2008 Forecasts revisited

Via New York Magazine, comes this amusing collection of bad forecasts
for the 2008 year:

• Jon Birger, senior writer, Fortune Investors Guide 2008
Smart investors should buy [Merrill Lynch] stock before everyone
else comes to their senses.”
Merrill’s shares plummeted 77 percent.

• Elaine Garzarelli, president of Garzarelli Capital, Business
Week’s Investment Outlook 2008
Buy some of the most beaten-down stocks, including those of giant
financial institutions such as Lehman Brothers, Bear Stearns, and
Merrill Lynch.
As of January 1, none of these firms will still exist.

• Sarah Ketterer, CEO of Causeway Capital Management, Fortune
Investors Guide 2008
“Fannie Mae and Freddie Mac have been pummeled. Our stress-test
analysis indicates those stocks are at bargain basement prices.”
Fannie and Freddie had lost 90 percent of their value.

• Jon Birger, senior writer, in Fortune Investors Guide 2008
Our bet is that in a stormy market investors will gravitate
toward, GE, the ultimate blue chip.
GE’s stock price tumbled 55%, and it’s on the verge of losing its
triple-A credit rating.

• Archie MacAllaster, chairman of MacAllaster Pitfield MacKay in
Barron’s 2008 Roundtable
“Bank of America will [not cut its dividend], I think they’ll
raise it this year. My target price for the stock is $55.”
BofA share price now hovers around $14, and it has slashed its
dividend in half.

• James J. Cramer, “Future of Business” New York Magazine
“Goldman Sachs… finishes the year at $300 a share. Not a
prediction — an inevitability.”
Goldman Sachs’ share price was $78, and the firm announced its
first quarterly loss — $2.2 billion.

Yes, the 2008 investment guides were HILARIOUS — but what makes you
think the 2009 guides will be any different.

In defense of quants

Recently, I have been mulling over the consistent criticism I’ve heard of quant traders. It’s a big topic and one which I intend to continue exploring in these pages, but I decided I had to start at some point, so here goes…

For starters, let’s define the quant trader. The traditional view is someone who uses a formula to analyze price and time data (e.g. charts, technical indicators, volume, etc.) to make investment decisions. I’d like to work on changing that view. In my mind a quant trader is someone who uses strict rules to trade. Taking it one step further, a quant trader is someone who can define before a trade is ever made, what the criteria will be for making the trade. The quant trader is a process-oriented investors/trader (used interchangeably for the sake of our conversation here.) Here’s  an example, hit on 16 or lower, stay on 17 or higher. It’s a rule for the casino dealers. They know that they might win or lose on any given hand, but that the process for deciding whether to hit or stay is built on a solid foundation. Similarly in investing, if you base your investment decision on logical, tested factors, you cannot control the outcome of any given trade, but at least you can be confident in your expected return in the long term.

A guy runs through a dynamite factory with a lit match and comes out the other side alive and screams, “You see!” Just because he came out the other side alive, doesn’t mean he’s not an idiot. Success, then, cannot be the deciding factor. The deciding factor must be the decision making process BEFORE he ran through the factory. In order to determine which manager to choose, or whether an investment is a good one, the quant trader goes through the process of defining the criteria for success BEFORE a trade is made, not after. 

Recently, a friend who helps manage a long/short equity fund disputed my arguments. He believes that to generate alpha, the truly great investors are able to make judgments better than others. Alpha is generated by being able to get a “feel” for a management team’s prospects. Alpha is generated by being able to have more exposure to winners and minimizing losers through portfolio weightings. That might be true, I countered, but would you be able to know which one of those managers was great BEFORE they were great? I would rather not look for those managers. I countered that to judge a management team is important, but you have to determine the criteria beforehand and be consistent for all management teams. Then you can compare them. Then you can rank them. Then you can have a good process.

My preference is to look at that process. Do you have a repeatable process? Does your process have predictive value? I don’t care as much about historical performance, because chances are pretty high that there will be some speculator out there who did better. The great investors to me are the ones who have a definable process. Benjamin Graham had a three factor value model. Completely quantitative. Completely fundamental. Repeatable. High predictive value. Simple, just not easy to implement.

