Monthly Archives: December 2013

Price momentum

This is a small article.  From Dorsey Wright research.  Requiring additional research on my part.  I will try to do that and add more to this post.  For my benefit.

More Supporting Data For Momentum

The WSJ reports the performance of Sam Eisenstadt’s, former head of research at Value Line, stock-ranking system from 1965-2012.

Though the system is proprietary, its two primary factors are known as “price momentum” and “earnings momentum.” A stock is ranked higher to the extent its performance over the trailing year has been good and its earnings growth has accelerated. Despite the name “Value Line,” the stocks it favors fall closer to the “growth” end of the spectrum.

The system has been phenomenally successful over the past five decades. From 1965 through 2012, according to data on Value Line’s website, Group 1 stocks on average have gained an annualized 12.9%, before dividends. That’s nearly seven percentage points per year better than the S&P 500′s 6.1% annualized return over the same period, and more than 22 percentage points ahead of the minus 9.8% return for Group 5.

Once again, the data confirms the effectiveness of price momentum.

Diced into smaller pieces, from Mark Hulbert:

The system has been phenomenally successful over the past five decades. From 1965 through 2012, according to data on Value Line’s website, Group 1 stocks on average have gained an annualized 12.9%, versus minus-9.8% for Group 5 — an average spread of more than 22 percentage points a year.

In recent years, however, the Value Line system has struggled. The advantage enjoyed by Group 1 over Group 5 has narrowed considerably. Over the past decade, it has been just 11 percentage points a year, on annualized basis; in the 1970s, for example, it was three times greater.

Yet its recent performance is still impressive, according to David Aronson, a former finance professor at Baruch College and currently president of Hood River Research, a quantitative-analysis firm in New York. “Indeed, quants on Wall Street often celebrate when they discover a stock-selection system that can identify a performance differential of just a few percentage points between different groups of stocks,” he says.

Eisenstadt says that, given the initial success of his system, it was inevitable there would be at least some narrowing of Group 1’s advantage over Group 5. “A successful strategy typically weakens as more and more investors start following it,” he says.

I think these are actually quoting the same article originally in WSJ.

Interesting interview from April 2012, talks a little more about analysis of stock market data in general:

Special Meet of QWAFAFEW, New York
April 16, 2012

Question: Please describe the circumstances that lead to the development of the Value Line Timeliness Ranking System. What needs were perceived to need addressing? When it started, did you have any idea how long it would take to complete?

Answer: No, it was an open-ended research project for us. The purpose was to produce an improved system. We noticed that interrelationships between highly related variables frequently caused factors to drop out of regressions. An example of this was IBM, a consistently up-trending stock, where the lagged price became the most important factor.

Question: The academic literature references relative earnings and price ranks, EPS growth, price momentum, and earnings surprise as being factors in the model. It has also been noted that Value Line was the first known system to use earnings surprise as a factor. How did this factor become a part of the system?

Answer:  A physics professor from Brooklyn Polytech, Professor Fabricant had detected that whenever an analyst’s earnings projection (next 12 months) was raised, the relative price action of the stock subsequently improved. The question became: “How could we take advantage of this action in the Ranking System?” We believed that by examining the reason for the revision, we might improve the System. We found that, more often than not, the revision took place after an earnings release.  Thus, by evaluating the earnings release, we could get a jump on the analyst revision itself. Hence the birth of the earnings surprise factor. It was tested, found significant, and introduced into the system prior to anyone else’s use of this factor (to the best of our knowledge).

Question: The first famous article about the Value Line ranking system as an “anomaly” to the Efficient Market Theory being trumpeted by academics was called “Yes, Virginia, There Is Hope; Tests Of The Timeliness Ranking System” by Dr Fischer Black. Could you tell us how the article came about; what assistance you provided in helping him perform his tests, and any other things you think we might find interesting?

Answer: Dr. Black was invited by Arnold Bernhard to test our ranking system using any procedures and tests that he could think of. The result was “Yes Virginia, There Is Hope;”. Value Line provided the computer power and Fischer was paid for his efforts. Several professors at the University of Chicago claimed that Dr. Black was “paid and quartered by Value Line”, thus suggesting that his results were biased towards a favorable outcome for Value Line. Subsequent results of the ranking system for many years would appear to have validated Fischer Black’s conclusions. Indeed, Value Line’s ranking system results might have resulted in some modifications in the Capital Asset Pricing and Efficient Market discussion!

Question: Why do you enjoy tinkering with data so much?

