The Stock Market

[badge]

Just covered my DAX and FTSE shorts(15mins ago) from 16th April.

If support fails I'll act accordingly.

Now more pressing matters; where to dine before the curfew draws in

[badge]

Badge

You can be assured that your "Schadenfreude" at present is inappropriate - in my case. To be on the "long side" as of the close of 5-20 suggests of course that I feel the Market will go up. Therefore your "Schadenfreude" would only be appropriate IF I were wrong - but that jury is of course still out.[...]

Perhaps in your world making two bull calls and seeing enormous declines leaves the jury out.

In my world making two bull calls and seeing enormous declines should mean the sensible man asks to borrow Midas dart board. Infact not only were they bad calls, they were exquisitely timed; it would have been hard to make a larger loss if one bought on your suggestion.

I didnt read the rest of your post, if you still cant demonstrate the humility of being wrong, theres no point, its rule #1.

[midas]

Midas

Every "rebound" tends to be "technical" at first or is perceived as such until more buying comes in to "resume the uptrend". What I see at present is a good "tradeable move up" - which very well could be the end of this "turmoil".

Interpreting charts - beyond my own personal "theory" - I see potential problems ahead. In other words - I can see we could go back to todays lows - after this coming substantial move up. However - I am not in the "Crash camp" nor even "Bear Market".

In mid April - I would have agreed with those expecting potentially a big drop - but now I think we had a "big drop".

Parvis

perhaps your perception of being near a bottom is what Robert Prechter of Elliott Wave is talking about here ? ( another person who believes in squigly lines )

The Endless Bear Market?[/b]

Other than to say "a long way down," Prechter wouldn't say how much further he thinks the market will fall, suggesting a repeat of the 1930-32 scenario when [b]"extremely sharp rallies" kept investors interested and "feeling like a bottom [was] forming."

"We should be in for [another] week or two of pretty serious selling," Prechter says. "They'll be bounces along the way...but I think this should last a long time. We should be on schedule for a very, very long bear market period."

http://www.zerohedge.com/article/endless-bear-market

[Parvis]

I understand how tough it is sometimes. For instance this morning - for a moment I thought I was wrong - but I was mistaken.

[Gambles]

You forgot to mention: - All successfull Economists are typically also successfull Mathematicians. Some of those successfull Mathematicians have received the Nobel Prize in Economics.

Uh-oh

LTCM!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

it would be better sometimes if they were historians too

beware the self-appointed Masters of The Universe, Parvis my friend, and you'll spare yourself a lot of future misery!

In the time between now and you're next trade please read "When Genius Failed" and maybe watch "The Bonfire of The Vanities"

Parivs - you are leaving something out of your " calculations " or expectations

If economic models assume people will act in a rational or predetermined way ...... at least that is what

I was taught in my economics lessons, I dont believe any mathematician or economist is able to factor into the economic models the effect

of humans acting very irrationally ? i.e. in a business transcation being told something is white and

hiding the fact it is really black i.e. FRAUD .

James K. Galbraith: Why the 'Experts' Failed to See How Financial Fraud Collapsed the Economy

Concepts including "rational expectations," "market discipline," and the "efficient markets hypothesis" led economists to argue that speculation would stabilize prices, that sellers would act to protect their reputations, that caveat emptor could be relied on, and that widespread fraud therefore could not occur. Not all economists believed this – but most did.

Thus the study of financial fraud received little attention. Practically no research institutes exist; collaboration between economists and criminologists is rare; in the leading departments there are few specialists and very few students. Economists have soft- pedaled the role of fraud in every crisis they examined, including the Savings & Loan debacle, the Russian transition, the Asian meltdown and the dot.com bubble. They continue to do so now.

http://www.zerohedge.com/article/james-gal...aced-profession

I'm doing a piece on Soros' Reflexivity speech at Cambridge last month but basically physics, maths, rational economics, EMH out the window - understanding history, people and mean reversions are in!

[Gambles]

You forgot to mention: - All successfull Economists are typically also successfull Mathematicians. Some of those successfull Mathematicians have received the Nobel Prize in Economics.