So when I hear people, investors, or some pension plan consultant criticizing quants, I have to question what they prefer. Maybe they should concentrate on their own process, and think of ways to measure themselves to reflect it. Was I consistent in my approach? Does my approach have predictive value to leading to good investment choices? Can I define my criteria before a trade? If so, can I measure that criteria and make good comparisons with all other investment choices? If they do that, if the incentive structure supports a process orientation, rather than a random results orientation, we would probably all be better off.

I.O.U.S.A

Hers a link to the 30min CLIP of I.O.U.S.A. Sobering stuff from Pete
Peterson and David Walker.

http://www.iousathemovie.com/

Oil Set for Rebound as Record Drop Spurs OPEC Cuts

These markets are manic but that still does not mean that I would
listen to the news to gain insight as to whats a good/bad investment.
That being said….OIL is most likely at the start of a bottoming
process.

By Grant Smith and Mark Shenk

Dec. 30 (Bloomberg) — Oil futures may rebound from their worst year
to average $60 a barrel next year as OPEC makes record production cuts
to counter the deepest economic slump since World War II.

The forecast, the median of 33 analysts compiled by Bloomberg,
represents a 50 percent gain from yesterday’s $40.02 closing price. A
14 percent reduction in supply, equal to 4.2 million barrels a day,
pledged by the Organization of Petroleum Exporting Countries will
erode U.S. crude inventories that rose 10 percent this year as the
slowing economy reduced world demand for the first time since 1983.

While oil tumbled from a record $147.27 in July consumers in the U.S.,
Japan and Germany faced their first simultaneous recessions in six
decades. The plunge risks curtailing investment in new rigs,
refineries and alternative energy sources, setting the stage for a
supply crunch later on.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a8g5N1x_fFjY&refer=home#

Bill Gary…interesting thoughts

Many economists and analysts compare the current recession
to those following the end of World War II. It is important to
note previous recessions were the result of Federal Reserve
tightening to reduce spending and/or to control inflation. The
current recession is not the result of Fed tightening… It is a
debt-liquidating recession. The Fed has pushed interest rates to
historic lows in an attempt to expand spending and inflation.
This recession is different than any experienced in the
post-war years. It was caused by an excessive buildup of
debt. The Treasury and Federal Reserve are attempting to
solve the excessive debt problem by expanding debt even
more. They hope to expand liquidity enough to offset the
overhang of old debt as well as stimulate demand to form new
debt creation. No one knows whether this grand experiment
will be successful or push our economy further into the abyss.
From what we can observe, the current debt overhang is
much too large to be neutralized in the near future. Some
investors are looking for signs the worst is over and hope to
take advantage of bargain level prices. This should provide
rallies in commodity markets from time to time. However,
debt destruction and liquidation should remain the dominant
market force for many months to come. Therefore, we see
little possibility of sustained price recoveries in commodities.

Newsletter of the year? Harry Schultz. Really.

Being right and making money…

I usually say that my selection method is highly scientific (I choose
whoever I feel like). And I have to say it particularly loudly this
year. Schultz was Letter of the Year in 2005. See Dec. 29, 2005 column,
which explains his nuanced gold-bug philosophy in more detail
But over the past 12 months through November, Schultz is down a
heart-stopping 76.05% by Hulbert Financial Digest count, vs. negative
36.68% for the dividend-reinvested Dow Jones Wilshire 5000.
This loss has wiped out Shultz’s strong post-2000 run, when he
benefited from the gold and commodities boom. Now, over the past 10
years, the HFD shows the letter achieving an annualized loss of
negative 8.73%, even worse than the negative 1.16% annualized loss for
the total return DJ-Wilshire 5000.

http://www.marketwatch.com/news/story/Newsletter-year-Harry-Schultz-Really/story.aspx?guid={03B23D71-21A4-4974-B442-ABE26C9DF2EA}

Look for a Rally — in Risk The Road Ahead by MacroMavens

Risk tolerance should be best felt in the NEED category. Think FOOD
WATER ENERGY.

