Quotable Quotes: Ignorance is Bliss

“What are the implications if originators no longer feel the need for due diligence, and the ultimate buyers do not have the skills or the information required to manage the risks inherent in the complex instruments they are buying?”
BIS 77th Annual Report

“As head of the financial stability unit at the Banque de France, Imène Rahmouni-Rousseau travelled to America this month to look at the current turmoil in the US subprime mortgage world. Although initially that had seemed an all-American saga, Ms Rahmouni suspected that French and other European investors also held assets linked to subprime securities. So on behalf of her central bank she wanted to assess the risks. What she discovered surprised her. There was little confidence about how to value the holdings. “Pricing data are difficult to obtain,” she says.”
Saskia Scholtes and Gillian Tett, FT article “Worries grow about the true value of repackaged debt”

“All you need in this life is ignorance and confidence, and then success is sure.”
Mark Twain

“Fear always springs from ignorance”
Ralph Waldo Emerson

“Make yourselves sheep and the wolves will eat you”
Benjamin Franklin

Have a good weekend.

Technical Thursdays: The (not-so-dumb) Little Guy

If the investment pros are the "smart money", then the little guy must be the dumb money. But is that true? Here are some facts to consider:


This chart contains the weekly data from the American Association of Individual Investors for 2007, up to last Friday. The blue bars are the net bullish over bearish results. The red bars are the 3 week moving average of the same data.






This is the weekly performance chart of the S&P 500 over the same time period.


So, what does the data reveal?


* The little guy was quite bullish right up the mini market correction of late February.
* He remained bullish, albeit less so, as the rally resumed.
* He swung dramatically to the bearish side just before the market flattened out in early May.
* He has remained neutral to slightly bearish ever since, moving slightly to the bullish side last week.

What does this tell us?

Investment Strategy Implications

According to this data, the little guy appears to have a little more on the ball than the "smart money" is willing to give him credit for. He rode the early 2007 bull run, then stuck around a bit too long. He bent but did not break as the mini correction shook the market. Then he resumed his bullish sentiment right up to the time when the market went flat.



Conclusion: Maybe not so dumb, after all.

To view a larger version of the above charts, click on the image.

An Orderly Decline

As investors await the FOMC’s rate decision, the focus of many will be on whether a rate cut is in the near future. However important such information is, the focus on these pages will be in the area of the balancing act the Fed must play between weak domestic growth, strong global growth, and fat tails and other uncertainties that financial innovation has wrought.

As the two month chart to your left shows, the equity markets seem to have settled into an orderly decline over the past month (note the tighter fit among the four major market cap sectors – large, mid, small, and micro). Its continued progress is dependent on the ability of the Fed to manage the delicate balance.

Investment Strategy Implicatins

It should be apparent by now that central banks around the world are seeking to deflate the liquidity bubble without bursting it. Call it a global soft landing, the aggregate concerns are centered on demand push inflation emanating from non US growth. The Fed has to strike the delicate balance between weak domestic demand and rising cost pressures from global growth, all the while being mindful of the risks presented by financial innovation. Based on the equity market’s behavior these past two months, investors seem comfortable with the economic environment. The consequences of failure will, however, produce a far more dramatic decline than most investors are prepared for.

You Don’t Know What You Don’t Know

Question: How knowledgeable do you suspect investors are with the following terms: Fat Tails, Complexity Science, Interdependency Risk, and Emergence? How familiar do you suppose investors are with phrases like “the brake becomes the accelerator”?

And how many investors are aware that “U.S. financial institutions now hold only 15 percent of total credit outstanding by the nonfarm nonfinancial sector: that is less than half the level of two decades ago. For the largest U.S. banks, credit exposures in over-the-counter derivatives is approaching the level of more traditional forms of credit exposure. Hedge funds, according to one recent survey, account for 58 percent of the volume in credit derivatives in the year to the first quarter of 2006.*”?

