Stock Exchange: Can Humans Compete with High Frequency Traders?

Many individual investors have been frustrated by the growing prominence of High Frequency Trading. Complicated algorithms can process new information and react in fractions of a second. It sounds intimidating, and in some sense, it is. Individual Investors would be poorly suited for direct competition.

Instead, stick to what the market is giving you. The connections made by these programs are often spurious – totally unrelated to the fundamentals of a given business. This is intentional. After all, they’re after a quick buck rather than a long-term investment.

For that reason, a stock being walloped for frivolous story in the 24-hour news cycle may present an attractive buying opportunity. It all comes down to the individual investor’s process and commitment to their goals.

To help give us perspective this week, we’re bringing in earnings expert Brian Gilmartin. Since 1995, Brian has managed Trinity Asset Management. You can find his regular writings on Fundamentalis.

This Week—Holmes sniffs out a deal

It can be tempting to make a trading decision based on a glance at its recent chart. Unfortunately, a stock that has underperformed in recent days might be providing a big opportunity. Holmes uses a mix of advanced trading techniques and technical analysis to avoid significant drawdowns. When he chases after a down stock, it’s because he sees some serious upside. Let’s see what he’s up to this week:


Holmes: This week I’m buying  Jack-in-the-Box (Jack) a restaurant chain in the U.S. (95.98).

It’s not easy finding stocks that fit the exact criteria I’m looking for. I try to find stocks that have been trending higher, then have broken down below that trend, and have started to base a for reasonable period of time.

This gives me a good entry with limited downside risk and upside gains that may get back to the previous levels before the most recent debacle. I like risk/reward ratios of 2:1 or better.  With Jack, my downside is 93.70(Stop), my upside is 106, risking $2.28 to make $10.02. Woof Woof!

Brian: a comp miss sent the stock down to its 200-day moving average after February ’17 comp’s for JACK as the industry that the “low-end” consumer has taken a breather. Forward earnings and revenue estimates are a little weaker following the February ’17 miss, but JACK is trading at 20(x) expected ’17 earnings for expected 17% growth. Even if EPS growth slips to 15% or even low teens the stock is cheap on a PEG (P.E to growth) basis.

Holmes: Glad to hear you approve! Jeff is usually a bit harsher.

Brian: It’s not a bad pick, depending on how long you’re holding onto this one.

Holmes: My usual target is about 4-6 weeks, though I wouldn’t hesitate to unload this if another downturn became apparent.

Brian: Solid reasoning – for a talking dog, at least…


Oscar: My big pick this week is the China Large-Cap ETF (FXI).

We’re in the midst of March Madness, so let’s call this pick a rebound. Not in the classic sense: that’s better suited for FXI’s behavior through early January.

Still, I made this my pick on 2/9 and hung with it for a couple of weeks. Now that we’ve seen another drop, I’m ready to jump off the bleachers and get back in the game.

Brian: BRIC’s and Emerging Markets have traded well since the bottom in Q1 ’16. FXI is the safer asset class in a crowded China ETF market. As someone who was never a fan of China as a strategic or even tactical asset allocation recipient, Emerging Market ETF’s might be a better risk / reward. The ETF is scraping along its 200-day moving average.

Oscar: So, you like this one too?

Brian: I’ve always thought China was like playing the US stock market in the late 1800’s – it is the Wild Wild West of outcomes, as a Communist country tries to centrally plan a free-market economy.

Oscar: It’s a risk I’m willing to take!



Continental Resources (CLR) is my next long position.

The decline here has been sustained and significant, which I find attractive. At $43.22, there is definitely potential for the stock to improve near previous highs above the $55 mark. I could hang onto this one for months.

Brian: Continental took a beating on Wednesday as crude oil fell 5%. The Energy sector is a battleground sector as crude gyrates around $50 per barrel and CLR is leveraged to the price of crude. The stock is oversold and trading below its 200-day moving average.

Felix: I agree the stock is oversold, but I don’t like the sound of that “battleground.” How do I know when I’ve hit a proper valuation here?

Brian: Tell me what crude oil will do and you can figure out what CLR will do.

Felix: Uh oh.


Athena: I understand my methods are often met with skepticism. That’s why I like to pause now and then and reflect on some small successes. Let’s review my recent foray into Advanced Micro Devices (AMD).

I recommended this stock back on 2/9/17, just after a huge spike in price. Put lightly, this was not my most-loved pick. That was fine by me. Because I had the right time frame in mind, I was able to collect a tidy sum and close out this position near the end of the month.

Brian: A semiconductor company that was a serial capital destroyer for most of its life and long an “also-ran” to Intel, AMD had an impressive string of “earnings beats” and raises in 2016. On the other hand, the valuation is stretched with the Street looking for $0.07 and $0.26 thus AMD is trading at 50(x) next year’s earnings.

Athena: Would you say something like this might be due for another pop in the near future? How hot is this trend?

Brian: The semiconductor space looks good both technically and fundamentally, and AMD is a resurgent laggard in the space.

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert or stock.


If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).


The growing establishment of High Frequency Trading algorithms has changed the investment landscape. However, that doesn’t spell doom for the individual investor. Overreactions to trivial matters, like a POTUS tweet, can actually create bargain opportunities. Keep these ideas in mind:

  • Do not compete directly by trying to react more quickly to news.
  • Find a method that differs in time frame.
  • Do not use stops that become limit orders.  A random move can take you out of a position at a poor price.
  • If possible, use the HFT algorithms to your advantage.  If a stock is solid, consider buying dips by having some standing buy orders.

Take what the market is giving you.

2016 in Review: Best of the Silver Bullet Awards Part One

Since the earliest days of A Dash of Insight, Jeff has brought attention to journalists and bloggers who dispel myths in financial media. We congratulate these writers with the Silver Bullet Award – named in honor of the Lone Ranger, who lived by a strict code: “…that all things change but truth, and that truth alone, lives on forever.”

In a year rife with misinformation and disinformation, it is fitting that we gave out a record 23 Silver Bullet Awards in 2016. For that reason, we’ll be doing this year in two parts; our winners for the first half of the year are summarized below. Readers may also want to check into our 20132014, and 2015 compilations, as many of the same issues persist to this day.