Uh-oh

LTCM!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

it would be better sometimes if they were historians too

beware the self-appointed Masters of The Universe, Parvis my friend, and you'll spare yourself a lot of future misery!

In the time between now and you're next trade please read "When Genius Failed" and maybe watch "The Bonfire of The Vanities"

Gambles my friend - I'll give you some of my books to read - for some of the year I live in Sausalito - just across the Golden Gate Bridge from San Francisco. Please - drop in some time.

Cool!

PM me - always, always, always willing to learn more.

[Gambles]

Badge

I don't actually use the DOW - but rather SPX. Looking at the chart - I can see - of course - that tonights low will be higher than the previous intraday low reached in early May. Therefore technically I should have said that was the low. However, those where "Intraday lows" - which often can give a "distorted view". Many "technical analysts will give you an "exact price" - by "drawing lines". My "theory" has very little to do with "technical analysis" and nothing to do with support - resistance - etc. (but I do not ignore them).

Therefore - to answer your question "to the best of my ability": We should decline to Dow 10340-10370 and SPX 1103-1108 tonight (which is roughly yesterdays lows) - before rebounding.

I really don't know if this is the big leg-down or whether we will see a solid bounceback before the storm breaks...

[Parvis]

Cool!

PM me - always, always, always willing to learn more.

Well - I am in Sausalito at the moment for a week - I think. Your "Sua Daeng friends" got on my nerves. But as I said - just across Golden Gate Bridge - please do drop in sometime.

Edited May 21, 2010 by Parvis

[Gambles]

You forgot to mention: - All successfull Economists are typically also successfull Mathematicians. Some of those successfull Mathematicians have received the Nobel Prize in Economics.

Uh-oh

LTCM!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

it would be better sometimes if they were historians too

beware the self-appointed Masters of The Universe, Parvis my friend, and you'll spare yourself a lot of future misery!

In the time between now and you're next trade please read "When Genius Failed" and maybe watch "The Bonfire of The Vanities"

Gambles

You dont seem to have any time for LTCM ?

Is LTCM the same as what Horizons AlphaPro Gartman ETF is ? :-

http://jessescrossroadscafe.blogspot.com/2...artman-etf.html

Gartman's flatline looks good in comparison -

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

[lannarebirth]

I understand how tough it is sometimes. For instance this morning - for a moment I thought I was wrong - but I was mistaken.

What is your target in time or price for the reversal this morning. I have none, but "thinking like a criminal" I wouldn't take anything other than a ST trading position unless it were at least 150 points lower (SPX). Maybe in a month.

[Gambles]

Well - I am in Sausalito at the moment for a week - I think. Your "Sua Daeng friends" got on my nerves. But as I said - just across Golden Gate Bridge - please do drop in sometime.

well...next time you're back in the LoS.......

[Parvis]

Well - I don't really have a target - I will see when the direction changes again - BEFORE it changes.

I agree we probably will have to revisit the lows before we can have a substantial move up. But for right now - I see the direction as up.

This Mornings down movement I did not expect - but I saw the possibility - based on how the Market closed yesterday. I also started looking at support closer - which so far I had totally ignored - and I saw support was roughly 10 SPX points below yesterdays close. But as I said my "reversal theory" is not based on support/resistance.

Edited May 21, 2010 by Parvis

[badge]

Just covered my DAX and FTSE shorts(15mins ago) from 16th April.

If support fails I'll act accordingly.

Now more pressing matters; where to dine before the curfew draws in

From that very point, DAX edged 0.1% lower, before advancing an extraordinaryly stout 2.5% in a straight line.

FTSE also advanced 2.5% in a straight line.

That, Parvis, is how to make a call, if I say so myself. No caveats. No excuses. Just a sensible model.

Had I said Id covered shorts(bought), and the markets declined, by 4%, or better still by the most in 2 decades, I think Id have to laugh and apologise. But it takes all sorts

[badge]

Well - I don't really have a target - I will see when the direction changes again - BEFORE it changes.

