The global gold rush is on.  (Green Sheet, The Reformed Broker)

Are ETFs causing a bubble in emerging markets?  (WSJ)

Felix Salmon, “Mutual funds are moving away from being a mass-market product, and becoming more of a niche product aimed at elderly investors who don’t know any better and who don’t worry much about total expense ratios.”  (Reuters)

The prospects for the stock market would be brighter if individuals would start putting money back into equity funds.  (NYTimes)

Checking in on investor sentiment at week end.  (Trader’s Narrative)

Seven durable concepts learned from the school of hard knocks.  (CSS Analytics)

SAC Capital is now in the middle of the growing insider trading investigation.  (WSJ)

Buffett’s motivations for purchasing Burlington Northern are:  a bet commodities, getting greener, or simple diversification?  (Baseline Scenario, WSJ, BusinessWeek)

The ethics of Warren Buffett in question.  (Big Picture, ibid)

Roger Ehrenberg, “Sadly, we live in a world of sound bites, and Congress and the White House have found far better sound bites to attack the denizens of the equity markets rather than the derivatives and debt markets.”  (Information Arbitrage)

David Einhorn calls CDSs “anti-social” and calls for their ban.  (FT also Information Arbitage, naked capitalism, Kid Dynamite)

How big a role did the failure of Lehman Brothers have on the financial crisis?  (Econbrowser)

Finance is a complex system.  Taking a look at the many ways it can fail.  (designing better futures)

US factories are “grossly underutilized.”  (Real Time Economics)

The BLS birth/death adjustment is back in the spotlight.  (Big Picture)

Just what is ‘systemic risk‘ anyway?  (macroblog)

A new model of inflation indicates muted long term expectations.  (Economist’s View)

Talk of a trade war between the US and China is heating up.  (Aiki14, Free exchange, Infectious Greed)

Should the Fed meet with bloggers as well?  (Aleph Blog)

An interview with Hunter of the Distressed Debt Investing blog.  (Simoleon Sense)

The Larry Summers profile every one will be discussing.  (Vanity Fair)

Why do people buy extended warranties?  Because they are in too good a mood when they are shopping.  (NYTimes)

The top clicks on Abnormal Returns this week.  (Abnormal Returns)

Anyone who wants their online reading simplified should check this out.  (Readability via David Pogue)

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1. Vitamin D and negative moods makes a positive difference in brain function.  (Scientific American, Reuters)
2. The 50 best albums of the decade (2000-2009).  (Paste Magazine)
3. The 50 best movies of the decade (2000-2009).  (Paste Magazine)
4. Felix Salmon, “..every move upwards in US stocks or gold or the Aussie dollar or junk-bond indices is another step in exactly the wrong direction: it’s a step towards yet another massive crash. And it’s all being turbo-charged by Fed policy.”  (Felix Salmon)
5. On the use of the 50-day moving average of the NASDAQ Composite as a general guide to get in and out of the stock market.  (Joe Fahmy)
6. Asset class performance has once again begun to diverge.  (The Capital Spectator)
7. What Goldman Sachs (GS) likes in the commodity space.  (The Pragmatic Capitalist)
8. The Periodic Table of Finance Bloggers. (The Reformed Broker)
9. Should we feel sorry for any one following Jim Cramer’s stock calls?  (The Davian Letter)
10. America’s biggest companies are “hoarding” cash at a record rate. (WSJ)

Maybe we should link to more non-investment related items.  Below are links to the five top Abnormal Returns-authored posts (excluding linkfests).

1. On the importance of learning the lessons from trading losses.  (Abnormal Returns)
2. On the difference between hedging and diversification and how cash can serve as an equity hedge.  (Abnormal Returns)
3. Commission-free ETF trading and more gimmicky ETFs.  (Abnormal Returns)
4. Punditry, predictions and profits.  Science is following finance into the trap of making bold predictions.  (Abnormal Returns)
5. What will Warren Buffett’s eventual successor do with the soon to be acquired Burlington Northern? (Abnormal Returns)

Thanks for checking in with Abnormal Returns this week.  As always you should feel free to drop us a line or leave a comment with your thoughts.

