Speculation – Page 38 – The Aleph Blog

Reinsurance: The Ultimate Derivative

Posted on 15 December 2007 by David Merkel

Some housekeeping before I begin this evening. Here’s my progress on the blog:

RSS as far as I can test has no problems.? If you have problems with my feed, please e-mail me any details.? Before you do, try dropping my feed, and re-adding it through Feedburner.
My logo was anti-aliased for me by BriG.? Looks a lot cleaner.? Thanks ever so much, BriG!
The comment error problem is gone, and I suspect also the same one that I have when I post.? It was a bug in one of my WP plugins that was not 2.3.1 compliant.
My descriptive permalinks are still lost, though.

I still need to fix my left margins as well, and make my top banner clickable.? Still, that’s progress.

On to tonight’s first topic: my view on derivatives differs from that of other commentators because I am an actuary (as well as an economist and financial analyst).? In the late 1980s, the life insurance industry went through a problem called mirror reserving.? Mirror reserving said that the company reducing risk through reinsurance could not take a greater reserve credit than the reinsurer posted.

That’s not true with derivatives today.? There is no requirement that both parties on the opposite sides of an agreement hold the same value on the contract.? From my own financial reporting experience (15 years worth), I have seen that managements tend to take favorable views of squishy accounting figures.? The one that is short is very likely to have a lower value for the price of the derivative than the one who is long.

But can you dig this?? The life insurance industry is in this area more advanced than Wall Street, and we beat them there by 20 years minimum.? :D? Given the way that life insurers are viewed as rubes, as compared to the investment banks, this is rich indeed.

Now, as for one comment submitted yesterday: yes, counterparty risk is big, and I have written about it before, I just can’t remember where.? I would argue that the investment banks? have sold default on the counterparties with which they can do so.? That said, it is difficult to monitor true exposures with counterparties; one investment bank may not have the whole relationship.

Also, many exposures are hard to hedge because there are no natural counterparties that want the exposure.? When no party naturally wants? an exposure, either a speculator must be paid to bear the risk, or the investment bank bears it internally.

The speculators are rarely well-capitalized, and the risks that the investment banks retain are in my estimation correlated to confidence.? When there is panic, those risks will suffer.? Were that not so, there would be counterparties willing to take those risks on today to hedge their own exposures.

So, is counterparty risk a problem?? Yes, but so is deadweight loss from differential pricing.

If Hedge Funds, Then Investment Banks, Redux

Posted on 14 December 200722 June 2017 by David Merkel

Every now and then, you get a reader response that deserves to be published.? Such was this response to my piece, “If Hedge Funds, Then Investment Banks.”? I have redacted it to hide his identity.

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I read your latest blog entry with interest because I have worked in the derivatives business and as a part of that helped to set up General Re’s financial subsidiary in 19XX – General Re Financial Products (GRFP). I was one of XX people that started that business from the ground up. I left shortly XXX Buffett arrived on the scene but I still knew a large number of people that remained and I have very good information about what happened there. I may be a bit biased so you should consider where I am coming from as you continue to read.

To be short about it, what happened at GRFP after Buffett took over was a complete mess. I can give you more information on that if you like but I will simply say that what Buffett writes about GRFP, has spin on it. Let me give you a somewhat quick example. Of that $104 million loss he refers to, how much of that could be attributed to salaries and operating expenses? How much of it was due to the forced unwinding of trades on the wrong side of the market? We know that there are high operational costs (these people are paid very well with nice offices, technology, etc.) and that one would expect to pay to get out of these transactions even if they are being marked perfectly correctly. It SHOULD cost money to unwind these trades. So why doesn’t Buffett, who normally gives us so much information, tell us how much of the loss was due to mismarking and how much was due to expected costs? I’ll let you guess at that answer. There’s a lot more to this story but let’s move on…

