Friday, May 30, 2008

Credit Crisis Deteriorating

As politicians and industry media assert the beginning of growth again. Prudent investors however would notice that recent moves in credit markets have yet again foreshadowed a different story. Ambrose Evans-Pritchard of the UK based Telegraph internet newspaper spotted the events, and the world should listen.

“The debt markets in the US and Europe have begun to flash warning signals yet again, raising fears that the global credit crisis could be entering another turbulent phase.

The cost of insuring against default on the bonds of Lehman Brothers, Merrill Lynch and other big banks and brokerages has surged over the last two weeks, threatening to reach the stress levels seen before the Bear Stearns debacle. Spreads on inter-bank Libor and Euribor rates in Europe are back near record levels.

…‘The steep rise in swap spreads this week is ominous," said John Hussman, head of the Hussman Funds. "The deterioration is in stark contrast to what investors have come to hope since March.’

Lehman Brothers took writedowns of just $200m on its $6.5bn portfolio of sub-prime debt in the first quarter even though a quarter of the securities had "junk" ratings, typically worth a fraction of face value.

Willem Sels, a credit analyst at Dresdner Kleinwort, said the banks are beginning to face waves of defaults on credit cards, car loans, and now corporate loans. ‘We believe we're entering Phase II. The liquidity crisis has eased a little, but the real credit losses are accelerating. The worst is yet to come,’ he said.”

Naked Capitalism also took notice of this, along with a few other observations regarding US treasury auction related issues. All said and done, things do not look great.

Unfortunately, having a negative economic bias has become politically incorrect today, and comments from Evans-Pritchard will probably never make it outside of England. Taking a stand against the crowd entails courage and conviction, as only the truth could help one avoid getting caught in the next market drop, and perhaps profit off it. Keep your mind open, stay informed.

Monday, May 26, 2008

Focus On A Few And Not "Diversify"

Many successful full time, professional traders engage entire days on one or two stocks or futures exclusively. No matter how little of an edge this practice offers, learning traders should grasp and take up whatever is available.

Floor Traders

On the exchange floors, the same traders engage in the same security day in and day out. This means that over time, their behavior could display patterns and therefore exploited by the retail trader who spends all his/her time on the associated stock or future.

Reduced Transaction Costs

This should be obvious. Operating a successful business requires expenses to remain at the absolute minimum, and so does trading on a professional level.

Reduced Mistakes

Everybody makes mistakes, and they cost money, at least in the amount of transaction fees. Volatility measure errors, fat finger mistakes like buying instead of shorting or keying in the wrong order volume become rare once the trader becomes familiar with the security.

Diversification Is Obsolete

The permanently optimistic analysts on TV or radio still scream about the well aged concept of diversification. The whole idea was created by an academic, not a professional security trader, decades ago. The highly correlated environment today, along with the credit contraction have created risks that were entirely overseen or intentionally ignored to deceive the public.

Either way, logical, profitable solutions always lie within something that the masses do not realize or engage in. At this moment, majority of the publicly uninformed still embrace the concept of “diversified portfolios” to reduce risk; didn’t turn out that way though for the past year, did it?

Wednesday, May 21, 2008

Moody's Error For Triple A Ratings On Worthless Debt

This is rich. It looks like they're getting desperate in search of avoiding liability. Their story holds full of contradictions, this isn't even a good lie. Just watch, the markets will likely tank hard in the coming months as the next wave of credit defaults commmence.

Enjoy the article!

FT Alphaville exclusive: Moody’s error gave top ratings to debt products

Moody’s awarded incorrect triple A ratings to billions of dollars worth of a type of complex debt product due to a bug in its computer models, an Financial Times investigation has discovered.
Internal Moody’s documents seen by the FT show that some senior staff within the credit agency knew early in 2007 that products rated the previous year had received top-notch triple A ratings and that, after a computer coding error was corrected, their ratings should have been up to four notches lower.

News of the coding error comes as ratings agencies are under pressure from regulators and governments, who see failings in the rating of complex structured debt as an integral part of the financial crisis. While coding errors do occur there is no record of one being so significant.
Moody’s said it was “conducting a thorough review” of the rating of the constant proportion debt obligations - derivative instruments conceived at the height of the credit bubble that appeared to promise investors very high returns with little risk. Moody’s is also reviewing what disclosure of the error was made.

The products were designed for institutional investors. In the recent credit market turmoil, those who still hold the products will have suffered some paper losses while others who have bailed out have lost up to 60 per cent of their investment.

On discovering the error early in 2007, Moody’s corrected the coding glitch and instituted methodology changes. One document seen by the FT says “the impact of our code issue after those improvements in the model is then reduced”. The products remained triple A until January this year when, amid general market declines, they were downgraded several notches.

