Thursday, October 31, 2013

The Downside of Math Whizzes

My first thought was a Seinfeldian Newman! Economists! but I suppose you could substitute Quants!

From the Boston Globe:
Do the math? Only if I agree with it!

It’s comforting, in these polarized times, to blame the idiots. Our failure to come together on issues like health care and gun control, climate change and economic policy, isn’t our fault, we like to tell ourselves. It’s a result of the talk-radio blowhards, the cable TV know-nothings, and the blind partisans—on the left and right—too dumb to look at the data and do the math.

But now new research is suggesting something different. The problem is not people who can’t do the math. The problem is the ones who can.

In a new working paper, Yale Law School’s Dan Kahan and three other researchers make the case that those more skilled at math are less likely to come to the correct conclusion on controversial matters—even when the numbers to support that conclusion are clear, empirical, and staring them in the face.

In the study, conducted this past spring, over 1,100 participants were asked to use numbers to assess whether a particular intervention had worked—either a skin rash treatment or a gun ban. In assessing the rash treatment, which had no political implications, those with lower “numeracy,” or math skills, were, as you might guess, far less successful than their “high-numerate” peers: They were likely to get the question right about one-third of the time, compared to two-thirds of the time for the group with better math skills.

But the question about the gun ban revealed something that Kahan called “shocking and really disturbing.” When doing the math yielded an answer that contradicted a participant’s politics, the high-numerates were about as likely to get it wrong as their low-numerate counterparts.

High-numerate conservative Republicans were far more likely to come to the right, data-based conclusion in the gun ban question if they had been told that crime increased—a result that squares with their ideology.

High-numerate liberal Democrats were far more likely to get it right if crime decreased. Perhaps most troubling, Kahan found, the numerate people were more polarized than those who struggled with the math: They were 45 percentage points more likely to get the right answer if the data backed up their views than if it didn’t. Low-numerate people, by comparison, were far less polarized.

“This study suggests that they’re using their greater numeracy in a kind of strategic, opportunistic way,” said Kahan, a professor of law and psychology. “They’re using their better ability to make sense of the evidence in a way that gratifies their state and fits their ideology.”...MORE

"Can Venture Capitalists Really Beat the Market?"

From the Wall Street Journal's Corporate Intelligence blog:
They may have taken on some of the sheen of Silicon Valley in the popular imagination, but do venture capitalists do to more conventional investment funds what the iPhone did to BlackBerry? Are they in another league, performance wise?

Not exactly. New numbers out from Cambridge Associates and the National Venture Capital Association show the industry performing better in the quarter ending June 30, with returns increasing for shorter and longer time periods.

But their U.S. Venture Capital Index, which is based on data compiled from 1,439 venture capital funds, shows venture capital funds outperforming indices like the Dow Jones Industrial Average only in the short term (the three months to June 30) or the long term (15 or 20 years)....MORE

UK Government: No Chance of Global Cooling For Hundreds of Years

From Hansard (Lords) 23Oct13:

Climate Change


Asked by Lord Donoughue
To ask Her Majesty’s Government what assessment they have made of (1) the likelihood and timing of any future phase of global cooling, and (2) the potential impact on the United Kingdom and global economies of any future extensive glaciation; and what precautionary plans they have to limit any damage they predict to the United Kingdom economy and its people from any such extensive glaciation. [HL2653]

The Parliamentary Under-Secretary of State, Department of Energy and Climate Change (Baroness Verma) (Con): The UK government has made substantial investment in research that concerns the likelihood and timing of future changes in global and regional climate.

All of the climate models and policy-relevant pathways of future greenhouse gas and aerosol emissions considered in the Intergovernmental Panel on Climate Change's (IPCC) recent Fifth Assessment Report show a long-term global increase in temperature during the 21st century is expected. In all cases, the warming from increasing greenhouse gases significantly exceeds any cooling from atmospheric aerosols. Other effects such as solar changes and volcanic activity are likely to have only a minor impact over this timescale.

With regard to future glaciation the timescales are very long. Changes in the Earth's orbit are considered to have driven the glacial cycles that have occurred every 100,000 years approximately, during the past one million years. The British Antarctic Survey has advised that the Earth is about halfway through the current interglacial period and the onset of the next glaciation is not expected for around 10,000 years at least. Although a future extensive glaciation would have huge geopolitical consequences, the transition into such a state would be slow, allowing for adaptation over many generations.

The slow changes in the Earth's orbit are not, however, expected to cause any net global cooling over the next several centuries, which will be dominated by a warming global climate due to greenhouse gas emissions.
Meanwhile, over at the BBC:
Real risk of a Maunder minimum 'Little Ice Age' says leading scientist
It’s known by climatologists as the ‘Little Ice Age’, a period in the 1600s when harsh winters across the UK and Europe were often severe.

The severe cold went hand in hand with an exceptionally inactive sun, and was called the Maunder solar minimum.

Now a leading scientist from Reading University has told me that the current rate of decline in solar activity is such that there’s a real risk of seeing a return of such conditions.

I’ve been to see Professor Mike Lockwood to take a look at the work he has been conducting into the possible link between solar activity and climate patterns.

According to Professor Lockwood the late 20th century was a period when the sun was unusually active and a so called ‘grand maximum’ occurred around 1985.

Since then the sun has been getting quieter.

By looking back at certain isotopes in ice cores, he has been able to determine how active the sun has been over thousands of years.

Following analysis of the data, Professor Lockwood believes solar activity is now falling more rapidly than at any time in the last 10,000 years....MORE
Not only do we have a disagreement it also appears that Professor Lockwood has had a dramatic change of heart from a "strong-form" Anthropogenic Global Warming view of six years ago:

I repeat:

I only bring this up because of a couple large directional bets that could be influenced by, well, you know, whether it's going to be freakin' hot or 'effin cold.

FT Editorial: "Europe’s flirtation with deflation"

From the Financial Times:

US is right to criticise Germany on its economic policy 
The US government could not have chosen a better day to attack Germany for pushing the eurozone into deflation. Hours after the US Treasury published a report that was highly critical of Berlin’s large current account surpluses, fresh statistics showed that inflation in the eurozone fell to 0.7 per cent in October, a four-year low. 

The US is clearly not in a position to lecture any country on economic policy making. For weeks, Congress has flirted with a US default, which would have been calamitous for the global financial system. This game of Russian roulette may well resume next February, when the US is expected to hit its debt ceiling again. Yet, the faults of the messenger do not invalidate what he has to say. While the blame for the eurozone’s disinflation does not rest with Berlin alone, the US Treasury’s analysis is both correct and timely....MORE
 ...After buttressing the single currency with its conditional bond-buying scheme, the ECB has done little to stop inflation undershooting its target of close to (but below) 2 per cent....

