/dev/random

Images of the Crisis

2009-02-20T18:43:00.000-08:00

The Freakonomics Blog at NY Times had a post about magazine covers illustrating current crisis.
Here are some more images I found on the covers of magazines:

Cover of the Ukrainian "Contracts" magazine depicting banker and homeowner fighting for mortgage money.
Another Ukrainian magazine called "Money". Looks like this rope is about to brake.

Anatomy of the bubble

2009-02-19T15:41:00.000-08:00

Today I found a nice illustration of a buble dynamics. What we see here is a land price index in Japan over time annotated with public sentiment about future direction of prices. As you can see buble has been correctly predicted approximately half way through to the top. However by the time prices peaked out most people tired of waiting for decline and accepted that new level of prices is absolutely justified. Similarily first stages of decline we accompanied by optimism. And only when prices reached bottom people capitulated and proclaimed that land ownership is inferior to just renting.

Similar sentiment dynamics has been observed in other financial bubbles as illustraded in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay.

Planes, trains, and financial market.

2009-02-17T19:58:00.000-08:00

I've never been late to a plain, train or any other mode of transportation with a set schedule. I guess I got it from my father. He always left in advance, was constantly in a hurry, and always had 2 hours before departure to spare when he arrived to an airport or a train station. I did the same. I left early, calculating every possible delay into my schedule. And even with traffic jams, long lines to check-in, and even longer line at TSA gate I always had at least an hour to kill at the gate. An hour to kill not counting any delays. So I've never been late to my flight.. That is I've never been late till today. Today I missed it by 2 minutes. But 2 minutes don't count when the plane is in the sky and you are on the ground looking at it's shiny tail waiving good-bye.

What happened to me today is very similar to a recent situation in financial markets. I used to be risk averse. And it never paid. In fact it was not very pleasant to kill all these extra hours at the gate not unlike it was painful for risk-averse money managers to see how guys next door make more money. In addition I used to fly from airports with relatively fast security line. On one occasion it took me mere 20 minutes from the door of my apartment to the gate. And in numerous other cases I had very predictable experience door-to-door. So I wrongfully assumed that "normal" familiar pattern that repeated so many times. In fact I counted on it to repeat. Similarly, calm and ever-growing financial markets of the past 4-5 years before the crash lead many people to believe, at least subconsciously, that same pattern will persist forever and ever .

And then all went wrong. I left to the airport 8 minutes later than I planned thinking that surely 8 minutes won't affect my plan that much. Then, I accidentally took the wrong turn and had to walk across the airport to the next terminal. Next there was a security line that was 4 times longer I normally see and it was moving 10times slower (I kid you not. It virtually felt like the line was not moving at all). Then, there were travelers with strollers, babies, and ticket problems in my line; there was an elderly gentlemen with extreme patience and deteriorated motor skills (3 minutes to untie shoes); there was a poor choice in picking which phalanx of line to pick (picked the longest one). And finally running with untied shoes to the farthest gate from checkpoint. And I was just 10 minutes late. Maybe none of these events in isolation would've caused me to miss my flight. But all together they were catastrophic (of course if you consider being late for your flight a catastrophe which I don't)

Of course you all know what happened in financial markets, or at least know as well as I do (if not, I can write about it in my next article). It was a perfect storm of sort. Many events unforeseen by most caused excessive strain on the system.

Unlike my obstacles, many obstacles that brought asset prices down were not uncorrelated (If you are a nitpicker, you might argue that my problems weren't uncorrelated too. When flying on Saturday from Orlando one might expect long lines to security, strollers, elderly gentlemen, and long distances all together).

So what is the lesson here? The lesson for me is that I need to allocate more time for all airport procedures when traveling next time. Instead of relying on averages and recently observed variances I should estimate reasonably bad cases and build time buffers for those. Similarly, when managing risks of a financial portfolio recent variance and expectations of analysts don't do you much good. (Like my reckless travel planning it works most of times until once it doesn't). Instead one should really think hard and estimate reasonable bad cases one wishes to avoid. Of course it is more art than science unlike math of variance and value at risk. And secondly, one must try really hard to avoid trap of proximity bias. Neuroscientists say that brain infers general pattern from only 3 observations. After seeing 3 white swans we assume all swans are white. Of course not many people consciously think that market will go up forever after 3 years of bull market (at least reasonable people). But subconsciously they might still believe, deep down inside, that the good times will roll.