Have any thoughts or predictions on what will dominate news cycles in 2017? Know of a great analyst flying below our radar? Feel free to post in the comments with any suggestions or nominations.


It didn’t take long to find our first Silver Bullet winner of 2016. Matt Busigin took on US Recession Callers ahead of the ISM data release:

Through a combination of quackery, charlatanism, and inadequate utilisation of mathematics, callers for US recession in 2016 are embarrassing themselves. Again.

The most prominent reason for recession calling may well be the Institute of Supply Management’s Manufacturing Purchasing Manager Index. The problem with this recession forecasting methodology is that it doesn’t work.

As we now know, the US economy did not slip into a recession in 2016 – lending further credence to Busigin’s critique of these methods.


Paul Hickey of Bespoke Investment earned the second Silver Bullet award of 2016. While others were content to see doom and gloom in the level of margin debt on the NYSE, Hickey dismissed this as a minor concern.

Although declining margin levels are often cited as a bearish signal for the market, Hickey believes that it is a small concern given the indicator’s coincidental nature. On the other hand, the prospect of rising rates spooks investors much more, and holds them back from buying stocks.

“Margin debt rises when the market rises and falls when the market falls,” Hickey said. “If you look at the S&P 500’s average returns after periods when margin debt falls 10 percent from a record high, the forward returns aren’t much different than the overall returns for all periods.”


The causation-correlation fallacy is a favorite of ours on A Dash. Robert Novy-Marx distinguished himself with an excellent paper titled “Predicting anomaly performance with politics, the weather, global warming, sunspots, and the stars.”

“This paper shows that several interesting variables appear to have power predicting the performance of some of the best known anomalies. Standard predictive regressions fail to reject the hypothesis that the party of the US President, the weather in Manhattan, global warming, El Niño, sunspots, or the conjunctions of the planets are significantly related to anomaly performance. These results are striking and surprising. In fact, some readers might be inclined to reject some of this paper’s conclusions solely on the grounds of plausibility.”

We often note how bloggers and media search back to find tedious explanations and tie a day together. For more reading, we recommend our old post “The Costly Craving for Explanations.”


“Davidson,” by way of Todd Sullivan, was recognized for writing on the confusion of nominal and real data on Retain and Food Service Sales. His key takeaway:

Retail and Food Service Sales are at the highest levels ever measured and trending higher. Would you believe that today’s pace is more than 35% higher than our last recovery. Comments in the media would lead you to believe otherwise. Perhaps you have heard a number of recession forecasts. I have heard at least a dozen well known investors say a recession will occur before this year is out. My view differs considerably and remains very positive.


Jacob Wolinsky found it suspicious that Harry Dent was predicting the next big crash – and happened to have just the product to help investors cope. This “Rounded Top” chart had started to make its way across the panicky world of financial media:

The whole of Wolinsky’s article is still worth a read (especially given its twist ending).


The economic impact of lower oil prices in early 2016 was surprising to many observers. We recognized Professor Tim Duy for his research on the economic impact of lower oil prices.

This problem, however, just scratches the surface. Look at either of the first two charts above and two red flags should leap off the screen. The first is the different scales, often used to overemphasize the strength of a correlation. The second is the short time span, often used to disguise the lack of any real long term relationship (I hope I remember these two points the next time I am inclined to post such a chart).

Consider a time span that encompassed the entirety of the 5-year, 5-year forward inflation expectations:


If we spent a little time looking for the newest conspiracy theory about the Federal Reserve, we could probably give out the Silver Bullet every week. Ethan Harris of Bank of America Merril Lynch (via Business Insider) got this week’s award for shutting down a new “theory” about central banks and the dollar.

“There is a much simpler explanation for all of this. Central banks have turned more dovish because they are being hurt by common shocks: slower global growth and a risk-off trade in global capital markets,” he argued.

“Hence it is in the individual interest of the ECB to stimulate credit and bank lending, the BOJ to push interest rates into negative territory and the Fed to move more cautiously in hiking rates,” he continued.

Some may also point out that there’s a gap between Yellen’s recent messages and some of the recent speeches from FOMC members.

But Harris has thoughts on this, too:

  1. Yellen has consistently leaned more dovish than others.
  2. Most of those more hawkish speeches were from nonvoting members.


The mythology surrounding the Fed bled over into the next week as well. We gave Steven Saville a Silver Bullet award for targeting ZeroHedge with this very thorough rebuttal:

A post at ZeroHedge (ZH) on 8th April discusses an 11th April Fed meeting as if it were an important and unusual event. According to the ZH post:

With everyone’s focus sharply attuned on anything to do with the Fed’s rate hike policy, many will probably wonder why yesterday the Fed announced that this coming Monday, April 11, the Fed will hold a closed meeting “under expedited procedures” during which the Board of Governors will review and determine advance and discount rates charged by the Fed banks.

As a reminder, the last time the Fed held such a meeting was on November 21, less than a month before it launched its first rate hike in years.

As explained at the TSI Blog last November in response to a similar ZH post, these “expedited, closed” Fed meetings happen with monotonous regularity. For example, there were 5 in March, 4 in February and 5 in January. Furthermore, ZH’s statement that 21 November was the last time the Fed held such a meeting to “review and determine advance and discount rates charged by the Fed banks” is an outright falsehood. The fact is that a meeting for this purpose happens at least once per month. For example, there were 2 such meetings in March and 1 in February.


During the economic recovery following the Great Recession, critics often argued that net job creation emphasized part-time and low-paying jobs. Jeffry Bartash of MarketWatch thought to look at the data, and concluded the US economy is still creating well-paid jobs. The key takeaway is in the following chart:


Breaking down mean averages can produce some strange results, and you can never be sure how financial bloggers might spin that data. We gave a Silver Bullet award to Jeff Reeves for breaking down this baffling valuation of Tesla.

$620,000 for every car it delivered last year, or $63,000 for every car it hopes to produce in 2020.

By comparison, General Motors Co’s (GM.N) $48 billion market value is equivalent to about $4,800 for every vehicle it sold last year.

Reeves’ full article, still available on MarketWatch, is still very smart and very readable.