UPDATED--"Spectre of destructive deflation looms over eurozone: analysts"

Update:  "FT Editorial: 'Europe’s flirtation with deflation'"
Original post:
I wasn't kidding with the earlier "This could get troublesome."
From Agence France-Presse via France24:
The near paralysis of prices is raising fears the eurozone may tip back into a deflation -- a vicious circle of falling prices, wages and output -- and is raising pressure on the ECB to act.

Even the US Treasury expressed concern this week over the "deflationary bias for the euro area, as well as for the world economy,"

Data released by the European Union statistics agency Eurostat on Thursday showed the annual rate of inflation across the 17-country eurozone fell to 0.7 percent in October, the lowest for four years.
At first sight this would seem to be good news for households which have seen their purchasing power eroded.

It should be the opposite of inflation, in particular hyperinflation, in which rapidly rising prices wipe out the value of money that people hold.

But in reality the "perverse logic" of deflation means it will have a sharply negative impact on households, according to Philippe Waechter, an economist at Natixis Asset Management....MORE

Reinsurance: "St. Jude" Windstorm ("Windstorm Christian") Losses Estimated at $1.7bn to $2.9bn--Credit Suisse

Despite the breathless warnings prior to landfall the storm was a bit of a damp squib at least in comparison to the 1703 storm* which seemed to come up in every other report.
From Artemis:
Insurance-linked securities and reinsurance-linked investment manager Credit Suisse has estimated that total insured industry losses from European windstorm Christian could be in the range of $1.7 billion to $2.9 billion but does not expect the event to impact its IRIS Low Volatility Plus fund.

The update from Credit Suisse comes via the DCG Iris London Stock Exchange listed insurance-linked securities fund, which is managed by Dexion Capital as a feeder fund into CS Iris Low Volatility Plus. With Credit Suisse not expecting any impact to its fund it also means that the DCG Iris fund is likely safe from windstorm Christian, as long as the insurance industry losses are within this range.
Credit Suisse describes the storms impacts:
Winter storm Christian (known as “St. Jude” in the United Kingdom) battered northern Europe  between October 27 and 29 affecting countries bordering the English Channel, North Sea and Baltic Sea. It was one of the strongest storms of the last few years and reached peak wind gusts of more than 190 km/h (119mph) with storm surges reaching as high as 7.5 metres. Christian first impacted the south of Great Britain early on Monday, October 28, then moved along the English Channel and across Denmark and reached north-western Russia on Tuesday, though significantly weakened.
While most winter storms in Europe typically reach their peak intensity over the Atlantic Ocean, Christian gained in intensity while crossing Britain, caused by the shape of the jet stream. It reached its peak intensity while crossing northern Germany and Denmark, with southern Denmark recording wind gusts of 194.4 km/h (121 mph), the strongest in the country’s history. France, Belgium, the Netherlands, southern Scandinavia and the Baltic states were also impacted.
Storm Christian caused widespread transport disruption in all affected countries as rail lines were blocked by fallen trees, airports cancelled flights and harbours delayed shipping traffic. 270,000 homes in Britain and 75,000 in France temporarily lost power. The northern German city of Hamburg recorded a storm surge as the wind gusts drove water upstream the Elbe river. Flooding was very limited, however, as water levels reached only slightly above the barriers. At least 14 fatalities have been reported so far, mainly due to falling trees.
Most of the damage is expected to have been caused by the wind gusts as flying debris and falling trees damaged homes and cars. As buildings in the affected areas are primarily of masonry construction, most of the damage was limited to rooftops and chimneys, but the storm affected a very large area.
It is very early to produce industry loss estimates for Christian, hence the wide range published by Credit Suisse and there is likely to be some movement as the true extent of damage and resulting claims becomes clearer in the coming weeks.... MORE
*They weren't even close to comparable as this report from Risk Management Solutions points out there were at least 8,000 people killed by the earlier storm.

UPDATED--Flash estimate: Euro area annual inflation down to 0.7 %

This could get troublesome.
From BusinessWeek:
Europe Gets a Halloween Scare on Inflation
Europe got a double dose of spooky news on Oct. 31, as new data showed inflation in the euro currency zone plunged to an unexpected 0.7 per cent during October, a four-year-low, while unemployment in September held steady at a record-high 12.2 per cent.

The inflation report ramps up pressure on the European Central Bank to cut interest rates, possibly as early as its meeting Nov. 7. October marks the ninth consecutive month that inflation has fallen below the bank’s 2 per cent target. “Even if the ECB were to keep rates on hold in November, we would still see a high chance of a rate cut in December,” London-based economists for UBS said in a note to clients. Most economist polled by Bloomberg News predict the bank will act in December, cutting the refinancing rate from the current 0.5 per cent to 0.25 per cent.

The euro currency dropped sharply on the news, trading at $1.36 against the dollar at midday in New York. “There was a big downward surprise,” Vassili Serebriakov,” a foreign-exchange strategist at BNP Paribas in New York, told Bloomberg News. “Markets build up long positions in the euro too quickly.” ...MORE
Here's the release from eurostat.
UPDATE: ""Spectre of destructive deflation looms over eurozone: analysts""

The FOMC, Repos, Inflation and Yield

From Alhambra Investments:

The FOMC Trap
That there was no change to QE was not really unexpected in October, though consensus about this kind of policymaking theater has become somewhat of a crapshoot. The reason is, contrary to pre-crisis experience, a growing and more obvious schism in the FOMC façade. There have been disagreements in the past, uncovered by the delayed release of full meeting transcripts, but they never seemed as deeply philosophical as they are now.

On the one side includes several FOMC members, particularly DC Board member Jeremy Stein. Appointed in May 2012, the former Harvard professor and Obama Administration member seems to have been at the forefront of the clique that advocated caution over asset prices. He noted in February 2013 that he was concerned about “overheating credit markets”, particularly in certain mortgage segments and high yield.

“The first stop on the tour is the market for leveraged finance, encompassing both the public junk bond market and the syndicated leveraged loan market. As can be seen in exhibit 2, issuance in both of these markets has been very robust of late, with junk bond issuance setting a new record in 2012… On the one hand, credit spreads, though they have tightened in recent months, remain moderate by historical standards. For example, as exhibit 3 shows, the spread on nonfinancial junk bonds, currently at about 400 basis points, is just above the median of the pre-financial-crisis distribution, which would seem to imply that pricing is not particularly aggressive.