2008-09-08T18:48:00.001-07:00

Checking out ping.fm

Magazine covers, expectations, and housing crisis

2008-06-30T20:12:00.000-07:00

Bernie Schaeffer, the father of the expectation analysis and mastermind behind Schaeffer's Researchhas a theory, that when magazine covers predicts doom and gloom things might actually turn for the better and, vise versa, when magazine covers are overly optimistic it might be time to sell your stock and stock up on ammo and canned food. And this applies even to serious publications. It must be said that quality of analysis and level of insight under the cover of above mentioned serious magazines might be very high. But it is the cover that sells and therefore the cover reflect sentiment of a potential reader much more than actuall analysis that goes under the cover.

Recent cover of the Business week magazine made me wonder if current real estate situation is really that bad. Everyone seem to have accepted by now that it is terrible and everyone is scared of it from investors on wall street to homeowners on main street. However, given that cover doesn’t look too pessimistic it might be some time till recovery actually starts. But it might be time to start buying.

One should be mindful though, that this is not the first time business week ran a cover story on housing crisis. So far they were right on the money. So much for contrarian indicator.

MSFHOO

2008-02-13T11:55:00.000-08:00

Yahoo finance posted a poll asking what people think the fair price would be for Yahoo acquisition. Opinions differ on this one. It is not surprising that Yahoo users value Yahoo higher than Microsoft did. What is surprising that many people vote for lower price and very few actually see offer price as "fair". It seems to me that people have strange concept of fairness. After all it's a free market and "fair price" should be synonimous to "current price"

Here is the snapshot of results:

What do you believe would be a fair price for Microsoft to acquire Yahoo?

$40 or higher	25%
$35 to $40	21%
$31 to $35	19%
$31 per share	9%
Under $31	26%

77885 Votes to date

Knowlege, Crisis and Risk Management

2008-01-30T20:30:00.001-08:00

-What do you call a medical school graduate with 2.5 GPA?
-Doctor

Everybody writes about recent mortgage market slash credit meltdown. And everyone has his or her own favorite explanation how we ended up in a situation like this. Some say it was the lack of adequate quantitative models led to mispricing of mortgage-backed assets and derivatives. Others say it was poor back-office operations that led to double-booking of same collateral. I used to say it was greed and proximity bias that let people to down play the risk every month the market didn't break down. Every month until it finally did. Some blame over-reliance on VAR and poor risk management in general.

I am sure all these are good reasons and there is truth behind every single one of them. It wouldn't be wise to try and pinpoint singe main reason and I am not trying to do it here. My post is more humorous than a serious one.

No to get to the point. Two weeks ago I came to think that the main reason is that people simply don't know what they are doing and do not understand markets and risk well enough. Here is why. Last November I took a test in Financial Risk Management. This is a standard certification by GARP (Global Association of Risk Management) which is designed to show that holders of this certificate are knowledgeable enough to manage financial risks. It is not required to be certified in order to work in a field. I don't do risk management myself at my job, I just interact with risk managers a lot so I decided to take a test to be able to understand what they do and what they think. I didn't study well enough for this test and was worried I might not pass. Surprisingly when results came not only had I passed but I had also gotten top quartile scores in every category (they don't tell you exact score, just the quartile). So essentially I know risk management theory better than 75% of people. Most of these people work in banks. And many of them are involved in risk management. Of course they have some practical skills that I don't have. But never the less level of knowledge that people in this business have is very discouraging.

So it begins

2008-01-22T20:53:00.001-08:00

Today I have started my own mutual fund. Not the real one thoug. The "pretend" mutual fund on marketocracy. Unlike many traditional funds I don't want to limit my new fund to any specific style or sector or market.