Answer: I was always looking for numerical solutions to stock price forecasting. Discovery of statistical solutions and significance, particularly in stock price forecasting provided a thrill – even if only a momentary one, at times. It shed a bit of light on the darkness that enveloped the subject. I think the thrill would have been there, even if the subject under investigation were other than stock prices.

Question: What other ranking systems and models have you been involved in testing and attempting to develop over the years?

Answer: I’ve developed a technical ranking system. Most technicians do not use statistical methods to construct and test their systems. This is one field that requires such testing since much of their beliefs are not justified by mathematical verification. The technical system provides a small amount of explanatory power with mixed results, particularly in recent years. Relative strength is the primary tool, but applied using multiple regression techniques. Also, in the early years, a model was constructed in order to assign quality grades to companies based upon growth and price stability.



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Austerity from Charles Hugh Smith

Here’s the link.  And here’s the post.  To paraphrase, the negative effects of austerity force a feedback loop that results in improvement.  Of course that’s true.   But some kinds of austerity can be bad, too.  Just like any government spending, some good, some bad, some austerity is better than others.

Sunday, December 29, 2013

Austerity Isn’t Negative–It’s Essential to Good Planning and Decision-Making

Austerity and crisis are not negative–they are the only dynamics that force smart thinking and the re-alignment of values, resources and strategic goals.

Unsurprisingly, the status quo position on austerity (real or imagined)–that it’s terribly, horribly negative–is precisely backwards: austerity is the one essential positive motivator of productive strategic planning, prioritization and decision-making.

By austerity, I mean a broad-based definition: when resources are not up to the demands of the status quo. In other words, austerity is a relative term; for the household accustomed to a lifestyle that requires $15,000 a month, a cut to $10,000 a month is a drastic austerity budget, even though the $10,000 per month budget is insanely bloated to those managing on $3,000 per month.

The dynamic of austerity being required to force productive planning, prioritization and decision-making is scale-invariant: that is, it applies to every bit of the spectrum, from individuals to couples to households to small enterprises to communities to corporations to government agencies to nation-states.

For a military machine accustomed to expanding outlays and a $700+ billion annual budget, a cut of $50 billion is viewed as extreme austerity–even though it wasn’t that long ago that the Pentagon budget was well under $500 billion.

An insightful article in the latest issue of Foreign Affairs describes how austerity has in the past forced the U.S. military to realign resources with goals via hardnosed, realistic, productive strategic thinking: How Budget Crises Have Improved U.S. Strategy.

When there is funding for every program and response to every potential threat, money is thrown around without regard to strategic planning, which is the process of assessing and ranking risks and threats and formulating a strategy that prioritizes resources and goals: in other words, smart planning.
the author of the essay neatly summarizes this process:

“In World War II, the paucity of the resources on hand actually forced U.S. policymakers to make tough but smart choices. A combination of austerity and crisis helped forge a core strategic concept, a new threat assessment, an appreciation of the indissoluble links between interests and values, and a calibration of priorities.”

The dynamic of austerity coupled with crisis is the key driver of smart, strategic planning for individuals, households, communities, organizations, enterprises and nations; without austerity/crisis-driven assessment, prioritizing and planning, resources are squandered on impractical, low-yield distractions that have been jumbled up with key priorities by muddled, politically-expedient thinking.

If you have enough borrowing power to fund everything that every politically potent constituency wants, you are ontologically (inherently) ill-prepared for crisis. Muddled strategic planning leads to a confusion of competing priorities, none of which are integrated in a grand strategy with clear goals, priorities and planning.

Historical analogies abound; here is one. In a previous Musings (When Risk Is Separated From Gain, The System Is Doomed, Musing Report 47, 2011), I discussed Japan’s muddled plan for the Midway campaign in World War II, a convoluted political marriage of competing Army and Navy plans. Rather than clarify the goal and prioritize the means to accomplish it, the Japanese high command attempted to please every key power center by combining each constituency’s ideas and goals into a complex tactical plan that worked politically but which was militarily diffused and internally inconsistent. Junior officers’ well-founded critiques of the plan were suppressed by top brass fearing political blowback.

The end result was a completely avoidable military catastrophe that essentially ended Japan’s hope of prevailing in the war: four aircraft carriers sunk, the cream of the Navy’s carrier pilot cadre lost. These losses forced a shift of strategy from expansion and victory to defense and a vain hope for a favorable settlement of hostilities.

This failure to force clear strategic thinking was the natural result of Japan’s string of early victories, which generated a widespread hubris in the leadership, i.e. the belief that available resources could magically accomplish any goal conjured by central command.

