Thursday, December 29, 2005

My 10 New Year's Resolutions

Here's my list of New Year's resolutions upon which entropy will be working its wonders....

#10. Do NOT Choose a Hotel on the Internet, Sight Unseen.
I could give numerous reasons and countless examples precisely why, though I reckon that most with a modicum of taste and a wafer of expectation will know what I am talking about. Yet, when in need at the last moment, I still find myself lured and ensared by slick-looking but apparently ten-year old photos taken from "the perfect angle" obscuring the view of the railroad yards or motorway across adjacent. How about "room cams"? On second tought, maybe not....

#9. Disconnect My Cable.
No, not in lieu of a satellite dish but for peace and quiet and added industriousness. I am certain that seventy-five channels are merely seventy-four ways (excluding BBC World) to squander one's meager allotment of time on this planet with drivel, nonsense and mis-information. If you're reading my blog, then you apparently already made an important disassociative step from enslavement by the evil box. IF however you are a frequent FOX watcher, it may be too late to help.

#8. Avoid Indian food.
It tastes so so good. And the burn of a spicy curry releases a torrent of endorphins that overwhelms me with narcotic contentment. But I always always always regret it afterwards....

#7. Try Again to "Understand" Conservatives.
If the Dalai Lama doesn't hate the Chinese considering what they've done to his beloved Tibet, but rather feels true sorrow for them, then I reckon I can try yet again to understand and be sympathetic to arguments for why selfishness is inherently superior, and why being kind to people who are less fortunate than me will somehow f*ck everything up. I'll admit that I've been unsucessful so far at really getting my head around it, but I promise that I'll try....

#6. Respect the Market.
There is quite often a paradoxical wisdom in the herd. They know a good thing when they see it. But they typically don't know how to price it. That in itself instinctually "feels" like an opportunity to a natural contrarian like myself. Yet, the crowd typically doesn't care about the price of that thing. Not a bit. It just cares that it's good and that they want it. This means the price of such a thing can remain very divergent for a very long time. As such, its useful to remember that when it comes to trading growth counter-trendwise, time is NOT on your friend.

#5. Enjoy the Crowd.
I am naturally wary of crowds. Too much company or consensus in a position makes me feel decidely nervous. I can't help that - it's my nature. But the crowd CAN do a lot of heavy lifting in maret sense (of prices). And since it appears we are living in a brave new world dominated by feedback trading trend-followers, I will endeavor to relax more when I find myself long of momentum.

#4. Finish Writing the Novel.
It's rather frightening to consider how many resolution lists this one will find itself. MY novel continues to gestate. In fact, I feel like I am already finished it in my head. All I have to do is commit it to paper. Why am I hesitating? OK, besides the house full of kids? I feel as though I am in swimming trunks contemplating a dive into a rather cold swimming pool on rather cold day. A very cold swimming pool. Jump, damnit! I just have to jump....

#3. Do Not Try to Think 'Economically' About My Boat.
A boat defies all economic logic. It makes no economic sense. Like a poor elderly people or a squadron of Stealth bombers. I must stop trying to rationalize it. It simply is uneconomic. I must accept it, even though it makes much more sense to charter one whenever the fancy strikes. Such is the price for the convenience of leisure on-demnd. Oh crap, I wish I could just stop moaning about it.

#2. Stop Banging My Head Against the Wall and Embrace Inflation and Imbalances.
I must stop caring about inflation and deficits and imbalances. Why should I care about them anyway? No one else does. That makes me a fool. A really big fool and one who is rapidly getting relatively poorer because I care. I must face reality. The reality is: our economic leadership is morally bankrupt, the American people (at least half of them) are selfish and don't want to pay for what they and their country need or consume, the result of which is a long inexorable debasement of the unit of exchange, since anything that halts that debasement will have such grave political consequences that it is completely untenable. The economist in me says "what is unsustainable will NOT be sustainable", and the markets will enforce the discipline that our leaders, and we as citizens (at least half of us) are too weak, inept or selfish to undertake. But in 2006, I will just "let go", leverage up, buy a truckload of speculative stocks and real estate in hot markets and if the train wrecks, then I'll suffer with everyone else. But what really sucks is the classic behavioural FUBAR of watching everyone else amass wealth while I worry about the ultimate conequence of inflation....

#1. Don't Short on Price (read: valuation).
Like the schoolboy forced to write his penance on the chalkboard during detention, I WILL NOT SHORT ON PRICE. I WILL NOT SHORT ON PRICE. I WILL NOT SHORT ON PRICE. (And if I do, then I will do so only briefly).

Happy New Year to all and may you have success with your own resolutions!! (except for the misogynous bastards that think its clever or fun to steal from their investors by ramping stocks in the end of the year in order to collect a bonus or incentive fee).

Tuesday, December 27, 2005


It came as no surprise to most of us who perservered through the tediously long dark days of Tokyo's bear without becoming bitter, jaded, sullen (or unemployed) that Japan was cheap and that this would - sooner or later - come to be appreciated by other less observant (and it must be said less patient) investors. But before we start pinning medals upon our own breasts, let us remember that most of the same things that became cheap in the waning days of 1997, were STILL cheap (if not cheaper) nearly six years later in the thawing spring of 2003.

Today, in the twilight hours of 2005, the pickings of low-hanging fruit are decidely thinner, and the risks associated with joining the value-investor or activist greenmailer bandwagon have decidely increased. This is not to say they won;t be rewarded further. Or that there isn't any juice left to squeeze. It's just an observation that quite literally, a Tsunami of buying at higher and higher prices has roared through the TSE in Q3 & especially Q4 leaving many a share price inflated.

One might speculate as to the cause: petrodollars, a breakout fancied by CTA trend-followers, macro allocators, pension funds below benchmark weights, increasing speculation and day-trading by domestic Japanese, as well as a proliferation of Japanaese and Asian focused hedge funds. In many cases, the last real price-sensitive marginal seller was taken out mid-way through Q3 (probably sometime in a August) and anyone looking for stock has had to pay higher and higher prices for it. In a great many cases, we are talking doubles, triples, and more. Why is there so little stock seemingly available for sale?

Of course this situation doesn't concern those who already have large positions. In fact, many of them are resposnible not only for taking out the last discretionary marginal sellers in many issues, but for subequently and mercilessly squeezing any shorts unfortunate enough NOT to have puked and for continuing to purchase even more at even higher prices in a dramatic denoument that will insure performance fees are crystallized and relative performance rankings preserved.

But why is there such a dearth of stock for sale at such higher prices (and valuations!) on the main bourse in what remains the world's second largest economy? Daiwa Securities has shed some light on the subject recently by highlighting the sheer quantities of stock that are NOT for sale. Take the Deposit Insurance Corporation of Japan (the DICJ to acronym buffs) for example who bought YEN 2,400,000,000,000 worth of stocks at book value from failed financial institutions. Then of course, there is the Banks' Shareholdings Purchase Corporation (BSPC) which bought YEN 1,600,000,000,000 worth of shares from major banks to assist them in meeting their capital requirements and reducing the volatility of their earnings tied to the equity market. And finally, there is the Bank Of Japan (BOJ) itself which in the course of nationalizing some of the major City banks acquired nearly YEN 2,000,000,000,000 worth of shares. Undoubtedly, given the moves over the past two years, and especially in Q4 2005, these values are conservative. That's a lot of zeros. And a lot of zeros - even in Japan - means a lot of stock. How much? Probably close to more than USD$50,000,000,000 at cost, which is probably more like USD$70billion given the dramatic rise in stockvalues in 2005.
So in considering more precisely why the TOPIX MID, TOPIX 2nd Section, and JASDAQ Indices are all at all-time historic highs, it's worth contemplating one of the more important reasons: no stock!, and that beginning perhaps as easrly as Q2 2006, these securities will begin to be liquidated, or as Daiwa terms it - re-liquidated. We may then see how much room investors have for that so-called "Wafer Thin Mint" so-immortalized by John Cleese.

Be careful what you wish for....

Japanese capitalism is of a distinctly different flavour than the American variety. This was initially drilled into me years ago by my Industrial Relations tutor at the LSE, and has stayed with me to this present day. But one need not be a Japan-o-phile, or a student in comparative finance or economics to appreciate the differences. Yet with the TOPIX MidCap, the TSE 2nd Section and JASDAQ indicies all at historic highs, a pertinent question arises as to whether "We are systemically converging upon them", or whether "They are systemically converging upon us"? Whatever the true answer, ,it is worth pondering the implications of such events.

If one closes one's eyes, one can conjure up images of Japanese-style Capitalism: keiretsu groupings and other business or legacy cross-shareholding relationships; long-range planning and even longer-term investment horizons; lifetime employment possibilities; promotion and pay based upon seniority; close banking relationships often cemented by part-ownership or primary creditor status; paternal responsibilities of corporations to employees during recessions and resulting good industrial relations; single-payor national healthcare; diversified constituencies of reponsibility exemplified by stockholders, workers, management, customers, government and community (not necessarily in that order of priority); negligible stock-ownership by professional managers; management by consensus; low ratio of average executive compensation in comparison to average worker salary; high priority on shop-floor capital expenditure vs. low priority on executive suite profligacy; self-deprecating and conservative managerial style; government assistance in defining the public interest for the benefit and detriment of corporations. There are of course other attributes that I've missed, but suffice to say, these are the primary ones that come to mind.

Now lets repeat the exercise with the American brand of capitalism: a rugged individualism of corporations (no cross-shareholdings); short-termism is the rule rather than the exception in both planning and investment considerations; little lifetime employment and "first-in-first out" firing policy to reduce costs by firing more senior, better paid people; purely competitive, sometimes predatory banking relationships; no paternal responsibilities (e.g. Wal-Mart not providing health insurance); bi-polar teated constituency: the shareholder and the executives: all others are deemed expendable or irrelevant; authoritarian style of management; worlds HIGHEST ratio of average executive compensation to average worker compensation; high management ownership ratio resulting from riskless incentive compensation awards at shareholder expense; low priority on shop-floor capex & high priority of boardroom & HQ expenditure; high prevalence of overconfidence and self-attribution biases.

