Psalm 25-and-one-half

This little prayer recently discovered in that most obscure of scrolls: "The Book of Financial Psalms"

Psalm 25-and-One-Half

 1^[a] To you, O LIQUIDITY, I open up my blotter and go long;

 2 for in you I trust, O Liquidity.
       Do not let me be put to shame,
       nor let The Bears or creditors triumph over me.

 3 No one whose hope (and position) is by you
       will ever be put to shame,
       but the holders of cash, and the unlevered will be put to shame
       for they ignore opportunity without excuse.

 4 Show me your ways, O LQUIDITY,
       teach me your many paths to profit: precious metals, commodities, equities, art, real estate, antiques

 5 guide me in your bounty and teach me gearing, and to love low cap rates and to not fear inflation
       for you are Liquidity my Savior,
       and my hope is in you all day long.

 6 Remember, O Liquidity, your power and will,
       for they make me bold.

 7 Remember not the sins of my youth
       and my rebellious ways;
       when I was bearish and full of doubt,
       for you are good, O LIQUIDITY.

 8 Good and upright is LIQUIDITY;
       for IT instructs pessimists to follow ITS ways.

 9 IT guides the humble in what is right
       and teaches them to borrow and never go short of stock.

 10 All the ways of the LIQUIDITY are giving and keep giving
       for those who keep to the demands of his covenant and don't go short, hold cash, or buy bonds.

 11 For the sake of your name, O LIQUIDITY,
       forgive my past cautiousness, for it was unwise.

 12 Who, then, is the man that fears the LIQUIDITY ?
       IT will instruct him in the way chosen for him.

 13 He will spend his days in prosperity,
       and his descendants will inherit the land, Shares, and Gulfstream-V.

 14 LIQUIDITY spanks those who fear him;
       he insures the levered's debt covenants are not violated, and that CDOs remain nominally solvent

 15 My eyes are ever on LIQUIDITY,
       for only IT will release my house from creditors.

 16 Turn to me and be gracious to me,
       for I am worthy and leveraged.

 17 The troubles of my loans have multiplied;
       free me from my margin calls.

 18 Look upon my affliction and my distress
       and lift-up all my underwater positions.

 19 See how Central Bank reserves have increased
       and how their coffers fill. Help them too!

 20 Guard my portfolio and rescue my positions;
       let me not be put to shame, and see my investors redeem
       for I take refuge in you.

 21 May leverage and beta protect me,
       because my hope is in you.

 22 Redeem NOT, dear investors, have faith in LIQUIDITY,
       IT will save us from all our troubles!

Footnotes:

1. Psalm 25:and-one-half This psalm is a translated acrostic poem, the verses of which begin with the successive letters of the Hebrew alphabet.

Farewell Kato

I have been waiting a year-and-a-half to find some way of working Peter Seller's sidekick, Kato, into this blog, who apart from being very amusing is consistent with my predisposition towards always being on the lookout for something that might blindside me. Now, with the clarification of just how cooked the books Katokichi Company's (TSE Code #2873) books actually were, founding family member and now-former President Yoshikazu Kato has decided to fall on his sword (metaphorically speaking, that is) and stepp down.

The total amount of faked sales were estimated at USD$1bn over the previous 6 years, reasonably in excess of initial estimates and amounting to somewhere between 5 and 10% of annual company sales. While I believe there will be phoenix-like value emerging from the ashes, I do believe that the eventual restatement of prior years' accounts will keep on a lid on things and cause further price distribution from liquidation and so would take any meager short-term profits, and as the old saw goes, get out of Dodge...

Thrice Lucky?

Thrice lucky. That must be the motto of Osamu Kaneko hard-nosed ebullient founder and President of real estate advisory and management firm Da Vinci Advisors KK (TSE Code 4314), now with a market cap of YEN 175bn, and Mr Kaneko still holding 25%. Not bad for a company with no sales in 2004. Such is the power of using leveraged finance in the acquisition of real assets.

But it wasn;t always so, as the title of this post - "thrice lucky" - suggests. For Mr Kaneko spent the 1970s and bubble years with Bubble-King themselves, Haseko Construction (TSE Code #1808), as head of their US ops. From first-hand experience, I can recall Haseko's presence in the Japanese enclave of Fort Lee, NJ cynically known as "Fort Ree", to the working class lads of Edgewater (pronounced "Ej-wooda" to purists ), during the height of the last US real estate bubble in late 80's. They had constructed several monstrous towers majestically atop the hills overlooking the Hudson. Unfortunately, it was at a time when many others had done precisely the same, only sooner, while others were still in the process of doing the same, many of whom would never finish. Whether this project was their undoing, or the acquisition of Japanese land at never-to-be-seen-again prices, Haseko, as it was, is, no more. Strike-one!

Next, in the 1990s, came "Sunterra", the self-proclaimed King of time-shares, arising out of the ashes of Signature Resorts, whereupon Osamu (affectionately known as "Sammy") was Chairman. Maybe its cultural, maybe its my occasional unabashed snobbishness, but there is something about "time-shares" that creeps me out. Maybe its because I like my own space. Maybe its because I my economic sensibilities are offended when someone parcels up something as pedestrian as an apartment, and peddles for 300 to 500% of face. I thought hotels exist for this purpose, and to this day fail to see the allure of the timeshare. But Sammy was the timeshare King, with all the Radio Pyongyang prognostications about growth, value, ideas, blah blah, until in 1999 things went horribly pear-shaped, leading to eventual Chapter-11, and shareholder lawsuits. Strike Two.