This is a precise analogy to the U.S., not just militarily, but every facet of its society and economy: politically expedient, kick-the-can-down-the-road “no limits on anything” means no strategy, no priorities, no planning and ultimately, no clear thinking at the top, which then guarantees complete failure.

This perfectly captures the essence of the Affordable Care Act (ACA or ObamaCare) monstrosity: a program intended to satisfy or placate every politically powerful constituency is a muddled, complicated mess doomed to systemic failure on multiple levels.The ACA was ultimately a political plan which ignored (thanks to a complete absence of austerity) the actual resources of the nation and its bloated, inefficient, perverse-incentivized healthcare system.

Austerity and crisis are not negative–they are the only dynamics that force smart thinking and the re-alignment of values, resources and strategic goals. Trying to fund everything to please or placate every powerful constituency ends up failing everyone in catastrophic fashion.

This essay was drawn from Musings Report 51, one of the weekly reports sent exclusively to subscribers and major contributors (i.e. those who contribute $50 or more annually).

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Read the Prospectus.

Seriously.  I know it’s a pain in the ass.  Many pages of legal crap.  But it is NOT due diligence to say, Hey, this is the biggest ETF in this category, so it MUST be OK!!!

Here is an example.  I won’t identify this ETF by symbol, but it is a precious metals ETF, in the top 10 in the category, which means it has >$150MM in assets.  I recently read this particular prospectus based on a question from a person considering buying it, which is why I picked it for this post.   I’m not a lawyer, but I will do my best to read this document and make my assessments of what it means to an investor.

If I misread this or make a wrong statement in here, please comment and correct me.  I would be THRILLED to know that my judgments here are not correct.

Let’s start on page 1:

Neither the Securities and Exchange Commission (SEC) nor any state securities commission has
approved or disapproved of the securities offered in this prospectus, or determined if this prospectus
is truthful or complete. Any representation to the contrary is a criminal offense.
So, right off the bat, this document is defined as useless.  The bold is theirs, not mine.  And if you say it’s not useless, you are committing a criminal offense.  Which really means, there is no legally binding information available about this investment, other than if you buy it, you legally own… something?  Maybe this is a boilerplate statement but I don’t see it in the prospectus of any PM fund I have owned.
Now page 2:
This prospectus, including the materials incorporated by reference herein, contains information
you should consider when making an investment decision about the Shares. You may rely on the
information contained in this prospectus. The Trust and the Sponsor have not authorized any person
to provide you with different information and, if anyone provides you with different or inconsistent

information, you should not rely on it.

OK, so we just said it’s not actually legally binding information, but you can rely on it?  And no one is authorized to provide different or inconsistent information?
Listed in the Risk Factors section, and yep, I guess this is a risk!:
Shareholders will not have the protections associated with ownership of shares in an investment
company registered under the Investment Company Act of 1940 or the protections afforded by the
Commodity Exchange Act.
Also a risk factor, interestingly, since insurance is how you mitigate risk:
The Trust’s lack of insurance protection and the Shareholders’ limited rights of legal recourse
against the Trust, the Trustee, the Sponsor, the Custodian, the Zurich Sub-Custodians and any other
subcustodian exposes the Trust and its Shareholders to the risk of loss of the Trust’s Bullion for

which no person is liable.

Now this is a really interesting risk factor.  Seems more like the entities collecting fees from the Trust are just transferring all the risk to the investors:
The Custodian’s limited liability under the Custody Agreements and English law may impair the
ability of the Trust to recover losses concerning its Bullion and any recovery may be limited, even in

the event of fraud, to the market value of the Bullion at the time the fraud is discovered.

Another risk factor, which again, sounds like not so much a risk as a method of transferring risk:
The obligations of the Custodian, any Zurich Sub-Custodian and any other subcustodians are
governed by English law, which may frustrate the Trust in attempting to seek legal redress against

the Custodian, a Zurich Sub-Custodian or any other subcustodian concerning its Bullion.

And some more regarding lack of legal recourse:
Although the relationships between the Custodian and the Zurich Sub-Custodians concerning the
Trust’s allocated Bullion are expressly governed by English law, a court hearing any legal dispute
concerning their arrangements may disregard that choice of law and apply Swiss law, in which case
the ability of the Trust to seek legal redress against any Zurich Sub-Custodian may be frustrated.
And some more “we’re not responsible.”  It’s like this fund was set up by teenagers:
The Trust may not have adequate sources of recovery if its Bullion is lost, damaged, stolen or
And, hands down, my absolute favorite:
Because neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians
who may hold the Trust’s Bullion, failure by the subcustodians to exercise due care in the

safekeeping of the Trust’s Bullion could result in a loss to the Trust.