I agree we probably will have to revisit the lows before we can have a substantial move up. But for right now - I see the direction as up.

This Mornings down movement I did not expect - but I saw the possibility - based on how the Market closed yesterday. I also started looking at support closer - which so far I had totally ignored - and I saw support was roughly 10 SPX points below yesterdays close. But as I said my "reversal theory" is not based on support/resistance.

Third time lucky?

Well for what its worth, after the expected continuing decline in stocks earlier today, the moment BEFORE I saw the direction change at lunchtime in Europe, I brought european futures, to cover shorts as mentioned previously.

From that point YM dipped 70, then reversed 290 in a straight line, and ES dipped 6 handles, then reversed 35 handles in a straight line.

Equity futures are by and large 'same same' thesedays.

Todays stock lows are key going forward to me(hence covering), and needlesstosay(is that one word?) any breach would incite further weakness. I won't mention Jun TBonds or spot dollars

So its up 'till it ain't

[Parvis]

Badge

คำแนะนำที่ดีสำหรับชีวิตต่อไป

Edited May 21, 2010 by Parvis

[badge]

No unnecessary punctuation marks Parvis, congratulations. Sadly I havent felt the inclination to learn written Thai yet. Is it another tip?

edit: Is'nt the internet wonderful Kind words, I think! Chok dee to you sir

Edited May 21, 2010 by badge

[Gambles]

http://www.theonion.com/articles/blue-line...11-percent,333/

5555555

[midas]

I realize my "projection of a specific level" which I gave rather "haphazardly" at "Badge" urging was undercut by some 200 points (profitably). But my original post on 5-19-2010 was:

5-20-2010 Bottom of Market per "Parvis Equilibrium for Strategic Non-Cooperative Derivative Trading".

5-20-2010 a temporary dead cat bounce of 60-120 points up as per "Midas Dartboard Method of Trading " ( for amateurs only )

and then a resumption of the downward trend in a BEAR market

Well there you go !

Last night DJIA finished at +125.38

It is patently obvious the "Midas Dartboard Method of Trading "

is far more reliable than the "Parvis Equilibrium for Strategic Non-Cooperative Derivative Trading".

But sorry its only for amateurs

Edited May 22, 2010 by midas

[midas]

this was posted under the " comments " section on another site

which many others responded to with a huge " I agree !! "

" This goes to the fundamental nature of the problem: These aren't markets. They are leveraged speculative flows. They have nothing to do with markets, nor business, nor productivity, nor allocating capital to productive endeavors. They have nothing to do with economic fundamentals.

In fact, because they are merely leveraged flows, they are subject to manipulation. That's why you can't even trade the technicals (much less the fundamentals).

Government bailout ==> Banks * leverage ==> short Governments

It's insane. It's not a market, those flows dwarf all capital associated with productive activity, which is why it will all fail. I refuse to play. "

[badge]

http://www.theonion.com/articles/blue-line...11-percent,333/

5555555

Im putting the blueline on my watchlist.

[Gambles]

this was posted under the " comments " section on another site

which many others responded to with a huge " I agree !! "

" This goes to the fundamental nature of the problem: These aren't markets. They are leveraged speculative flows. They have nothing to do with markets, nor business, nor productivity, nor allocating capital to productive endeavors. They have nothing to do with economic fundamentals.

In fact, because they are merely leveraged flows, they are subject to manipulation. That's why you can't even trade the technicals (much less the fundamentals).

Government bailout ==> Banks * leverage ==> short Governments

It's insane. It's not a market, those flows dwarf all capital associated with productive activity, which is why it will all fail. I refuse to play. "

noise traders do help to distort and disguise reality for sustained periods - the best simple explanation I've read was in Andrew Farlow's pieces about the UK property markets from several years ago (at the time it seemed to be an amazing insight into housing markets - now I realize it's essential reading to understand any asset markets and it's the greatest explanation of just how and why sub-prime could run the way that it did -

2.1.2. Financing Risk/Noise Trader Risk

Noise traders are “investors who make decisions regarding buy and sell trades without the use of fundamental data”9. The presence of noise traders forces others – both other noise traders and nonnoise traders – to face risks that they would not face in a world devoid of noise traders, i.e. the world of classical finance. This can be analysed from various angles.

