Que Sera Sera

Bill Gross has done it again in his 2012 prediction. The coverage is impressive with depth and live reference to the current market conditions. I read the article twice, and then I realized what has been bothering me in the current financial patois. This is the phrase “fat-tails” it is quickly replacing “black swan” in popularity. Talk about herd behavior in markets.

In this article B. Gross is moving fast back and forth with this fat-tail talk. It was not a comfortable read for me.  Some of it comes from the real depressing content.

I am trying to bring it together in my mind; this immediate financial past as we understand it and what is to come, all fat-tail driven.

In standard normal distributions bulk of the incidents happen in the main body of the curve. But really juicy, rare happenings are exiled to the extreme tails.  As life goes on, distributions change without any warning, randomness is the operative mode. The main body of the distribution becomes less, as the fat from main body flows towards the tails: Thereby the “fat-tails”. That means that the extreme events happen more often. As the events of 1987, 2000, 2007 showed us brutally. We later decided in retro that we now have better understanding of these events. I doubt it.

After all, the extreme tails suppose to retain some of the characteristics of the initial distribution. I always thought that this is what they mean by claiming that “markets have some memory”. The problem I have been tackling for some time is the process of remembrance. Why and how is it that market remembers?  Why only a tiny, insignificant part of the market remembered 1929 vividly in the summer of 1987.

Even though I have detailed understanding and deep knowledge of memory formation in Computer Architectures as to how memory starts, enhanced and finally erased. I practically have very limited knowledge of memory formation and access methods in my brain and in markets as well.  I am reading Daniel Kahneman, hoping to gain more understanding than ennui, tune in later...    

Higher order moments (skewness and kurtosis) of normal distribution give additional knowledge. But I am not sure we can reliably determine market’s higher order moments. When we are able to do it with some certainty it is too late.

I still like most of what he is saying and probably agree with most of the end results. Yet, I am not sure about the path to that ending. Between now and then there are thousands of possible paths and we don’t know which one will be.  Doris Day was right: Que Sera Sera.

 

Two Awards

As customary at the end of every year, I try to measure my market calls against what really happened. For two basic reasons: First is a practical one. I manage my family’s retirement portfolio so I carry great responsibility and take it very seriously. This is an ongoing learning process at the same time it is very humbling if not outright humiliating experience. The main idea is to improve our portfolio by preserving capital first and then try to make some return on it, if possible.

In 2011, I made two macro calls that I am very proud of. Our portfolio was mostly in cash (USD) and Treasury long bonds, % 66 combined allocations. Both proved to be rewarding asset classes for the year.  On the down side, my targets of 9000 and 900 for DJI and S&P respectively were way off; but I am sticking with them until 3^rd Q in 2012, probably by the mid-2012 we will hit both numbers.  The remaining %34 of the portfolio is in quality stocks and ETFs (GE, CHL and similar). They are all good staff with fairly decent dividends, but unfortunately bought at the wrong price. This is the so-called “entry point risk” which will be the subject of a future article.

As I judge myself fairly; I also do unto others the same; but, that does not mean I don’t enjoy occasional, seasonal Schadenfreude over the grossly distorted market calls made by big-deal market makers...

To this end, with the seasonal sprit of giving I dedicate two awards: The Irving Fisher award, named after by now infamous Yale economist who just before the crash of 1929 claimed that the stock market reached “a permanently high plateau”. This award goes to Bill Gross of PIMCO who in April 2011 decided that the long US bond and the US dollar were good for nothing and therefore they should be shorted. Being a man of words he changed the mix of his impeccable real return bond accordingly.  Since then the PIMCO fund’s 1 Year return  tanked to the less than half of  Bar Cap US Agg Bond TR USD’s return.  Meanwhile the long bond returned about %30 for the year, actually more if you count the not so shabby %4.375 coupon making long Treasuries one of the best asset classes of 2011 if not the best. The US dollar is up against most currencies and the U.S. Dollar Index (DXY) moved up above 80, my comfort level. I get edgy if DXY goes to 74 and below.

No matter how much delight we take in another’s misfortune, this award makes me uncomfortable personally. There is no doubt that Bill Gross is the go to bond guy. I have learned a lot and taken immense pleasure reading his monthly ruminations. But he is also rational and smart; once he realized his mistake; without hesitation he made a 180 degree turn in his “PIMCO Total Return Fund”. His long term record is impeccable and the fund (PTTDX) slowly recovering certainly belongs to most retirement portfolios. I am looking for a proper entry point (again) to add to our portfolio.

The second award was to be the “BECKET” award for excellence in acting in the financial field. But I soon realized that there are no excellent actors in finance just real duds.  Therefore the award became a contra-award for excellence in bad acting. Think of it a kind of short on good-acting.  BECKET is obvious to movie funs. Briefly, Richard Burton as Thomas Becket after becoming Archbishop of Canterbury decides to reform and have faith to the enormous dismay of Peter O’Toole as King Henry II.  The King would like to continue with debauchery and other assorted good stuff that they carried together for sometime, whereas Becket would have none of it. Both actors are superb at the height of their acting powers. My favorite is King’s heart wrenching line; Peter O’Toole teeth clenched almost spitting “Who will rid of me this turbulent priest”.  As usual, there are always obliging, venal people around and surely Becket was murdered in Canterbury Cathedral. This is also a good object lesson in life as in markets nothing is what it seems. It is after all the same Henry II who introduced the new procedure of trial by jury and laid the foundation of the jury system as we know it. That was in 1170.  I don’t want to belittle the controversy between Becket and Henry II as they did in the movie. For England, there were fundamental issues at stake; as to which was to be prime: Canon Law or the Civil Law

Since the BECKET award morphed into a contra award, it is given to the worst financial acting in public during the past year. The award goes to Jon Corzine of formerly Goldman Sachs, and of the State of New Jersey, and very recently MF Global Investments. The favorite contra line is by Jon Corzine in front of a House committee “I simply don’t know where the money is”.  The money in question is 1.2 Billion dollars; yes Billion with a B not the kind that we got used to lately with an M as 100 Millions. For the sake of numerical clarity that is 1200 Millions, just for a moment try to imagine that amount. He delivered his line with complete plasticity, no expression, no emotion, cruelly as-a-matter-of-fact. As if saying what is the big deal.  This is the guy who used to run Goldman Sachs and the State of New Jersey, and he says that he has no clue as to how that kind of money disappeared from customer accounts.

I must admit this second award was a tough call with so many contenders. There were a number of obvious, illustrious candidates. There is Madoff; no, just too easy and pathetic. There are the Euro twins Merkel and Sarkozy with their constant smug and out-of-touch utterances on the euro-finance. Again this would have been almost unsporting and too close to politics which is not our main concern but finance is. So that is how the award went so deservingly to Corzine.

Happy New Year