Market Impact


  • Companies Squeeze 401K Plans From Facebook to JPMorgan This should not surprise, many companies shrink labor costs $$ Feb 15, 2014
  • Wells Fargo edges back into subprime as US mortgage market thaws Isn’t a problem now, problem comes w/imitators $$ Feb 15, 2014
  • Homebuyers Get Break as Loan Rates Defy Fed Tapering Housing & general economy weakened, so mortgage rates fell $$ Feb 13, 2014
  • Pension politics @felixsalmon points out how defined benefit plans r in general better 4 workers. Mind the PBGC $$ Feb 13, 2014
  • Colleges Raise Record $33.8B Exceeding US Peak in 2009 Donations always follow creation of unrealized cap gains $$ Feb 12, 2014
  • Some Lines Say Maybe the Stock Market Will Go Down @matt_levine correctly criticizes the 1928-9 $SPY graph overlay $$ Feb 13, 2014
  • 1929 Stock Market Crash Chart Is Garbage Unequal left & right scales make the relationship look tighter than it is $$ Feb 12, 2014
  •  When to Ignore the Investment Experts “When all the experts &forecasts agree — something else is going 2 happen.” $$ Feb 11, 2014
  • Comparing Economic Recoveries In 1984-2006, growth was borrowed from future by increasing debt levels-> #payback $$ Feb 11, 2014
  • Aluminum Lines Still Trouble the London Metal Exchange Aluminum inventories will b a prob, til short intrates rise $$ Feb 11, 2014
  • Top Anecdotal Signs of a Market Bubble Good piece, like one of mine: Watch the credit cycle $$ Feb 11, 2014
  • Ten Stocks to Own During a Market Correction Good list. I own a few of them. $$ Feb 11, 2014
  • Does trend-chasing explain financial markets? Partly. Difference between investment IRR and total return is big $$ Feb 10, 2014
  • “Security. Safety. Stability.” from @reformedbroker Gold is useful at certain points, but only when it is hated $$ Feb 10, 2014
  • Flows Don’t Follow Value, They Follow Performance @reformedbroker wrote this little gem. Learn & internalize it $$ Feb 10, 2014
  • Long Term Charts 2: Western Markets Since The Middle Ages Interesting charts from very messy data at Zero Hedge $$ Feb 10, 2014
  • Most Expensive Place to Find Out Who You Are @jasonzweigwsj : Your reaction 2 minor crisis shows yr risk tolerance $$ Feb 10, 2014


Companies & Industries


  • AIG Takes $832 Million Charge on Death Bets as Hedge Funds Gain Life settlements should b illegal $$ $MET $AIG $PRU Feb 14, 2014
  • To Stop the Coffee Apocalypse, Starbucks Buys a Farm $SBUX helps create a variety of rust resistant Arabica trees $$ Feb 13, 2014
  • Former BlackRock Manager Finds Billions on Rice Energy Few investment mgrs have operating talent; Daniel Rice does $$ Feb 13, 2014
  • Buffett’s Pal Munger Heads a Very Weird Company Growth of $DJCO thru investing leads 2 # of growing pains & 13F $$ Feb 13, 2014
  • Here’s Why the Biggest Cable Company in the Country Thinks It Can Get Bigger Feds tolerant of cable re antitrust $$ Feb 13, 2014
  • Why AOL ended up spending millions on ‘distressed babies’ $AOL chose 2b in healthcare biz 4 its employees & lost $$ Feb 13, 2014
  • 3 High-Yielders To Buy On The Pullback In total $SNH issues more stock than it pays in divs. Divs -> cap losses $$ Feb 13, 2014
  • Who is John Thompson? A look at Microsoft’s new chairman May have right stuff to protect new CEO from meddling $$ Feb 10, 2014


US Politics & Policy


  • Runaway Drones Map Land, Film ‘Wolf,’ Knock Down People, FAA Gives Chase Drones r here 2 stay; time license them $$ Feb 15, 2014
  • Teacher Tenure Put to the Test in California Lawsuit Tenure has outlived its usefulness; older teachers can b lazy $$ Feb 15, 2014
  • Lincoln’s Foreign Policy in Today’s World Kept England & France from joining Civil War; otherwise pragmatic $$ $SPY Feb 15, 2014
  • What Would Lincoln Do? A clever man w/principles, who did not cease to be pragmatic pursuing 1 main goal – Union $$ Feb 15, 2014
  • Harvard Professor Attacking Google Thrives as Web Sheriff At some point, lack of disclosure will blow up on him $$ Feb 14, 2014
  • The $2.2B Bird-Scorching Solar Project Get used 2 idea: almost every form of energy imposes environmental costs $$ Feb 13, 2014
  • Obamacare Damage-Control Teams Seek to Calm Complaints Things r tough when u r trying to avoid media embarrassment $$ Feb 13, 2014
  • Billionaire Musk Gets Brownsville to Pay for SpaceX Like a football owner bargaining 2 get taxpayers buy a stadium $$ Feb 13, 2014
  • Snowden Swiped Password From NSA Coworker & it cost him his job. Snowden denies it; NSA is Not Saying Anything $$ Feb 13, 2014
  • Puerto Rico Legislators Amend Bill Calling for Bank-Deposit Shift Provincial govt’s attempt 2raid cookie jar stopd $$ Feb 13, 2014
  • Obamacare Will, in Fact, Encourage Employers to Cut Jobs As the employer mandate comes into force, jobs will b cut $$ Feb 12, 2014
  • Tea Party Scorns Republicans as House Lifts Debt Ceiling t-party can b “pure” as Dems raise ceiling w/few GOP $$ $TLT Feb 12, 2014
  • A Lame Duckish Calm Falls Over the Capital Parties in DC act as if the next event is the November elections $$ $TLT Feb 12, 2014
  • Obama Rewrites ObamaCare Another day, another lawless exemption, once again for business; WSJ bangs populist drum $$ Feb 11, 2014
  • The US Senate Again Insists on USPS Saturday Mail Delivery 2 timid; end Wednesday & Saturday delivery $$ $UPS $FDX Feb 11, 2014
  • US firms ‘paid effective tax rate of 2.2% in 2011’ More than a tax haven, Ireland helps insurers shave reserves $$ Feb 11, 2014
  • No Honeymoon for Janet Yellen QE withdrawal will bite, & what will become of all the deposits? $$ Feb 11, 2014
  • Please Hold Your Bernanke Applause Remember, when Greenspan left, he was viewed as a success, same as BB now $$ $TLT Feb 11, 2014
  • Sounding the Tax Alarm, to Little Applause IRS stiffs whistleblowers who often lose employability 4 being a tipper $$ Feb 10, 2014


Rest of the World


  • Putin is Playing a Game of His Own Not so fast. Russia has significant resources & influence in Eastern H’sphere $$ Feb 15, 2014
  • Boy’s Life Hanging on 8-Hour Trip Shows Why Venezuelans Protest Socialism is like a cancer that spreads til death $$ Feb 14, 2014
  • Let’s Watch Venezuela Destroy Itself Logical extreme of Socialism falls apart; pity that Chavez never lived 2c it $$ Feb 14, 2014
  • Chinese Join Winklevosses in L.A. Luxury Home Hedges Amazing what the wealthy will pay 4a fancy foreign retreat $$ Feb 14, 2014
  • Next crisis won’t come from the emerging markets Argues France, Germany, Britain, Australia & Canada-> 2 much debt $$ Feb 13, 2014
  • Mister Donut, Pan Am and Friendster Found Alive and Well Old brands never die, they just move overseas & make $$ $SPY Feb 13, 2014
  • Bank of England points to 2015 rate rise, blurs guidance More precision than 1 can know; the world is messy $$ $FXB Feb 13, 2014
  • Italy Pays Record Low to Sell 3-Year Debt at Auction Let the leverage build for the next crisis $$ Feb 13, 2014
  • Fink to Mobius Touting Emerging Stocks Fails to Stem Outflow A time 2 nibble, not a time 2 gulp $$ $EEM Be wary Feb 13, 2014
  • Greek Truckers Show Plight as Groceries Show Up Frozen Freeing up the labor market will work as attitudes change $$ Feb 13, 2014
  • Tunisians Bolt Doors Even After New Constitution Passed Constitutions cannot create cultural change; asks 2 much $$ Feb 13, 2014
  • Israel Desalination Shows California Not to Fear Drought When resources r tight there are incentives 2 create tech $$ Feb 13, 2014
  • London Walkie Talkie Owners to Shield Car-Melting Beam Reflective parabolic curve of building melts cars @ a spot $$ Feb 12, 2014
  • Rouhani Seeks Economic Fix as Iran Commemorates Revolution Will have to get the agreement of unelected true rulers $$ Feb 11, 2014
  • Argentina to Replace Bogus Inflation Index to Mend IMF Ties Argentina tries 2 find cheapest way out of this mess $$ Feb 11, 2014
  • Who Should Pay for Trusts that Go Bust? If China is smart, protect depositors, but let banks & WMP holders fail $$ Feb 11, 2014
  • Iceland Girds for Fight as Suit Targets Half $14B GDP Icelandic taxpayer will refuse the bill; UK will b stiffed $$ Feb 11, 2014
  • Mobius Says Emerging-Market Rout Near End as Valuations Lure I dunno, a 4% earnings yield premium seems small $$ $EEM Feb 11, 2014
  • Rehabilitating Portugal Long; Argues that a Greek-style bailout should b done, or Portugal will eventually default $$ Feb 11, 2014
  • Iranian TV Shows Rare Broadcast of Band Playing Music Christianity has always been easier on music than Islam $$ Feb 11, 2014