Another market valuation tool says the easy money has been made.  (Value Plays)

“You can’t trade everything. Well, at least you can’t trade everything well. At some point, you should limit the universe of things you trade.”  (Milk Trader)

Interesting goings on as the PowerShares DB US Dollar Index Bullish ETF (UUP) runs out of shares.  (Nancy Miller, The Pragmatic Capitalist)

The spread on Berkshire Hathaway (BRK-A) bonds may go down even though its credit ratings are dropped due to the Burlington Northern (BNI) deal.  (Bloomberg)

What will Warren Buffett’s eventual successor do with the soon to be acquired Burlington Northern? (Abnormal Returns)

Second time is a charm?  Citigroup (C) plans to relaunch its hedge fund operations.  (FT, Dealbreaker, Daily Intel)

Working on Wall Street means never having to say you are sorry.  (Dealbreaker)

The pace of ETF closures is accelerating.  How to tell if your ETF is about to close.  (IndexUniverse earlier Abnormal Returns)

IndexIQ plans to launch a merger arbitrage ETF.  (ETF Database)

Commission-free ETF trading and more gimmicky ETFs.  (Abnormal Returns also WSJ)

Do hedge fund investors “share” their investment ideas?  (SSRN via FinanceProfessor)

Why do traders gamble on the shares in bankrupt companies?  Lottery-like characteristics.  (SSRN, ibid)

Fewer Harvard MBAs going to Wall Street is a good thing.  (DealBook)

A bad week for the widening Wall Street-Main Street divide.  (Deal Journal)

The Feds have turned a profit on their financial company debt guarantees.  (NYTimes)

Sarbanes-Oxley is about to get “gutted.”  (Floyd Norris also Big Picture)

Are central clearinghouses for CDS and other derivatives truly a ‘magic bullet’?  (naked capitalism)

Yet another ugly employment report.  (Free exchange, Calculated Risk, EconomPic Data, Atlantic Business, Crossing Wall Street, The Stash)

Bad jobs numbers are unleashing a wave of lousy economic policies from Congress.  (Steven Pearlstein)

Felix Salmon, “If the US no longer drives the global economy, then the rest of the world will be much less inclined to fund its twin deficits to the tune of trillions of dollars per year.”  (Felix Salmon)

Which bloggers were invited to the sit down with Treasury officials?  (Aleph Blog, ibid also Marginal Revolution, Kid Dynamite, Baseline Scenario)

A new (virtual) hang out for distressed debt investors.  (Distressed Debt Investing)

How a background in finance can help you get to the finals of the World Series of Poker.  (Texas Hold’em Investing)

A list of the top books that discuss equity return distributions and market bubbles.  (World Beta)

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The eventual successor to Warren Buffett as CEO of Berkshire Hathaway (BRK-A) is going to get asked that question a great deal.  Unfortunately for him (or her) they will not be able to do many of the things that Buffett can.  This due in large part to the capital, both public and personal, Buffett has built up over his long career.

The amount of digital ink spilled over the Berkshire Hathaway acquisition of Burlington Northern (BNI) is breathtaking.  After you get past the details of the deal most analysts focused on the meaning behind the deal and the implications for the future of Berkshire Hathaway.

There is no shortage of motives assigned to Buffett’s motivations for the deal.  They include:  anxiety about sitting on cash, a general economic play, a bet on another stimulus, a bet on coal, a bet on a turn in the rail economy, a desire to make Berkshire easier to run for a successor, or a desire to be a member of the S&P 500.  Then again it might be as simple as the fact that Buffett thinks Burlington Northern is undervalued.

Whatever the motivation, the deal in question is going to play a big role in how Berkshire Hathaway is run going forward.  This deal certainly helps deplete the firm’s current cash hoard.  Therefore forcing the new CEO to make fewer (big) investment decisions.  But at the same time it exacerbates the conglomerate issue.

A problem for that CEO is whether Berkshire Hathaway can remain a conglomerate indefinitely. Wall Street hates conglomerates.  (The irony being that Buffett greatly helped the other big conglomerate GE (GE) last year with a $3 billion investment.)  A term exists, conglomerate discount, to measure the degree to which a diversified firm’s market value lags the sum-of-its-parts.  Therefore corporate focus has been an important them in corporate America for decades.  It just so happens somebody forgot to tell Warren Buffett.

