GalaTime

Live Science: The Financial Fiasco: Emotional, Irrational, Inevitable

James Grant, editor of Grant’s Interest Rate Observer, was quoted in The New York Times as also pointing out the irrational side of financial decisions: “People keep stepping on the same rakes because money, like romance, is only partly an intellectual experience. Money, like sex, brings out some thought — but also much heavy breathing and little stored knowledge.”

On a societal or global level, why don’t more cautious-minded people balance out those who take foolish risks? In essence, Kuhnen says, people are unwilling to bet against irrationality all the time because they might “simply run of money while betting against the irrational guys.”

Bloomberg: Taleb’s `Black Swan’ Investors Post Gains as Markets Take Dive

Universa Investments LP, the Santa Monica, California-based firm where Taleb is an adviser, has about $1 billion in accounts managed to hedge clients against big moves in financial markets. Returns for the year through Oct. 10 ranged as high as 110 percent.

The Black Swan Protection Protocol bought puts and calls on a portfolio of stocks and S&P 500 Index futures, along with some European shares. The Black Swan Protocol doesn’t rely on commodities, currencies or insurance on bonds known as credit default swaps

Forbes: Dimon, Munger, Rohatyn: No More Vegas

Munger wants Wall Street balance sheets reduced by 70% and insists that the firms “be a market maker, a broker, an underwriter and a custodian of securities but not the hedge funds they have become.” He wants to restrict leverage to 50% on every securities transaction except for the Treasury trading desk where “you’re dealing with the safest securities around.”

 The abhorrent excessive compensation on Wall Street is bound to be severely reduced. If Wall Street firms can only be leveraged 10 to 1 instead of 30 to 1, then the excessive gains made on borrowed funds will be reduced by two-thirds. So the path to $5 million to $10 million annual payoffs will be more reasonable but still in the millions. Hamptons summer homes will be reduced in price. Private jets will be out of range for many. Applications to law school should go up.

Will screw up the RoI calculations for a lot of recently minted MBAs.

October 2007: People were buying Indian equities because prices were going up.

October 2008: People are selling Indian equities because prices are going down.

Sometimes, it really is just that.

. . . for something to believe in.

• John Mauldin’s Investors Insight: The Dash To Trash And The Grab For Growth

The growth universe appears to be made up of two kinds of stocks. Firstly, the ones we would expect to find within this universe - the Googles, Apples and RIMMs of the world. These stocks have extraordinary cash flow growth embedded within their market price (in excess of 40% p.a. over the next 10 years) - surely madness. The second sort of stock in the growth universe are cyclicals masquerading as growth stocks. Some of the general industrials and the miners are priced for quite incredible long-term growth.

. . . there are two major flaws in the decoupling arguments. Firstly, people always forget lags at the turning points in cycles. So if the US housing bubble bursting brings down the US consumer, it is ludicrous to assume that highly export-dependent nations will be able to withstand a demand drought. Secondly, the decoupling arguments reek of cognitive dissonance - the desire to hold two contradictory viewpoints simultaneously. Those who now speak of decoupling used to talk of globalisation. This is oxymoronic, you can believe in one or the other but not both.

• Bloomberg: Death of VaR Evoked as Risk-Taking Vim Meets Taleb’s Black Swan

Value at risk, the measure banks use to calculate the maximum their trades can lose each day, failed to detect the scope of the U.S. subprime mortgage market’s collapse as it triggered more than $130 billion of losses since June.

Lehman uses four years of historical data to calculate VaR, with a higher weighting given to more recent time periods, while Morgan Stanley provides VaR calculations using both four years and one year of market data.

All of the risk-measurement tools failed to prepare Merrill for the unforeseen declines on triple-A rated securities backed by subprime mortgages . . .

Talk about timing - Taleb’s ‘The Black Swan’ is practically selling itself! Wonder how widely VaR is (ab)used in India.

• Psychology Today: 10 Ways We Get the Odds Wrong

The human brain is exquisitely adapted to respond to risk—uncertainty about the outcome of actions. Faced with a precipice or a predator, the brain is biased to make certain decisions. Our biases reflect the choices that kept our ancestors alive. But we have yet to evolve similarly effective responses to statistics, media coverage, and fear-mongering politicians. For most of human existence, 24-hour news channels didn’t exist, so we don’t have cognitive shortcuts to deal with novel uncertainties.

The physiological consequences of overestimating the dangers in the world—and revving our anxiety into overdrive—are another reason risk perception matters. It’s impossible to live a risk-free life: Everything we do increases some risks while lowering others. But if we understand our innate biases in the way we manage risks, we can adjust for them and genuinely stay safer—without freaking out over every leaf of lettuce.

• Economic Times: India’s GDP growth to slow to 8% in 2008: Calyon

India’s gross domestic product (GDP) growth may slow to 8% this year from 8.5% in 2007 as the impact of the central bank’s tightening begins to show, Calyon said in a research report on Tuesday.

“We do not expect much more monetary tightening in H1 2008, but the economy may continue to feel the impact of past tightening measures.”

“We look for dollar-rupee to reach 36 at end-2008 and 35 at end-2009, which is consistent with our optimistic medium-term outlook for the Indian economy.”

