The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Tadas Viskanta is the founder and editor of the finance blog Abnormal Returns. Tadas has over twenty years of professional experience in the financial markets. He is also the author of the forthcoming book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere.

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There has never been a better time to be an individual investor.

Said another way one could argue that we are in the golden age of the individual investor.  That might seem like an odd thing to say coming off what some people call a ‘lost decade for stocks.’  However over that same time period the technological advancements that made Web 2.0, like Facebook, Twitter and LinkedIn, possible have also led to unprecedented opportunities for investors not previously seen.

We are for the moment leaving aside the state of the markets at the moment.  We could have written this same post a couple of months ago when the stock market was 20% lower.  We are also leaving aside the issue of whether the zero interest rate policy of the Federal Reserve represents a “war on savers” or is simply the byproduct of necessary policies.  The failure of MF Global and the systemtic risks it poses for all account holders are also outside the scope of this post.

This is not a novel theme for us.  Indeed one thing we note in our forthcoming book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere, is that investing has never been “cheaper or easier.”  Some of this has to do with the rise exchange traded funds.  In other respects it has to do with the blossoming of the options markets.  In large part, it has to do with technology.  In short, never before have investors had access to data, analysis, opinion and social tools that are commonplace today. Let’s take these points one by one.

1. Easier:  Investors today can with a brokerage account and a computer is now only a few mouse clicks away from a globally diversified portfolio of ETFs that in terms of expenses rivals what institutions paid a decade ago.  For all intents and purposes the expense ratio on the big ETFs is closer to 0.0% that 1.0%.  Many brokers now allow online trading of individual bonds and overseas securities.
2. Cheaper:  Brokerage commissions continue to get driven towards $0 over time.  In fact, many brokers today provide commission-free trading of a range of ETFs.  Options strategies that would have been cost-prohibitive a few years ago are now viable strategies today.  Do you remember when you used to have to pay extra for real-time quotes?  Today those are a commodity.
3. Richer:  The range of asset classes, sectors and strategies available via ETFs is truly dizzying.  It is even for interested parties hard to keep up.  Will most of these more exotic strategies fail?  Probably.  But sometimes a strategy, like low volatility investing, that is based in deep academic research, becomes available to investors.
4. More social:  Blogging and microbloggging (StockTwits & Twitter) has opened up the world of idea generation to the masses.  Anyone with a computer these days can put their ideas out there.  The blogosphere and Twittersphere is a meritocracy, albeit imperfect, where the smartest and most generous contributors rise to the top.  The social model is pushing into things like earnings estimates with Estimize and institutional-grade services like SumZero.  Many bloggers these days make fun of the raft of ‘free’ webinars that go on these days.  But if you think about it the software and Internet speeds were not there to make mass online seminars possible not all that long ago.
5. Smarter:  The raw material for investment analysis and trading is of course data.  Financial and price data is for the purposes of most individual investors is free these days.  Many firms are using data in interesting ways.  In the area of fundamental data some firms like Trefis and YCharts are making fundamental analysis easier.  A firm like AlphaClone allows you track the moves of (and invest) like the big hedge funds.  When it comes to portfolio level data firms like Wikinvest are aggregating account data making analysis easier for investors.

Most of the above discussion focuses on do-it-yourself investors.  However on the managed portfolio front things are changing for the better as well.

1. Brokers vs. RIAs:  The wirehouse brokerage model is going the way of the dodo bird.  Brokers and their clients now recognize in increasing numbers the conflicts inherent in that model.  Brokers are going independent as registered investment advisors in order to provide their clients with a conflict-free model.  That does not necessarily mean they are going to generate above-market returns, simply that these firms are no longer working at cross-purposes to their clients.
2. Online access to managers:  Not only is the fee-only model taking hold.  It is taking hold online in a big way.  If you can eliminate, to a degree, the human element inherent in portfolio management you can also reduce the end cost to the investor.  Some firms that are operating in this space include:  Wealthfront, Personal Capital, Covestor and Betterment.

In the New York Times this past weekend there was an article talking about the many changes we are seeing through the analysis of “big data.”  The applications of big data has taken hold faster in the world of personal finance, like BillGuard, than it has in investing.  However one can easily see how access to data on individual trading decisions could make for an interesting recommendation engine.  In the end, more algorithmic investment tools and services coming one way or another.  The fact is that a simple, well-designed algorithm can do a better job of managing in real-time a portfolio than the vast majority of investors or investment advisors.

In many ways the automation of much of what constitutes investing today will be a godsend for investors.  The majority of investors really don’t want to manage their own portfolios.  Not do they a hyper-personalize portfolio.  An algorithmic service that managed in a low-cost fashion portfolios it would allow those investors to focus on the things over which they have some control.  The stuff of truly personal finance like:  savings rate, lifestyle choices and retirement options.

