Thursday, August 30, 2007

Advice to Germany: "Stick to Manufacturing"

Pssssst. You. Herr Doktor Finanzenarbeiterwirschafter. Yes You. Come here. I've got a bit of advice for you (and anyone else of Germanic lineage that sees themselves in the mold of Soros , Tudor Jones, Cohen or Kovner

Nothing personal but....


Errrr....that's all.

Wednesday, August 29, 2007

Queasy Sights

Anyone who has spent lots of time on boats (particularly oceanic offshore swells) with those who have not or with whom it simply disagrees, will know the unmistakable tell-tales of seasickness. First the colour disappears from the suffering one's cheeks. They appear listless in posture, staring into the distance. They hug the sides or rails to provide them with a reassuring proximity to the sea in order that they not embarrass themselves in the event of ummmm an event. Then, they point their nose to the wind desperately hoping and praying that the unsettled feeling that they are going to imminently vomit will pass. They slouch yet further, appear even more pallid - even green. Then, in an involuntary spasmodic contra-digestive ballet, the afflicted sort of weave and wave back and forth trying in vain to hold in what must, against all decorum and effort, come up and out, in a violent, but ultimately cathartic LIFO explosion. This is NOT a pretty site if the afflicted were consuming beer and Cheese-Doodles before they were overcome by the need to involuntarily regurgitate.

Markets, particularly the onset of bear-markets, I would argue, repeatedly display certain similar tell-tales. These may not be readily reducible to numeric formulas, or DeMark counts, but one can often distinguish them when they encounter them, much like the sea-sick would-be sailor. Some are particularly adept at recognition in a BLINK! kind of way. And others seemingly do it more or less continuously. But whereas the human body is bounded by a limited set of vital signs, and the swell of the ocean and rocking of the boat induces a more or less consistent interaction and reaction with the our biological constitutions, financial markets are dastardly complex, rarely if ever invoking precisely the same set of interactions between variables, with the importance of variables themselves evolving dramatically over time. And perhaps the biggest mind-fuck is that markets typically play out over much longer periods, with innumerable traps along the way that plausibly attempt to sway opinion or cause even the most detached observer to waver in her conviction or investment plan. Nonetheless, keen observation, experience, distillation, coupled with constant re-examination, and perseverance can allow one to filter the noise and essentially achieve the same result as looking at the soon-to-be-seasick sailor and correctly forecasting the technicolour yawn about to ensue.

While Lance Armstrong is reputed to have oxygen-carrying arteries the size of a thoroughbred and Roger Federer is (according to sports physiologists) reputed to have a uniquely broad range of motion conferring physiological advantage, one might reasonably look back at Wayne Gretzky and wonder what it was that made this small and slight Canadian probably the greatest hockey player who ever lived, for on the surface it wasn't a physical advantage, in most physical of sports. I recall in an interview, that he described it as vision. To someone who is not an aficionado, ice-hockey is mind-blowingly rapid and chaotic, even for those that skate. But to Gretzky, he apparently sees it all in slow-motion. He is able to visually take it all in and sub-consciously and effortlessly anticipate where and what everyone will do next, adjusting and responding to optimize each turn, movement and pass of the puck. For he wasn't not faster. He just thinks, and responds quicker and better. But for purposes of analogy, I am taken by the concept of seeing with extreme-clarity, in slow-motion, something incredibly noisy, chaotic and complex.

I am no Gretzky, nor do I fancy myself as one. But I do have reasonable and deep experience, and I do ruminate upon events, markets and the macro-economy at length from a position both above and within the trenches, and for what it's worth I have this uncanny feeling that I am seeing this cycle and this probable cyclical and market-top evolving in slow motion in almost picture-perfect fashion, the kind that financial historians will be able to aptly describe while posing the question "What the fuck were they [the leveraged speculators and providers of credit of the era] thinking?!??"

The Good, the Bad & the Ugly

Equity Market Neutral funds come in a variety of flavours and strategic pursuits. Some are dsciplined, other nebulous by design. But like footprints in the snow, one cannot hide from the trail left by one's returns. This could be good or bad, depending upon whether the results in fact, corroborate one's pursuit, or unveil it's charlatan roots for all to see. The past month's events provides a fascinating peep into this world, with a guided tour by yours-truly.

First is the BMNIX, the Rosenberg Laudus small-cap value fund that plunged so spectacularly and sympathetically with Tyhke, GS, AQR, and Renaissance. BMNIX is unabashedly skewed towards the smaller-cap and the value on the long side, presumably versus things with less value on the short side. Rosenberg has always had a healthy respect for momentum, so, potentially, their pari-passu was NOT on the short-side, but on the long. Interestingly, they meaningfully recouped most of the extreme dislocation drop, probably as a result of higher turnover, and the fact that value-oriented pari-passu small-cap were as illiquid on the up-bounce as they were on the puke. Bravo!

Next we have the approx $2bn JP Morgan Market Neutral Fund. Yeeeehaw! OK so he's recovered most (down only 2% mtd), but an 11% unleveraged peak-to-trough drawdown with probably 400 to 500 names per side. Ooooooch! I cannot infer what exposures caused that, but my guess is he must have had excess resource and value exposure on the long side coupled with the pari-passu short portfolio that WENT-UP when the market was going south.

