Putting the spice back into investing.

The trend dividend is your friend

Saturday, November 29, 2003
The recent rebound in the stock market has shown the investing class that they were right all along. Returns come via price increases - discussion over. Well that hasn't always been the case. The most recent past (since about the middle of the 1990's) has profited from a huge expansion in valuations and a concurrent rise in share prices. But this notion of return via valuation change is not something we should take for granted. Longer time series show hat most return was generated through and can be explained by dividends.

Classical finance theory holds that dividends are irrelevant - lower dividends mean that the firm is investing more into lucrative internal growth opportunities which will grow future earnings. Sadly this relationship doesn't seem to hold. Buybacks are also often used to explain the irrelevance of dividends. The problem with buybacks is that they are seldomly used to really retire stock. A nice overview of what a buyback really tends to be used for (hint: stock options!) can be found in this paper by Kathleen Kahle. The effect of buybacks is pretty small - this working paper estimates buybacks to contribute around 0.25 - 0.5% to earnings growth per annum via higher earnings (and dividends) per share.

How much return should we expect going forward? The current S&P dividend yield is around 1.6%. All we have to do now is to add in our expectations of future dividend growth and changes in valuation. The upper bound of dividend growth should be economic growth - it stands to reason that whole economy dividends shouldn't exceed real economic growth in the long run. We should then keep in mind that the world is not a static place - we'll see future economic growth being driven by new entrants and we'll see that some of our existing earnings flow being diluted. Taking these two points into account leads me to expect dividend growth of around 3% going forward. The last part of our equation is future change in valuation. Regular readers of this blog know that I'm not all that happy about current valuation levels - I'll assume no change in valuation - i.e. multiple expansion - going forward.

Adding up the numbers tells me that I should expect a real stock return of around 4.6% going forward. A far cry from what other investors seem to be expecting (see page seven)! either prices need to fall to achieve expected returns, or we'll have to accept the fact that long run stock returns will turn out to lower than we thought. Or I'm just wrong and we'll see continuing multiple expansion and rising prices going forward.

Numbers galore

Wednesday, November 26, 2003
Lots of numbers out before the holiday. In a nutshell: capital goods orders looked good with the core number up 1.7% which was pretty much in line with what people were expecting. The big question was "who bought all the aircraft?". Inventories are starting to build up again - we saw the first rise in along time. This restocking should be a positive going forward.

Initial unemployment claims are down which is good and serves to confirm the trend. The problem is that long term unemployment has been rising for a while now. The rather bleak labor market picture was confirmed by the Chicago PMI with the employment index dropping to 48.5 from 53.1 in October. New orders are at the highest levels in 10 years and the 14 point rise in the index is impressive!

Consumer confidence came in slightly weaker than expected.

The gist: everything is just dandy - except for the fact that people are still not finding jobs. No jobs, no sustained recovery past Q2 2004.

GDP Revision - you read it here first

Tuesday, November 25, 2003
The GDP revision I expected yesterday came in today at 8.2% for Q3 a red hot quarter. A look at the components shows that consumer spending was adjusted downwards slightly, residential investment was up and - good news - companies capital spending was way up. Jim O'Sullivan from UBS had this to say (from Reuters):

"It's not totally out of the blue. Whatever way you slice it, it's a strong quarter. The bottom line is it was a very strong quarter, not just for growth. When you look at the increase in profits ... it reflects surging margins, thanks to spectacular productivity growth. And that's setting the stage for increased investment and hiring."

Just what I wrote yesterday - with one caveat: higher profits through productivity gains do not automatically feed through into more jobs. Only when companies are not able to squeeze more work out of existig people and machines will they start hiring and investing again - memories of massive overcapacity are still too bitter in some industries.

Burning down the house

Monday, November 24, 2003
If you've been reading this blog for a while, you'll have noticed that I'm a little skeptical about the current recovery. Now don't get me wrong - I'm not a raving bear but I'm just not (yet) convinced that were not just seeing a minicycle which will burn itself out by Q3 2004. I've discussed my doubts before, so I'll use this post to focus on something I haven't covered before - the state of the housing market.

Dr. Ed Yardeni, the high priest of shopping as applied to investment strategy, starts off last week's Investment Strategy Weekly with this comment:

I believe that a widespread concern among equity investors is that consumer spending could weaken in 2004. Of course, investors have been worrying about the sustainability of consumer spending for the past three years. Over this period, I’ve been confident that Americans would continue to shop, and wouldn’t drop as long as they have the money to spend. After all, we Americans understand that the true meaning of life is shopping!

Any bear that reads this will roll over in his cave, raise an eyebrow and mumble something about tax cuts and irresponsible fiscal policy before going back into hibernation. Tax cuts have undoubtedly fueled consumption to a pretty large extent - just as mortgage refinancing has. This is the reason why I'm so interested in the goings on in the housing market. Tax cuts petering out and mortgage refinancing stopping might lead to a significant economic double whammy in 2004.

Falling interest rates led to rising demand for houses and significant mortgage refinancing activity. Refinancing managed to compensate for at least some of the negative wealth effect of the stock market in 2001 and 2002. Refinancing accounted for around 70% of total mortgage origination over the past half year. Over half of the refinancing activities involved equity cash-outs. As interest rates are off their historical lows savings generated via cheaper debt are lower.

Much of the cash released via refinancing has been parked in savings accounts - Dr. Ed writes:

"Nothing To Fear But Fear Itself. Since May 2000, 30-year fixed mortgage rates plunged 343 basis points from 8.64% to a low of 5.21% during the week of June 13, 2003. This rate then rebounded, along with bond yields, to 6.44% recently (Figure 4). Refinancing activity soared as mortgage rates fell (Figure 3). When they refinanced, many homeowners also borrowed more money. Why would they have parked much of it in savings deposits? Fear: fear of losing their job; fear of wage, salary, and bonus cuts; fear of investing in stocks; fear of terrorism. As these fears dissipate, they are likely to spend and invest whatever cash they have left from their cashouts."

Well that's his opinion - it could also well be that consumers don't shake off their insecurity and use some of the mattress money to pay down debts or just keep the money in money market funds. Add in the fact that windfalls payments to households via tax cuts will fade by Q2 of 2004 and you're there where we started: People having to depend on normal income to finance their lifestyles.