Investment Strategy Implications

If ever there was a case where the title of today’s blog applied, it is the state of investor knowledge regarding a transformed world, the “end of capitalism as we know it.**” Yet, many investors appear comfortable with the risk management tools of the financial engineers, and in the process have apparently bought into the idea that the social science of investing has become sufficiently exact as to resemble the physical sciences.

The problems surrounding the thus far contained crisis of credit derivatives, hedge funds, and Bear Stearns are simply a manifestation of this certainty gone awry. Yet, to get swept up in the obvious (i.e. contagion) is to fail to see the larger, more thematic, and, therefore, more significant picture.

Circumstances are far more complex than is apparent. We don’t know how deep the rabbit hole is. We don’t know what we don’t know.

*”Credit Markets Innovations and Their Implications”
Timothy Geithner
President and Chief Executive Officer, Federal Reserve Bank of New York
Vice Chairman, Federal Reserve Bank

**Tom Wolfe

Are We in Las Vegas or On the Titanic?

excerpts from this week's report

"This week all eyes will be focused on the FOMC meeting. And the much of that focus will be on the language re easing. This is a side dish to the far more important meal of understanding the position of the Fed vis-à-vis credit derivatives, spillover effects (a/k/a contagion), and Fed policy before, during, and after periods of stress.

The perma bulls will say that the current bout of problems centered on sub prime mortgages will not metastasize, and that the sub prime problems are a lot like Las Vegas - what happens in the sub prime space, stays in the sub prime space. On the other hand, the perma bears believe that sub prime problems are more like the Titanic - just the tip of the iceberg.

Whatever one’s view, the sense is that we are entering a very challenging period for asset managers. The stress fractures caused by..."

"Neither the global economy nor the financial markets have been stress tested re globalization and decoupling and credit derivatives and unregulated money. The sub prime problems of Bear Stearns may..."

"This is no longer Greenspan’s Fed. And the solution to every major financial crisis may not be blowing yet another bubble. In fact, in speech after speech, the emphasis by the Fed heads and Treasury Secretary Paulson is on..."

also in this week's report

* Current Blue Marble Research Fed Model
* Model Growth Portfolio
* Key Economic Indicators

Note: To view this week's report, please click on the Blue Marble Research services link to your left.

Quotable Quotes: Memo to Blackstone

While Congress contemplates changing the tax rules for private equity, here are a few sage quotes on taxes from 2 US Presidents (Reagan, Coolidge), 2 Senators (Goldwater, Long), and 2 economists (Friedman, Keynes):





“The taxpayer - that's someone who works for the federal government but doesn't have to take the civil service examination.”
President Ronald Reagan

“Collecting more taxes than is absolutely necessary is legalized robbery.”
President Calvin Coolidge

“The income tax created more criminals than any other single act of government.”
Senator Barry Goldwater

“A tax loophole is something that benefits the other guy. If it benefits you, it is tax reform.''
Senator Russell Long

“I am favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it's possible.”
Milton Friedman

“The avoidance of taxes is the only intellectual pursuit that carries any reward.”
John Maynard Keynes

Have a good weekend. (No doubt Schwarzman and Peterson will.)

Technical Thursdays: What’s the Deal with Intel?

Rare is the occasion when a devout ETF-only investment strategist ventures into the individual stock space, but it is hard not to notice the two incredibly bullish technical signals re Intel.

To begin, INTC’s momentum and MACD data are very positive. And its relative strength vis-à-vis the broad market has finally emerged after years of dismal results. But it is the plain old chart pattern stuff that really leaps out. As the chart to your left shows, the multi year downtrend line has recently been broken. Moreover, the upside breakout has taken place at precisely the top end of what looks like perhaps the single most powerful bullish pattern: an island reversal. Granted, this last point could easily be reversed, as the upside gap is all of a ¼ point. However, if the gap does not close, INTC will have produced the rarest of the rare: a one year plus island reversal.


Investment Strategy Implications

Since the bull market started over 4 years ago, the semiconductor group has trailed the broad market very badly. Competitive issues, among other factors, have been a drag on revenues, earnings, and corporate profitability. So, when the technicals of a leadership stock like Intel produce what appears to be a major upside breakout, it’s worth taking a closer look.