Work Trends


  • Sheep-Shearing Wells Fargo Banker Bridges US Income Gap Sells coffeemakers too; many in US work multiple jobs $$ $TLT Feb 13, 2014
  • Workers Shed Caution, in a Healthy Sign for Labor Market When workers r willing 2 quit, labor mkt is healthy $$ $TLT Feb 11, 2014




  • A Little Valentine’s Day Straight Talk Sage counsel 2 younger women if they want to get married: start early $$ Feb 15, 2014
  • The Sex Question Readers Want Answered Most Even Long-Married Happy Couples Ask, ‘How Can We Have Sex More Often?’ $$ Feb 11, 2014
  • Ten Ways You’re Probably Leaving Money on the Table Simple list of ways to save money for avg upper-middle class $$ Feb 11, 2014
  • Why Mom’s Time Is Different From Dad’s Time Husbands, u can win if u reduce chaos for your overburdened wives $$ Feb 11, 2014




  • US Scores Fusion-Power Breakthrough Bad news is Tritium very expensive @ $100K per gram; takes much energy 2 make $$ Feb 13, 2014
  • If Ocean Heat Pump Switches On, Expect to Feel It Speculative; we don’t understand climate or hurricanes well $$ Feb 11, 2014
  • Who is Steven Reisman? Meet Hip-Hop VIPs’ Favorite Lawyer, The Man With The $2 Bills Weird. Very, very weird $$ $SPY Feb 11, 2014
  • What Really Happened to Flappy Bird? Beware the success u wish 4? Also: Still a puzzle $$ $SPY Feb 11, 2014


Wrong, etc.


  • Skeptical: Blackstone-Fueled Single-Family Home Boom Lifts Chicago In past hi levels of investor ownership bearish $$ Feb 15, 2014
  • Wrong: Pros Panic, Retail Investors Stay Cool on Emerging Markets Too short a period time to judge $$ Feb 14, 2014
  • Wrong: Social norms: The indignity of no work New technologies will create new jobs & make the whole world better $$ Feb 13, 2014
  • Wrong: Warren Buffett is laughing at you for selling Poorly thought-out piece glues 2unrelated ideas together $$ $EEM Feb 13, 2014
  • Wrong: The #1 High-Yield Investment Of America’s Elite Spammy article that talks about REITs as if they r a secret $$ Feb 11, 2014


Replies, Retweets & Comments


  • 10 miles west of Baltimore, MD, we got ~15 inches of snow over the last last 2 days. #snow #weather #pax $$ Feb 14, 2014
  • “I made this comment six months ago:… & then, I tipped the SEC. …” — David_Merkel $$ $DJCO Feb 13, 2014
  • “Administrative Services Only” plus individual stop loss protection is in general the smart way2…” — David_Merkel $$ Feb 13, 2014
  • “This is a common confusion in statistics — you can have a high correlation and a low beta. Second…” — Merkel $$ Feb 13, 2014
  • RT @Pawelmorski: Scary parallel my foot. Feb 12, 2014
  • @davidgaffen that would only be a temporary fix. I wrote this 3.5 yrs ago on the topic: The internet eats USPS Feb 11, 2014
  • @quakkelaar I miss you too. If you are ever near Baltimore/DC, let me know; we can get together, brother. Last few years have been hard Feb 11, 2014
  • RT @ReformedBroker: Please explain how the wording of this investment advertisement on the Washington Post site could be legal:… Feb 10, 2014
  • ‘ @quakkelaar Hail old friend. Yes, same old mistakes, b/c those wishing to retire are making the money sweat, until it rebels on them $$ Feb 09, 2014


Failure. We’ve all experienced it. Can we benefit from it?  The answer is maybe, depending on the costs of failure.

If the costs of failure are high, e.g., repaying debts for the rest of life, people will avoid taking risks.  As a result, society will stagnate, because few take risks.

But if the costs of failure are low, people will take more chances, start more businesses, try experiments that might prove something bold.  That is one great thing about America; the penalties for failure are low.  Some have said we are the land of unlimited second chances.  After resigning from the presidency, Richard Nixon became an influential voice on foreign policy.

Megan McArdle uses her own life and many other societal problems to illustrate how a proper use of failure  can benefit individuals and society as a whole.  Failure is how we learn.  As some have said, “The wise learn from the failures of others, normal people learn from their own failures, but the stupid don’t learn.”

I enjoyed this book a great deal, but I want to point out a few of the chapters that particularly struck me.

In Chapter 8, she described the various ways that ideologues described the causes of the financial crisis.  The Left and the Right chose their own monologues to explain the economic failure that occurred.  The truth was far more banal, as average people bought into a housing mania, with financial institutions more than willing to facilitate it, levered as they were.  When the bull market ended, many people found themselves with too much debt relative to the value of their houses.

Chapter 9 was the one from which I learned the most, as it described a probation method used in Hawaii, that I would describe as the judicial equivalent of spanking.  When one on probation violates a term of probation, he gets sent to a rather grim prison for a short period of time.  Like spanking, it is short, and sharp.  Those on probation get tested randomly and regularly.  Most quickly get the idea that they need to change their lives.  The recidivism rate on this program is low.  Small failures get punished.  Resistance to the system means permanent jail.  No failures means freedom.

But what I really appreciated in the book was the willingness of the author to expose her own life failures — jobs, caring for her mother’s health, bad relationships, etc.  She learned from her mistakes, and ended up with a husband who loves her, a good job, and a home in DC, where there is not much debt on the property.  Well done.

My own life has had its share of failures, and they have all taught me something.  The question to you, reader, is what have you learned from your failures?  Memorialize failures, so that you can avoid them and their cousins in the future.  In that sense you can fail well.

There is not a bad chapter in this book.  I recommend it highly, and you will learn a lot.  I learned a lot.



Who would benefit from this book: Anyone could benefit from this great book.  If you want to, you can buy it here: The Up Side of Down: Why Failing Well Is the Key to Success.

Full disclosure: The PR people offered me a book, and I accepted it.  I am glad that I did.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.


I’m not crazy about the idea of wealthy people and corporations avoiding taxes by creating subsidiaries with no economic function in tax havens.  Sometimes I wonder if the budgets could be balanced if we were able to eliminate the tax havens.

So, why not have a meeting of NATO of the G-20, or even the Useless United Nations, and discuss a common strategy of dealing with rogue nations/city-states that invite people and corporations to do business through them in order to avoid taxes.

One strategy could be this: use NATO to blockade these places, and tell them to end their tax-avoidance-facilitation policies, or else.

Now that ‘s a little harsh, but almost all of the tax havens with the exception of Ireland are little places that can’t defend themselves.  But maybe there is an alternative.