2.1.2.i. Horizon risk

Even if prices will eventually converge, the process may not be smooth or rapid. Shiller10 remarks, in the context of eToys, “Absurd prices sometimes last a long time.”

What happens if mispricing deepens – say, if noise traders’ beliefs become temporarily even more extreme – even though it is known (to the informed arbitrageurs taking short positions) that price will eventually revert to fundamentals? This creates uncertainty about the resale value of the assets on which those positions are taken. The closing of the position cannot be guaranteed. Those lending resources to the arbitrageurs to take such positions will require more security as the position deviates ever further from fundamentals. The risk and cost of this has to be factored in. Treating arbitrage as a game, horizon risk relates to the number of repetitions of the game until the market corrects. Horizon risk can be viewed with and without fundamentals risk.

Case of horizon risk without fundamentals risk:

A good example of horizon risk without fundamentals risk is Royal Dutch/Shell11. Royal Dutch and Shell are traded on nine exchanges worldwide with an arrangement to split cashflows 60:40 even though they are completely separate legally. Yet, according to these markets, there is a minus 30% to plus 20% deviation from theoretical parity in market size – contrary to what efficient pricing would suggest should be the case. The financing/noise trader risk explanation is that if the price is wrong by, say -10%, and an arbitrageur initiates a ‘put’, and yet price deviates even further (to say -25%) then the arbitrageur faces large margin calls. If there is significant momentum (the degree of which is related to the number of noise traders present), then the risk of possible margin calls makes short positions very difficult to take on. If financing/noise trader risk can cause trouble in such obviously arbitrageable cases, it suggests real trouble in much less obviously arbitrageable cases like national housing markets. Even in these obvious cases of mispricing, as the time taken to convergence increases, the return to arbitrageurs’ falls dramatically. Some simple figures12 illustrate the problem. Investments that are expected to yield 15% return over 92 days will generate an annualized return of 47%. If the number of days till termination halves, to 46, the annualized return rises to 238%. But, if days to termination rise, by just half, to 138, the annualized rate drops to 14%. In a proper model of risk – incorporating the risk of further deviation caused by noise traders, and the fact that further capital will need to be sought – this may well just not be a high enough return to justify taking on the risk in the first place.

Case of horizon risk with fundamentals risk:

A case of horizon risk with fundamentals risk would be a situation where the value of house prices can deviate from fundamentals for long, but uncertain, periods of time. If an owner sells and waits for correction (in the absence of forward markets this is the only strategy possible) the market may nevertheless get even more out of line before correcting. Combined with the fact that the fundamentals may not have been well specified in the first place, this becomes a very risky strategy13.

Many current warnings of a possible real capital loss of 20% to 30% (or simply a warning that life-time wealth will be lower by buying now) are not enough to incentivise many current consumers to sell out or to put off buyers (though first-time buyers are currently at a record low); either they do not believe the overvaluation story or they find it just too risky to act given the horizons (and transactions costs) involved. Any house buyer who believed the story a year ago (when it was almost certainly already true) and had acted upon it, will have since seen prices rise even further and their entry or return to the market pushed off even further. The ultimate ‘truth’ of the overvaluation story is irrelevant in such situations. Banks also face horizon risk. They have to resist supplying fresh – but currently highly profitable – loans on overvalued properties, and resist using overvalued prices as collateral for consumption loans. Uncertainty pertains to when the loans become unsupportable, and whether fundamentals turn out to make them unsupportable anyway. Meanwhile those banks that take arbitrage positions to short the market (i.e. they don’t lend, which is the only way they can arbitrage the market) are destroyed by loss of market share and removal of capital due to poor performance. Any mortgage bank that believed the overvaluation story a year ago and had acted upon it, will have seen their profits heavily hit compared to those banks that ignored it14. Survey evidence (more on this below) indicates that the housing market is full of noise traders! And fundamentals risk is high. In combination, this makes for the sort of environment in which banks will not easily take short positions.