Another dubious horse from the same JPM stable is the Highbridge US Market Neutral Fund. Though apparently different managers, and different holdings (this one is seemingly more concentrated and less diverse) it too suffered what was a 10% unleveraged drawdown. And again while nothing jumps out on the long side, without detailed analysis, one might assume that it was the ill-behaved short-portfolio that was the culprit. Maybe it was THEIR fault, for Highbridge admitted deleveraging, and the pari-passu would of course have hit their sister-short portfolios. The de-risking also perhaps accounts for why they only recovered less than half their loss, for if they cut (even some), they would have locked in losses at distressed levels indeed.

The next rung down on the ladder, we have TFS MArket Neutral Fund, who got slammed on the order of 13.5% peak-to-trough unleveraged. Ouch! Perusing his holdings, the only thing I can say is that his 150 or so long portfolio positions resembles everyone else (and the market) less than perhaps any other manager. They are certainly NOT "value" (portfolio PE of 65x), and are skewed to the tech and growth areas so their yearning for "Capital Appreciation" must be founded upon hope and prayer. Judging from performance, this market neutral iconoclasm should not be worn as a badge of courage. The horrid time must have been exacerbated by high pari-passu on the short side.

Near the bottom, we have the Robeco Boston Partners Market Neutral Fund. I found this interesting because they've historically done a nice job of unearthing attractive value+growth on the long side that encouraged Robeco to "buy the firm". They are more fundamental than their brethren, but that apparently doesn't guarantee success. I would suggest their approach is more an over/under valuation relative to more sophisticated sector/market/stock-level valuation, for their returns regress upon this factor rather highly. And notably, the level of relative over/under valuation has indeed been a poorer predictor of returns since mid-Q2 than most other simple value or price-reversion factors. But -12% from their highs and nearly -5% ytd, one must ask why these valuation tails are not more effective. The answer probably lies in the misfourtune of the over-shorted short side which should (and will) go down and underperform, but probably not until existing shorts puke more and unwind positions diminishing short-interest to levels where actually selling will take the price down.

Finally, at the bottom, we have a fund hilariously called "THE GERONIMO FUND", who in sympathy with its moniker, has also taken a grand leap into the abyss. In attempting to mimic HFR index hedge fund performance, the managers Mssrs. Prokupek & Krause, have managed to flame-out spectacularly, thereby insuring a return to higher education or a career change into Colorado's hospitality industry.

Monday, August 27, 2007

So Long AG A.G.

So farewell
Alberto Gonzalez -
80th AG of
the US of A

What took
you so
long to pull

As GWBs "yes man",
And Lawyer to Enron
Who (amongst other illustrious things):
Fought Congress to keep Cheney's Energy Commission docs "Secret"
Dimmed the lights on the Freedom of Information Act
Argued the Geneva convention was for Sissies
Sanctioned PMCs to do what might otherwise land your bosses in Jail
Legal architect of Spying domestically Without Warrants
Denied existence of the constitutional right of habeas corpus
Fired 9 US atorneys following 26 meetings but couldn't recall any of it
Repeatedly Lied to the House & Senate
You would have made H.R. Haldeman proud!

Not since the
days of US Grant
has a pustule
like you been
lanced from
public service.

Most memorably,
you accomplished the
You made
John Ashcroft

Friday, August 24, 2007

Financial Look-a-Like

Surely I am not the only one who's noticed the uncanny resemblance between US FRB Chairman Dr Bernanke and esteemed Afghan Grand Poobah & LA Restauranteur Hamid Karzai. ...

Chairman Bernanke <<------------------------------>> Hamid Karzai

(with apologies to Private Eye)

Thursday, August 23, 2007

Gross: "Rescue the Homeowners..."

I think it is a noble thing indeed to rescue the home-owning people and so save America from errrr itself(?!?). But which home-owning people? Are two-home-owning people more deserving of a life-buoy than than one who owns but as single home? "Who" are we we saving "them" from? Faceless foreclosure? The bank? Chinese mortgage-backed paper-holders? Our pension funds who own mortgage-backed paper? Are the folk who bought stupid interest-only low-teaser-rate mortgages more deserving than the ones who simply paid too much and find themselves in negative equity? Should we save those that patriotically took out home equity loans following 9-11 in order to spend as they saw their patriotic duty? Or should we "save" those who continually withdrew equity from their homes to cruise the world or buy a plasma TV, such that, like Icarus, they simple consumed too close to the sun?!? What about the people, who deserved the good life, and in whose pursuit deservingly stretched to buy an extra 2000sq ft with pool, 3-car garage, and gallery ceilings, leaving no wiggle room for the inevitable "shit" that all-too-often happens in the course of life. Perhaps, the US gov't can recoup costs by having a 24-7 reality TV show that combined CourtTV with "Judge Judy" and "How to be a Millionaire " in a macabre publicized real-life drama showing precisely "how" they got there, and throwing themselves on teh mercy of the errr court/government/panel have you to see if they qualify for a "subsidized mortgage", "elimination of some principal off the loan", "temporary interest rate relief"," stay of execution in respect of foreclosure, or for the lucky few (and truly deserving) few, outright annulment of the mortgage loan, and award of the contested home free and clear.