*Disclosure: Blue Marble Research has established long positions in INTC in several accounts that it manages. No shares of INTC are owned by Catalano nor by any members of his family.

Curiously Oscillating Around Fair Value

Is it a coincidence that the market appears to be oscillating around fair value?

Using my updated modified Fed Model (see table to your left), the expected return for stocks has traded right around 0% for the past several weeks, thanks to the combination of higher stock prices and higher interest rates. Coincidence? Maybe. However, since reaching these levels, the market has largely stagnated despite several outstanding earnings results reported thus far, not much in the way fearful pre-announcements, and expectations that 2Q07 GDP growth will rebound to a 4%+ number. Coincidence? Maybe. Or perhaps investors are toying with the idea of moving into overvalued territory, a zone it hasn’t occupied since the bubble days.

The bulls would argue that adding 90 basis points to the base Fed Model* is a mistake and that a lower risk premium/higher capitalization rate resulting in a higher valuation level is justified. I guess that's what makes it a market. What cannot be argued, however, is the need for a valuation guidepost in which investors can play their “What if?” scenarios.

Of course, one can debate whether any valuation model makes sense, even in the most predictable of times (which, despite trends like the “Great Moderation”, these are not). This is understandable, given the highly subjective nature of valuation. Nevertheless, we investors are compelled to render such view. No getting around this fact of investing life. Therefore, I invite you to consider what your Fed Model inputs might be and whether fair value has been reached.

*The extra 90 basis points is the average risk premium/capitalization rate added throughout this bull market. This was noted in last Friday’s Financial Times article in which I was quoted (see excerpt in left column below).

The Mind of the Chairman

There is little doubt that the actions of the Fed have a powerful influence on the financial markets. And if the Fed has a chairperson who commands respect, then it behooves all investors to try and understand the mind of that individual.

Last Friday, Ben Bernanke gave a speech that, in my opinion, revealed much of his fundamental perspectives on key aspects of monetary policy. In a speech titled “The Financial Accelerator and the Credit Channel”, Chairman Bernanke described and expanded upon his original 1983 work on the same topic. The speech was most informative on a number of levels, including the his view of non-bank lending.

In the traditional areas of credit creation (specifically bank lending), Bernanke's financial accelerator thesis is useful in “understanding the nature of the monetary policy transmission process.” It is also useful in understanding the Chairman’s view of the current housing slump and how “If the financial accelerator hypothesis is correct, changes in home values may affect household borrowing and spending by somewhat more than suggested by the conventional wealth effect because changes in homeowners’ net worth also effect their external finance premiums and thus their costs of credit.” Given the importance of the US consumer, how the Fed views the impact of the current housing slump on consumer spending should be of great interest to all investors.

Yet, it is Mr. Bernanke’s comments re non-bank lenders that, unfortunately reserved to the next to last paragraph, investors might wish take special note. Chairman Bernanke believes that “non-bank lenders also face an external finance premium” and that “the ideas underlying the bank-lending channel might reasonably extend to all private providers of credit.” In other words, he sees little reason to view the explosion in non-bank sources of capital any differently than bank lending. This could be a big mistake as the Fed could easily underestimate the "financial accelerating" characteristics of this powerful, largely unregulated force of money.

Investment Strategy Implications

The speech is of value to all non-economists if not for anything than as a worthwhile exploration of many of the key concepts that nearly all economists rely on. Since most investors are not practitioners of the dismal science yet markets are heavily influenced by their opinions, a better understanding of how an economist thinks is always of value. It is of even greater value when the speech is from the single most important financial figure in the world and on a subject that is clearly close to his heart.

To view the speech, Click Here

The Skeptic and the Cheerleader

excerpts from this week's report

"Investment styles boil down to whether an investor is a contrarian or a momentum player. Is an investor naturally skeptical and takes with a grain of salt every news story that describes how great things are and will be for the foreseeable future? Or is that investor emboldened to join the party and shout “Booya” with every market advance?..."