In 1998, perhaps because Sammy knew more than he told to the unfortunate Sunterra shareholders of the time, he extricated himself from day-to-day management oversight, and founded Da Vinci KK, eventually IPO-ing in Dec 2001. While he needed to wait a couple of years before property values bottomed following the collapse of the bubble, cleaning up and recap of the banks, and the return of foreign carpet-baggers to Japan, the phrase "being in the right place at the right time" was rarely more apt. Inheritance law changes, asset sales and de-leveraging by all manner of corporations, securitisation and emergence of REITs, all happened in a relatively short period of time culminating in the launch of large managed fund that would secure steady management fees for years to come once the funds were deployed. Coincidental to this was one of THE most spectacular post-bubble ramps seen in Japan with DavVinci's share price vaulting ten-fold from YEN20,000 to YEN 200,000 during CY 2005, including a 4th quarter leap from YEN 60,000 to 200,000!! This assault was led by JP Morgan who, in the market, had amassed more than 20% of the outstanding shares that represented perhaps one-half of the float. Such is the power of the largest marginal investor, they it must be said that by mid December one retail mania had gotten hold of the theme, they presciently sold more than half of their monstrous position very near the top.

But this is history, left for the reader to make his or her own judgments. What has my attention today is that an apparent DaVinci subsidiary has been active in the secondary markets, acquiring a 10% position in the Ohtani's TOC (through presumed Davinci sub Algrave YK), and vocally opposing the ostensible YEN 800/share "take-under" from the family (see yesterday's poetical epitaph). Today, DaVinci offered YEN 1100/share for the same. Note that the Ohtani's have the effective control of TOC, though their take-under offer was apparently so insulting, and left so much juice, they will likely be required to pay-up in order to take it private, and there remains the possibility of other bidders emerging.

But perhaps for non-merger arbs, looking forward, it is more interesting to note that the same DaVinci vehicle, Algarve YK, that is spoiling the Ohtani's party, has also emerged as the holder of 9%+ stake of asset-rich Toei Corp (TSE Code# 9605) which in addition to its large holdings of TV Asahi and Toei Animation (equal to 40% of current market cap), owns a very large and reasonably valuable film library of Japanese animation and a massive amount of under-valued and under utilized real estate through out Tokyo in the form of offices and movie theatres. Presumably, Sammy sees what asset-investors have seen for the better part of a decade: the break-up value inherent in a number of venerable asset-rich companies. Whether an iconolastic outsider from Indiana State University with a chequered past will be more successful than those before are IMHO even-odds at best, but those are much better than one would have gotten from the bookies at any time in the past.

Farewell TOC

So farewell
then TOC
TSE# 8841,
land-lord,
linen-lord,
and would-be
lord of
health-tonics.

As a listed
company,
you always
traded cheap,
never
getting
the respect you
deserved.

Now,
With a TOB price
equal to a 5.5% cap rate,
you'll be remembered
as having been
"taken-under"
by the Otani's
rather than
"taken-over".

(with apologies to EJ Thribb, aged 5-1/2)

Katokichi: Cooking the Books?

In most other developed markets (and many emerging ones) major league fraud would spawn hundreds of news articles and much hand-wringing searching for culpability from janitors to auditors. Katokichi Co Ltd. (TSE Code# 2873) food manufacturer and distributor of frozen convenience foods, and owners/operators of variously-themed restaurants and pubs admitted recently ((see Yomiuri article here to (no pun intended) cooking the books. Katokichi has long stood out as a steady and profitable grower in an otherwise moribund sector, that, for the most part, has rather limited international growth and appeal. For despite the international popularity of sushi, none of Japan’s “ceremonial rice cake” makers, or “natto” (peculiarly foul-tasting fermented bean paste adjacently pictured) have succeeded in landing that contract with Whole Foods, WalMart, of WuMart, thus transforming themselves into the much sought-after secular growth company that, it would seem, so enamors foreign hedge fund investors.

In respect of the book-diddling at hand, Katokichi apparently fabricated sales transactions and related invoices between affiliated companies in a carousel fraud over a period of three years, to the tune of up to YEN20 billion gross sales per year, presumably in a bid to window-dress firm sales and profits (although it remains possible, pending investigation, that it was a scheme for parochial enrichment). At the top-line, this is a drop in the bucket for a co with YEN350 billion of sales, though it is potentially very meaningful at approx 3x the company’s reported net profits which were in the vicinity of YEN6.5 billion, hence the reaction of the firm’s share price (see chart left relative to the TOPIX). The company said: “it’s investigating and can’t comment”. Un-named sources, according to the Yomiuri daily suggested the amounts of false profit or fabricated indebtedness were negligible relative to aggregate turnover and recent firm net profit levels, though such intimations were apparently insufficient to prevent almost half the float from changing hands in the ensuing three weeks to date.

So while disclosure is far from sufficient, fear of roaches is now, an international phenomenon. Dump first, ask questions later. Such fear however, has, despite the potential for more ugliness, created an interesting opportunity to acquire interests in one of the few growing, successful, diversified food manufacturing and distribution business at a nice discount to peers, absolute historical valuation, peer-relative valuation, and probably a 30% discount to prevailing fair value, with a now-diminished foreign ownership ratio.

Feeling brave?

Thinner than Gruel

Attention all Japanese Equity Fund Managers: If you are outperforming the index, then you are incredibly lucky; have a narrow, cap-weighted portfolio; or are incredibly lucky AND have a cap-weighted narrow portfolio. There is almost nothing credible in between. This is highlighted by the implausibly low percentage (less than 25% as of 2nd week of April) of stocks outperforming either the Nikkei or TOPIX First Section on a rolling 12 month basis.

While good news for disciples of the MSCI Japan Index, and even better news for those prescient enough to make the TOPIX Large 70 their index of choice, this is decidedly BAD news for broader indexers, slaves to more inclusive benchmarks, as well as those with purely small and mid-cap mandates. Now, my data is reasonably good and extensive, going back to the early 1980s, and such widespread under-performance is historically unprecedented. Unprecedented BOTH in absolute percentage terms (less 25%) and for the duration of time (> 2-1/4 years) that the percentage has been deteriorating enroute to its current depths.

Now this may be as it should. Many of Japan's largest enterprises happen also have global, rather than purely domestic, markets, and benefit from the labour supply shocks boosting transnational enterprise profitability. Sales growth on one side coupled with cost relief on the other is, it must be said, virtuous for investors, in comparison to the obverse.

