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Archive for December, 2008

Volatility & Footprint Size Lead to Marketplace Inefficiency in Leveraged Derivative Trades

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Eric Oberg ran a 2 part series explaining why the returns on many double leveraged EFTs are less than one might expect.

The leveraged trades against the S&P 500 represent a small amount of volume compared to the EFT volume short financials or real estate (like SRS)..thus the trades against more liquid indexes do a better job of tracking their goal (of providing a leveraged mirror of what happened in the marketplace). In the smaller markets the derivative leveraged trades create a lot of marketplace volume that can overshadow the market and dislocate capital.

If someone buys that short-sided ETF from a market maker, the market maker does not really have “the other side” to mitigate his risk, thus he either waits for someone to unwind a pre-existing position or he goes out and shorts the underlier. This puts pressure on the underlier, which creates more interest in being short. This, magnified by the leverage, magnifies the volatility, which magnifies the negative convexity, which eats into returns. Thus the “savvy trader” who thinks he or she is doing a “smart trade” is contributing to his or her own underperformance while still having the right idea — the wrong execution of the right concept.

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December 26th, 2008 at 3:36 am

Posted in investing

Capitalism, in a Nutshell

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Education is Ignorance

Everybody reads the first paragraph of The Wealth of Nations where he talks about how wonderful the division of labor is. But not many people get to the point hundreds of pages later, where he says that division of labor will destroy human beings and turn people into creatures as stupid and ignorant as it is possible for a human being to be. And therefore in any civilized society the government is going to have to take some measures to prevent division of labor from proceeding to its limits.

There’s a side current here which is rarely looked at but which is also quite fascinating. That’s the working class literature of the nineteenth century. They didn’t read Adam Smith and Wilhelm von Humboldt, but they’re saying the same things. Read journals put out by the people called the “factory girls of Lowell,” young women in the factories, mechanics, and other working people who were running their own newspapers. It’s the same kind of critique. There was a real battle fought by working people in England and the U.S. to defend themselves against what they called the degradation and oppression and violence of the industrial capitalist system, which was not only dehumanizing them but was even radically reducing their intellectual level. So, you go back to the mid-nineteenth century and these so-called “factory girls,” young girls working in the Lowell [Massachusetts] mills, were reading serious contemporary literature. They recognized that the point of the system was to turn them into tools who would be manipulated, degraded, kicked around, and so on. And they fought against it bitterly for a long period. That’s the history of the rise of capitalism.

Comment on the $3.3 billion in TARP money given to Amex

Another theory not heavily subscibed to (but growing now that it is more obvious) is that large corporations are actually Antimarket, meaning they don’t fit the idealized free market that is stated as the moral driver of our economy….they actually are in the business of restricting competition and teaming with governent to command the economy at the expense of the consumer. Autos, Big Pharma, the Weapons industry…

A Highly Evolved Propensity for Deceit

Deceitful behavior has a long and storied history in the evolution of social life, and the more sophisticated the animal, it seems, the more commonplace the con games, the more cunning their contours.

Don’t Regulate the Free Markets!

Here’s one of the simple truisms that gets lost in the political (i.e., bumper sticker) discussions.

Don’t regulate the free markets! Don’t interfere with innovation! Don’t stifle incentives!

What bullshit.

One of the best ways to win a debate is to control the language used. This was one of the elements George Orwell was discussing in 1984, and why the language in the novel was degraded to phrases like “double plus good.” All nuance was dismissed. He who controls the language controls the political economy is what Orwell was saying. In modern times, its done not with boot-jacks and guns, but with catchphrases and clever marketing. Its not as heavy handed, its just more insidious.

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December 23rd, 2008 at 2:52 pm

Posted in economics

Catfish Industry, Commercial Real Estate Developers Asking for Bailouts

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It seams consumer mortgage was just one piece of the cycle, and the news is getting worse every day. And the approach to fixing it (leaving consumers up to their eyes in debt while bailing out the banks) fails to account for the positive feedback loop from falling consumer demand.

We are already bailing out mortgage (Fannie Mae & Freddie Mac), insurance (AIG), the banks, autos, and now the cancer is spreading…where government funds are being asked for by hedge funds and commercial real estate developers.

From the Financial Times:

Hedge funds will be allowed to borrow from the Federal Reserve for the first time under a landmark $200bn programme intended to support consumer credit.