• Via BeEarly, Credit Suisse: The Power of Fear

By the time Risk Appetite enters the panic zone (1.5 standard deviations below average), the worst is usually over for world wealth and global equities; small declines tend to occur between entering the panic zone and the ultimate trough; and very strong performance is typical in the three and twelve month periods following the risk appetite low. Note that the buildup to this panic episode has been close to average, although the distribution is different, with emerging equities doing a lot better than average, Japanese equities much worse, Germany a little better and the US a little worse. Absolutely in line with the real economy.

Time to buy?

• Bill Rempel: Know Your Leverage, Know Yourself

When someone comes to the market without a clearly-defined method, blows up from using too much leverage on a single trade, a trade which was known to be an account-threatening bet when it was made – then I believe that person didn’t want to make money, or at least, that money wasn’t their primary motivation for trading. I believe that person wanted the thrill of the game, the excitement and ego-boost of the big score, and was using trading, at least primarily and at the moment of blowup, as a venue to work out some serious emotional issues, primarily related to risk-taking.

Know your leverage. Know what level of adverse move is dangerous to your account, and whether or not you can stand that kind of move. Just because your broker lets you use that much leverage, doesn’t mean it’s a good idea.

Wise words.

Amidst the stock market plunge in the US, Barry Ritholtz looks at a possible indicator of market tops:

• Fox Business Channel Market Top?

The Fox Business Channel debuted on October 15, 2007. With its first quarter officially behind it, how has the market performed? On the last trading day before FBC debuted, the Dow closed at 14,093. Yesterday’s Dow close was 12,159.21 — 60 points shy of a 2,000 point whackage.

At market tops, TV ratings soar, and Publishers sell lots and lots of magazines. Bottoms occur when the public is disgusted with stocks: They certainly don’t want to hear about them on TV or read about them during their leisure hours.

In India, CNBC TV18 is certainly amongst the most popular TV channels. And there’s no dearth of new finance magazines, stock market portals (yes - that includes Moneyoga), etc. Wonder what a slow market in 2008 would do to financial media?

• Via Abnormal Returns, Scientific American: The Mind of the Market

The moral sense of fairness is hardwired into our brains and is an emotion shared by most people and primates tested for it.

The Gordon Gekko “Greed Is Good” model of business is the exception, and the Google Guys “Don’t Be Evil” model of business is the rule. If this were not the case, market capitalism would have imploded long ago.

• Yahoo Finance: Beijing wages psychological war on prices

Under the new measures, retailers of food products such as milk, pork and eggs will need to seek permission from local price bureaux, institutions that have long ago ceased to have any effective controls over produce markets.

. . . the price controls may indicate that inflation is worse than the official figures suggest. “Maybe the government has information that inflation is even higher,” he says. “They may just be buying time to handle the issue.”

Have price controls ever worked?

• WSJ: Historic Surge In Grain Prices Roils Markets

This year the prices of Illinois corn and soybeans are up 40% and 75%, respectively, from a year ago. Kansas wheat is up 70% or more.

The prospect for a long boom is riveting economists because the declining real price of grain has long been one of the unsung forces behind the development of the global economy. Thanks to steadily improving seeds, synthetic fertilizer and more powerful farm equipment, the productivity of farmers in the West and Asia has stayed so far ahead of population growth that prices of corn and wheat, adjusted for inflation, had dropped 75% and 69%, respectively, since 1974.

• BCA Research: Anti-U.S. Housing Trades

• Michael Mauboussin of Legg Mason: Was Harry Potter Inevitable?

Predictions are difficult in culturally biased realms. Through a novel experiment, researchers showed an average song can become a hit or a clunker based on the principle of cumulative advantage.

The main challenge to counterfactual thinking is the issue of causality. In some situations, cause and effect is clear. You are wet because you didn’t bring your umbrella. But in many social systems, indeed in all complex adaptive systems, cause and effect are frequently difficult to link.

The Halo effect: we tend to observe success, attach attributes to that success, and recommend others embrace these attributes to achieve their own success.

As applicable to Dalal Street as Wall Street: Seven rules for bull-and-bear predators in a ‘brutal, manipulative world’

10. ‘The more visible your power, the more its limits are known’.

They mimic stealth bombers. Revealing nothing unless forced to, even controlling the en-forcers. Wall Street operates behind a veil of secrecy, a “happy conspiracy” as Vanguard founder Jack Bogle calls it. They live by deals with politicians, lobbyists, SEC staffers, corporate CEOs, money managers, cable anchors, brokers, bankers — the list goes on.

17. ‘Those who are dependent on you will be the most faithful’.

Back in the mid-1990s Wall Street initiated a major strategic move to expand into the asset-management business and control vast sums of money. Since then they’ve brainwashed investors into a childlike dependency.

Cynical, yet true?

This is one occasion where I hope the magazine cover indicator will fail to work as a contrarian sign:

Here’s the intro piece.

PS: Anyone find a bigger image?

• Michael Mauboussin: Turtles in Omaha

The attributes of successful traders or investors are not limited to those realms. In fact, we argue that there is an approach that distances the best performers in all probabilistic fields from the average participant. The approach has three central elements:

1. A focus on process versus outcome.

2. A constant search for favorable odds, including a recognition of risk.

3. An understanding of the role of time.

• Jeff Mathews’ multi-part series: Pilgrimage to Omaha

“We knew during the Long Term Capital Management Crisis that there would be a lot of opportunities, so we just had to read and think eight to ten hours a day.”

“We have no system for estimating the correct value of all businesses. We put almost all in the ‘too hard’ pile and sift through a few easy ones.”