"Slow growth developed countries, most notably the US, have been on a high consumption binge with capital flows rushing out the export door at a fairly quick pace. At the other end of the capital flow channel, high growth, slow consumption emerging countries gladly accept the money flows, which they then export that capital right back to the slower growing, higher consumption developed countries in the form of..."

Investment Strategy Implications

"As noted many times before, financial innovation and globalization are two major themes that are altering the economic and financial landscape in an unprecedented manner. And on a scale and scope that dwarfs previous occurrences.

Perhaps all’s well that ends well. Perhaps the concerns..."

Note: To view this week's report, please click on the Blue Marble Research services link to your left.

Quotable Quotes: Four Bills

“In 2007 alone, nearly 2 million mortgages will adjust their yields and required monthly payments skyward by an average of 250 basis points. Similar hikes loom ahead in 2008.”
Bill Gross

“As I also like to remind our analysts, if it’s in the papers, it’s in the price.”
Bill Miller

“If GM had kept up with technology like the computer industry has, we would all be driving $25 cars that got 1000 MPG.”
Bill Gates

“Oh, nothing. It was a game of two and I got there first.''
Billy the Kid

Have a good weekend.

Technical Thursdays: Diverging Trends

As the equity markets work off their deep oversold conditions, it is most productive to measure the breadth of the upside move. The two charts to your left are useful in gauging the current power of the move. Both utilize the advance/decline line - one for the NYSE, the other for NASDAQ.

The NYSE chart (first one) is very short term (two months) and points to the confirmation process that the current rally would need to produce should the S&P 500 climb to a new all-time high. As the chart shows, the potential exists for a first time in this bull market non-confirmation of price and a/d. Too early to say for sure, but worth monitoring fairly closely. However, it is also worth noting that both momentum and MACD are signaling a continued weakness to the power of the move - a point first made in my May 23rd blog entry.

The NASDAQ chart (second one) is fairly long term (five years) and clearly shows a very serious divergence between the index and the a/d. Moreover, the recent bull run has been met not with confirming strength but further deterioration. This is the single most significant divergence to the overall bull market, but one that has yielded little beyond a curiosity as the index has marched to new recovery highs regardless of the breadth of that market.

Investment Strategy Implications

The ever present mountain of liquidity will clearly need to take some time to work off. However, the potential of a market topping process is in place, especially when you have substantial technical damage via the recent market drop.

Valuation Update: Expectations of a 16% Increase in Earnings

This morning's retail sales number makes it clear that the correction experienced thus far is solely an interest rate related event. As my modified Fed Model to your left shows, at current levels (light blue) the expected return for stocks is right around zero. Clearly, investors do not believe in earning a flat to negative return. Therefore, let's look at what earnings level the market is pricing in to generate a positive return.

Assuming that rates rise another 25 basis points and taking your standard 12% expected return for large cap US stocks, the earnings needed to generate such a 12 month return for equities equates to $108 in operating earnings for the S&P 500 (lavender). That's $108 for the next twelve months, to mid 2008.

Of course, if investors believe that the market should not price in an added risk factor of 90 basis points (something it has done throughout the current bull market), then something less than $108 would generate a 12% return.

Investment Strategy Implications

Just as many bond investors have had to adjust their thinking re Fed rate cuts and the global inflation/US domestic stagflation, so, too, equity investors may have a similar adjustment process to go through should the next 12 months earnings growth not match current expectations. A key will be the upcoming 2Q07 earnings reports and guidance commentaries that should help shed light on the earnings part of the valuation equation.

At current levels, expectations of $108 operating earnings (which represents a 6 month earnings increase of 16%) seems a bit overly optimistic. Needless to say, the potential disappointment factor is quite large should earnings go the other way, say to $88 (yellow for yeow!).

