HOW DO WE RECONCILE ALL THE OPTIMISM IN THE FACE OF DIRE ECONOMICS WOES

Currently the world financial markets are undergoing a remarkable spike in positive sentiment, with many of the most vocal bears becoming reformed bulls.

The question the bearish camp are probably asking, and I am one of them is, “what happened?” “did I miss something?” To add fuel to this burning stock market rocket the earning season has begun with a Watusi and Asian Economies are suddenly showing statistical signs of economic life.

 

So let’s try and understand whether the bears have it wrong and the worst is over, or are we just going through a phase in the bear cycle. I was having a cup of coffee a short while ago, and I thought the following analogy may explain some the more recent bullish behaviour. But before I begin I must add I have been working for months on a hypothesis that time perceptions create a kurtosis in the symmetry of the zero sum gain certain market theories support and lies at the heart of my analogy.

 

After looking for a home for more than 6 months Brad finally finds his dream home for his beautiful and large family. Brad and Angelina are keen to step things up a bit from their existing 8 bedroom home and their interest lies in a 10 bedroom mansion overlooking the Sydney Harbour bridge in prestigious Point Piper. Brad realises that he will need to step it up a bit to meet the monthly mortgage repayments as this is a whole new league with a hefty price tag of $30 million.

 

After gorgeous Angelina has called all her friends to tell them about her new home and the beautiful parties she will be having for the crew, Brad sits down to do some hard financial analysis. Actually Brad is not a numbers guy so he calls Abie his trusted accountant and says, “Abie come on over, we need to go over some figures.” Unfortunately for Abie it wasn’t the kind of figures he was hoping for as Brad had been told by the government to cool it with his extra-curricula activities.

 

The picture starts becoming clearer, Brad is good for $20m and he will need to borrow $10m which at the current interest rate means he will need to repay $50,000 per month for the new home. Brad is a resourceful kind a guy and although he isn’t working right now he is sure he can make it all happen. The day for settling the purchase of the new house looms, and Brad is feeling the heat. No it isn’t the Sydney moist summer heat, it is the heat from the bank over how he is going to pay them back every month when he is in semi-retirement. To add to his financial woes Brad still needs to come up with the $20m down payment, and he is having difficulty laying his hands on it. Not because he doesn’t have it but because a lot of it is tied up in investments that have stiff penalties should he wish to exit early.

 

Brad is starting to wonder why he got himself into all this stress as he was renting a most beautiful apartment on the North side of the bridge and he was sitting on a pile of cash in the bank. As quickly as he thinks about his reasoning he sees the beautiful Angelina and the 5 kids and he knows he has made the right choice. After a couple more weeks of hectic administration Brad and Angelina pick up the keys to their beautiful home having settled the purchase price to a former investment banker who has now had to sell his house to pay for his margin calls on the stocks he had been buying without telling his wife.

 

Brad has been cautious on advice from Abie and he has stashed a quarter of a million dollars in an account to cover the mortgage repayments for the next 5 months. It is all happy days in the Brad and Angelina household, the parties start rolling and before long all the socialites in the Brad and Angelina circle are having function after function at this most magnificent address, even Brad has forgotten about the stress that he had encountered in making this dream happen. It is simply happy days and Brad is very forcefully shutting out of his mind the fact that 4 months have elapsed and that with all the entertaining and jet-setting the cash resources in the household were fast depleting. A further concern was that many of Brad’s investments in other assets which he had hoped to live off for a while if not until he died were starting to turn sour.

 

In essence Brad now owned a house for $30m but could be worth closer to $25m as he was an eager buyer and pushed hard for the deal to happen, and the market had suddenly changed. His other investments were not worth what he thought they were and his cash flow was looking extremely anaemic. This story of Brad and Angelina continues in cycles of fear, resentment, hope, anger, joy, etc, for the life of their ownership until they have either paid the house off in full, or to an affordable level, or sold it and downgraded to something they can afford.

 

I believe this story is symbolic of the current financial crisis. Just like Brad secured a 5 month kitty, he was then able to dismiss the dire state of his finances and proceeded along normally, actually very happily. It wasn’t a lie, for Brad the reality was all was well over those 5 months, he wasn’t thinking beyond so his reality was positive. Again things took another bad turn for him he was able to dig deep and come up with a nice little deal that bought him another 2 years, and so the cycle continued. Yes the bears have painted a bleak picture and yes the economy and the world financial markets stare down an abyss of horrible consequences, but Brad and his counterpart society at large are resourceful and resilient and will continue to fight hard for their investment.

 

As bears we need to accept that in terms of our perception of reality which incorporates the entire picture which may take 10 years to fully unfold, there will be many periods of lucky deals that provide grease for the machine to continue ticking over and the system to appear sound. We need to roll with these waves of emotions and be ever vigilant to the fact that maybe just maybe this will be the one time that Brad either goes to the banks and says here are the keys or in facts sells it for half its purchase price.  

 

The forces driving our financial markets are groups of people and corporations each with their own perception of time. Some people involved with investments assess them hourly, daily, weekly, monthly, quarterly, yearly, etc; it is through the disequilibrium of these perceptions of time preference that cycles form into a reality that is diffuse from the underlying fundamentals, but is reflective of the overwhelming time preference of the dominating society at that particular point of overlap.

