Goldilocks to review her portfolio. This time around there is not a single ETF in her watch list with a relative strength above one. At the same time she takes account of her portfolio and notices that her equity has declined by more than 51%. She has to admit that the bear has won the game and resigns.

When I introduced Goldilocks in October of last year, I was convinced that I had something that would surely succeed in the market. Testing based on historic data showed stellar results. Back then I had no idea that we were staring a bear market down the throat.

But so it goes. It is better to fail during paper trading than in the reality of the markets, isn't it.

The Great Panic of 2008

2008-10-13T17:40:00.003-04:00

Wow, the last couple of weeks were quite something to watch. Sure it was unpleasant for most of us with money in the markets, but the interaction of the crowd's emotion with the markets is as magnificent as a Beethoven symphony.

Tension rose to crescendo when the finale began last Friday. The Dow Jones Industrial Average entered into a steep decent. It plunged some 800 points. This is the always the point where the public investors – those who thought themselves geniuses during the prior bull market – dump their shares.

The market promptly reversed and closed with a relatively small loss of 140 points. Today, the symphony's finale is concluding with a terrific rally to heights that seemed out of reach just a few days ago.

Despite numerous claims to the contrary, nobody knows how the finale will conclude. It is quite possible that market action will swiftly turn the fear of those who dumped their shares at the bottom to greed. They will re-enter the market with abandon, convinced they can make up their losses in a few days. That is the point at which the ursine beast will turn on them, and from there it will lead the market into a plunge to new depths.

Taking advantage of the wave of fear, Hanky Panky scared the US Congress into action. They passed a $700 billion banker enrichment bill. Granted the first attempt failed in the House, but it passed nevertheless on the second attempt after the bill was loaded up $150 billion worth of goodies for the law makers' buddies. At the same time Congress passed a $615 billion dollar defence spending bill. There was no mention of the defense spending in the mainstream media, of course.

The mainstream media is focusing instead on misleading the public as to the causes of the global financial crisis. They are showing the politicians blaming deregulation, backing of Fannie and Freddie and other red herrings.

But what is the real reasons behind the turmoil in the financial markets? I believe that the culprit is the profligate spending and reckless money creation politicians and bankers have engaged in over the preceding decades. I believe that monetary mayhem are to blame. I order to support my position, I call history to take the witness stand on my behalf.

Here is the list of historic events that will provide a perspective on what is happening today:

Panic of 1837
Panic of 1873
Depression of 1893
Panic of 1907
The Great Depression 1929 – 1942
The Bear Market of 1973 – 1974
The Bear Market of 1968 - 1970
The Crash of 1987
The Dotcom Bust 2000 - 2002

Let's examine these events one by one over the next few weeks.

The Bear Is Back

2008-10-15T21:06:00.005-04:00

In Monday's (October 13) post, I speculated that this market would turn up and suck in the weak at heart - those that dumped their shares at them bottom. And what a counter move it was indeed. The Dow had a spectacular ascend into Tuesday morning. By mid morning the Dow had hit a brick wall and reversed promptly.

Throughout the day today the descent steepened - down over 700 points. Oh market, oh mighty god of Western civilization, what will you do next. We have sacrificed our spirit on your altar, expecting material wealth in return. Yet, shamelessly you betrayed us. Now, we face financial as well as moral bankruptcy.

OK - enough sarcasm for now. Our own Stephen Harper, old and new Prime Minister of Canada, hinted that this could be an excellent buying opportunity. It will be most exiting to watch what the market will do next. It may rise to new 'recovery highs,' plunge to new depth or do something entirely unexpected. One thing seems certain, the Panic of 2008 will be immortalized in history.

Volatile Times

2008-10-16T20:20:00.002-04:00

What a difference just a few hours make. Sometime around 11:00 AM the Dow was down some 400 points. Then it rallied 800+ points and closed up 401 points for a gain of 4.7%.

Again, the ursine beast is camouflaging its true intentions. Will it retreat now and hibernate this autumn and winter? Or is it just hiding, in order to pounce and devour those market participants drawn in by perceived bargains?

Time will tell how the drama unfolds.

Bear in Retreat

2008-10-20T20:24:00.001-04:00

It appears that we hit a deep pocket of panic. The current incumbent in the White House has proven himself a master at creating them. Even now as he tries to calm the markets with his bailout pronouncements, stock experience severe bouts of vertigo and go into free-fall. The individual retirement investor has all but abandoned his dream of an early retirement in the lap of luxury.

With this backdrop the markets promptly reversed and raised ahead. Just today alone, the Dow was up 4.7%, NASDAQ up 3.4%, S&P500 up 4.8% and the resource laden TSX up a whopping 7.2%. At this hour Asian markets are rallying strongly. It seems the credit crunch is a thing of the past.