Dec. 24: In the very near-term, there are a variety of reasons to
anticipate a rally in risk. First is the massive destruction witnessed
to date. Our dogmatic [insistence] that markets needed to give back
all the gains built on the housing-bubble lie has largely come to
pass. Virtually every market is at or near pre-bubble lows, from
stocks to bonds to commodities…[so] the financial deleveraging may
largely be complete. Most notably, yields on corporate credits have
climbed to multidecade (and in the case of junk, record) extremes. At
the same time, cash [must be] burning a hole in investors’ pockets
with 0% yields before inflation and dollar debasement. This is by
design. The Fed is taxing responsible behavior in a bid to prod
investors to get out and take risk….[and] the yield-pickup from cash
to corporate credit is substantially more alluring today! One would
think pension funds and others trying to fulfill 8%+ return mandates
in a 2% Treasury world would have no choice but to hold their noses
and get long risk.

– Stephanie Pomboy

Cash at 18-Year High Makes Stocks a Buy at Leuthold

Im long the fund…not doing any of us any good

By Eric Martin and Michael Tsang

Dec. 29 (Bloomberg) — There’s more cash available to buy shares than
at any time in almost two decades, a sign to some of the most
successful investors that equities will rebound after the worst year
for U.S. stocks since the Great Depression.

The $8.85 trillion held in cash, bank deposits and money- market funds
is equal to 74 percent of the market value of U.S. companies, the
highest ratio since 1990, according to Federal Reserve data compiled
by Leuthold Group and Bloomberg.

Leuthold, Invesco Aim Advisors Inc., Hennessy Advisors Inc. and
BlackRock Inc., which together oversee almost $1.7 trillion, say
that’s a sign the Standard & Poor’s 500 Index will rise after $1
trillion in credit losses sent the benchmark index for American
equities to the biggest annual drop since 1931. The eight previous
times that cash peaked compared with the market’s capitalization the
S&P 500 rose an average 24 percent in six months, data compiled by
Bloomberg show.

http://www.bloomberg.com/apps/news?pid=20601213&sid=ahP6Cp0P5m2k&refer=home

Potential Bubble for 2009

While 2008 is coming to a close and hopefully the “housing bubble” also comes to a close, I may suggest that another bubble is coming with all the bailout money and extreme risk aversion:

Treasury outperformance over Commodities – to be burst

Mish on Insurers

Annuity And Pension Time Bomb

I still have not seen a mainstream media discussion of one of the big
problems facing life insurers: guaranteed annuities. Many insurers
offer annuities that guarantee 6% or more. Many pension plan
assumptions are 8.5% or higher. The stock market is down 41%.

If I am correct, the S&P 500 is headed for 600, well over a 60%
decline peak to trough. This is happening right as boomers are
retiring and will be tapping those guarantees. Finally, the stock
market will not come roaring back to new highs wherever it bottoms.
For more discussion why, please see Peak Earnings.

Commodities as an asset class…

In their work, first published in 2004 (revised 2005) titled “Facts and Fantasies about Commodity Futures”, Gary Gorton, of Wharton School, and K. Geert Rouwenhorst, of Yale make an interesting case for commodities. From their abstract:

While the risk premium on commodity futures is essentially the same as equities, commodity futures returns are negatively correlated with equity returns and bond returns. The negative correlation between commodity futures and the other asset classes is due, in significant part, to different behavior over the business cycle. In addition, commodity futures are positively correlated with inflation, unexpected inflation, and changes in expected inflation.

Commodities as an investment pose a problem for traditional value investors. An investment can be analyzed by splitting into its components: income potential and capital appreciation. While traditional value investors necessarily focus on some sort of discounting of cash flow, liquidation value, etc. they (we? still undecided) might be doing themselves a disservice.

The question then becomes how to value the uncertain capital appreciation. Volatility models don’t seem to work quite right these days. This paper suggests that even without leverage, using an equally weighted portfolio could lead to an interesting investment opportunity. Coupled with the recent postings on Esterlings insights into the impact of starting inflation and valuation on stocks, it would be interesting to see the performance of this portfolio against the Y-curve proposed by Esterling. Then we’d be able to look at performance in inflationary, deflationary, and price-stability environments.