Sometimes in the midst of volatile markets we can forget just how far things have come.  Just a few years ago who thought you could trade a leveraged on $VIX futures.  But today you can.  Who would have thought you could buy an ETF for the Egyptian market, but you can.  However this example points out the double-edged sword that is today’s markets.  Now we do have access to all manner of investment and trading vehicles.  However like any tool these vehicles need to be used responsibly.  The vast majority of investors should likely take a pass.

The reason is that despite the many technological advancements we have seen in investing our brains are still largely hardwired for an age of scarcity.  That is why so many of the behavioral biases we have accumulated over time work against us when it comes to investing.  That is why we consistently buy high and sell low, i.e. the behavior gap.  That is why we oftentimes only seek out (and recognize) that information that conforms to our long held beliefs, i.e. confirmation bias.  In the end the most difficult hurdle to investment success is not the market environment or the range of investment vehicles, it is us.

So despite the advances we have seen, most investors would be well-served in investing in a low cost, globally diversified portfolio which they systematically rebalance and occasionally revisit.  The upside is that this sort of investment process is, as we said, now cheaper and easier than before. In the end no one knows what the markets will do, but the vast majority of investors can do more by doing less.

The full application of technology to the investment world will simultaneously open up novel areas of investment for adventurous investors and simplify the mechanics of portfolio management for the average investor.  Investors have to choose which path they will follow.  They simply need to recognize that their own, somewhat flawed brains, are coming along for the ride.

*I know I have likely omitted some very cool startups in the investing and personal finance space.  This is not meant to be a comprehensive accounting of the field.  Feel free to include in comments any interesting firms in this space.

I met Joe Fahmy a few years ago at Lindzenpalooza. He has a great way of communicating his trading skills to a novice to intermediate traders based on his 16 years of trading. Fahmy has guided his hedge fund to outperformance over the past 13 quarters. As previously mentioned, I wanted to present something less technical and chart focused;

This is our second attempt at bite size, easy to understand, bullet points for traders. The first post is here.

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1) Loss cutting:  Trading has this amazing historical footnote: If you study the great traders throughout history, they all share the same statement as their number one rule: CUT YOUR LOSSES! Capital preservation “keeps you in the game.” It is especially important once you understand the math: a 25% drawdown requires a 33% gain to get to break even; Down 33% means you need to rally 50% to get back to square one; As we saw in 2008-08, a -50% loss requires a +100% gain to get back to even. In sports “Defense Wins Championships.” The same goes for stock trading. Most traders need to focus more on defense.

Even Warren Buffett understand the traders credo: “The first rule of investing is don’t lose money. The second rule is don’t forget Rule No. 1.

2) Confidence: There is nothing worse than seeing a great opportunity but not having the courage to “pull the trigger” and execute the trade. Freezing up due to fear does NOT happen to great traders. These thoughts don’t even enter their mind because they are confident in their plan. They know wht they will do if the trade goes their way, and perhaps more importantly, they know what to do if it goes against them. Confidence cannot be taught. It comes from making decisions, taking action, and learning from experience.

3) No ego:  Successful traders may have big personalities, but they separate their ego from their trading. They might have serious conviction behind their positions, but when the market proves them wrong, they don’t argue with it. They simply move on and accept it.

Two things I never argue with: the stock market and women. Both of them are smarter than me, and both are always right! (BR: Spoken like a married man)

4) Consistency: The best at anything are the best because they are consistent. Michael Jordan isn’t considered the best basketball player ever because he scored 30 points ONCE in a game. It’s because he averaged 30 points per game over his ENTIRE career.

Traders should not obsess with their day-to-day profit & loss. Rather, they should shoot for consistent positive months, quarters, and years with minimal draw downs. You do not want to be the “boom and bust” trader who does well in a strong market but gives it back during market corrections. These guys are a dime a dozen and typically get blown out of the market at key pivot points (Last cycle, I knew a few who became mortgage brokers — how is that for timing?)

5) Students of the market: Successful traders NEVER get complacent. They are always eager to learn, constantly looking to improve their skills.

One way to improve is through post analysis of your trades. It is important to look at your numbers and make sure your losses are smaller than your gains.

For technical traders, studying your entry points and looking at charts that worked (and didn’t work) is part of the constant learning experience of becoming a confident and consistently profitable trader.

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Fahmy holds seminars for active traders who want to improve their returns.   Readers of the Big Picture who are interested will get a $500 discount on the full day event. Go to TradingBigWinners.com and enter the promotional code: “bigpicture500” for the New York (3/3) seminars. I will be discussing trader psychology and cognitive errors at this seminar.

David J. Merkel is a CFA, FSA. His forthcoming equity asset management shop is tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities.where he researched a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. From 2003-2007, he was a leading commentator at the investment website RealMoney.com.

These are his Eight Rules of Investing:

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My objective in guiding investors is to teach them how to tilt the odds of success in their favor. As a value investor that rotates sectors, I have eight methods that each tilt the odds a little in my favor. Individually, each tilt is worth a little. As a group, they have been very powerful for my past results. Unaudited, these methods have allowed me to beat the market since the strategy started in September of 2000.

1. Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.
2. Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.
3. Stick with higher quality companies for a given industry.
4. Purchase companies appropriately sized to serve their market niches.
5. Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.
6. Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.
7. Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.
8. Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.

Each of these rules enforces a discipline on the overall portfolio that most professionals and individual investors do not possess. It takes the emotion out of investing, and forces us to think like risk-sensitive, profit-seeking businessmen. I agree with Buffett when he said, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.” The two disciplines mutually reinforce each other, leading to better results.

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Part II is after the jump

Read the rest of this entry »

Less than meets the eye at Facebook
Barry Ritholtz,
Washington Post
February 11, 2012

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Facebook is valued at “plenty”
By Wall Street’s tech cognoscenti,
Take 1 billion friends
Times 5 dollars, then
Times IPO multiple: 20!
— Limericks Économiques

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Last week, I made a surprising discovery about Facebook: It has far fewer “active” users than it claims. I learned this from a note buried deep in the company’s S1 — the IPO document it filed with the SEC in order to go public. Based on its S1, the social-networking giant’s value is probably much less than most investors seem to think.

One advantage of working in finance is that you get to meet lots of very nice, really smart people such as David Wilson, who writes the Chart of the Day column for Bloomberg. His column is my Sudoku, as I challenge myself to poke holes in the correlations it identifies between various assets. It’s good wonky fun.

On Feb. 3, the column used Facebook’s SEC data to show how fast the firm was growing. FB was becoming a “daily habit for more users,” and the numbers from the IPO filing were extraordinary: 845 million Monthly Active Users and 483 million Daily Active Users.

MAU? DAU? I had never heard of either metric, and novel accounting for public companies is always a red flag. Don’t just take my word for it, ask a Groupon investor.

I thought these metrics were suspect. If you do not have to go to Facebook.com to be counted as an active user, are the metrics misleading? I asked Wilson, who pointed to details in the S1:

“Daily Active Users (DAUs). We define a daily active user as a registered Facebook user who logged in and visited Facebook through our Web site or a mobile device, or took an action to share content or activity with his or her Facebook friends or connections via a third-party Web site that is integrated with Facebook, on a given day. We view DAUs, and DAUs as a percentage of MAUs, as measures of user engagement.”

Let me translate: If you clicked a “Like” button anywhere on the Internet, then you are a Daily Active User. Even if you never go to Facebook.com.

As huge as those MAU/DAU numbers were, I wondered how this detail might affect revenue. The Facebook metrics for annual revenue per user were stunningly modest: Facebook picks up $5 per user each year. Compare that to Google, which garners more than $30 per user per year. Netflix takes in closer to $144. Is this why Facebook’s annual revenues are so low compared to its 850 million user base?

Why does this user-behavior metric matter? Consider what it means in terms of how “daily users” will generate revenue and profits. If all users do is click a “Like” button, but never make it to Facebook.com, they cannot be “monetized.” They cannot be marketed to. They do not see any advertising. They cannot be sold any goods or services. They take advantage of FB’s extensive infrastructure to tell their FB friends (who may or may not see what they did) that they liked something online. That’s all that happens.

So they not only fail to generate revenue for Facebook that day, but they are actually a cost. It’s not cheap to maintain that massive infrastructure of Like buttons everywhere. Someone’s got to pay for the server farms that handle the back-end of this.

Consider what happened when MySpace tried to increase profits from users. With lots of pressure to drive revenue, they doubled the ads on the site. As they tried to monetize users, the site became ad-congested, a real eyesore. Users left in droves.

So how does this play into Facebook’s sky-high valuation? The company’s worth has been pushed ever higher by a series of private deals, all made before the SEC filing was made public. Microsoft made a well-timed investment of $240 million in 2008 at a $15 billion level; Elevation Partners paid $120 million at a value of $23 billion in June 2010. Goldman Sachs poured up to $2 billion into the social network at a $50 billion valuation in January 2011. All of these private investments were made by sophisticated investors, but without the benefit of the SEC data.

A year ago, I offered five questions for Facebook private investors:

• FB claimed (in January 2011) 500 million subscribers. How many of these are active users — at least once or twice a week? How many of these are dead accounts, with no activity for 30 days, 90 days or more?

• What is the average revenue per subscriber? How are you planning to grow this?

• How much churn does Facebook go through? For every 100 new subscribers, how many subscribers leave?

• What is the life cycle of the typical Facebook subscriber? How active are they for how long; what sort of arc do they cut across their FB life cycle?

• Besides advertising, how will you monetize your user base? Are you selling their data to buyers? What about anonymized data — are you selling this also?

Last month, I compiled a new list for Facebook IPO investors. Those of you thinking of buying Facebook’s IPO at these rich valuations should be comfortable with the answers to these:

• What is the IPO offering price going to be? What market capitalization will FB come public at?

• What are the key pricing metrics? P/E, growth rate, price to book, price to sales?

• What is FB’s growth potential? At 800 million users, where do they begin to plateau? Top out?

• What is FB’s plan for penetrating China?