Hedge Fund Seminar Observations: A Soprano-like Ending

One of the major benefits that come with conducting events over a given period of time on an important topic such as hedge funds, it helps to provide a unique perspective. As a result, yesterday’s Hedge Fund seminar produced here in San Diego was remarkable on several levels. Most notable was the degree of sanguineness regarding certain risks that was at odds with the sentiments that were raised at the previous such seminars that I have conducted over the past four years. Perhaps it had to do with the specific work performed by the four panelists. Or, perhaps, it is a reflection of the comfort bull markets generate. Hard to say but certainly not hard to notice.

One of the risks that I am referring to is the risk management capabilities of hedge funds in general: the ability of hedge funds to manage the downside risks that are inherent in leveraged strategies. Blowups may be inevitable but none of my four panelists seem to be particularly concerned with a systemic contagion. This was surprising to me considering the fact that both the nominal and leveraged amount of money in the alternative investments world (hedge fund/private equity) has grown considerably over the past four years.

Another risk that I raised that did not seem to produce much in the way of a concern was the issue of correlations, within and across markets. A point made by one of my panelists was a belief that, while the markets may be highly correlated, the world’s economies are less so. This is the decoupling story, one that in my opinion has not been tested.

Investment Strategy Implications

As informative as yesterday’s event was (they always are), the standout item was the degree of sanguineness of my expert panelists. Fear and concern was fairly absent. As I stated above, perhaps this was a reflection of the unique markets or experiences that my panelists operate in. Or it is a sign of a broader investor sentiment. Hard to say, but definitely not hard to notice. In this case, I will take a page from the final episode of The Sopranos and let you decide what the outcome will be.

Time for a Little “What If”

excerpts from this week's report

In light of last week’s upside breakout of the 10 year Treasury rate complete with confirming momentum and MACD (see chart in this week's report*), perhaps it’s time to play a little “What if” with our modified Fed Model.

What if rates continue to rise by another 50 basis points? What if earnings growth disappoints over the next twelve months producing a modest decline to, say, $88 operating earnings for the S&P 500? What might be the likely market impact?

As our modified Fed Model shows (see table in this week's report*), a market decline of approximately 10% from current levels is not out of the question (and some might say long overdue)...

Investment Strategy Implications

Given the highly correlated nature of ALL equity markets, a self reinforcing downward spiral could easily develop, particularly if weakness continues into the end of the current quarter and portfolio managers...

*subscription required. For more info, click on Blue Marble Research services link to your left.

Quotable Quotes: The Blind Men and the Elephant

"Rates go up, stocks plunge."

Maybe it's more than that. Consider the following parable:


The Blind Men and the Elephant

It was six men of Indostan, to learning much inclined,
who went to see the elephant (Though all of them were blind),
that each by observation, might satisfy his mind.

The first approached the elephant, and, happening to fall,
against his broad and sturdy side, at once began to bawl:
"God bless me! but the elephant, is nothing but a wall!"

The second feeling of the tusk, cried: "Ho! what have we here,
so very round and smooth and sharp? To me tis mighty clear,
this wonder of an elephant, is very like a spear!"

The third approached the animal, and, happening to take,
the squirming trunk within his hands, "I see," quoth he,
the elephant is very like a snake!"

The fourth reached out his eager hand, and felt about the knee:
"What most this wondrous beast is like, is mighty plain," quoth he;
"Tis clear enough the elephant is very like a tree."

The fifth, who chanced to touch the ear, Said; "E'en the blindest man
can tell what this resembles most; Deny the fact who can,
This marvel of an elephant, is very like a fan!"

The sixth no sooner had begun, about the beast to grope,
than, seizing on the swinging tail, that fell within his scope,
"I see," quothe he, "the elephant is very like a rope!"

And so these men of Indostan, disputed loud and long,
each in his own opinion, exceeding stiff and strong,
Though each was partly in the right, and all were in the wrong!

So, oft in theologic wars, the disputants, I ween,
tread on in utter ignorance, of what each other mean,
and prate about the elephant, not one of them has seen!

John Godfrey Saxe (1816 - 1887)

In a complex world, sometimes the truth requires a more holistic view.

Have a good weekend.

Technical Thursdays: Part II - On the Cusp?