But I will ask the question: Are not the savers deserving too? Perhaps the savers should unite and ask the government to provide them with some redemption for the lax fiscal policy and negative real interest rates that have spawned inflation in the real basket of goods and services one uses and consumes each day. It IS perverse justice that the prudent one's who save for a rainy day, and consider wisely, the possibility that something might upset the best laid of plans, and so do NOT borrow 6-times their income on absurd luxury that the less wise did, and who as a result were so stretched they could not afford to landscape in the first instance, nor now they can afford the energy to heat or cool the royal waste of space. Where is culpability or responsibility?

That there has been a large transfer of wealth from savers and the equally-weighted American to military contractors, leveraged asset-buyers and their intermediaries is undeniable. Perhaps, in similar fairness we should create a look-back tax that assesses the gains (some or many ill-gotten) made from the asset inflation and money illusion and redistributes it the ordinary savers and pensioners? We can call it the Sowood Tax in sympathy with Mr Larson's magnanimous gesture of returning previously-earned performance fees to investors following his Fund's recent debacle. America is not for wont of wealth, but is for wont of more disperse distribution of it. When however the distribution is sooo skewed, taxing the average to save the average citizen seem reasonably daft, given the enormous tax holidays and munificent gifts adorned upon the upper-most percentiles. Perhaps the time has come for more meaningful sacrifices that begins to tackle what almost every objective observer sees as a way of life that depends upon unsustainable consumption, encouraged by absent levies upon the many externalities this life spawns. The bubble, is perhaps in the American Way itself. And everyone sees it, but Americans themselves.

Rant over.

Tuesday, August 21, 2007

"I Know Nothing...."

Anyone who read David Marsh's "The Bundesbank" intimately knows just how tight and conservative Germans, and the culture of German banking really are. Maybe its because they experienced first-hand and all too vividly the post-Versailles Weimar Inflation, or more likely the impoverished and inflationary days following the end of the second world war.

This is not to say that Germany sailed through the last four decades without financial indiscretion, slip or scandal. Some may be old enough to remember the spectacular failure of private Cologne-based Herstatt Bank, for which settlement risk is now indelibly associated. And there was was Jurgen Schneider, seems to have bit off a development or an office building-or-five-too-many. And let us not forget the almost equally spectacular blow-up of Metallgesellschaft who was perhaps single-handledly responsible for $10 oil that nearly sunk Texas and sent revolution throughout the middle-east. One might also include the giant LBO (fully valuing @ 1:1 ost/west DM conv the DDR, in the folly-list where caution was throw to the wind. But this was, to be fair, wholly political even. The hangover, still is being felt today.

But despite these occasional past lapses, it is still surprising that in the land that birthed BuBa chiefs, Helmut Schlessinger, Karl-Otto Pohl, and articulate anti-housing bubble provocateur Ottmar Issing, that we discover IKB and Sachsen Landesbank with ummm rather large (in my book) dollar sub-prime zaitech portfolios that one must assume are worth rather less than their historical cost-base, yielding what will undoubtedly be sizable if not catastrophic losses. As a result, it is incumbent upon Germans and non-Germans to ask: "WTF guys???" "What were you thinking??!?" "Have you a secret desire to work deep in the mines of the Ruhr?" Didn't you see what happened to Bob Citron? Or the jail facing BAWAG's Elsner & Zettler??

My knowledge is indeed limited here, and so I can barely comment but please, someone tell me whether we are witnessing a "Schneider-ish" fraud or a "Schultzianly oafish" investment strategy.

Monday, August 20, 2007

That GS Confidential Memo


TO: All Goldman Sachs Marketing & Communications Staff
FROM: Mark Carhart & Ray Iwanowski - Gllobal Alpha
DATE: August 17 2007
SUBJECT: 2007 Performance & Semantic Guidelines


Following recent market volatility, presumed temporary hiatus of modeled performance, and $3bn vote of confidence from Mr Greenberg and the GS Capital Committment Committee, we think it is advisable to unify the lingo that we use to describe investment performance, market conditions, and the factors that drive our P&L. At the suggestion of David [Viniar], we will heretofore employ the straight-forward and highly descriptive (unoffical) acronyms of the US armed forces as follows:

BEIFT - Behold, Every Indicator Forebodes Trouble; (pronounced "beefed")
BOHICA - Bend Over, Here It Comes Again
CF - Cluster F*cked (i.e. multiple factor failure)
CHAOS - Chief Has Arrived On Scene (i.e. deleveraging imminent)
FISHDO - F*ck It, Sh#t Happens, Drive On (not to be used in the presence of P&E clients)
FUGAZI - F*cked Up, Got Ambushed, Zipped In; (refers to out-of-control situation such as a chaotic jungle warfare combat or extreme market volatility environment where we can't get out of positions, and can't due more due to losses)
FUBB - F*ck#d Up Beyond Belief
FUBAR - F*ck#d Up Beyond All Recognition
FUBER - F*ck#d Up Beyond Economic Repair
FUMTU - F*ck#d Up More Than Usual
FUNDY - F*ck#d Up, Not Dead Yet;
GFU - General F*ck Up
GMFU - Grand/General Market F*ck Up
JANFU - Joint Asset 'N Financing F*ck-Up
JAAFU or JAAFFU - Japan Asset Allocation F*ck-Up; (note: the use of JANFU combined with a radical increase in Japan Asset Allocation F*ck-ups, has led to the rare but increasing use of JAAFU/JAAFFU
LUUBO - Luck Used Up, Bail Out!
MOAFU - Mother Of All F*ck-Ups
MUBAR - Mortgages Unraveling Beyond All Recognition
REMF - Rear Echelon Mother-F*cker (i.e. short-squeezed by others deleveraging)
SAMFU - Self-Adjusting Market F*ck Up (inspired by Andrew Lo@MIT)
SAPFU - Surpasses All Previous F*ck Ups (Viniar: a 1-in-10,000 year event...??!)
SMUBAR - Spread Markets Unwinding Beyond All Recognition
SNAFU - Situation Normal: All F*cked Up (i.e. V.A.R. risk measures)
SUSFU - Situation Unchanged: Still F*cked Up
TOFU - Things Ordinary: F*cked Up
TARFU - Things Are Really F*cked Up
TUIFU - The Ultimate In F*ck Ups

(with thanks to Wiikipedia)

Friday, August 17, 2007

Scary Movie ?