These are dramatic differences, often at the opposite end of the spectrum. And so since foreign investors have been pouring billions of dollars into Japan, it is worth speculating whether these are "pure price momentum investment flows" or whether they are directing these billions because they admire these cultural differences. Or on the other hand, perhaps because they expect these differences to narrow? Some in fact, like the carpetbagger-cum-greenmailer, Steel Partners, are vociferously demanding change to more mono-constituency (i.e. "shareholder focused) regimes". Is this reasonable and/or rational? Will they kill the proverbial golden goose in the process?

Investors should be careful what they wish for. One would be forgiven for questioning whether it is realistic for investors to expect management to selectively reward shareholders without discarding many of the other conventions and attributes that are cornerstones to the success of the Japanese enterprise and society. For instance, IF Japanese corporations go to FIFO, management and workers would rightly expect greater compensation of shouldering the adjustment risks inherent in the employment relationship. And with these risks come large annual riskless stock option grants, "gross-ups" (expensive in high-tax Japan) and other such awards that diminish cash profits dilute shareholder earnings. Higher employee turnover and less paternalism in a Japan with impending demographic implosion and 4%-unemployment means higher and more competitive wages, lower employee productivity and loyalty - all which come at a price to shareholders. And Capex, long the cornerstone of Japan's edge, would also be a victim. It would also be unreasonable Japanese managers not to emulate their American peers and not spruce up their corporate offices, putting in gymnasiums, kitchens, games rooms, not to mention the odd helicopter and Gulfstream corporate jet. But don't forget golden parachutes. All this raiding, uncertainty, and greenmailing will have repercussions upon the stress-levels of Japanese executives that can only be ameliorated with sufficiently large separation packages.

I think it would be an interesting exercise to "play dress-up" with the average Japanese company, by "Americanizing" or "Yankifying" their income statement to reflect Japan's presumed migration from multi-teated to shareholder capitalism. It may be that I exaggerate the implications. It may be that the benefits to shareholders to be had from cutting R&D expenditure, advertising expense, and capital expenditure (classic telltales of accounting conservatism) raping the workers' retirement fund and underfunding their legacy obligations (ones which haven't taken advantage of Daiko Henjo), putting the "asset pedal to the balance-sheet metal" and use every spare dollar of cash to squeeze the share float, and then use some not so spare dollars leverage it further but swapping debt for equity in order to approach a more Stern-Stewart-like capital that Mr Stern or Mr Stewart could be proud of.

Immortality, Fertility & Conscience

Nobel laureate economist Dr Milton Friedman was interviewed by Charlie Rose, the result which was aired late yesterday evening on America's PBS. This in itself is an amusing paradox worth considering since most of Dr. Friedman's close friends and disciples would eschew the very concept of a Public Broadcasting Corporation, thus depriving us of the still-lucid old man's oftentimes contentious views about the state of the world and the great economic debates of our times.

He commented upon many subjects: the Reagan years; his self-stated unequivocal victory over JK Galbraith and the Keynesians; the moral turpitude of communism and central banks (as well as most central bankers), Greenspan and Bernanke excepted. He also weighed in on Japan, the details of which I reveal shortly. While I respect Dr Friedman (as a Nobel Laureate), and what he has achieved in his life and career, I must say I find many of his opinions as disagreeable as those of Ayn Rand. While this is not the time for a long missive and though I am not qualified to find fault in his economic theory (my BSc being no match for his PhD and distinguished teaching career), my gripes with the famous laureate center upon the philosophical and social implications of his theory and rhetoric. In particular, while I don't doubt that in economic terms a nation where government occupies less than 15% of GDP may indeed be more efficient and create greater total output than a nation where government subsumes a 45% share, and while I would even admit that, distributionally-speaking, it MIGHT result in "more things for more people", I have grave concerns and reservations about what the social face of this society would resemble in the modernity in which we find ourselves.

For I am the first to admit that it would be wonderful indeed if the village (and her villagers) looked after its own. If children cared for their parents in old age. It would indeed be preferable (and novel) if a strong work ethic were universally distributed, as it would be if the same were true of education, wisdom, opportunity, and physical health and ability. That there were no indigent, malevolent, periodically sick or ill, nor wars; if greed, corruption, and dishonesty were rare as edelweiss in Florida, and people always did "the right thing" whether that was to pay taxes, or respect the common good or interest. In THAT world, on THAT planet (which is seemingly far from this terrestrial orb) a 15% slice for government might even be too much. But OUR world, THIS world, IS different....much much different. And as a result, I find it ironic that progressives and liberals are the actual pragmatists fostering and nurturing solutions that MIGHT help create better outcomes for people that those callously dealt by the market, and minimize the externalities resulting from the econonomic and social relations between men and women (where "better outcomes" is defined by, and includes words like "dignity", "need", "charity", "opportunity", "accident", "kindness", "respect" and yes, even "altruism". By contrast Friedman (and his disciples) appear quixotic in their objectives since the world required for Friedman-ite philosophy and economic theory to prosper - and more importantly - be superior to progressive social democracy, differs dramatically from the world as IT IS and as we know it.

With that off my chest, the reason for this post, was that Mr Friedman spoke about some things Nippon that I have promised to reveal. They are surprisingly close to my own thoughts. He said, Japan is in better shape than it has been for a long time, and their prospects are bright. BUT (and there always is a "but"), BUT, Japan is a nation with a severe dearth of births (my words, not his) which in combination with the wholesale lack of immigration, is both worrying and troublesome. He pointed out that the demographic contraction of the Japanese people over the coming decades will be dramatic and severe and unlike anything we've experienced in the modern age - something that is likely to have economic consequences.

Does this mean the TOPIX will fall? One cannot say. But it is interesting to observe that the impending demographic implosion has caught the prescient eye of Dr Friedman. This will likely mean, whether one agrees or disagrees with the good Professor's social conscience (or lack of one) that these concerns will at some not-too-distant point in the future, be front-page news, and capture the imagination of pundits and investors alike.

Wednesday, December 21, 2005

J-Comm, Mizuho & the TSE (part III)

Practical Market Philosophy Question #217: What's worse for an exchange : (a) admitting an error or mistake and taking steps to justly correct it, or (b) allowing the exchange become of farcical cariaciature of its intention and its members honor?

Yes, I've created a straw man of the the view that I think absurd. But what good does the latter serve with respect to the primary objective and function of the largest stock exchange in the world's second largest economy? How can this possibly represent the interests of the companies that are listed on the exchange without which the stock exchange would be nothing short of a pari-mutuel off-track betting office for the ponies? How can allowing the trade to stand possibly further the conception of a fair and orderly market? One look at the daily price and volume recap of a company with 15,000 Shares outstanding reveals the patent absurdity of anything less than "BUST THE TRADES!".
(Remember there are 15,000 shares outstanding, the float of which is only 3,660!!

12/08/2005 772,000 708,000 (~500,000 lollipops taken from the baby at 572000)
12/09/2005 Not Traded
12/12/2005 Not Traded
12/13/2005 Not Traded
12/14/2005 1,020,000 215 (Bid-only, Limit Up Allocation)
12/15/2005 1,220,000 342 (Bid-only, Limit Up Allocation)
12/16/2005 1,420,000 6,472 (Limit Up - Allocation on close)
12/19/2005 1,620,000 1,622 (Limit Up - Allocation in close)
12/20/2005 1,920,000 1,826 (Limit Up - Allocation in close)
12/21/2005 1,900,000 1,367

It was less than 10 mintues, between the huge, ridiculuous and obviously mistaken offer of non-existant shares and the time when the clever-cats knowingly lifted more than 500 times the shares sold at the IPO. By way of precedent, if your bank makes a mistake and puts money on your account that is NOT yours, you are not permitted to keep it. If you spend it, you are liable. If you are shopping in teh supermarket, and a bag of candy has broken open, that is NOT free booty for you as a shopper to loot. If bags of money fall out of a Brinks truck, it is NOT finders-keepers, irrespective of how irresistible it may seem. Yet, the news media continues to treat this as though "the lucky ones" won the lottery, or "pulled triple-sixes on the one-eyed bandit's grand jackpot" in a fair game of chance. I admit it makes for a wonderful spectacle, and interesting reading as to how a twenty-four year unemployed programmer will spend his windfall, but won't someone, BOJ Gov Hayami, PM Koizumi, Kofi Annan, Billy Graham, SOMEONE, ANYONE please please please just take a stand and admit it is just plain wrong??!!

Friday, December 16, 2005

J-Com ...Ayn's Shame?

Two days after UBS publicly stated it won't keep the gains from the errant Mizuho trade in J-Comm (Code #2462), an eerie silence hangs from the others: Nikko, Lehman Bros, CSFB, and Morgan Stanley. Susquehanna, Evolution Master Fund LP, and Tiedeman by contrast have bot, flipped and gone.