In a statement to the FT, Moody’s said: “Moody’s regularly changes its analytical models and enhances its methodologies for a variety of reasons, including to reflect changing credit conditions and outlooks. In addition, Moody’s has adjusted its analytical models on the infrequent occasions that errors have been detected.

“However, it would be inconsistent with Moody’s analytical standards and company policies to change methodologies in an effort to mask errors. The integrity of our ratings and rating methodologies is extremely important to us, and we take seriously the questions raised about European CPDOs. We are therefore conducting a thorough review of this matter.”

Credit ratings are hugely important within the financial system because many investors - such as pension funds, insurance companies and banks - use them as a yardstick either to restrict the kinds of products they buy, or to decide how much capital they need to hold against them.

The world’s other major credit agency, Standard and Poor’s, was the first to award triple A status to CPDOs but many investors require ratings from two agencies before they invest so the Moody’s involvement supplied that crucial second rating.

S&P stood by its ratings, saying: “Our model for rating CPDOs was developed independently and, like our other ratings models, was made widely available to the market. We continue to closely monitor the performance of these securities in light of the extreme volatility in CDS prices and may make further adjustments to our assumptions and rating opinions if we think that is appropriate.”

Full article and details to follow in tomorrow’s FT.

Using The TICK For Profitable Trading

The NYSE TICK (ticker symbol ^tick at or $tick at gives a net difference between stocks moving up against those on the decline, and it could help provide an edge for short term traders. As this indicator moves in a mean reverting fashion, interim emotional buying and selling become easier to identify.

Applying TICK for profitable trading

Naturally, you want to buy if TICK closed at extremely low levels the previous day, and vice versa. However there is more, and I will provide an example for a buying opportunity.

Alongside a low TICK value, this usually means below -800 for me, price action also matters. If accompanied by a dip in the indexes, then an opportunity is present for a buying entry. On the open of the next day, get in ONLY if price opens below the close of the previous day.

The opposite works for short positions. This scheme provides a slight edge for the learning trader. If liquidated at the end of the days, these theoretical opened positions would have all ended profitably for the past two months on the SPY (see above graphs). Yes it takes a heck of a lot of patience to trade it, well at least it would help your trading performance in the positive while the search for high returns goes on.

Tuesday, May 20, 2008

Jim Rogers' Opinions

Jim Rogers is one of few successful investors of today who speaks boldly, a strong point making him very interesting to listen to.

Wednesday, May 14, 2008

Who Is That?

OK, I see this at the front page of US Treasury. I know that’s Paulson in the middle, but who is that behind him? I bet the mystery guy calls the shots!

Monday, May 12, 2008

About Victor Niederhoffer's Experiences

In 1979, Victor Niederhoffer turned $50K into $20Million within 18 months, and became one of the first traders known for quantitative perception. Like any other business, his performance has had ups and downs throughout the decades, and perhaps we could all learn something from the experiences.

I came across this article a few days ago, and it really begs the question of practicality concerning quantitative finance developments today. Mr. Niederhoffer had assumed that stock markets generally moved upwards, a fundamental concept behind current theories in mathematical finance, and this belief had hurt his performance.

Stock prices drift downwards, too

The assumption that stock fundamental values generally stay static while risk-free interest rate serves as an upward drift parameter, i.e. value added via inflation, simply does not apply for actual, realistic market behavior. Companies fail, and more often than not speculative bubbles become mistaken for genuine added value.

Ignoring “unlikely” risks, weaknesses of applied mathematical models, generally makes blowing up a statistical eventuality (Mr. Niederhoffer had blown several hedge funds, but had always managed to get back up and fight another day). No matter how infrequently storms occur, boats are built to withstand the heaviest of them. So should your trading strategy.

Change of paradigm

Fundamentally and statistically, it does not take much for businesses to fail, and yet it requires everything for a moment or two of success. Business and liquidity cycles all point to very dissimilar perspectives than that of Mr. Niederhoffer, or the typical public investor.

It does not matter if your convictions are right or wrong, your objective remains to come out profitable. Pride plays no part in the markets. With that, maybe it is time to take a deeper look into your risk management, so that you WILL survive the worst of times.

Thursday, May 8, 2008

Did Oil Prices Hit A Short Term Top?

As Goldman Sachs announced higher oil price expectations, it means they currently look to liquidate their oil related holdings. Therefore it becomes highly probable that oil prices will drop in the near future.

How did it get this high in the first place?