But before ye lucky ones start patting each other on the backs and spending one's accrued, but uncrystallized performance fees, I must be point out that this Golden Era Of The Large Cap, of the Most Deserved Enterprises In Japan, also happens to coincide with the period in which East Asian Surplus Capital - both Japanese and Chinese and others, has been flowing uphill to ostensibly finance the Americaland in its rather errrr unsustainable consumptive binge. And as a "Cassandra", I will give fair warning that the last time "The Deserving Few" shone so brightly, so too did they violently and terrorizingly under-perform for not less than a full Calendar year.

Despite however despicable some might find the YEN, (and make no mistake, there are no shortage of reasons) the Yen WILL become untethered from USD in spectacular fashion, and in the process crucify those with implied short yen bet buried within their "Market Cap Bet". I cannot say "when", but everyone has been warned and the prescient should - at the very least - take the opportunity to hedge hedge hedge.

That IMF Statement in Full

Regarding the recent IMF meeting, the member representatives wish to issue the following joint communique statement to the Press.

For Immediate Release.

"I SEE NOTHING....I SEE NOTHING.....!"

So Long Reversion

In an April 10th research report, Daiwa's numerical gurus Yoshino and Sagawa wrote the epithet for naive price reversion strategies in the Japanese equity market. That price reversion has been the mainstay of many a naive arbitrageur in Japan from the bubble to the depths and back is noteworthy, though official pronouncements a brokerage firm of anything that reduces customers' trading turnover is rare to say the least. But Mssr's Yoshino and Sagawa have - up until now - been doing nice work, so their research, if nothing else, should be weighed carefully.

Their preamble summarizing the literature and history is coherent enough. And their gross numbers, while pathetically inadequate DO mirror the general condition of naive reversion, highlighting in particular the dearth of return since 2002. And while they arrive at a possible replacement in the form of a simple sector reversion model, it's paltry return is in all likelihood not robust to transactions costs and security borrowing limitations.

But in my mind, they fail to address the most nagging question of all: Why should reversion have persisted in Japan, contravening the normative behaviour of return persistence patterns highlighted by Jegadeesh in the US, and replicated by others for virtually all other global equity markets? For in even weakly efficient markets, BOTH naive reversion AND naive momentum shouldn't exist. Nonetheless, it [reversion] did, and rather than mourn and eulogize its passing, researchers with any sense of curiousity should set to work on why it was, historically speaking, so omnipresent.

Sordid Business of Predicting A Crash (con't)

Kurtosis in the daily cross section of US equity returns is as elevated and extended as it has every been, YET the skewness remains highly positive, a truly anomalous circumstance. Historically, this has reliably foretold something ominous to come. Today, in answering the question I posed and whose answer I hinted at in my early March post of similar namesake, I will reveal why this happenstance exists. The answer is: "Private Equity".

Collectively, they [private equity], and the speculators who move security prices on the basis of rumours surrounding "who's next", are the ones responsible for the positively-signed, bountiful premiums, gapping certain stocks in the distribution higher in relation to the the rest of the distribution, which only inches forward. And as Stephen Ratner forthrightly said in his Bloomberg interview detailed below, they [his own private equity firm, Quadrangle] will continue to take things private so long as liquidity is abundant AND lenders are willing to buy debt at rates and on terms that, as Ratner says, make little economic sense from the perspective of the lender.

So in itself, the higher moments of the US equity market are whispering "bubble", though the bubble is seemingly located in the credit markets, with the equity market but a reflection thereof. This doesn't leave equity markets free and clear by any stretch of the imagination, for the chain of dependencies and linkages are many and complex, but it does explain the highly unusual circumstances of the higher moments. And by explaining away the fragile state of the higher moments, it perhaps takes the heat off of a collapse based upon unsustainable speculative internals, and pushes it towards the exogenous sustainability of the credit markets' extreme generosity and munificence.

Historically they have been related, and, as such such, the higher moments of the US equity market may themselves be the tell-tale of the bell-ringing ebullience of us dollar-based credit markets.

Wood to BOJ : Normalize now!!

In a Bloomberg news report today, CLSA's iconoclastic forecaster extratrordinaire, Christopher Wood & Lombard Street's esteemed Brian Reading, are reported to have called upon the BOJ to normalize rates. Contrary to most neo-mercantilist apologists who worry about the possible entrenchment of pernicious deflation (vs. the logically and naturally occuring benign type witnessed in Japan over the past decade and a half), the duo suggest that normalizing rates will INCREASE consumption, buoy financial sector earnings and property prices, and set Japan on the road to retail recovery.

Having not seen my own copy of "Fear & Greed" yet, I am relying on Bloomberg's report that Wood doesn't expect this anytime over the next three months. Needless to say, I agree on all accounts, but have a more cynical and more Machiavellian view on BoJ intransigence which is that it is NOT the result of conservative policy error, but rather, the lynchpin in a well-honed trade & industrial policy that is intent on retaining all commercial advantage for its enterprises visa-vis both its customers and its primary east-Asian competitors.

I would so love to see the bar-room brawl between chief apologist Stanford's Prof MacKinnon, and the pragmatic and experienced prognosticator, Mr Wood, though, like BoJ policy, we are unlikely to witness this event any time in the next three months.

Where are all the Jewish Momentum Investors?

Many would find financial research a curious pursuit. And while most curious financial researchers have their own peculiar or arcane interests, one area of modern finance continues to intrigue and mystify me: "Why are there so few Jewish momentum investors?" Now before the ADL or JDL launches protest a to Blogger's management taking issue with this post before giving it a fair read, let me first clarify several points at the risk of spoiling my punchline. Firstly, by way of full disclosure, I have strong affiliations with the Tribe itself (of Abraham that is) - and little to no affiliation with the Church of Serial Correlation, the Cult of Momentum, or The Turtle Traders). Secondly, despite the fact that I am an unashamed peacenik, frequent critic of Likud, and an admirer of famous Israeli's such as Amos Oz, Y. Rabin, D. Barenboim and Y. Beilin, I AM an admirer of both the Jewish faith, and some of the things Israel has accomplished. This qualified and tepid opinion, however, does NOT - I repeat does NOT - in any way whatsoever make me anti-semitic. Thirdly, and contrary to your suspicions, the accompanying image, as any native from Calgary might tell you, strangely enough has nothing to do with the Star of David, or Momentum. It is in fact a sheriff's badge presumably labelled to express disaffection over the "mess" and chaos their annual rodeo-related Stampede creates. But it does a nice job of visually marrying my seemingly unrelated subjects.