• How are the privacy concerns going to be handled? What else might come out of the closer FTC scrutiny of Web firms’ use of personal data?

• How long are insiders/VCs going to be locked up? Are they committed to holding onto shares for the long haul, or are they cashing out at the IPO or as soon as possible thereafter?

What I learned from Facebook’s filing was that they have 161 million active users who actually go to Facebook.com each month. That’s not shabby — but it’s a far cry from the MAU claims of 850 million. That definition of active users is probably overstated by a factor of 500 percent. I suspect that the $100 billion valuation may be overstated by nearly as much.

Me? I’m sitting this one out.

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Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture.

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I met Joe Fahmy a few years ago (at a StockTwits event) and I have been impressed with his trading skills and diligence in refining his craft. He has been trading for 16 years, and has developed a rigorous investment strategy. As a hedge fund manager, he has successfully outperformed the markets for the past 13 quarters. You can read more about him at the end of this post.

His writing tends to be a little technical and chart focused; We spent some time chatting on the phone last week about his approach, and I suggested breaking a few topics into bite size, easy to understand, bullet points. This is the first of what hopefully turns into an ongoing series.

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When should traders be in or out of the market?

There are times when traders should NOT be in the market. There are other times when the market is rocking and traders should get aggressive. How can you tell the difference? Here are 5 helpful tips.

Note: I’m a trader, not an investor. I am looking for superior out-performance by being in the best stocks I can find during healthy times.

1) Accumulation and Distribution Days: When should traders go to cash? Follow the big boys! The big institutions control the market, so pay attention to their actions by tracking accumulation and distribution days. When institutional selling builds up over a short period of time (2-4 weeks) AND leading stocks start to break down, that is a great sign to start raising cash. Why? Because 4 out of 5 stocks move in the general direction of the market. I don’t care how good the company is, when the market’s in a downtrend, you don’t want to fight it.

2) Uptrends and Downtrends: Don’t get caught up with the terms Bull and Bear market. Just recognize if we are in an uptrend or a downtrend. For example, use the 50-day moving average on the NASDAQ Composite as a general indicator to be in or out of the market. Above the line usually means we’re in an uptrend and it’s a green light to be in stocks…below the line, downtrend and red light.

3) Scale In: When conditions start to improve, SLOWLY scale back in. There’s no reason to rush. Take a few positions and test the waters. If the rally is for real, there will be PLENTY OF TIME to make money. If you are wrong, at least you can get out quick with minimal damage and protect your portfolio. Think Defense First!

4) Buy the Strongest Earnings & Sales Growth: When markets are in a confirmed uptrend, what stocks should you buy? Be in the best! Don’t settle for low rate stocks. Look for companies that have strong earnings and sales growth. Why be in dead-money stocks with little growth potential? We’re in this to make money, right? So be in stocks that have a higher probability of moving up!

5) Fundamentals AND Technicals: Why does it only have to be one or the other? Why not USE BOTH! We want as many factors as possible in our favor when trading the market. Therefore, start with strong fundamental companies AND combine the proper technical timing to identify ideal entry points to effect your best risk vs reward trades.

These are my 5 measures for when to be in or out of the market. Note I do not rely on a single factor, but instead use multiple disciplines to facilitate trading, protect my capital and maximize returns.

Using every weapon available significantly improves your chances of surviving — and thiving — as a trader.

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Fahmy holds seminars for active traders who want to improve their returns (I will be discussing trader psychology and cognitive errors at the next NY seminar). Readers of the Big Picture who are interested will get a $500 discount on the full day event. Go to TradingBigWinners.com and enter the promotional code: “bigpicture500” for either the Los Angeles (2/18) or the New York (3/3) seminars. (I am only speaking at the NY event, and cannot get to the LA event — maybe next time).

A modern Pecora Commission could right Wall Street wrongs
Barry Ritholtz
January 28 2012

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What shall we make of this surprise pronouncement in President Obama’s State of the Union address? A belated investigation has been launched into the role of fraud in the financial crisis.

This much is clear: Despite rampant illegalities, bank fraud and countless cases of perjury, the response to date — at the federal level and from most, but not all, states — has been underwhelming, cowardly even. A few principled holdouts — the attorneys general of Delaware, New York, Nevada and California — refuse to rubber-stamp a pre-investigation settlement with banks, but that’s all. Despite chances to bring crooks to justice, there has been little action.

So, here we are, four years after the great financial collapse, three years after the recovery began and in the last year of Obama’s term — and the president has finally decided to investigate the role of fraud in the great global financial crisis. Hence, this new task force — the unit of Mortgage Origination and Securitization Abuses — begins behind the curve. The statute of limitations is, in many cases, close to elapsing.

