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Yves Smith “On Traders Behaving Badly and Cognitive Bias”


Yves Smith of Naked Capitalism is doing “the Lord’s work” and asking for traders who have specifics on the various market manipulations shady trading behaviors perpetrated by Wall St. funds, banks, etc. to come forward and blow the whistle. The timing of her request is somewhat an effect of Jon Stewart’s recent battle with Cramer (See the more recent appearance and discussion from Jon Stewart vs Jim Cramer or the original Stewart spat against CNBC that started it all), which made very public an interview Cramer had done back in 2007 where he talks frankly (and yet not specifically enough as Smith points out below) about how funds would manipulate markets for profit.

Very interesting stuff, and since we’ve seen no successful persecution of this behavior, I have little reason to believe that future regulations will stop it. What does that mean? It means that investing in the markets is an incredibly risky business for laypeople as you are unavoidably swimming with the sharks.

The Jim Cramer chatter precipitated by his Daily Show appearance included some links to an infamous interview Cramer gave in 2007, where he discussed how he would, as a hedge fund manager, push the prices of stocks he was short down via the futures market. It was arguably a public admission of market manipulation.

What was most striking about this incident was how quickly it was forgotten.

Now, of course, one can cynically say, that’s what traders do. And there have been times when I’ve had the vast misfortune to be watching the ticks (I hate trading, I put on very few trades, and I sweat them all and second guess myself hugely) and have seen more than once some end of day action that was clearly tape painting (and my pro investor buddies saw it the same way).

But nobody seems offended at the notion that the markets aren’t safe for mere mortals, just the sharks, even the whole US investing mythology touts how transparent, open, and well policed US securities markets are.

That’s one level of heinousness.

As long as banks are playing with other people’s money, and the higher ups have plausible deniability, they have no incentive to rein this stuff in, save maybe a token case here and there so they can pretend they really were on top of things. And I’m being charitable and assuming the higher ups were not actively enabling it.

So why isn’t there more understanding of and outrage about this? After all, this is the heart of the looting that went on. If firms will tolerate (or even encourage) overly aggressive behavior that appears to generate profit, it isn’t just the nominal miscreants that are at fault, but the whole chain of command all the way to the top (after all, just as in the Jett case, they profited and therefore had reason not to probe too hard).

So here is my theory: the details are not specific enough for the public to see it as real. And if they can’t formulate a picture, they can’t believe it happens all that often (after all, if it did, surely it would be in the Wall Street Journal).

That is an example of a cognitive bias called the availability heuristic. If we can have examples, the more concrete the better, the more likely we are to believe that a phenomenon is valid (that is why anecdotal evidence is more persuasive than it ought to be).

Go back and look at the Cramer tape. It’s actually brilliant. He is not very specific! There is no “when I was short X stock in 2004, I did F, T, and H and the price fell by $Z and I made $100,000 in two days.” It’s all murky, to the point where Henry Blodgett, in parsing the transcript, had to insert words at quite a few junctures to make what Cramer say make sense to him (and note I in reading the transcript would have inserted different words). That’s why this incident never really stuck to Cramer. It all came off like knowing innuendo, but he didn’t present a smoking gun.

So unless we have a Pecora commission, or a lot of ex-traders and trading managers coming forth with particulars, the great unwashed public is not going to know enough of what happened to know where to direct its diffuse but well warranted anger over having been had.

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The Money quote on Gold from Chris Wyke


Tim at TheMess has a fantastic quote from Christopher Wyke which, in only a few sentences, pretty much sums up the strength of gold as an asset class (I am unabashedly long gold, and this is not to be considered investment advice!).

Here’s Wyke:

Wyke: I think people have been investing in gold as a safe haven, as an alternative to stocks. But what’s really impressive is that the gold price is up by about 25 percent in the last four months at a time when the dollar’s been strong and no one’s been worried about inflation. I think, when that turns around, when the inflation concerns arise again, and if the dollar is to fall again, then gold could move very sharply ahead.

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Jim Rogers: We are buying land in Brazil and Canada and starting to farm it

Quotes from Jim Rogers’ interview (video at bottom):

  • “We’re still going to eat probably. We’re still going to wear clothes probably. You know nobody — Farmers cannot get loans for fertilizer right now. So the supply of everything is going to continue under pressure. Uh the inventories of food are the lowest they’ve been in 50 years. We have serious supply problems developing for many mining goods, oil, agriculture. So even if demand goes flat or down as it did in the 30s as it did in the 70s you can still have a nice market.”
  • “What we’re doing is buying land in Brazil and the other is buying land in Canada. … If I’m right agriculture is going to be one of the great industries of the next 20 years or so … 30 years … maybe we can change this to CNBC agriculture.”
  • “We are buying some land … and turning raw land into farm land. . . . we are hiring farmers.”
  • “You know the IMF is trying to sell their gold and if they do then they may drive the price of gold down a lot and if they do Martin you better buy all you can because that will be the last opportunity to buy gold in a long, long time.”
  • “Throughout history when governments have printed huge amounts of money it’s always – it’s always led to higher prices.”
  • “I still own the yen and hope to buy some more yen if it continues to consolidate for awhile.”
  • “I expect to own commodities for years.”