Having dispensed with formalities and belied critics who might impugn my creditibility based upon THEIR politics, I will return to subject: the dearth of Jewish momentum traders. This puzzle initially gestated from meditations regarding the relative contribution of nature vs. nurture upon one's political beliefs. Proposing too much nature, it seems, is a contentious thought to some folk as I've discovered, for after espousing it, I've had people look upon me as puzzled and suspicious as if I were Kim Jong-Il doing a Liza Minelli impersonation, even though it's a quite innocuous observation. It goes like this. Based upon keen but anecdotal observation, populations seem to have roughly similar distributions of political archetypes between what one might broadly categorize as "progressive" or "conservative", irrespective of ethnicity, religion, or nationality of the entire population. Whether it's exemplied by Republican or Democrat, Labour or Conservative, Social Democrat or Christian Democrat there seems to be a rough equivalency in the percentages of these divisions in society. This seems to hold even if the specific ideological anchors have different coordinates in the political spectrum in different places. As other personality traits such as optimism and empathy have been shown to be strongly influenced by genetic predisposition, my probably unoriginal hypothesis by way of extension was quite simply: Why not politics? Perhaps everyone is born with a certain greater or lesser predispositon towards progressivity or conservatism, which themselves are possibly based a general affinity towards being receptive of, and embracing change (in the case of the progressive), or being cautious and suspicious of said change (as befits the conservative). The resulting conclusion: people underestimate the role of such genetic predisposition in political belief structures, in general, and in their own idelogical make-up in particular. While I am not an anthropologist nor a sociologist there are many examples of similar less-than-physical pre-disposed traits in relatively consistent proportions across varied populations (e.g. homosexuality). And while learned people who have studied this are not necessarily in agreement as to which competing theory best explains WHY the phenomena exists, there is little disgreement over the existence of the objective phenomena itself. This is NOT meant to disavow or diminish the influence of nurture, or to discount free will of the spirit which both have a role. But it is interesting, if not uncomfortable, to speculate that we may not be as free as we would like to believe.

Teleport now to the floor of the CBOT or the CBOE where mixed amongst the overly tall brokers are traders and speculators of many persuasions. Scalpers, market-makers, front-runners, discretionary liquidity providers, strategic traders, trend traders, and counter-trend traders, some disciplined, some emotional some visceral or instinctive. But here too there seems to be a similar archetypical personality divisions: that of the "trend-trader" or "counter-trend trader". One can also think of it as momentum-oriented or reversion oriented (or short-premium option traders vs long-premium option traders for our derivative friends). Might not genetic predisposition have a similar role in whether one felt more comfortable "riding a trend" or "or trying to anticipate a reversal"? Or in "buying a breakout" or "fading a pop"?? Or "Buying growth" or "buying value"? After all, these dichotomies are essentially attributable to the inherent optimism vs pessimism, or safety vs. adventuresomeness which we already have good reasons to believe are strongly influenced by nature.

Whether one agrees or not at this point, I hope you'll see a consistency and logic to this thread so far, that, if not probable, is at least plausible. Now comes the puzzle: if the general population consists of some relatively consistent distribution of, for simplicity's sake, "momentum-traders" and "reversion traders", why does there seem to be such an asymmetrical distribution specifically amongst the Jews? It's certainly not for lack of prowess at making money. Trading is in our blood and has been since our days refueling camels at the Judean cross-roads of civilisation. As a tribe, we account for some of the greatest value investors, but we seemingly can't ride a trend. Even Sol Waksal for example, whose company has the ultimate momentum theme - a cure for cancer, felt compelled to trade his position lest it's value be [temporarily] knocked by some petty little FDA concerns about experimental design. Few would argue that we are over-represented in the world of arbitrage, but under-represented amongst the great CTA's. Or that we have a keen eye for spotting and picking up the four-cent nickels, but have more difficulty sticking around to turn $1 dollar in $10. I could be way off base, but I think there is a pattern here. Is it something peculiar to "us" or is there something about momentum? Maybe it's just the "feel of it"? Or maybe it's the risk vs. reward proposition that is intuitively (or objectively) unappetizing? Or perhaps momentum requires something more of the mind or spirit, something that we simply cannot give?

It would be useful at this stage to better define "momentum". Though I am no expert on the subject, it may be helpful to separate it into different categories. One is "naive momentum" which is quite simply using past returns to predict the future direction of returns. "What's gone up will keep going up". What is outperforminmg will (hopefully) keep outperforming. For academics analyzing the stock market's cross-section of returns, this phenomena is typically viewed as relative in nature, or normalized performance ranks. Through this lens, persistence in relative return has been found to exist for as yet undiscovered and undiscernible reasons, confounding theorists - especially those espousing market efficiency. But the real Momentum-Men (and they ARE men as not a single famous woman springs to mind), are the practitioners that call themselves "trendfollowers" and would perceive themselves as more sophisticated and discriminating than the naive crowd. Here, simple moving averages give way to complex pattern matching techniques and endlessly catalogued contingency tables - all integrated systematically to find the holy financial grail which will allow them to distill the real trend that has the higher probability of persisting and thus being the motherlode that will take an ounce of gold that broke out from $454 to the stratospheric price of $5,000/oz (or beyhond!). This is a periodically prerequisite necessary to pay for for all the shakeouts, false starts, and ubiquitious reversals that are the by-product of the financial equivalent of chaos. That a number of practitioners have been reasonably (if not fabulously) successful employing these methods would seem to indicate that one dismisses them at their peril. Yet, others employing quite similar methods have crashed and burned spectacularly. But there is no shame in making (and losing) a fortune, for aside from being an adventure, it generates notoriety. And with such fame (infamy might be more accurate), one can always write a book, or post his musings on a website, or teach others to trade using trend-following techniques (but hopefully a more complete set than they used - one that incorporates counter-measures against periodically going nuclear). But perhaps the most amusing description of something with momentum was by Leif Ericson (on Peter Greenfinch's website) which he posited "was the battle between those with more money than intelligence against those with more intelligence than money.