I am sure you felt safe quoting someone like Buffett – meaning he is likely to get things right almost every time, but even Buffett is not perfect and he has his blind spots. I believe that derivatives may be such a blind spot. I could go into detail about where I see holes in Buffett’s arguments however the bottom line is that I believe the vast majority of transactions done in the derivatives market are plain vanilla transactions that are extremely easy to mark. Did you know that the US Treasury market is now quoted as a spread off of swaps? That is how liquid the plain vanilla instrument is these days. These transactions will certainly not have two traders both booking a profit even though they are on opposite sides of a transaction. Bid/ask spreads in the plain vanilla market are less than 1 basis point per year in yield. I am certain there are exotic transactions that are mismarked for all the reasons that Buffett mentions but how many of these are really out there? My suspicion is that the total number is small enough to not be of any huge concern from a systematic standpoint.

Here is something interesting to consider. Why would the leader of a AAA-rated institution (a financial Fort Knox) that competes in many ways with other large financial institutions wish to lead people to believe that those other institutions may be engaged in a business that is particularly risky?

Just thought I would add my two cents (looks more like 25 cents now).
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For the record, both he and I are admirers of Buffett, but not uncritical admirers.? The initiator of a trade usually has to offer a concession to the party facilitating the trade.? Forced sellers or impatient buyers typically don’t get the best execution.? What my correspondent suggests here is at least part of the total picture in the liquidation of GRFP.? All that said, I still think there are deadweight losses hiding inside that swap books of the major investment banks.

Personal Finance, Part 5 ? Inflation and Deflation

Posted on 6 December 2007 by David Merkel

This is another in the irregular series on personal finance.? This article though, has implications beyond individuals.? I’m going to describe this in US-centric terms for simplicity sake.? For the 20-25% of my readers that are not US-based, these same principles will apply to your own country and currency as well.

Let’s start with inflation.? Inflation is predominantly a monetary phenomenon.? Whenever the Fed puts more currency into circulation on net, there is monetary inflation.? Some of the value of existing dollars gets eroded, even if the prices of assets or goods don’t change.? In a growing economy with a stable money supply, there would be no monetary inflation, but there would likely be goods price deflation.? Same number of dollars chasing more goods.

Let’s move on to price inflation.? There are two types of price inflation, one for assets, and the other for goods (and services, but both are current consumption, so I lump them together).? When monetary inflation takes place, each dollar can buy less goods or assets than in the absence of the inflation.? Prices would not rise, if productivity has risen as much or more than the amount of monetary inflation.

Now, the incremental dollars from monetary inflation can go to one of two places: goods or assets.? Assets can be thought of? as something that produces a bundle of goods in the future.? Asset inflation is an increase in the prices of assets (or a subgroup of assets) without equivalent improvement in the ability to create more goods in the future.? How newly printed incremental dollars get directed can make a huge difference in where inflation shows up. Let me run through a few examples:

?In the 1970s in the US, the rate of household formation was relatively rapid, and there was a lot of demand for consumer products, but not savings.? Money supply growth was rapid.? The stock and bond markets languished, and goods prices roared ahead.? Commodities and housing also rose rapidly.
In? the mid-1980s the G7 induced Japan to inflate its money supply.? With an older demographic, most of the excess money went into savings that were invested in stocks that roared higher, creating a bubble, but not creating any great amount of incremental new goods (productivity) for the future.
In 1998-1999, the Fed goosed the money supply to compensate for LTCM and the related crises, and Y2K.? The excess money made its way to tech and internet stocks, creating a bubble.? On net, more money was invested than was created in terms of future goods and services.? Thus, after the inflation, there came a deflation, as the assets could not produce anything near what the speculators bid them up to.
In 2001-2003 the Fed cut rates aggressively in a weakening economy.? The incremental dollars predominantly went to housing, producing a bubble.? More houses were built than were needed in an attempt to respond to the demand from speculators.? Now we are on the deflation side of the cycle, where prices adjust down, until enough people can afford the homes using normal financing.