What has just happened? Well you see there are formulaic scenes in early every horror flick: the boy with excess curiousity, the waif running away who trips, the rise from the dead calm following victory, and so forth.

The young boy whose incessant curiousity compels him against all good reason to explore the spookiest nooks and crannies of the rickety house with viewer thinking, "OH NO! DON'T, PLEASE DON'T PLEAEEASSSE DON'T OPEN THAT DOOR', after which the innocent opens it followed by chaos, terror, blood, screams and mayhem. Yes that describes the credit bubble, of which the US sub-prime mortgage mess is but one expression.

Then there is the archetypical scene in which the lovely, scantily-clad, and always young and female is running away from something terrible, horrible possibly supernatural, and ALWAYS very dangerous (ostensibly through the woods, often when its raining) who inevitably slips, falls and twists an ankle (breaks a leg, get trapped under something-or-other), leaving our heroine helpless and paralysed by fear as the imminent danger encroaches upon her. Sometimes she does manage to [temporarily] escape or is [temporarily] rescued by heroism or happenstance. Equity markets it would seem, have just witnessed such an occurance with foreign Japanese equity "longs", and Japanese domestic housewives short the YEN vs high carry currencies , both proverbially spraining ankles in their haste to runaway! runaway! runaway! from IT.

And there is of course the scene where the hero or heroine believes the danger to have mortally passed, with the villain/monster/beast/alien either [apparently] incapacitated, injured, mortally wounded, and perhaps appealing to the emotions and superior sympathy of the hero (and viewer) and usually accompanied by weepy music, in order to make a confession/apology of sorts, drawing the hero closer closer closer dropping his guard until with a rapid fury and force accompanied by loud suspenseful music, we get.....RATE CUT!!!! RATE CUT!!!! , mauling [at least temporarily] the shorts, doomsters, nattering naybobs, and those that sold their Japanese stocks down 10 or 15% last night, all at once.

Needless to say, following more excessive force, multiple gunshots, or help from rescuers, the villain, alien, credit monetser or what-have-you, is usually slayed [really!, and for good!] despite the previous fits and bouts apparent recovery. But lingering again, one never really knows for certain. I think I'll rent "Dead Calm" tonight just to keep me on my toes....

Tuesday, August 14, 2007

An Autopsy

Here are my observations on the recent, errrr ..... hiccup (?) in quant-land (note for the squeamish that the photo is of an "Autopsy Dummy", available by mail order for those parents looking for an out-pf-the-ordinary gift for their pre-med inspired offspring):

1. Obviously some folks puked in July. You know who you are (either because it is YOU, or because YOU are an investor), so there is no need to repeat the roll-call here.

2. The usual suspects (as in the past) are "Macro-oriented Multi-Strats", de-leveraging, probably as a result of losses elsewhere (replay of same old song).

3. As is apparent to all, others vomited positions sympathetically, either because they panicked, they were told to, they had to as a result of external forces, or because of some type of stop loss.

4. It is unlikely that IBs predated funds since they all have rather large similar positions of their own.

5. Smallcap value got hit the worst , providing an eye-opening wake-up call to principals, risk-managers, and portfolio managers alike as to the true potential cost of trading this type of inventory in the modern age of limited dedicated liquidity provision. (Truc du chef: when grilling Quant PMs insure you ask them about the cost of liquidation during times of others liquidating. Any single digit whole number percentage estimate should be viewed with suspicion).

6. "Short-interest" IS a fine proxy for pari-passu risk. Anal-retentive types can have some confidence in piecing together competitors' portfolios with quarterly 13F-HRs, the absence of positions within these disclosures, and published short-interest even with the poor granularity, data quality and omissions.

7. The biggest contributor to out-sized (and yes, unprecedented) moves, in my opinion, was NEITHER the size of unwinding of positions, NOR the pari-passu or its concentration (though young 'uns who got spanked should take note), but the fact that the quantitative & stat-arb communities are the dominant liquidity providers in the US equity markets. It was their withdrawal from providing liquidity, exacerbated by mimetic liquidation and prevailing market structure that made it seem so bad. Likewise, when the news was "out", and rumour was fact, and demands for liquidity reversed direction, so too were the liquidity-providers absent permitting the similar magnitude reversal on Fri and Monday.