The coalition of the willing would go to each of the tax havens, and make a deal with them.  “If you raise your tax rates and definition of income to our levels, we will remit foreign aid to you to partially compensate you for your loss.  Remember, we can use military or economic sanctions against you — think of Iran, or North Korea.”

Why it won’t Happen

The main reason it won’t happen is that wealthy supporters of politicians will complain, and many politicians are wealthy themselves.  Sad, but true, and it will remain so until a significant nation nears default.

I’ve mentioned before how all of my old articles at RealMoney were lost.  This was the draft version of Real Estate’s Top Looms published on 05/20/05.  I followed it up with  Housing Bubblettes, Redux on 10/27/05 and  September 2005 — The Residential Real Estate Inflection Point on 02/14/06.  Also, there was Wrecking Ball Looms for Big Housing Spec on 11/27/06, where I explained why it was likely that the subprime residential mortgage market was likely to blow up (can’t find the draft of that one).

But those links above no longer work — a real pity, and the one link below is corrected to point to the republished article at my blog.  Anyway, enjoy this if you want, because it outlines my thinking on how to recognize whether you are getting near the end of the bull phase of a market.

(Note: the italicized, indented portions, quote the original article The Fundamentals of Market Tops.  Much of what I write compares how residential real estate is similar to and different from stocks.)


About a year and a half ago, I wrote a piece called The Fundamentals of Market Tops.  It was an important piece for me because I received a lot of positive feedback from readers.  It was also important because it disagreed with the view of the firm that I worked for, and nearly led to my termination there, because they encouraged me to stop writing for RealMoney.  Neither termination happened, but it was touch-and-go for a while.

This piece unofficially represents the views of the firm that I work for, because my views of macroeconomics have become the firm’s views, but I don’t directly control our investment actions.  What I will try to accomplish here is to try to apply the logic of my prior article to the residential real estate market.  As opposed to my earlier article, I will try to show why I think we are close to a market top in residential real estate.  There is reason for pessimism.

The Investor Base Becomes Momentum-Driven

Valuation is rarely a sufficient reason to be long or short a market. Absurdity is like infinity. Twice infinity is still infinity. Twice absurd is still absurd. Absurd valuations, whether high or low, can become even more absurd if the expectations of market participants become momentum-based. Momentum investors do not care about valuation; they buy what is going up, and sell what is going down.

This is what I see in many residential real estate markets now: panicked buyers are saying “this is my last chance,” and buying houses using risky forms of financing.  At the same time, I read stories of despair as some potential buyers give up and say that a house is out of their reach for now; they waited too long.  Occasionally, I see a few articles or e-mails regarding people who seem to be bright selling their homes and renting, but this is a minority behavior.

In the face of this, residential real estate prices continue to rise, particularly in the hot coastal markets, which tells me that the price momentum can continue a little while longer until it fails because there is no incremental liquidity available to expand the bubbles.

You’ll know a market top is probably coming when:

  1. The shorts already have been killed. You don’t hear about them anymore. There is general embarrassment over investments in short-only funds.

  2. Long-only managers are getting butchered for conservatism. In early 2000, we saw many eminent value investors give up around the same time. Julian Robertson, George Vanderheiden, Robert Sanborn, Gary Brinson and Stanley Druckenmiller all stepped down shortly before the market top.

  3. Valuation-sensitive investors who aren’t total-return driven because of a need to justify fees to outside investors accumulate cash. Warren Buffett is an example of this. When Buffett said that he “didn’t get tech,” he did not mean that he didn’t understand technology; he just couldn’t understand how technology companies would earn returns on equity justifying the capital employed on a sustainable basis.

  4. The recent past performance of growth managers tends to beat that of value managers. (I am using the terms growth and value in a classic sense here. Growth managers attempt to ascertain the future prospects of firms with little focus on valuation. Value managers attempt to calculate the value of a firm with less credit for future prospects.) In short, the future prospects of firms become the dominant means of setting market prices.

  5. Momentum strategies are self-reinforcing due to an abundance of momentum investors. Once momentum strategies become dominant in a market, the market behaves differently. Actual price volatility increases. Trends tend to maintain themselves over longer periods. Selloffs tend to be short and sharp.

  6. Markets driven by momentum favor inexperienced investors. My favorite way that this plays out is on CNBC. I gauge the age, experience and reasoning of the pundits. Near market tops, the pundits tend to be younger, newer and less rigorous. Experienced investors tend to have a greater regard for risk control, and believe in mean-reversion to a degree. Inexperienced investors tend to follow trends. They like to buy stocks that look like they are succeeding and sell those that look like they are failing.

  7. Defined benefit pension plans tend to be net sellers of stock. This happens as they rebalance their funds to their target weights.

Houses aren’t like stocks for several reasons:

  1. Unlike stocks, houses are used by their owners every day.
  2. We can short stocks, but we can’t short houses.  (Personally, I hope no one comes up with a clever way to do so.  We have enough volatility already.)  The most someone can do is sell his home and rent.
  3. Perhaps the equivalent of a long-only manager is someone who owns his property debt-free, like me, and doesn’t see the need to lever up by moving up to a larger home.  Measured against the standard of “what might have been” is a terrifying taskmaster from an investment standpoint.  I avoid it in equity investing, and in home ownership.
  4. I am aware of a number of people (I have been assured that they are not mentally incompetent) who have sold their homes and started renting.  This to me is the equivalent of going totally flat in equities, or other risky assets.  Not that one faces negative carry, because the ratio of rent to in the hot markets is pretty low.  In many markets, you can earn more off the proceeds than you pay in rent (leaving tax consequences aside).  This leaves aside the issue of appreciation/depreciation of housing values, but when one can rent more cheaply than buying, it is a negative for the housing market.
  5. My point about momentum strategies is definitely pertinent here.  With the existence of contract-flipping, a high level of amateur investment (seemingly under the guise of “buy what you know”), and a high level of investor interest (10%+), there is a lot of momentum in real estate investment.  People buy because prices are going up.  Some buy because it is “the last train out,” and they have to jump rather than be stranded.  Nonetheless, momentum tends to maintain in the short run, and the slowdown posited last fall definitely has not occurred.
  6. Value vs. Growth does not exactly apply here, but in the housing market, people are paying up for future prospects more than they used to, which is akin to growth investing.
  7. This is just an opinion, but those who are making money in residential real estate today are inexperienced and less rigorous than most good businessmen.  They see the potential for profit, but not the possibility of loss.
  8. Unfortunately, it is difficult to partially own a home.  Home ownership is largely a discrete phenomenon.
  9. Using a concept from value investing we can look at the earnings yield that residential real estate is throwing off.  Compare the rents one could receive from a property versus the cost that it would take to finance the property on a floating rate basis.  What I am seeing is that more and more hot coastal markets earn less from rents than they require in mortgage payments.  Property price appreciation is no longer a nice thing; it is required to bail out inverted investors.  Contrast this with those that invested in tech stocks on a levered basis in early 2000; they paid cash out to hold appreciating positions, before they paid cash to hold depreciating positions, before they blew the positions out in panic.

Corporate Behavior

Corporations respond to signals that market participants give. Near market tops, capital is inexpensive, so companies take the opportunity to raise capital.  Here are ways that corporate behaviors change near a market top:

  1. The quality of IPOs declines, and the dollar amount increases. By quality, I mean companies that have a sustainable competitive advantage, and that can generate ROE in excess of cost of capital within a reasonable period.
  2. Venture capitalists can do no wrong, so lots of money is attracted to venture capital.
  3. Meeting the earnings number becomes paramount. What is ignored is balance sheet quality, cash flow from operations, etc.
  4. There is a high degree of visible and/or hidden leverage. Unusual securitization and financing techniques proliferate. Off balance sheet liabilities become very common.
  5. Cash flow proves insufficient to finance some speculative enterprises and some financial speculators. This occurs late in the game. When some speculative enterprises begin to run out of cash and can’t find anyone to finance them, they become insolvent. This leads to greater scrutiny and a sea change in attitudes for financing of speculative companies.
  6. Elements of accounting seem compromised. Large amounts of earnings stem from accruals rather than cash flow from operations.
  7. Dividends become less common. Fewer companies pay dividends, and dividends make up a smaller fraction of earnings or free cash flow.