The media always pushes for supply and demand concerns, but as we know TV anchors do not usually understand how markets function (if they did they would not need to work as TV anchors obviously).

A patron at, S2007S, made a very wise comment about this situation.

“… If you really think an economy thats already in a recession can handle 100+ oil and over $4.00 at the pump you are a fool. Today people are predicting 150-200 a barrel, Pure SPECULATION, thats ALL THIS RUN IS BASED ON, this reminds me of every other single bubble, all the hype and the outrageous predictions on how high oil will go is just a becoming a game now. This is a bubble, oil and the rest of the commodities are going to correct EXTREMELY HARD, Just like every bubble ALWAYS does...”

Profiting off this information

You can take short positions on oil based ETFs such as USO, OIL, GSP, and etc. If you do not feel comfortable with directional bets, option strategies exist to exploit the coming volatility, and most of these ETFs have options available.

Of course solid entry/exit plans remain crucial to profitable trading, and inherent risks need managed, especially that of position sizing while taking short sales. The above edge only helps in the regard that even if your execution carries no finesse, it could still end profitably.

Tuesday, May 6, 2008

Stock Investments Superior To Real Estate

Several fundamental, logical grounds make long term stock investments more viable than real estate. As investments initiate with general objectives of selling later down the line for an increased amount, added value means everything.

Added Value Explained

Potential buyers in the future, especially those with rationality, would only offer higher prices for the same commodity/security/land, if they recognize additional value on top of whatever the original investors had acquired. This could mean new products, higher demand, brand name, intellectual property, land, and etc.

Real Estate Offers Little Value Growth

Aside from discovering gold, oil, or dinosaur bones in the backyard, the land itself offers absolutely no added value. The building itself actually depreciates over time, and requires additional expenses (or risks for the investor) for upkeep.

Inflation backs this illusion of consistent growth over time, and collective investor sentiment determines short term price fluctuations. Nevertheless, prices always revert to the mean, i.e. they come back down to the expected, inflation adjusted value (minus depreciation on the building). John Villareal explains this concept clearly at the Super Genius.

Businesses Operate To Increase Value

Stock investors own shares of the company. With each venture, active, determined people toil every single day with the objective of value enhancement. Therefore, despite the short term up or downside swings, companies operate to exploit every opportunity to add value for shareholders in the long run and some do it quite rapidly.

Of course even for long term investors, risk management remain crucial for success. Investing itself equates to that of a self run business where value improvement lies at the end of the road.

Saturday, May 3, 2008

Government Backed Bonds Not Always Safe

The city of Vallejo, California, faces bankruptcy, if it goes through creditors may lose all investments, worth several hundred million USD. Apparently, the US credit mess has not passed but worsened, as fixed income vehicle investors ready for some wild rides.

Vallejo, not likely an isolated incident

Mentioned in the Vallejo article, rising labor costs and plummeting housing related taxes set off their circumstance. Since no counties, states, or even nations have avoided these concerns, more fiscal volatility will arise, probably by September as Californian adjustable mortgage rates schedule to reset.

What it means for the banks

Credit unions, banks invest heavily in government backed securities. This again leads to the possibility of bank failures, like every other economic downturn the US had faced in the past. Money in the bank is not as safe as many have taken for granted, especially in this unprecedented financial environment.

What it means for New Zealand credit investment funds

This includes financing companies and various investment funds who bought US debt and associated derivatives like hot cakes during the bull rush of last few years. Many assumed safety via diversification; it certainly did not turn out that entirely well.

With US (or UK) commercial and investments banks like JP Morgan (at -$90.72Billion Enterprise Value) and Barclay (at -$500Billion Enterprise Value) facing harsh times, the NZ funds are basically stuck with these “toxic-waste” debt instruments. Then of course liquidity remains low, as no rational institution would buy them without significant discounts.

What to do to protect your money

Learn to hedge on your own, or find an investment fund where active arbitrage strategies are utilized, instead of the buy, hold, and hope types. As general sentiment becomes more optimistic, institutional traders prepare for the next sell off. Become informed, and you will not end as a statistic.

Friday, May 2, 2008

King of Queens (Net Prophets Episode)

In this episode, they attempt to trade a tech stock and make pretty much all the newbie mistakes in a light hearted manner, notably the lack of entry/exit strategies, and allowing emotions to take hold. The show is hilarious.

Part 1

Part 2

Part 3

Higher Risks, Lower Rewards, and a Shrinking Safety Net (Elizabeth Warren Lecture)

Elizabeth Warren teaches contract law, bankruptcy, and commercial law at Harvard Law School. This is sort of a big deal. This lecture entails the increasingly harsh financial conditions of the middle class family today.