I can give you more examples.? The main point is that inflation does not have to occur in goods in order to be damaging to the economy.? It can occur in assets when people and institutions become maniacal, and push the price of an asset class well beyond where its future stream of cash flow would warrant.

Now, it’s possible to have goods deflation and asset inflation at the same time; it is possible to save too much as a culture.? The boom/bust cycles in the late 1800s had some instances of that.? It’s also possible to have goods inflation and asset deflation at the same time; its definitely possible to not save enough as a culture, or to have resources diverted by the government to fight a war.

The problem is this, then.? It’s difficult to make hard-and-fast statements about the effect of an increasing money supply.? It will likely create inflation, but the question is where?? Many emerging economies have rapidly growing money supplies, and they are building up their productive capacity.? The question is, will there be a market for that capacity?? At what price level?? Many of them have booming stockmarkets.? Do the prices fairly reflect the future flow of goods and services?? Emerging markets presently trade at a P/E premium to the developed markets.? If capitalism sticks, the premium deriving from faster growth may be warranted.? But maybe not everywhere, China for example.

The challenge for the individual investor, and any institutional asset allocator is to look at the world and estimate where the assets generating future inflation-adjusted cash flows (or goods and services) are trading relatively cheaply.? That’s a tall order.? Jeremy Grantham of GMO has done well with that analysis in the past, and I’m not aware that he finds anything that cheap today.

We live in a world of relatively low interest rates; part of that comes from the Baby Boomers aging and pension plans investing for their retirement.? P/E multiples aren’t that high, but profit margins are also quite high.? We also face central banks that are loosening monetary policy to reduce bad debt problems.? That incremental money will aid institutions not badly impaired, and might eventually inflate the value of houses, if they get aggressive enough.? (Haven’t seen that yet.)? In any case, the question is how will the incremental dollars (and other currencies) get spent?? In the US, we have another demographic wave of household formations coming, so maybe goods inflation will tick up.

We’ll see.? More on this tomorrow; I’ll get more practical and less theoretical.

Ten Notes on Our Crazy Credit Markets

Posted on 5 December 2007 by David Merkel

This post may be a little more disjointed than some of my posts.? Recently I have been working on calculating the fair value for mezzanine tranches of a series of real estate oriented CDOs.? Not pretty.? Anyway, here are few articles that got me thinking yesterday:

