Trend Analysis

When you do analysis, depending on the data used the results have some degree of objectivity. For example, if you have a population of rats and feed them large quantities of a substance and have another population that has the same diet except for the particular substance, variation between the two populations may be related to the presence or absence of that substance. The more you can eliminate other potential causes of variation, such as genetics and environment, the results increase in value. However, even in a controlled experiment, the potential for some unknown factor to enter the experiment that normally you need to prove the results are repeatable, meaning that someone performing he same analysis halfway around the world would get the same results.

Now when you have analysis performed in an area where variables cannot be controlled the reliability of the results is questionable. For example, you often hear free market advocates talk about how a free market is the best way to promote growth and prosperity. Of course, it is hard to prove this experimentally so they use logic and examples. Now, the United States with something of a free market economy did better than the Soviet Union under communism. This may have been because of the economic systems or any of a million other differences between those two countries. Certainly I have no way of proving the free market economy of the United States was not a significant influence in the outcome, I just can't prove it one way or the other.

Now, consider some of the analysis you hear about financial trends. There are so many different factors influencing most industries that even if you successfully spot a trend, it is impossible to know for certain that there is not some countervailing trend you haven't spotted. Of course, if you can accurately predict that smart phones are taking more and more market share and therefore manufacturers of smart phones and smart phone components should do well, you also have to factor in how much they are losing if they currently manufacture dumb phones and if the phone they come out with is going to be popular or successfully promoted. The i-Phone was a phenomenal success and the Palm Pre and Palm Pixi weren't. I have read many reviews where the Palm products were considered technically better than the Apple phone but one took off with the right amount of hype and growing market share and one didn't.

Of course after the fact you see analysis as to what happened, and sometimes this post mortem seems perfectly logical, however, that is after the fact and somewhat irrelevant to most investors. Consider the events that happened today and the impact they had on the market. First China's announcement concerning the Yuan led to a higher start as this was perceived as another indication that the economic recovery was continuing and that foreign products would become more affordable in China. This trend held the market up for a while and then we had the assault on the banks as first one analyst said that a double dip in the housing market was a certainty and another analyst said that the financial reform bill would be a disaster for the banks. Further, we found out China was holding more gold than previously thought. Each of these factoids and analysis had some impact on the market and by late afternoon, the earlier increases had been erased and the overall market was slightly down. Of course the afternoon sell off may have nothing to do with the negative comments, it could simply be a combination of fund managers taking some profits and others seeing a trend develop, jumping aboard.

In fact, the one thing that is certain is that no trend goes unobserved. Once a sell off becomes clear, selling becomes the thing to do. You can always buy the stock back cheaper after it goes down some. If you are shorting the market, a sell off is a cause for jubilation. In fact, one thing you can count on is that on days with late day drops, there will be a bounce near the close as some traders get out of positions to avoid overnight risk.

Of course that trend analysis has very little real validity.

Victimology

To be honest I didn't have the patience to listen to the President all the way through last night. The things said at events such as that have little to do with what ultimately happens. Now for some reason, it tends to go over well to hear tough talk at times like this. I simply would like to see a solution. This was a horrendous event, and while BP may very well have ignored risks that ended up causing it, they clearly didn't want it to happen. That brings us to the question of competence and/or negligence.

In making decisions we all have to decide the proper line between cost and safety. Certain threats always exist but are so remote that for us to take preventive action would make us, well odd. For example, we all take are exposed to many potential contagious opportunities in a given day. Sometimes we actually get infected. Most of the time we don't. Most of the time the contagions are relatively minor and we recover. Sometimes they are major and sometimes fatal. However, we all hopefully take some preventive actions, such as washing our hands, but if you end up wearing surgical masks and gloves at all times, you are, in the opinion of most people, overreacting.

It should always be remembered that when you look at risk from the point of view of the victim, it always seems much worse than it really was. The victim is a victim and the risk potential has become real. If the victim's chances were only 1 in a million to start, well now it is 100%. So of course when you see a show that interviews victims it seems pretty dire. Of course if you only interviewed non-victims, it would represent reality better but be pretty boring.