Which got me thinking about whether these people and organizations (ex-UBS) are devotees of Ayn Rand. This, to me, seems the most plausible of explantions for their collective actions: They are devotees of the Cult of Selfishness, which in Ms Rand's eyes is not only wholly justified when pursued in rational self-interest, but benefits everyone and makes them better off. I can hear Ms. Rand's voice with her sour unpleasant dosposition exclaiming her thoughts on the Mizuho fiasco:

"Vot kind of vimpy altruists these Swiss (UBS) have become! Can't they [UBS] see that such actions stem from ze pressure of vot other people think??! Where is their mettle? Where is their resolve? Do you think they become one of the biggest banks in the vorld being NICE to people? Bah!" They are nothing but sissies! Take that firm Morgan Stanley - the one with lots of men who possess chiseled chins, strong capitalist handshakes, an unwavering confidence and resolvein the correctness of their actions. Now that's a firm that KNOWS it's destiny. THAT's a firm which is not held back by insignificant concerns about "intention", "meaning", or "spirit". Nyet! THEY know that THEY are destined for greatness. THEY understand the difference between themselves and the weaker men who suffer from their brain-voshed bonds of altruism and vorry. THEY ALONE VILL RULE THE WORLD BY WINNING AND WINNING AND ACCUMULATING ALL THE CHIPS! VE MUST WIN! WIN ALL THE CHIPS! ACCUMULATE MORE CHIPS! IT IS GOOD FOR THE PEOPLE. DON'T BE A CHUMP AND OFFER YOUR HAND TO THE WEAK. IT WILL POLLUTE YOUR RESOLVE. ....MUST HAVE MORE CHIPS THAN THERE ARE CHIPS! MORE SHARES!! ...MUST GET MORE SHARES THAN THERE ARE SHARES! AAAARRGH DESTINY! POWER! GLORY! AAARGH!!! LET THE SOFT VIMPS VALLOW IN THEIR OWN PITY. MONEY IS POWER IS FREEDOM IS DESTINY IS LOVE IS POWER...."

Ahem. Well as I was saying, perhaps they are devotees Ayn Rand. Or maybe, it's that their lawyers are simply discussing the implications and technicalities of how to bust the trades without setting a bad precedent. Time will tell....

Wednesday, December 14, 2005

Financial Omerta

Where I grew up, several families lived at the end of the street who were reputed to be "mafiosi". They were said to launder money through the local pizzeria they were rumored to own. We would drive by and see them playing bocce on their front lawn - damning evidence for a naive eight year old. And so my innocent mind started thinking about "Fat Tony", "Big Nicky", the Godfather, honor, and their renowned code of silence, "omerta". I took comfort in the fact that while their code of Omerta made them virtually impenetrable, their honor made it a crime to harm innocent women and children.

In a related subject, most have read and commented upon Mizuho's "J-Comm error" where, upon initial listing of the shares, a now-shamed execution trader entered an incorrect order that offered to electronically sell several times more shares than were in issue, whereafter the more astute brokers/traders, with the deepest pockets scooped up the shares. In another situation, this would have been termed "a perfect corner" - the trading equivalent of "checkmate". Subsequently, Mizuho's shares themselves were violently sold off until because of the potential fear of an open-ended (or at least half billion dollar) liablity. Then they rallied as it was said to be the Exchaange's problem, and then Fujitsu's problem (who responsnible for the stock exchange's computers & software). Either way, particpants saw it in terms of black and white, winners and losers while ignoring the spirit of the rules and the intention of the game itself.

People forgot that "a corner" is against the spirit of the exchange, and illegal. And they forgot that an obvious and genuine mistake of this magnitude is...well... an obvious and genuine mistake. This was pit against honor, word and reputation, that are (or used to be) nearly everything in banking and financial markets. Commentators offered their amazement that it could happen and gawked over the potential profits of the successful bidders (more than 3 years worth of ordinary trading profits for UBS, it was reported!!) but were wholly silent upon the ethics.

But today the "omerta" was broken (at least by one), ironically by UBS the firm who got nailed by an identical error following the IPO of Japan's largest advertising agency, Dent-su. They announced that they had no intention of keep "the profits" from the transaction. Others profiting wildly, Nikko-Citigroup (the underwriter, no less!!) Morgan Stanley, Lehman Bros. and CSFB have, as of this moment, "no comment".

Why it was UBS iis uncertain. Perhaps because they profited most. Perhaps because there is residual guilt from WWII, and their illustrious record highlighted by the Volcker report. Why it took so long, I do not know. One would suspect greed or avarice, driven the same drunken euphoria that one might encounter if "a few hundred million dollars" fell at one's feet off the back of the Brinksmat truck. It might take a short while to come to one's senses that it is WRONG TO KEEP THE MONEY. That it's SOMEONE ELSE'S MONEY. That money doesn't, so to speak, grow on trees (though it seems that way following the great American debasement of the dollar over the last two decades).

A similar error (and subsequent trabsactions) in the shares of Corinthian Colleges (ticker COCO) in later 2003, that resulted in a far smaller loss, and that was far less obvious of "an error" was "busted" by the exchange in but a few hours. Is this because the US exchange has less "honor"? Or less "integrity"? In my Nov05 posting "Responsibility 101", I highlight some of the cultural aspects that suggest things are indeed different between the US and Japan, with the US distinctly erring on the side of utilitarianism and self-interest. While no one is suggesting that exchange authorities too-frequently exercise role-playing of "the Almighty", there is clearly a time and place to wield and exercise such over-riding power. And in a modernity where participants cannot apparently distinguish between right and wrong by their own volition, it is ever-more incumbent upon the authorities to take decisive action.

Tuesday, December 06, 2005

United Arrows' Xmas Present to Investors

United Arrows (TSE Code 7606) is a well-run, rapidly growing, Tokyo-based clothing specialty retailer thought highly of by investors, analysts and customers alike. By way of full disclosure, I am not conflicted by having a long or short position one way or the other. With that out of the way, I would bring to your attention that their Board has done something quite unusual, and it might even be said, magnanimous for their more performance-conscious shareholders: they have announced a more-than 1.5 million share buy-back (almost 7% of share outstanding) to be completed between today and December 27th.

My first thought was "Hallelujah & Merry Xmas!". My second thought once the emotion had subsided was: "How Generous!" and what a coincidence of timing to announce the fixed-period repurchase of 6.3% of your stock at the most illiquid time of year. Then I noticed the caveat: they'll only buy shares at YEN 5208, and not a YEN more. Which is fine except that momentum and growth investors have pushed the stock towards the more lofty level of YEN 7000. Bah Humbug!!

But what does this really mean? Yes, the company has put a 25% stop-loss under the current share price. Is is it simply public relations? Or are they trying to buy it on the cheap by suckering in a large and unwitting shareholder into selling at a discount? Is it a statement about the current value of the company? Is it a statement about the Owner's / Manager's / Board of Director's (yes they happen to be one and the same) view of prevailing fair valuation? It would indeed be novel for them (as owners of stores selling clothes fit for an emperor) to come out and say that "the emperor has no clothes" so to speak, or in this case that he is "over-dressed". After all, the stock is trading at quite lofty multiples (36x FY06 and 31x FY07 consensus EPS) for a company with forecast growth of 15%. It must be considered, however, that the Board are simply sophisticated and experienced stock market operators, and that YEN 5,208 is simply the result of hard, cold and objective analysis. It may be the modeled liquidity discount that a small-float, highly accumulated and probably-over-valued momentum stock would command in the open-market if such a cmparably-sized shareholding were to be sold in the open market and predatory traders were able to sniff it out. Nothing pejorative intended, nor insulting towards the foreign growth aficionados who see diamonds where others see quartz.

Perhaps I'll put in a call to the founder/owner/manager Shigematsu-San and ask for the real skinny....

Friday, December 02, 2005

Educating Riso

I have an interesting story about Riso Kyoiku (TSE Code# 4714), a humble family-run private education company running ju-ku, or cram schools, not dissimilar from America's SAT review courses. It is a story that Elliot Spitzer should be interested in for it exemplifies just how far the investment management business has travelled. But more, It is a tale that reveals the sordid impact of what this reality has wrought. But to fully appreciate it, one needs race through my short course in Financial History from 1979 to the present.

[fade in to an Appalachian-looking cottage with Hay-seed (yours truly) playing banjo on the porch with a mongrel dog buzzed by flied at his feet, and a 1955 Buick upon on blocks in the yard] A long time ago, when I was a boy, in the good old days, when Republicans were socially conservative, AND fiscally conservative (but no less un-hip), a healthy tension existed between those who might have thought it wise to short a stock, and those of a more bullish persuasion who were inclined to buy it from them. They were innocent times. No channel checkers. No one rummaging through your rubbish or supbeoning your e-mails. No hedge fund analysts running around trying to interview disgruntled employees, count cars in teh factory parking lot or bribing doctors affiliated with clinical trials in order to obtain material non-public information. Investors, even large ones it must be said, generally bought stocks because they thought (for better or worse) they were good investments and that their prices would go up in the future because others would recognize the same. And while some even made money in this good old-fashioned kind of way, few bought stocks with the intention that they would make them go up come proverbial hell or high water.

I don't believe there is a clear line of demarcation when money management moved from the discreet rooms and plush carpets of the Trust companies and boutique patrician firms to the big-time, but it probably began in earnest once the horrors of Volcker's bloody massacre of inflation began to dissipate and Reagan's great democratisation of credit providing 24-7 leverage to the masses really took off. These were good years. Vietnam and oil shocks faded, as did "day-glo" and bell bottoms (thank god!). Pony-tails were cropped. House prices rose. Ordinary middle-class Americans began to save, but had very little knowledge or savvy about what to do with it. Not that the rich had any better clue, they simply had enough of the stuff (money) that substantial amounts were left over once the Trust Co had helped themselves such that it didn't matter. And besides, it was bad form to haggle over price as folks at the club might get wind of it and think that one was having "problems".

Recall that CD's were considered bold financial innovations, brokerage commissions were only recently deregulated and the mutual fund was still a novelty. Those who invested directly in stocks typically suffered from bad halitosis. With double-digit interest rates and single digit PE's (that had been double-digit themselves not long before), equity mutual funds were clearly NOT the au fait topic at cocktail parties. Not in 1981. The boom may seem obvious in hindsight (as it always does). The first movers who seized the opportunity grew to inconceivable size - something few could have dreamed of only a few years earlier watching President Carter deliver his "Malaise Speech" in that dark cardigan. If they had been able to conceive of it, maybe a Johnson from Boston, rather than a Kennedy from Chappaquidick would have resided in the large white house atop Pennsylvannia avenue.