Let’s? start with CD rates.? Bloomberg had a nifty table on its system which I can’t reproduce here, except to point you to the data source at the Fed.? Note how one-, three-, and six-month CD rates have been rising, somewhat in sync with LIBOR, but widening the gap with Treasury yields. (Hit your “end” button to see the most recent rates…)
As a result, I have been debating whether the FOMC might not do a 50 basis point loosen next Tuesday.? CDs aren’t the bulk of how most banks fund themselves, but they can be a way to get a lot of cash fast.? Remember that after labor unemployment and inflation, the Fed’s hidden third mandate is protecting the depositary financial system, particularly the portion that belongs to the Federal Reserve System.
Now, I’m not the only one wondering about what the FOMC will do.? There’s Greg Ip at The WSJ, who speculates on the size of the cut, and whether the discount rate might not be cut even more, with a loosening of terms and conditions as well.? Bloomberg echoes the same themes.? Even the normally placid Tony Crescenzi sounds worried if the FOMC doesn’t act aggressively here.
The US isn’t the only place where this is a worry.? The Bank of Canada cut rates yesterday, as noted by Trader’s Narrative, partly because of credit pressures in Canada and the US.? The Financial Times notes that Euro-LIBOR [Euribor] is also rising vs. Government short-term yields, which may prompt the ECB to cut as well.? Or, they also could cut their version of the discount rate, or liberalize terms.
It doesn’t make sense to me, but the Yen is weakening at present.? With forward interest rate differentials narrowing as more central banks tip toward easing, I would expect the carry trade to weaken; instead, it is growing.? For now.
As noted by Marc Chandler, the Gulf States have largely decided to keep their US Dollar peg.? I found the article to be interesting and somewhat counterintuitive at points, but hey, I learned something.? Inflation is rising in Kuwait after they switched from the US Dollar to a basket of currencies, because residential real estate prices are rising.
Credit problems continue to emerge on the short end of the yield curve.? Accrued Interest has a good summary of the problems in money market funds.? It almost seems like Florida is a “trouble magnet.”? If it’s not hurricanes, it’s bad money management.? Then there’s Orange County, which has a 20% slug of SIV-debt in its Extended Fund.? It’s all highly rated, so they say, but ratings don’t always equate to credit quality, particularly in unseasoned investment classes.? Then there’s the credit stress from borrowers drawing down on standby lines of credit, which further taxes the capital of the banks.
As a final note, both here (point 6) and at RealMoney, I was very critical of S&P and Moody’s when they decided to rate CPDO [Constant Proportion Debt Obligation] paper AAA.? I’ll let the excellent blog Alea take the victory lap though.? We finally have CPDOs that are taking on serious losses (and here).
In summary, we are increasingly in a situation where the major central banks of our world are reflating their currencies as a group in an effort to inflate away embedded credit problems.? Most of the credit problems are too deep for a lowering of the financing rate to solve, though it will help financial institutions with modest-to-moderate-sized credit problems (say, less than 25% of tangible net worth — does the rule of thumb for P&C reinsurers apply to banks?).? This can continue for some time, and credit spreads and yield curves should continue to widen, and inflation (when fairly measured) should increase.? Some of the inflation will move to assets that aren’t presently troubled, perhaps commodities, and higher quality equities, which are doing relatively well of late.
Quite an environment.? The big question is when the “free lunch” period for the rate cuts end, and the hard policy choices need to be made.? My guess is that would be in mid-to-late 2008, just in time for the elections.? Now, wouldn’t that spice things up? 🙂

On the Value of Secondary and Primary Markets

Posted on 3 December 20074 December 2007 by David Merkel

My main thesis here is that secondary and primary markets benefit investors in different ways, but that they are equally valuable to investors, and the public at large. Government policy should not discriminate in favor of one or the other.

I come at this topic from the point of view of someone who has been both a bond and stock investor professionally. When managing bonds, one boss of mine would say, “Primary market levels validate trading levels in the secondary market.” His point was that in the bond market, since a large proportion of the dollar value of transactions came from new issues, those deals in the primary markets were a good indication of where trades should go on in the secondary market for similar pieces of paper. He had a point; bigger markets should dominate smaller similar markets in discerning overall price/yield movements.

In the primary markets, deals have to come a little cheap on average in order to get deals done. That cheapness is necessary in order to get a lot of liquidity from investors at once. But that level of cheapness attracts flippers, i.e., people who buy the cheap new issue, and sell it away for a quick profit in the secondary markets. Bond underwriter syndicates do what they can to detect flippers, but some almost always get in. Even so, the flippers have some value. They reveal the level of discounting inherent in the offering process; when the discounting is high, there’s a lot of fear in the marketplace, and new deals stand a decent chance of performing well. Vice-versa when discounting is low, or even worse, when a new deal “backs up” and closes below the IPO price.

One way to tell how hot the market is, is how rapidly deals close. Seven minutes? Days?? Mania and Lethargy are common attitudes for the market.? Normal behavior is, well, abnormal.? Abnormal behavior provides clues into what is likely to happen next, even if the timing is difficult.? Hot IPO markets eventually go cold, and vice-versa.

The secondary markets provide valuable clues for the primary market as to where deals should be priced, whether equity or debt.? Even if the primary market were dominated by buy-and-hold investors (more common in bonds, less common in stocks), the speculation inherent in much secondary trading provides real value to the IPO syndicates, and longer-term investors.

Longer-term investors who buy-and-hold, or sell-and-sit-on-cash provide clues to speculators as well. The longer-term investors are the ones who create “support” and “resistance” levels.? They care about valuation.