(H/T to Tim)

Rogers has been busy lately (Or in high demand). Here’s more from him:



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Jim Rogers Doesn’t Mince Words About the Crisis


The title of this interview with Maria Bartiromo is dead-on as billionaire investor Jim Rogers speaks the hard truth about what has happened and should happen on Wall Street as well as what he sees coming down the pipeline.

Rogers’ comments are brief, succulent and refreshing — so much so that they make me wonder why we don’t hear these things from the other members of the billionaire club. By way of poignant comparison (Soros co-founded the Quantum Fund with Rogers), George Soros’ flip-flopping in recent weeks makes him come off as a sort of Elmer Fudd (See George Soros finally gets it). What is going on? Why is Rogers so cocksure of himself? Why is he so brutally honest?

One argument is that Rogers, like many other commodity bulls, is just talking his book. And even though talking your book doesn’t make you wrong, it inevitably makes you biased.

I think there’s a bigger reason Jim Rogers is being so frank. He can afford to be. Compare him with Warren Buffett or George Soros, two other wizened investors who are considered go-to gurus on the economy. Both of these guys* are hugely invested in the United States both financially and politically. Meanwhile, Rogers sold-out his house in New York and seems to have moved most of his investments into real assets (Agriculture, metals, etc.) and China. Jim Rogers has protected his wealth and situated himself for economic turmoil!

He has no reason to be afraid of telling the truth. Let the banks go bankrupt. Call out the CEOs who made millions while destroying their companies!

It really doesn’t matter that he’s talking his book when he’s right, does it?

The full interview isn’t long, but my favorite parts are snipped below. For all the folks out there (like us) who held out and didn’t buy a house in the boom, can I get an “Amen!?” How about the ones who didn’t buy into the bull market bull and went short only to get wiped clean by Fed market intervention?

Thank you, Jim!

What do you think of the government’s response to the economic crisis?

JIM ROGERS: Terrible. They’re making it worse. It’s pretty embarrassing for President Obama, who doesn’t seem to have a clue what’s going on—which would make sense from his background. And he has hired people who are part of the problem. [Treasury Secretary Tim] Geithner was head of the New York Fed, which was supposedly in charge of Wall Street and the banks more than anybody else. And as you remember, [Obama’s chief economic adviser, Larry] Summers helped bail out Long-Term Capital Management years ago. These are people who think the only solution is to save their friends on Wall Street rather than to save 300 million Americans.

So what should they be doing?

What would I like to see happen? I’d like to see them let these people go bankrupt, let the [banks] go bankrupt, stop bailing them out. There are plenty of banks in America that saw this coming, that kept their powder dry and have been waiting for the opportunity to go in and take over the assets of the incompetent. Likewise, many, many homeowners didn’t go out and buy five homes with no income. Many homeowners have been waiting for this, and now all of a sudden the government is saying: “Well, too bad for you. We don’t care if you did it right or not, we’re going to bail out the 100,000 or 200,000 who did it wrong.” I mean, this is outrageous economics, and it’s terrible morality.

What about Citigroup (C)? What about the car companies?

They should be allowed to go bankrupt. Why should American taxpayers put up billions to save a few car companies? They made the mistakes! We didn’t make the mistakes! I’m sure they’ll give them the money, but I’m telling you, it’s a mistake. It’s a horrible mistake.

I totally understand what you’re saying, but the banks are under massive pressure.

They all took huge, huge profits. Who was the head of Citigroup? Chuck Prince? I mean, how many hundreds of millions of dollars did Prince take out of the company? How many hundreds of millions of dollars did other Citibank execs take out of the company? Wall Street has paid something like $40 billion or $50 billion in bonuses in the past decade. Who was that guy who was the head of Merrill Lynch (MERR)?

Stan O’Neal?

Right, Stan O’Neal. He got $150 million for leaving, even though he ruined the company. Look at the guy at Fannie Mae (FNM), Franklin Raines. He did worse accounting than Enron. Fannie Mae and Freddie Mac (FRE) alone did nothing but pure fraudulent accounting year after year, and yet that guy’s walking around with millions of dollars. What the hell kind of system is this?