But all too often the bear returns when people believe him gone. He waits just long enough for the greedy to re-enter the market. He then grabs them and mauls them badly. Technical analysts are working feverishly to divine the future direction of the markets. Are the chart patterns they see just a manifestation of randomness? Conclusive proof of the patterns' predictive properties does not exist. Pure faith will have to fill the void.

Sometimes the market does not turn back to re-test or break previous lows. It happened two decades ago. After the October 19, 1987 crash the market never broke below crash lows. The real economy was unaffected by the crash. Fundamental analysts exercise their craft, trying to determine whether equities are undervalued. They will enter the market based on the belief that they have found value. Will the strength of their conviction leave them, if the market breaks down to new lows?

A Time to Buy?

2008-10-23T22:24:00.001-04:00

Global stock markets have been pummelled. In fact they have received a drubbing in such a short period of time the likes of which we have not seen in many decades. In times like these the visceral bargain shoppers instincts kick into high gear. Warren Buffet sees value in US stocks and has been buying in his personal account.

Is he right? Is this the right time to buy? Does the scoundrel from Omaha get special deals not available to individual investors? Perhaps, but moping about this does not aid our decision making in the least. The dominating question on many minds is whether the brisk, sharp decline from recent peaks signals a buying opportunity. The answer to this question is an unequivocal No! While there may exist some very short-term counter-trend trading opportunities, such an inverse relationship does simply not exist longer term! If you have any doubts about this fact, you can start your research with my July14, 2007 post About Causation Traps.

This aspect of the market seems to be consistent with randomness. In other words, prices have no memory. Future prices are independent of past prices!

Is there then any metric by which we can gauge buying opportunities? I think the answer to this question is a limited Yes. We can use a very simple metric – PE Ratios. Before you start protesting take a look at my review of PE-Ratios versus returns posted on June 6, 2007 and June 8, 2007.

So where are we today. Are we staring a buying opportunity of lifetime in the face? Well, you be the judge for yourself. But here is what the current S&P 500 PE ratio is telling us.

As of September 30, 2009 Standard & Poor's shows 12-months trailing 'as reported' earnings of $50.21 for the S&P 500 index. The S&P 500 index closed at 908, which gives us a PE ratio of 18. Going back to the June 6, 2007 About PE ratio post we obtain an expected return of 48% over a five year holding period. This is not the buying opportunity of a lifetime in my book. There is no guarantee for a 48%. As a matter of fact, the probably for a much lower return than 48% is high.

So it goes...

A Near Catastrophe on the Western Front

2008-10-25T22:30:00.002-04:00

In the early morning hour of Friday, October 24, 2008 the forces of the bear launched an all out assault against the West and its allies. It began with a ferocious artillery barrage on the Western alliance's front line positions. The amount of shells fired was unprecedented. High explosive shells, shrapnel and even munitions filled with poison gas rained onto the alliance's positions.

The enemy's infantry followed closely behind the advancing curtain of artillery shells. The first line, the Asian markets, fell without any sign of resistance. The second line, the European markets, was also unable to offer any resistance whatsoever to the bearish onslaught. At this time everything seemed hopeless. The long dreaded market crash seemed inevitable.

The third line, the US markets, was in the grip of naked terror long before the bearish enemy reached it. The S&P index futures locked limit down before the market opened. Then the enemy reached the line. Storm troopers quickly penetrated it by some 500 Dow points. At this desperate hour a miracle began to unfold

Resolute front-line commanders rallied their troops and organized a determined counter attack. By mid afternoon success seemed close at hand. The Americans had taken back about two thirds of the territory lost earlier in the day. But in the end it was not to be. Heavy machine-gun fire forced the Americans back. When the fighting ended at the end of the trading day, the American line had been pushed back 312 Dow points from the previous close.

A portion of the third line was occupied by Canadian force. The centre of the Canadian line was formed by the elite forces of the Royal Bay Street Infantry Brigade. It had taken heavy losses in the action of the preceding days and weeks. At the time the forces of the bear reached the Canadian lines nobody would have believed that this badly bruised brigade would carry the day and would become the last beacon of hope for the Western alliance.

Yet everything seemed hopeless at first. Enemy storm troopers pushed through and quickly took away 700 points from TSX Composite Index. But quickly the Bay Street boys took heart. They remembered the word of General Flaherty. He earlier voiced his opinion that Canada is well positioned to weather the global crisis.

The day before the brigade's young dynamic commander Brigadier General Mark Carney had declared the Canadian financial system sound. At this dire moment the Brigadier somehow manages to inspire his troops. Undaunted by heavy machine-gun fire they go over the top and counter attack. The advance is slow but steady until noon. They are pushed back a hundred points or so, but the consolidate their line and push ahead a yard by yard. By the end of trading they have almost reached the original line. They end the day with a small loss of 37 points.