Secondary markets need primary (IPO) markets also.? Without the possibility of a company being bought out, share prices tend to suffer.? When few new companies go public, it is often a sign that the secondary markets are cheap.

My main point here is both markets are valuable, and they need each other.? Speculation is an inescapable part of the capital markets, and it should not be legally discouraged.? (Note: I am not about to become a speculator; I am a longer-term investor, and will stay that way.)

How does the system discourage speculation?? There are differential rates of taxation based on holding period, or investment class. My view is that all income, no matter how generated, should be taxed at the same rate.? All income generation is equally valuable, whether it comes quickly or slowly.

So, when I read drivel like this fellow Lawrence Mitchell is putting out, advocating high taxes on short-term investing, I sit back and say, “You’re not thinking systematically.? You’ve only thought through the first order effects; the remaining effects have eluded you.”? Imagine a system where we are all forced to become buy-and-hold investors through tax policy.? Where would the price signals for the primary markets come from?? Where would liquidity come from?? Would activist investing shrink, with the honesty that it helps to bring?? Who would be willing to step up to an IPO if he knew that tax policy favored him holding for ten years?? What would happen to venture capital if the secondary markets dried up because of tax policy?? Where would their exit door be?

A world composed of only long-term investors would not be as rich of world as we have now.? Though many short-term investors are only “noise traders,” the ability of short-term investors to take advantage of market dislocations helps stabilize the markets.? There should be no penalty to short-term investing versus long-term investing.

Now, if that’s not controversial enough, perhaps I will write a post where I say that tax policy should not favor savings over consumption.? Let people make their own decisions on buying and selling, and let the IRS take a consistent cut, but social policy through tax preferences is for the most part not a good idea.

Notes on Fed Policy and Short-term Credit

Posted on 28 November 2007 by David Merkel

I just did my usual review of my FOMC indicators.? The FOMC should cut 25 basis points at the December 11th meeting.? Whatever the formal “bias” is, the verbiage will be a little of this and the a little of that, something like:? “Yes, we are worried about the solvency of some financial institutions.? That’s why we cut.? But this cut very likely should be enough, so don’t expect anymore.? Now leave us alone.”
So Goldman sees a 3% Fed funds rate in mid-2008?? So do I.? Small moves in FOMC policy don’t achieve the desired ends, either when policy is rising or falling.? Large cumulative moves are needed to affect the behavior of market participants.
The TED [Treasury – Eurodollar] spread is at its largest one-year moving average since 1990.? That’s significant short-term credit stress to the large banks, and it is worth watching.? It’s not just a US phenomenon either; in the UK the banks are under stress as well.
Residential housing is driving the decisions of the FOMC.? As prices fall, more houses become non-refinancable, and non-salable (except at a loss).? All it takes then is for a problem to happen… death, disability, divorce, unemployment, or casualty, and another house goes on the market because of insolvency.
So, I agree with Accrued Interest (great blog, doesn’t everyone want to read about bonds?).? Many Fed governors talk between meetings, and they trot out their baseline scenario, but often it is the worry of avoiding a somewhat likely negative scenario that can drive policy.
At some level though, if the dollar falls far enough, the FOMC will have to reverse course, as Caroline Baum has pointed out.? Remember, that’s what drove the FOMC to tighten in 1986-87.
Of course, the credit stress in the short end of the market has led some money market fund sponsors to bail out their funds (Legg Mason, Wachovia and B of A, while GE lets a pseudo-money market fund take a hit.? Remember, with money market funds, it’s not wise to stretch for yield, particularly not in bear markets for credit.
One more weak Commercial Paper [CP] funding structure: using it as part of a “super senior” tranche in CDOs.? Now in this case, the collateral is weak — subprime mortgage loans, but this could be true of any CDO where the collateral comes under stress in the future, including high yield corporate bonds.? I wrote about this three months ago, but this one is still unraveling.
I haven’t talked about it, because I wasn’t sure I had anything to add to the discussion, but the M-LEC, or super-SIV, proposed by the major banks seems like hooey to me.? After all, if this shifting of assets from one pocket to another created value, why wasn’t it done before?? It doesn’t change the underlying asset prices, and for the banks as a whole, it is just a zero sum game, unless new parties enter, at which point, they will have to offer a discount to move the paper, which eliminates one of the reasons for doing the deal.
Putting another nail in the coffin, HSBC takes their SIVs onto their own balance sheet, cleaning up their own financing, and making it more difficult for the other banks who want to do the Super-SIV.