With this growth came lower fees. Explicit ones, at least. Granted they wer not much lower, but they were lower. Mostly, however, the heady growth just meant pots of money for the investment management company. But there was competition. Someone was always doing better, and when they did, money flowed to them and THEY grew at a faster pace. Don't shed a tear for the others though. There was plenty to go around. At the same time came Wall Street's resurgence. Greed was Good!, Gordon Gecko told us. MBA's, CFA's, VC's, CEO's, PhD's, all setting their sights on the pots of gold were followed by LBO's, MBS's CMO's IPO's, QQQ's and ECN's. Of course there were some minor setbacks (1987 & portfolio insurance, Gulf War I, LTCM, 9-11), but for the most part, money and credit were easy, easier, and easiest and more or less has remained that way to this very day. Wealth was created and had to be invested. Firms grew, and either ate or were eaten to become ever-larger and more powerful, controlling larger percentages of assets. And this is the opportune moment to point out that the combination of ambition, power, and buckets of other people's money is a certain a recipe for folly and possible financial calamity.

Fast-forward to the miliennium. Jerry Garcia is dead. Johhny Cash is playing a cameo with a grunge band. Netscape, THE Bubble, Enron, WorldCom, Adelphia, Janus "20" Fund, all were tell-tales of "something" in people and America that many obserrvers still seem not to have fully grasped. Games (big games!) were played. Sometimes well (by Jeff Vinik and Cap Research), some less well, like Janus, who let (and encouraged!) investors to pour so much money into the Janus-20 Fund ($30 billion?+) ostensibly focused on "their twenty best ideas" that the annointed stocks therein powered to unimaginable heights. And like Gerry Tsai before her, Helen Hayes was presumed a genius (as was Ameriindo Vilar & First Hand Landis)! Yet there wasn't a one article in Fortune, Forbes or the Wall Street Journal that questioned the wisdom (or queried the market price impact impact) of focusing multiple billions of dollars of liquidity upon non-megacap stocks through open market purchases. Nope. Performance was self-attributed to "amazingly perceptive research analysts" ("one step ahead", we were fallaciously told) and prescient portfolio managers. Kahneman & Tversky have words for these people, and they are technical and not pejorative in nature. But I too have words for them....less techincal... and more plebian descriptors: fraud and stupidity. Not because in 2002 it all went horribly wrong leading to the [deserved?] near-destruction of Janus, but because it was ill-conceived and cynically dishonest from early on creating a redistribution of wealth from those whose need for it in the future will be more, to those whose immediate need for it wasless. And if it wasn't premeditated and cynically dishonest then lord please have mercy upon their very stupid souls!

But what does this have to with the saga of Riso Kyoiku, the humble operator of 50 or so juku schools in and around Tokyo? In the post-bubble meltdown that also hit Japanese stocks hard, Riso was minding it's own business, and fairly well one might add. It had grown it's business beyond many peers and as ambitious people do, garnered a TSE listing. This is not unusual as most juku operators in Japan are for-profit, and numerous are publicly listed - some more time-honored, some more aggressive. Sometime in 2001, the "for-profit" education theme captured the imagination of US investors and the few available stocks had their growth (much by acquisition and in hindsight less-than-scrupulous enrollment methods) were rewarded with doubles, triples, and more. UOPX, APOL, CECO & COCO were present in almost every growth, momentum, and thematic portfolio. By the end of 2003 the private education theme was, as they say "white hot". And so in early 2004, it spilled over to Japan.

It's is hard to know whether such the decision to select and ramp Riso is the result of a mechanical formula for choosing a few active-weight companies which will be annointed "The Ones" (like Neo in teh Matric), chosen above those of its brethren. Perhaps they throw darts. Maybe they write the co names on slips of paper and stuff them inside a paper mache donkey and have a pinata party (the Senior Portfolio Manager getting to swing the bat first?). Maybe it's the sector analysts' call and they, in fact, choose meritocratically on fundamentals. It's only of passing interest and once the stock passes the two-bagger level, matters little to the outcome. As it happens Riso does have growth (both historical and forecasted). And this growth is forecasted to be higher than peers. But this is independent of the cynical disregard for all decorum (and probable legality) in what happened next.

In this instance, the very large American fund management company chose Riso. And they chose. And they chose. And they continued choosing. They chose it for their value funds, their growth funds, their global funds, their country funds. They chose it on Mondays, Tuesdays, and Wednesday, as well as Thursdays and Fridays. For Riso (and it's owners), this must have been like winning the lottery, for they sold some shares. And from when they began choosing to the end of the first quarter, they had taken Riso from YEN 2,500 to YEN12,500 (on a split-adjusted basis). A significant and eye-popping amount of this performance was the first of three following a large stock splits (see my previous post "10 Divided by 1 = 3", for an explanation of the split-ramping anomaly) which must have. This must have been welcome news to the American Co's various portfolio managers who held this previously unknown nano-cap juku operator, and even though their holding may be small, even a 25bp position that quadruples in value can contribute a potentially quartile-changing return.

But things were to get even more curious. By end of Q1 2004, humble Riso was sporting google-like valuations (and returns!). It was quite obviously was no longer a value stock, yet it remained a member in a myriad of style contradicted funds. The owners sold a reasonable number of shares which were apparently hoovered up by "interested parties" who by this time had filed with authorities of >5% ownership. The stock price came off to near it's pre-split ramp price (still 2.3x, it's price at the beginning of the ramp), but leapt to a new high just eclipsing its prior high on the back of rises every day in Jun4 2004 which coincided with this investor acquiring another 6% of the company. Following this quarterly pump, the price again dumped 25%. But a combination of another round of splitting, split ramping, insider sales, and accumulation by interested parties who raised their stake by another 5% to nearly 15% of shares outstanding or about a third of the free-float, took the stock up 27% in the last of Aug, and other 15% in Sept to conveniently set another new high for the end of Q3 2004. Maybe it was causual coincidence that they increased there stake so substantially at higher and higher prices which coincided with important fund valuation periods and random perhaps, but curious all the same. But as an observer of randomness, I have my doubts.

The price fell back 30% into Q4. Maybe this large shareholder was lightening up.
Maybe they were trying to send a message to management that while they have mutual interests in seeing a higher a share price, they will NOT buy any more stock from the owner & family at these high prices. Perhaps the message hit home. For in Q1 of 2005, the co. announced yet another split, vaulting the shares another 35% back to their prior highs. Since then, the American investment manager so enamoured prior, has cut its ownership by more than half to Q3 2005, and the price has nearly halved. One might wonder what would happen to the share price if they unloaded the rest of their position.

But what this is about is our tolerance of obviously manipulative behaviour, without investigation, or even a footnote in the financial, academic or regulatory press. Martha Stewart went to jail for far less (not that I approve of what she did). And the thing is that YOU can't do this at home. And it is a direct result of the size these firms have reached, the placing of their parochial interests as an investment manager in front of the interests of their shareholders and their role as a fiduciary. THIS is where financial history has taken us. THIS is the sad result of size and questonable ethics upon markets. And everyone is poorer - except Mitsugu Iwasa - Chairman and founder of Riso, who has indeed seemingly drawn four aces from his relationship with his institutional investor.

Topix 2nd Section Hits All-Time High

Pop the champagne corks everyone! In a little noted event the TOPIX Second Section index has surpassed YEN 4500 in latte November, and thus has clocked an all-time high! That's right, higher than in early 1990 when a a handerkerchief-sized piece of Tokyo was emminently more valuable than the entire Isle of Sheppey.

According to Bloomberg this equates to 121x trailing earnings, 26x forecast earnings, 1.6x book and 8.1x cashFlow. These remain undemanding by way of comparisons to the US market (S&P's "MID" Index stood at 20x forecast earnings, 2.6x book, and 11.4x cashflow). On the other hand, this is Japan, and the owner of many TSE2 securities also finds themselves essentially as a minority shareholder.

Should this command a discount? First thing to remember, despite all of the hyperbole surrounding change in Japan is that in Japan's version of Capitalism, the Shareholder is but one constituent alongside, but not necessarily superior to, workers, customers, suppliers, and government and the community at large. The SHareholder is becoming more important, but doesn't sit atop the pile by any stretch.

Second thing to remember is that as a minority shareholder, one is often "taken under" rather than taken over. This is to say that the minority shareholder seldom achieves fair value when consolidation, divestiture or acquisition is taking place, since these transactions are typically done in the interests of the controlling shareholder. This is far from the situation in America, and warrants some nebulous discount. How much? Who knows. Damodaran has some novel views on this and would be wise to consult his site on my links sidebar.

But my main point is to bring attention to the tardiness of the media's recognition of "Japan's Re-Emergence", and phenomena more than three years old, and as the chart above indicates, far far less cheap than it was but 24 months ago. Bargain hunting? It may be wiser to start in Korea, or at least be very discriminating when looking at the fruit that remains on tree on the TSE.

Tuesday, November 29, 2005

Lemmings Demystified

Animal metaphors are abundant when it comes to describing archetypical investor behaviour. Few are as visually exciting at that portrayed by L. Lemmus (the Common Lemming). Conjure an image of hordes of investors falling over themselves to acquire shares in JDS Uniphase, Northern Telecom, or Global Crossing, (or for our Japanese friends Softbank, Trans-Cosmos, or Jafco) during the bubble only to realize that, like the notorious lemming, they have been led over the edge the cliff, and that their portfolio is now in financial free-fall enroute to oblivion.

Demagoguery whether political (such as neo-conservatism) or financial (like the Lemming imagery) is insidious because it is - at first glance - plausible, preying upon fear and ignorance to influence potential adherents. Both the current US administration and the lore of L. Lemmus are no exceptions. While I cannot with sound conscience defend Bush & Co., I am able to come to the defence of the Lemming and her otherwise soiled reputation.