In short, cash is the lifeblood of business. During speculative times, watch it like a hawk. No array of accrual entries can ever provide quite the same certainty as cash and other highly liquid assets in a crisis.

  1. Every time a new home is sold, a privately placed IPO is held, with one buyer.
  2. When rates are low, it is no surprise that the homebuilders try to take advantage of the situation, and provide supply to meet the demand.  But if it is only rate-driven, rather than from growth in real incomes in the economy, the quality of the new buyers will be low, because now they can just barely finance the house they could not previously.  If their income level falters, they will not have any safety margin allowing them to hold onto the house.
  3. Private investors in residential real estate have multiplied at present.  This is akin to an increase in venture capital.
  4. Leverage for new buyers has never been higher.  This occurs through second and third mortgages, as well as subprime mortgages.  Interest only mortgages are commonplace among new mortgages.  Beyond this, investors hide themselves so that they can get the cheap rates associated with owner-occupied housing.
  5. With housing, making the earnings estimate means being able to pay the mortgage payment each month.  The degree of slack here is less than in the past.

Other Gauges

These two factors are more macro than the investor base or corporate behavior but are just as important.  Near a top, the following tends to happen:

  1. Implied volatility is low and actual volatility is high. When there are many momentum investors in a market, prices get more volatile. At the same time, there can be less demand for hedging via put options, because the market has an aura of inevitability.
  2. The Federal Reserve withdraws liquidity from the system. The rate of expansion of the Fed’s balance sheet slows. This causes short interest rates to rise, making financing more expensive. As this slows down the economy, speculative ventures get hit hardest. Remember that monetary policy works with a six- to 18-month lag; also, this indicator works in reverse when the Fed adds liquidity to the system.

One final note about my indicators: I have found that different indicators work for market bottoms and tops, so don’t blindly apply these in reverse to try to gauge bottoms.

 There is no options market for residential housing, but the Federal Reserve is still a major influence in the housing market.  When the Fed is withdrawing liquidity from the system, the price of housing tends to slow down, if not reverse.  Like the equity market, this is not immediate but follows a six- to 18-month lag.  This is another case of “Don’t fight the Fed.”

No Top Now

There are reasons for concern in the present environment. Valuations are getting stretched in some parts of the market. Debt capital is cheap today. There are an increasing number of momentum investors in the market. Making the earnings estimate is once again of high importance. Nonetheless, a top in the market is not imminent, for these reasons:

  • The Fed is on hold for now. Liquidity is ample, perhaps too much so.
  • Actual price volatility is muted.
  • Since all of the accounting scandals of the last few years, many corporations have cleaned up their accounting and become more conservative.
  • Cash flow from operations comprises a high proportion of current earnings. More dividends are getting paid.
  • Leverage has not declined, but most corporations have succeeded in refinancing themselves in a low interest rate environment.
  • Conservative asset managers have not been fired yet.
  • Most IPOs don’t seem outlandish.

Not all of the indicators that I put forth have to appear for there to be a market top. A preponderance of them appearing would make me concerned, and that is not the case now.

 Some of my indicators are vague and require subjective judgment. But they’re better than nothing, and kept me out of the trouble in 1999 and 2000. I hope that I — and you — can achieve the same with them as we near the next top.

The current market environment is not as favorable as it was a year ago, but there are still some reasonably valued companies with seemingly clean accounting to buy at present. Right now, being long the market is more compelling to me than being flat, much less short.

I would retitle this the “The Top is Coming Soon.”  The reasons that I mentioned to be worrisome remain:

  • Valuations are getting stretched in some parts of the market.
  • Debt capital is cheap today.
  • There are an increasing number of momentum investors in the market.
  • Making the earnings estimate is once again of high importance. (Gotta pay my mortgage!)

But there is more that makes me even more bearish:

  • The Fed is on the warpath, and liquidity is scarce.
  • Appraisals overstate the value of property that financial institutions lend against.
  • Homeowners have a smaller margin of safety than they have had in the past.
  • Leverage has increased for the average homebuyer.
  • People are paying more than they ought to for new and existing homes.

I am decidedly a bear on housing prices (at least in the hot coastal markets) at present, but I recognize that momentum can carry prices far beyond sustainable levels.  That’s the way markets work.

Nonetheless, I am still a bear on those who build homes, and those who finance them.  We are at an unsustainable place in the ability to finance the residential hosing market.  Either an increase in interest rates or a decrease in ability to pay for housing can derail the market.  This is the inflection point that we are at over the next year.

A letter from a reader:

Dear Mr. Merkel,

I am organizing an investment contest in my university and I want to do it properly. Can you provide me with data of stock divided into 10 groups based on volatility? I searched for it in Yahoo Finance, but if you have it compiled in a better way, it would be really helpful. 

Also, what do you mean when you say a minimum capitalization limit? Do you mean that the students should hold a certain amount of cash, that they are not allowed to invest?

Sometime in 1985-1986, [Corrected from 1983-1984 — DM] Value Line held a contest where it asked participants to pick ten stocks, one from each of ten price volatility groups, ranked from lowest to highest.  Why such a contest design?  Well, with most stock picking contests, the winner picks a really volatile stock, it soars, and he is the winner by accident.  I say “by accident” because there were others with similarly volatile stocks that lost.

Forcing players to pick a portfolio of stocks, including less volatile stocks, creates a real challenge that resembles real portfolios.   Even though the contest will still run over 6 months[Corrected from 3-6 months — DM], the luck component is substantially reduced, even though results over a short time horizon are highly affected by luck and momentum.

Well, I’ve created a file that divides the US-traded market into 10 volatility buckets for you, using data from a screening package.   Here’s the link.

3,589 stocks made the cut.  No ETFs, closed-end funds, etc.  No market caps below $100 million. No stocks with less than 3 years of trading history.  The market cap limit is there because really teeny stocks can fly, and skew the results.  And no, no cash is in the results, just the average returns of 10 stocks.

Here are the average price volatilities by bucket.  [Volatility is actual price volatility for 36 trailing months]

BucketAvg Price Volatility

As for industries, the volatilities are what you might expect:

Ten Least Volatile

  • 1206 – Natural Gas Utilities
  • 1203 – Electric Utilities
  • 1209 – Water Utilities
  • 0512 – Fish/Livestock
  • 0506 – Beverages (Non-Alcoholic)
  • 0524 – Tobacco
  • 0715 – Insurance (Property & Casualty)
  • 0503 – Beverages (Alcoholic)
  • 0933 – Real Estate Operations
  • 0730 – S&Ls/Savings Banks

Ten Most Volatile

  • 0912 – Casinos & Gaming
  • 0930 – Printing Services
  • 0124 – Metal Mining
  • 0409 – Audio & Video Equipment
  • 0427 – Photography
  • 0969 – Schools
  • 0118 – Gold & Silver
  • 0803 – Biotechnology & Drugs
  • 0966 – Retail (Technology)
  • 0424 – Jewelry & Silverware

That said, such a contest would force some choices from both safe and volatile investments.

Smaller stocks are a lot more volatile than large stocks on average:

Mkt Cap Bucket

Average Vol Decile













Over 100B


Finally, some countries are more or less volatile than others.  Of the 50 countries represented, trading on US exchanges, here are the most and least volatile:

Least Volatile

  • Colombia
  • Denmark
  • Panama
  • Philippines
  • Turkey
  • Belgium
  • United Kingdom
  • Chile
  • Switzerland
  • Japan

Most Volatile

  • Israel
  • Bahamas
  • Finland
  • Portugal
  • Russian Federation
  • India
  • Monaco
  • Greece
  • China
  • Argentina


My point in showing some of the divisions is to give an idea of ways to analyze and play the game.  You could also do it by momentum or valuation variables.  Momentum would probably work best in a short contest.

As for me in the early ’80s, I was a busy graduate student, so I looked at the stocks rank ed highest for Timeliness by Value Line in each volatility group, and selected the one for each group that I thought was the most promising.  As it was, I finished in the top 1%, but not high enough to win a prize.

Anyway, I think this is a great contest design, because it minimizes the ability of players to pick volatile stocks.  With ten stocks of varying volatility in the portfolio, stock-picking skill has a greater chance of being revealed.  Better would be a longer-term contest, but few have the patience for that, and players will argue that they should be allowed to trade, making for a more complex contest.