2.1.2.ii. Margin risk

If the position moves against an arbitrageur, he/she will have to make a margin call – a partial payment in the face of new values of securities. Just as they face the greatest potential returns, they have to reduce exposure to meet the calls. This has proved to limit the power of even large hedge funds, and so, collectively to reduce their unwillingness to correct market overvaluations. Even the largest of hedge funds find themselves as informed ‘agents’ trying to convince less well informed ‘principals’ – their financial backers – to invest more even as their previous investment decisions look not to be working. Such situations never arise in classical models of arbitrage where institutions don’t matter and where capital is not, strictly speaking, at risk. The possibility of this situation arising might itself limit positions in the first place – so as to have some liquidity in case of movements even further away from fundamentals15.

2.1.2.iii. Short covering risk

This refers to the risk of involuntary liquidation. An arbitrageur borrows stock to short it, but if the lender of the stock finds it difficult to maintain the level of supply they may even ask for it back; the arbitrageur has to liquidate any positions prematurely.

Technical points on volatility and fundamentals risk:

There are a couple of interesting technical points regarding the relationship between the degree of volatility of a market and fundamentals risk. They suggest further reasons why housing markets may be even more difficult to arbitrage than other markets (and it is a feature in which segmentation works to aggravate the matter):

Higher volatility night be associated with more frequent mispricing – and hence plenty of profitable opportunities for arbitrage. If all volatility were due to noise trader sentiment, then the out-performance of arbitrageurs relative to a benchmark is roughly proportional to the standard deviation of the noise trader demand shock. But high volatility does make arbitrage less attractive if the expected outperformance relative to the benchmark does not increase in proportion to volatility – in particular when fundamental risk is a substantial part of volatility. Fundamentals risk reduces the attractiveness of trade.

And the ratio of expected outperformance-tobenchmark to volatility may be low – for example for situations where the resolution of uncertainty is slow, and where noise trader sentiment can push prices a long way from fundamentals before disconfirming evidence comes in. So, the long run ratio of expected outperformance-to-the benchmark to volatility may be high, but the ratio over a horizon of, say a year – or several years in the case of housing – may be low (or very low). For arbitrageurs who care about interim consumption and whose reputations (mortgage banks for example) are permanently affected by their performance over a year or two, the ratio of reward to risk over short horizons may be very relevant. So, higher volatility (ceteris paribus) deters arbitrage against mispricing. Again, poorly defined housing market fundamentals are a danger sign not a reassurance.

9

http://www.investopedia.com/terms/n/noisetrader.asp.See also DeLong, J.B., A. Shleifer, L. H. Summers and R. J. Waldmann, 1990; and DeLong, J.B., A. Shleifer, L. H. Summers, and R. J. Waldmann, 1991.

10 Shiller, R.J., 2000, p176.

11 Unilevar N.V./Unilever PLC is a similar case

12 From Montier, J., 2002, p 45, taken from Mitchell, M., T. Pulvino, and E. Stafford, 2001.

13 Even more so if utility functions contain some sort of ‘regret’ term.

14 This raises the issue of why the stock market does not correct this. In fact, ultimately, the arbitrage failure lies there.

15 See Longstaff, F., and J. Liu, forthcoming.

[badge]

A couple of things I like to observe in US equity markets.

The VIX Index is at levels where traders are as confident of portfolio gains as they were in Mid 2007.

The (smoothed)Total Put/Call ratio also shows how cosy traders currently feel.

Lastly Investors Intelligence sentiment reading of BUllish and Bearish newsletter advisors. Bullish respondants are at levels seen in Early Jan '10 and Jan '08, there are however slightly more Bearish newsletter pundits now compared to Jan '10, but fewer still than Jan '08.

Just looking again at one of these very simple market measures, the (smoothed)total P/C ratio, we can see two things of note to my eye.