The “flattening” yield curve had become the newest scare issue by late May. Barron’s Gene Epstein and Bonddad’s New Deal Democrat both took this to task, with satisfying results. In particular, the latter’s article had a solid mix of compelling charts with snappy writing:

In the last week or so there have been a spate of articles – from the usual Doomer sources but also from some semi-respectable sites like Business Insider vans an investment adviser or two ,see here (… ) – to the effect that the yield curve is flattening and OMG RECESSION!!! Here’s a typical Doomer graph – that draws a trend line that ignores the 1970s and neglects to mention that 2 of the 4 inversions even within the time specified don’t fit:


We gave this week’s award to the former President of the Minneapolis Fed, Narayana Kocherlakota. As conspiracy theories persisted, he explained the nature of Fed meetings and their timing:

Timing alone, though, hardly merits so much attention. To understand why, consider two possible scenarios. In one, the Fed starts raising rates in June and then adds another quarter percentage point at every second policy-making meeting (once every three months) for the next three years. In the other, the Fed waits until the second half of 2017 and then adds a quarter percentage point at each of the next 12 meetings. The second path represents slightly easier monetary policy, but most economic models would suggest that there would be almost no difference in the effect on employment or inflation.


New Deal Democrat earned a second Silver Bullet award for his work debunking a notoriously deceptive chart:

“The problem with this graph is that includes two slightly to significantly lagging indicators.  Your employer doesn’t start paying withholding taxes until after you are hired.  State tax receipts aren’t paid until a month or a quarter after the spending or other taxable event has occurred.  Worse, since both have seasonality, both have to be measured on a YoY basis, which means the turn in the data will come after the actual turn in the economy.”

Conclusion – Part One

As always, you can feel free to contact us with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you’ll find them here. Expect to see Part Two of our Silver Bullet review later on in the week. Happy New Year!

Things I Don’t Care About — And Neither Should You!!

One of the biggest challenges for investors is filtering out bad, useless, or even costly “information.”  I have a method for screening out the noise and using my time more effectively.  Part of it is keeping the TV on mute and using TIVO to check out anything that is really significant.  You can also just skip articles that obviously do not meet the test.

Here is a good starting list of what to ignore.  Feel free to suggest additions.

  • The Hindenburg Omen – or any other method using BO (i.e. backtested overfitting) and failing the smell test.
  • Commentary from people who are famous for being famous – their websites confuse media appearances with credentials.
  • Tobin’s Q – a great idea fifty years ago, but not relevant for modern companies.
  • Bond guys opinions about stocks – don’t ask your barber if you need a haircut (Warren Buffett)
  • Stock guys opinions about bonds – see above.
  • PMI data lacking multiple business cycles – you have to start somewhere, but we do not need to believe it.
  • Recession predictions from some “expert” who cooked up a model last week – too few cases, too many variables.

You can save many hours and also avoid some bad decisions by rejecting this useless and harmful noise.

Expensive Misconceptions

The investment world abounds with research reports.  Intelligent and educated people generally benefit from careful study and accrued knowledge.

While it seems unfair, the investment world is different.  A little knowledge can be a dangerous thing!

There are many examples of this.  I have been stalled on this important topic because I was trying to do a comprehensive analysis.  It is often better to just get started!  I will start  with some of the most egregious and costly temptations for consumers of financial information.  I welcome more nominations to the list.  This is a great topic for us all to share ideas.

Shifting Indicators

This happens when the “rules” for interpreting data change to fit the per-conceived conclusion.  One recent example by bears related to the divergence of small cap stocks.  When the Russell 2K stocks were leading, the market was “frothy.”  When they lagged, it was a warning divergence.

Other indicators like sentiment, the Baltic Dry Index, Hindenburg omens, etc. are cited only when they fit.

Bullish analysts do the same.  If the monthly report does not fit the story, just look at non-seasonally adjusted data. year-over-year, or something else.  Many reports are susceptible to various spins.  The only solution for this is to know the agenda of the source.  This is rarely provided.

A persuasive chart

Please consider this chart, which is offered weekly as evidence that long-term investors have little to gain in the next decade while facing a lot of risk.


I have a simple question for you:  Could you step up in front of a group of people and explain this chart?  If not, why do you believe it?  A smart and influential guy presents something that you cannot really evaluate.  Why is this a sound basis for your decisions?

It is unchallenged because of the lack of peer review in the investment world.  It is challenging to explain the errors, partly because so few could appreciate the arguments.

A plausible story

So many investment arguments depend upon simple analogies that are immediately convincing.  The frog in the pot story (even though it is not true) is one example.  These are stories that enable us to imagine an outcome without any real data.

  • Stall speed for the economy.  Graphic but wrong.  Economic expansions generally do not stall out, despite the intuitive appeal.
  • The aged bull market.  This is another argument that appeals to intuition but has no supporting evidence.  Whenever there is a streak that exceeds normal history — a hitter in baseball, a basketball team winning many games in a row — there is a temptation to say that this must be ending soon.  In fact, a winning team or player is actually just as likely to continue the streak.  Bull markets and economic cycles that have longer-than-average length are no more likely to end soon. (Nice survival analysis from SF Fed).

Your intuition and the confident-sounding talking heads are both wrong.  It is plausible spin.  You can take a profitable contrarian position by betting on further economic recovery.

The insightful investor fights spin with data and analysis.


2013 in Review: Best of the “Silver Bullet” Awards

ResizedRegular readers of my WTWA series know that I occasionally give the Silver Bullet Award.  This recognizes writers who take it upon themselves to debunk dangerously misleading financial analysis. Their often thankless work reminds me of the Lone Ranger, whose adventures often upheld the notion that "…that all things change but truth, and that truth alone, lives on forever."

Over the course of the past year, I included a Silver Bullet segment in my weekly post only a dozen times. As 2013 draws to a close, it seems fitting to revisit these highlights.  Each is an important story that you might have missed.

April 21: Mike Konczal reveals key Rogoff and Reinhart errors

It is a long-standing position of mine that financial bloggers have a responsibility to put academic findings into a real-world context for our readers. This is precisely what Mike Konczal did when he broke the story about a celebrated academic study on the relationship between debt to GDP ratios and the rate of growth.