Indeed, momentum has its uses, and has made some people (particularly brokers and exchanges, as well as some investors and traders) fabulous amounts of money. But it's not for the faint-hearted, and not without large and attendant risks. But that still doesn't answer why Jews are under- or unrepresented here. What's preventing them from joining the search for the leprechaun with real potfulls of gold at the end of the rainbow for the lucky few?

For a start, it seems that being long momentum requires faith. Similar in nature to the good old-fashioned bible-thumping fire-breathing kind. But faith in what? It's difficult to say just what that something is, and theoreticians remain perplexed. One might say it's essentially faith that the future bias of returns will continue to resemble the past. But is this wise or even acurate? It's not a bad bet with respect to things like whether the sun will tomorrow, whether the leaves will turn color this autumn, or whether the government will suddenly feel geneorous and abolish tax. And it's not unreasonable have some more-then-ambivalent confidence in a directonal movement when something is converging towards some probable equilibria. But the odds and thus confidence intuitively diminsh as one moves farther from equilibria (assuming one has a reasonably accurate estimate of probable equilibria). Consequently, risk increases. By contrast, it is "doubt" which comes easy to us Jews. Faith comes much harder. We desire proof. We NEED proof. A Covenant, for example, would work well. As would a burning bush, or some directives or commandments carved in stone. Recall, God had to crack the whip many times before people were convinced. And it took lots of smiting. And even then, there was backsliding. Moses was skeptical at first and took multiple minor demonstrations of transmutation to convince him. And I would guess that when he took his demands to the Pharoah, he probably had his doubts. At least until Pharoah's kingdom was over-run by toads. That was his nature - to doubt.

Maybe we eschew Momentum because we're just contrarians? While it's true that we are always up for a good debate, it is unfair to say that we are contrarians for the sake of it or just for kicks. Having said that, one must remember that we are wary of crowds as historically, when we Jews have seen the crowd coming, it was time to leave. And fast. Over the generations it's become burnished in our minds. But suspicion of the herd is not pathological. When there is sale on, we are the first to queue up and often lead the stampede. No obvious contrarianism there. And one must not forget that the God of the old testament is severe. He can (and often did) take away what he'd bestowed, not to mention the ever-present threat of smiting. Momentum needs time, and these things in combination have always made time an issue for us which, while it makes us good bankers, does put some behavioural boundaries upon our holding period. The old saw "One in the hand is worth more than two in the bush", would take on special meaning if one not might be around to collect.

Jews are studious, value education, and usually pretty rigorous. The faith required of a momentum investor resembles closing one's eyes when taking risk. We are used to and not shy of taking risks, but they are typially calculated risks. Like the risk of taking that "Home Office Deduction" against our income tax. We can do the math. But we disapprove of pure gambles. When was the last time you a saw one of our tribe win a large Pick-6 jackpot?!? Or when was the last time your Jewish friend invited you to go the racetrack, or wager on the greyhounds? We intuitively know lotteries are poor odds. That's why when we went to Vegas, we would rather "be the house" and "be paid" than "pay the house" and be played. When we do go to casinos as a customer its for the free drinks, and not for thrill of trying our luck against the odds. We prefer investment to speculation. At least with an investment, one can estimate probabilities and calculate expected returns. And hedge. Only then do we pray. And when we pray, we pray to God not for "good luck" but rather that the hedge holds.

Without being disparaging, momentum is useful as a discipline for people who have no other. And some form of discipline is better than none. We've an inherent intellectual flexibility which in investment terms is important in order to integrate new information and fight against hard-to-overcome cognitive biases. Maybe that's because we've always been moving and have had to learn the ways of new people and places. Unlike the way many conservative strict-constructionists in America prefer an ossified constituition, or the way fundamentalists of all religious persuasions strictly interpret their religious texts, Jews are constantly re-examing and re-interpreting the meaning of their scripture (amongst other things). Trend-following is a disciplined system that proxies for intelligence-derived flexibility. It dictates change in response to something, even if that something is facile, and often ill-logical, and frequently uneconomic. Our nature results in a demanding need to know "why" and to reach our conclusions by way of intellect, rather than faith. This creates decision flexibility (to react to, or incorporate change) which inhibits belief anchoring without sacrificing understanding.

Or perhaps we're just not optimistic enough to "close our eyes and buy"? It seems that most momentum traders are optimists by nature. Optimistic in their belief market solutions are always better. In conservative republicanism. In low taxes. I would not deny the suggestion that as a people we are not renown for our positivism. Not in art, literature, nor psychiatry. But in finance, optimism is independant of, and should not be confused with, monentum. Sometimes there is good reason to be optimistic about the direction of price movement, and sometimes not. And while I would agree that optimism serves many useful functions in the human struggle for survival, it's been shown by researchers that pessimists perception of objective reality is in fact closer to objective reality. Optimism is an important tool in sports, healing the mind and spirit or achieving personal goals, but it cannot and will not move market prices. Full stop. Objective reality (or at least reasonably accurate perception of reality), on the other hand, is extremely useful and of paramount importance when assessing probabilties, making expected return calculations, or discerning the sign and location of the fat tail..

What is the final take-away? Though untested, and unproven, the asymmetry seems to result from an unusually strong combination of natural predisposition towards progressivity inherent in our genes coupled with a multitude of social nurture factors eminating from our idiosyncratic history, religion and culture, all which reinforce our predilection for value and the counter-trend. This is not to discount the potential contributions momentum can make. But that doesn't mean we have to like it, or for that matter, pursue it, which in aggregate, we apparently don't. After all, no one really "likes" insurance, but we still buy it....