Sales of existing houses have constituted another source of cash for households. Fed Chairman Greenspan said this back in March:

"An even greater support to the economy than cash-outs last year was the extraction of home equity associated with a record 6.4 million existing home sales, including condos, at record prices. This pace of ownership turnover of the existing housing stock also reflected the near-record-low mortgage rates."

This boom in property prices is especially robust. Low interest rates opened up attractive buying opportunities for those not previously able to afford to buy. This has led to a surge in property prices - home prices are up by around 7% this year. This is a marked contrast to personal income which is only up by around 3% yoy. This - along with rising rates - has led to housing becoming less affordable over the past few quarters. The National Association of Realtors Housing Affordability Index shows that homes are not a bargain - add in rising rates and they'll become downright expensive if prices don't fall.

My call is that the stimulus to consumption via tax cuts and cheaper mortgages will fade going into 2004. This will turn the spotlight firmly on the underlying factors such as personal income and - ultimately - the job market. Keep in mind that rising productivity can mean that ever fewer workers are needed to produce the same amount of output - not the best way to reduce unemployment.

I'll led the Fed Chairman have the last word (Ok. I admit he was wrong in with regard to the year):

In summary, the frenetic pace of home equity extraction last year is likely to appreciably simmer down in 2003, possibly notably lessening support to household purchases of goods and services.

Morning roundup

The morning news trawl turned up this little nugget about the bearish stance of Merrill's chief US strategist. The gist of the piece is:

Amid a rising tide of complaints, Merrill Lynch & Co.'s chief U.S. strategist, Richard Bernstein, is seeking to defend his bearish view of the stock market from investors who believe he is hopelessly wrong. and "the report outlined reasons for his negative views -- such as a projected slowdown in profit growth at U.S. companies -- and bemoaned current levels of investor optimism."

Wow! I hold some of the same opinions as he does - now if someone would just adjust my compensation!

Not much news flow expected today. The ongoing story is the friction between the US and almost everybody else on the subject of trade. The steel dispute will probably slink out the back door this week - much commentary and analysis on that subject showed that the tariffs were hurting key US industries as much (more?) as they were "helping" dfomestic steel producers. My call is that tariffs go in the next two weeks and get replaced by some sort of monitoring system. I wouldn't bet on the textile lobby getting it's way either - the announcement to limit the import growth of some textiles was a pretty smart move by the Bush administration. The textiles in question only account for a small fraction of Chinese exports (and conversly US imports) but measures like this sound tough and make the adminstration look good ahead of the election year.

Tomorrow will see happy faces - Q3 GDP will get revised to something above 8% on stronger data out of the construction sector.
10:21 AM :: Karsten :: permalink ::


Saturday, November 22, 2003
We have guests this weekend so I won't be able to do much in the way of posting. I have two or three ideas of things I want to write about so I'm sure that you'll see new material on here by Monday. See you then.

Paper watch

This paper (Religion and Economic Growth) was referenced in last week's Economist. I haven't gotten around to reading the whole thing - but the title and writeup in the magazine looked pretty interesting to me. What is it about?

Authors Robert Barro and Rachel McCleary analyze the influences of religious participation and beliefs on a country’s rate of economic progress. The authors use six international surveys conducted between 1981 and 1999 to measure religiosity -- church attendance and religious beliefs -- for 59 countries.

So what's next?

Wednesday, November 19, 2003
After this what? Broke brokers snatching piggybanks?

The Bulls They are A-Ragin' Revisited

Peter over at the Gammaholic read my post on CotC (thank you) and was nice enough to comment on it.

Point one, however, is weaker than it seems. Yes, investor confidence is high by some measures. The first measure Karsten brings up is the CBOE's volatility index, which he points out is extremely low. Now, anyone who mentions the VIX index in a blog is OK in my book. However, the idea that the current low level of the VIX indicates investors are complacent strikes me as a misinterpretation.

The VIX index is not driven only by customer purchases and sales of options but also by the actual volatility of the market. You could buy options, thinking they are "cheap" and eat a lot of decay if the market does not move enough. Over the past six months, the the realized volatility of the S&P 500 index has been lower than at any time since a brief period in 1998, and before that 1996. The current "low" reading for the VIX would have looked "high" in the mid 1990s. The market may simply be adjusting to the end of the bubble-bear market period of the last 5 years. Perhaps investors not jumping in and out of the market can be seen as a sign of complacency, but that seems a bit of a stretch.

"The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500® index options prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility." I've taken this quote directly from the CBOE.

The VIX is a sentiment indicator - it tells us what investor's expectations of future (30 days) volatility are. I agree with Peter that the VIX is - partly - driven by historical volatility - just as all option prices are. People use all kinds of methods to make assumptions about future volatility. Some - if not most - of these use historical volatility as inputs. The thing to keep in mind is that historical volatility can (and will) diverge from implied volatility as calculated from market option prices. CBOE goes on to call the VIX a "market fear gauge" and then demonstrates that there is a negative correlation between the VIX and the underlying index. The CBOE says: "VIX measures market expectation of near term volatility conveyed by stock index option prices. The original VIX was constructed using the implied volatilities of eight different OEX option series so that, at any given time, it represented the implied volatility of a hypothetical at-the-money OEX option with exactly 30 days to expiration."

My reading of the VIX is that investors are not willing to pony up much money for put options (see also the P/C ratio) which in turn reduces prices and implied volatility (i.e. exactly what the VIX measures). Or maybe it is the other way 'round: people expect future volatility to be low so that they are not willing to pay high prices for insurance.

Karsten points out that the Yale School of Management 1-year investor confidence index is at a high level. Given that the chart indicates a certain lack of data going back past a few years, I am not sure how good a contrary indicator this is. The institutional confidence indicator has more data, and that seems to indicate confidence was almost this high in 1991 (good time to buy), 1998 (good time to buy), and 2001 (veeery baaad to buy). So, again, I fail to see how this is a reliable contrary indicator.

We also get the AAII (American Assoc. of Indiv. Investors?) Investor Sentiment Index. This is above the bearish 70 level. Of course, it went to that bearish level in early 1995 when the S&P index was around 500. Personally, I wouldn't feel too cocky having missed the bear market by means of missing the preceding bull.

True enough. All I wanted to do is get some "pure" sentiment data on the table. I don't think that anyone should rely on any one single indicator - please consider the two aforementioned ones as a backdrop for the other cited indicators. I'd like to stress the fact that I was trying to show that there is a whole series of little mosaic stones which - taken stone for stone - can all be singled out for criticism. If - in contrast - you look at "the big picture" you get an impression of a very sentiment-driven market. This can be a positive if the real world catches up to animal spirits. The way you read the data depends on your underlying assumptions about the economy - investors are either smart or greedy right now.