The first thing that must be higlighted about the metaphor is that, insofar as it pertains to equity markets, there is apparently nothing wrong with either being a lemming, or acting like a lemming, because it seems that, in financial terms, the lemmings know where they are going and what they are doing. Almost all momentum research confirms that "being a lemming" doesn't impair your wealth. For if you bought last year's "winners" and sold short last year's "losers", you would (over time) have made a reasonably positive spread return at most intermediate-term forward holding period intervals. This is bog-standard MBA coursework in financial anomalies. This will come as a relief to those who've been trying - without success - to figure out the mysteries of how to play the stock market. What remains a mystery is "why" being a lemming produces financial something out of financial nothing. Some say the market underreacts. Some say it overreacts. Others say it underreacts then overreacts. Still others say people just behave badly. I personally sympathize with those that say that "markets have important things to tell us", though I also think markets are prone telling us those things to great excess especially when appropriately cajoled . This says the word Lemming - like the often derisory term "Liberal" - should be seen as a badge of honor and proudly defended rather than viewed as a piece of chewing-gum stuck to one's shoe.

Equally important in defending the reputation this small (and cute) member of the rodent family is to debunk the myth popularized nearly half a century ago that lemmings are stupid and unwittingly commit some form of mass-suicide. Thanks to recent research by University of Helsinki population biologists Olivier Gilg, Ilkka Hanski, and their colleague Benoit Sittler of the University of Freiburg, the mystery has now been been solved. Scientists have known that Lemmings don't actually commit mass-suicide, not in response to over-population, nor by following each other over cliffs, or by any means for that matter. This fiction was implanted in the popular consciousness by Walt Disney's 1958 film "White Wilderness", and was reportedly (though unconfirmedly) staged by the production crew who alledgedly chased them over a cliff wielding brooms. What IS real are the periodic cyclical population explosions of lemmings (sometimes increasing by 100-fold), and their subsequent rapid decline. But scientists never knew precisely WHY the populations dwindled after such massive expansions. Thanks to the careful observation of the nordic researchers, it has now been confirmed that the subsequent rapid dwindling are due to the quick responses of their main predators AND an increase in their rates of predation, the combination of which can reduce the lemming population by upwards of 2 to 3 percent per day! Though the original myth of mass-suicide was induced by hundreds of years of periodic sightings of numerous dead lemmings (typically around water) in Scandinavia, these apparently result from routine drownings during otherwise routine migrations, as they move through the swamps and lakes in the north. Lemmings, while good followers, are appparently poor swimmers.

Make no mistake: while I come to the defense of those who are unable or incapable of defending their interests (like the lemmings or the disenfranchised), and while I will point out the scientific evidence that "sort of", "kind of", justifies the actions of people who behave like lemmings, I am NOT a lemming, nor do I recommend any such mimetic behaviour. For while there may indeed be some abnormal economic returns to investing like a rodent, there are better ways to make a buck. I, for example, have been able to extract higher returns with far superior risk characteristics by selectively taking the other side of many of their trades. Just because there is no dishonor in being a lemming, doesn't mean one should blindly emulate them.

Friday, November 25, 2005

Electronic Herd Thunders Through Japan

In my previous Nov 11th post "Confidence Isn't Everything" I entertain alternative explanations for why Japan has historically been characterised as a "reversion market". While there are significant constraints peculiar to Japan, I proffered that it it also likely to be influenced by "behavioral" factors, most notably the lack of "overconfidence biases" amongst Japanese investors for cultural-specific reasons.

This is hindsight however, and while this may explain the historic reasons for Japan's unwillingness to participate in the global momentum party, trend persistence (serial correlation of individual stock returns) has emerged as a potent factor in Japan. Is this a so-called sea change, or simply a syle speed bump en route to more reversion and disappointment? This question may only be answered ex-post, but one thing is clear: the emergence of momentum has accompanied the tsunami of long-only and hedge funds buying and selling (though mostly buying)Japanese shares.

Senior Equity Strategist Goro Kumagai discussed the rising importance of the individual on-line investor in Japan over the past few years. Account numbers have been steadily rising to more than 1.8 million accounts across the major on-line brokers. This, according to Mizuho's Kumagai accounts for more than YEN 1 Trillion in funds (~USD $9 billion). With an average account size of YEN 3.5 million (USD $30,000), and a fortnightly turnover (24x per year), this equates to YEN 200 trillion in turnover - almost double the YEN 100 trillion of annual institutional turnover on the TSE. Clearly they are a force to be reckoned with (or at least ignored at one's peril).

Which brings me back to this post's question: is this emergent momentum "the kind found in the USA which, to the contarian feels like being impaled upon hot rusty poker, or does it resemble the "good old days" of tha late 80's and 90's where speculators bought and sold "whisper stocks", or fashioned daily themes in response the prognostications of Nui Onouoe's buddhist toad? This was a time when long margin positions were systematically gunned due to their predictably low pain threshold and loss aversion and short margin inversions resulted in dizzying and elongated melt-ups with astonishing predictability.

But what if this electronic herd are a "new breed"? What if they are not salarymen playing the financial ponies (poorly, I might add), but financial equivalents of Yoyogi-park Elvis' that are fast becoming as sophisticated, tenacious, and coordinated as the US IBD momentum crowd? What if they are, in short, diverging from their historical stereotypes, and becoming overconfident like their US kindred spirits.

A larger and decidely different electronic herd, replete with overconfidence and self-attribution, and myopic loss-aversion biases, in combination with an increasing concentration of size at both hedge funds and large long-only complexes, would have a profound and disturbing effect upon the behaviour or Japanese equity markets.

In the same way global warming has (according to everyone except the present US Administration and a lone Scandinavian skeptic who has since been discredited) has laid the conditions for larger and more vicious tropical storms, these changes whereby speculators, hedge funds and long-only fund complexes tend towards the same positions stylistically - call them behavioural aligments - would result in an increase in consensus within the market. This is not the same as efficiency, since it's only temporary. This would very likely lead to be bigger, and longer accumulations and distributions, a greater stretching of valuation boundaries, and a generally dichotomous approach towards the selection of securities: "There will only be good stocks and bad stocks". In this savage and binary world, its wonderful if you're a "good stock" with some or all of the characteristics the market is desirious of, and it's lucifer's barbecue if you present the market with an earnings torpedo or anything resembling a temporary setback after which your only friends will be Brandes or Silchester. Once in a while, however, the god-awful piece-o-crap stocks will revolt - whether for a month or a quarter - and vault in an amazing, colon-cleansing path, while the "great ones" will revulse" for no apparent reason". Well, almost no apparent reason since hindsight might suggest it was because too many people were in the same place, at the same time when someone per chance yelled "Fire!"

The choices that this style-tyranny creates (or dictates for the truly fatalistic) for thoughtful portfolio managers, allocators, and trustees are at once both stark and grim. The thoughtful portfolio manager is forced to become like Louis Navellier and "Do what works" (Shit! I wish I'd thought of that). Game or be gamed! It's a tough choice, but being prudent or sensible, results in returns that feel little different from taking a big long piss into a strong headwind. For the allocator, often an intermediary her self, there is little advantage to going against the flow. She is not penalized for failing conventionally, but is chastised (literally!) for making a bolder call, and getting it wrong. Take risk, just don't get it wrong! And for the trustee, few have the latitude, the intelligence, or the incentive to step out onto a non-conformist limb like David Swenson - irrespective of the correctness or the upside. All this is to say that while there is little question where one "ought" to be, there is great question as to whether one, one's investors, or the trustees of one's investors can stomach it. And it is precisely this conundrum that will make the opportunity that much more rewarding. Eventually.

For style consensus, and less-than-justified valuation dispersion - particularly the kinds that are non-economically driven ALWAYS end in tears. The challenge to the thoughtful contrarian and the opportunist in this brave new momentum world in Japan is to insure that one gives a wide berth to the new style consensus so that one is around to play the game when the style gods are less agreeable.

Monday, November 21, 2005

Learning to Get Shorty

Wanted: Trainee to learn the art of short-busting stocks with large short interest positions held by panicky, inexperienced, poorly informed or poorly capitalized short-sllers. Applicants should have a special interest in ramping highly accumulated or over-valued securities with established short interests. CFA, prior fundamental equity analysis not required, but experience in short-seller investor psychology, behavioral finance, making false and misleading statements, school bullying, thieving from widows and/or orphans or generally misogynistic behavior preferred.

I'll admit, you've never seen an "ad" like this. But according to last week's Wall Street Journal, these are people are real and exist in the flesh. The WSJ (& just for the record, let it be known that I strongly disapprove of their editorial policy) noted that a number of investors were rumored to readying themselves to play a game called "Get Shorty", a game in which they are said to buy more of the stocks that they, or others, have already bought in spades during the calendar year to-date. This past accumulation frequently accounts for such stocks stellar YTD returns in addition to often-elevated levels of short interest. The expectation is that additional rough and tumble ramping into the year-end will force the shorts to respond with the financial equivalent of the well-known bomb-shelter drill called "duck & cover". "Get Shorty" also provides the not unwelcome benefit of dramatically lifting the "end of year marks" on said favorite positions, thus allowing unscrupulous managers to pocket an otherwise less-than-deserved performance fee (or bonus) at their investors' collective expense.

Ruminating over the significance of what seems to be thought of as "harmless fun", I started thinking: How exactly DOES one learn to bust shorts? How has it evolved that some of the supposed best and best brightest financial minds of American capitalism have seemingly veered off down such a dark ignominimous road? And not only doesn't anyone appear to find anything wrong with it, they seem positively amused and admire it for it's ballsy ingenuity! Is this what Yankee cowboy capitalism has spawned - a world resembling some kind of financial Gomorrah ? Little more than a decade has passed since the corpse of the former Soviet Union's commmand economy imploded after failing miserably to attain anything like an efficient allocation of resources by willful neglecting an efficienct market. Might not our system, with its cariacature of market anarchy, suffer the same fate, arriving from the polar opposite direction?