“On the other hand, the high-yield share for 2012 was above its historical average, suggesting–based on the results of Greenwood and Hanson–a somewhat more pessimistic picture of prospective credit returns.16 This notion is supported by recent trends in the sorts of nonprice terms I discussed earlier (exhibit 4). The annualized rates of PIK bond issuance and of covenant-lite loan issuance in the fourth quarter of 2012 were comparable to highs from 2007. The past year also saw a new record in the use of loan proceeds for dividend recapitalizations, which represents a case in which bondholders move further to the back of the line while stockholders–often private equity firms–cash out.”
He called this cumulative behavior “reaching for yield”, which is exactly what has been warned for years going back to the original ZIRP. In some sense it is a contradiction because the Fed intended for this happen, though not to this degree (I assume, at least for some of them).

But that wasn’t the end of it either, as Governor Stein went further along the “reach for yield” thesis and right into repo financing and systemic liquidity. It was “collateral transformation” that was really driving concerns over potential risk.

“Collateral transformation is best explained with an example. Imagine an insurance company that wants to engage in a derivatives transaction. To do so, it is required to post collateral with a clearinghouse, and, because the clearinghouse has high standards, the collateral must be ‘pristine’–that is, it has to be in the form of Treasury securities. However, the insurance company doesn’t have any unencumbered Treasury securities available–all it has in unencumbered form are some junk bonds. Here is where the collateral swap comes in. The insurance company might approach a broker-dealer and engage in what is effectively a two-way repo transaction, whereby it gives the dealer its junk bonds as collateral, borrows the Treasury securities, and agrees to unwind the transaction at some point in the future. Now the insurance company can go ahead and pledge the borrowed Treasury securities as collateral for its derivatives trade.

“Of course, the dealer may not have the spare Treasury securities on hand, and so, to obtain them, it may have to engage in the mirror-image transaction with a third party that does–say, a pension fund. Thus, the dealer would, in a second leg, use the junk bonds as collateral to borrow Treasury securities from the pension fund. And why would the pension fund see this transaction as beneficial? Tying back to the theme of reaching for yield, perhaps it is looking to goose its reported returns with the securities-lending income without changing the holdings it reports on its balance sheet.”
We saw exactly this kind of behavior in the housing bubble. Apart from the “reach for yield” in the mortgage space through securitizations, several of the now-notorious Wall Street firms engaged in the collateral transformation business as well as other more “risky” transactions that ultimately proved disastrous. AIG was a perfect example.

So it is not necessarily the search for returns that is problematic, but the systemic and ultimately endemic behavior it engenders. All the while, such risk is so deeply embedded that it never gets appreciated outside of cursory reviews like Fed speeches or even investigations. I think this argument was persuasive enough to at least temporarily commit the Chairman, Bernanke himself, to begin thinking and talking about “taper.”
On the other side sat not necessarily the ultra-doves like Eric Rosengren (Boston Fed), who at least tried to formulate (badly) cover for taper despite being formerly and squarely in the QE-forever faction, but the “deflationists” like James Bullard (St. Louis Fed). Bullard’s first (and it seems, only) priority is disinflationary conditions and anchoring behavior. He warned all the way back at the June FOMC meeting, during the height of the bond selloff, that, “the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings.”

And so it seemed as if the “risky behavior” camp squared off against the “deflationists”, with taper in control, until the summer turned decisively in favor of the latter despite little respite for the former’s concerns. Inflation has been consistently below target, and that is a bigger problem for the FOMC than “risky” behavior or asset bubbles (in their orthodox views).
ABOOK Oct 2013 CPI Core PCE


Journalist as Personal Brand: The Economics

From the Nieman Journalism Lab:
Is the economic power of star journalists growing or shrinking? Depends on the news organization.

Divorces can be such fun, especially media divorces.

This week, David Pogue and The New York Times split after 13 years. Last month, The Wall Street Journal couldn’t renew their vows with Walt Mossberg and Kara Swisher. Over the past year, Nate Silver’s bid adieu to the Times and Andrew Sullivan severed his relationship with The Daily Beast, just months before Tina Brown did likewise.

The terms of disendearment are never announced, and everybody wishes everybody luck in their new ventures.

What’s the value of media personality these days, and how is that value changing? There are always personality differences, miscommunications, and feelings of unshared gain (or sacrifice), as in all relationships. These more recent splits, though, may tell us about the new value of personality power in the digital media world — as well as its limits.

The Pogue parting is no big surprise. His far-flung business activities posed potential conflict after potential conflict; then-Times public editor Clark Hoyt’s 2009 column on Pogue served only as a public iceberg tip for concerns long simmering in the newsroom. Pogue’s own earlier statement, taken out of context, he points out — “I am not a reporter, I have never been to journalism school” — certainly didn’t help, as Gawker, among others, ridiculed that stance as disingenuous.

David Pogue is a wonderfully successful personal tech writer, probably more show biz than news biz, and now he’s taking his talents to Yahoo, where, according to CEO Marissa Mayer, he ”will lead a major expansion of consumer tech coverage.” Pogue gets more money and presumably less interference with his ventures, which include TV (PBS Nova specials, CBS Sunday Morning stories), books (Missing Manual book series), and magazines (a Scientific American column. A Broadway composer, you can check him out singing Tom Lehrer-like parody (“I Write the Code”) on YouTube. Pogue’s been multi-platform since before there was multi-platform.

Across town, The Wall Street Journal had developed its own multi-platform success. Since its launch in 2007, AllThingsD has moved comfortably from web to mobile, a top-three go-to site about digital deal-making, and back into the terrestrial world. The annual D conference is prototypical of the new events businesses now being jump-started by big and small publishers alike (“The newsonomics of the new Chattanooga Choo-Choo”).

Let’s consider the business case of star power. It’s morphed some since I first wrote about it three years ago (“The newsonomics of journalistic star power”) because of the changing economics of the business. Then it was institutions like Bloomberg and the National Journal making their moves, poaching higher-end talent like Fareed Zakaria and Howard Fineman.

Why invest in such talent? Certainly, there’s the barker factor. David Pogue, Marissa Mayer believes, will bring new readers into the Yahoo tech tent. More audience is, of course, the goal. But in 2013, audience growth is less valuable than it used to be. With the digital ad flatness that almost everyone other than Google, Facebook, and Twitter are seeing (Yahoo itself was down 7 percent in display ad revenue in Q3), the tie between audience growth and ad return is weakened. These days, the money is in matching audience to ad, as programmatic buying and other ad technologies transform the business. (Marketplace covered this issue well in its Pogue-related coverage; AllThingsD’s revenue plusses and minuses were best covered by Bloomberg’s Ed Lee.)