Industry Ranks 6_1521_image002

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, “Where are trends under-discounted?” Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled “Dig through.”

You might notice that  I have no industries from the red zone. That is because the market is so high. I only want to play in cold industries. They won’t get so badly hit in a decline, and they might have some positive surprises.

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone — don’t look for momentum, look for mean reversion. I generally play in the green zone because I hold stocks for 3 years on average.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I’m not saying to change if things are working well. I’m saying don’t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don’t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy — no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology stocks here, some industrials, some consumer stocks, particularly those that are strongly capitalized.

I’m looking for undervalued industries. I’m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don’t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is pretty cyclical at present. I will be very happy hanging out in dull stocks for a while.

That said, some dull companies are fetching some pricey valuations these days, particularly those with above average dividends. This is an overbought area of the market, and it is just a matter of time before the flight to relative safety reverses.

The Red Zone has a Lot of Financials; be wary of those. I have been paring back my insurers, but I have been adding to P&C reinsurers.  What I find fascinating about the red momentum zone now, is that it is loaded with cyclical companies.

In the green zone, I picked almost all of the industries. If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

Will cyclical companies continue to do well?  Will the economy continue to limp along, or might it be better or worse?

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 5 of 9 balance sheet safety categories, and with returns estimated over 12%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don’t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence, not hot names to buy.

I’ve loosened my criteria a little because the market is so high, but I figure I will toss out lot when I do my quarterly evaluation of the companies that I hold for clients and me.

Industry Ranks 6_19997_image002

 Note: this is the 100th weekly edition of sorted weekly tweets.

Market Impact


  • Standing Out from the Crowd: Measuring Crowding in Quantitative Strategies Overinvestment in strategy precedes losses Feb 08, 2014
  • Does Fair Value Accounting Contribute to Market Price Volatility? An Experimental Approach Short answer: no $$ $XLF Feb 08, 2014
  • The Deeper Causes of the Financial Crisis: Mortgages Alone Cannot Explain It But they were the leading cause $$ $XLF Feb 08, 2014
  • Contagion Rejected as Biggest Bond Buyers Double Down on Junk Makes me think the correction will b another crisis $$ Feb 08, 2014
  • Hedge Funds Preparing for $1T Property Bill Key Q: Will they limit their risks prior to the next commercl RE bust? $$ Feb 08, 2014
  • Apollo Credit Twice Size of LBOs Shows Private-Equity Shift Not a good sign, nonstandard lenders r fragile $$ $APO Feb 07, 2014
  • Five Pointers on Floating-Rate Funds Don’t chase performance, rates may not rise, nor yields, adds credit risk $$ Feb 05, 2014
  • Inverse VIX Fund Gets Record Cash on Calm Market Bet Be careful to not hold it long $$ $VXX Feb 05, 2014
  • World’s cheapest stock markets: Where are shares cheap? Gives u a rough idea as 2 where values may b found $$ $SPY Feb 04, 2014
  • Gundlach Shows Why Betting Against Treasuries Is a Fool’s Game Interesting that he is in long Tsys $$ FD: + $TLT Feb 03, 2014
  • Monday’s Selloff, by the Numbers That’s 2 large >2% down days in less than 2 weeks $$ $SPY Feb 03, 2014


Companies & Industries


  • Big Pizza Chains Use Web to Slice Out Bigger Market Share Easier 4 large chains 2 implement online ordering $$ $PZZA Feb 08, 2014
  • SodaStream’s New Mainstream Rivals: Coke and Green Mountain All the more reason 4 $PEP 2 buy $SODA $$ Feb 07, 2014
  • Why Discount Airlines Draw Fewer Complaints (Hint: It’s Not Better Service) Friendlier attitudes r better service $$ Feb 07, 2014
  • Satyajit Das: The Truth About Bank Earnings Bank earnings r lower quality; getting harder to increase them $$ $XLF Feb 05, 2014
  • Experts testify on true cost of Target breach Magnetic stripes will go away, & chips &/or PINs will appear $$ $TGT Feb 05, 2014
  • Apple Quietly Builds New Networks $AAPL certainly has spare $$ to throw at it, enhancing service quality $NFLX $GOOG Feb 04, 2014
  • H-P Finds Accounting Errors at Autonomy Unit We knew it was a dumb deal at the time, now $HPQ shows just how dumb $$ Feb 04, 2014
  • Prophet of No Profit: How Jeff Bezos won the faith of Wall Street. Moats, operating leverage, pricing power $$ $AMZN Feb 01, 2014
  • Ask Buffett what he would be willing 2pay 4 $AMZN — after all, it has significant moats. I think he would put it in the “too hard” pile $$ Feb 01, 2014


Rest of the World


  • China, the Death Star of Emerging Markets @williampesek points at financial bubble in China; what will make it pop $$ Feb 08, 2014
  • Scandal Tests Chinese President’s Standing With Military Corruption is a major issue 4 China, between Party & Army $$ Feb 08, 2014
  • Saudi Twitter Debate as Citizens Criticize Government Social media allows criticism tht would not b done in public $$ Feb 05, 2014
  • China Savers’ Penchant for Property Magnifies Bust Danger Anytime a single investment strategy dominates -> worry $$ Feb 05, 2014
  • Pimco’s Bill Gross Says He Avoids China ‘Mystery Meat’ Great phrase as we do not know much about indebted China $$ Feb 05, 2014
  • Sao Paulo Biggest Water-Supply System May Run Dry Within 45 Days Many water systems r near their limits globally $$ Feb 05, 2014
  • Emerging Stocks Drop to 5-Month Low Led by China as Ruble Gains Not all emerging mkts r equal, some financed wrong $$ Feb 04, 2014
  • Japan Sees Worst Developed-Stock Rout as Nikkei 225 Drops Current mkt reveals weak underlying fundamentals $$ $FXY Feb 04, 2014
  • Dad Can’t Buy Daughter Shoes as Argentine Currency Falls “Do you know how I feel buying my daughter used shoes?” $$ Feb 04, 2014
  • Argentina Scrambles To Raise $10B, Avoid Reserve Collapse; BONARs Bidless Only hold hard assets in Silverland $$ Feb 04, 2014
  • EM rout? Or Intervention Sunday? Difficult to tell what Developed Mkt policymakers will do, they r strapped @ home $$ Feb 04, 2014
  • Argentina Bust Lures Investors After 200 Years of Defaults Invest in the hard stuff, land does not depreciate $$ $IRS Feb 04, 2014
  • Emerging-Market Rout Seen Enduring on Low Real Rates Funding structures of some emerging markets fall, $$ goes 2 $TLT Feb 04, 2014
  • Canadian Oil Rises as California Ships in Record Amount by Rail Retweet after me: Pipelines r cleaner & safer $$ Feb 04, 2014
  • Analysis: Emerging markets outlook not rosy, but valuations tempt This may b a time 2nibble, not a time 2gulp $$ $EEM Feb 04, 2014