Firstly, that the recent correction in US stocks has recorded far more extreme readings than previous corrections over the last 15months. It is thus fair to conclude it is a different 'type' of pullback to that we have witnessed over that time.

Secondly, that the elevated levels in 'insurance' are consistant with US market lows - however short term - from the darker days of the 2008 rout.

[sokal]

this was posted under the " comments " section on another site

which many others responded to with a huge " I agree !! "

" This goes to the fundamental nature of the problem: These aren't markets. They are leveraged speculative flows. They have nothing to do with markets, nor business, nor productivity, nor allocating capital to productive endeavors. They have nothing to do with economic fundamentals.

In fact, because they are merely leveraged flows, they are subject to manipulation. That's why you can't even trade the technicals (much less the fundamentals).

Government bailout ==> Banks * leverage ==> short Governments

It's insane. It's not a market, those flows dwarf all capital associated with productive activity, which is why it will all fail. I refuse to play. "

Thats right, even Jim Cramer was piss hot mad about the ponzi casino game on friday.

[sokal]

this was posted under the " comments " section on another site

which many others responded to with a huge " I agree !! "

" This goes to the fundamental nature of the problem: These aren't markets. They are leveraged speculative flows. They have nothing to do with markets, nor business, nor productivity, nor allocating capital to productive endeavors. They have nothing to do with economic fundamentals.

In fact, because they are merely leveraged flows, they are subject to manipulation. That's why you can't even trade the technicals (much less the fundamentals).

Government bailout ==> Banks * leverage ==> short Governments

It's insane. It's not a market, those flows dwarf all capital associated with productive activity, which is why it will all fail. I refuse to play. "

noise traders do help to distort and disguise reality for sustained periods - the best simple explanation I've read was in Andrew Farlow's pieces about the UK property markets from several years ago (at the time it seemed to be an amazing insight into housing markets - now I realize it's essential reading to understand any asset markets and it's the greatest explanation of just how and why sub-prime could run the way that it did -

2.1.2. Financing Risk/Noise Trader Risk

Noise traders are "investors who make decisions regarding buy and sell trades without the use of fundamental data"9. The presence of noise traders forces others – both other noise traders and nonnoise traders – to face risks that they would not face in a world devoid of noise traders, i.e. the world of classical finance. This can be analysed from various angles.

2.1.2.i. Horizon risk

Even if prices will eventually converge, the process may not be smooth or rapid. Shiller10 remarks, in the context of eToys, "Absurd prices sometimes last a long time."

What happens if mispricing deepens – say, if noise traders' beliefs become temporarily even more extreme – even though it is known (to the informed arbitrageurs taking short positions) that price will eventually revert to fundamentals? This creates uncertainty about the resale value of the assets on which those positions are taken. The closing of the position cannot be guaranteed. Those lending resources to the arbitrageurs to take such positions will require more security as the position deviates ever further from fundamentals. The risk and cost of this has to be factored in. Treating arbitrage as a game, horizon risk relates to the number of repetitions of the game until the market corrects. Horizon risk can be viewed with and without fundamentals risk.

Case of horizon risk without fundamentals risk:

A good example of horizon risk without fundamentals risk is Royal Dutch/Shell11. Royal Dutch and Shell are traded on nine exchanges worldwide with an arrangement to split cashflows 60:40 even though they are completely separate legally. Yet, according to these markets, there is a minus 30% to plus 20% deviation from theoretical parity in market size – contrary to what efficient pricing would suggest should be the case. The financing/noise trader risk explanation is that if the price is wrong by, say -10%, and an arbitrageur initiates a 'put', and yet price deviates even further (to say -25%) then the arbitrageur faces large margin calls. If there is significant momentum (the degree of which is related to the number of noise traders present), then the risk of possible margin calls makes short positions very difficult to take on. If financing/noise trader risk can cause trouble in such obviously arbitrageable cases, it suggests real trouble in much less obviously arbitrageable cases like national housing markets. Even in these obvious cases of mispricing, as the time taken to convergence increases, the return to arbitrageurs' falls dramatically. Some simple figures12 illustrate the problem. Investments that are expected to yield 15% return over 92 days will generate an annualized return of 47%. If the number of days till termination halves, to 46, the annualized return rises to 238%. But, if days to termination rise, by just half, to 138, the annualized rate drops to 14%. In a proper model of risk – incorporating the risk of further deviation caused by noise traders, and the fact that further capital will need to be sought – this may well just not be a high enough return to justify taking on the risk in the first place.