So how much, financially, is a David Pogue or a Nate Silver worth The New York Times?
The value equation has two parts. First, media can count the direct revenue driven by a contributor’s posts, columns, videos, or event appearances. Then there’s the elusive — but very real — brand-building. Personalities do help build brands.

The bigger the brand, though, the more value the brand may confer on the personality, as compared to the reverse. As we try to disentangle the value of Andrew Sullivan’s pay model from the value of his previous employers, we see that he’s both proving out a new model and showing us the limits of it. Both the Beast and The Atlantic, his previous home, conferred a fair amount of brand authority on him.

It’s an elusive relationship, as hard to achieve in media as marriage: “The sweet spot is the combo where both benefit from and feed off each other,” sums up Justin Smith, the new CEO of Bloomberg Media and former Atlantic Media president.

What we may seeing in the Pogue departure, as well as the AllThingsD split, is a new media company assessment of that brand value, as those companies struggle with lesser, ad-depleted revenue value....MORE
Every Journalist a Personal Brand
Adventure Capital: Ebay Founder Omidyar And NSA Nightmare Glenn Greenwald Team Up in a $250 Million Journalism Venture
Google Goes Longform: In-Depth Articles to Accompany Topical Search Results (GOOG)
Journalism: Henry Blodget and Business Insider Investing in Longform Writing
Today in OccupyWallStreet News: "I'm a F***ing Journalist, You Motherf***er!"Columbia Journalism Review: The extraordinary promise of the new Greenwald-Omidyar venture
"The Journalist’s New Escape Plan: Start-Ups" (and Bloomberg goes VC)
"Why Aren’t Top Journalists Rich?"
 Media: It's the Talent, Stupid!
"Journalism: Go Longform or Go Home"
"How Will the End of Print Journalism Affect Old Loons Who Hoard Newspapers?"

Collusion: How Apple, Google, Intel and Adobe Agreed to Suppress Employee Pay

From the Verge:

Workers in Silicon Valley no-hire scandal granted class-action status

Programmers and other technical employees whose wages were allegedly kept artificially low by widespread no-hire pacts between Apple, Google, Adobe, and Intel are being granted class action status. California district court judge Lucy Koh ruled that the antitrust concerns of the "overarching conspiracy" between 2005 and 2009 warranted trying the case en masse. According to a lawyer representing the plaintiffs, over 64,000 employees who worked at the four companies are potential class members. Intuit, Pixar, and Lucasfilm had been named as defendants in the original complaint, but have reached tentative settlements with the plaintiffs totaling $19 million, Bloomberg reports....MORE

Natural gas: Storage Comes in a Bit High, Weather Looks Bearish

We have been distracted by the decline in crude but now as we get within six bucks of the target ($90 WTI) we'll be spending more time with natural gas.
Today's action via FinViz, $3.5910 last:

From the EIA:
Weekly Natural Gas Storage Report
for week ending October 25, 2013.   |   Released: October 31, 2013 at 10:30 a.m.   |   Next Release: November 7, 2013

Working gas in underground storage, lower 48 states Summary text CSV JSN

Historical Comparisons
billion cubic feet (Bcf)

Year ago
5-Year average
Region 10/25/13 10/18/13 change
(Bcf) % change (Bcf) % change
East 1,964   1,947   17  
2,086   -5.8   2,055   -4.4  
West 552   549   3  
539   2.4   504   9.5  
Producing 1,263   1,245   18  
1,274   -0.9   1,161   8.8  
   Salt 318   311   7  
298   6.7   206   54.4  
   Nonsalt 945   933   12  
977   -3.3   955   -1.0  
Total 3,779   3,741   38  
3,899   -3.1   3,721   1.6

And from the CME:
...Weather Tealeaves
Forecast Courtesy of Meteorologist Steve Gregory
Thought of the Day: Warmer but Stormy Weather Ahead
A highly progressive flow is now in place across much of North America, with a stormy pattern expected across much of the nation during the next 2 or more weeks. Major storms systems are seen across the nation at approximating 6-7 day intervals. Temperatures will average above-normal across the Eastern half of the nation, with strong warm-ups every few days ahead of each approaching storm, followed by a 'cool down' to near normal temperatures following each storm and associated cold frontal passages. Net gas-weighted heating demand will average 20% below normal during the next 7 days. For more information on this and other Weather Products & Services, contact: Steve Gregory at 
Notes of Note:

**Last week's weather was a whopping 90% cooler than same week/last year and 34% cooler than the 5-year average: 
**Supplies from the Northeast/Midwest regions improved a combined 0.2 Bcf/d W-o-W due to increased flows on TGP, Transco and TCO pipelines in the Pennsylvania portion of the Marcellus Shale. 
**In the Southeastern US, higher production levels were supported by a 
0.4 Bcf/d increase in onshore Gulf Coast flows. 
**Pipeline imports from Canada improved 0.7 Bcf/d W-o-W as imports into the Midwest, Northeast and Western US increased 0.4, 0.1 and 0.1 Bcf/d, respectively. 
**Total demand increased 6.6 Bcf/d W-o-W and was 6.0 Bcf/d higher than 2012 levels;
**Industrial demand:19.4 Bcf/d, +0.7 Bcf/d W-o-W, +0.8 Y-o-Y;
**Res/comm: 23.6 Bcf/d, +6.2 Bcf/d W-o-W, +6.2 Bcf/d Y-o-Y; 
**Power demand: 19.9 Bcf/d, -0.5 Bcf/d W-o-W, -1.1 Bcf/d Y-o-Y; 
**Nuclear generation: 80.6 GW, -1.7 GW W-o-W, +8.7 GW Y-o-Y; 
**BPA hydro output:153.9 GWh, +1.6 GWh W-o-W,+13.1 GWh Y-o-Y;
**CAISO hydro output: 35.2 GWh,+0.8 GWh W-o-W,+0.3 GWh Y-o-Y;
**ERCOT wind output:72.6 GWh, +4.9 GWh W-o-W,-44.0 GWh Y-o-Y;
**BPA wind output: 0.9 GWh, -4.6 GWh W-o-W, -20.5 GWh Y-o-Y;
**Total supply increased 0.9 Bcf/d W-o-W; It was 1.3 Bcf/d higher than 2012; 
**Dry gas production: 65.7 Bcf/d, +0.2 Bcf/d W-o-W, +1.2 Bcf/d Y-o-Y; 
**Net Imports: 3.9 Bcf/d, +0.6 Bcf/d W-o-W, +0.5 Bcf/d Y-o-Y.