The Fed said on Friday it would offer low-cost three-year funding to any US company investing in securitised consumer loans under the Term Asset-backed Securities Loan Facility (TALF). This includes hedge funds, which have never been able to borrow from the US central bank before, although the Fed may not permit hedge funds to use offshore vehicles to conduct the transactions.

From the WSJ

With a record amount of commercial real-estate debt coming due, some of the country’s biggest property developers have become the latest to go hat-in-hand to the government for assistance.

They’re warning policymakers that thousands of office complexes, hotels, shopping centers and other commercial buildings are headed into defaults, foreclosures and bankruptcies. The reason: according to research firm Foresight Analytics LCC, $530 billion of commercial mortgages will be coming due for refinancing in the next three years — with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off.

Look for more violent swings in SRS. I wonder how far along talks are, and how this news will influence the market.

Nassim Taleb, author of The Black Swan, remains uncertain and hopes the situation is not getting worse:

But the extent of the bailout requests is absurd. Even the catfish industry is asking for $50 million, as reported by the (now bankrupt) LA Times:

“The catfish industry is on the verge of collapse,” said Marty Fuller of the Catfish Farmers of America, citing high feed prices and an increase of imports. About 6,000 jobs are at stake, mostly in economically depressed areas in states such as Arkansas, Mississippi, Alabama and Louisiana. Officials are talking about seeking $50 million in aid as a stimulus.

As Barry Ritholtz said, “Capitalism without failure is like religion without sin.” How many industries can the US government bailout before the dollar collapses? Looking at all the bailouts makes me want to go on vacation, rather than earning a lot of money so it can be confiscated by taxes and handed to crooks.

I can’t wait to read Bailout Nation! Great timing on the book, though I imagine there will be a need for an update in another year or two.

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December 21st, 2008 at 11:58 pm

Posted in credit

US Real Estate & Deflation: Why is SRS Near 52 Week Lows?

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Massive Deflation?

I am new to investing (outside of investing in websites we own and operate) but some stuff that happens in the market simply does not make much sense to me. We have deflation rates that have not yet been seen since the Great Depression.

via the NYT

Real Estate Deflation

While the real estate market is already down about 25% from its peak, experts like Robert Shiller believe it still has a ways to go.

  • On a historical basis, US residential real estate prices are still way above normal averages (if you compare rent price to sale price or sales price to median home income – lots of research in this PDF)
  • the future of commercial real estate is looking grim, with consumers cutting back on spending
  • and there is going to be a ton of Alt A and ARM mortgages resetting in the next couple years

Shouldn’t Real Estate Deflate?

So if we are seeing rising unemployment, a contraction of credit, and are in for massive deflation, then an asset class that is still well above its historical prices (like residential and commercial real estate) should be easy to trade against, but for some reason (maybe the US government backstopping incompetent companies – and fears of more of the same?) that trade has been a failure in the current market. ProShares UltraShort Real Estate (SRS) is a leveraged fund that “seeks daily investment results that correspond to twice the inverse daily performance of the Dow Jones U.S. Real Estate Index,” but it reached fresh 52 week lows only 2 days ago, traded up yesterday, and then gave back most of those gains today.

There can be a small decay rate associated with such leveraged funds that can cause them to lose out on some growth, but it should not be so much that real estate backed assets are seemingly increasing in value.

Commercial real estate firm Simon Property Group (SPG) has a price to earnings ratio over 30 (50% higher than Google’s!!!) while ShopperTrak reports foot traffic in malls is down 17.9% year on year.

Refinancing Rising, but Few New Home Purchases

People have not been buying many new homes, but mortgage refinance is up sharply on lower interest rates.

How Much Inflation Can the Fed Create Before US Bond Yields Rise?

Longterm treasury bond yields are exceptionally low, killing trades against it – like TBT. The US Dollar has been sliding hard against the Euro recently, and the is planning on using inflation to help stimulate the economy. How far can they push this string?

Chicken or the Egg?

With the US recycling money (and attempting to inflate the crap out of it) to prop up an overpriced asset and stimulate the economy, either real estate or treasuries will eventually get killed…though I am not smart enough to know which bubble has further downside in the short run, and was recently on the wrong side of a trade/bet against the fed.

Are those trade so obvious that there is no opportunity left? How long can the market deny fundamentals? How steep is the market decline when it does happen?

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December 20th, 2008 at 2:08 am

Posted in investing

Inflation is Good – 1930’s Keynesian Propaganda Video

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Classic video about the virtues of inflation, with the complete opposite approach as Whip Inflation Now. 😉

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December 16th, 2008 at 9:05 pm

Posted in economics