8. We all have known that (like US energy policy) US equity market structure is fragmented and sucks. One couldn't have designed such a byzantine order even if that were one's expressed objective. We know that specialists are the scum of the earth having been granted monopoly front-running privileges (which they pursue in earnest), and that, in their place, the new breed of liquidity provider (DEShaw, Two-Sigma, Citadel, Tykhe, Highbridge, and the IBs) are purely discretionary in their dedication and application of capital. This should serve to heighten awareness of what it might cost to "get-out", and lead EVERY participant to qualify any answer regarding the cost of trading, and b y extension the value of "mark-to-market" in general, and the cynicism and discounts that an investor may wish to attribute to such values ascribed to holdings by agent-managers.

9. Lots of Capital remains deployed in relative value long vs. Short strategies. Short-interest remains asymmetrically high on the tails of this deployment in aggregate, particularly i "expensive" thematic high-growth, high-earnings momentum situations. On the long-side a reasonable amount remains dedicated to smaller-cap and value-biased situations that en-masse, have a higher-sensitivity to market-wide earnings . Some of the recent poor performance is related to exposure to this "spread" and the market herd's current preference for earnings stability and growth "at any price" rather than suffer the humiliation (and pain) of the long-side higher-probability earnings torpedoes. This is a secular preference of the market and will diminish only with evolution of new macro info.

10. SO: We've large dislocation. Large reversal. Some cuts, scrapes, and bruised egos. But being back where we started, I cannot help but think the conditions that led to "the event" remain: excessive leverage in a deteriorating credit and risk-appetite environment, high- pari-passu, shitty market structure, uncertain behaviour in respect to stomaching losses, and portfolio assymetries that have the potential to continue to yield negatively skewed risk vs. reward in the short-term. Look for some backfill as participants look to take advantage of the bounce to reduce leverage further.

11. Last but not least: Four-dollars of long position and four dollars of short position short per dollar of equity?!?! These guys really are either extremely stupid, or have a cigarette-smoking like death wish. I am not going to preach and moralize about it, but IF during "normal" times, one is carrying the kind of gearing, it simply leaves no margin for error in the event of the unforeseen, and as I have said before "Sometimes shit just happens...". I guess there are still somethings that a PhD at Stanford, MIT or UChicago cannot teach you....

Sunday, August 12, 2007

7 Suspects

Lots of finger-pointing all around over the past two weeks as to who is responsible for the market turmoil. Here are some suggestions for everyone to mull over as we begin the new week:

7. The Tasmanian Devil?
Known for creating havoc in my favorite animated cartoons (and you thought this was highbrow commentary!), he is the ideal scapegoat because he is not real, and, from his dialect, an obvious foreigner. Ans Americans are pretty certain "damn foreigners" have something to do with it. And Congressmen - especially Dems - are as guilty as pandering to this fear as anyone else.

6. A Feather?
This has two potential meanings: the first is the classic Doonesbury reference to GHWB (better know Bush-the-First) as an invisible man, represented by a feather, foir it was this time that Mr Greenspan cut his central banking teeth, in what historians will view as the agent of near-omnipotent (unless your name was Lamont) Central Banker. Abyone who read David Marsh's book on the BuBa would concur. But the better metaphor (abd the one I am thinking of here) is the classical reference to the chaotic interconnected impact of a butterfly flutttering its wings in the moutnains over Tibet causing tornadoes in North America or unending torrential rains in Gloucestershire.

5. Aliens?
"The Great Gazoo?", "Q?". ET? The Sithe? Of course there is great explanatory power from the media's point of view in settling upon forces that are deemed plausible, but well-nigh impossible to prove (or disprove). I give this low probability as I really just wanted an exceuse to use this picture of Gazoo and see who, if anyone, remembers him. If it were "Q", having yet another laugh at humanity's expense, the volatility would be exacerbated, for he - like humans - requires instantly gratifying fun...

4. A Straw?
A straw...remember the "Krazy Straw" advertised on television in the late 60s and 70s? Everyone HAD to have one (despite there being no earthly way to actual wash them other than sucking detergent through them. Well this straw that might have caused the current mayhem is the straw that broke that camel's this case that would be a realization by lenders that "The Bernanke Put" may be struck farther out of the money than "The Greenspan Put". Amen!

3. The Gipper.
Yes, the father of our current bubble in credit can be traced back to Mr Reagan, along with the laughable Laffer curve that encouraged deficits following a period of relative austerity under the Dems by ballooning government spending (mostly on defense) concurrent to chipping away at the higher marginal rates. Apart from an interlude of tight-money that followed a roaring late 80s bull-market in assets, temporarily removing their lustre, leveraging-up to buy real things has been a one-way bet, one that implicitly understands that elected officials will not voluntarily be seen to be fiscally sane. Of course, markets (the bond market in particular) used to play this role until a certain Dark Lord took the bond-market's manhood and put it safely into a lockbox.

2. Dr. Evil? - Macro-Man is known for coining "Voldemort" as the covert referrence of choice for the PBoC's market activities. The obvious metaphor for Hedge Funds, is Mike Myers stroke of genius, Dr. Evil (& Mini Me). There are of course some upstanding citizens out there, some of whom have even refunded performance fees earned prior to going nuclear. As for the more cynically Randian elements, YOU know who YOU are....