Signposts: "Wave of private equity money flows into shipping"

It may be nothing or it may, when combined with the order by Maersk of 20 of the world's largest container ships at $190 million per and the $11 billion bet by John Fredriksen on tankers and rigs, mean something is cooking in the shipping biz.
From the Financial Times:
The shipping industry has endured its worst crisis in 25 years. But there are some signs it may be navigating its way out of choppy waters – not least a surge in the amount of “smart” money from private equity flowing into the sector.

The record influx of funds so far this year is seen by many as a watershed after five years of weathering the storm that caused several ship operators and owners to collapse during the economic downturn.

Dagfinn Lunde, head of shipping at DVB, says the German bank has probably been the most active on private equity deals in the sector, providing the senior debt in various deals involving 45 buyout groups since 2010.

He says typically these deals involve a private equity fund providing about 80 per cent of the equity to buy a ship, with the shipowner providing the rest. “That is new in the last three years. This year has been the most active, it is [spreading] like wildfire,” he says.

Until the financial crisis most shipowners could borrow enough from banks to cover $7 out of $10 towards the cost of buying new ships. But banks are now unlikely to lend much more than half – even to shipowners with very strong balance sheets – meaning they need to come up with more money, according to Urs Dur, managing director of Clarkson Capital Markets....MUCH MORE

Watching for a Head-and-Shoulders Chart Formation in Tesla (TSLA)

If one was going to form the next few days should be up.
$158.98 down 24 cents.
From Alpha Capture:
What a ride it’s been. First the stock caught fire, then the car itself caught fire. But when it’s over, it’s over.

No matter what happens from here, Tesla has without doubt been the stock of 2013, and Elon Musk is surely a lay-up to be Time’s person of the year. This exit signal however helps underline an important point....MORE

How to Hide From Cameras

From Motherboard:

A Last-Minute Halloween Costume That Makes Your Face Illegible to Computers

Instead of going as Edward Snowden or digging out that tattered skeleton outfit, you could simply apply a little makeup to become a new kind of Halloween ghost: The Person Impervious to Face-Recognizing Cameras.

According to a helpful makeup video on YouTube, all you need is some tape, scissors, eyeshadow and something called CV Dazzle. Developed by the artist Adam Harvey, CV Dazzle is a modern take off on the dazzle camoflage from World War I, which was used to protect warships from submarines. This one is designed to hide from cameras ("CV" means computer vision). The video is a take off too, by an artist named Jillian Mayer, and is just as deadpan. "The more you distort your look" by applying the bright paint around the nose, bridge, lips or ocular region around the eyes, she says, "the harder time computers will have identifying you." Face paint works too. (Apparently the camoflage of the future will be wildly visible)....MORE
There must be a downside.

Wednesday, October 30, 2013

Quantology: Coupled Hidden Markov Models--USD/CHF and Gold, for example

From Futures Magazine:
The profitable, hidden and Markovian couple of Swiss and gold
Ask anyone on Wall Street, “What is the state of the market?” and chances are you’ll get one of three answers: Bull, bear or sideways. To the casual trader, these terms paint a rough picture of where the market is moving. But to a certain concept in mathematics, these terms precisely describe where prices are heading.

This concept is hidden Markov models (HMM). It was developed by Harvard Ph.D. mathematician Leonard E. Baum and his co-workers. The premise of the model is that the market is in one of five states — super bear, bear, sideways, bull or super bull — at any given time and transitions between states obey the Markov property. That is, transitions are dependent only on what the market’s state was one time interval before and not any earlier. How the market switches between the five states is indicated by transition probabilities that tell us the probabilities of one state transitioning to another.

The assumption that the market obeyed the Markov property occasionally was thought of as a good one because it removes the problem of lag. This occurs when a current calculation holds little value because it is based on price action much further in the past. The further back you go, the less of an effect price action should have on current trading decisions.

Just as how we know a bear and a bull market behave differently, each state is given a different probabilistic distribution of the observations it can output. Observations are any form of physical quantity we can measure from the market, namely price and indicators. Their uses are two-fold. One, if we know that the market is in a certain state, we can infer from that state’s distribution what the next observation could be. Two, a sequence of observations can be used to figure out the state of the market (see “State transitions,” below).
Over the last decade, HMMs have been creeping into the arsenals of some hedge funds. Because of their logically sound modeling process and subtle application of the Markov property, quants have found good use of HMMs in generating profitable trading signals.

However, HMMs showed their limitations when the time came to incorporate the next wave of trading techniques. Hedge funds experienced a gradual realization that more than one dimension of data was needed to outwit the market. Multi-time frame trading techniques in which two time frames were studied together were explored. Pairs trading in which prices of two assets were analyzed at the same time was the emphasis. Intermarket analysis in which the forecasting of an asset in one market considering the dynamics of another asset in another market was developed. The early form of HMMs weren’t conducive to integrating these new ideas and needed to be extended to allow for this possibility. Thus, the coupled hidden Markov model (CHMM) was born.

Unlike Baum’s original HMM, which is standard literature in applied mathematics, the CHMM is new research starting around the mid-2000s and doesn’t have a canonical formulation. While the CHMMs developed by researchers from different universities vary in their specifications, all of them share a common underlying theme: To take two HMMs and couple them by way of their transition probabilities.

Let’s start by giving our two HMMs names. HMM1 will model the currency market, and HMM2 will model the commodity market. Both of them make up our CHMM. Just as before, as time progresses, the state of each market will switch to another state with certain probabilities. Unlike before, this probability now depends on that market’s and the other market’s current states. Therein lies the coupling between both markets (see “Two HMMs coupled,” below).
With the two markets represented in our model, we also need two observations to track, namely the price or indicators of our currency and of our commodity. We feed both observation sequences into our CHMM to have it reconfigure itself to best represent each market.

The result is a model with the predictive power to forecast the next observation for both the currency and the commodity markets. Throughout coupling the two HMMs, we have not removed the Markov property when switching between states. The positives of HMMs are retained, the problem of lag kept buried and the possibility of incorporating another dimension of data made available. Quants were quick to explore pairs of assets to couple for the CHMM....MORE

Another Energy Hedge Fund Quits

From FINalternatives:
Energy Hedge Fund Elustria Ends Short Run
Elustria Capital Partners will close its doors just two years after launching.

The energy hedge fund told investors yesterday that it would liquidate "with deep regret." Co-founders Andrew Waranch and Eric Kimmel wrote that, "over the past two years, the power space has faced numerous challenges."

The liquidation was first reported by Absolute Return magazine.

