The Aleph Blog » Blog Archive » Nine Notes on Speculation

Nine Notes on Speculation

Recently I have been clipping articles, and arranging them by category, so that I can comment on them as a group more easily.  Tonight’s topic is speculation again, but these articles are all of the odd bits that don’t follow any particular theme.

  1. Sometimes I think that the major financial press that covers Wall Street should send chocolates to Jim Cramer for creating  Where else would they get high quality journalists the understand the markets?  Writing for RealMoney, Matthew Goldstein would occasionally e-mail me with a question.  He was the one who covered financials in the news group for TSCM.  Financials are harder to learn than industrials, and I thought he would go far.

      Well, he has gone far, to Business Week.  The advent of hedge funds has created a great demand for shorting stock, and there are concerns on the part of some with naked shorting, where one does not borrow the shares before they are sold.  This article describes the probe into stock lending, and what may come of it.  Personally, I wonder why investment banks don’t create single-name total return swaps.  E.g., receive three month LIBOR plus or minus a spread, pay IBM total return.  That would allow the same economics of shorting, without the stock borrow, and no charges of naked shorting.  Why not?

  2. Brave new world; the uptick rule is history.  Well, that should provide more liquidity to buyers.  I’m indifferent on this one, though I would warn anyone doing a death-spiral convert that the elimination of the uptick rule means there is no way that the short sellers won’t win.
  3. Once you have derivatives, almost anything is possible.  Insider trading can be hidden through derivative instruments, because they are not publicly reported.  Now, in practice, it may not be that simple, because derivatives are a zero sum game, and the counterparty loses what the one with information wins, unless they are hedged.  Whoever bears the loss after the takeover is announced has a concentrated interest to find the one who ended up winning, because they might get back what they lost.
  4. I think it is inevitable that there will be different ways of trading large and small blocks of stock.  Most industries have different distribution methods for wholesale and retail.  Dark pools of liquidity don’t surprise me; when I was a bond trader, if I wanted to trade a large fraction of some bond deal, quietness and anonymity were crucial.  My view: have the SEC serve as trading apprentices a large equity or bond shops, and see why large trading is different from small trading.
  5. Fitch gets it, maybe.  They see why hedge funds might be weak holders during a crisis.  I’m not sure what Fitch will do with it, but that skepticism will make for a better rating agency.
  6. 130/30 seems to be coming along at the wrong time.  There is too much pressure on the borrow from hedge funds already.  My opinion is that short-selling is getting close to useless on average, given the high level of shorting.  When the bad event happens, the covering keeps the stock afloat.
  7. No more earnings guidance? Yay!!  Let analysts be real analysts, and not just take what management has fed them.  I like it when companies I follow eliminate earnings guidance, because it increases the advantage of analysts who really understand what is going on.
  8. Investing in commodities was a great idea until players started to invest in an indexed manner on the front month.  This has forced the front month to be low versus future months, and the continuing roll depresses returns.  If I were running such a fund, I would invest in a ladder of contracts similar to the pro-rata ladder of contracts currently traded; that would minimize the antiselection.
  9. Finally, be wary of funky ETFs that don’t actually own the underlying assets in a direct way.  There are too many ways for those vehicles to go wrong.  Good ETFs have direct ways of hedging that keep the prices in line with what they are trying to replicate.

That’s all for now.  My own investing has gone well so far this week, but who can tell what the future will bring?

General, Macroeconomics, Portfolio Management, Stocks, Value Investing | RSS 2.0 |

5 Responses to Nine Notes on Speculation

  1. Scott McCartney says:

    David, you’re really hitting your stride with the blog’s overall content. It’s impressively wide and deep. I tell my PMs to “put on a pot of coffee” before reading you. Terrific, terrific stuff. Keep it up.

  2. Ben Williams says:

    1) We already have SSFs (single-stock futures) from which you can simulate swaps. They are publicly-traded (although lightly-traded). No borrowing to short futures, of course, and better margining.

    9) Maybe an ETF/ETN hybrid would be useful. Think of an insurance company’s separate accounts. Rather than owning a piece of the general corporate liability of the fund backer (ETN), hybrid holders would look to segregated, correlated assets with a guarantee from the backer. Should result in higher recovery for the holders in case of failure, and also provide better transparency as to the adequacy of the assets along the way, while preserving the value of an ETN (the ability to track an index that an ETF could not practically invest in, such as spot crude or Indian stocks, and maybe a little tax magic).

  3. Scott — Thanks. Just trying to do my best for readers.

    Ben — 1) I know about SSFs, but they really haven’t taken off, and they are subject to reporting in ways that swaps are not. They would work though if they were liquid enough. 9) Cute idea — reminds me of separate account GICs. The only difficulty that I see is that the ETN would have slightly lower fees, because the sponsor gets an implicit borrowing subsidy from the relatively cheap financing that the ETN delivers.

  4. Chris Dudko says:

    re: earnings guidance… doesn’t a company issuing guidance increase many participants’ focus on the “wrong thing” (i.e. short term business performance) and create more inefficiency around ST events (inefficiency that you, as a longer-term thinker, can see through and thus exploit)? It seems to me that the more arm-waving and carrying-on about ST events, the better. If the act of issuing guidance changes the way the business is MANAGED, that is a different story…

  5. Chris — good points. When guidance is provided, the sell side typically clusters near it, adjusted for the normal degree of conservatism of management (or lack thereof).

    Regarding following earnings estimates in the short run: if I didn’t work for a hedge fund, I would probably ignore them entirely, but since I have to make some short term plays, in the short run I bet against the errors embedded in the estimate. They cluster more tightly when management gives guidance, so perhaps I am wrong in the short run as well. Surprises against a cluster would have more impact in the short run than against a scatter.

    That said, I spend the least amount of time on the income statement, and much more on balance sheets and cash flows.


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

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