Warren Buffett gets a pass on the conglomerate issue.  As he very well should.  The problem is that the new CEO will not have this same luxury.  The Buffett aura at Berkshire may persist for some time, but it will not be unlimited.

Tough decisions will have to be made in the future by a new CEO of Berkshire. That list now includes what to do with that huge railroad company we own.

No direct positions in any of the securities mentioned herein.

Charles Schwab & Co. (SCHW) recently launched a handful of broad-based equity ETFs with rock-bottom expense ratios.  Good. In addition they also announced that Schwab customers can now trade these ETFs commission-free.  Great.

On the face of it there is nothing to object to here.  However Schwab isn’t doing this out of the goodness of their collective hearts.  They have two goals.  The first is to attract assets to their ETFs.  Second they want to attract enough trading interest in the funds to bring down the funds’ bid-ask spreads.  If this tactic works for Schwab you can bet that other firms with a client list of sufficient size to try this as well.

There the risk that Schwab stops this program at some point in the future.  There is also the risk that the ETF industry gets further splintered into walled fiefdoms where one can trade only house-branded funds commission-free.  (See Ron Rowland at Invest With an Edge for other possible industry outcomes.)  While this may not be a horrible thing, but it should give one pause.

Izabella Kaminska at FT Alphaville reports that one ETF issuer in Europe, db x-trackers, have gone so far as to waive fees on their ETFs.  She notes other ways, like securities lending and index arbitrage, that firms can profit off of ETFs even if they are not earning explicit fees.  In conclusion Kaminska writes:

To surmise, commission-free ETFs may very well lower fees for the industry as a whole, and that is a good thing, but there’s no real benefit to investors unless the business they attract tightens bid-ask spreads too.

Going from low fees to high fees in the past week or so OOK Advisors LLC launched two new state-focused ETFs, the Oklahoma ETF (OOK) and the TXF Large Companies ETF (TXF).  Two points on these funds.  The first complaint about these funds is that they are “gimmicky.”  As Vincent Fernando at The Money Game writes:

While the concept of capturing the Texas economy is good, the ETF itself appears to be little concerned with actual Texas exposure and more so with making high fees and appealing to many people’s affinity with the state.

Don Dion at TheStreet notes that the index construction is flawed in that it focused on firms headquartered in the state as opposed to firms deriving revenues primarily from within the state.  On the other hand Roger Nusbaum also at TheStreet has a more favorable view of the Oklahoma ETF and thinks it might be a viable small to mid-cap energy play.

A second more vexing issue than the composition of the two funds is the issue of fees.  As Michael Johnston at ETF Database writes:

The old saying that everything is bigger in Texas apparently applies to expense ratios as well. TXF charges 85 basis points, more than ten times the fees charged by the cheapest ETF options for exposure to large cap equities (two of Schwab’s new ETFs offer expense ratios of 8 basis points).

High fees are bad enough.  As Johnston notes over time the difference in fees compounded can have a material affect on returns.  But the funds’ sponsor is implicitly justifying these fees by noting:

A minimum of ten percent of OOK management fees will go to Aaron’s Bridge to facilitate access to more treatment options in Oklahoma and Texas for children with developmental disabilities, including Autism Spectrum Disorder.

Charitable giving is a worthwhile endeavor and this sounds like a worthy cause .  However it does not follow that the way to do this is on the back of the firm’s ETF shareholders.  As Fernando notes:

That’s the worst, when you snag clients with higher than necessary fees by making yourself look charitable.

As you can well see there are a number of moving parts with these funds.  At the very least investors need to go in with their eyes open in regards to these funds’ portfolio construction and fees.

Just because some gimmicky funds catch fire with investors and advisers does not mean they were good ideas to start.  The sad fact is that many gimmicky funds end up as zombie ETFs on the ETF Deathwatch.

Update: Matt Hougan at IndexUniverse commenting on the Schwab moves, “An over time, I expect the Schwab funds will gain significant assets. It just won’t happen overnight.”