Even so, do not dismiss the investigation out of hand because of the timing: History informs us that a serious investigation can begin four years after the fact. Recall that Ferdinand Pecora was the fourth chief counsel for the Senate committee that investigated the Wall Street crash of 1929 and subsequent Depression. He was appointed in 1932 and received broad investigatory powers in 1933. His report ran thousands of pages. Thanks in large part to Pecora’s findings, Congress passed the Glass-Steagall Banking Act, which separated commercial and investment banking; the Securities Act of 1933, which established penalties for filing false information about stock offerings; and the Securities Exchange Act, which created the Securities and Exchange Commission to regulate the stock exchanges. Nearly 50 years of financial stability followed.

The personality in charge can make all the difference. In an encouraging sign, Obama appointed to the task force New York Attorney General Eric Schneiderman, one of the few attorneys general not railroaded into a premature settlement with banks of the robo-signing-foreclosure scandal.

Critics have derided the task force as little more than election maneuvering. The politics are obvious: Both Occupy Wall Street and the tea party were very unhappy with the bank bailouts; they seem even less happy with the lack of prosecution.

It’s fair to ask: Is this new task force a meaningless exercise?

It is too soon to tell, of course. Like good poker players, we can look for “tells” that signal whether this will be a farce or a serious player. We’ll find clues in the structural setup of the office as well as the areas it investigates.

In the setup of the office, four aspects are crucial:

• Does the office have subpoena power (as the New York attorney general’s office has through the Martin Act)?

• Are there going to be public hearings (preferably in the Senate)?

• Will the commission have a significant budget?

• Will it be a forum for whistleblowers and crowdsourcing?

Without such powers, the office would be a farce, helping to shield banks from the fallout of their wrongdoings.

What the office investigates will also reveal how serious this is. Both pre- and post-crisis topics should be investigated, including:

• MERS: Mortgage Electronic Registration Systems was created by banks without any authority or enabling legislation. It allowed the rapid transfer of mortgages, avoiding state and county filing fees amounting to billions of dollars. Without MERS, it’s hard to imagine that the massive volume of mortgage securitizations could have occurred. How were lenders able to circumvent mortgage filings with town and county registrars? Did they engage in illegalities? How many billions of dollars do they owe in fees for transferred notes? And what percentage of MERS assignments were fraudulent, made for entities that did not exist?

• Origination fraud: Why did lenders accept “stated income” loans? Why did they abandon traditional standards? Michael White, a Countrywide subprime unit employee, called this “origination fraud,” observing, “Eliminate the verification of income for a mortgage borrower, and you eliminate your ability to predict the likelihood of repayment or default.”

• RMBS: Wall Street’s securitized mortgage pools (residential mortgage-backed securities) contained a broad variety of flaws, some so egregious that they amounted to fraud. In plain English, we’re talking about bad paperwork and misrepresented pools of mortgages to borrowers whose debts were significantly understated and whose median incomes and credit scores were significantly overstated.

• Insurance fraud: Look at a bank tactic in which legitimate home insurance is canceled and new insurance provided at a substantially higher fee through a subsidiary or affiliate of the bank mortgage holder. This extra expense in some cases led to foreclosures.

• “Pyramid” servicing fees: An illegal practice in which current payments are applied to past late fees, generating more late fees and additional interest owed and creating a delinquency where none existed. This tactic also led to foreclosures that were probably unlawful.

• Lost mortgage notes: How is it possible that the most important part of the mortgage contract — the promissory note — was consistently lost or misplaced by banks? It is unfathomable to anyone who has ever handled documents. At best, it’s gross incompetence. At worst, it’s willful document destruction during litigation.

•Document fraud for sale: There were many examples of alleged document fraud, but the one crying out for investigation involves Lender Processing Services’ DOCX subsidiary. The firm seems to have been selling fabricated documents for a fee to lawyers and banks. Indeed, Lender Processing Services, which processes nearly half of all U.S. foreclosures, could require a separate investigation.

•False affidavits, perjury (robo-signing): We do not know who ordered the robo-signing of foreclosure documents, the false notarizations, fraudulent written statements to courts and perjury. This should be easy to investigate, like flipping a nickel-bag dealer to get to the drug kingpin. Astoundingly, this easy-to-investigate felony (via notarized perjurious statements submitted to foreclosure courts) has yet to be prosecuted.

• Foreclosure mills, process servers: Law firms engaged in rampant fraud that corrupted the foreclosure process. If found guilty, those folks should be disbarred and jailed. Same for the “sewer service” process servers who threw away legally required notices to delinquent homeowners.

• Soldiers and Sailors Relief Act: Federal law protects active-duty service members from foreclosure and eviction. I find violation of this law reprehensible. If it were up to me, I would let the Special Forces — Navy Seals and Army Green Berets — handle this as they see fit.

Even with criminal statutes of limitations elapsing, we can achieve some measure of justice against the crisis wrongdoers. Lawyers can be disbarred and corporate insiders banned from serving in publicly held firms again. CEOs and CFOs can be fired. A significant investigation, with subpoena powers, a real budget and public hearings would go a long way toward restoring public confidence.

Schneiderman has an opportunity to create a legacy for himself that lasts far beyond the next election cycle. If he lacks the tools to do so, he should demand them or resign in protest.

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Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture.