Well, this one is a close second:
Physical Bullion allocated to the Trust in connection with the creation of a Basket may not meet
the Good Delivery Standards and, if a Basket is issued against such Bullion, the Trust may suffer a


And there’s more.  But to summarize, to this point:  This document is useless, but it’s all you can get.  You have no legal rights, and if you think you do, it will go to court in England.  Or possibly Switzerland.  Good luck there.  Also, we’re not responsible for the stuff we are buying for you, and we are not holding anyone else responsible either.  And we’re not insuring it.  And it might not be the real stuff anyway.
If you continue reading then you get to the part where it says, We are using the same awesome financial controls as MF Global did (in so many words, i.e. unallocated accounts).  Also the part that says that they don’t really even know what the custodians are holding for them.
On the bright side, I didn’t see anything in here about them loaning out all the assets like some other precious metals ETFs do.  Then again, who would want to borrow something as indeterminate as this.
Please, please, someone correct me, and tell me I’ve got this all wrong.

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Economics, the discipline

Warning:  this post is really not fully researched.  I may come back and try to fill in with more and better references later.

This post from Wendy Carlin contains the kind of broad brush statement about economics that makes smoke roll out of my ears:

So why are economists in the doghouse? Everyone now knows that we missed the boat in 2008. Trends in house prices and indebtedness were in the data but we did not pay attention to them. Nor did we later provide convincing explanations of what went wrong. Some economists advocated policies that contributed to the onset of crisis and exacerbated the resulting unemployment and economic insecurity. These failures may be traced to complacency among economists that a largely unregulated market economy would take care of itself.

Really?  Is that last sentence true?  I would contend that #1, economists have not in the last decade supported the idea that a largely unregulated market economy would take care of itself, and #2, that the US and world economy cannot be described as “largely unregulated,” and #3, that the US and EU economies have hardly been free to “take care of itself.”

The housing bubble was probably partially caused by government policies and GSE behavior.  (counterpoint here)  And the deregulation that occurred over the 20 years prior (which it did,) was to the benefit almost solely of the big banks and institutions.  Which is not free market, or for many participants, “largely unregulated.”  Barry Ritholtz has a great piece on the whole thing which touches on a lot of the issues.

The FT opinion piece later discusses how economics is supposed to be a mathematical way of describing human behavior.  With the small amount of statistics I have learned, I find that laughable.  If AIG was blown up by the Black-Scholes options model, that was certainly not due to complacency regarding the big picture or regulations.  It was because no one knew what they were using, and that, in fact, the statistical underpinnings of the model were demonstrably false.  It was a model that had known issues, that was being used anyway.  All models have issues, many known.  And lots of models are used anyway.  But it is possible for this kind of huge error to occur, and then someone learns from it.

This is where the “take care of itself” part comes in.  Instead of allowing these insolvent institutions to go bankrupt, and individuals who had failed to do their jobs properly, and in many cases had committed illegal acts, to face unemployment and/or criminal justice, instead, the biggest and most insolvent were bailed out with taxpayer funds. And they have continued to be rewarded in ways big and small.

Next came the regulations.  After the crisis, economists and politicians got on this “unregulated” bandwagon.  So the big banks wrote up regulations that punish the small banks (which did not cause the crisis, although they did suffer from it).  That’s what we have now.  New regulations, that mostly are not being enforced on the big banks, but where they are, impose a much smaller institutional cost on them than on smaller banks (who were mostly responsible citizens during the crisis, and when not, were peacefully and methodically eliminated/reorganized by FDIC).

As far as complacency of economists, clearly the ones with power were in fact in favor of deregulation when it occurred.  Thinking Rubin/Greenspan/Summers/Clinton, Mankiw/Bush.  Maybe that’s what is being referenced here.   But I wouldn’t call it complacency.  More like collusion or conspiracy, lol.  And were all of them in on this?  I find that difficult to believe.  But not finding any evidence otherwise at this point (not looking very hard).

To me, the bottom line is this:  Why isn’t everyone complaining about the crony capitalism?  The total lack of a free market economy?  When I read something like that one sentence, it ruins the whole rest of the article for me.  Maybe there is something of value in there, but when you start from that premise, how can it be valid?  Check your assumptions.

Note:  I don’t think the CORE econ project is a bad idea.  Julet Schor has a very insightful piece on their site.


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