Despite all the things we see in the news every day, generally most of us avoid being victims the vast majority of the time. Now, I don't know how much the oil in the gulf is going to hurt the economies of those states. I actually think that the amount of income generated through recovery efforts and victim compensation may well exceed the income lost. Of course in addition there is the environmental damage, but cleaning that up will also create a lot of jobs and income. Will the income go to the people who were the actual victims? I don't know, but as bad as it seems, I would be willing to bet that, from a purely economic point of view, more money will be generated than is being lost. Of course we see habitat destruction and other impacts and it surely is sad but nature has a way of healing itself over time. Getting the spilled oil out of the water is a challenge that can be met once the flow into the gulf can be stopped.

This is mostly rambling and there are victims from the oil spill (remember 11 died) and there will be others. However, if you can't fish, but get compensated, I'm not sure that makes you a victim.

 

 

Looking for Risk

There is the old saying that only two things in life are certain, death and taxes. Actually some people manage to avoid the second quite well so maybe there is only one thing actually certain. Everything else has a degree of risk. Somehow humanity has struggled along and in fact I think it is safe to say that most people are better off than their ancestors were. All of this was accompanied by risk.

In today's economy we are recovering from a significant risk event, triggered by the sub-prime mortgage situation. Now when you look at that situation many of these mortgages were clearly not justifiable except in a scenario where prices climbed forever. Once prices stabilized and started to fall, as they had to eventually, the sub-prime people were doomed. Further, that collapse had all sorts of repercussions as the instruments designed to mitigate risk started to pay off and the companies that had to pay couldn't.

Now had the issuers of the subprime mortgages not been able to package and sell them raising money to issue more that they packaged and sold, etc. etc., the subprime mess would have been contained. Of course for a certain period of time this activity led to increased economic activity in construction, furnishings, appliances, well just about everything as houses were built, sold and provisioned.

But what was probably the most interesting part of the whole crisis for many investors, was that a few people made extraordinary amounts of money. Now you can make money in a good market, sort of the old fashioned way, relatively slowly and over time. However in a collapse you can make a whole lot of money in a very short time. This is quite appealing to many who now are constantly looking for the next big collapse so they can short it.

Now, identifying this risk is not very rewarding unless you can convince everyone else the risk is real and maybe even cause a panic. The European debt crisis looked ripe and did cause a decline but without actual defaults it didn't attain the level required to really cash in. If you trade instruments that require defaults by Greece, Spain, Portugal, they go up and down in value until the actual default happens. Those looking to really cash in will hold hoping that like a lottery ticket they become the next big winner, and the next legendary trader.

Mostly this won't happen since those types of panics are relatively rare and those who hold these instruments will probably hold them too long since cashing them in before the default seems like throwing away the golden goose.

Liquidity

Liquidity in the marketplace is a justification you hear about a number of behaviors that might not otherwise be justifiable. For example, someone buys a stock hoping or thinking it will go up, and then that stock is borrowed by a short seller who sells it trying to drive it down, it is OK because it adds liquidity to the market. Of course then there are the high frequency traders who have computers make trades that net very small profits individually but because of the volume they make a lot of money. This has nothing to do with investing since most of the action is computer driven based on pre programmed scenarios. However, they add liquidity to the market.

What exactly is the value of this liquidity? Well, it is nice to know that if you want to buy or sell just about any stock, your order can be executed any instantly when the limit you place is reached. However, is that really that important? Generally you would think publicly traded stocks would reach price points in a marketplace without the need for additional liquidity.

Recently we have seen France and Germany come out against short selling. I have discussed short selling before and no matter how I look at it, it seems designed to provide Wall Street insiders a way to gamble and manipulate the market. Now, it is a simple math problem. Increase the number of shares you can sell without increasing the total number of shares will correspondingly increase supply and unless demand already exceeded supply it will drive a price down, exactly what a short seller desires. Now yes, at some point the short seller will cover his short and that will create a sort of artificial demand, but why is this practice anything other than manipulation? Some short sellers have argued that they help to expose weak companies. Maybe they do, but what they then accomplish is to drive these companies down, below where a "normal" market would price them. In the scenario where the short sellers smell blood in the water as the price drops, real investors sell (often losing money) and analysts and lenders lose confidence in the company, often over something that without the short sellers wouldn't even have caused a ripple in the stock price. They love to exploit every possible way to drive prices down and some have become influential enough to be the cause of a dip.

And it leads to greater liquidity?