Hedge funds have been prime beneficiaries of this ‘carry trade’ as their returns have been uniformly positive in 2009.  (EconomPic Data)

Mohamed El-Erian, “It is totally rational for risk markets to rally in the very short term when the FOMC flashes a green light for the dollar-funded carry trade. The challenge is that, in the process, they accentuate what is already a wide gap between valuations and the outlook for economic fundamentals in 2010.”  (FT Alphaville)

Checking back in on the VIX:VXX ratio.  (VIX and More)

The line to short JGBs is getting longer.  (FT Alphaville)

Doug Kass is not crazy about the Burlington Northern (BNI) acquisition.  (TheStreet)

Adam Warner, “So by all mean, simulate new sorts of positions on paper first, it will help. Just know that “managing” said position will differ once the lights go on.”  (Daily Options Report)

How mood can affect your “trading business.”  (TraderFeed)

Speaking of mood, how “solar winds” could affect your trading decisions.  (Behind the Headlines)

The economics behind how mutual fund fees are set.  (Atlantic Business)

Just how big are Wall Street bonuses going to be for 2009?  (WSJ, NYTimes, Dealbreaker)

Why would any board of directors provide incentives to CEOs to do deals?  (Breakingviews)

Goldman Sachs (GS) is paying less on its long term debt than Uncle Sam.  (WSJ)

Aswath Damodaran on the issues involved with estimating the equity risk premium post-crisis.  (SSRN)

Fama vs. Fox on the role of the efficient markets hypothesis in the credit crisis.  (Curious Capitalist)

The ten year Treasury-TIP spread has touched 2%.  (Carpe Diem)

Paul Vigna, “The Fed better hope it gets inflation, because if it doesn’t, it may get that other thing, the thing no central banker dares speak of.”  (DJ Market Talk)

Edward Harrison, “Why aren’t more municipal bonds being downgraded by the ratings agencies Fitch, Moody’s and S&P?”  (Credit Writedowns)

Legislation to break up too big to fail institutions is worthless without reform of the OTC derivatives business.  (Rolfe Winkler)

Recent productivity statistics are “stunning.”  (Crossing Wall Street)

Fifty years of economic history in one graph.  (Marginal Revolution)

Which central banks are next in line to raise benchmark rates?  (The Money Game)

Is China playing with fire by not letting their currency appreciate?  (Baseline Scenario)

Bloggers “mouth off.” Senior Treasury officials listen.  (Interfluidity)

Three potential trading-related bubbles blowing for retail investors. (The Reformed Broker)

Punditry, predictions and profits.  Science is following finance into the trap of making bold predictions.  (Abnormal Returns)

Checking in with the guys who bet against the bubble and won.  (Daily Intel via TRB)

More positive reviews of Greg Zuckerman’s The Greatest Trade Ever.  (market folly, Bloomberg)

The decade of Steve (Jobs).  (Fortune)

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Humans have a large appetite for forecasts and predictions across a broad spectrum of domains. – Michael Mauboussin*

Given this quote it is not surprising that the financial media is a voracious machine in constant need of analysts and commentators ready with clever sound bites.  For this class of analysts prediction is the currency by which they gain entry into the upper echelons of media stardom.  It need not matter whether these predictions turn out to be true, or even falsifiable.  These analysts need only be willing and able to promulgate their predictions into the ether.

This problem is not isolated to the financial world.  The cable news networks are filled with faux political strategists who provide a stream of predictions.  Even the world of science has gotten caught up in this wave.

Stuart Blackman writing at The Scientist (via Arts & Letters Daily) notes how “ill-judged predictions” are damaging the authority of science.  Akin to the worlds of finance and politics there are plenty of reasons for a scientist to embrace prediction.  Blackman writes:

Of course, scientists have a strong incentive to make bold predictions—namely, to obtain funding, influence, and high-profile publications. But while few will be disappointed when worst-case forecasts fail to materialize, unfulfilled predictions—of which we’re seeing more and more—can be a blow for patients, policy makers, and for the reputation of science itself.

Until there is some sort of disincentive to go public with bold predictions scientists are going to continue speaking with the media.  Blackman has four pieces of advice for scientists on how to “predict responsibly.”  These include:

1. Avoid simple timelines;
2. Learn from history;
3. State the caveats;
4. Remember what you don’t know.

This advice is generalizable to other fields.  But don’t expect financial analysts to embrace them any time soon.  There is too big a pay off for those who do make a correct prediction (no matter their batting average).  Not least of which is the fame that comes with media exposure.