I've never seen a course in predatory trading or short-busting in any MBA or PhD Econ guidebook. So where and how does one learn to play and orchrestrate such games with the market? It's important to distinguish this from ordinary healthy speculation, of the kind that's been around as long as the olive oil press has existed. Short-busting, on the other hand, is entirely different witht he distinct between "Murder-One" and "manslaughter" coming to mind. The former being conceived with bad intent, results from a concentration and abuse of market power. Not everyone can play, even if they want to. This is a game for the big, the elephantine, or the veritably gargantuan. Premeditation is also a helpful prerequisite, along with a bit of collusion (with other investors, brokers, and sometimes the company). For there are quarterly SEC filing requirements to skirt, and a host of other variables that will effect the economics of how much stock one might get, the higher one is willing to pay, not to mention the risk that the company itself might surprise you with a spot secondary or a jumbo-sized, low-premium mandatory, convertible issuance. Despite these risks, a truce generally exists between management and large shareholders since they NEED each other (in a Machiavellian way), even as their interests begin to diverge.

But what really makes it is possible, is the reality that markets are not perfect. A good "squeezer" knows, by trial and error, approximately how elastic the supply curve is for the free float for the stocks he's predating. Some have done this more systematically than others. Monroe Trout's primary strategy is supposed to have evolved out of cataloguing the impact of set order sizes upon an instruments' price at different times and under different conditions, and then measuring the subsequent effect. Sometimes, one triggers stops and it seems like Christmas-come-early. Other times, the market bids with you just because your bidding since the market is indeed reflexive. This sharply contrasts with the archetypical vision of markets which are that of a liquid and unbounded system. Reality more often resembles NOT infinite liquidity, but a finite and closed system. Here, only a fraction of shares are typically for sale in response to the recent change in price, so the squeezer who buys additional shares from liquidity providers (i.e. traders, specialists, market-makers, who don't own it but will facilitate the trade), and who is willing to buy more at higher and higher prices will, quite often, force the liquidity provider to buy the shares back from the purchaser at a higher price than that at which he sold them. The market may seem big and deep, (and it is for some of the largest stocks), but for the great majority of others, it's not much different than poker night with the boys. At this table, an oversized bankroll goes a long way towards creating unfair advantage in these games. And this would be harmless if only it WERE entertainment, and not the financial central nervous system of humanity, whose integrity is responsible for allocating scarce resources.

One might be thinking: "Why the f*%k should you care?" Well, call me an idiot, but when I see my neighbor being burgled, I telephone the police. When I see someone shoplifting, I notify the shop-assistant. When I see someone picking flowers from the public park, I chide them. It is the reflexive result of a good moral upbringing and strong civic pride. My late New-Deal Democrat-of-a-grandfather used to return his social security checks to the gov't because he was still working at age 78 and reckoned he "didn't need it just then". I fear it doesn't count for much in the ME! ME! ME! times of modern America, but I do think Scooter Libby could have used just a fraction of the integrity my grandfather had to 'fess up, and save us (the People of the USA) the millions spent by Mr Fitzgerald and his Grand Jury to investigate the retaliatory kneecapping of former ambassador Joe Wilson.

So what exactly is the harm of the frat bros hazing the shorts for fun and profit? First, it is - generally speaking - a divergent game that drives prices further from efficiency, which contrasts with many reputable short-sellers who simply provide liquidity or focus on uncovering fraud and divergent valuations. Interestingly, while Get Shorty alledgedly focuses upon stocks that have already been bought, and have already gone up, cheap stocks too tend to get cheaper during this period. Any look at the attribution of intermediate-term momentum returns across the calendar will confirm this. So this raises the question: is "Get Shorty" an independent short-squeezing game coupled with random underperformance of laggards, or is it a more integral part of a momentum-like, money-flow relative performance game? While clearly there are idiosyncratic exceptions, I would wager upon the latter. "Get Shorty" could be likened to a pathetic justification for an agent (i.e. an investment manager of a large investment pool) to throw more of someone else's money (the Principal, be it hedge fund investor, mutual fund investor, Pension Fund) at stocks with lower forward returns, in order to artificially (and temporarily) raise their prices, to insure the agent earns and crystallizes performance fees, collect incentive bonuses, or further their immediate performance rankings, and thereby enhance the value of the agent's investment management franchise. At best (where the players are skilled and manage to reverse the positions at a net profit), it is akin to an unauthorized "loan" from the principal investor to the agent, one which is quite adrift from the spirit implied in the princpal-agent relationship. At it's worst, for those who play the game clumsily (i.e. where net investment return is thrown away to the market), this is outright theft for parochial advantage, and is no different from the miscreants who profited from mutual fund timing.

But aren't they simply playing the game well, and winning? If Barry Bonds or Jose Canseco can make a $100 million, why shouldn't a ballsy clever financial games-player sitting in the hot seat at DOSH Partners be entitled to do the same? OK Maybe they are bad examples, because for starters, they were "juiced-up" and cheating. But the point remains: Why shouldn't the fittest survive in the market test of wits? Because, contrary to protestations from Bear Stearns in their "Kwiatoski Defense", financial markets are first and foremost NOT entertainment. They are mechanisms by which mostly educated and mostly skilled agents allocate the scarce resources of our world, making decisions that collectively provide the signals facilitating their movement from less productive undertakings to more productive endeavors. Theoretically, the efficiency by which they do this is essentially predicated upon the accuracy and efficiency of market price signals. This is why we SHOULD be concerned with whether or not stock options are expensed, or if management is smoothing profits through bogus accruals or dubious reinsurance contracts, or whether Telecoms companies are doing bandwidth swaps to paint false and misleading pictures of revenue thereby causing umpteen billions of dollars to chase illusory return in optical fiber and WDWM growth when they perhaps should have been investing in an LNG terminal, sour-crude refining capacity, or improvements to our healthcare or education systems. This is precisely why as a society, we SHOULD be concerned with whether our financial markets have integrity, or whether they are cynically viewed as enrichment schemes for those fortunate enough to be sitting in a catbird seat where, taking the traders' option, they can shoot the moon (and planet's aligning) and "win". But if price distortions are the result, the "victory is pyrrhic and impoverishes everyone in society. It is a vivid example of how the interests of the many, are minutely sacrificed for the larger gain of a few, that not only has no positive wealth gains for society, but results in probable wealth destruction from the resulting mis-allocation of resources. This holds unless one believes that the trickle-down effect from the Sheriff of Nottingham is a more potent economic motivator for the people of Nottingham and Sherwood forest than a world perceived as less corrupt, where more honest mannners of earning, exchanging, and investing one's wealth are transparent and just.

Whether or not one believes that Elliot Spitzer went too far in his prosecution of the market manipulation and bid-rigging in the insurance and reinsruance industries, one thing has been revealed with clarity: there were many otherwise decent soccer mom's and church-going dad's proceeding about their daily (corrupt) business practices, who came to see what they were doing (price-fixing, bid-rigging, kickbacks, extortion) as "normal", and even necessary. And everyone was worse off because of it, because everyone is effected by insurance markets to a greater or lesser degree. Squeezing shorts and other anti-social "financial market-as-a-game" equivalents, should be seen in the same light because everyone but the abuser of the privilege of their market power suffers. And for the record it must be noted that in a land where anti-trust still has traction even against the wealthiest man in the country, market size and power is a privilege with social responsibilities to many constituents, and NOT an alienable right irrespective of what some Ayn Randers, paranoid Republicans, or Supreme Court nominees might try and argue.

What can or should be done? First it must be understood that size and concentration of financial power - if abused - are the enemies of market efficiency, and thus the public interest. Markets may at times be peculiar and confound popular belief, but they are typically powerful positive forces and undeniably convey important information signals when they are large, deep, fair, and democratic. But I would be loathe to call a market "democratic" where large portfolio investors can buy monster amounts of stock unchecked, skirt regulations through numerous loopholes, collude with other participants in order to further abuse their size and power solely to garner parochial financial advantage.

The SEC can step up enforcement. Short-busting is illegal by the spirit of the law and regulations of the land. As a result they can demand more transparency of both short-sales and long purchases. They could also demand short-delay revelation of institutional investors' trades. And this could (should?!) include time and sales. No more hiding behind VWAPs. The tradeoff and responsibility for size must be complete and total transparency - on both the long and the short side (including all materially similar economic interests representing the same e.g. forward sales, swaps, OTCs bargains & options, futures, etc.). All of which should help make manipulation more difficult, which will undoubtedly make the market more efficient.

Unless in some strange kharmic sense, America somehow deserves to have resources allocated by trigger-men. Perhaps, rather than increasing the transparency, we need MORE short squeezes, more Enrons, more fraud, more dark unlit fiber. As a patriot, I reject this view and believe that money should be made from honest productive pursuits, rather than by stealing it. As a result, I believe financial regulation should endeavor to make it's policy and subsequent enforement on the very same basis to protect the vital integrity of our markets.

Thursday, November 17, 2005

The Fcuk Factor

A few years ago, after a number of customers suffered what one might call grave financial contusions, BARRA capitulated and included their first non-fundamental factor in an otherwise fundamental factor model. This factor was called "Momentum" (note the capital 'M'). Never mind that it couldn't be explained. Or that consternation doesn't stop at it's puzzling properties. Though they weren't consulted for comment regarding this post, I do ocassionally wonder at precisely how much sleep the financial engineers at BARRA lost over the issue. That's because it (like the left-right political divide) causes visceral emotions best exemplified by reports of mild-mannered tweed-donning academics nearly coming to fisticuffs about it. It causes otherwise rational people to anthropomorphize or even deify it in stark terms of good or evil, and virtue vs. vice. I even have some good friends and colleagues who to this day get completely spastic over the fact that it exists at all, even though it seems like it shouldn't.