Given the severity of the market decline thus far today, there are two technical analysis rules of thumb that bear noting:

1 - If the advance/decline and volume ratios equal or exceed 10x (up or down), a major trend change is underway.

2 - Chart pattern trendline breaks are significant, especially if they occur out of chart patterns that signify trend reversals.

As of 2:30 PM today, both of the above conditions are met. The up/down ratios for both stocks and volume is >10x and the chart pattern reversal - Rising Wedge* - has solidly broken its uptrend line.

If all conditions hold until the close, expect market technicians to trumpet the above.

My bet: the a/d and volume ratios don't hold and the market rallies enough by the close that will encourage the bulls (even embolden them, buy-the-dips mentality) and disappoint the bears (what's left of them). If I am wrong, things are likely to get very nasty.

*see May 24 blog entry

Technical Thursdays: Risky Business

If there is a fault line to the market that has the potential of turning what has passed for a market correction thus far into the real deal (>10%), today’s excellent Wall Street Journal article ("The Sure Bet Turns Bad") on hedge funds, investment banks, and sub prime derivatives may be it. As the chart to your left shows, the price action of the big investment banks appear to reflect a concern that may be more widespread than simply “rates are rising, stocks go down”.

As you can see, only Goldman (blue) is beating the market thus far this year, with Bear Stearns (maroon), the focus of the Wall Street Journal article, marooned at the bottom of the performance list. Coincidence or an indication of heightened risk?

Investment Strategy Implications

Investment banks are at the epicenter of the financial innovation universe. And, as has been noted on this blog and in my reports, financial innovation is pushing the envelope in ways no one, literally no one, has a real firm grip on. Since gaining insight into the consequences of financial innovation and engineering is, at best, a work in progress, perhaps the markets can help.

Granted, there are many other aspects as to why the common stocks of complex financial institutions rise and fall. After all, they are levered to the market and economy. But it is hard to ignore the potential connection between financial innovation and risk.

Perhaps the price action of the major US investment banks is trying to tell us something.

Note: A worthwhile visit to International Swaps and Derivatives Association is in order.
http://www.isda.org/

And, to gain a sense of one measure of the growth in derivatives, visit
http://www.isda.org/statistics/pdf/ISDA-Market-Survey-historical-data.pdf

The Complacent Correction

Perhaps my May 24th forecast of a market correction (see blog posting, “4 Reasons Why a Market Correction is Imminent”) is now underway. If so, the issue then becomes just what type of a correction will this be?

I submit to you the following three versions of a market correction that US stocks are likely to experience:

1 – The Alfred E. Newman Correction

This version is more anecdotal than quantitative and easily fits in magnitude with version #2 below although less violent, a relatively tranquil-like downward float. The strategist and pundit talk should center on the “healthiness” of a correction - which is a true statement but of concern when accompanied by a sanguine tone. The quantitative manifestation of this version follows.

2 – Painfully Short and Sweet (scare the bejesus out of ‘em) Correction

In 2005, 2006, and early 2007, this version (<10%) has been the correction du jour. Sharp down, seemingly out of the blue, yet, when completed, not all that bad. Kind of like some nasty tasting medicine – bitter but brief. Final damage is in the 5 to 8% range.

3 – The Real Deal

The US equity markets have not experienced this version at any point during this entire multi-year bull market. I am speaking of the >10% variety. A steady corrosive decline down (versus the sharp, sweet #2 version) that, after a while, shifts sentiment from complacency to concern to capitulation.

Investment Strategy Implications

Regardless of which version you think will occur (I suspect most will opt for versions 1 or 2, which means the contrarian in me says to lean toward version #3), the issue of what to do comes to the fore. If you believe in version 1 or 2, then you’re a buy-the-dip investor. After all, that’s what has paid off recently*. If you’re a version 3 person, however, then the issue of correlations becomes a consideration.