Adam Warner at the Daily Options Report notes how there is an entire class of analysts who are more than willing to call tops and bottoms in the market.  Unfortunately for the listener (or reader) these calls are useless as investment advice.  He writes:

Calling the top should not be anyone’s real goal unless you aspire to a career in punditry. It has very little value whether you’re trading or tending to a portfolio. If you caught a top or bottom incredibly well once with actual money, you got lucky, don’t expect to do it again…what sounds like brilliance on TV is terrible money managing advice for everyone else.

Adam gets to the heart of the matter.  Calling tops and bottoms is for aspiring pundits who are trying to look “brilliant.”  The investment blogosphere is filled with analysts trying to play this game.  Fortunately each of us has the option to follow those bloggers who don’t play this game.

The hard work of trading and portfolio management has little to do with bold predictions and more to do with an ongoing process of learning, improvement and refining one’s craft.  While that does not sound nearly as sexy as making predictions, it does have the benefit of having something to do with actual money management.

*Michael Mauboussin, Think Twice, 2009, Harvard University Press, p. 116.

How the July “momentum thrust” has played out so far.  (Trader’s Narrative)

Adam Warner, “If your goal is to look brilliant, by all means, call turns. If your goal is to manage money well, you’re better off joining in later.”  (Daily Options Report)

Just how Buffett-like is Buffett’s purchase of Burlington Northern (BNI)? (Rolfe Winkler, Atlantic Business, Reuters, Manual of Ideas, Breakingviews, WSJ)

Is Warren Buffett “doubling down on the carbon-intensive economy“?  (Free exchange also Credit Writedowns)

Paging T. Boone Pickens.  The US is awash in natural gas.  (WSJ)

Hedge funds see less seed money.  (DealBook)

On the importance of learning the lessons from trading losses.  (Abnormal Returns)

Or just be like Goldman Sachs (GS) and never lose.  (Fund My Mutual Fund, Zero Hedge)

Putting together a “dollar proof” portfolio.  (Morningstar)

Research into just how “lucky” options grants were for independent directors and company CEOs.  (SSRN)

Bankrupt companies that have activist hedge funds as their major creditors outperform.  (All About Alpha)

David Leonhardt, “So it’s a good time to remember that when an economy is just coming out of recession, its weaknesses are always more obvious than its potential strengths.”  (NYTimes also Calculated Risk)

The US recovery is “underway” but is ultimately dependent on the resumption of employment growth.  (Econbrowser)

The Fed is going to have difficulty reversing its current policies.  (Real Time Economics)

The Feds are propping up housing to the tune of $300 billion this year.  (Curious Capitalist)

Why it may be possible to have a sustainable advance in stocks without a sustainable recovery by American consumers.  (The Big Money)

Felix Salmon, “There’s a big difference between a too-big-to-fail bank and a too-big-to-fail automaker: leverage.”  (Felix Salmon)

Barry Ritholtz, “The belief in the validity of their models — like the theories they are based upon — is the Achilles heel of the profession.”  (Big Picture)

Bloggers go to the Treasury.  Still no plan to really deal with TBTF.  (naked capitalism, Accrued Interest, Financial Armageddon, Aleph Blog, Across the Curve, Kid Dynamite)

Why did Nobel Prize winners in Economics choose economics?  (Mostly Economics via Economist’s View)

Why a high IQ does not necessarily make you smart.  Hint, decision making skills matter as well.  (New Scientist via True/Slant)

Even the great ones, like John Paulson, have doubts from time to time.  (Dealbreaker)

Jim Ledbetter talks with Gregory Zuckerman about his book The Greatest Trade Ever.  (The Big Money also Dealscape)

An interview with Randall Munroe of xkcd fame (a webcomic of romance,
sarcasm, math, and language).  (mental floss)

The 20 best TV shows of the decade (2000-2009).  (Paste Magazine)

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The most important skill a trader can acquire is the ability to take losses.  Small losses, taken quickly are the hallmark of a great trader.  This is by no means an easy skill to acquire.  It therefore stands to reason that this skill will be all the more difficult to acquire if their first trades are winners.