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My Sunday Washington Post Business Section column is out. This morning, we look at the newly impaneled Office of Mortgage Origination and Securitization Abuses.

Print version had the headline A Chance for a modern Pecora Commission to right Wall Street wrongs.

It’s fair to ask: Is this new task force a meaningless exercise? The article looks at the ways to tell if this office is for real. How the structural set up of the office will reveal if this is a whitewash; further, the areas that get investigated will also tell us if this a serious investigation.

Here’s an excerpt from the column:

“So, here we are, four years after the great financial collapse, three years after the recovery began and in the last year of Obama’s term — and the president has finally decided to investigate the role of fraud in the great global financial crisis. Hence, this new task force — the unit of Mortgage Origination and Securitization Abuses — begins behind the curve. The statute of limitations is, in many cases, close to elapsing.

Even so, do not dismiss the investigation out of hand because of the timing: History informs us that a serious investigation can begin four years after the fact. Recall that Ferdinand Pecora was the fourth chief counsel for the Senate committee that investigated the Wall Street crash of 1929 and subsequent Depression. He was appointed in 1932 and received broad investigatory powers in 1933. His report ran thousands of pages. Thanks in large part to Pecora’s findings, Congress passed the Glass-Steagall Banking Act, which separated commercial and investment banking; the Securities Act of 1933, which established penalties for filing false information about stock offerings; and the Securities Exchange Act, which created the Securities and Exchange Commission to regulate the stock exchanges. Nearly 50 years of financial stability followed.”

The dead tree version of the paper has a classic photo of Pecora:

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click for ginormous version of print edition

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Source:
A modern Pecora Commission could right Wall Street wrongs
Barry Ritholtz
Washington Post, January 29 2012
http://www.washingtonpost.com/business/a-modern-pecora-commission-to-right-wall-streets-wrongs/2012/01/22/gIQAJ3uoYQ_story.html

Washington Post Sunday January 29 2012 page G6 (PDF)

What do the markets have to do with the election? Not much.
Barry Ritholtz
Washington Post, January 15 2012

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Just about this time every campaign cycle, the pundits get all excited about what Mr. Market is saying about the election: What does this candidate or that mean for the stock market returns? Will an incumbent victory bode well or poorly? Are stock prices telling voters which candidate will be friendlier to future market returns?

In a word, no. Markets do not rally or sell off because one candidate or the other is more likely to win. This might strike some as a bit radical, but here it is: Markets don’t give a flying fig about any of this nonsense.

First, consider the classic “causation/correlation error” — one that pundits make all the time. This occurs when two factors happen at similar times, and an assumption is made that one is causing the other. Correlation errors confuse cause and effect. Typically, a more significant but overlooked factor is driving the outcome.

Here is a classic example: “The incumbent’s poll numbers are rising, and the S&P 500 likes it. It has been rallying in response.”

Not exactly. There is a third explanation, and understanding this requires thinking about what is common to both incumbent polls and stock markets. Instead of assuming that one is causing the other, we need to look for broader forces that are driving both elements.

Most of the time when an incumbent is doing well in the polls, it is because the economy is doing well enough (or improving fast enough) that it is generating solid corporate earnings, strong hiring and positive consumer spending. That not only drives stocks and markets higher, but also makes voters feel economically secure. This works to the advantage of the sitting president. Note that the opposite is also true: Markets do not do poorly because the challenger is polling well; rather, the conditions that help a presidential challenger obtain victory — weak job availability, unhappiness with the economic conditions, desire for change — are negatives for earnings and the markets.

Don’t expect to hear this straightforward reasoning from the punditry. During the silly season, politicos and cranks push all manner of sophistry and ignorance onto an unsuspecting public. We’ve seen it in the editorial pages, from guests on my pal Larry Kudlow’s show, and all over the intertubes. Too many folks blame every twitch of the market as a reaction to the politician they like or dislike the most.

The shorter-term swings are especially nonsense.

Let’s consider what is driving day-to-day stock prices: It’s not expectations about changing capital gains taxes or broad shifts in health-care spending — issues that arguably can be game-changers in elections.

Rather, large hedge funds and high-frequency traders are the biggest participants short-term. The machine-driven mathematical traders have no interest in politics; their stock purchases are held for milliseconds, and their buying is driven by quantitative formulas that have nothing to do with any candidate. Hedge-fund managers certainly are not making bets dependent on the outcome of elections 10 months hence. They are more concerned with monthly, weekly and even daily performance. The technical factors driving what they do are far removed from whatever is happening on the campaign trail.

These simple facts never seem to get in the way of the op-ed writers at various journals who seem to favor arguments along these lines: “Worries about possible policy changes are weighing on markets ahead of the year’s presidential elections. Candidate X’s rise in the polls is a risk that is giving the stock market jitters. Stock prices are wobbling, all leading to uncertainty. (And the markets hate uncertainty.)”