Quote of the Day

Steven Rattner, former Lazard co-hort of Felix Rohatyn, general all-around straight-shooting good-guy, and in his spare time working for the home team (or at least the lesser of the evils, politically) now Chief Buyout Honcho at his own shop, Quadrangle, spoke to Bloomberg News in an interview today, and said:

"there may be a change, that this gushing well of liquidity that we've all enjoyed for the past several years now is coming to an end.

He continued that it's hard to tell precisely if its now for certain, and that for the moment, it seems to be contained. Then, in a moment of clarity and forthright honesty for which I most admire him, he went on (and it's verbatim):

Our view for some time has been that we are in a credit bubble and that there is money being lent and that we're happily borrowers of it on the private equity side at rates and on terms that really frankly don't make a great deal of sense from the standpoint of the lenders...but we're the borrowers, and we're happy to take advantage of that, and so as long as we can continue to finance our deals with that money, we will continue to do it."

What can one say, but, "a fool and his money [lent fixed, for too long, too cheap, and on shitty terms] are soon parted"...

The Sordid Business of Predicting A Crash

First let me state that I am patently NOT in the business of prognosticating stock crashes. That said, please allow me to forecast one that, against all good, common sense, I believe, may be coming to a bourse near to you rather soon, in perhaps the next 30 to 40 trading days. And I say "good, common sense" because statistically predicting crashes is, for those who pursue it, a truly rotten profession. Far more difficult than trying to predict, say a "0" or "00" on the spin of roulette wheel (at a mere 1-in-37). It is more akin to 1-in-120 call, AT BEST, and perhaps a 1-in-500 or even 1-in-1000 longshot-of-a-call at worst, assuming of course that I do not need to accurately flag the precise day, but or days, but only the general vicinity in time.

Surely you will ask "why" I have embarked upon so ludicrous and statistically unrequited and unrewarding a path. The first reason in all honesty is that since I am not paid for this forecast, I cannot be fired for being wrong. Second, because I am master of my own fate, and because I am rather reasonably hedged and crash-neutral insofar as market exposure is concerned in my professional portfolios, I needn't worry about firing myself, for being wrong. Third, IF as a result of this rather bold and outlandish prediction, I turn out to be correct, then I shall have no problem (with all of my readers' testaments in hand), in pursuing a new (and leisurely!!) career as an ‘Investment Letter Writer’, one that I can pursue from a suitably comfortable location, be it surf-side or slope-side (for which the prices of said bricks & mortar will - no doubt - be dramatically reduced in the event).

The more skeptical amongst you will no doubt endeavor to ask, what manner of evidence I might possess to back up this apparently farcical and visceral hunch. And here, I will reveal to you, that which is of true value. It is not a secret of dark magic or of statistical smoke & mirrors, though it is somewhat obscure, and off the beaten path of ordinary observers. For "it" is buried deep in the cross-section of the distribution of stock-market returns, in particular, within the higher moments, which, I would hold out to my readers, have a remarkable tendency to (historically speaking) whisper things that are terribly important, be it "danger" or "opportunity".

To be more specific, I am referring to the cross-sectional skewness of daily returns in the investable portion of the US equity market, and, even more precisely, a three-month moving average of such a measure, systematically removing of course, the most extreme daily observations. Typically, this measure tends to have a negative sign, which if my feeble knowledge of statistics serves me right, implies that the associated tail risk of the distribution sports a negative sign, in relation to the average daily return (which has incidentally over the past 25 years typically been (small) positive. The kurtosis then, a sensitive cubed measure, relates to us just how far from the mean that [usually] negative tail lies. Periodically, in the US, this measure of cross-sectional skewness of returns climbs to positive territory, and, on a few even rarer occasions, the departure into the positive is rather greater and more elongated than at others. These, historically speaking, have coincided with, or presaged significant market events.

On some occasions (as one might expect), such a flip-flop into a state of highly elevated positive skewness has FOLLOWED extreme corrections such as those seen in the Aug through October period in 1987, the May through early October period in 1998, or the June 2002-> March 03 capitulation of the NASDAQ. On such occasions, it has been a benign signpost of recovery, signaling what momentum traders term: a breakout, or trend-continuation, of sorts. This is intuitive since, following a grand capitulation, with the veil of fear and uncertainty is lifted, gaps to the upside, recovering earlier losses, are unsurprising and tend towards continuation. Such moves are typically consistent with, and converge towards, some future sustainable intermediate-term equilibrium rather than away from it.

On other occasions however, such positive skewness periodically follows elongated positive return runs that resembles something like a melt-up. At such times, positive returns perhaps have induced panic buying, or panic short-covering that causes the tail-risk to have - at these instances – an uncommonly positive sign. Such was the case in April to August run-up in 1987, the second quarter of 1998, the fourth quarter of 1999 into the beginning of the year, and, yes, mid-February 2007. In fact, mid-February 2007 saw the most elevated measures seen I’ve seen in the US market since my data for this commences 25 years ago. Now I’ll admit that these may not be apples-to-apples comparisons since the nature and number of listings in the “investable” cross-section has changed over time, but nonetheless, the elevation recently witnessed is, in a single word, unprecedented.

None of this will escape practitioners, who can see it and smell it in the trenches, perhaps using other technical descriptive terminology or endogenous market indicators, but it is, nonetheless an additional systematic tell-tale, less commonly observed by most. Now add to this a kurtosis measure of the same cross-sectional returns. Somewhat expectedly, during selective panics, (for example the 2002 tech-wreck), skewness is highly negative, and kurtosis is highly elevated signaling a negative tail well-departed from the mean. During 1987, by contrast, or September 11th, the crashes were rather more democratic, and while skewness was negative, kurtosis was not nearly as elevated as at other times of less-universal panic. For during a crash the average return tends to be rather negative, with the tail not too far off the mean, as correlations tend to converge. Importantly, at both “significant tops” AND recovery rallies, kurtosis is typically diminished, or at a local minima. This may reflect investor behavioural preferences to take profits on large the positive tail, but it nonetheless has a subduing effect in keeping the tail closer to the mean on those occasions when the skewness does turn positive. Yet again, in mid-February, somewhat unprecedentedly, we have witnessed very elevated positive skewness AND reasonably elevated kurtosis. In my experience, this is twilight-zone stuff. All we need now is Rod Serling to tell us what it means.