Unfortunately our brains are hard-wired to undercut this process.  Recent research (via Scientific American) on how our brains learn from positive and negative experiences shows that the brain experiences a surge of dopamine after a success and this helps improve neural processing.  However the brain can get “thrown off by mistakes instead of learning from them.”  From the article by Frederik Joelving:

The pleasurable feeling that comes with the successes is brought about by a surge in the neurotransmitter dopamine. By telling brain cells when they have struck gold, the chemical apparently signals them to keep doing whatever they did that led to success. As for failures, Miller says, we might do well to pay more attention to them, consciously encouraging our brain to learn a little more from failure than it would by default.

This task is by no means simple.  Trying to emphasize the lessons from failure is a difficult task for many.  As Brett Steenbarger writes:

At some level, many traders equate losing with being a loser.  This frustrates them, depresses them, makes them anxious—in short, it interferes with their future decision-making, because their P & L is a blank check written against their self-esteem.

No wonder losses are hard to take.  It stands to reason that novice traders that have experienced only winners are going to find it difficult when it comes time to take losses.  Traders need to learn from mistakes, but our self-esteem is dependent on us forgetting mistakes as soon as possible.

Some analysts recommend that novice traders start out paper trading, in part, so they can get used to taking losses.  We are in favor of paper trading to the extent that it helps traders learn the mechanics of trading (and taking losses).  However there is no substitute for experiencing the ups and downs of actual dollars on the line (no matter how small an amount).

Fortunately for novice traders there is no better time to learn how to trade with actual risk capital.  Electronic trading and rock-bottom commissions make trading small lots easier then ever before.  Therefore novice traders can get their education underway doing actual trading (and taking actual losses).

Update: On a related topic FT Alphaville cites some research that shows why it is psychologically so difficult for investors to separate themselves from the herd.

Warren Buffett is betting on the American economy (and continued stimulus spending).  (The Money Game, Beanieville, Fund My Mutual Fund, Big Picture, MarketBeat)

Black & Decker (BDK) was attractive in part because of its cash horde.  (Deal Journal also Breakingviews)

How the “leverage cycle” affects how much individuals are willing to pay for certain assets. (WSJ also Trader’s Narrative)

Howard Lindzon, “The few that made big coin in the stock market [since the March bottom] – in an honest way – were those that honored price.”  (Howard Lindzon)

What to do in the face of a VIX spike.  (VIX and More)

What Goldman Sachs (GS) likes in the commodity space.  (The Pragmatic Capitalist)

Pensions continue to up their allocations to emerging markets.  (Pensions & Investments)

An IPO filing shows that the retail forex business is rapidly growing and very, very profitable.  (FT Alphaville)

Brett Steenbarger, “..trading has to fit into your life; your life can’t fit into trading. Be who you are, and you will have the opportunity to become the best trader you can be.”  (TraderFeed)

Does Vanguard feel threatened by tactical asset allocation strategies?  (market folly)

The Supreme Court is considering big changes to mutual fund fees.  (Morningstar, Washington Post, Law Review)

There is one mutual fund firm cutting fees voluntarily.  (Fortune)

Consider your taxpayer funds “invested” in General Motors and Chrysler as good as gone.  (Deal Journal, NYTimes)

The Brits are not afraid to break up bailed out banks.  (Washington Post)

Hank Paulson’s “gift” to the banks added around a $100 billion in value by one estimate.  (Real Time Economics)

Just how close is the Fed to draining liquidity from the system?  (WSJ)

The Australian central bank hikes rates for the second time.  (The Money Game)

“There are people in the [investment banking] industry who, when you get right down to it, have no real interest in money. People who couldn’t give a flying f*** in a rolling donut whether they make $3 million, or $10 million, or $100 million a year, as long as they make more than the next guy.”  (Epicurean Dealmaker)

Should we feel sorry for any one following Jim Cramer’s stock calls?  (The Davian Letter)

Joshua Brown, “Guru, Rock Star, Wiz, Wunderkind, Prodigy, Hot Hand, Hotshot…if any of these terms are being used to describe you or the person managing your money, curl up in a ball and hide.”  (The Reformed Broker)

Did you know that the Motley Fool has raised some $80 million during its existence?  (paidContent)

Happy 3rd blogiversary!  (World Beta)

The 50 best movies of the decade (2000-2009).  (Paste Magazine)

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