The authors, Rogoff and Reinhart, found that "median growth rates for countries with public debt of 90 percent of GDP are roughly one percent lower than otherwise; average ( mean) growth rates are several percent lower." While financial media had a tendency to portray this result as a consensus within the field, Konczal popularized a competing report that cast doubt on Roff and Reinhart's conclusions. Herndon, Ash, and Pollin – the authors of the new report – found a number of errors within the original study's methodology, concluding for themselves that "relationship between public debt and GDP growth varies significantly by time period and country…[therefore] the evidence we review contradicts Reinhart and Rogoff's claim."

May 5: Doug Short exposes a distorted ZeroHedge chart of real income

 Zero Hedge reappears consistently as the source of many misleading financial "news." Doug Short earned a special mention after he thoroughly deconstructed an erroneous chart back in May. As I wrote at the time:

As usual, whoever was writing as "Tyler Durden" did not give a link to the alleged David Rosenberg comment, so we do not know if it is accurate. I get frequent questions from readers about ZH analyses and conclusions. The stories usually combine a smidgen of real data with severe distortion. This makes them difficult to refute, especially when the story appeals to the preconceptions of most readers.

The latest installment takes a single month of real income, distorted by anticipated tax changes, multiplies the result by 12 to "annualize" and make it seem bigger, and then go for the scare. Doug exposes this methodically and carefully. Most readers will not want to consider the full refutation – and that is what "Tyler" counts on.

May 11: Joe Taxpayer busts comparison of the S&P in 2012 to the Nasdaq in 1999

Josh Brown initially brought Joe Taxpayer's refutation of this bogus chart to my attention.


Joe explains: " …the move from 1250 to near 1600 on the S&P is about 28%. In comparison, the Nasdaq move took it from about 1500 to 4500, a 200% increase. You can easily take any move in the market and with a bit of manipulation, create a chart as you see above. The key in this case is the two different scales,  the S&P on the left, Nasdaq on the right. Had the charts been produced using the same scale, they’d show no resemblance to each other."

August 4: Bob Dieli sets the record straight on part-time employment

 Bob Dieli won the Silver Bullet award over the summer with a timely reminder on the correlation-causation fallacy. His analysis is now publicly available here, and below are my reactions at the time.

There is a deceptive theme about employment, disparaging the quality of the net jobs created. Some of the writers have obvious political motivations or enjoy reputations as leaders of the tin hat movement. What is alarming is that the theme has gained credibility with some mainstream pundits who spend too much time on the wrong websites. Egregiously bad was the John Mauldin article citing Charles Gave's analysis. Not only is this wrong on the part-time employment issue, it blames everything on QE. I tweet infrequently, but I managed a 140 character response to this one:

To Charles Gave and John Mauldin: Blaming QE for the trend toward part-time employment is like blaming the firemen for the fire.#causation

August 17: Dave Altig tackles the link between employment and low paying jobs

 A big thanks to Dave Altig for taking on the alleged link between employment and low paying jobs. As I wrote in August:

[Dave's] creative use of charts and data reveals the truth about employment and low-paying jobs. There is a recurring theme that recent job creation has emphasized the worst jobs. Dave started with a recent WSJ story that captured mainstream thinking. I cannot possibly do justice to this post in a few words. There is a fascinating animated gif that shows wage changes by sector over time, so check out the full article.

Meanwhile, the following chart illustrates one of the themes: The changes are part of a long trend, not a post-recession effect.


September 1: Derek Thompson calls attention to a key error in stats on youth residency

 At the time, major financial media sources were abuzz with stories of how 1/3 of young adults were forced to live at home due to a tepid economic recovery. Derek Thompson saw past the gloom of doom and pointed out that college dorm rooms counted as "home" for the purposes of the study. Thompson writes:

It comes down to a very sneaky definition of "home." In the Current Population Survey that provides these figures, "college students in dormitories are counted as living in the parental home." Dormitories! This might strike you as absurd — and it certainly strikes me as questionable – but it's Labor Day Weekend, and I'm not going to waste it fighting with the folks at CPS, so there it is. Dorms = your parents' place, according to the government.

This is a huge deal for the Millennials-living-at-home figures, because college enrollment increased significantly during the recession — 39% of 18- to 24-year-olds were enrolled in college in 2012, compared with from 35% in 2007 — and college enrollees are much more likely to be living at home (er, in dorms) than students who skip college, drop out, or finish early.

October 19: Cullen Roche debunks "The Biggest Scam in Human History"

 As a clever cartoon video on the evils of fiat currency made its way around financial circles, Cullen Roche was one of the few people patient enough to provide a blow-by-blow refutation. Roche's full article is well worth reading, but here is a small excerpt:

…[the cartoon character] defines money in a very peculiar way so that it doesn’t include anything that doesn’t serve as a store of value.  According to his definition money is a store of value, medium of exchange, unit of account, portable, durable, divisible and fungible.  He then claims that gold fits this definition.  But gold doesn’t fit this definition!  First off, you can hardly use gold to buy anything in the real economy.  Try going into Wal-Mart with a bar of gold.  They’ll tell you to piss off.  Better yet, try transporting all your gold around with you where ever you go.  Gold doesn’t even fit his own definition.  In fact, it fails almost completely in money’s most important function – as a medium of exchange.

Of course, most of our dollars don’t serve as a good store of value.  In fact, holding paper currency or even bank deposits is a pretty dreadful way to try to maintain your purchasing power.  Does that mean bank deposits and paper currency are not money?  Of course not.

November 3: Stephen Suttmeier and Barry Ritholtz on margin debt

Stephen Suttmeier and Barry Ritholtz earned their Silver Bullet Award by addressing the idea that current margin debt levels indicate a market top. This had been on my agenda for some time, so I thought it warranted to a more thorough evaluation:

I have looked carefully at the charts and the variation seems largely coincident, with margin levels sometimes leading and sometimes following…

Merrill's Suttmeier includes the margin debt rate of change as an indicator of whether a rising market is peaking or breaking out. Barry notes, "If the rate of change data somehow corresponds to past shifts in secular markets from bears to bulls, this is potentially a very significant factor."

This analysis is much more sophisticated than what you usually see on this topic. I would love to see more research here, but this provides some needed balance. Here is a summary chart of the basic relationship, but I recommend reading the entire post.