 

I look forward to making this all seem a lot clearer by setting it our more robustly in an algebraic statement.

 

Michael

 

 

FW: JUST SPOTTED THIS TODAY

 

By chance I came across this today, I found it quite interesting and leads on to my current thinking.

Mike

 

posted by americade on Tuesday 14 Jul 2009 21:58 BST

Peter J. de Marigny, DITMo Strategies / AMERICADE (14July09)

deMarigny: Classical Statistics, The NEW Paradigm

Any student of classical statistics knows better than to discard observations in a data series that are not outliers. For instance, to a clasical statistician "Sortino" is an abhorrent measure.

However, in physics there is a law large things (like Relativity) and small things (like Quantum Mechanics). In a macro form there is meaninglessness. In a micro form there are patterns that has recently given rise to the use of "FRACTALS." So as not to turn this into a technical mathematics and physics lesson, let's just focus on the idea of a "data series" that is the central focus of risk and portfolio measurement.

Professor Nassim Taleb is the author of "The Black Swan," a book about the likeliness of outliers though represented as improbable. There is no paradigm for the prediction of these events. In a prior short article on Albourne Village I proposed that using Parametrics to predict Black Swans is like using Carbon Dating on the geological record. Non-parametrics is better applied, but there is another consideration that relates to a "data series" to predict Black Swans. I noticed that this is connected to the psychological theory called "The Hundredth Monkey Phenomenon" made popular by author Kenneth Keyes. But what is the underlying paradigm that gives rise to the idea of how trends start from nowhere, and when a Black Swan event happens?

I propose that a data series is NOT a data series at all, but that applying ideas from Quantum Mechanics (the law of small things where order is observed) we recognize characteristics hidden from the macro view of the entire data series.

I believe that in each observation there is its own data series of which it is a part. All of our statistical tools try to make sense out of the interconnection of these observations of a data series (i.e. GARCH models, etc). What is the individual observation itself is the result of its own data series so that a data series (such as a return stream from payoffs) is not an input of an independent variable in some statistical model, but is composed of the interconnection of sub-data series? That is, an observation of a data series is not part of any data series but is a data series unto itself with its own parametric and non-parametric characteristics.

If we view observations as a representation of its own data series rather than an instance in a macro data series we would have a completely different view of parametrics, Modern Portfolio Theory, and Total Quality Management that uses classical statistics as its underpinning.

Peter J. de Marigny / DITMo Strategies / AMERICADE

 

FW: The future...

 

 

From: Michael Berman [mailto:micksonmatch@gmail.com]
Sent: Thursday, 16 July 2009 10:16 AM
To: 'Dani Peer'
Subject: RE: The future...

 

Hi Fonz,

 

We are loving the new house.

 

I have like the Elliott guys been expecting the market to climb on higher, my error in judgement was that I thought there would be a steeper pullback before we went higher. I am more convinced than ever that Fundamentals and Sentiment are 2 separate beasts or maybe more correctly the causality link is the reverse of what is commonly believed. That is the sentiment ultimately fashions the fundamentals.

 

Looking at sentiment and fundamentals as 2 separate entities for now, I think fundamentals are very slow moving metrics but they are reactive not causative, always reacting to changes in sentiment. Sentiment on the other hand contains this inner charge of its own energy and it tends to be shorter in its cycles but it contains within it deeper levels or layers. What we are experiencing is the cycle of sentiment whereby there is a need for hope and this has caused the sentiment to improve despite the economic fundamentals.

 

The causative link is only as strong as the underlying conviction of the sentiment. Hope tends to be a very weak emotion and usually ends in disappointment. I think were we may have been at fault isn’t being too pessimistic it is perhaps being too rigid in our beliefs and not accepting that the market is an expression of many peoples emotions and therefore requires more intuitive understanding.

 

I am currently working with a mathematician in the US a freelancer on the markets imbedded memory. I started with this line of thinking a number of years ago, and Charis, Ebrahim and myself collaborated on a paper whereby we were able to prove that data is “sticky” and contains traces of memory, i.e.   more recent data has a greater significance than older data, this is what drives those feedback loops which cause markets to behave irrationally to what we would expect. I maintain there is a way to predict these patters on a probabilistic basis, this incorporates the Elliott Wave Principle and a few quantitative overlays.

 

I edge closer to the grail but I believe there is an element of evolution to all these understandings which means that 1 model will not fit all circumstances. Anyway that is my thinking currently.

 

Mickson

 

From: Dani Peer [mailto:dpeer@bigpond.net.au]
Sent: Thursday, 16 July 2009 8:44 AM
To: Michael Berman
Subject: The future...

 

Hello Mickson...

 

I hope that you are enjoying your new home. Don't rush to finalise everything at once. That's your mother's style. Just take it as it comes. There's always lots to do.

 

I must say that I am surprised with the market's behaviour over the last week. From what I understood, the engine was much more damaged. There's still quite a few toxic debt instruments to step up, more unemployment in the pipeline and a very underpowered consumer - the backbone of Western GDP. However, the mood seems upbeat and there's much talk of emerging from the crisis and better days ahead.

 

Have you and I been too pessimistic? How do you account for such optimism at a time of such fundamental headwinds? Am keen to hear your thoughts.

 

Fonz

 

 

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