Case of horizon risk with fundamentals risk:

A case of horizon risk with fundamentals risk would be a situation where the value of house prices can deviate from fundamentals for long, but uncertain, periods of time. If an owner sells and waits for correction (in the absence of forward markets this is the only strategy possible) the market may nevertheless get even more out of line before correcting. Combined with the fact that the fundamentals may not have been well specified in the first place, this becomes a very risky strategy13.

Many current warnings of a possible real capital loss of 20% to 30% (or simply a warning that life-time wealth will be lower by buying now) are not enough to incentivise many current consumers to sell out or to put off buyers (though first-time buyers are currently at a record low); either they do not believe the overvaluation story or they find it just too risky to act given the horizons (and transactions costs) involved. Any house buyer who believed the story a year ago (when it was almost certainly already true) and had acted upon it, will have since seen prices rise even further and their entry or return to the market pushed off even further. The ultimate 'truth' of the overvaluation story is irrelevant in such situations. Banks also face horizon risk. They have to resist supplying fresh – but currently highly profitable – loans on overvalued properties, and resist using overvalued prices as collateral for consumption loans. Uncertainty pertains to when the loans become unsupportable, and whether fundamentals turn out to make them unsupportable anyway. Meanwhile those banks that take arbitrage positions to short the market (i.e. they don't lend, which is the only way they can arbitrage the market) are destroyed by loss of market share and removal of capital due to poor performance. Any mortgage bank that believed the overvaluation story a year ago and had acted upon it, will have seen their profits heavily hit compared to those banks that ignored it14. Survey evidence (more on this below) indicates that the housing market is full of noise traders! And fundamentals risk is high. In combination, this makes for the sort of environment in which banks will not easily take short positions.

2.1.2.ii. Margin risk

If the position moves against an arbitrageur, he/she will have to make a margin call – a partial payment in the face of new values of securities. Just as they face the greatest potential returns, they have to reduce exposure to meet the calls. This has proved to limit the power of even large hedge funds, and so, collectively to reduce their unwillingness to correct market overvaluations. Even the largest of hedge funds find themselves as informed 'agents' trying to convince less well informed 'principals' – their financial backers – to invest more even as their previous investment decisions look not to be working. Such situations never arise in classical models of arbitrage where institutions don't matter and where capital is not, strictly speaking, at risk. The possibility of this situation arising might itself limit positions in the first place – so as to have some liquidity in case of movements even further away from fundamentals15.

2.1.2.iii. Short covering risk

This refers to the risk of involuntary liquidation. An arbitrageur borrows stock to short it, but if the lender of the stock finds it difficult to maintain the level of supply they may even ask for it back; the arbitrageur has to liquidate any positions prematurely.

Technical points on volatility and fundamentals risk:

There are a couple of interesting technical points regarding the relationship between the degree of volatility of a market and fundamentals risk. They suggest further reasons why housing markets may be even more difficult to arbitrage than other markets (and it is a feature in which segmentation works to aggravate the matter):

Higher volatility night be associated with more frequent mispricing – and hence plenty of profitable opportunities for arbitrage. If all volatility were due to noise trader sentiment, then the out-performance of arbitrageurs relative to a benchmark is roughly proportional to the standard deviation of the noise trader demand shock. But high volatility does make arbitrage less attractive if the expected outperformance relative to the benchmark does not increase in proportion to volatility – in particular when fundamental risk is a substantial part of volatility . Fundamentals risk reduces the attractiveness of trade.