Margin debt

November 16: David Merkel and Tom Brakke on the risks investors face on the quest for yield

David Merkel took on the subject of leveraged, closed-end municipal bond funds at the end of September. In combination with Tom Brakke's creative use of charts, it should be abundantly clear to individual investors what the risks are at play. I highlighted his conclusion in my post:

Big yields (especially tax-free ones) are so alluring and so dangerous.  Most investors can't parse the risks and, frankly, many of those purporting to provide guidance aren't going to bother to educate them.

Big yields

November 23: Dan Greenhaus adds essential context to a chart by Andrew Wilkinson

This Silver Bullet award was likely the most complicated one of the year. For the sake of clarity, I have embedded the relevant segment from my Weighing the Week Ahead post below:

Dan Greenhaus of BTIG debunked the chart below and was featured by Joe Weisenthal. Greenhaus wrote as follows:

Indeed, we recently devoted an entire conference speech to pushing back on the idea of an equity bubble. How do we know the story remains? The chart below, overlaying the S&P 500 today against equities in the 20s/30s is now starting to make the rounds. Without getting too personal, "chart overlaying" is lazy and this is no less so. But it does remind us that as much as everyone thinks everyone else is "all bulled up," these views still persist and have shown no indication they are going away any time soon.


This was good work, exposing a typical bogus chart, but there was much more to the story.

It turns out that the original source was Andrew Wilkinson of Miller Tabak. He did the work to normalize the data, generating equal percentage changes. The result is a chart that is a fair comparison of the two periods. Business Insider also covered this story, in a nice post by Steven Perlberg and Andy Kiersz. Here is the comparison chart from Wilkinson's original piece:


The entire story illustrates one of the drawbacks of modern social media. People take something out of context and pass it around. The average person sees the message at face value.

This may be our most complicated "Silver Bullet" story, but I found it fascinating. There was a lot of good work. Sadly, my guess is that most recipients of the bogus chart never saw the refutation.

December 28: Paul Krugman and John Lounsbury on whether a debt "trigger point" exists

Most recently, John Lounsbury spent some time during the holidays to look over some old Paul Krugman papers. I explained to readers the imporance of keeping your politics and your investments separate, and John brought the point home with a couple key charts. 

I know that many readers just tune out anything from Krugman, but this is poor practice for investors. One of the key stories of the year has been the austerity debate and the flawed work of Rogoff and Reinhart – still continually cited by those who think you are uninformed. A key question is whether there is a debt "trigger point" that causes a decline in economic growth. Once again, I care as an investor, not as a voter – despite the politically charge that has been applied to the issue. So here are the facts in two charts.

The first shows the relationship with Japan as an outlier.


The second shows the members of the EU with a different marker.


See John's post for the full explanation about why it helps to have your own currency.



As always, you can feel free to contact me with recommendations for future Silver Bullet prize winners at any time. Whenever someone takes interest in defending a thankless but essential cause, we hope you'll find them here.  Have a Happy New Year and a profitable 2014.

Who gets the jobs story wrong? Everyone!

Tomorrow morning we will have the monthly ritual:  The Employment Situation Report.

Here are the main steps (rinse, lather, repeat).

  1. A stellar cast will be assembled to pontificate for a couple of hours on CNBC and Bloomberg.
  2. Leading economists and bloggers will quickly give reactions that will be instantly posted in MSM summaries.
  3. Alan Abelson (with help from assorted perma-bear sources) will explain in Barron's on Saturday why the world is about to end — second only to Harold Camping.

What you should know, but will not hear

Why do we care about employment data?  Two reasons.

  1. Understanding the current economy.
  2. Figuring out how to fix it.

Understanding the past is crucial for good policy decisions.  The President and Congressional leaders should be paying attention, but there is no evidence that they are.

Failures of Understanding

There is a list of topics that are repeated monthly mistakes by the assembled jobs punditry:

  • Focus on net job creation.  This is the most important.  The big story is the teeming stew of job gains and losses.  It is never mentioned on employment Friday.  The US economy creates over 7 million jobs every quarter.
  • Failure to recognize sampling error.  The payroll number has a confidence interval of +/- 105K jobs.  The household survey is +/- 450K jobs.  We take small deviations from expectations too seriously — far too seriously.
  • False emphasis on "the internals."  Pundits pontificate on various sub-categories of the report, assuming laser-like accuracy.  In fact, the sampling error (not to mention revisions and non-sampling error) in these categories is huge.
  • Negative spin on the BLS methods.  There is a routine monthly question about how many payroll jobs were added by the BLS birth/death adjustment.  This is a propaganda war that seems to have ended years ago with a huge bearish spin.  For anyone who really wants to know, the BLS methods have been under-estimating new job creation.   Who could have known?

As one who has lived in both the academic and trader worlds, I understand the tension.  One good thing about the academic process is openness and peer review.  Most of the Wall Street commentary skates by without any criticism.

With this in mind, check tomorrow's employment summary.  I'll bet that none of the sources mention the crucial points I highlighted above.

Failures of Prescription

If the only issue was mistakes by all of the leading media sources, the indvidual investor could celebrate.  It would provide yet another opportunity for us to gain an edge.  The problem is that investors are also citizens, and we demand and need effective leadership.

If leaders do not understand what is happening, how can they get policy proposals right?  A key question is whether policymakers should go for a macro solution or do targeted programs.  I plan to take this up in more detail, so today's analysis is really only a preview.

Regular readers know that I have enjoyed the intellectual stimulation from the Kauffman Conference of Leading Economic Bloggers.  Kauffman does a quarterly survey of these bloggers and the results are quite helpful.

General topics that have been covered repeatedly include support for immigration and free trade.  Nearly all economists are on board with these ideas, despite the popular objections.  Readers who think the economists are dead wrong should compare their own current views about Greece and a possible referendum.

Turning to specific ideas, the most recent Kauffman poll raised a number of questions, summarized in this table.


I am particularly interested in the XL pipeline question.  This raises a classic issue of absolute regulation versus marginal economic calculations.  I have participated in these debates for decades — scientists versus economists — and I freely confess my  bias.  I do not like absolute rules.  A typical question happened when an economist thought of an area as a "basin" where there was a reasonable tolerance limit at low cost.  The scientists idea of reasonable cost was "zero."