The New York-based firm's fund debuted in September 2011. Waranch and Kimmel founded it after stints at Elliott Associates and Kottke Associates, respectively.

Climateer Line of the Day: Oil Settles at a Four Month Low Edition

"Crude stocks have risen six weeks now. 
This is quite bearish for WTI."
-Tim Evans, energy analyst at Citi Futures Perspective

Although not as sweetly understated as Izabella Kaminska's comment on money, the analyst captures some of the same flavor.
I don't have a whole lot to add, long time readers know the drill, links below.
Brent $109.77 up 76 cents, WTI  $96.77 down $1.56.

From MarketWatch:
Oil ends at four-month low; supply up sixth week
Crude prices fall to session lows after Fed policy statement 
Oil futures settled lower Wednesday, with a U.S. government report showing a hefty increase in crude-oil supplies for a sixth straight week, and a widely-expected decision by the Federal Reserve to continue its monetary-stimulus measures sending prices to their lowest close in four months.

Crude oil for December delivery CLZ3 -0.12%  fell $1.43, or 1.5%, to settle at $96.77 a barrel on the New York Mercantile Exchange. Tracking the most-active contracts, futures prices settled at their lowest level since June 28....MORE
We've been following oil to the detriment of our natural gas coverage but it has been the easier trade:
Aug. 23
Crude is up $1.74 at $106.77.
Our medium term mental map is a fake-out shake-out, i.e. higher to suck in some buying and then a 10-15% drop, back under $100.
There is a lot of oil sloshing around and Asia isn't going to be needing it for a while....
Aug. 30 
Sept 24 
Sept. 25 
Ya think?
WTI $102.54 down 59 cents Brent $108.36 down $0.28
There is an awful lot of the stuff sloshing around. 
Sept 27 
There's a lot of oil out there and if Libya and Nigeria get their acts together there will be a lot more.
Oct. 3 
Despite yesterday's pop, 2%, on short covering and news that TransCanada would be commissioning the southern portion of the Keystone pipeline this month (700k bbl/day Cushing>Gulf Coast), oil is trading "heavy", supply weighing on the market....
Oct. 9 
I'm getting sick of saying it but "There's a lot of oil around".
Oct. 17 
First the boilerplate:
I'm getting sick of saying it but "There's a lot of oil around".
Oct. 21
We've been targeting Brent $95 and WTI $90 for too long....
...It's hard to decide whether to call this decline stately or majesterial....
Oct. 23 
There's a lot of oil sloshing around.
And many more.

Questions America Wants Answered: Why Don't Companies Advertise on the Homeless?

Australia also wants answers.
From Freakonomics:
Question of the Day: Why Don’t Companies Advertise on Homeless People?
Callum Linley, an 18-year-old reader from Melbourne, Australia, writes to say:
So why aren’t there companies lining up to advertise on homeless people?
My guess is it’s an image problem – not wanting to be associated with the “failure” of being homeless. But wouldn’t that be compensated by the fact you could put forward the idea that you are a socially responsible and sympathetic company who cares for the less fortunate?
Well, the world already has given us Bumvertising and homeless people as wi-fi hotspots, and I wouldn’t be surprised if homeless advertising has shown up on TV (hey Simpsons and Family Guy and South Park fans etc., let us know). But how would you answer Callum’s question?  Does it fall into the category of:

a) Questions that are so obvious that they don’t need an answer; or
b) Questions that should be asked more often, but aren’t; or
c) Something else entirely.

"India and gold (1): jewellers in a desperate spot"

Coming into the Diwali holiday a couple timely posts.
From the FT's beyondbrics blog:
What can India do about its gold habit? In the first part of a beyondbrics series, to accompany the FT’s Analysis of India and gold, we look at the impact of recent measures to curb the country’s gold appetite on the jewellery industry.

India’s insatiable appetite for gold has been growing as income levels rise. Imports of the yellow metal have spiraled from 471 tonnes in the 2001 fiscal year to 1,017 tonnes in the year ended this March.
These shipments have been weighing on the nation’s external finances and helped push the economy into its worst financial crisis in over two decades earlier this year. If demand had stayed at 700 tonnes, India’s current account deficit would have been $17bn lower in the last financial year – when it reached an unsustainable $87.8bn or 4.8 per cent of GDP.

This January finance minister, Palaniappan Chidambaram, signalled he was serious about curbing imports of the precious metal and a series of policy measures have followed. Import duties have gradually increased from 4 per cent to 10 per cent and importers are now required to re-export a fifth of their shipments.
These measures have worked in bringing imports down – at least for now. But what impact has this had on India’s jewellery industry?
Gold jewellery plays a big part in India’s culture. It is gifted to the temples to decorate icons, given to a bride on her wedding day – and used as an inconspicuous store for illegitimate wealth.
Half of India’s gold purchases are centred around weddings, according to the World Gold Council, when jewellery is traditionally presented to a bride in her trousseau and to the groom’s family in the form of a dowry....MORE
And a look at the larger problem facing the Indian central bank from the FT's flagship blog, Alphaville:

Hurrah for India’s FX swap strategy, or not?
The Indian government’s efforts to support the rupee seem, for now, to have worked:
In fact, the reversal has been so strong that the Reserve Bank of India, saw fit to roll back some of the emergency measures it put in place in July to support the currency. On Tuesday, the RBI cut its Marginal Standing Facility rate by 25bps to 8.75 per cent, in a bid to ease liquidity in the banking system.

A lot of the turnaround may, of course, be linked to the Federal Reserve’s eventual non-taper. But there is also an argument to be made that some of the RBI’s emergency support policies were more successful than others.

Arvind Subramanian at the Peterson Institute for International Economics provided an interesting analysis earlier this month of which measures worked. Among the most effective, in his opinion, was the government’s relatively original use of FX loans rather than sales.