This analysis — to use the word loosely — is misleading and flawed. Investors should avoid misconstruing information from polling and extrapolating it toward markets. Here are some other arguments to watch out for:

Misplaced credit and blame: Presidential blame and credit for the markets is greatly exaggerated. The U.S. chief executives get far more credit than they deserve for good markets, economies and business cycles. They also get more blame when the economy is weak than is reasonable or fair. This is true regardless of which party wins the White House, or where the economy is in its cycle.

The Obama bull market: Perhaps you don’t buy my arguments. Then you must obviously be rooting for an incumbent victory. Why is it that? Consider how the markets did under George W. Bush, the most recent “pro-business president.” Then imagine how markets probably reacted to the anti-business socialist from Kenya.

I have some disappointing news those of you who believe in such utter silliness: The S&P started at 850 the day Obama was sworn in; last week it hit 1292 — a better than 50 percent gain over three years. (If that’s anti-market, I’ll have some more, please.) In 2001, when Bush was sworn in, the S&P stood at 1343. He left at 850 — a decline of about 37 percent.

If you buy into the foolishness that presidents drive markets, than given his giant stock gains, Obama is your guy.

Anthropomorphizing markets: Politicos make another analytical error in the language they use: Markets “prefer” one candidate over another; polls are validated by short-term rallies; a disliked candidate’s latest stump speech is what drove the last sell-off. It is a trick used to frame issues, and it is disingenuous at best. Indeed, with these silly claims, pundits manage to combine all of the analytical errors discussed above.

Perhaps it helps to think of markets as future discounting mechanisms. Whenever an economy is slowing, markets price in the possibility of worse profits and sales. (My experience is this occurs three to six months in advance.) Markets are imperfect, subject to excesses of crowd behavior, but they get the big picture correct eventually. When the economy is improving, you will see that reflected in improving stock prices, often in advance of the stronger economic data.

Weak job creation and slow sales both affect equity prices, the electorate and the incumbent party’s election fortunes. When folks are content with the status quo and feel secure in their financial futures, they vote for more of the same; when they are not, they vote for change. Thus, the cause is the weakening economy and its discontents thereto. The effect is the rise of candidates claiming to be change agents — and the fall of those representing the status quo.

The underlying conditions that lead to strong equity markets — robust growth, job creation, brisk consumer spending, income gains, tame inflation, etc. — also work to aid the incumbent. It is not that markets like incumbents, it is that both markets and incumbents do better when the overall economy is doing well.