1. Pinball Al?
Oh I do not have space here, suffice to say, if it looks like a bubble, smells like a bubble, tastes like a bubble and is beginning to have rather rampant distributive effects upon the real economy, then it probably IS a bubble. I mean what was all this shite, hemming and hawing about not being able to tell, "maybe its not" , "productivity blah blah", state change yada yada..." Oh fer crying out loud EVERYONE even my elderly near-senile housekeeper could tell it was a bubble. OK, maybe not the sole cause, but I'd like to hear hear Mr greenspan say "mea culpa" just once, and say he regretted NOT telling the "W"-Bush admin to take their tax cuts and shove 'em else real rates would remain at levels that would insure "W" would never get re-elected in 2004. (Apologies to Prudent Bear for lifting their cariacature)

Friday, August 10, 2007

(No arms, no legs),But Not Dead Yet...

Today, when all the dust settles, "quants" will almost certainly have witnessed a huge bounce between the liquidated long vs. short positions, perhaps on the order of 3 to 5%. This is as massive a one-day convergence upon diversified portfolios as was the unprecedented just-seen divergence.

Having seen many puked-out evidenced by the price action, the question is: Who held their nerve, and not only didn't cut, but doubled-up?? Those who didn't puke will see some reasonable rate of P&L recapture. Those who increased later from positions of low leverage will be net positive, while those who cut last will be lamenting their actions. We'll know shortly who'll be getting blue ribbons...

Top 10 - What You Should Do If You Are a Stat Arb or "Quant" Trader

As a newly-unemployed Stat Arb entering a period of diminishing liquidity, you will indeed need to re-acquaint yourself with life, the universe and everything in-between. You will need to stop obsessively checking your P&L and unwind (no pun intended). Here's a list of some suggestions to get you started....

10. Get to Know Your Kids.
As a work-a-holic with something to prove, who's spent the last decade commuting to London or New York from the suburbs, you should learn your children's names, find out what they like, and try to spend some quality-time with them, that doesn't include YOU reading the Wall St. Journal.

9. Apologize.
Most recovering addicts, whatever their addiction begin with an admission that there is a problem, before continuing on the making an apologiy and asking one's forgiveness. Given the large number of investors that will have been stung by your excessive leverage and your failure to recognize the similarity in positions across the market, you'll have a lot of potential work to do here to take your mind off of the model failure.

8. Do Some Charity Work
Nothing helps the soul more than helping someone else worse-off than you (unless you're a Ayn Rand or similarly-inspired Republican). Though failure may seem traumatic at this point in your life, there are people who don't drive BMWs, have good health and savings in the bank (though you should which one), and send their offspring to private school. Doctors Without Borders is excellent, as are Oxfam, Amnesty International and The Sea Shepherds (aquatic life has few other champions!).

7. Join The Peace Corps.
De rigeur in the 60's, there is still much thatyou can gain personally, and that your experience can deliver to the third-world experience. Think of all the potential sub-prime borrowers who could benefit from your modeling experience!

6. Get Yet Another Degree.
Since you've already got at least two degrees (and probably three), why not take the down-time to add yet another??! Perhaps "psychology", "or "behavioural finance", "game theory" ? Lord knows they might even be useful in avoiding the same again in your next incarnation.

5. Escape to an Ashram.

Ego's are easily bruised, especially when they are large and outsized. When David Weill went nuclear and lost boatloads of Rothschild and GAM money in the mortgage disaster of the early 1990s, he completely wigged-out and ran off to an ashram in India to try to rediscover the real "him". Sometimes people need great ego shocks to kindle their inner spiritual awakening.

4. Get Religion.
Heck, maybe it happened to YOU because you didn't have faith in your respective deity?? The The Hebrew God it must be said has been to smite mightily in the old testament. And Jesus always preached charity, and helping the less fortunate. Perhaps your fee deferral has transgressed your deity of choice's charitable sensibilities? Stranger things have happened (remember those 40 days and 40 nights of rain and that mad-man with the ark?!?)

3. Get Around to All That DIY.
OK, You've been busy, and paying someone else to do all that DIY in the home. Now, of course, you'll be wanting to save money and you'll have lots of time on your hands, you might as well put that engineering degree to work and get down to it. Needless to say, building materials are a "buyers" market at the moment.

2. Start a Blog.
Ahem. Well errrr it IS cathartic not to mention a hoot. And one DOES meet lots of nice people (even if they might be 13 yr old with braces and a large vocabulary for his age). And who knows...maybe it will form the foundation of investment strategy newsletter, tipsheet, or you'll use the material in a book one day...

1. Non-Mea-Culpa - Do it All Over Again.
Never admit responsibility. But of course, none of this was your fault. You were innocent roadkill. So you can take the time to conjure up exceptionally profound explanations and positive spin as to why you did better than the average stat arb, and would have made money if ONLY you been able to hold your positions. Ans like JWM and Brian Hunter and a Phoenix, you will rise yet again so that you can fulfill your destiny.

Thursday, August 09, 2007

One Shoe Dropping....

What is the sound of one shoe dropping? Squisssh? Plop? Crack? You can take you're pick. But what I CAN tell you is what it looks like (see picture left). This is a yearly chart of "BMNIX", the Laudus-Rosenberg Market Neutral Fund, an open-ended US Mutual Fund. It is a quantitative in nature (per Rosenberg's long experinence in risk-modeling), highly diversified (hundres of names long and hundreds short), uber-neutral, (thus equal amounts of long versus short stock), no leverage per-se, although it does, I will suggest, have some style bets, chiefly some small-cap, and some value. Which given current circumstances is about as appealing as eating a rotten oyster or (I can just about imagine) catching a venereal disease.