The concept is a mix of strategic long-term investments in companies that I like on a level beyond financial ratios and an opportunistic value-base investement in out-of-favor companies.

On strategic side I choose companies where I buy the idea behind business and think that long term trens in economy, society and global politics work in favor for these companies. In addition I usually like this company products or services, their approach to customer service, business model, and brand portfolio. Sometimes I like all aspects listed above, but sometimes I just like one of the sides of the business or one of the aspects so much that I downplay the importance of others.

On value-based bargain hunting side of the book I look for cheap companies where I believe market is scared to much and beats down the stock below what I think it deserves based on business, finances and market outlook. I run a few fundamental screens to find my picks, or I just find some ideas in financial press.

Ideally I want to find a stock that falls into both categories. For example Starbucks and Wholefoods are 2 companies that I like. I would by both at higher prices that market offers today, but I love them even more when the price is right.

So today I opened my account on marketocracy, created a fund and placed a few trades. I haven't given much thought into this initial allocation as it tends to happen when you are given free million dollars. Especially when it's a million dollars that you can only invest in fake mutual fund and can't buy a real Ferray with. But since I am investing on my own, run some screens, and contemplate new investments and strategies almost daily I don't view this as a hasty decision. I will refine my portfolio as we go, given that so far it's still more than 60% in cache.

Initial portfolio constists of both stocks and ETFs since I don't want to micromanage my asset allocation and if I think some secotor is attractive I might choose to buy an ETF and pay a management fee rather than try to pick best stocks in the sector in which I am not an expert. Plus I get better deversification this way. I am not a Peter Lynch. I don't have time to manage 700 stocks portfolio.

Here are the main themes for todays batch of purchases.