My take is as follows: we are at a monumental turning point in America’s twenty-five year experiment in leverage, and systemic speed bump in Bretton Woods II. We are seeing the telltales of a liquidity-induced blow-off that’s been fueled by ever-easier credit and nearly free-money that - up until now - has fed nominal earnings growth, but that is on the cusp of rolling over, on many and diverse fronts due to systemic contradictions, inconsistencies and imbalances. Yet some high-rollers awash with investable funds and brass cojones seem to be betting that even more liquidity (the Fed "put", Bernanke's helicopter, whatever) will be thrown at it by authorities, that will assuage any drop in nominal prices. AND they must also believe that this liquidity, like that which has been thrown at markets since 2002, will continue NOT to spike rates, and NOT to puke the USD, and NOT cause the ire of Pelosi and her labour constituents, and so not fan inflation but further fuel yet another bout of asset price spirals such as those seen in commodities, stocks, Art, REITs, Credit Spreads, beachfront property, wine, Chelsea homes, and the famous Honus Wagner T205 baseball card. The era of risk anaesthitization is ending.

Understand, I am not a bear looking for an excuse to be bearish. Rather, I am looking at an indicator of an unusually rare market occurance, searching for an explanation, whose more plausible answer is pointing towards something eventful, with returns that are likely to be more volatile, and with a greater frequency of negative signs than those witnessed in the preceding four years. As an immediate forecaster of things bad, I must admit to being unnerved by the post-hiccup jack-in-the-box company of Mssrs. Faber, Edwards, and Tice, irrespective of their esteemed and cogent analyses. But IF the whispers of "the higher moments" again prove prescient, it is highly likely that the brief turbulence witnessed last week is but a proverbial “shot across the bow” presaging an episodic fit that will - in hindsight - be measured in months, and nominal losses into measured into double-digits.

Sub-Prime Poetry v1.0

So Farewell
then
New Century
Financial.
You're implied yield
was 452.38%
before
it was ZERO.

You lent
to those who
might not be able
to pay.
And they
Didn't.

The Laws
of prudent
lending, were,
one presumes,
apparently
were not so
NEW.

(with apologies to EJ Thribb)

ClineSpeak

Bloomberg's Tom Keene stewarded a nice interview with the eminent Dr. William Cline, now Senior Fellow of the Peterson Institute for International Economics, and whose textbook on International Monetary Policy, incidentally, was cornerstone of my course work on the subject in the early 1980s.

His main points (though nothing new), were nice to hear as they were realyed in the most sober and un-hysterical of terms:

* The current path of US deficits is clearly unsustainable. If left uchecked. modelling US ratio of debt to GDP will tend towards 140% in the following decade. It needs to stabilize at nearer to 50% to have any chance of intermediate term sustainability.

* This will necessarily require a cut in the CA deficit, to at least 3% of GDP from current 7% levels.

* In the modelling the policy outcomes required to get there, the US will also need flatten the fiscal gap to zero, perhaps even running a mild fiscal surplus, from currently yawning levels.

How does th US achieve these goals?

* Reversing Bush tax cuts will only get the US fiscal gaps to the -2 to -3% level, though mounting intergenerational liabilities will require further fiscal action and measures on reveues, spending, or both.

* USD must continue to depreciate on the order of another 15 - 20%. Asian nations, in general, must allow their currencies to rise. Japanese YEN should be in the vicinity of 90; and the RmB too, should be substantially higher. I could detect (like my own opinion) a rather scathing tone towards Japanese intransigence YEN appreciation.

* To avoid a meaningfully hard and rapid crisis-induced adjustment, participants probably should enact and abide by a new Plaza-like Accord whereby participants agree NOT to intervene in FX markets; NOT to accumulate reserves for mercantile advantage; and let the markets tend towards natural adjustment. Failure to due so will inevitably spawn more a meaningful adjustment crisis.

* He was rather disturbed by the fact that current adjustment requirements (even today) are more demanding than historical ones, YET policy-makers remain sanguine, and wholly unmotivated to seek multilateral solutions.

I would add, almost needless to say, that all plausible solutions are contractionary, whether undertaken sooner or later. The earlier they are implemented, the more likely that recovery benefits from a lower currency and lower rates will feed through to cushion the overdue adjustment.

Aesop Revisited

(the following joke that I'd like to share was e-mailed to me by a perceptive Swedish friend, its ultimate attribution which cannot be established, so apologies in advance to its pithy author for any copyright transgressions.

A Japanese company (Toyota) and an American company (General Motors) decided to have a canoe race on the Missouri River. Both teams practiced long and hard to reach their peak performance before the race. On the big day, the Japanese team won by a mile.

The Americans, very discouraged and depressed, decided to investigate the reason for the crushing defeat. A management team made up of senior executives was formed to investigate and recommend appropriate action. Their conclusion was the Japanese team had 8 people rowing and 1 person steering, while the American team had 8 people steering and 1 person rowing.

So American management hired a consulting company and paid them a large amount of money for a second opinion. They advised that too many people were steering the boat, while not enough people were rowing. To prevent another loss to the Japanese, the American's rowing team's management structure was totally reorganized to 4 steering supervisors, 3 area steering superintendents and 1 assistant superintendent steering manager. They also implemented a new performance system that would give the 1 person rowing the boat greater incentive to work harder. It was called the "Rowing Team Quality First Program," with meetings, dinners and free pens for the rower. There was discussion of getting new paddles, canoes and other equipment, extra vacation days for practices, and bonuses.

The next year the Japanese won by two miles. Humiliated, the American management laid off the rower for poor performance, halted development of a new canoe, sold the paddles, and canceled all capital investments for new equipment. The money saved was distributed to the Senior Executives as bonuses and the next year's racing team was outsourced to India.