The success of this contrasted sharply with the RBI’s early attempts to boost the currency by lifting short-term rates, which Subramanian says did little to boost confidence and were poorly designed.
So what was it about FX loans (or swaps) that proved them to be such a useful policy tool?...MORE

"Gillian Tett has a talk with Alan Greenspan"

From the Columbia Journalism Review's The Audit blog:

The ‘Maestro’ admits he didn’t understand derivatives he touted; calls for bank breakup
The Financial Times’s Gillian Tett sits down with Alan Greenspan for a two-hour interview and gets some eye-opening admissions from the fallen “Maestro”:
What also worries Greenspan is that this swelling size has gone hand in hand with rising complexity - and opacity. He now admits that even (or especially) when he was Fed chairman, he struggled to track the development of complex instruments during the credit bubble. “I am not a neophyte - I have been trading derivatives and things and I am a fairly good mathematician,” he observes. “But when I was sitting there at the Fed, I would say, ‘Does anyone know what is going on?’ And the answer was, ‘Only in part’. I would ask someone about synthetic derivatives, say, and I would get detailed analysis. But I couldn’t tell what was really happening.”
This is simply outrageous. As Tett notes, Greenspan, who we now know didn’t understand them at all, touted the risk-dispersing benefits of derivatives as Fed chairman and fought those who would regulate them.
Here’s Greenspan in 2002 in a speech in London:
Financial derivatives, more generally, have grown at a phenomenal pace over the past fifteen years. Conceptual advances in pricing options and other complex financial products, along with improvements in computer and telecommunications technologies, have significantly lowered the costs of, and expanded the opportunities for, hedging risks that were not readily deflected in earlier decades. Moreover, the counterparty credit risk associated with the use of derivative instruments has been mitigated by legally enforceable netting and through the growing use of collateral agreements. These increasingly complex financial instruments have been especial contributors, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter-century ago.
Perhaps we should have known that in oracle-speak, “increasingly complex” meant “I can’t understand them.”

The same day, he attacked regulation of derivatives, saying “regulation is not only unnecessary in these markets, it is potentially damaging, because regulation presupposes disclosure and forced disclosure of proprietary information can undercut innovations in financial markets just as it would in real estate markets” because it would undercut their “quasi-monopoly rents.”...MORE
Roger that, over.
See also:
Remarks by Chairman Alan Greenspan
Understanding household debt obligations
At the Credit Union National Association 2004 Governmental Affairs Conference, Washington, D.C.
February 23, 2004

Greenspan says ARMs might be better deal

There's NSA Spying And Then There are Chinese Hackers

I may want to rethink the 'Internet of Things' enthusiasm.
From the BBC:

Russia: Hidden chips 'launch spam attacks from irons' 
Screengrab from Rossiya 24, with inset of the "hidden chip"  
How Russian TV covered the story about the chips, shown inset

Cyber criminals are planting chips in electric irons and kettles to launch spam attacks, reports in Russia suggest.

State-owned channel Rossiya 24 even showed footage of a technician opening up an iron included in a batch of Chinese imports to find a "spy chip" with what he called "a little microphone". Its correspondent said the hidden devices were mostly being used to spread viruses, by connecting to any computer within a 200m (656ft) radius which were using unprotected Wi-Fi networks. Other products found to have rogue components reportedly included mobile phones and car dashboard cameras.

The report quoted one customs brokerage professional as saying the hidden chips had been used to infiltrate company networks, sending out spam without administrators' knowledge. News agency Rosbalt reports that while the latest delivery of appliances was rejected by officials, more than 30 devices had already been sent to retailers in St Petersburg....

Tesla Is Buying Batteries for How Many Cars? (TSLA)

I don't think any corporate news short of a buyout matters to the shares right now, when stocks get broken they don't get fixed in a fortnight. The numbers do show the growth though.
$161.34 down $3.13.

From Barron's Tech Trader Daily:
Tesla’s Big Battery Order: How Many Cars is That?
Tesla (TSLA) needs batteries like a character in a Lou Reed song needs a fix–and Panasonic is willing to be The Man.
The Associated Press has the details on Tesla’s order.
Under the pact announced early Wednesday, Panasonic will supply nearly 2 billion cells over the next four years. The automotive grade lithium-ion battery cells will power the Model S sedan as well as the Model X SUV, which is scheduled to go into production by the end of 2014, Tesla said.
The agreement amends a 2011 contract between Panasonic and Tesla that promised enough cells for 80,000 vehicles — or approximately 560,000 cells — through 2015.
Deutsche Bank’s Dan Galves does the math...MORE
The stock hit its all-time high, $194.50, thirty days ago:
Chart forTesla Motors, Inc. (TSLA)
Tesla Has Helped Bring Panasonic Back From the Dead (TSLA; 6752)
Will Tesla End Up Using All the World's 18650 Lithium-ion Batteries? (TSLA)
Chartology: Tesla Breaks Down
Chartology: Tesla's Head and Shoulders Formation (TSLA)
"Jim Chanos Hints He is Shorting Tesla Short (Sorta)" (TSLA)
Hitler is Short Tesla and Not Happy (TSLA)

Automating the Newsroom: The AP's Robot Copy Editor

If only we could automate government and do away with the courtier-politicians.
From Poynter:

AP’s new Lingofy plugin is like a robot copy editor
Lingofy is a browser plugin that “checks website content for AP Stylebook’s spelling, language, punctuation, usage and journalistic style guidelines,” the Associated Press says in a press release. The for-purchase plugin also checks against Webster’s New World College Dictionary, the primary dictionary for the AP Stylebook.

Automated checkers aren’t new for AP — it introduced its StyleGuard in 2011, a plugin that checks writing done in Microsoft Word. Lingofy works for people writing directly into a CMS they access via a web browser. Users can add stylebook entries, and its dictionaries “improve over time,” the AP says. “The longer you use Lingofy, the more the system can learn about your unique writing style and the better the software gets at spotting errors and suggesting corrections.”...MORE

"The Best Little Hedge Fund You Never Heard Of"

The post immediately below with its commentary on LTCM reminded me of another fixed income arbitrage fund that has lasted a bit longer than Meriwether and the Nobels did.
First posted September 2010:
From the New York Post:

Small fund, big $
Hoboken hedger 'swaps' places with titans

Call it the best little hedge fund you never heard of. 

Hoboken, N.J.-based Barnegat Fund is up a whopping 132 percent this year -- or $352 million -- hoisted through 2008's turmoil by its 40-year-old founder Bob Treue. By way of comparison, the average hedge fund is up less than 19 percent this year, and only a handful of funds have recovered 2008's harrowing losses.
Treue's fund lost 37 percent during the turmoil of 2008, but his triple-digit gains in the last 12 months have more than made up for the damage. 

The Detroit native, who lives just six blocks from his office and bikes to work, attributes his success in part to the lessons he learned from his first experience with financial calamity in 1998. It was the year of the infamous implosion of Long-Term Capital Management, a hedge fund that lost $4.6 billion in a matter of months, triggering fears of a wider financial damage and requiring a bailout orchestrated by the Federal Reserve....MORE
Here's a bit more on the fund from HedgeWorld:
Fixed income arbitrage: a marketer’s nightmare, a manager’s opportunity
By Bob Treue, Barnegat Fund Management

Fixed Income Arbitrage is most famous for going bankrupt. There is no shortage of examples, starting with Long-Term Capital Management in 1998-1999. The strategy is full of concepts that investors love to hate, such as leverage and adding to trades that lose money initially. However, 2012 has been a particularly good year for this type of relative value strategy.