All these sentiment indicators miss one major point. They point out what people say, not what they do. You can be bullish but not long, or bullish and long. Those two possibilities have different implications for the future of the market. Further, I am unaware of any time series study that has ever shown these indicators to work. That may speak more to my ignorance, though. (To his credit, Karsten also mentions the put-call ratio. Given that this is an indication of actual bets people have made, it seems a better indicator than the others.)

Well the VIX measures exactly what people do - it looks at the prices people are paying for options. So does the Insider buy/sell ratio which Peter didn't comment on. Other indicators of investors putting their money where their mouth is, are discounts on closed end funds and market volumes.

Discounts on closed end funds are a staple of behavioural finance research (this is a good summary). A shorter explanation of the uses of this indicator is taken from Marketgauge:

"Closed-end funds rarely trade exactly at their Net Asset Value (NAV). They often trade at a discount when investors are bearish, or at a premium during optimistic periods. The discount or premium at which closed-end funds trade is a reflection of investors' appetite for stocks. Although this index is relatively new, it has demonstrated that extremes in the average discount may be early predictions of future market conditions."

This indicator is telling us that the discount is exceptionally low at the moment. This is another bearish signal which is generated by doing, i.e. buying the funds - not by saying, i.e. taking part in a survey.

The most telling signal of putting your money where your opinions are is market turnover. Let me cite this paper by Statman, Thorley and Vorkink: "Specifically, market-wide trading activity in NYSE/AMEX shares is positively correlated to past shocks in market return, with the turnover response lasting months and perhaps years. This increase (decrease) in market-wide trading activity subsequent to bull (bear) markets can be explained by either the overconfidence hypothesis or the disposition effect."

Turnover has been dropping in the past couple of months but is still very very high.

Finally, Karsten discusses PE ratios. This may be the time that PE ratios give a good signal about the future, but it hasn't happened much in the past. There is simply no evidence PEs work as a predictor. They were plenty high in 1932, after the market had dropped to its Great Depression low. A high PE could have shaken you out of the market in the late 90s or the early 90s. Besides, instead of just looking at past averages of PEs, shouldn't we look at the ratio as adjusted for taxes and interest rates? We have the lowest interest rates since the 1950s, and then the marginal tax on capital gains was 50% and the top tax on income (for instance, dividends) was about 90%. So while today's PE may look high, it may well be closer to the new norm ("permanent high plateau", anyone?).

Let me try to go after these valuation aspects in sequence. Multiple expansion could be justified by positive tax effects - this would then imply that companies offer higher net returns, which in turn lead to a higher price for these earnings. I know too little about the US capital gains regime, so I have to pass on the pure capital gains side. What I do know is the fact that dividend taxation has changed. For this positive tax move to feed through into higher multiples, companies have to pay out dividends. Now as far as I know, dividend yields have been steadily falling - management has chased internal investment opportunities instead of paying out the booty to shareholders. All told, I can't imagine tax effects justifying the kind of multiple we're seeing right now.

The interest rate argument (Fed Model) usually contrasts earnings yield with the T-Bill yield. There are a couple of points that trouble me with this comparison. The minor one is that we should compare corporate bond yields with earnings yields. The second one is that this comparison handles inflation in a lopsided way and assumes a lasting positive correlation between bonds and equities. Typical equity valuation models use some form of discounted cash flow model. These models have an inflation-component in both cash-flow and discount rate. This leaves the result in real terms.

In reality investors have been dropping their discount rates in lockstep with falling bond yields. The reason that these yields have been falling in the first place was low inflation. So far so good. What investors haven't been doing, is revising cash-flow projections in the same manner (to account for disinflation). A look at Japan show that correlation turned sharply down just as disinflation turned to outright deflation. "Expensive" bonds got more expensive and "cheap" equities kept getting cheaper!

My read on P/E's is as following: P/E's tell me what the market is expecting. A look at today's P/E of around 30 (trailing) or 18 (12 mth) tells me that investors are looking for very strong earnings growth looking forward. I just can't find any reason for this ongoing multiple expansion. The tax argument might be valid, but I just can't see it accounting for this dramatic increase in the multiple. Again: I might be very wrong - the real world could quickly catch up to the market by showing us a very sharp and sustained recovery - my problem is that I just can't seem to find evidence for the sustained part.

I certainly don't know which way the market will go. I have been bullish since a too early July 2002. The day after the market low last October, I wrote "the market here is the mirror image of the top". I wish I had just said "Buy" and then I could claim to have made a great call, rather than just the murky statement I made. With the FED pumping in money and unable to raise rates soon, I continue to be bullish. This may look awfully silly if the last leg of the bear market is waiting to smack down on all our heads, but I figure life without the prospect of looking foolish is not worth living.

The Fed pumping money is helping turbocharge economic growth - some calculations have found that the massive fiscal stimulus is the reason for almost all nominal GDP growth. The liquidity argument is also often cited in a different way: "Just look at all this mass of money on the sidelines - when these guys get out of the money market, we'll really surge!". Logical? Well, not really. Imagine you have a friend called Ed. He has been sitting on 100k of spare cash in his money market mutual fund. He represents all this spare liquidity. He is pretty peeved that he missed out on the positive market performance. He now comes into the market and buys Stocks from Ted. So now Ted has the cash. Did anything really happen here?

Forex in the spotlight

The euro reached an alltime high against the dollar, rising to 1.1950 at the time of writing. The european currency managed to breach the resistance around 1.1850 and then just kept rising.

Ex Treasury Secretary Robert Rubin went on record to say that the US had made a hrrid fiscal mess for itself and that "that there's a day of reckoning out there". Sounds almost biblical! Commentators are trotting out the hotting up of the US-China trade dispute and capital flows.

(Adjusted) Capital flows look like the bigger story to me. September data show the the massive selling of US equities by Europeans and the equally massive buying of foreign (mostly Japanese and Taiwan) equity by US investors caused significant pressure on the greenback.

The big story regarding capital flows has to be the significant decline seen in the foreign purchases of US Treasuries. Foreigners invested $ 30bn in August - this then slumped to $ 13bn in September. This lack of demand for government paper directly feeds through into currency demand.

Some action going on in the gold market. Rember to visit The Gold and Silver Blog for updates!