US Politics & Policy


  • AOL is leading the way to make 401(k)s worse for everyone Meh; new employers will compensate workers that lose $$ Feb 08, 2014
  • ‘Six Californias’ plan difficult but doable, assessment shows Ideas like this come & go in a fragmented California $$ Feb 08, 2014
  • No, CBO did not say Obamacare will kill 2M jobs Rather, will discourage 2M from working full-time; big deal $$ Feb 08, 2014
  • Ex-NSA Chief Details Snowden’s Hiring at Agency, Booz Allen Snowden set back US intelligence by 20+ yrs. Good. $$ Feb 06, 2014
  • The Tyranny and Lethargy of the Times Editorial Page Inside baseball, picture sums up story $$ Feb 05, 2014
  • Puerto Rico Has Credit Rating Cut One Step 2Junk by S&P also Well-deserved, default coming $$ Feb 05, 2014
  • Going on 30, Living With Mom and Dad Part is being slow 2 marry, then education, poor career choices, motivation $$ Feb 04, 2014
  • Crop Insurers Win as Congress is Poised to Pass Farm Law If we can’t reduce ag subsidies when ag is healthy… $$ Feb 04, 2014
  • Obamacare Wonks Flunk Data Analysis You can show lots of savings if u show your winners & hide your losers $$ $SPY Feb 04, 2014
  • CBO: Obamacare Will Lead To 2M Fewer Workers In Labor Force By 2017 Unintended consequences; fix this, break that $$ Feb 04, 2014
  • Fed Presidents Say Stock Decline Unlikely to Derail QE Taper In the short-run true, but if the decline persists… $$ Feb 05, 2014
  • Investment Manager Explains Why 99.5% Of Americans Can Never Win Tax code is cockeyed, wealthy can avoid taxation $$ Feb 04, 2014
  • How Feds’ Double Standard Enables Bad Bankers Simple: little bankers get prosecuted; big banks get fined $$ $BNK $XLF Feb 04, 2014
  • Early Drive for Hillary Clinton Unsettles Democrats Some Worry It Will Siphon $$ from Candidates in Midterm Elections Feb 04, 2014
  • You Can Thank or Blame Richard Stanger for Writing 401(k) Many important laws r accidental; killed DB pensions $$ Feb 04, 2014
  • ISM Miss Is Ugly All Around I’ve been arguing that the economy is weaker than it looks 4 a while; here’s a clue $$ Feb 04, 2014
  • US Banks Ease Loan Standards in Fed Survey as Demand Rises Can inflation b far behind if this persists? $$ $TLT $TIP Feb 04, 2014
  • California Dries Up as Brown Pushes $15B Tunnel If u don’t allocate water economically, becomes a political fight $$ Feb 04, 2014




  • Financial Blogging: How to Write Powerful Posts That Attract Clients My longer review: $$ Feb 08, 2014
  • Why I Did Not Go To Jail @bhorowitz good read on the importance of proper company, legal, & incentives structure $$ Feb 08, 2014
  • Daniel Suarez Sees Into the Future ‘Influx’ may propel sci-fi writer in2 void left by Tom Clancy &Michael Crichton $$ Feb 08, 2014
  • Why Melted Cheese Does the Trick Creaminess enhances the textures and flavors of other foods $$ $KFT $DF Feb 06, 2014
  • Deadly New Bird Flu Strain Spawned by Virus Behind H5N1 This is overblown. People die from the flu each year $$ $SPY Feb 05, 2014
  • Young Bankers Seek ‘Good Yield’ With Their Own Nonprofits Wealthy & powerful like 2b thought benefactors $$ Lk 22:25 Feb 04, 2014
  • How the Seattle Seahawks solved Peyton Manning Even if u r not into football, interesting 4 understanding strategy $$ Feb 04, 2014
  • Super Bowl Safety Is Blow for Broncos and Las Vegas Sportsbooks The odds r interesting to read 4 unusual bets $$ $SPY Feb 04, 2014
  • Microsoft Adds Momentum to “Open Science” | Understand that scientists r not neutral observers; they have 2 publish $$ Feb 04, 2014
  • Carney leaving CNBC for WSJ’s “Heard on the Street” | @carney gets a significant promotion! Congrats! $$ $SPY $TLT $GE Feb 01, 2014


Other Economics


  • Free Checking Is Disappearing Perk Smaller banks often offer better deals than big banks on checking $$ $XLF $SPY Feb 08, 2014
  • More Men in Prime Working Ages Don’t Have Jobs 1 of the qualitative factors that show how punk the economy is $$ $SPY Feb 08, 2014
  • An International Gold Standard Beats The Rule Of The Governing Elite Old, makes point gold standard was better $$ Feb 05, 2014



  • Wrong: High unemployment putting the ECB in isolation Loose monetary policy doesn’t lower L-T unemployment $$ #global Feb 08, 2014
  • Wrong: America The Startup Worth a read, but the writer does not really understand the Pilgrims or the Puritans $$ Feb 04, 2014


Retweets, Replies, & Comments

  • @HistoryInPix Cemented the creation of the graphical user interface, buggy in prior versions, aside from pricey Macintosh ghetto Feb 06, 2014
  • ‘ @catofwallstreet the credit cards will have chips, not us- already have these in Europe. Also, consider amillenialism or postmillenialism. Feb 05, 2014
  • RT @PUMPSandDUMPS: This fan says it all #pennystocks Feb 05, 2014
  • Ice falling, branches too, west of Baltimore — kind of pretty $$ #weather Feb 05, 2014
  • @DavidSchawel The difference between dollar-weighted & Time-weighted returns is crucial but few get that. Good tweet on $DBLTX $$ Feb 05, 2014
  • RT @DavidSchawel: Retail psychology: chasing performance, then puking the bottom & missing the bounce-DBLTX Fund assets vs adjusted NAV htt… Feb 05, 2014
  • RT @cate_long: Cheers! “@carney: Thanks everyone! Very excited to be joining the @wsjheard team! Some details here Feb 01, 2014
  • @dpinsen not all, but a majority Feb 01, 2014


Strategy One: “Consistent Losses, with Occasional Big Gains when the Market is Stressed”

Strategy Two: “Consistent Gains, with Total Wipe-out Risk When Market is Highly Stressed”

How do these two strategies sound to you?  Not too appealing?  I would agree with that.  The second of those strategies was featured in an article at recently — Inverse VIX Fund Gets Record Cash on Calm Market Bet.  And though the initial graph confused me, because it was the graph for the exchange traded note VXX, which benefits when the VIX spikes, the article was mostly about the inverse VIX exchange traded note XIV.

Why would someone pursue the second strategy?  Most of the time, it makes money, and since January 2011 we haven’t a horrendous market event like the one from August 2008 through February 2009, it makes money.

I would encourage you to look at the decline in the second half of 2011, where it fell 75% when the VIX briefly burped up to around 50.  But given the amazing comeback as volatility abated, the lesson that some investors drew was this: “Volatility Spike? Time to buy XIV!”  And that explains the article linked above.

You might remember a recent book review of mine — Rule Based Investing.  In that review, I made the point that those that sell insurance on financial contracts tend to win, but it is a volatile game with the possibility of total loss.  To give another example from the recent financial crisis: most of the financial and mortgage insurers in existence prior to 2007 are gone.  Let me put it simply: though financial risks can be insured, the risks are so volatile that they should not be insured.  You are just one colossal failure away from death, and that colossal failure will tend to come when everyone is certain that it can’t come.

But what of the first strategy?  How has it done?

Wow!  Look at the returns over the last few weeks!  Rather, look at a strategy that consistently loses money because it rolls futures contracts for the VIX where the futures curve is upward-sloping almost all the time, leading to buy high, sell low.

Does it pay off in a crisis?  Yes.  Can you use it tactically?  Yes.  Can you hold it and make money?  No.

Back to the second strategy.  People are putting money into XIV because they “know” that implied volatility always mean-reverts, and so they will make easy money after a volatility spike.  But what if they arrive too early, and volatility spikes far higher than expected?  Worse yet, what if Credit Suisse goes belly-up in the volatility?  After all, it is an exchange-traded note where owners of XIV are lending money to Credit Suisse.

Back to Basics

Do I play in these markets?  No.

Do I understand them?  Mostly, but I can’t claim to be the best at this.

What if I try both strategies at the same time?  You will lose.  You are short fees and trading frictions.

What if I short both strategies at the same time?  Uncertain. It comes down to whether you can hold the shorts over the long term without getting “bought in” or panic when one side of the trade runs the wrong way.

Recently, someone pinged me to speak to CFA Institute, Baltimore, where he wanted to talk about “not all correlations of risky assets go to one in a crisis” and pointed to volatility investing as the way to improve asset allocation.  Sigh.  I’m inclined to say that “you can’t teach a Sneech.”

I favor simplicity in investing, and think that many exchange traded products will harm investors on average because the investors do not understand the underlying economics of what they own, while Wall Street uses them as a cheap way to hedge their risk exposures.

There may be some value to speculators in using “investments” like strategy one for a few days at a time.  But holding for any long time is poison.  Worse, if you are accidentally right, and the world comes to an end — this is an exchange-traded note, and the bank you lent to will be broke.  That will also kill strategy two.