Market is scared about the whole subprime mortgage situation. I agree that it's bad. Concievably very bad. But everybody knows that already. People in online forums discuss which local bank will collapse first and what happens to mortgate if bank goes belly-up. Those are regular people, mind you, not traders or portfolio managers. And my friends call me worried that a mutual fund they invest in for 401k might go bankrupt. And that's a big, diversified equity fund, not some leveraged CDO-buying, crazy-things-doing fund. So I think financials are priced cheaper than they deserve for the reason of fear. I am not saying that today is absolute bottom, but risk-revard looks atractive. So I bought Citigroup (C), Washington Mutual (WM), the old Freddy (FRE) and Fannie (FNM). I like citigroup mostly because it has the biggest of all banks share of it's income coming from outside of US. Some global play here. Plus it has been getting a lot of bad press lately. I always liked WM as a retail bank. Don't know much about them, just seemed cheap. I might be wrong here, and may look at WM deeper when I have time to read accounting data. As far as Freddy and Fanie go, these guys always had strict requirements for mortgages they buy. Plus they are government-backed, so they will get capital if they need it. And they will be first in line to get it given deep pokets of Fed and AAA rating. They posted losses primarily because they had to adjust loss reserves. But that was not a loss yet. Moreover if reserve adjustment was adequate it won't continue in next quarter. Plus both companies had all their earning-manipulation schenenigans sorted out back in 02-03. So at this price level I am buyer.
Companies that I like are Starbucks and Wholefoods. I am a devoted customer of both of them and I don't really agree that lack of refinancing money will cause consumers to switch to cheaper competitors. In my mind both these companies offer unique customer experience and it's not another place where you buy coffee or groceries. Not even same ballpark. Sure 7-11 offers coffee 3-4 times cheaper. But I won't go to 7-11 for coffee.
Few companies just poped up on my screen when I looked for cheap but well-managed companies based mostly on varios ratios and how they compare to peers in same industry. In this category I bought Nautilus (NLS), Mannatex (MTEX) and Sanderson Farms (SAFM). Nautilus was having all sorts of troubles lately and stock is really beaten down. They used to make nice excercise machines and ratios tell that they still do, and do it efficiently. I do not know anything about MTEX, but it was on the screen. Since I am not familiar with this company I allocated smaller portion of capital to it. Sanderson makes chiken meat. Personally I am vegetarian, but I think fast-food move to use more chicken vs. beef is still at large and company is much more efficient than it's peers in slaughtering birds.
Homebuilders. These guys are in a lot of trouble. And things might even get worse judging from what I hear. But everybody knows that. Builders are selling below book value. Here we must be cautios since book value is not a rock-solid thing for homebuilders. It's based on book value of land that they carry. And land can get cheaper. But never the less discount is big enough to convince me. It might be too early but I am prepared to increase position later. I bought DHI since it looked best on my previous research and in addition I bought homebuilders ETF - ITB. It looked better than 2 other ETF that claim to be homebuilders sector ETFs as well. It had mostly homebuilder companies while others had related first such as home depot as well. And in this strategy I want a pure builders play.
One of the big trends that I see is a return of a cold war. With Russia back in control of "iron hand" of current government and plenty of oil money in reservers it can start building weapons and flex muscles right and left. In addition to all middle-east situation it's reasonable to assume that US will maintain or expand military spending. Since I like airplains a lot I started my "cold war portfolio" with Boeing (BA) and Lockheed Martin (LMT). In addition to military contracts I like Boeing for it's comercial aircraft arm. Airbus is having trouble with A380 while boeing seem to be on track. And globalization leads to increasing number of routes and growing demand for planes. Once more Chineese enter middle class they would want to see Europe and it's a long way if you don't take a plane. In addition there is deregulation of trans-atlantic routes which might increase demand for jets from companies that would want to enter lucrative market of trans-atlantic flights.
As we know from economics 101 growth in GDP comes from growth in productivity. And growth in productivity comes from better technology. So technology is another sector that I like. I started simple with MSFT - it's the biggers research center on topic of computer science, it has most influential patent portfolio, everybody hates Microsoft while still using their products at home and at work, and they have money, smart people and experience to do things.
Another technology company that I like and that happen to trade at attractive prices is Seagate (STX). It makes hard drives. And I buy hard drives every year. And more than one. Hard drive is where I store my stuff. And every year there is more stuff. It used to be just text. Next came pictures. I take tons of pictures on my camera, and as camaras are getting better, pictures are getting bigger. Then there are videos. Those take even more space. In addition I don't want to loose my stuff, so I make redundant copies. That's even more hard drives. And hard drives are not only in computers anymore. Tivo has it. Soon they will be in cars. If you want to argue that nobody will store any data at home but rather will upload everything to google, well that's posible. But that only means that google will buy more hard drives. They can save a little on space by storing only one copy of "Star Wars" movie that you and I both bought, but my pictures are still different from yours.
Also I bought EBAY. Stock has been range-bound for ages and might stay that way for a while. It seem to have support at 25, but the main reason I bought it is that I think EBAY is unique company. You see, usually when new idea of how to use internet comes to mind of some young genious and gets implemented possibly making said geneous reach other less bright people immediately clone, extend or transform original idea and create dozens of knock-offs. Look at blogs or social networks for example. Online auction idea was geneous. But in addition ebay could pull it off on lage scale while nobody else seem to be able to do the same. Maybe only Amazon comes close and that's another internet company I like, it just seems too rich now.
Last but not least was just a random pile of companies I knew and followed for some time. I bought BNI because Buffet was buying late in summer and pice is still there. People tell me that given high price of gasoline railroads became very attractive form of transporation for goods. I tend to agree. Also I bough royale energy (ROYL). I personaly know their management and like them on personal level. Also I follow their exploration projects and am optimistic about current and future prospects. Stock has been trading cheap lately since company struggles to make any money, which is bad thing but for now I would bet small porition of my mutual fund that guys in charge will sort out the issues and show some profits in near future.

I'll try to continue managing my fund and will also try to keep posting updates on this blog. It is actually fun to write and I might enjoy it. I don't expect high turnover in my fund so and I will be mostly in a buying mode for now untill I get initial portfolio all built up. Rules of Marketocracy don't allow short sales (unless it's long only fund) so I'll stick to simple long-only equity investments here.