Yesterday's data came in in line with expectations. Prices are still looking weak with the core rate at 1.3%. If you look at the numbers you'll see that there isn't much upward pressure on prices. The constant murmuring from the Fed is unchanged: no rate hikes in sight, rates can stay low because there is still excess capacity.

News Update

Tuesday, November 18, 2003
Just a short news roundup:

Sec. Snow downplayed the threat of a trade war because of the US steel tariffs (which are probably hurting US manufacturing - think "cars" - as much as they angering exporters).

The economic data that came in was pretty strong - we had the Empire State Manufacturing Survey jumping to 41.01 with new orders looking very strong. A negative is/was the employment data with the index edging down to 10.26 from 11.54 - as the average workweek rose, this looks like companies are still increasing productivity by squeezing more bang for the buck out of their labor force.

Currency markets were subdued, the EUR couldn't break the 1.1849 resistance and it seems as if the traders are torn between good data coming through for the greenback and negative sentiment via new fears of increasing terrorist activity.
10:03 AM :: Karsten :: permalink ::

The Bulls They Are A-Ragin'

Friday, November 14, 2003
Welcome to singalong-time at CurryBlog. I've chosen a slightly modified version of an old favorite by Bob Dylan for our little weekend diversion. I've taken the liberty to slightly change the lyrics:

Come gather 'round investors
Wherever you roam
And admit that the greed
Around you has grown
And accept it that soon
You'll be drenched to the bone.
If your money to you
Is worth savin'
Then you better start sellin'
Or you'll sink like a stone
For the bulls they are a-ragin'

The trademark cry of every frothy market phase is "it's all different this time 'round". Well it is - for a while. Last week I pointed out that investors seem very complacent to me. I try to challenge my notions so as not to fall into the trap of seeking only confirmatory information but I keep coming to the same conclusion.

A look at market volatility shows that insurance is exceedingly cheap right now - nobody wants to buy any! The put/call ratio shows that investors are very much looking to participate on the upside - not hedge the downside.

Come analysts and brokers
Who prophesize with your pen
And keep your eyes wide
The chance won't come again
And don't speak too soon
For the market's still in spin
And there's no tellin' who
That it's namin'.
For the loser now
Will be later to win
For the bulls they are a-ragin'

Investors are rushing in to the market in a fashion not seen for a couple of years. The Stockmarket Confidence Index is showing us that over 90% of individual investors are confident that the market is going to go up over a one year span. This is about the same degree of confidence that we saw in late 2001 and early 2002. Institutional investors aren't far behind individuals with a confidence reading of around 90% - again close to the peak of 2001. The low VIX volatility finds its counterpart in investor's attitudes regarding the possibility of an impending market crash. Over 49% of individual investors say that they are confident that there will be no crash in the coming six months. This in turn leads to very low demand for protection and low (to low?) option prices - especially for (very) out of the money put options.

Dr. Shillers data is confirmed by the AAII Sentiment Index Ratio. Investor sentiment is very good. Actually its great!

Come investors, moneymen
Please heed my call
Don't stand in the doorway
Don't block up the hall
For he that gets hurt
Listen to what the insider has called
There's selling outside
And it is ragin'.
It'll soon shake your windows
And rattle your walls
For the bulls they are a-ragin'.

While individuals are rushing for the entrance, insiders are leaving through the alley. Insider selling is going on in very large amounts. Vicker insider 8 week buy/sell ratio is at 6.23 - readings over 2.5 are generally considered bearish signals. Even accounting for the fact that some sales might result from pent up demand for liquidity (didn't want to sell at earlier, lower prices but need money now) doesn't soothe my feelings on this matter. I wonder why the "smart money" is selling hand over fist and everyone else is eager to buy? Who would you rather trust?

Come mothers and fathers
Throughout the land
And don't criticize
What you can't understand
Your investments and pensions
Are beyond your command
Your old strategy is
Rapidly agin'.
Please get yourself a new one
Otherwise your losses will be grand
For the times they are a-changin'

The asset management profession has a very important goal and that is looking good to investors. I had a very interesting discussion couple of years ago - I was a very earnest graduate - with a seasoned portfolio manager. I asked him about what aspect of his job he considered to be the most important. I was waiting to hear something grand along the lines of "my mission in life is to generate superior returns for my clients...". He said "The most important part of my job is putting on a show for my clients." Gulp. Cynical? Yes, but probably true for very many investment advisors and managers.

If you look at investment funds level of investment, you'll see that cash levels are (still) low and have been declining. No manager wants to explain to investors why "he didn't get it". Better to crash and burn with everyone else than to be the only laggard. Or as Keynes put it : "Worldly wisdom teaches that is better for reputation to fail conventionally than to succeed unconventionally".

The chart it is drawn
The curse it is cast
The buying one now
Will later be last
As the present now
Will later be past
The valuation is
Rapidly fadin'.
And the first one now
Will later be last
For the bulls they are a-ragin'

Valuations are still looking stretched to me - the S&P 500 P/E Graham&Dodd P/E is at over 30. A level that implies high earnings increases going forward. That would - by itself be a contentious fact - but keep in mind that investors are not looking for valuations to come back in line via stagnant prices and rising earnings! They are looking for price increases (i.e. return) as well.

The annual SIA survey tells us that: "On average investors expect a return of 10% on their investments, compared with 13% in 2002, 19% in 2001, 33% in 2000, and 30% in 1999. Dear readers, irrational exuberance is still with us.

I hope that our little musical interlude calmed the savage bull. If you at any time feel the bullish urge, feel free to whistle our little ditty.

Music and original lyrics are of course copyright by Bob Dylan.

Update^2 The relationship between the roulette wheel and markets revisited

Wednesday, November 12, 2003
Alexander Crawford had this to say about my roulette wheel analogy:

You should re-examine the roulette wheel analogy. The "Vig" or vigorish of a roulette wheel with a single 'zero' and a roulette wheel with BOTH a single 'zero' AND second "double zero" differs according to the differing statistical designs of each.

Perhaps I am misunderstanding your case, and if so I apologize. But compare one wheel with a single zero versus another with two zeros. Because each spin on the two wheels is a unique statistical event, there is the possibility that over a million spins on each, that the wheel with only one 'zero' will actually produce less profit for the House than the wheel with two 'zeros'. Yet this would be a statistical abberation. In the vast, vast majority of cases the person who identifies the greater statistical advantage to the House using a double zero roulette wheel over another House using a single zero roulette wheel would be wise to bet on that House that is LIKELY to enjoy a higher profit due to using the double zero roulette wheel.