So, my advice to you is this: avoid either side of this trade.  Stick with simple investments that do not invest in futures or options.  Complexity is the enemy of the average investor.  I can understand these investments and they don’t work for me.  You should avoid them too.

PS — before I close, let me mention:

Good article in both places.

Okay let’s roll the promoted stocks scoreboard:

TickerDate of ArticlePrice @ ArticlePrice @ 2/4/14DeclineAnnualizedSplits

































































































































































Tonight’s loser-in-waiting is Fresh Healthy Vending [VEND].  But before I go there, let me point you to an article I read today regarding promoted stock scams.

We’ll start with the fact that there is [sic] essentially four kinds of penny stock companies in the Pump & Dump world: (1) the kind where the management is in on the scam and is directly knowledgeable and complicit with the intent to deceive the public; (2) the kind where some poor schmoe has a great idea (at least he thinks it is) that requires financing, and becomes the mark of a parasitic “funder” who makes all kinds of promises of unlimited monies and riches beyond the mark’s wildest dream; (3) the kind where the company is absolutely for real but the shares have been hyped (sometimes hijacked) into ridiculous valuations; and, (4) a hijacked empty and inactive shell.

The following article explains each type of promoted stock scam.  I appreciated it, because it clarified my thinking — I’ve seen all four of these, but I did n’t realize it until now.  My error was looking for one common modus operandi, when there are a variety of parties that can benefit from a stock promotion.

Fresh Healthy Vending fits the first category of promoted stock scams.  Read this portion of the Disclaimer:

The Wall Street Revelator and/or its publisher, Andrew & Lynn Carpenter, dba The Wall Street Revelator has received a total amount of Seventeen thousand five hundred dollars in cash compensation to assist in the writing of this Advertisement, as well as potential future subscription and advertising revenues, the amount of which is not known at this time with respect to the publication of this Advertisement and future publications. Brown Dog Marketing, Inc. paid two million three hundred thousand dollars to marketing vendors to pay for all the costs of creating and distributing this Advertisement, including printing and postage, in an effort to build investor and market awareness.

If successful, the Advertisement will increase investor and market awareness, which may result in increased numbers of shareholders owning and trading the common stock of Fresh Healthy Vending Inc. increased trading volumes, and possibly increased share price of the common stock of Fresh Healthy Vending Inc.

Brown Dog Marketing, Inc. was paid by non-affiliate shareholders who fully intend to sell their shares without notice into this Advertisement/market awareness campaign, including selling into increased volume and share price that may result from this Advertisement/market awareness campaign. The non-affiliate shareholders may also purchase shares without notice at any time before, during or after this Advertisement/market awareness campaign. Non-affiliate shareholders acted-as-advisors to Brown Dog Marketing, Inc. in this Advertisement and market awareness campaign, including providing outside research, materials, and information to outside writers to compile written materials as part of this market awareness campaign.

The bolding is mine.

The scam is rarely this bald.  The type for the disclaimer is 5 or 6 points.  Very tiny, though I have seen smaller.  But why be so plain?  Because few read it, and it immunizes them from any lawsuits.

In this case, one guy owns ~65% of the company, and he got the shares at a very low cost in the reverse merger that converted a “green advertising” company into a company that vends healthy snacks.  He has a history of his own that should raise a yellow flag.  But the rest of the holders that provided financing, have the chance to get out at much higher valuations as a result of the pump and dump going on here.

As a result of the reverse merger, this is a real company, unlike most promoted stocks.  It has real revenues, but still has negative net worth and regular losses.  Why this company has a market cap over $100 million is a mystery to me, aside from the promotional activity over the last few months.  Aside from that, its revenue growth is slowing, and it faces a number of lawsuits over its behavior as a franchisor.

Given trading volumes since the promotions began, it would not surprise me if the selling shareholders are out of their positions in full by now.  It would also not surprise me if this company did a PIPE or a secondary to monetize the gains of the main holder at a lower valuation.

As with all promoted stocks, this is something to stay away from.  On a speculative level, one can never tell where a stock like this will break down, but I can tell you this, it is coming soon, and holders at this price level will lose money.

I would encourage you to have a read of the 2014 Baltimore Business Review.  Produced by the CFA Institute  — Baltimore, and Towson University, it  is a great example of how academics and practitioners can work together.  Here is my article, reformatted so that it looks better on my blog:

Differences in US States’ Unemployment over the Last 36 Years

Unemployment is often treated as a national issue, but unemployment is often driven by regional or industry sector issues. This article pries apart the causes of unemployment since 1976, state-by-state.

Though there is a national component to every US state’s unemployment level, it is notable that local factors often dominate national trends. Here are some examples:

  • North Dakota has an energy boom amid increasing unemployment following the housing bust in 2008.
  • Texas had increasing unemployment in the mid-1980s as energy prices fell dramatically, in the midst of an economic boom.
  • Coastal economies benefited during the housing boom (pre-2008), and were punished in the bust – this is parallel to the US economy as a whole, but more severe.
  • The Rust Belt prospered slowly in the early 1980s as the rest of the nation began to prosper rapidly.

The rest of this article will explain the causes of unemployment over the last 36 years, related to how connected a state is to the rest of the US economy, and how well the industry mix in a given state is doing.

Data & Method

Unemployment data for each state and the US as a whole was obtained from the St. Louis Federal Reserve’s Federal Reserve Economic Data (FRED) database. The data covers the period from 1976 to August 2013. Ordinary least squares regression was used to calculate how sensitive unemployment rates were in each state relative to overall US unemployment rates. The equation looks like this:

Ustate,t = αstate + βstateUUS,t + ϵstate,t

The intuition behind this equation is that the unemployment rate of a given state can be explained by the amount that it varies in proportion to the unemployment rate for the US as a whole (the beta term), a fixed difference (the alpha term), and the error term. Here were the results by State:

StateAlphaBetaAlpha SDBeta SDR-squaredAlpha T-statBeta T-StatCorrelation Group
Michigan     (2.50) 1.67        0.25      0.04


           (9.98)         17.82


Nevada     (2.44) 1.42        0.22      0.03


         (11.22)         12.80


Indiana     (2.47) 1.35        0.20      0.03


         (12.42)         11.63


Alabama     (1.80) 1.32        0.23      0.03


           (7.72)          9.06


West Virginia      0.28 1.24        0.48      0.07


            0.59*          3.42


Ohio     (1.10) 1.23        0.17      0.03


           (6.49)          9.21


Rhode Island     (1.03) 1.17        0.26      0.04


           (3.88)          4.33


Illinois     (0.51) 1.17        0.14      0.02


           (3.64)          8.08


Tennessee     (0.86) 1.17        0.15      0.02


           (5.65)          7.29


North Carolina     (1.44) 1.14        0.19      0.03


           (7.40)          4.85


Oregon     (0.00) 1.13        0.17      0.03


           (0.03)*          5.11


South Carolina     (0.72) 1.13        0.18      0.03


           (3.94)          4.69


California      0.20 1.12        0.18      0.03


            1.14*          4.61


Washington      0.07 1.09        0.15      0.02


            0.49*          3.98


Florida     (0.53) 1.07        0.18      0.03


           (2.93)          2.80


Pennsylvania     (0.33) 1.07        0.14      0.02


           (2.40)          3.52


Wisconsin     (1.30) 1.07        0.17      0.03


           (7.49)          2.57


Arizona     (0.50) 1.06        0.18      0.03


           (2.81)          2.28


Kentucky      0.20 1.05        0.20      0.03


            1.00*          1.56*


New Jersey     (0.10) 1.01        0.21      0.03


           (0.47)*          0.32*


Mississippi      1.57 0.99        0.27      0.04


            5.86         (0.29)*


Missouri     (0.28) 0.97        0.12      0.02


           (2.35)         (1.54)*


Georgia     (0.22) 0.96        0.16      0.02


           (1.37)*         (1.81)*


Delaware     (0.83) 0.95        0.20      0.03


           (4.05)         (1.73)*


Connecticut     (0.41) 0.91        0.23      0.03


           (1.80)*         (2.79)


Utah     (0.60) 0.88        0.15      0.02


           (3.91)         (5.13)


Idaho      0.36 0.88        0.20      0.03


            1.77*         (4.09)