Which commodities are worth buying or holding on to?

I recently bought more of all of them. But I really think agriculture is going to be the best place to be. Agriculture’s been a horrible business for 30 years. For decades the money shufflers, the paper shufflers, have been the captains of the universe. That is now changing. The people who produce real things [will be on top]. You’re going to see stockbrokers driving taxis. The smart ones will learn to drive tractors, because they’ll be working for the farmers. It’s going to be the 29-year-old farmers who have the Lamborghinis. So you should find yourself a nice farmer and hook up with him or her, because that’s where the money’s going to be in the next couple of decades.

*I’m uncertain as to how Soros’ portfolio weighs out though he’s certainly made some bad bets in the recent market crash (See stockpickr)

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While Rome Burns…ile-rome-burns/

John Mauldin over at the Ritholtz’s Big Picture writes about long-term investing, what it means (He defines as a 20 year horizon), and when it works (He also discusses how Europe is in big, big trouble, but that is another topic that is being widely discussed).

As part of this long-term investing discussion, he takes to task some of the bromides bantered about regarding missing bull markets, “no pain no gain,” blah blah buy! buy! buy! etc.

It’s a long read for a blog post, but there is some worthwhile nuggets. What I really took away was here:

In the 103 years from 1900 through 2002, the annual change for the Dow Jones Industrial Average reflects a simple average gain of 7.2% per year. During that time, 63% of the years reflect positive returns, and 37% were negative. Only five of the years ended with changes between +5% and +10% – that’s less than 5% of the time. Most of the years were far from average – many were sufficiently dramatic to drive an investor’s pulse into lethal territory!

Almost 70% of the years were “double-digit years,” when the stock market either rose or fell by more than 10%. To move out of “most” territory, the threshold increases to 16% – half of the past 103 years end with the stock market index either up or down more than 16%!

Read those last two paragraphs again. The simple fact is that the stock market rarely gives you an average year. The wild ride makes for those emotional investment experiences which are a primary cause of investment pain.

The stock market can be a very risky place to invest. The returns are highly erratic; the gains and losses are often inconsistent and unpredictable. The emotional responses to stock market volatility mean that most investors do not achieve the average stock market gains, as numerous studies clearly illustrate.

Not understanding how to manage the risk of the stock market, or even what the risks actually are, investors too often buy high and sell low, based upon raw emotion. They read the words in the account-opening forms that say the stock market presents significant opportunities for losses, and that the magnitude of the losses can be quite significant. But they focus on the research that says, “Over the long run, history has overcome interim setbacks and has delivered an average return of 10% including dividends” (or whatever the number du jour is. and ignoring bad stuff like inflation, taxes, and transaction costs).

The 20-Year Horizon

But how long is the “long run”? Investors have been bombarded for years with the nostrum that one should invest for the “long run.” This has indoctrinated investors into thinking they could ignore the realities of stock market investing because of the “certain” expectation of

ultimate gains.

This faulty line of reasoning has spawned a number of pithy principles, including: “No pain, no gain,” “You can’t participate in the profits if you are not in the game,” and my personal favorite, “It’s not a loss until you take it.”

These and other platitudes are often brought up as reasons to leave your money with the current management which has just incurred large losses. Cynically restated: why worry about the swings in your life savings from year to year if you’re supposed to be rewarded in the “long run”? But what if history does not repeat itself, or if you don’t live long enough for the long run to occur?

For many, the “long run” is about 20 years. We work hard to accumulate assets during the formative years of our careers, yet the accumulation for the large majority of us seems to become meaningful somewhere after midlife. We seek to have a confident and comfortable nest egg in time for retirement. For many, this will represent roughly a 20-year period.

We can divide the 20th century into 88 twenty-year periods. Though most periods generated positive returns before dividends and transaction costs, half produced compounded returns of less than 4%. Less than 10% generated gains of more than 10%. The P/E ratio is the measure of valuation reflected in the relationship between the price paid per share and the earnings per share (“EPS”). The table below reflects that higher returns are associated with periods during which the P/E ratio increased, and lower or negative returns resulted from periods when the P/E declined.

Look at the table above. There were only nine periods from 1900-2002 when 20-year returns were above 9.6%, and this chart shows all nine. What you will notice is that eight out of the nine times were associated with the stock market bubble of the late 1990s, and during all eight periods there was a doubling, tripling, or even quadrupling of P/E ratios. Prior to the bubble, there was no 20-year period which delivered 10% annual returns.

Why is that important? If the P/E ratio doubles, then you are paying twice as much for the same level of earnings. The difference in price is simply the perception that a given level of earnings is more valuable today than it was 10 years ago. The main driver of the last stock market bubble, and every bull market, is an increase in the P/E ratio. Not earnings growth. Not anything fundamental. Just a willingness on the part of investors to pay more for a given level of earnings.