My point is that even a system with a predictable statistical model, when averaged across innumerable 'events' that are unique in and of themselves within that model, possesses a nasty surprise or three that are unavoidable if a handful of outcomes of those 'events' are what one is risking upon. (Personally I like craps as a gambling analogy better than roulette). To the House, roulette isn't considered a "game of chance" (it doesn't pay 'true' odds!). Every casino "gambling" game has a designed in Vig that the House depends on to evaluate it's long term profitability. Even in Craps, which (with behind the line odds) allows an individual player to come closest to 'true odds' with the House, there is STILL enough of a Vig to make it worth the House's effort to run Craps tables.

Whether a particular roulette wheel 'loses' more than it 'wins' for a casino over the short term isn't really a consideration, as unless there's some specific design flaw the casino knows this is a abberation, and that as ALL it's roulette wheels generate more and more individual 'events' towards infinity, the House will continue on average to profit via the vigorish.

I had this to answer: the roulette wheel just serves as an example of a generator of random numbers. I was not contrasting the possible p&l in a casino to an investors p&l.

The main difference between markets and gambling is that we can calculate the odds in gambling. The house can then adjust payoffs to the probabilities - it is understood that the house has a lot of money so it can stay the duration. If the house does a good job in calculating the odds and has a large enough bankroll it will keep making steady profits (on average).

There is no orderly returns-generator behind finacial markets. Imagine playing roulette in a casino where the table is in one room and the wheel is in another (locked) room. The croupier then goes in the locked room and comes back with a number.

This is what happens in markets. We have no idea if he actually uses the wheel or if the wheel is fair if he does use it. The casino could at times spin the wheel and make up numbers at other times.

As we human beings are orderly, we look at the past - say - 10.000 numbers and say "wow, this looks like such-and-such a distribution". This assumption holds up until the guys in the locked room start getting frisky and come up with numbers that are not even on the roulette table. We then add the numbers to the table and incorporate this event (think "fat tails") into our model. This new and improved model is then used until it fails. This process keeps going on. That is why I consider tools like VaR to be pretty flawed - they are only valid as long as everything stays in the context of the model. The problem is that massive loss events usually happen outside the model assumptions. That is why "VaR fails us, when we need it most".

My point is that it is a fallacy to compare a decision under risk (gambling with a fair wheel - i.e. known odds) with a decision under uncertainty (life and markets).

Update on my recent CoTC Post

Tuesday, November 11, 2003
I'd like to say hello to all the people visiting from the Accidental Jedi, this week's host of the Carnival of the Capitalists. I'd like to thank all readers who've since commented - all feedback (positive and negative) is appreciated. A very nice and respectful "thank you" goes out to Jonathan from Chicago Boyz for mentioning my contribution on that fine blog.

I finally found a reference I was meaning to include in the original post concerning thinking in expected value. As I have nothing much else to post today - not because of a dearth of news, but because I actually spent the whole day working and can't be bothered to come up with something original - you can enjoy this little gem here:

Horse racing offers researchers a platform which is in some respects similar to investing. Steven Christ, the publisher of the Daily Racing Form has this to say about betting at the track:

"The point of this exercise is to illustrate that even a horse with a very high likelihood of winning can be either a very good or a very bad bet, and the difference between the two is determined by only one thing: the odds. A horseplayer cannot remind himself of this simple truth too often, and it can be reduced to the following equation:

Value = Probability x Price

This equation applies to every type of horse and bet you will ever make. A horse with a 50 percent probability of victory is a good bet at better than even money (also known as an overlay) and a bad bet at less (a.k.a. an underlay). A 10-1 shot to whom you take a fancy is a wonderful overlay if he has a 15 percent chance of victory and a horrendous underlay if his true chance is only 5 percent. There are winning $50 exacta payoffs that are generous gifts and $50 exacta payouts where you made a terrible bet."

The next sentences can be applied directly to investing in the market (replace the horses with the financial instrument of choice):

"Now ask yourself honestly: Do you really think this way when you're handicapping? Or do you find horses you "like" and hope for the best on price? Most honest players will admit they follow the latter path.

This is the way we all have been conditioned to think: Find the winner, then bet. Know your horses and the money will take care of itself. Stare at the past performances long enough and the winner will jump off the page.

The problem is that we're asking the wrong question. The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory"

Read the whole excerpt here.

Ex orient lux

Monday, November 10, 2003
I spent some of my weekend blogjumping and was astounded by the sheer volume of commentary on Iraq which is out there in the blogosphere. I don't want to add to all this political/military blogging but thought that it should be possible to find something vaguely Arabic/Islamic to write about. As luck would have it, I stumbled across an article about Islamic finance yesterday evening - this in turn led me to proclaim today to be "Islamic finance day" on CurryBlog. I'd like to start our little tour with a success story from a region best known for other kinds of stories.

As we all know, Pakistan was the best performing stock market in 2002. This is due (at least in part) to two separate effects: the central bank has kept the Rupee low against the dollar and interest rates below the inflation rate, which has led to Pakistan booming. The second reason for the great performance was the US Patriot Act. This piece of legislation included a provision to freeze suspected terrorist funds. Very many Pakistanis didn't trust US authorities (freeze assets now and ask questions later) and withdrew their assets from US banks. This repatriation of capital added to the already high amount of liquidity sloshing around the system and furthered the positive market performance. We should be glad that our mutual fund companies haven't cottoned on to this yet - we would otherwise see brokers running around touting Pakistan as the next China (and then late-trading the funds).

Our next stop on the tour takes us back in time to Baghdad around the year 780. This date marks the birthdate of Abu Ja'far Muhammad ibn Musa Al-Khwarizmi. Al-Khwarizmi was one of the foremost mathematicians of his time and laid the groundwork for much of the math that people studying finance have fun with today. He was a very practical mathematician who described the purpose of his work as teaching:

... what is easiest and most useful in arithmetic, such as men constantly require in cases of inheritance, legacies, partition, lawsuits, and trade, and in all their dealings with one another, or where the measuring of lands, the digging of canals, geometrical computations, and other objects of various sorts and kinds are concerned.