Will their heroic deed inspire financial markets around the world to take back their losses from the forces of the bear? We shall see. Time will tell.

Collapse of the Western Front

2008-10-27T21:48:00.002-04:00

The situation on Monday, October 27, 2008 approached desperation. The gallant Royal Bay Street Infantry Brigade was unable to hold its trenches. The hope of the West rested on the Bay Street boys soldiers, who fought their way back so valiantly last Friday. It was all for nothing. The brave Bay Street Boys were completely routed. The bearish forces took nearly 800 from their TSX Composite Index.

The US side of the front did not fare much better. By mid day the Paulson Bailout brigade had gained some 200 points. But in the end they had to give up 203 Dow points from the start of the day. The ammunition in the form a $700 billion rescue package rushed to the front by Colonel Kashkari provided the initial thrust for the push forward, but it was inadequate nevertheless to save the day.

Tonight, the situation along the entire seems hopeless. The bearish forces are already working on the Asian flank of the Western alliance. It does not appear as if the Asians can hold their ground whatsoever. Hope has all but abandoned the once so proud Western alliance.

There can be no doubt that October 2008 will find its way into the annals of history. They may well mark this October as the point in time when the era of Western hubris ended...

Prechter Was Right After All

2008-11-24T21:25:00.001-05:00

Yes, Prechter was right on so many issues that I got wrong. He predicted for many years that the dollar would rally at the beginning of the deflationary storm. And that is precisely what is happening now. Sure the dollar was constantly under pressure and declined for years against major foreign currencies and in particular against the Euro. Yet, this trend has reversed completely.

Prechter argued against the notion of peak oil. For quite some time he looked like a lunatic, as the crude oil price pushed relentlessly towards $150 a barrel. The situation looks quite different now. Oil has collapsed below $50 a barrel inside of a couple of months and seems poised to challenge $10 a barrel once more.

Most of all, Prechter predicted that the bull market of the 80's and 90's would end in a deflationary collapse. He was absolutely on the mark here, even though the main stream media is still parading 'experts' in front of the public, claiming that the financial alchemists at the FED are so much wiser today than they were in 1930's.

Prechter predicted that the FED would be pushing on a string, trying to stop deflation. So far he has been right on the money on this issue as well. Despite massive cash and credit infusions by the FED and other central banks, equities, housing, most commodities and prices for goods and services have been deflating rapidly.

Yet the verdict whether they can stop this deflationary bout is not yet in. Helicopter Bernanke and his buddy Paulson have been flying non-stop missions dropping money like never before. Current estimates are around US$ 7.5 Trillion when all is said and done. The stakes are high in this epic drama. If they fail the mighty US dollar and with it the empire will fall.

Prechter predicted that government bonds would initially rise and they have.

Then there is gold. He predicted gold would fall. OK, this one he got wrong. And his timing was off a bit. He believed that deflation would strike after the 1987 crash. I did not. He subsequently anticipated deflation several times – too early. However, his score is nearly perfect as far as what would happen during a deflationary cycle.

Inflation or Deflation

2008-10-19T16:51:00.002-04:00

After the bursting of the penultimate bubble – now often referred to as the Dotcom bubble, professionals and armatures alike were asking the question whether inflation or deflation would be the predominant force in the global economy. It was considered vital to get the answer to this question right, as it would determine what assets to invest in for profits or wealth preservation.

In particular the latter day disciples of Ralph Nelson Elliot were particularly mesmerized by an imminent deflationary episode, leading directly to the second coming of The Great Depression. We now know that after a brief period of (stock) asset price deflation, inflation returned at an increasing rate.

The bursting of the Dotcom bubble has lead directly to the current situation. Again, we are experiencing rapid asset price deflation. For the time being, every asset class with the exception of gold and may be Treasury Securities seem to be affected. Consumer prices are 'deflating' only moderately at this time. This becomes particularly apparent when one compares food and energy prices from a couple years ago to today's prices.

But this comparison of consumer prices is misleading as far as understanding the phenomenon of inflation is concerned. Many see inflation as a rise of the average price of a basket of (consumer) goods. Does not the Federal Reserve and central banks in other countries use this measure to gauge inflation? They do precisely that of course. Yet in order to understand inflation and deflation, we have to look deeper than this.

Let's begin by looking up the definitions for inflation deflation in the dictionary.

inflation
[Economics] a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency

deflation
[Economics] a fall in the general price level or a contraction of credit and available money

Both the definition for inflation and deflation indicate a direct connection with the money supply. In fact inflation and deflation are opposite ends of the same stick. Let's have a closer look at the interplay between money supply and inflation. Steve Saville, The Speculative investor has written an interesting commentary.

