Loose threads 25 Nov 2006

Just a few items I've bookmarked in the last few days for passing along.


Hank Greenberg: Ever want to know what he's keeping an eye on? Well, I'm not sure if it's this particular Hank Greenberg, but this news-clipping service of a Hank Greenberg showed up as a recent hit on one of Guambat's stews.

Citadel: This story started a few days back and has progressed, so far, along these lines:

Market talk of trouble at hedge fund fuels dollar selling. This is a curious one because my google seach references statements linking the "trouble" to Citadel (e.g., "... "Rumors of a major US hedge fund collapse appear to be behind the dollar's latest dip," said ... Dolan said the speculation centers on Citadel Investment Group. ... "), but the article (no longer??) has that reference.

Hedge Fund Rumors: Citadel Tell WSJ "It Ain't Us"

Troubled hedge fund rumours point to Citadel....

Citadel Investments said it is having a strong year despite talk in the financial markets that the $12 billion hedge fund may be suffering losses.

Citadel manager leaves firm

Are hedge funds dangerous? "When we discuss the effects of hedge funds on the financial markets, I believe it may be useful to compare the crisis at Amaranth, which I described in the beginning, with the crisis at LTCM. The effects on the financial markets were very different. Despite the fact that Amaranth’s losses were much greater than those of LTCM, no authority needed to intervene; Amaranth was able to close its positions of its own accord and in a smooth manner. The large positions were sold (at a substantial discount, one assumes) to JP Morgan and Citadel, another large hedge fund.
The Riksbank’s view as regards further regulation is that the focus should be on the hedge funds' counterparties - particularly the systemically-important banks - being able to manage their risks. Improving the banks’ risk management with regard to hedge funds has been the objective of a number of initiatives by the Basel Committee on Banking Supervision and other organisations ever since the LTCM crisis in 1998. From a stability point of view, the central issue is that the systemically-important banks should manage their counterparty exposures correctly – take sufficient collateral, have appropriate limits and be capable of managing potential liquidity problems. The arguments for further regulation of hedge funds are in this context weak."

Stefan Stern on John Monks in the Financial Times: Rise of ‘casino capitalism’ shakes faith of moderate Monks "When the John Monkses of this world say enough is enough, that the capitalist system itself is sick, you can be sure that elsewhere in the world there is deep-seated, lingering resentment and unhappiness."


Mark Hulbert: Not sure if this is evidence that the guy is right or wrong but Mark Hulbert seems to think he's finally got it right:

Fosback, for those of you unfamiliar with him, is a serious student of the stock market. He helped found the Institute for Econometric Research in the early 1970s, and for years was editor of a number of investment advisory publications, most notably Market Logic. After Time Warner acquired those publications in the 1990s and subsequently folded them, Fosback inaugurated his current newsletter.
For some time now, Fosback has been closer to the bearish end of the bull-vs.-bear spectrum, and sometimes a lot closer. As recently as this past summer, in fact, his econometric model was projecting that the stock market would produce a slight loss over the subsequent 12 months and a meager 13% total return over the subsequent five years - equivalent to just 2.5% annualized, far less than the stock market's long-term average and even lower than a riskless money market fund.
But in the issue I received on Monday, Fosback reports that his model is now projecting an 11% return over the next year and a 38% return over the next five years (equal to 6.7% annualized). Though this is not a wildly bullish forecast in and of itself, it represents a significant improvement in the stock market's prospects in a very short amount of time.
I was surprised, because market timing systems like Fosback's which use econometric techniques to distill a large number of fundamental and technical indicators the usual cause of such a markedly improved forecast in such a short time is a big decline. But Fosback's model has improved during a time in which the stock market has gone up, not down.
The Dow Jones Industrial Average today is more than a thousand points higher than where it stood when Fosback's was projecting little more than a flat market for the subsequent five years.
What has been the source of his model's brighter outlook? It's not been the market's valuation, since - as Fosback points out - "Valuation numbers (P/Es, yield, price/book ratios, etc.) have not changed significantly of late - i.e. they are still bearish to moderately bearish." Nor has there been much improvement in the monetary indicators that Fosback's model incorporates.
Instead, Fosback's model has improved because of a number of technical indicators. One is the market's breadth, as measured by the advance-decline line, "which had been quite weak last summer, but is now as strong as ever." A related indicator, which also has improved markedly since the summer, is relative strength of small-cap stocks over large-caps.
A lesser known technical indicator that also has recently exhibited a lot of improvement is known as the "High Low Logic Index." This indicator, which Fosback says that he invented in the 1970s and which he terms one of his favorites, is bearish whenever there is a large number of both new 52-weeks highs and new 52-week lows on the NYSE. The rationale behind the indicator is that "under normal conditions, either a substantial number of stocks establish new annual highs or a large number set new lows - but not both ... When the Index attains a high level, it indicates that the market is undergoing a period of extreme divergence ... Such divergence is not usually conducive to future rising stock prices."
Fosback reports that the High Low Logic Index has "improved dramatically" since earlier this year, and is now "actually nearing a buy signal."

So, this guy's model was showing a dead market, but the Dow went up about 10% at which point the model followed and "turned" bullish. Sounds a bit like a dog chasing his tail. What's to get so excited about? Even Hulbert noted, "To be sure, Fosback is not advising his clients to throw caution to the winds. A 6.7% annualized return over the next five years is still below the market's long-term historical return, and only modestly above the 4.6% return of the 10-year Treasury note." Perhaps we should just file this under "left-handed compliments."

Barry Ritholtz: Barry innocently created a classic blog discussion about market statistics and their assumptions and applications. You will have to read the post and all the comments, but it is just dandy stuff and a timely reminder to test your assumptions from time to time:

917 trading days since down 2% day

Ross Gittens on Milton Friedman: "Something they won't tell you is that the first reason cited for the Nobel Prize Friedman was awarded in 1976 was his development of a theory much more orthodox and long-lasting than "monetarism": the "permanent income hypothesis".

This is the contention that people adjust their consumption spending not in response to changes in their current income but to reflect what they expect will be their lifetime income.

But let's get on to monetarism, the idea most associated with Friedman's name. The first point is that it wasn't his new idea....."