Colorado     (0.01) 0.87        0.17      0.03


           (0.04)*         (5.06)


Maine      0.31 0.87        0.19      0.03


            1.61*         (4.49)


Massachusetts      0.17 0.86        0.24      0.04


            0.72*         (3.94)


Minnesota     (0.29) 0.82        0.12      0.02


           (2.43)         (9.78)


District of Columbia      2.45 0.81        0.18      0.03


          13.40         (6.86)


New York      1.48 0.81        0.18      0.03


            8.45         (7.28)


Arkansas      1.46 0.79        0.18      0.03


            8.23         (7.87)


Virginia     (0.30) 0.78        0.08      0.01


           (3.84)        (18.90)


Maryland      0.31 0.78        0.12      0.02


            2.66        (12.83)


Iowa     (0.17) 0.77        0.19      0.03


           (0.86)*         (7.98)


Vermont      0.06 0.74        0.19      0.03


            0.34*         (9.04)


Louisiana      2.45 0.73        0.38      0.06


            6.40         (4.69)


New Hampshire      0.12 0.68        0.20      0.03


            0.60*        (10.73)


New Mexico      2.67 0.64        0.21      0.03


          12.78        (11.36)


Montana      1.84 0.61        0.21      0.03


            8.65        (12.16)


Oklahoma      1.49 0.59        0.22      0.03


            6.70        (12.25)


Wyoming      1.48 0.56        0.29      0.04


            5.08        (10.17)


Alaska      4.52 0.53        0.28      0.04


          16.05        (11.13)


Hawaii      1.46 0.52        0.27      0.04


            5.52        (12.07)


Texas      2.89 0.52        0.19      0.03


          15.10        (16.90)


Kansas      1.68 0.48        0.13      0.02


          12.53        (25.79)


Nebraska      0.61 0.46        0.13      0.02


            4.62        (27.48)


South Dakota      0.95 0.45        0.11      0.02


            8.93        (34.82)


North Dakota      1.49 0.39        0.18      0.03


            8.14        (22.19)


* Indicates not statistically significant from zero for alpha, and one for beta at a 5% level.

The difference in sensitivity to the US unemployment rate is considerable by state. If the unemployment rate rose 1% in the US, Michigan’s unemployment rate would tend to rise 1.67%, while the North Dakota’s unemployment rate would only tend to rise 0.39%.

The states were then divided into five beta groups, symmetric around 1.0, with a width of 0.2 for the three middle groups. On a map, it looks like this:



The highest sensitivity states to US unemployment rates are largely found in states with high exposure to the Auto and Gambling industries. When times are bad, people shepherd their money more carefully. They cut back on buying new cars, and gambling. High sensitivity states tend to have a lot of gearing to industrial activity, which tends to be more boom-bust than other economic activity. Average sensitivity states tend to have balanced economies, reflecting a mix of business similar to that of the US as a whole. Low-sensitivity states tend to have a large amount agriculture, resource extraction, financial sector concentration, or Federal government work.

Note that the recent boom and bust would argue that financials are more cyclical than previously believed, but that was during a small period during the study period.  The same applies in reverse to agriculture and resource extraction, which benefited from increased demand for raw materials from the developing world, making these industries appear less cyclical than previously believed.

Betas reflect the overall sensitivity to moves in US unemployment rates from 1976 to 2013, but the correlation of the residuals of the states highlight hidden factors that were influential in unemployment rate movements.

Typically, the factors stemmed from the economic sectors prominent in each group of states, as their profitability waxed and waned.

Starting with ten groups of states randomly divided, the groups were iteratively adjusted, combining groups that were highly correlated with each other until there were no more improvements possible, ending with six groups. Here is the average correlation matrix:


Avg Corr







Group 1


Group 2



Group 3




Group 4





Group 5






Group 6







And here is the map identifying the groups:


Groups 1, 2 and 5 correlate strongly internally and moderately among each other. The same is true for 3, 4 and 6. The rest of the group correlations are weak if not negative.

Groups 3, 4, and 6 cover the center of the US. They have proportionately more economic sectors in agriculture, energy, consumer cyclicals, and basic materials.  Much of the area is rural. Groups 1, 2 and 5 cover the coasts of the US and are more heavily urbanized. Their economic sectors have a greater proportion of finance, healthcare, and technology.  Post-2007 unemployment was relatively worse in groups 1, 2 and 5 versus the other groups, because they were part of the hot housing markets, and lost more construction jobs as a result.

Here is a graph of the average unemployment residuals for the six correlation groups over the 36-year study period:


Description of the Correlation Groups

Group 1 – composed of Maryland, other Mid-Atlantic States, New England and Hawaii, this — had high unemployment relative to the rest of the US in 1976 and 1997, and low unemployment in 1987. It has high relative exposure to the consumer noncyclicals and financials sectors, and low relative exposure to energy and technology. The high weight in financials helps explain the employment gains from 1976 to 1987, as financial companies benefited from falling interest rates, rising equity markets, and expanding product offerings.

Group 2 – composed of the Carolinas, Georgia, Arizona and Nevada — had high unemployment relative to the rest of the US in 2011, and low unemployment in 1984 and 1991. It has a lot of relative exposure to the consumer noncyclicals and utilities sectors, and low relative exposure to energy, financials, and technology.  During the mid-1980s to early 1990s, this group benefited from the growth in demand for noncyclical goods from the Baby Boomers. After the popping of the financial bubble in 2008, weakness in construction and gambling in Arizona and Nevada led to higher levels of unemployment.

Group 3 – composed of the Midwest, parts of the South, Utah and Oregon — had high unemployment relative to the rest of the US in 1976 and 1992, and low unemployment in 1986. It has high relative exposure to the consumer cyclicals and noncyclicals and basic materials sectors, and low relative exposure to energy and technology. The US economy as a whole peaked and troughed along with group 3, which makes sense given their relatively large exposure to cyclical sectors.

Group 4 – composed of Texas, Missouri, Kansas and Colorado — had high unemployment relative to the rest of the rest of the US in 1987 and 2003, and low unemployment in 1976. It has a lot of relative exposure to the energy and utilities sectors, and low relative exposure to financials and technology. Performance of the energy sector is the critical factor here – it was relatively strong in the mid-to late 1970s, but weak after oil prices bottomed out in the mid-1980s and late 1990s.

Group 5 – composed of the densely populated coastal states of California, Florida, New Jersey, Massachusetts, Connecticut and Rhode Island — had high unemployment relative to the rest of the rest of the US in 1976, 1992 and 2012, and low unemployment in 1986. It has a lot of relative exposure to the healthcare and technology sectors, and low relative exposure to energy and consumer noncyclicals. In the early 1990s, the aerospace industry in California went bust while the commercial property markets were at the deepest point of their slump. Most of the rest of the unemployment cyclicality can be attributed to the more cyclical nature of the industries in this group – an amplified version of the US economy.

Group 6 looks like a bunch of leftovers, but it is not.  Composed of states in the Northwest and Alaska, New Mexico, Louisiana, Arkansas and Alabama, West Virginia and Pennsylvania, this group had high unemployment relative to the rest of the rest of the US in 1987, and low unemployment in 1976 and 2009.  It has a lot of relative exposure to the agriculture and basic materials sectors, and low relative exposure to financials. The stagflation of the mid-1970s benefited agriculture and basic materials, as did growth in demand from emerging markets in 2009. Those factors were
absent in 1987, as financial firms were booming.

Maryland’s unemployment rates have held down well being next to Washington, DC. The growth in the US government during the last 10 years has supported employment in Maryland. The grand question to ponder is what would ever happen to Maryland, Washington, DC and Virginia if significant cuts were made to Federal payrolls?


There are two main conclusions:

1) State level unemployment is a result of sensitivity to US unemployment levels and the mix of local industries. Policymakers should know how sensitive their state is to the national economy, and what industries are doing well or poorly before taking credit for low unemployment rates. More often than not, the employment rates are low or high due to factors beyond the control of policymakers.

2) In general, greater employment stability exists when that industry mix is more diversified. This is something policymakers can limitedly affect. Most states have efforts to attract businesses to their states. If you want unemployment levels to be more stable, aim your efforts at attracting businesses that diversify your existing mix.