What an interesting time in the short-term debt markets.? For now, prudence dictates staying high quality in what financial institutions you lend to short term.

Ten Chosen Items from the Current Market Troubles

Posted on 27 November 2007 by David Merkel

Superstition is alive and well.? Google at $666?? Personally, I think it is all hooey.? There has always been a morbid fascination about the Antichrist in Western Culture.? Would that they had more concern about Christ.
Longtime readers know I am no fan of FAS 157 or FAS 159.? From the Accounting Onion, here is a good demonstration of what could go wrong as FAS 157 is implemented.? In my opinion, the concept of fair market value allows managements too much flexibility.? For assets that have a liquid market bigger than the holdings of the company in question, fair market value is not a problem.? It is a misleading concept otherwise, because the ability to realize that asset value in a sale is questionable.
This is an “uh-oh” moment on two levels.? Level one is defined benefit pension plans exiting US equities.? They are big holders, and a reallocation could hurt US stock prices.? Level two is that foreign markets have outperformed the US by a great deal over the last few years.? Perhaps the DB pension plans are late to the party?
There are no “almosts” in investing.? I have owned Genlyte twice in my life.? Great company.? I had it on my candidate list in my last reshaping.? I didn’t buy it then.? Now it is being bought out by Philips Electronics.? Good move for Philips; the only way they could make it better would be to take the management team of Genlyte, and have it run Philips.? That won’t happen; it is more likely that Philips will ruin Genlyte.
Activist hedge funds don’t always know best.? Smart managements and boards don’t get scared.? They calculate.? What’s the best thing for shareholders in the long run?? Do the hedge funds really have the willingness to fight?? Personally, I think it is usually best for managements to “call their bluff” and make the hedge funds work for control, rather than wave the white flag early.
Higher US dollar oil prices are only partly a dollar phenomenon.? Oil prices are rising in almost every currency; there is a relative shortage of crude oil globally.
Want an antidote to pessimism?? Read this post from VOX.? Personally, I think the lending issues are bigger than they think, but it is true that corporate balance sheets are in good shape.? Would that we could say the same for the consumer or the government.
Appreciation of the Chinese Yuan versus the Dollar may be accelerating.? Alongside that, many of the Gulf States are re-evaluating their peg to the US Dollar.? Given the inflation, who can blame them?
$300 Billion in losses from US residential mortgages?? That’s a believable figure to me.? Underwriting got progressively worse from 2003 to the first quarter of 2007.? Needless to say, that would kill a lot of non-bank mortgage lenders, and a few banks as well.
Could Japan be the great countercyclical asset in this market phase?? There is more speculative fervor in Japan at present, and many Japanese investors are buying stocks and selling bonds, partly due to relative yield measures.

That’s all for now.? More to come.