Every period of above-9.6% market returns started with low P/E ratios. EVERY ONE. And while not a consistent line, you will note that as 20-year returns increase, there is a general decline in the initial P/E ratios. If we wanted to do some in-depth analysis, we could begin to explain the variation from this trend quite readily. For instance, the period beginning in 1983 had the lowest initial P/E, but was also

associated with a two-year-old secular bear, which was beginning to lower 20-year return levels.

Look at the following table from my friend Ed Easterlin’s web site at

(which is a wealth of statistical data like this!). You can find many 20-year periods where returns were less than 2-3%. And if you take into account inflation, you can find many 20-year periods where returns were negative!

Look at the 20-year average returns in the table above. The higher the P/E ratio, the lower (in general) the subsequent 20-year average return. Where are we today? As I have made clear in my last two letters, we are well above 20. Today we are over 30, on our way to 45. In a nod to bulls, I agree you should look back over a number of years to average earnings and take out the highs and lows of a cycle. However, even “normalizing” earnings to an average over multiple years, we are still well above the long-term P/E average. Further, earnings as a percentage of GDP went to highs well above what one would expect from growth, which is usually GDP plus inflation. Earnings, as I have documented in earlier letters, revert to the mean. Next week, I will expand on that thought.

And given my thesis that we are in for a deep recession and a multi-year Muddle Through Recovery, it is unlikely that corporate earnings are going to rebound robustly. This would suggest that earnings over the next 20 years could be constrained (to say the least).

In all cases, throughout the years, the level of returns correlates very highly to the trend in the market’s price/earnings (P/E) ratio.

This may be the single most important investment insight you can have from today’s letter. When P/E ratios were rising, the saying that “a rising tide lifts all boats” has been historically true. When they were dropping, stock market investing was tricky. Index investing is an experiment in futility.

You can see the returns for any given period of time by going to

Now let’s visit a very basic concept that I discussed at length in Bull’s Eye Investing. Very simply, stock markets go from periods of high valuations to low valuations and back to high. As we will see from the graphs below, these periods have lasted an average of 17 years. And we have not witnessed a period where the stock market started at high valuations, went halfway down, and then went back up. So far, there has always been a bottom with low valuations.

My contention is that we should not look at price, but at valuations. That is the true measure of the probability of success if we are talking long-term investing.

Now, let me make a few people upset. When someone comes to you and starts showing you charts that tell you to invest for the long run, look at their assumptions. Usually they are simplistic. And misleading. I agree that if the long run for you is 70 years, you can afford to ride out the ups and downs. But for those of us in the Baby Boomer world, the long term may be buying green bananas.

If you start in a period of high valuations, you are NOT going to get 8-9-10% a year for the next 30 years; I don’t care what their “scientific studies” say. And yet there are salespeople (I will not grace them with the title of investment advisors) who suggest that if you buy their product and hold for the long term you will get your 10%, regardless of valuations. Again, go to the Crestmont web site, mentioned above. Spend some time really studying it. And then decide what your long-term horizon is.

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China Feasts on Miners as “Bank of Last Resort”…VMA&refer=home#

What’s China to do with their $2 trillion in reserves (world’s largest)? Spend it, of course. And what better place to spend that money than on real assets?

An interesting, if not predictable (to some), development.

Wuhan Iron & Steel Group and Jiangsu Shagang Group Co., China’s third- and fifth-largest steelmakers, are shopping for iron ore mining stakes in Australia and Brazil, executives said in interviews.

“We are evaluating and selecting” candidates in Australia and Brazil, said Shen Wenrong, Jiangsu-based Shagang’s chairman. “Going overseas is the government policy, so I believe we will get financing from Chinese banks.” Wuhan spokesman Bai Fang said his company is “looking for opportunities” amid lower acquisition costs for iron ore assets in Australia and “won’t rule out other countries.”

The world’s top metal user, China has agreed to acquire $22 billion worth of commodity assets this year after a 70 percent drop in metals and oil since July ended a six-year boom in raw materials. With U.S. and Australian banks still hesitant to lend, Rio Tinto Group and OZ Minerals Ltd., laboring under combined debt of $40 billion, agreed this month to sell stakes to Aluminum Corp. of China and China Minmetals Corp., respectively.

“China has turned out to be the bank of last resort,” said Glyn Lawcock, head of resources research at UBS AG in Sydney. “China is a net importer of copper, bauxite, alumina, nickel, zircon, uranium. China is looking for ways to secure supply of these raw materials.”