I emphasize that "A Dash" is not a political blog.  I endorse an agnostic approach, where we can make profits no matter which party is in power.  Having said this, I am astounded by the current Obama policy.  Promoting job creation should include reducing excessive regulation.

I am disappointed that The Kudlow Report once again missed the main stories on job creation, but they did a good job tonight on the pipeline.  Take a look.


If any of the  big-time sources cover the missing elements I have described, feel free to prove me wrong in the comments!

Past References

Inside the Obama Plan

Errors on job creation

Perhaps my best prior article on this theme

And a little fun….

The Kauffman bloggers were invited to write their thoughts in the form of a haiku.  I failed to organize readers of "A Dash" in support of my effort, but it would not have mattered.  Maybe I'll be more imaginative next time.  Here was my entry:

Jobs are needed now

Austerity is ill-timed

Action is required

Here are the top four choices.  I'll bet you can all pick the winner!



A Consumer Guide to Investment Forecasting

If you are an investor, you cannot escape forecasting.

Those who criticize predictions are guilty of an obvious blunder.  If you are making investment decisions, your conclusions — and the hidden assumptions and reasoning — depend on forecasts.

So don't kid yourself.  You are a consumer of forecasts made by others.  These predictions influence your investment decisions in dramatic ways.  Suppose, for example, you have decided to sell all of your stocks.  Josh Brown explains why this is a mistake:

When you go to 100% cash, something changes in your mind.  You get to this place where mentally you won't be satisfied unless you pick the perfect entry point.  It's harder to do some buying at 100% cash than it is at 75% cash or 50% cash – at least then you're "adding to positions" rather than taking a stand from scratch.  Price will drive you crazy without an existing position or average cost to anchor you, whether it's higher or lower than the current quote.

Do not depend on this single quote from a fine article.  I urge you to read the entire piece.  The concept of avoiding extremes may be the single best way to improve your investment performance.

The first step in this process is realizing the most important fact:  Like it or not, you are a consumer of investment forecasts.

Putting a finer point on this, you are probably terrible at evaluating these predictions.   When you go to buy a car or a refrigerator, you do some real work.  How much effort do you make when evaluating investment forecasters?

Avoiding Bad Pundits and Gurus

In a very fine article on the general topic of pundit reviews (once again, well worth reading in full), Scott Anthony's Harvard Business Review Article recommends Four Strategy Gurus to Avoid.  There is a lot of worthwhile nuance, but here is the quote that you will find to be most useful:

 The opiner. Michael Mauboussin, the Chief Investment Strategist at Legg Mason Capital, eloquently describes how the key thing to evaluate when looking at equity investors isn't what they buy but how they choose what to buy. In other words, ask "What models do they use to make decisions? What process do they follow to gather data?" The same holds true for pundits. Offering opinions without explaining underlying assumptions or mental models isn't helpful. The real world is complicated and any prediction ought to at least spell out the assumptions that would have to be true for a prediction to hold. Wrong predictions based on well-reasoned (at the time) assumptions are useful because they help strategists develop their own instincts for assessing future technologies.


What to Evaluate

With all of this in mind, here is my summary of how to evaluate forecasters:

  1. Is the forecaster an expert in the subject at hand?
  2. Does the forecaster have a track record?
  3. What model is being used?
  4. What assumptions have been made?

 If major media outlets actually applied these tests, there would be a crisis!  They would have no content!

Major Arenas of Forecasting

Here are the most important issues.  If you knew the answers to these questions, you could make big profits from your predictions.

  1. Will there be a recession in the next year?  This means a specific definition with a time frame.  No BS.
  2. What is the forecast for corporate earnings in the next year?  Be specific.
  3. Will the European governments successfully contain their debt problems?
  4. Will the Supercommittee reach a conclusion that will be enacted into law?

Investment Conclusion

Regular readers of "A Dash" know that I am working on all of these fronts.  The average investor has been bombarded with negative news on economic headwinds, the economy, Europe, recession odds, and plenty of politically-charged commentary.

My own take is that the ill-informed punditry is too negative.  Most of the popular pundits fail all of the tests we recommend. This is good news — very good news — since it suggests an extreme in market valuation.  It helps to explain why stocks like Microsoft can trade at six times next year's cash flow.

I have written past pieces on all of these specific topics, but today it is important to pull it all together.  I plan more specific analyses of each of the major arenas.


While I read many sources, I have a special reliance on Abnormal Returns.  When I am on the road for a few days (as I was last week) I know how to make sure that I am completely in touch with the market.  This story was inspired by links from AR.  People should realize the synergy in the blogosphere.  Excellent curation of financial stories stimulates new stories.

[long MSFT]

Finding the Best Information about Europe

Every day US equity investors awaken and check futures trading and the latest news from Europe.  What might seem like small tidbits of information have major effects on the total market cap for US stocks.  It may not make sense, but it is the reality.

In this environment, it is important to ask:  Whom do you trust?

The answer is more elusive than we might think.

The chief candidates are the following:

  • The market
  • Political leaders
  • Bank executives
  • Leading analysts, pundits, and bloggers
  • Rumors

Maybe I missed something, but that should get us started.

This morning's market action showed the problem.  Mark Gongloff's prolific blogging at the WSJ kept you on top of the twists and turns.  The market rallied on early comments from Treasury Secretary Geithner offering a guarantee against a Lehman-like event in Europe.  There was then selling because of a report that Austria had rejected expansion of the EFSF.  Then we had a rebound when it was only a delay.

Get ready for months of this, as the 17 different legislatures consider the EFSF, the ECB deliberates, the IMF ponders, the G7 and G20 consider….. well, you get the idea.

If you are a long-term investor, the volatility represents Mr. Market offering you a chance for good prices — assuming that you are not in the end of the world camp.

If you have a shorter time horizon, or have genuine worries about the financial system, you need to know whom to trust.

My Handicapping

Here are a few thoughts on each of the sources you might consider.