The Fund has a daily STDev of perhaps 0.35% at the outside, reflecting its well-hedged and diversified nature. What in Merriweather's name could possibly flatten this fund like 'possum-on-a-country-lane minus-seven-percent roadkill? Minus 7% in a week!! What is probability of THAT! Poor stockpicking? Happenstance? Black Swans? Pari-passu risk? We will see and hear more today.

Interestingly, Bloomberg has struck a deal with Algorithmics to make their risk software available on the Professional terminal. This includes, VAR, scenario analyses, and "stress-testing" where they take a variety of risks that scare the living pooh out of risk managers (and principals) alike: "Sept 11", "Flight-to_Quality" , "Small-Cap Puke", "Rising Rates", "Fading Recovery". But as I suggested yesterday., the risk that will inevitably bite investors' collective arses will be the risk that has not been seen before. In this case, that risk is a systemic de-leveraging cascade. This is different than a flight to quality. A "flight-to-quality" substitutes low risk assets for high-risk assets. Systemic de-leveraging destroys both assets AND liabilities, shaking up the co-variance matrix of relative pricing in the process, and most-likely laying waste to lots of excess in asset prices.

BMNIX's rapid price destruction is the tip of but one shoe to drop, the reflection of some's forced liquidation. But sitting atop this , are a whole array of expensive securities squeezed up by passing temporary demands for liquidity, but which entropy will inevitably see return to more sensible levels, so dropping the second shoe. The bold will short them hard as others are squeezed. Most will watch in awe and wonderment. THe carnage will yield wonderful medium-term opportunities to buy assets on the cheap, from those who surfed too-close to the edge and perhaps terminally de-boarded...

Tuesday, August 07, 2007

(Dis)location, (Dis)location, (Dis)Location

Attention US equity market peoples: if you haven't already noticed, you are experiencing a capital dislocation event. This (as you must already have seen) is not about the level OF the index, but the relative levels of what is INSIDE of the index. It is spelled d-i-s-p-e-r-s-i-o-n, and if you have not already been run over by it, then you are probably pursuing a dysfunction investment strategy, with an extremely low sharpe ratio, and BOTH LOW expected return, coupled enormous FUTURE tail-risk.

As described in my previous post, Q3 2007 to-date has seen the complete decimation of value and price-sensitive factors at the expense of growth, revision, surprise, and price-momentum based factors, BOTH on the tails and within the cross-section. What this means is that the better the short-term expectations AND (and this is the most important "AND") the higher the however-framed p4ice momentum, the greater the return (and vice-versa). So, things with lower quality AND low momentum (irrespective of valuation, and, in fact in spite of it) the more it seems to go down.

In my previous post I hypothesized why this might be so using a flight-to-quality and bad-beta framework implying aggregate distaste for co's whose earnings have a higher sensitivity to market-wide earnings and similar infatuation for those uncorrelated , typically aliasing high, growth, high earnings momentum, positive earnings change etc. which are hypothesized to be more sensitive to the rate of discount which, in the markets estimation, has been newly determined to be staying put, at worst, removing hypothetical uncertainty as to the present value of a dollar of optimistic future earnings.

But there is a another possibility, and I think it perhaps more likely. SOME VERY LARGE FUNDS ARE IN THE PROCESS OF DE-LEVERAGING/LIQUIDATING (EITHER FORCIBLY OR VOLUNTARILY), THE NAMES OF WHICH WILL BECOME APPARENT TO ALL SHORTLY. This means that they are having to buy-in their shorts presumably a combination of expected under-performers, most likely from the realm of the shitty, the overvalued, the large cap & cap-weighted ETFs or all the preceding, and sell/puke those generally smaller-cap alpha-generating things that are "cheaper" or exhibit characterstics of value that are likely to yield positive relative return in the future, AND THEY ARE SELLING THEM WITHOUT RESPECT TO PRICE OR VALUE BECAUSE THEY HAVE TO, either because investors have asked for their money back, or to meet margin calls elsewhere, or because their lenders have pulled their lines, and so on.

Make no mistake: This is a liquidation event, and it is of a magnitude much larger than seen in 04, 05, 06, or early 2007, and rapidly approaching that of 2002. While GS/Mark Carhart's $10 bn Alpha fund was down 8% in late July, IT IS LIKELY THAT THE LOSSES FOR HIS AND SIMILAR FUNDS IN AUG TO DATE WILL STAGGERING BY COMPARISON.

For those under-leveraged and under-exposed, this will be opportunity. For those investing in the typical beta fund with concentrated smaller-cap longs versus ETFs, with any kind of value bias, there will be no exit. The response by the end investors - particularly HNW retail who for the most part are absolutely clueless about risk, and generally feedback trading, the will be redemption PANDAEMONIUM as knaves digest the realization that oh-so-much is, in fact correlated to credit, and that their loss-tolerance is, contary to bluster and swagger, very small indeed.

Anyone care to take a guess or two as to "WHO" precisely is getting waterboarded by the market??!?

Friday, August 03, 2007

Two Red Cards

It's Friday.
It's raining.
It's August.
The markets are as squishy as one can imagine.
Non-dollar, non-yen cash (my SOV of choice) is looking just fine.
So rather than rant I will share this amusing article from today's "Daily Yomiuri".

The Yomiuri Shimbun

The Japan Sumo Association suspended yokozuna Asashoryu for two tournaments and docked his pay by 30 percent for four months Wednesday after he was seen running around a soccer pitch while on sick leave. It is the first time a yokozuna has been suspended from a tournament.