Avarus animus nullo satiatur lucro

There is the wonderful scene in the "Life of Brian" where our hero is caught by a Roman sentry (played by John Cleese) writing anti-Imperial slogans on the wall, and, rather than being hauled away is professorily corrected, and made to write it ad infinitum, all over the walls of the plaza.

Thinking of our recently-humbled carry traders, perhaps a similar exercise is in order. Now repeat after me:

Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.
Avarus animus nullo satiatur lucro.

(and so on....)

Literal translation: A greedy mind is satisfied with no (amount of) gain

Factor Failure

Hello Houston....We've got a problem!

And so it is with "growth factor" measures in Japan. Not that this has much historical return attribution in any event, but even so, February 07 has been horrid to growth! In big round "top v. bottom decile" numbers, irrespective of the inanity or robustness of the measure, they are down ~5% in the MTD. This is even more interesting because this is not on the heels of some extended outperformance in prior intervals. It is, for whatever reason, monumental factor failure in the grossest sense. Yet despite this failure, somple naive price-momentum continues to motor away, with long-window portfolios accounting for much of this. But growth often correlates with "quality", and here we see similar potholes for "quality" concious, be it Margin, ROE, CFROI, EVA, volatility of earnings, forecast dispersion, etc.

So what is responsible? Non-price earnings revision, somewhat idiosyncratic longer-dated momentum, sector-effects and the global liquidity-sensitive names, all skewed towards larger-cap resulting in a rather strange and narrow mixture that does not explain well systematically-speaking, nor bode-well for all but the most trend-hugging reactionaries. It is very Darwinian, as the survivors continue to see more money ploughed into them, while those that pause or miss - irrespective of attributes,get mercilessly torpedoed.

Explaining what's worked (the brokers' term) is always more useful with other practitioners' input, so anything that any other observers might wish to add would be interesting to ruminate upon.

BoJ's Pennies in a Fountain

Everyone will offer you something today regarding the BoJs latest rate decision. Some will be dripping with sycophancy about BoJ independence, while others puerilely describe why zeropointtwo-fivepercent is a bold and decisive action by the obviously concerned public servants at one of the world's most important central bank. I will simply express to you my opinion that it is a most pathetic gesture...an insult to both right-minded central bankers and those concerned about the health of the international monetary system.

The analogy that immediately came to me was the carefree tossing of a penny into a fountain, after making a decidedly pleasant but juvenile wish. Call me unsentimental, but if one REALLY wants something badly and desperately, one should NOT rely upon a wish imbued upon a penny tossed into a fountain, or for that matter, the first star one saw last night. Rather, one should go and proactively try to make it happen. For a central banker in general, this means NOT sucking-up to the politicos, or whinging ninnies, irrespective of which side of the fence they are calling from. For the Bank of Japan more specifically, it means: if you really need near-zero rates of interest because the civilized world will disappear tomorrow and take the global financial system with it, then leave the bloody rate unchanged. IF, on the other hand, nearzeropercent rates of interest in a large somewhat open and important economy near the center of the international monetary system, are in fact long-run destabilizing and fostering asset-price bubbles and global imbalances that will be even more painful to wean-off of in the future (which this writer believes they are), then do not be zeropointtwofivebasispoint pansy, but be a man, and raise the rate.

Mr BoJ, you have done quite enough damage, thankyouverymuch, to the integrity of things monetary for the sake of your own parochial advantage. Now it is incumbent upon you to more seriously clean up the mess, and normalize your official lending rates, NOT over the course of the next four years, but soon.

Earnings Hooliganism

If you'd asked me, I 'd have thought that "hooligan" was certainly Dutch in its lexigraphical derivation. In actual fact, the OED tells me that it is derived from "Hooley's Gang", an apparently tough Irish group of thugs wreaking havoc at the turn of the century. It comes to mind because the latest interim earnings earnings season has yielded to a singular mob-like behaviour in dealing the short-term fortunes of stocks in Japan. Some academics have previously termed it the "MBE" phenomena where there is a decided post-announcement drift divergence effect in the performance of securities that "meet of beat" expectations, while the guillotine awaits those that don't. Mind you, if it were just the Japanese domestic investors, they might be forgiven for quarterly earnings announcements and all the pathetically panicked and outsized portfolio readjustment that results is new to the island, a bone to the foreign institutional demanders of transparency, despite the stupidly myopic short-termism it has has brought to American markets, poignanly discussed by Rappaport in his damning paper on the subject.

Of course we've seen this before. Certainly, in the US, where systematic earnings yob-ism is the norm, and to an increasing extent in Europe, and at least since 2004 when the Gaijin returned to Japan, without guns and uniforms. Historically, the effect was confined to the smaller cap names, at least according the numerous academics. But the perrformance-incentivized hooligans now so prevalent in Japan have driven a post announcement wedge between the perceived good & seemingly bad (at least as determined by the most recent 9mo interims) unlike anything we've seen to date. But interestingly, in Tokyo, the hooligans are unconcerned by size, or other attributes, perhaps ass a reuslt of the inferior expectational data and more limited liquidity. But it IS better if its got positive ex-ante momo and it MBE's. This may be the result of short covering, or mischievous elves trying to force them to cover, or mechanical bots trying to capture some post-revision drift. However, is history is gauge, except for the cheaper secs., they will likely be paying too much.

But since they are aggressively shorting the ones that do NOT MBE, this is where the opportunity lay for the patient. Make no mistake, I have nothing against a punter making a calculated short-term bet. In fact I thrive on it because they are creating opportunity. History may tell them it's a good one, in the short term. They should just hope they are asking the correct question. And that they do not oversize their position. For, in Japan, when they begin drilling reasonably hig-quality names to the tail of the dsitribution, despite contextual fundamentals, for a few bp's of hopeful short-term performance, potential buyers should take note, and use the mechanical myopia to wisely and patiently acquire positions, for they will be returning shortly to reverse their positions.