  • Markets.  Should we accept the verdict of the market on Europe — the high credit default swap rates, etc?  Is Greece definitely going to default?  Here is the dilemma.  Everyone pointing to the market as the ultimate source on this is a liar!  If you asked them if they believed markets were efficient, they would say "no."  Otherwise they would have no job.  All of us get edge by finding market mistakes.  So pointing to the markets on this one occasion is hypocritical, self-serving and inaccurate.  It is confirmation bias in action.  Furthermore, I believe (but cannot prove) that the CDS market on European sovereigns and banks is relatively thin in relationship to what some can make by shorting the banks.  This is not like 2008.  We do not have an AIG selling CDS instruments with no collateral, so the price can be driven up more readily.  Then you email David Faber to make sure that he reports the bad news.
  • Political Leaders.  Should we accept the statements of political leaders? We all know that they are trying to maintain confidence.  We also know that there are no guarantees.  When the Geithner news came out this morning, CNBC reported from both Rick Santelli and Bob Pisani — veteran floor observers.  No one on either floor believed Geithner!  Here is the dilemma.  We all know that it pays to be contrarian.  Maybe everyone is too skeptical.  The collective memory of the Street is sketchy and simple.  For proof, do you really know what Bernanke said when he talked about subprime being "contained?"  If you do, you are one in a thousand.  Most people just accept the Wall Street Truthiness.  When it comes to this subject, no one is a contrarian. It is "smart" to dis the politicians.
  • Bank Executives.  In 2008 we saw a number of statements from executives that proved to be inaccurate.  They could have been lying, mistaken, or inaccurate in their expectations about upcoming behavior.  Most of them did not see the collapse of short-term lending and the aggressive impact of FASB 157.  Is there a lesson?  What I do is to listen carefully — very carefully — for specifics.  I consider the overall exposure to dubious lending, the acknowledged level of markdowns, and the reliance on short-term fund sources.  Most traders reject corporate executives because they have "learned the lesson of 2008."  This is a gross oversimplification.  There is a legitimate concern that this is a crisis of confidence, so we need to evaluate each statement on the merits.
  • Pundits.  Hooray!  Here is our chance to shine.  Anyone who can parse the information and avoid a knee-jerk reaction adds value.
  • Rumors.  Forget them!  Enough said.


Most traders and pundits are wrong about Europe because they are over-weighting markets and under-weighting information from political leaders.  This is not black and white, but it is a dark shade of gray.

I expect that there will be some European solution that will drag out, displease many, and consist of a patchwork of plans.  My trader friends think in simple heuristics and binary solutions, so they will not see this coming.  It is a classic wall of worry, playing out over months.

Since I mostly focus on US equities, I have a second line of defense.  There is really no evidence of a US risk, other than the fact that stocks have declined.

Investment Implications

The most aggressive play would be European banks, but this does not fit my risk/reward criteria.  You can get plenty of leverage on this situation with US stocks, especially financials and those perceived to have European exposure.

I hold JPM and MSFT, as two good examples.

Political Power: Who Makes the Call?

Last week saw the FASB proposals for some modest adjustments in the mark-to-market rules.  We were on the road for a campus guest lecture, trying to do a little giving back.

The coverage of this was amazing.  Seeking Alpha had a block of stories, all Editors' Choices. They all were very opinionated and critical about the decision.  Apparently Seeking Alpha could not find anyone who thought it was a good decision, since there were no Editors' Choices in support.  Bloomberg and other MSM sources bemoaned the "political pressure" on FASB.

These commentators all need to go back to school.  We have so many blogging economists now.  Why can't we get some help from some blogging political scientists or public policy types?

There is no subject where the gap between the self-perception of knowledge and the actual understanding is so great.

Let us try some examples.

How Experience and Education Colors Advice

Let us take a problem like environmental policy.  Let us further suppose that you had our job, teaching young people about these issues.  Your team included an economist, a scientist, and you.

Would it surprise you to learn that the economist favored a free-market solution with minimal regulation?

Would it surprise you to learn that the scientist thought that all pollution was bad?

The public policy problem is one of reconciling competing viewpoints and finding outcomes that generate something good for society.  (Defining this is difficult, so books are written about it.  Defining the public interest is beyond our scope.  For the moment, let us just accept that there is a  broad public interest, and it would be good to find it.)

On the environment, the solution might be a recognition that driving pollution to zero is too costly.  We might recognize that some firms can improve more readily than others.  The trading of "pollution rights" was an idea from the 70's and we are still debating it now.

Please note well that there is no criticism of either the economist or the scientist.  They are very intelligent and have great knowledge.  They are smarter and know more than most of those pundits evaluating their comments.  They are good!  The problem is that they see the world through their own experience.

We need a broader viewpoint.

Let's try another example, one that is familiar in the decision-making literature – the Cuban Missile Crisis.  Briefly put, the US discovered that the Russians were building missile bases 90 miles from our shore.  It was a challenge that could not be ignored.

A team of advisors presented information and options to President John F. Kennedy.  For those of us who are old enough to remember, this event was the closest we came to nuclear war.  It was important.

(An aside — Art Cashin uses this as a training story, since he was then a rookie trader.  The question was how to trade the crisis.  The answer was to buy, since if it was not solved, trading longs would not matter!)

The Air Force advisors recommended a "surgical air strike."  Further evaluation showed that the strike might not be as precise as hoped.

The Army thought that an invasion of Cuba was called for.

The Navy recommended a blockade, preventing further delivery of missiles and material.

The State Department sought a political solution.  They thought that the Russians were bargaining about Berlin.  They suggested that we might give up our Turkish missile bases, something that was no longer really relevant for US strategy.

Political advisors thought that a quid-pro-quo in Turkey would be a sign of weakness.  If we did this, it should be through a back channel.

Please note that all of these advisors were very intelligent and had great knowledge.  They were all good — very good!

The public policy problem was to reconcile the differing advice.  The actual decision — a "moving blockade" giving Khrushchev time to respond and to allow the back channel to work –is hailed as an example of excellent Presidential decision making.  We did not go to war, and the missile bases were removed.

Implications for FASB

So what does this have to do with the Financial Accounting Standards Board (FASB) and the mark-to-market decision?

The first thing to understand is that the SEC, which has the decision about where to vest accounting rules and oversees FASB, is not a branch of government, like the Supreme Court.  It is an Independent Regulatory Commission.  There is insulation from normal politics, since it is not wise for routine politics to govern accounting rules.  The SEC must have at least two members from each party in a five-member commission.  The President has the power to appoint, but not to fire members.  There is significant insulation from routine politics, but it is not like the Supreme Court.