It contains an enlightening perspective about the concept of money velocity. I particularly like how Steve explains the relationship between money supply and inflation:

A pronounced and sustained increase in the rate of money-supply growth ALWAYS leads to substantially higher prices somewhere in the economy, but due to the time-lags involved it will often be difficult to see the link between money-supply changes and price changes. For example, the rapid rises in the prices of many everyday items over the past three years occurred while the money supply was growing slowly. These price rises were an effect of the rapid money-supply growth that occurred during the first few years of the decade. Also, the quickening in the rate of money-supply growth that has just begun and looks set to continue over the coming year will probably be accompanied by a slowing rate of increase in the general price level, thus setting the scene for a "deflation scare". The reason is that the prices of everyday items have yet to react to the slower money-supply growth of 2005-2007.

Let me add that the effect of an increase of the money supply everyday items is not limited to everyday items. Often asset prices rise first. Looking at recent history, we note that real-estate prices experienced a parabolic rise, followed by commodities and stock prices. By now those bubbles have all but burst. Asset prices have been in a free-fall. Yes, we are currently at the deflation end of the stick. How did we get here and who is responsible for it?

The mainstream media is now full of ad hoc analyses. The mechanics of the sub-prime mortgage meltdown induced credit crisis are being explained ad nauseam. The mainstream media assigns well deserved blame to home owners, mortgage originators, Fannie Mae, Freddie Mac, bankers and Wall Street. Even the Maestro of one to two decades ago – Alan Greenspan – is pronounced guilty for keeping interest rates too low for too long in 2003. All this is certainly valid, but the systemic problems at the heart of the issue are generally ignored.

It appears that long-term inflation is a property of today's fiat currencies, the occasional deflationary bout notwithstanding. It is just too tempting for governments to finance all sorts of programs through the printing press. Defense spending for instance is extremely inflationary. After the fireworks have gone up in smoke, the money created to pay for them keeps circulating through the financial system in search for an acceptable rate of return. It attracts all sorts of shady characters. Today many believe that investment bankers are the most nefarious of them all. The next time around it will be a different line-up of thugs for sure.

The 'liquidity bubble' continues to inflate for a while. Then cracks appear. For instance, interest rates rise and some debtors default on their loans. Loan defaults are tantamount to a shrinkage of the money supply. The shrinking money supply then causes an often sudden bursting of the inflationary bubble. Inflation flips to (often temporary) deflation. And this is where we are today...

Seasonality and The Black Swan

2009-01-22T20:29:00.003-05:00

I have been reading Nassim Taleb's Black Swan. As I was reading I remembered writing about seasonality in the stock market. I concluded at the time that there is validity to seasonal effects in the long run. There was disagreement with my conclusion of course. Be that as it may, the presence of Black Swans calls into question the usefulness of seasonal effects. What is a Black Swan?

A Black Swan is rare event that appears predictable only with the benefit of hindsight, has an enormous impact and is relatively rare. Even though it is rare, it occurs more frequently than the normal bell curve would indicate. Examples of Black Swans are the Crash of 1987, the Dot Com bubble, the bust of the Dot Com bubble, the Panic of 2008...

Black Swan's make seasonal and other strategies much more risky than normal risk measures - Sharpe Ratios, etc. - would indicate.
The public failure of my Goldilocks trading system that I presented on these pages through real time paper trading is an instructive example of the Black Swan's impact.

Of Stocks Houses and Turkeys

2009-01-25T19:25:00.003-05:00

At the turn of the year, the chattering classes were falling all over each other reminding us how bad 2008 was. It is good that it is behind us. Then they proceeded to speculate what the new year will have in store for us. How nauseating! They are behaving as if there is something special about the old year ending and a new year beginning. Magical thinking... The reality is: There is no magic about it. Everything is just the same today. There is no difference between conditions at the end of last year and this year.

Turkeys!!!!

Speaking of turkeys, Nassim Taleb makes this observation in his book The Black Swan:

A turkey is fed for 1,000 days - every day lulling it more and more into the feeling that the human feeders are acting in its best interest. Except that on the 1,001st day, the butcher shows up and there is a surprise. The surprise is for the turkey, not the butcher.

Home buyers and stock holders have learned the same lesson the turkey learned in its short life span. The 'banksters' and stock brokers are acting in the publics best interest for a time. Then from one day to next everything changes. The long knives come out and the slaughter begins.

This theme permeates all facets of life - not just the realm of finance. Having left the United States years ago and observing what looks to me like outright worship of the 44th U.S. president - Barack Obama, I wonder: Will the Obamatrons share the turkey's experience one of these days?