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=560042

Oil looks cheap, but investors are wary

By Jane Merriman – Analysis

LONDON (Reuters) – A flight into cash during the credit crisis has
helped drive oil and other commodity prices down so steeply that they
are a potential “buy” for pension funds with a longer view.

But timing is everything.

“People are sitting on cash — big lumps of it,” said Mark Mathias,
chief executive of commodity fund manager Quantum Asset Management.
“Everyone is worried about when to go back in. Long-term, oil is
cheap, but who knows where it goes in the short term.” Investors are
searching for evidence that could signal whether the global downturn
may be near to the bottom.

In these troubled times, the Baltic Freight Index has become a key
leading indicator of economic vitality.

“The Baltic Freight Index is the electro-cardiogram for the world
economy,” said Hilary Till, principal, Premia Capital Management.

The Baltic Exchange’s main sea freight index .BADI has risen over the
last 10 days, but prices to ship commodities are still near their
lowest in more than two decades.

Mexican Shoppers Go North, Seeking Bargains

Immigration and the kindness of strangers is going to be the best
route to get out of the US slowdown.

By JOHN DOUGHERTY

TUCSON — Mexican shoppers with fists full of cash and long Christmas
lists are pouring across the border into hotels, restaurants and
shopping malls here, providing an economic boost in a downward
spiraling economy.

The families, mostly middle- and upper-income, are traveling hundreds
of miles to take advantage of a much wider selection of products at
substantially lower prices than can be found in their hometowns in the
Mexican states of Sonora and Sinaloa — even after the recent 30
percent devaluation of the Mexican peso against the dollar.

For many, it is a long journey by car that includes multiple searches
at Mexican police roadblocks, followed by a huge traffic jam at the
border crossing in Nogales, where delays of two hours or longer to
enter the United States are common. But even with the exasperation,
Mexican shoppers said it was still worth making the trip.

http://www.nytimes.com/2008/12/24/business/24border.html?_r=1&sq=mexico&st=cse&scp=5&pagewanted=print

Gas Producers’ Club, Based on OPEC, Will Have Doha Headquarters

A new version of OPEC?

By Lucian Kim and Stephen Bierman

Dec. 24 (Bloomberg) — Russia, Iran and other countries controlling
the world’s biggest natural-gas reserves agreed to coordinate
forecasts, investments and relations with consumers to defend their
market interests amid volatile energy prices.

The 15-member Gas Exporting Countries Forum, which adopted a charter
in Moscow yesterday, will locate the headquarters of its new
secretariat in Doha, Qatar, the biggest source for world liquefied
natural gas shipments. LNG may eventually form the basis for more
global gas trading.

Western consumer countries have warned against a “gas OPEC” modeled
after the Organization of Petroleum Exporting Countries. Producers
will face a challenge shaping the market, where 70 percent of gas is
still sent by pipeline to regional consumers and no global benchmark
price exists on an exchange.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aOAM5carRJt8&refer=home

Russia’s Central Bank Devalues Ruble for Third Time in Week

It would seem that Russia is going to NEED to do something quickly in
order to boost the price of OIL.

Dec. 24 (Bloomberg) — Russia devalued the ruble for the third time in
a week, sending the currency to its lowest level against the dollar
since January 2006, as oil’s drop below $39 a barrel dimmed the
outlook for growth.

The ruble, down 18 percent against the dollar since the beginning of
August, weakened 0.9 percent against the U.S. currency to 28.6862 and
1.4 percent versus the euro to 40.1539, near an all-time low.

The central bank allowed the ruble to fall about 1 percent against a
basket of dollars and euros, accelerating the slide after spending 27
percent of reserves, or $162.7 billion, trying to defend the currency
over four months. Oil, Russia’s biggest export earner, lost 4.7
percent on the New York Mercantile Exchange and is down nearly 75
percent since the July high. The government requires oil to average
$70 to balance its 2009 budget.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a61UnlEMIH1c&refer=home