In the short few short years since they've added Momentum to their model(s), the world has come a long long way. Microprocessor clock speeds are now measured in gigahertz. The price per megabyte of memory has long since put a lid on EMC's share price. Telecommunication costs are less than the price of a colourful gumball. Much financial data is now virtually free (though quality remains dubious), and "data-mining" has supplanted "strip-mining" as a concern amongst thoughtful graduate students. Even momentum, once thought of as inexplicable, has, with the help of graduate student slave-labour, neural nets and non-linear models, now been found to alias more plausible sounding things such as sector return, forms of growth (or is inverse), and various nuances of relevant first derivative-like variables.

Yet, even with all this power imbued in the cooked sand of the microchip, in combination with all the quantitative model-building prowess of the best and the brightest, some securities continue to defy our abilities to systematically explain why they are up (and won't go down), or why others are down (and won't go up). And so to insure that my PhD. hasn't been an utter waste of time, effort, paper, and federal & university endowment grant money, as well as to altruistically further the knowledge of academic finance, I would like to propose that BARRA introduce what would be their second non-econometric factor: "the Fcuk Factor". Once introduced, I am confident that this factor will systematically explain the previously inexplicable returns on tails of the cross-section that have been baffling rational investors and financial sleuths for years.

With momentum, BARRA set about to measure and fit an observed (technical?) factor into their otherwise fundamental framework of systematic risk descriptors. They could have just as easily used "Relative Strength" or MACD, but that is a hornets nest for another day. The Fcuk Factor WOULD have a-reasonable r-squared to Momentum. But not all stocks that load highly on momentum will have a high loading on the Fcuk Factor. But since their factors are not orthogonal, this is of little consequence anyway. For some momentum stocks should have momentum. They DESERVE it at the time of measurement by virtue of their attributes, irrespective of whether they will live up to them in the future. FOr THAT moment, they have earned the right to bask in whatever expectational glory is they call theirs. But the Fcuk Factor would describe otherwise inexplicable or difficult-to-explain returns on the tails that - to date - BARRA calls "residual", since they are not explained by the model. As such the returns of securities with let's call it "undeserved momentum" are believed to be idiosyncratic and therefore specific to that stock. But I would propose to you that "the Fcuk Factor" will SYSTEMATICALLY help to explain large anomalous recent (~12mo) returns amongst otherwise historically uncorrelated and econometrically unrelated securities. The individual pieces are already out there in the body of public domain research - visible for all to see. BARRA need only take their stockpot and mix the composite soup of final derivation based upon the inputs, including, but not limited to: short interest ratio, short interest as percentage of float, degree of separation of short interest from market price action, probability-adjusted tradeable float, concentration of institutional ownership, change in institutional ownership; clustering of institutional ownership by investor type; # of inappropriate funds in fund family holding the security; the # of phone calls between the Company CFO and leading analyst; divergence from most forecasted absolute & relative equilibrium prices on the majority of rational models; scale and persistence of window-dressing activity; anomalous microstructure activity (end of day marks & other non-random footprints); "tip-sheet" popularity; # of positive mentions by "Cramer" in last 3 months; membership in IBD 100; Large change in IBD's Proprietary ranking, aggregate option open interest, and anomalous expiry activity.

The most important contribution of accurate measurement of the Fcuk Factor will be a dramatic increase in the efficiency of markets as well as its numerous applications to the investment management indsutry in general - especially the largest of long-only managers (Fidelity, Cap Research, etc.) and incentivized & well capitalized equity hedge funds. It will, for example, allow the largest marginal buyers to justify why many of their largest relative "active" positions in their portfolios are in some of the most implausibly overvalued crap & shite in the universe. I can already picture a large Boston firm's compliance officer's conversation: "Well you see Mr Spitzer, we were short the Fcuk Factor according to BARRA, so we purchased a million shares at the close of the quarter to insure our portfolios were balanced...". Uh huh. And it will be a bonanza for hedge funds who no longer will have to fish for justifications for ramping shares: "Dear Investors, Q3 returns were robust as we were correctly and aggressively bullish on the Fcuk Factor....". But the real boon will be to short-sellers, who can dramatically improve their returns by recognizing in advance as to which stocks to short and when (the answer to the latter, for those with elevated "Fcuk Scores", categorically being NEVER!). And with fewer shorts "getting in the way" of the largest investors having their way with their fav stocks, market efficiency will be much improved since the equilibrium price for such a security will be reached far quicker than might be the case without the fitting and estimation of a Fcuk factor into BARRA.

So I urge you BARRA, implore you BARRA to get to work beginning yesterday and sort it out. Measure it. Tweak it. Smooth it. Include it. And in so doing save hapless shorts from further one-way tickets to hell.

Wednesday, November 16, 2005

Stretching It Thin

There is a tenuous but symbiotic relationship between a bold and persistent securities analyst and the bold, persistent speculators and investors who heed his advice. And at it's most bizarre, it resembles a James Dean-like games of "chicken" where two cars proceed in head-on directions to each other, with the loser being the one who veers off first. The difference in the game of chicken between the analyst and sympathetic investors is that the winner is typically the one who bails out first.

In the Shangri-La world of the "perfect market" such dilemmas rarely arise. The analyst there, is unbiased, prescient, and if it weren't for the salary that he was drawing, one might even venture that he was altruistic. And in that magic kingdom, the investor has access to infinite liquiidty at a price, and has nothing more to do than to placce his bet, and wait for the spin of the wheel which will decide whether he is a living legend or a schmuck. He is pitting his wits against the invisible hand of the multitude of faceless investors, all with their fingers on the trigger ready to make a rational investment decision on the turn of a price.

[Camera Fade from the paradise of Shangri-La, to the Labrea Tar Pits, replete with flames, bubbling and oozing black slime]. Now back in the real world, companies pay analysts based upon commission revenue generated and possibly upon banking and advisory fees earned. And investors certainly can't access sufficient liquidity at a price. In fact, the price moves when Fidelity or Cap Research even LOOKS at a stock. In the Labrean tarpits, contrary to economic theory (particularly in Japan), much stock has no elasticity of supply. Whether the shares are held for strategic purposees, in trust, for control purposes, or whether capital gains may simply be "too large" to realize, supply is far more insensitive to price than modeled or poipularly believed. Then there are the umteen trillions of dollars to invest, which in combination with the aforementioned, are ever-tempted "to cheat" by using one's investors money to move the price of a security a great distance from its starting point in the generally desired direction.

So far so good. At this stage, not only isn't there a conflict of interest between the analyst and the investor, but there is a genuine alignment of interests. This is the symbiotic part where an investor, having acquired a position in a company, benefits from favorable analyst reports and comments, and the analyst benefits from the investor's subsequent market impact of more more shares at higher prices, thereby enhancing the analysts reputation for timeliness and prescience. At this point it is important to say that both the analyst and the investor are better off if "the story" is not completely fabricated, and has a modicum of plausibility, be it a rising earnings or revenue trend, new product(s), the spectre of product price increases or increasing market share, hidden value, etc., something than can be pointed which engenders hope and expectation. Failure to heed this important point typically results in both critical inverstor and analyst casualties. So long as the analyst doesn't transgress this point, his toolkit is virtually unlimited. He can claim a stock is cheap to its growth, cheap to itself, cheap to its history, cheap to similar securities, that it possesses unique growth qualities, better management, increasing sympathy to shareholders interests. And as things get whackier, he can even make comparisons to the most ludicrous of peers in an attempt to justify a rising price in the future. For this is what is required for the financial equivalent of Pax Romana, a prerequisite to keeping those commission dollars rolling in.

This may go on for many months. The analyst reiterates his "buy" recommendation, and raises his price target)s). The investor buys more. And more. By this point, the investor has accumulated a rather large position and has "taken out" most of the real marginal price-sensitive sellers as he's bought (it's definitely a "he", as "she"'s rarely do this) more stock at higher prices. The "story" is still in tact as the earnings trend is rising, the new product is still expected to come on line some time next year or the year after. Hope spring eternal. But the "rating" as our friends at the FT's Lex likes to call it, has doubled or tripled. What might have been cheap at 12x FY2 earnings is now 25 or 30x. Admittedly the ranks of the shorts are not what they once were. Famous US short-seller David Rocker admits to having learned lessons "the hard way" to "never short on price".

Yet there is a nascent but growing conflict here between the analyst and the investor. Just as it is likely that the sun will rise in the east tomorrow, so to is it likely that the higher the "rating" (or valuation premium) a security achieves, the lower the expected economic return. This is not pessimism, bearishness, liberalism or communism,(as certain Libertarian trend-followers would have you believe) but rather simple and objective mathematics - the physics of finance, so to speak. This is the this point tensions emerge., for what is good for one is bad for the other. Their optimal strategy is to maintain the status the quo. But the rewards for breaking ranks are high and the penalties for NOT breaking ranks are also severe. The analyst can issue another "buy" recommendation, but at 30x or more FY2 estimated earnings, what will justify this? Now the analyst must begin worrying about HIS reputation, and his I.I. or Starmine ranking. For the investor he too is trapped. As the largest marginal buyer, he might have tripled the rating. Now other buyers are few (maybe a few shorts, some momentum junkies, and some index or benchmark buyers). But nowhere near the demand required to move the position currently on his shelves. Should he try? One thing is certain: he has a better chance of moving SOME if he does it when the momentum guys are buying AND when the analyst is reiterating his support. When these reverse, the only net will be the price at which he (the investor) desires to throw good money after bad.

And how does this game of "chicken" typically end, the curious might ask? The Pax Romana ended with barbarian hordes systematically pillaging the "civilized" empire culminating in the sacking of Rome. Janus was similarly savaged by the market in 2002 during their puking of THEIR technology positions. Henry Blodget was fired, as were many of his contemporaries who fabricated similarly outrageous stories and comparisons to justify seemingly conflictual committments. My suspicion is that in the absence of motivating factors to the contrary, both analyst and investor will "veer away" from the head-on collision because it is in their interests to do so. However, vocal reiterations of past recommendations will become less intense and less frequent, while purchases at even higher prices by the investor will also cease outside of important month-end and quarter-end portfolio valuation dates. They have become, in effect, inseparable, in their prisoners' dilemma, and will, whatever, happens sink or swim together because they have little other choice....