And the ratio of expected outperformance-tobenchmark to volatility may be low – for example for situations where the resolution of uncertainty is slow, and where noise trader sentiment can push prices a long way from fundamentals before disconfirming evidence comes in. So, the long run ratio of expected outperformance-to-the benchmark to volatility may be high, but the ratio over a horizon of, say a year – or several years in the case of housing – may be low (or very low). For arbitrageurs who care about interim consumption and whose reputations (mortgage banks for example) are permanently affected by their performance over a year or two, the ratio of reward to risk over short horizons may be very relevant. So, higher volatility (ceteris paribus) deters arbitrage against mispricing. Again, poorly defined housing market fundamentals are a danger sign not a reassurance.

9

http://www.investopedia.com/terms/n/noisetrader.asp.See also DeLong, J.B., A. Shleifer, L. H. Summers and R. J. Waldmann, 1990; and DeLong, J.B., A. Shleifer, L. H. Summers, and R. J. Waldmann, 1991.

10 Shiller, R.J., 2000, p176.

11 Unilevar N.V./Unilever PLC is a similar case

12 From Montier, J., 2002, p 45, taken from Mitchell, M., T. Pulvino, and E. Stafford, 2001.

13 Even more so if utility functions contain some sort of 'regret' term.

14 This raises the issue of why the stock market does not correct this. In fact, ultimately, the arbitrage failure lies there.

15 See Longstaff, F., and J. Liu, forthcoming.

It was all explained well in this book that was written in 06.

[Gambles]

It was all explained well in this book that was written in 06.

Good writer, some very interesting observations and always kind and generous to share his ideas - I've said before and I'll say again Peter Schiff is a good guy....

but you should read Andrew Farlow

[Gambles]

Dear all,

Please find below the latest update from MBMG International.

One of the men who predicted the credit crunch is now warning of a potentially 'vicious' debt crisis.

No not yours truly.

Not GMA's John Sheehan.

Not Scott Campbell or Martin Gray but in fact Nassim Taleb, who wrote the books "Black Swan" and "Fooled by Randomness" now believes, as do we, that the world debt problem in total, is worse now than it was at the height of the credit crunch.

Like us he thinks that the time has come to ditch equities and US Treasuries. Taleb is backing hard assets.

Taleb told Bloomberg that governments have failed to learn the lessons of the banking crisis and have allowed the debt problem to morph into a new and more 'vicious' sovereign form:

'I had detected fragility in the banking system and it is still there and we need to do something about it....We have had a couple of years since the meltdown and the risks have increased and taken a much more vicious form.'

Sharing our concerns about the Fed Governors who admit that policy is unproven and that basically policymakers are flying by the seat of their pants, he warns that theories not backed by empirical evidence, such as the pricing of assets and risk, and says the globalisation has made events and outcomes totally unpredictable and he shares our concerns about the extent to which the entire global economy has become more inter-connected.

Taleb brands the government bailouts of the financial system and the transfer of debt from the private to the public sector as 'a fast-track to increasing moral hazard' and like ourselves and critics such as Ron Paul, he is scathing about the profits made by the banks over the past year.

'Look at all of the money they made with our backing- it is like they spat in our faces....We have a lower tax base than two years ago because less people are in work than two years ago and are now depending on economic forecasting by governments. Obama is forecasting a deficit of $4-7 trillion depending on the parameters you use but a small glitch can mean the deficit for the next 10 years swells to $20 trillion.'

Greece was recently forecasting debt to GDP of 3%, which now stands at 14% and rising - deteriorations can take place very quickly -

'The same thing will happen to the US- typical government underestimating.'

It's good to have some company once again in the bear pit!

Enjoy your day!

Once again, very best regards,

MBMG International

[AlexLah]

No worries, it's the "Parvis" cycle........

[Parvis]

2010-05-21

Well - I don't really have a target - I will see when the direction changes again - BEFORE it changes.

I agree we probably will have to revisit the lows before we can have a substantial move up. But for right now - I see the direction as up.

No worries, it's the "Parvis" cycle........

Edited May 25, 2010 by Parvis

[AlexLah]

It's as easy as playing black or red on the roullete table Parvis.

[Parvis]

It is even easier to state the obvious after the fact Alex