He is probably most famous for helping to introduce Hindu-Arabic numerals to the west. The title of the book "Al-Khwarizmi on the Hindu Art of Reckoning" was translated into the Latin "Algoritmi de numero Indorum" gave rise to a very familiar word - the algorithm. This book set the stage for western mathematicians to abandon the roman numerals which proved to be a major hindrance to any kind of advanced calculation.

One of the most famous people in western mathematics, Leonardo of Pisa (1170-1240), commonly called Fibonacci, drew heavily on Al-Khwarizmi's work. Arab traders very much an important factor during Leonardo's time and Arabic was almost the lingua franca of world trade during the middle ages. For those interested in further information: William Goetzmann has written a very accessible account of Fibonacci which is freely available here.

The next stop of our tour leads us to the practical side of Islamic finance. One of the basic tenets of an Islamic financial system is that the real economy is always the dominant partner in any kind of transaction. Dr Muhammad Nejatullah Siddiqi described the relation as follows during his speech at the Harvard University Forum on Islamic Finance "Islamic Finance: Challenges and Global Opportunities" Cambridge, Mass. USA October 1 & 2, 1999:

"When two parties, the financier and the entrepreneur, agree that an opportunity for creating additional value exists, they come together to realize the gain and share it. Since economic activities are, by definition, value creating activities, sharing as a basis of finance is inconceivable without economic activity."

Christianity started disregarding the prohibition on interest in the 14th and 15th century with instruments such as the "contractus trinus" taking the place of outright interest. This practice of using rental-purchase agreements as a substitute for the charging of "pure" interest is a fixture of most Islamic financial systems. The Qur'an expressly prohibits "riba" (which translates to increase) while permitting ijara (leasing) or murabaha (cost plus financing). The common denominator is that all these instruments have some element of risk sharing and always lead to investment in real assets. Insurance, the classical division of risk, is also different in the Islamic world because of the injunctions against gambling (maysir) and agency problems (gharar). A thought provoking (short) discussion on these subjects can be found here. The Malaysian highway company Silk structured a single A-rated bond issue which doesn't pay direct interest. This shows that large transactions involving capital markets are possible in the context of Islamic law. I can recommend this site to anyone interested in further information.

The last stop of our short financial tour is the subject of Islamic investment. Many western banks have been trying to carve out a share of this attractive market. UBS has even launched a subsidiary with the name Noriba (get it?) to serve Islamic markets. There are now Islamic mutual funds on offer worldwide and some pundits are looking 50 - 60% of all Muslim savings being in such investments by 2010.

The proper catalyst for the growth of Islamic (or any other kind of) finance in any country is - in my view at least - a successful economy with secure property rights. This is something which has been sorely lacking up to now. We should all hope that the removal of the Iraqi dictator paves the way for economic freedom in a rebuilt Iraq. It would be a pity if the country that gave us - amongst others - the aforementioned Al-Khwarizmi couldn't manage to get back on its financial and political feet in the next couple of years. I started with an Iraq reference and am ending with one and I hope that you enjoyed my little tour.
12:30 PM :: Karsten :: permalink ::

Koizumi clings on to a majority

Sunday, November 09, 2003
Koizumi wins. The main opposition party, the DPJ, managed a good showing and increased its total number of seats to 177. Although this is still pretty far away from the goal of 200 seats it looks like Japan is heading into a two party future. The win should silence some critics of Koizumi in the LDP and strengthen his mandate as a reformer (Highway corporations, banks, postal savings system). Most market-watchers will have expected a win so this should be a non-event market-impact wise.

Koizumi might start off the week by quelling the dispute which has arisen because of this:

"Japanese students have caused an uproar in China by wearing bras and cups over their private parts during a festival in Xian, flaming anti-Japanese sentiments leading to large-scale protests... (more)"

Credit Quality -

As this is Sunday (i.e. not much news) I thought I'd point you to a very nice data source on the (US) economy. The Office of the Comptroller of the Currency (OCC) administers the Shared National credit program (SNC). Don't worry if you've never heard of the program, most people haven't. The SNC monitors syndicated loans over $ 20 million which are shared by at least three institutions.

The leader of every such loan syndicate has to report each loan to the administrating authorities by the end of January. This sets the review process in motion during which every loan is reviewed and Rated. The rating structure is:

PassNo risk apparent
Special MentionPotential risks or weak points
Classified (Substandard, Doubtful, Loss)Houston, we have a problem

The institutions are advised to harmonize the SNC ratings with their internal ratings i.e. use the ones from the SNC (there is an appeals process). Large loans are subject to a Re-Review after 6 months (usually September/October). Results are Published by the FED and make for interesting reading.

The gist of the most recent report is that:

The quality of large syndicated bank loans stabilized this year, according to the Shared National Credit (SNC) review released today by federal bank regulators. However, regulators noted that adversely rated loans remain at an elevated level, and will require continued vigilance.

Adversly rated (Special Mention and Classifed) loans were at a level last seen in 1991 - the problem being that the number of loans went down and the number of problems stayed the same. Telecoms and energy sectors were - alongside Argentina - the main culprits this year.

The SNC report is a very useful tool to monitor trends in loan quality. What I find interesting about the report is that although loan quality (as measured by the SNC) has declined sharply since 2000, US Bank's ratings have gone up. The resilience of the US-banking sector has been quite remarkable - many US institutions have turned out be astute lenders. A look at the report shows that the deterioration in credit quality affected foreign banks to a larger degree. The report says:

To a great extent the deteriorating trend in SNC credit quality at FBOs is explained by their higher share of riskier energy commitment holdings relative to U.S. banks.

Seems like US Banks smelled a rat and got out in time leaving the field open for stupid (insert country here) money. The new round of the SNC starting next year will be a further clue to the state of the economy in 2004.

We have ways of making you talk invest!

Saturday, November 08, 2003
German investors can look forward to a new asset class from January 1st onwards. The so called Investment modernization bill enables individual investors to buy hedge funds just as they can now buy "normal" mutual funds. The only restriction is that investments have to be in fund-of-fund structures - although single manager funds are allowed if they are sold to qualified investors. All hedge funds carry this "surgeon general" type warning: The german minister of finance warns that investing in this fund can be hazardous to your wealth lead to you losing all the money that you've invested (no, I'm not kidding).

This change in the investment law is not the big leap forward it might seem like. Investors have been able to buy certificates representing hedge fund investments for a couple of years now. What the law will do is let big mutual fund companies finally jump into the fray with their own funds. This will probably give the asset class a bad name because the quality of your sales force is more important than your investment acumen in the retail arena.