The saga began when the yokozuna handed in a sick note excusing him from this month's tour of Tohoku and Hokkaido on the grounds he had a stress fracture to his lower back and niggling elbow injuries. He then flew to Mongolia--reportedly for treatment--and was shown on Japanese TV playing in a charity soccer match supported by the Mongolian government. Although the yokozuna scored, his antics did not impress the sumo association, which immediately condemned his behavior and demanded an explanation.

An apology to association Chairman Kitanoumi on July 30 was deemed insufficient, and Asashoryu's punishment was agreed on at a special board meeting Wednesday.

As well as the suspension and pay cut, Asashoryu has been grounded--he is not to go anywhere except his home, Takasago stable or the hospital where he is receiving treatment until the final day of November's Kyushu Grand Tournament.

His stablemaster, Takasago, also received a 30-percent pay cut over four months.

(Aug. 2, 2007)

Wednesday, August 01, 2007

Equities are from Venus, Bonds are from Mars

The world is often a unusual and oft-varied place. Take women and men, the latter of whom I am told are from Mar, and the former from Venus, which if my spouse and I are any indication, is accurate indeed. Or more to the point of this blog, take the fixed-income and equity markets. Bizarrely, in the USA over the past three months, "price" and "Value" have, it must be said, mattered ever more and more to lenders, evidenced by widening credit and swap spreads. This is perhaps it always has been or should always have been excepting the past four-year interlude of essentially negative real interest rates, coincidental to massively loose fiscal policies (globally) coupled with floods of both petrodollars and overseas surpluses
"willing" (at least via official sponsors) financing any and all US CA requirements at knock-down prices. This has, in Q2 and last month , been more or less halted with the mauling of the sub-prime market, and the emerging credit and de-leveraging cascade that seems to have been irreversibly set in motion.

But over in USA equityland, which I will term the "Venus" of markets for her (and it IS a "Her") frequent irrationality, unpredictability, and sheer volatile irascibleness, things have moved in the opposite direction. For over the past four months, price-related (i.e. value anchored) factors have not only had no relevance at all, but have attributed negative alpha in large quantities, not seen since 1990, Q3 2002, and the tail-end of the internet bubble in 1999. Undoubtedly, PWMT (poor white mortgage trash) things like NEW, AHM and the like have contributed on the tails. But I am measuring the returns in a variety of ways, both tails, AND cross-sectionally, and while the extremes DO impact the tails, the cross-sectional pictures are fascinating.

The flip-side of price/value factors are typically non-price factors such as variously-framed naive price momentum, earnings revision & earnings momentum, and earnings growth viewed WITHOUT respect to price/value-based factors. And these factor returns I will point out to you, resemble accelerating runaway trains. This is true in EVERY momentum frame, and most earnings-revision, earnings-momentum, and earnings-growth frames. On top of this, the fat-tail over the past four months (following Cassandra's whimsical ill-timed Crash Prediction) has NOT been on the torpedo side, but rather on the positive side of the daily distribution of returns, with some contributions from PE takeovers and mergers, but most often from a positive earnings surprise.

In a layman's nutshell, "the market" has been buying overt earnings growth, positive changes in earnings forecasts, and what went up historically WITHOUT RESPECT TO ABSOLUTE OR RELATIVE PRICE OR VALUATION ANCHORS. This is nothing new, for the market, in its periodic syphilitic or hormonal fits does de-couple from what prudence and the amthematics of discounting would otherwise suggest.
But I will point out that the gods (and probability theory) does not favor those betting with the apparent crowd at these junctures.

But as one who heeds and respects the wisdom of the crowd (though rarely follows it in positions) one must always ask whether probability (the rear-view mirror) is potentially yielding erroneous results, and the future will [continue] to depart from the past in meaningful fashion. SO what's going on? In equityland, "Value" is viewed as the anti-christ. "Growth" is the saviour himself. Like the Saviour, who is viewed differently by different cultures, so to is "growth. Some see HIM in earnings revision. Some see him in quality (EVA, CFROI, Asset turns etc.) Others in high earnings growth, and still others (the Evangelical sect IMHO) in price momentum. "Value" is unreliable as a saviour for such company earnings are too highly correlated to the market's earnings, hence have little appeal to alpha-seeking investors desiring to stand-out. This, in turn, creates a feedback loop reinforcing behavours and data-miners alike . So during times of heightened risk, the "flight to quality" disregards price, opening large anomalies for those better skilled in the art of discounting, willing to warehouse quality risk and stomach the P&L variability. Needless to say, during times of a macroeconomic dislocation that sees deleveraging as the norm, taking on additional quantities of such "risk", ends up pretty low on the totem pole, when firms are coming to terms with redemptions, margin calls, untold quantities of dubious mortgage & junky PE debt on their books, in addition the opportunities that such fixed-income spread widening yields to all.

There IS opportunity in this equity spread for cowards. But given that the positive momentum tail is so absolutely expensive, and the "cheap tail" not all that absolutely cheap, either to the market or itself, for the brave, the trade is probably to drill the most expensive stocks, particularly ones with some US PCE component or sensitivity, for many of these players are also leveraged, and systematic, and amidst a crappy market, a fishing expedition for stops and pain thresholds in ostensibly very overvalued situations might shake more fruit from the tree than otherwise might be the case.