Given the high degree of correlations among and within markets, the ability to “bury the money in defensive issues” is taken somewhat off the table. Granted, there is some comfort in the lower beta aspects of certain sectors and styles, but in fully synchronized, highly correlated markets, across the board losses tend to be more certain. Accordingly, non-correlated assets are nearly impossible to find, which leaves only the asset allocation decision as a tactical course of action for most investors. And that may a problem for some, as it is a market timing approach that many investors (as opposed to speculators) are not completely comfortable with.

Note: Going into this week, the Model Growth Portfolio (MGP) is currently 86% in equities with several hedged positions, including a short in long term US Treasuries (TLT) and a long position in the Ultra Short QQQQ (QID). To learn more about the strategies employed and MGP, click on the Blue Marble Research services link to your left. A modest subscription is required.

*see May 29 blog posting "Just How Smart is the Smart Money" re the behavioral finance tendency of recentness.

The New PE Ratio

It can be heard with increasing frequency that your standard P/E (price to earnings) ratio should be replaced with a new PE (private equity) ratio. As the chart to your left shows, the combination of stock buybacks and PE deals is reducing supply of equities and, thereby, adding fuel to the bull market fire.

At around $2 trillion and counting, corporate cash and PE deal money (not to mention the $1.5 trillion in cash plus the 4 to 8 times leverage from the hedgies) are clearly having a profound impact on many areas of the investment landscape.

Investment Strategy Implications

Equity valuation 101 teaches us that private market values are always higher than public market values. Accordingly, investor expectations can be reset to a higher level if enough investors believe more deals are on the way. A price to deal ratio, if you will.

As with all new era talk, however, it is advisable to temper the enthusiasm as expectations based upon a continuation of the extraordinary stock buyback + PE driven deals at the current pace may not be sustainable resulting in PEs reverting back to P/Es.

The Frontiers of Finance

excerpts from this week's report

“…investment banks have recently changed out of all recognition.”

“We make it impossible for investors and analysts to understand what is going on.”

“A Special Report on International Banking”
The Economist
May 19, 2007

"Next Monday, I will moderate my next Hedge Fund/Alternative Investments seminar for the CFA Society of San Diego. Having conducted numerous such events over the past 4 years, I have a fairly good idea as to one of the main topics to be discussed – risk. Specifically, where does the risk in hedge funds reside? The bottom line answer will almost certainly be (as it has before), “no one knows for sure.” The intermediate answers are complements of the financial engineers at the investment banks – derivatives in all its forms.

At just north of $500 trillion, derivatives are not just staggering in size. They are, more importantly, a black hole of..."

Investment Strategy Implications

"The boundaries of finance are being stretched and tested in ways and on a scale and scope never before seen. The 21st century masters of the universe are producing products designed to satisfy the needs of their clients and the marketplace and, in the process, reaping the rewards for their firms. As long as global conditions remain conducive for growth and stability (liquidity and benign economic conditions), the problems may not..."

Note: To view the entire report (including the all-ETF Model Growth Portfolio) and for information regarding our subscription service, please click on the Blue Marble Research services link to your left.

Quotable Quotes (and a little V - TV)

“…we remain alone in our view that S&P 500 earnings are the most cyclical in history (dating back to 1940!). If that is true, then one should be careful when making statements about low PE ratios for the overall index. If earnings are indeed the most cyclical in history, then a low PE might simply reflect peak earnings.”

Rich Bernstein

“We have trouble recognizing how much information is enough and how much is too much. We pay excessive attention to low-probability events accompanied by high drama and overlook events that happen in routine fashion. We treat costs and uncompensated losses differently, even though their impact on wealth is identical. We start out with a purely rational decision about how to manage our risks and then extrapolate from what may be only a run of good luck. As a result, we forget about regression to the mean, overstay our positions, and end up in trouble.”

Peter Bernstein

"There are two kinds of investors, be they large or small: those who don't know where the market is headed, and those who don't know that they don't know. Then again, there is a third type of investor - the investment professional, who indeed knows that he or she doesn't know, but whose livelihood depends upon appearing to know."

William Bernstein

“To achieve great things, two things are needed; a plan, and not quite enough time.”

Leonard Bernstein


…and for a little V – TV, see the following blog entry.


Have a good weekend.