Here is a starting link for al my German readers about how many of your euros to put in hedge funds. Have a great weekend.

Investing with your Palm

I use my Palm PDA pretty intensely and am always interested in investment-related software. One of the best products I've found is the fantastic WMS Mobile. This program offers you the possibility to manage hundreds of stocks and indices. You get a portfolio-management tool (with custom filters), charts with RSI, MACD, MAs, OBV and momentum indicators, a ranking of winners and loosers and much much more. You can update data via Hotsync or by using your mobile phone.

This is what the chart looks like on the device:
WMS Mobile Chart

Carry Trades are back!

Friday, November 07, 2003
Just saw an article on Reuters (can't find it on the web) about carry trades being back. This brought back fond memories of the good old Yen carries a couple of years ago. A simple carry trade - for those who are wondering - would be to borrow yen, sell them against the dollar and then invest the proceeds in treasuries. It is pretty easy to see why everyone used to use the yen - low funding costs and and not much risks of quick currency appreciations.

Now the prime funding currency seems to be the swissie which is then sold vs. the mexican peso. The rationale being that Swiss interest rates and growth prospects are low while the peso acts like the US on steroids (meaning that all movements are amplified). The Swiss-to-peso trade nets the investor around 0.36 percent per month from the interest rate differential. A favorable exchange rate move adds, a negative move subtracts from that.

The nice thing about carry trades is that they can really move the market if enough people get into them. Selling the funding and buying the investment currency will - for a time - work as positive feedback.

Two random thoughts to end this little piece:
Quite a few Germans fund their home buying in the swissie or the yen (do people in the States do that? Do banks offer mortgages in other currencies? Mail me or leave a comment if you know).

The peso is a great currency to lose all your money with :-)

Good news from the jobs front

Payrolls for October came in looking very strong - 126k rise in payrolls was much higher that the 58k that were expected. The jobless rate fell to 6%. The Dollar is looking strong against the EUR, S&P and NASDAQ futures are up vs. fair value, Europe is higher across the board.

It's official: buying high and selling low is the name of the game in mutual fund investing

Thursday, November 06, 2003
Well, actually it isn't. But it is what a lot of retail investors do. Dengpan Luo of the Securities Litigation & Consulting Group finds evidence of trend chasing amongst mutual fund investors. I just have to quote this little gem from the abstract:
"Mutual fund investors' economic trend chasing behavior and their negative reaction to changes in the future expected stock market returns provide some evidence that they are irrational and could play a destabilizing role in the financial markets."

From a regulator's point of view you would probably have to lock all those pesky little investors up - can't have then destabilizing the market with their irrationality! Good thing that the funds themselves are well run and incredibly honest (cough, sputter).

One question still remains: how does someone with the "Securities Litigation & Consulting Group" find spare time to engage in research during these litigious times?


Jobless claims plunged in the United States last week to their lowest level since January 2001 - 348k people filed new claims vs. the 380k expected. Productivity came in a little weaker at 8.1%. This - especially the jobless claims - is potentially very good news if it filters through into the payroll numbers tomorrow.

BoE raised rates as expected, ECB let rates stay put. No surprises there.

Data Watch

New orders for manufactured goods rose 0.5 percent in September with orders for non-defense capital goods compensating for a drop in defence-related items. The number was pretty close to expectations and didn't cause anyone to get excited. Although most people thought that the ISM non-manufacturing index was going to come in somewhat weaker, it surprised market watchers (including myself) by to 64.7 from 63.3 in September.

Even with all these strong numbers coming through I'm still not convinced that we're seeing a sustainable and broad-based recovery. The positive effects of the tax refunds is slowly starting to wane before it picks up again in Q1 of next year. A negative scenario would see this severly impacting Q4 retail sales which would weigh heavily on sentiment.

The Japanese leading indicator came in at 80 which was slightly lower than the 83 that people were looking for but still the fifth straight reading above the dividing line at 50. This coincides with Japanese auto-makers posting some very good-looking numbers for the fiscal half year.

European markets are looking a little weak right now - all eyes on the Bank of England's MPC. A rate hike of 25bp is broadly expected. The ECB is meeting today as well, no major news expected from that front.
10:00 AM :: Karsten :: permalink ::

Complacent investors?

Wednesday, November 05, 2003
We saw some action in the bond market with Treasuries inching higher after the downbeat report by Challenger Gray & Christmas yesterday. The outplacement firm announced 172k job cuts in October which is the highest numer of jobs lost in one year. This does not bode well for a strong rebound in the labor market. We'll have to keep looking at what the payroll numbers tell us on Friday. The big piece of data out today is the ISM Non-Manufacturing Index out today @ 15.00 GMT - most people are expecting it to decline slightly.

No big news on the equity front with most major indices treading water ahead of the data coming out from Cisco today and the labor market data out on Friday. An indicator that I like to watch is market volatility which you can follow via any number of indices. If you look at the VIX, you'll see that we're at a multi year low. This means that protection can be had for very little money (and/or that noone is actually buying any). This looks like a very large bunch of complacent investors out there to me. Could be the time to buy puts. Speaking of which: I'm sure most of you are familar with the old "rule" that most options expire worthless. I don't want to discuss the veracity of the statement itself (it probably isn't true), I'd prefer to point out that the amount of worthless options doesn't matter at all.

The thing to keep in mind in investing is that you're always trying to optimize your expected value. There is no special award for being right more often than being wrong. To quote George Soros "it doesn't matter how often you are right or wrong - it only matters how much you make when you are right, versus how much you lose when you are wrong."

This is so obvious that most people seem to ignore it. The simple reason is that people love being right. No investor likes losing money on a daily basis while waiting for a trade to pay off in sufficient magnitude to make a total profit. You need mental stamina and a lot of money (to be able to take the constant small losses) to even begin thinking of investing in such a fashion. You then have to able to identify investment opportunities that other investors are systematically undervalueing. The good thing is that there seem to be such investments. Take the aforementioned VIX - it tells us that most investors are assigning a very low probability to the S&P crashing.

I agree with Nassim Taleb that very many people (and market participants) are not able to correctly price "unlikely" events. Risk managers, money managers and individual investors cling to the notion, that returns can be described by some statistical distribution or other. The problem with the assumption is that things keep happening that are - in the context of the models - almost impossible. Roger Lowenstein says this on the Crash of '87 (Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2000)):

"Economists later figured that, on the basis of the market's historical volatility, had the market been open every day since the creation of the Universe, the odds would still have been against its falling that much in a single day. In fact, had the life of the Universe been repeated one billion times, such a crash would still have been theoretically unlikely."