In 2008, in the wake of the global financial crisis, many of the large fixed income relative value shops either went out of business (Endeavour Capital, Ross Perot’s Park Central, JWM) or shrank dramatically (Myron Scholes’ Platinum Grove, London Diversified). Since then, Dodd-Frank and the Volcker rule have also reduced the competition from bank proprietary desks. Considering the 2008 crisis, increased government regulation and the despised concepts of leverage and adding to losing trades, Fixed Income Arbitrage is a marketing disaster. As a result, the space is sparsely populated.

During this same post-crisis period, governments have increased their market interventions. Recently, the Europeans injected €1 trillion via the Long Term Refinancing Operation (LTRO) and another €200 billion via the Securities Market Program (SMP). The U.K. and the U.S. have also been active in their own versions of quantitative easing. These market interventions have produced a bevy of opportunities in the fixed income space.

As with any business, reduced competition and increased opportunities make for an appealing situation. Our Fixed Income Arbitrage fund, The Barnegat Fund, was able to survive 2008 and has outperformed for the last twelve years. Barnegat has a compound annual rate of return of 18%/year since our launch in 2001. Our share price has gone from 1.00 to nearly 8.00 during that time....MORE
We have no connections to Barnegat, no money with them, no old school ties, no nephews on their desk but think it's interesting to see an operation so different from LTCM playing in the same sandbox. Plus I like this approach noted in the Journal last year:
...Mr. Treue is honest about his strategy's potential downside, which is one reason he hasn't seen a rush of investors to his fund. He recently sent a letter to potential investors listing 11 reasons not to invest with Barnegat, including the fact that it only has six employees. Mr. Treue says "99% of investors pass" after they read his warning....

Black Box Investing Versus Common Sense Quant

From Turnkey Analyst:
Quantitative investing has developed an unjustified PR problem based on the unfortunate tendency of many to associate all quantitative approaches with “Black Box” investing.
That which must not be named
The problem with a black box is that you don’t know what’s inside it, because by definition it’s opaque and non-transparent. You don’t know how it works. You put X in on one side, and Y comes out the other, but you don’t know how confident you should be that Y will resemble your expectations for the box’s output. For this reason, Black Boxes are a dangerous place to invest capital.

A famous example of Black Box investing is Long Term Capital Management (LTCM). LTCM was a hedge fund, run by Nobel Prize winners, and used leveraged “market-neutral” strategies that initially generated returns in the 40% range. The chart below tells you all you need know about how things ended for this Black Box:

Cliff diving, LTCM style
Yet LTCM had good reasons not to be transparent about what they were doing. They wanted to guard their “secret sauce” and preserve a reputation that they were doing something unique. They didn’t want other firms to know their positions, which could jeopardize their ability to unwind them. They didn’t want to hear opinions about how much risk they were taking. As it turns out, all these reasons came back to bite them.

LTCM initially pursued bond arbitrage strategies, but then grew hungry for ways to continue making high returns with more capital. They pursued pairs-related “convergence” trades. They made bets in merger arbitrage. They explored technically driven approaches, involving trend analysis and pattern recognition. In the end, they were not doing something unique, they could not unwind their positions, and they were taking too much risk....MORE
HT: Abnormal Returns

Because LTCM's demise was so dramatic (and because Merriwether & Co were such arrogant twits) we've looked at them a few times:
Time to Attempt the Reverse Long Term Capital Management: Long Treasuries/Short Junk? (TLT; TMF; HYG; JNK)
Attempting a 2 1/2 twisting Meriwether, not that high a D-ifficulty score, so to pull it out the execution must be flawless.... 
...And yes! He sticks the faceplant landing!
Stuff I think about when dreaming up relative value and convergence trades.

LTCM was shorting the more liquid on-the-run treasuries and buying the less liquid off-the-run to catch a few points or shorting treasuries and buying other sovereigns. It worked until Russia defaulted and the crowd did the flight to quality thing: spreads blew out and it was game over.... 
LTCM Co-Founder, Nobel Laureate, Scholes Says the Fund Was Doomed From the Start (we are still using 1998 as a mental map for 2011)
How many Nobel Laureates Does it Take to Make Change...And: End of the Universe Puts

Degree of Leverage Required To Earn Average Returns in Various Interest Rate Trades
A very nice catch by the FT's Tracy Alloway:

This is almost exactly what I was thinking of when I intro'd yesterday's "Is Alpha Dead? Beating the Market Has Become Nearly Impossible":
Fortunately, in real markets anyway, you can take either side of  a bet.
That's why, when I see stories on the end of the commodity supercycle or some such, I get as interested on the short side as I would chasing the latest anti-obesity-drug-touting-biotech on the long.
It helps....
The returns are still there. You may have to leverage it up and it isn't easy money as you really better be right, but the returns are still available. And you don't have to gear it at 100:1 as LTCM did....

Tuesday, October 29, 2013

PIMCO's Bill Gross: "Capitalism needs ‘carry’"

From MarketWatch:
Bill Gross has some strong words for the Federal Reserve. The Pimco co-chief investment officer took to Twitter Tuesday to draw a connection between central bank programs that reduce “carry” and a stall in the normal functioning of capitalism....
...Carry, as Gross describes in his August letter to investors, is another word for yield, or the potential income earned on a bond investment. In addition to simple yield, taking different forms of risk that aren’t dependent on interest rates produce carry (think credit risk, volatility risk, and currency risk). But with the Fed holding short-term interest rates at near zero percent, a good amount of that risk premium has indeed been reduced.

So why does that impede the capitalistic plumbing of our economy? We’ll have to go all the way back to Gross’s June letter to investors – one of his more prolific — for the answer to that one:
“Just as profits are critical to the longevity of our capitalistic real economy so too is return or “carry” critical to our financial markets. Without the assumption of “carry,” or return over and above the fixed, if mercurial, yield on an economy’s policy rate (fed funds), then investors would be unwilling to risk financial capital and a capitalistic economy would die for lack of oxygen. The carry or return I speak to is most commonly assumed to be a credit or an equity risk “premium” involving some potential amount of gain or loss to an investor’s principal. Corporate and high yield bonds, stocks, private equity and emerging market investments are financial assets that immediately come to mind. If the “carry” or potential return on these asset classes were no more than the 25 basis points offered by today’s fed funds rate, then who would take the chance?”...MORE