The Problem

The mission of FASB is accounting.  The intelligent and expert members of this group make very good decisions, but they look at the world from the perspective of accountants.  They want to force companies to reveal information to investors.  It is their mission, and they do it well.

The current problem is that FASB instituted FAS 157 at the worst possible time.  It was a new rule and probably a good one.  The implementation of this rule led many accountants to take the most conservative view of assets held by financial institutions.  While the rule provided some flexibility in implementation, most accounting firms in the post-Enron era chose a conservative course.  Many had the government-dictated death of Arthur Andersen and the loss of accumulated partnership interests at the forefront of their thinking.  Why take such a risk?

Meanwhile, the problem was much broader than the accounting question.  The new rules might have been implemented quite safely a few years ago.  Accountants could learn the rule and also the exceptions.

Instead, the implementation came at the worse possible time.  The forced write downs of assets contributed (did not cause, but contributed) to a death spiral.  Capital was subtracted from firms faster than the government could add TARP money.  Private capital was frightened away by the threat of further write downs.

Some misguided pundits and bank analysts have seized upon the continuing losses as evidence that they were right.  In fact, the rules were designed to make them right.  Had the rules been addressed in a timely fashion, the death spiral might have been stopped.

Enter Congress

Many in Congress noted that there was a wider public interest, something extending beyond the strict notion of accounting rules.

Congress, as part of the original TARP legislation, mandated a study of these rules within 90 days.  Former SEC Chair Christopher Cox and company conducted the study.  There was plenty of evidence, including some from us.  The Cox group made a finding, just before the door hit them on the way out.  Their conclusion was that the FAS 157 rules were not that important for bank failures.  This conclusion, an official finding by the SEC, is rightly viewed as biased by many of us.  It is nevertheless cited by many in supporting the current rules.

Unhappy with this outcome, a sub-committee of the House Financial Services Committee held hearings and expressed some displeasure.  There was some tough questioning of SEC and FASB leaders.

Is this political pressure?  Of course.  It is a completely appropriate exercise of Congressional oversight, warning FASB that thei
r viewpoint was too narrow for the circumstances.

There is absolutely nothing wrong with this Congressional action.  There was not even any legislation — just some nudging in a public hearing.  This is precisely what Congress should do — focusing attention on the broad public interest.

The Outcome

The result of this political "pressure" was a very modest tweak to the FAS 157 interpretation, much less than many thought was needed.

The pundit reaction to this has not been accurate.  Various opponents of change claim that FASB caved in to political pressure.  This is an easy story for journalists to write and for pundits to criticize.  None of them exhibit any understanding of how the American political system works.  They are writing to a receptive audience, which shares their pre-conceptions about how government should work.

We are still awaiting the actual new guidance from FASB, but it seems to be pretty tame.

The delay in addressing this issue has been a failure of the political system, which moves slowly and must deal with those in power.  Had the issue been raised eariler, or if the crisis had come later, the outcome might have been quite different.


We have had many emails from accountants.  Please note what we are not saying. Accountants are  intelligent and serving their mission.  Like the Air Force in the Cuban Missile Crisis they are good — very good!

The problem is that their perspective is too narrow.  We need rules that provide information to investors without crippling the US economy.  Since concern about declines in regulatory capital is not their defined mission, they do not make it part of their decision.

FASB is not elected by anyone.  FASB should not run the economy.  That is what we mistakenly allowed to happen.

Market Curiosities

So many issues — so little time.  Let us try a few quick takes on some current issues.

Selling the GE News.  We watched with some wonder as selling ensued on the basis of a the announcement by S&P of a negative outlook for GE's triple A bond rating, perhaps in two years.  Surely the issue was widely known, as is Jeff Immelt's determination to avoid this outcome.  If investors doubt his plan, why wait until the S&P announcement?

Additionally, when did everyone suddenly decide that the ratings agencies "got game."  At one moment they are the villains of the CDO fiasco, but now they know better.  Were we alone in this reaction?  No, we see that the astute team at Bespoke Investment Group is on the story.

Bush Delay on Auto Companies.  When the Senate failed to pass legislation to help the auto companies last week, there was some interesting bargaining and speculation.  The measure had majority support, but a procedural vote brought to the floor by Majority Leader Reid showed that the votes were not there to block a filibuster.  In the aftermath, there was widespread speculation that conservative Republicans held firm because they "knew" that President Bush would come to the rescue.  Others speculated that the UAW held the line because they had the same tip.

In short, the parties did not want to negotiate a solution in haste, preferring to sit around a table with a few months to reach a solution.  Now that everyone sees the effect on car sales (see Calculated Risk on Chrysler) and the Bush delay, we wonder if there are any second thoughts.  We still expect action, but it not have the form expected by the parties last week.

Gaius Marius is on this case, discussing the problems with the bankruptcy alternative.

Our take.  The government role should be to create the right incentives for the needed bargaining and let the parties work it out.  This means a firm deadline and some guidelines, but not a dictated solution.  Sen. Corker seemed to be making some headway on this.  The goal should be to achieve the restructuring without the stigma.

Warren Buffett.  In our introduction of the concept of Wall Street Truthiness we noted recent criticism of The Oracle of Omaha, including suggestions that he has "lost it."  Regular readers know our preference for the long term and real data versus an incident or two.  Mebane Faber has a great analysis of the Buffett record, including data and simulation tools.  The results had some surprises, even for those of us who are Buffett fans.

Fed Policy Moves.  It took less than twenty-four hours before the punditry decided that the Fed moves were going to be inflationary — or ineffective — or both.  This pattern of market reaction has been typical for months.  Policies that take many months to implement and get traction are declared worthless in the absence of instant results.  Many of those leading the critics, including the CNBC "devil's advocates" do not have much background or expertise on the subject.

Why not look to someone who has both the knowledge and experience?  Readers should consider Bob McTeer's viewpoint.  He has been a practical voice of reason for many months.  Since he is a courteous man, and not a loud and fast talker, he seems to get shouted down on these programs where they put up six or eight talking heads at a time.

Our Take.  There will be time to move from fighting deflation to fighting inflation.  Readers who are not familiar with the importance of the velocity of money should bone up.  You are going to be hearing a lot about the concept.