The fact to keep in mind is that the market is not a game of chance - we're not playing roulette. In gambling you're talking risk, in investing you're talking uncertainty. A roulette wheel is a generator of a statistical distribution which can be represented very nicely by a model. If you assume that the wheel hasn't been manipulated you can figure out your odds pretty quickly. If you compare this with the markets you'll see that you never get a chance to understand the process ("the wheel") by which the returns ("the numbers") are created. But we still attempt to model the stochastic process (think VaR!).

If you apply this thinking to options you'll see that there are very many people out there, who think that they know the "real value" of an option. They base their price on an underlying statistical model which is probably going fail at some time in the future because the underlying generator of returns (the market) does something unexpected. This will then lead to some option buyers making a killing and others - naked sellers blowing up.
12:06 PM :: Karsten :: permalink ::

News Update

Tuesday, November 04, 2003
Markets were higher pretty much across the board - strong construction spending proves that the housing sector is still one of the pillars of strength in the US economy. The ISM Index rose to a higher than expected 57 from 53.7 - Consensus was looking for a number around 56. The bad news is that the employment index is still at a sub-par 47.7. Inventories are looking interesting - it seems that customers inventories are way down - this could signal a burst in purchasing going forward. This would - in turn - spell good news for the weak manufacturing sector. I'm looking for further strong data out this week (productivity, payrolls).

Japan had some good news coming through overnight - their version of the ISM, the manufacturing sector PMI rose to 55.6 from 53 in September. You'll see this being called a "record high" - but don't expect the survey to date back to the Shogun - please keep in mind that the survey is only two years old. This did help the JPY overnight and is slowly giving me a stronger yearning for the Yen.

Deutsche Bank is disregarding all the noise coming from Moscow - they bought a 40% stake in the Russian Bank UFG Financial.

Alright then, I'm off to Graal-M├╝ritz on the Baltic for some business, I'll be back this evening and will then try to get in some more of the insightful commentary that you've come to expect from this blog.
10:09 AM :: Karsten :: permalink ::

Update: Khodorkovsky blinked.

Monday, November 03, 2003
Just a little update on my little story on the russian mini crisis from a few days back - Khodorkovsky quit as the chief of Yukos. This will probably lead to a general calming of nerves and sends a strong signal to the other russian oligarchs to play nice with the Kremlin. The RTX is up by over 7%.

We'll just legislate the yuan away!

The US Treasury released a report on October 30 examining what US trading partners currency regimes are like. The conclusion reached in the report did not satisfy all the China bashers out there. I'm quoting from the linked press release:

"The report finds that no major trading partner of the United States meets the technical requirements for designation under the Omnibus Trade and Competitiveness Act of 1988 during the first half of 2003. The report notes that while a number of countries continue to use pegged exchange rates and/or intervene in foreign exchange markets, a peg or intervention does not in and of itself satisfy the statutory test. Treasury has consulted with the IMF management and staff, as required by the statute, and they concur with our conclusions. The Administration strongly believes that a system of flexible, market-based exchange rates is best for major trading partners of the United States."

China does get a minor slap on the wrist:

"China has pegged its currency since 1994 at 8.28 to the dollar. This policy is not appropriate for a major economy like China and should be changed. The Administration has engaged in direct talks calling on the Chinese to move towards a flexible exchange regime. The Administration has utilized bilateral and multilateral forums to urge China to move toward greater flexibility."

This has of course caused uproar - someone has to be to blame for the (twin) deficits and everyone knows that the Chinese are sneaky! The Senators in the Banking Committee sure know their economics and regaled Secretary Snow with comments such as:
"The Chinese are cheating" (Sen. Jim Bunning Kentucky Republican)
"This report is a whitewash. It treats China with kid gloves when it should be taking off the gloves and confronting China about the fact that it's manipulating the yuan" (Sen. Charles Schumer NY Democrat)

Now I won't even mention the fact that Senators are probably more interested in the election cycle than in the economic cycle and that most market participants have qualified the comments as noise. I will mention this little piece of commentary by David DeRosa. He makes a very simple point:

"Wake up, senators. All that's happening is that China is riding in the U.S. currency motorcycle's sidecar. Since the dollar has dropped against the yen and the euro, so has the yuan."

I'm sure we'll see a lot of posturing by both houses as the elections come nearer. A simple search for "yuan" turns up this - a harbinger of things to come.
12:26 PM :: Karsten :: permalink ::

Sunday update: random musings on mutual funds

Sunday, November 02, 2003
I was leafing through the print version of the german business weekly Wirtschaftswoche, when I came across a little article about the retirement of a japanese fund manager. It seems that Masato Kawada managed to achieve a return of more than 500% in the three small cap funds he was managing for Invesco during 1999. His lucky streak didn't hold all that long - he lost half of his gains in 2000. My first reaction on reading this little factoid was thinking "wow, he must have generated alot of inflows for Invesco during that time" - my second reaction was to think about mutual fund investor's obsession with ratings and rankings.

I can understand that the sheer amount of funds out there are really overwhelming and therefore positively beg for classification and ordering. The only question is if all this sorting, ranking and rating actually generates value for investors. The underlying assumption is that a fund run by a "good" or "hot" manager will be a good investment going forward. The investor implies that this performance is persistent. The problem with this assumption is that the superior returns delivered by the manager could just be the result of luck - something which is pretty difficult to sniff out if you don't happen to be sitting across from the manager in question.

To paraphrase Nicholas Taleb - if you have enough monkeys typing on typewriters you shouldn't be surprised to see one of them banging out Shakespeare's Hamlet. Just ask yourself if you want to wager money on the monkey typing Romeo and Julia next. There are about a million academic papers on persistence out there - a good start is Performance Persistence for Mutual Funds: Academic Evidence (May 2003 Prepared by: Hossein Kazemi, Thomas Schneeweis and Dulari Pancholi). According too most research "good" managers are somewhat likely to repeat their good performance while "bad" managers are also likely to repeat their "bad" performance. The problem for investors is that they will find it impossible to make money off of this effect. The positive alpha is usually pretty small and transaction costs, load and fund expenses wipe out the rest. Add in the time spent poring over tables and reading the financial press and you get a pretty much losing proposition.

Alright then, real news tomorrow.