Putting the day-to-day noise into the larger context of quarters and years will help make you a better, smarter investor.

~~~

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. Twitter: @Ritholtz.

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My Sunday Washington Post Business Section column is out. This morning, we look at the false claims of the pundits about what markets “say” about elections.

The print version had the short headline The markets don’t care how you vote;
The online version has the longer What do the markets have to do with the election? Not much.

Here’s an excerpt from the column:

“Most of the time when an incumbent is doing well in the polls, it is because the economy is doing well enough (or improving fast enough) that it is generating solid corporate earnings, strong hiring and positive consumer spending. That not only drives stocks and markets higher, but also makes voters feel economically secure. This works to the advantage of the sitting president. Note that the opposite is also true: Markets do not do poorly because the challenger is polling well; rather, the conditions that help a presidential challenger obtain victory — weak job availability, unhappiness with the economic conditions, desire for change — are negatives for earnings and the markets.

Don’t expect to hear this straightforward reasoning from the punditry. During the silly season, politicos and cranks push all manner of sophistry and ignorance onto an unsuspecting public. We’ve seen it in the editorial pages, from guests on my pal Larry Kudlow’s show, and all over the intertubes. Too many folks blame every twitch of the market as a reaction to the politician they like or dislike the most.

The shorter-term swings are especially nonsense.”>

I really like what the Post did in the dead tree version of the paper — the layout and art work is great:
>
click for ginormous version of print edition

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>

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Source:
What do the markets have to do with the election? Not much.
Barry Ritholtz
Washington Post, January 15 2012  
http://www.washingtonpost.com/what-do-the-markets-have-to-do-with-the-election-not-much/2012/01/12/gIQAPygezP_story.html

Washington Post Sunday, January 15 2012 page G6 (PDF)

Investing in 2012: Get ahead of forecaster folly
By Barry Ritholtz,
January 1, 2012

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The new year has arrived, and so investors are inundated with all manner of lists: Best and worst stocks for 2012, forecasts of where the economy is going, favorite investments for the year and more.What’s an investor to do? You should start by ignoring those lists. Let’s conduct a little experiment to demonstrate why: Do a quick Google search for “where to invest in 2011.” I read through the first dozen or so. For the most part, the performance was pretty awful. Before the excuse-making starts — 2011 was an unusual year, the ECB/Fed intervened, etc. — let me clue you in to this fact: Forecasters are pretty awful every year.

Whenever I see one of those “Buy this now for the new year” columns, I diary them in my calendar or use the free Web site Followupthen.com. A year later, I look back at these recommendations and forecasts, and, for the most part, they’re terrible.

Because of this folly of forecasting, I try not to make many predictions. Whenever I am asked where the economy is going, who is going to win that year’s elections or what the markets are going to do, I steal a trick from the weatherman: Always couch your forecasts in probabilities. That way, when I am wrong — and anyone who pretends to know what will happen in the future will frequently be wrong — at least I can declare the outcome was an anticipated probability.

“As we stated last January, there was a 10 percent chance that the Federal Reserve’s Hobbensobbers were going to be trounced by the bond market’s Rebblesacks — and that’s exactly what happened!”

It’s a great cheat to avoid saying silly things in public that could come back to haunt you.

These are my 10 forecasts as to what the forecasters will be forecasting for 2012:

1 Stocks will trounce bonds this year: We heard this one a lot in 2010; it turned out to be wildly wrong. Stocks were flat in 2011, while bonds gained about 13 percent. Indeed, turning conventional wisdom on its head, bonds have outperformed stocks the past one, 10 and 30 years.

Hey, maybe stocks will beat bonds next year. If you keep making the same prediction, eventually it will come true.

2 Housing has bottomed: A perennial favorite from the usual suspects, who have been consistently, insistently and persistently wrong about this since residential real estate peaked in mid-2006. As the most recent Case-Shiller data show, home prices fell another 3 to 4 percent in 2011. From prices that remain too high to an excess of inventory to slow household formation, there are many reasons the bottom has not yet occurred.

3 Election forecasts: In politics, six months is a lifetime. Just look at how often the poll leader has shifted in the Republican nomination race over the past six months. Making a forecast 11 months out about politics is sheer folly. But consider: Lots of people will make forecasts about who will win the primary, what the final tickets will look like, who needs to win which states to gain how many electoral votes. The sheer number of forecasts means that someone will, if only by chance, get it right.

4 Buy these 10 stocks: You must buy THESE 10 stocks — not those 10 stocks or even these 10 stocks, but THESE 10 stocks. Looking back at all of these lists, it is surprising more people didn’t get something right, if only by accident.

The question investors should be asking themselves is why am I buying stocks at all and not simply indexing? Answer: Makes for too short an article.

5 The economy is better than the data suggest: We see this over-optimistic discussion every year. It is consistently wrong. If anything, data about the economy tend to overstate growth, employment and sales while understating inflation.

There is a period when the economy is better than the data show it to be: At troughs, when a long downturn is reversing itself. Are we at that sort of a juncture? Considering it has been nearly three years since the market lows of March 2009, and 30 months after the recession ended in July 2009, that hardly seems to be the case. The economy was better than the data implied in mid-2009, not today.

6 The Apocalypse is coming! This is the over-pessimistic view. Yes, we know, the end is near. You tell us this year after year, and it is terribly tiresome. After the Apocalypse, you have full license to say “I told you so.” Until then, please go away.

7 Banks will come roaring back: My favorite terrible forecast for 2011 was “Buy the Banks” (NYSE: XLF); a variant was “buy Bank of America” (NYSE: BAC). And just how well did that work out? The financial sector was among the worst performers of the S&P in 2011. In a year when markets were flat, financials fell 20 percent. As to Bank of America, it collapsed 60 percent, in percentage returns, the worst forecast of the year.

Every year some value managers come out pounding the table on whatever sector got beat up that year, regardless of the reasons for it. They are always sorry to learn that mean reversion is not tied to a calendar.

8 Hyperinflation: During the 2000s, we hardly heard forecasters say much about inflation. You might recall that during that decade, oil rallied from $20 to $147, foodstuffs skyrocketed, and education and health-care costs had double-digit annual gains.

Post-credit crisis, the economy has been in a deflationary mode. Asset prices are flat-to-negative, labor utilization is way below trend, and demand for goods and services remains soft. No matter how much money central banks print, these are not the factors that lead to Weimar Republic-like hyperinflation.

9 Buy gold: On a related note, the gold bugs got some comeuppance this year. As of mid-August, gold had gained more than 33 percent year to date (according to the gold-tracking ETF: NYSE: GLD). But the enthusiasm for the trade got way ahead of itself, and gold lost more than a quarter of its value, with GLD falling $46.59. After a spectacular decade of gains, the shiny yellow metal failed to achieve gains of even 10 percent in 2011 and was outperformed by bonds.

10 Buy emerging markets: Mulligan! This was another favorite forecast for 2011, and it was wildly wrong. China and Hong Kong were down 20 percent; India and Brazil were off by a third. The decoupling thesis never goes away — that despite the interconnected global economies, some regions will do well even when their biggest trading partners slide into recession.

The key thing you should remember when it comes to investing is that nobody truly knows what tomorrow will bring. Nobody. These predictions are, at best, educated guesses. Yesterday’s predictions are undone by tomorrow’s news. Circumstances change. New economic data are released. Unanticipated events unfold.

All good reasons to avoid forecasts altogether.

~~~

Ritholtz is chief executive of FusionIQ, a quantitative research firm. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. He previously discussed this subject in The Folly of Forecasting on 06/07/05.