Seven Observations From Barron’s

Posted on 17 November 200718 November 2007 by David Merkel

Kinda weird, and it makes you wonder, but on the WSJ main page, I could not find a link to Barron’s. I know I’ve seen a link to Barron’s in the past there; I have used it, which is why I noticed its absence today.
I found it amusing that the mutual fund that Barron’s would mention on their Blackrock interview, underperformed the Lehman Aggregate over 1, 3 and 5 years. Don’t get me wrong, Blackrock is a great shop, and I would work there if they offered me employment that didn’t change my location. Why did Barron’s pick that fund?
I’m not worried about the effect of a financial guarantor downgrade on the creditworthiness of the muni market. Munis rarely fail. Most of those that do fail lacked a real economic purpose. What would be lost in a guarantor downgrade is liquidity. Muni bond insurance is a substitute for analysis. “AAA insured, I’ll buy that.” Truth, an index fund of uninsured munis would beat an index of insured munis, because default rates are so low. But the presence of insurance makes the bonds a lot more liquid, which makes portfolio management easier.
I’ve been a US dollar bear for the last five years, and most of the last fifteen years. Though we have had a little bounce recently, the dollar has of late been at record lows against currencies that trade freely against the dollar. I expect the current bounce to persist in the short term and fail in the intermediate term. The path of the dollar is lower, unless the Fed decides to not loosen more. Balance needs to be restored in the global economy, such that the rest of the world purchases more goods and services, and fewer assets from the US.
I don’t talk about it often, but when it comes up, I have to mention that municipal pensions in the US are generally in horrid shape. The Barron’s article focuses on teachers, but other municipal worker groups are equally bad off. The article comments on perverse incentives in teacher retirement, which leads older teachers to retire when it is feasible to do so. For older teachers, I would not begrudge them; they weren’t paid that well at the start, and the pension is their reward. Younger teachers have been paid pretty well. I would not expect them to get the same pension promises.
I like Japan. I own shares in the Japan Smaller Capitalization Fund [JOF]; it’s my second-largest position.

Japan is cheap, and small cap Japan is even cheaper. I would expect a modest bounce on Monday.
We still need a 15-20% decline in housing prices to bring the system back to normal. There might be an undershoot in price from the sales that forced sellers must do. Hopefully it doesn’t turn into a self-reinforcing decline, but who can be sure about that? At that level of housing prices, man recent conforming loans will be in trouble, much less non-conforming loans.

Full disclosure: long JOF

Getting Closer to a Bounce

Posted on 13 November 2007 by David Merkel

Over at RealMoney.com, Jim Cramer occasionally talks about the “oscillator” during times of market stress.? Well, I will offer you my guess at what the oscillator is: a 10-day moving average of NYSE & Nasdaq up volume, less NYSE & Nasdaq down volume.? When that figure gets too high, the market is short term overbought, and when that figure gets too low, the market is short term oversold.? We are close to that oversold level now.

That doesn’t mean that the market is a long-term buy, but that sellers are getting short-term tired.? As the market has fallen, my own cash position has shrunk from 17% of assets to 11% of assets.? I have added gradually to out-of-favor positions, and will add more if the market declines further.

Miscellaneous note: some readers asked what relative strength figure I use.? Typically, I use 14-day RSI.? Why?? It’s the default on Bloomberg.

Circuit Breakers, but no Curbs

Posted on 8 November 2007 by David Merkel

Posted today at RealMoney:

		David Merkel
		Bye-bye to Trading Curbs
		11/7/2007 2:37 PM EST

When the NY Composite fell 2% today, no trading curbs kicked in. Program trading went on unfettered by a need for upticks. Around 1:20, when the curbs would have kicked in, the market fell a little, stabilized, and began to rally. So much for the curbs. Now all that remains are the circuit breakers, which kick in when the DJIA is down 10% and 20%. The circuit breakers only came into existence in 1987, and to the best of my knowledge, have never been triggered. (Anyone else know for sure? I don’t have intraday data.)

Using closing data since 1900 (again, I don’t have intraday), the circuit breakers would have been triggered 5 and 2 times each. That’s once every 21 and 54 years, respectively. To me, that’s not frequent enough to have a rule in place, even if intraday data would double the frequency.

Position: none

As it was, the market finished down nearly 3% today.? I suspect that curbs wouldn’t have helped much, but who can tell.? The market is a lot more game-friendly than it used to be; far fewer rules to observe (or flout).

On an unrelated note, here are my two REIT charts from yesterday, in thumbnail form, for those who had a hard time with them yesterday.

Mortgage REITs

Equity REITs