Friday, November 11, 2005

Confidence Isn't Everything

Dr. John Brush of Columbine Capital, a mathematician by training, has dedicated mostl of his long career in financial research to the study of price momentum. Though he publishes for parochial gain rather altruistic enlightenment, this doesn't devalue his work. In his topical Twenty-Year Retrospective on Momentum made public in 2003, he stated categorically that contrary to his findings in other developed markets, Japanese (along with Scandinavian) markets exhibit strong properties of intermediate-term REVERSION, and NOT Momentum. This means the higher the historical relative return has been, the LOWER the forward relative return has been over the most fertile of intermediate-term momentum horizons (which is 12-months). To put it even more succintly: For the portfolio manager in Japan, buying what's "gone up" vs. selling what's "gone down" has been, over the last 30 years, one of the quickest routes to unemployment, not to mention penury.

This is most curious, since virtually all esteemed academic research indicates the opposite has been true in the rest of the world. Which is why hackneyed (but apparently true, on average) "old saws" exist like "Cut your losers & let your winners ride", or "Don't catch the falling knife". While they clearly have logic flaws if you examine their premises in greater detail, they are, like most demagoguery, based upon kernels of truth. So is Japan "different", and if so why? While it is true that collectively, the Japanese people believe themselves unique in many ways (their rice is supposed to be "purer", their beef is less contaminated, western medicines don't work as well as upon them, their snow is suublimely different so that European skis don't work as well in the mountains near Nagano, etc.), I would suggest they (the Japanese) have no monopoly on this belief since most cultures like to perpetuate myths about THEIR Tribe's superiority. But why on earth would or should Japanese financial markets be seemingly governed by different natural laws than our own markets?

For years I've meditated upon precisely this question, to the detriment of my golf swing and my love-life. To be sure, many plausible-sounding explanations have come and gone. Some have even survived the test of time (particularly those that cannot be easily measured). Here is my current (and most plausible) version: Since in the "longer run" stock price generally follows earnings, it's reasonably determinstic that continued price persistence of a security requires above-average growth in earnings (or long-run below-average earnings in most other stocks, though this route to relative momentum would, in fact, be bounded). Such positive earnings growth requires growth in sales and/or profit margins (though alone, the latter, too, would theoretically be bounded). So if reversion was to be considered the rule, rather than the exception in Japan, then growth must be bounded OR/AND the market's prices must be wrong (or a little of each). And they must be wrong enough such that when buying the portfolio formed upon prior high returns whilst selling the portfolio formed upon low measured prior returns, one not only doesn't make any money in the next period, but one loses it in buckets. This would tend to be indicative that too much return or discounting must have occured in the prior interval in the one or the other or both of the respective high and low return portfolios. In Japan, one has been rewarded for catching the proberbial knife, and penalized for being greedy and riding your winners.

But again, one might ask "why"? In reply, the arguments for bounded growth are seductive and numerous if not compelling. First there is GEOGRAPHY: Japan is an island and not a terribly large one. For those who received only passing grades in their georgraphy studies, it's located smack in between the Korean peninsula and China - both of whose peoples speak different if not mostly unintelligible languages and both of whom, more importantly, thoroughly detest the Japanese. This is not fertile growth territory for the convenience store chain wishing to to expand across the Sea of Japan. Second is DEMOGRAPHICS: Fertility rates in Japan are extremely low (and still dropping), and the population is aging rapidly. This is good for adult-use diapers, but less good for the unit sales of manga, toothpaste, or home furnishings. And they are a thrifty people, by necessity and nature. They are, by many accounts, also quite xenophobic too and outside of what they need for their immediate labour requirements (lapdancers, leather-workers, bargirls, TEOFL teachers, etc.), there is basically no immigration nor refugee uptake. Third, there is CULTURE: Japanese people speak errr ... umm ... Japanese. No one else in the world speaks (nor desires to speak) Japanese. This is both insulating and limiting. Microsoft did not arise in Japan possibly because Bill Gates was American, but more probably because the marriage of the Japanese language and the computer is a wholly unnatural act, sort of like asking a Snowy Egret to mate with a Belon oyster. Their culture also elevates the collective at the expense of the individual, and historically has fostered large oligopolistic behemoths at the center, with small depedent suppliers on the periphery. Together, this has been stultifying to entrepreneurship, limiting emergent growth to a handful of inconoclasts. Finally there is HISTORY: Japan's overseas "pecadilloes" (note: this is the polite term) during the first half of the twentieth century made them rather unpopular (note: also the polite term) with their immediate neighbors as well as with the rest of Asia (not to mention the people of Hawaii). Despite ideological differences, even Ho Chi Minh was more than happy to look to Uncle Sam for help to rid them of the Japanese occupiers. So deep and intense has this hatred been that the Chinese, from time-to-time, still feel it cathartic to do the old "smash-'n-'grabs" at anything visibly Japanese resting upon Chinese soil. Yet Japan HAS grown dramatically. The Japanese ARE world-class engineers, manufacturers, and scientists with an eye to detail and an unusual and mostly pleasant aesthetic, not to mention a strong work ethic. These ingredients have combined to form the basis for some of the World's largest and most fabulously successful firms that are champions in their industries. They have grown to an immense size, but done so relatively quickly. But this size, once obtained, itself constrains the size of future growth rates. And then there are the rest of the firms which have historically been constrained the limitations listed above. Finally, the biggest ones were also defined by, but limited by the consensual nature of Japanese society, and the brand of capitalism that was forged in post-war Japan which was one where shareholders are but one of many constituents (but which also include management, employees, suppliers, community, and cusomters). This has limited earnings growth at the expense of what western academics might term "empire building" - something that benefitted shareholders less than it conferred benefits upon the other constituents, including Japan Inc. collectively.

Clearly the price has been wrong (since, ex-post, they HAVE been excessive in the prior period) on sufficient numbers of securities or else reversion would NOT be pervasive. If, on the other hand, price had erred on the side of cautiousness in the prior formation period, then it would follow that price would continue in the same direction in the next interval. In this situation, if one was looking backward after holding the high and low portfolios for 12-months (with full knowledge of future returns) one would likely describe the Share Price as having "underreacted" to their prospects in the prior frame.

But "WHY" was the price wrong? Were investors historically just always over-reacting whatever they did - extrapolating trends forward that were not recurring and undertaking myopic loss aversion whenever a speed bump or earnings miss was encountered? I had always thought that the Prices were wrong in hindsight because the constraints upon growth (detailed above) led to two direct effects. First, the lack of growth meant that whenever the price of a share appreciated in the absence of growth, it was unlikely to be justified. The second was that the paucity of real and persistent growth opportunities across listed companies made such enterprises so scarce that their prices inevitably were bid up to levels above and beyond the associated levels of growth. So much so, that their future relative share-price performance were victims of their success, such that it was well-nigh impossible to keep up with expectations. And so the puzzle, having been explained, was kept in its box and trotted out ocassionally to VIPs when asked to explain why things were the way they were.

Then Kahneman & Tversky won the Nobel prize and behavioural finance exploded. Some alternative explanations appeared, and quite compelling ones at that. Academic researchers still do not agree on what precisely causes momentum. Some deny it exists altogether and claim it is a yet to-be-discovered risk factor. Others claim it is aliasing other things (future earnings & growth or changes thereof) and that while not explicable by CAPM, it IS rational. And there is some proof that this is true at least in part. Still others say that while it exists, it's loopy, looney, irrational and is firmly rooted in behavioural causes such as self-attribution bias or myopic loss aversion. These accounts say, that while it exists in the USA, it may plausibly be explained by "overconfidence" and "self-attribution biases". Tamura (2003) turned this on its head and suggested that "Reversion" is the rule in Japan because, citing behavioural psychologists Kitayama, Takagi & Matsumoto (1995), Japanese people seem to be guilty of little self-attribution bias. This is highlighted in the paper by the fact that when they succeed in something, the Japanese will ascribe it to external factors (e.g. "the simplicity of the task" or "luck"), rather than their own ability. Moreover, when they fail at something, they tend to blame it on personal factors such as the lack of ability, poor training or insufficent effort. So rather than being over-confident (which Daniel Hirschleifer & Subrahmanyam posited maybe be prerequisite for self-attribution bias and thus explaining the continuation effect), the Japanese are more critical, self-effacing, self-deprecating.

What is interesting is that Japan is now in the throes of a rip-snorting momentum craze. It is fast becoming a momentum market, resembling the other large western markets of the world. And the emergence of this momentum has coincided with a rise in the percentage of foreign ownership of the Japanese market, but more significantly, from the even larger increase in the percentage of turnover accounted for by "foreign" investors in general, and hedge fund investors in particular. Perhpas one could discount this as the inevitable trend towards "globalization". But while there is an element of truth in this, it is not the whole story since there remains stark cultural contrasts between Japanese investors and the foreign capital now calling the TSE its playground. The traditonal "bounds to growth" arguments remain plausible in some respects, but they too may be ebbing with time as a new generation whose hatred of things Nippon fades in intensity, and global fund managers blur the national distinctions and domicile of manager and funds managed.

For my view, I continue to pay quiet respect to the Momentum Gods, whose power carries with it the ability to cause large mark-to-market losses, and thus undesired margin calls, not to mention the transmission of material non-public information. But I remain suspicious of the longevity of these Idol's power, particularly where less-than substantiated by evolving objective fundamental changes, and where induced by the parochial greed and cynical disregard for fidcuiary resposnibility by agent fund managers with assymetrical incentives or motivations.