No, the Political Futures Markets Didn’t Fail
Posted by Eddy Elfenbein on March 23rd, 2010 at 9:17 am

Just after the healthcare bill passed, Daniel Gross shows up to deliver his annual misunderstanding of the political futures markets:

Is there a larger lesson here? (Aside from the obvious one, which is political futures markets usually aren’t very good at predicting what actually will happen in the future?) I think so. And it’s this: Don’t short Obama. In fact, that’s been the lesson of Obama’s entire career so far.
Think of Obama as a stock. When he came onto the national scene, he was small and undercapitalized. Some investors (i.e., donors and organizers) went long, but plenty of the heaviest hitters bet against him. During the campaign, the prospects of his success were continually downplayed by the Clintons, the national media, and the Republicans.

Leaving aside his schoolgirl crush on the president, we have to once again say that political futures markets are not “predictions markets,” they merely odds setting markets. They attempt to place the odds that some event will happen in the future. And guess what, those odds can change!
Just because the odds for healthcare’s passing went from low to high doesn’t mean the markets got it wrong. Perhaps it was an accurate reflection of reality. As far as I follow these things, that seems to be pretty much what happened. After Scott Brown won in Massachusetts, lots of people thought healthcare was dead. The outlook changed and the futures market followed.
Also, the futures markets were correct in the end. The contract to pass healthcare cross 50 three weeks ago, and was running around 97 moments before the roll call, which had a margin of just four votes. Doesn’t sound like failing to me. Also, just because something happen doesn’t mean it wasn’t a long shot. That’s what odds are about. Shares of DuPont (DD) are at a new high today. Does that mean that the stock market has failed?
There are problems with the political futures markets. These markets tend to be very small and illiquid. I also think Intrade does a very poor job of selecting what real world events to follow. They should steer clear of things like who will be the Vice-Presidential or Supreme Court pick. That outcome is solely determined by one person’s judgment. The markets work better when they’re trying to determine the outcome of something with many more variables. Even the outcome of the healthcare bill was largely determined by Nancy Pelosi’s determinations (or intransigence, depending on your point of view).
The markets didn’t fail. They adjusted. That’s what markets do.

Odd Lots
Posted by Eddy Elfenbein on March 22nd, 2010 at 4:09 pm

Gary Gorton vs. Michael Lewis
Ritholtz’s Agenda for Financial Reform
Seabreeze’s Kass on U.S. stocks: ‘I have been wrong’
Buffett Better Credit Risk than Obama
RIP: Shirley Eleanor Nash
WW II bombs threaten AC/DC concert
Goat grabbing competition held in Kyrgyzstan
10 Luxury Business Hotels That Will Make You Forget You’re On Business

We’re Up 11.82% in Six Weeks
Posted by Eddy Elfenbein on March 22nd, 2010 at 3:58 pm

Today was an outstanding day for our Buy List. The average of our 20 stocks was up 0.95% which nearly doubled the S&P’s gain of 0.51%. Seventeen of our 20 stocks closed higher. Ten were up more than 1% and two were up more than 2%.
Since the near-term low on February 8, the S&P 500 is up 10.32% but we’re up 11.82%. That’s a 150 basis point outperformance in just six weeks.
Barron’s just noted that Gilead (GILD) is going for “only 12 times expected-forward earnings. The company has plenty of free cash and impressive growth.”

Gene Simmons on Estate Planning
Posted by Eddy Elfenbein on March 22nd, 2010 at 1:59 pm

From Bloomberg. Yes, Bloomberg:

Gene Simmons, singer and bassist for the rock band Kiss, said high-net-worth individuals should better prepare to protect their wealth after they die.
“You should know what your choices are in planning your estate,” said Simmons, co-founder of Cool Springs Life Equity Strategy, in an interview with Bloomberg Television in New York today.
Simmons said his company can benefit athletes and entertainers who earned fortunes without building financial expertise. Kiss has broken box-office records set by Elvis Presley and the Beatles, according to Simmons’s Web site. The band benefits from licensing agreements that sell apparel, wine bottles and jewelry emblazoned with the Kiss logo.

Kiss wine? It says too little and yet too much.

What If Women Ran Wall Street?
Posted by Eddy Elfenbein on March 22nd, 2010 at 1:41 pm

New York Magazine has an article provocatively titled “What If Women Ran Wall Street?” It says pretty much what you’d expect.
I will add one thing about finance and gender. Wall Street is the world’s capital of the overcompensating male. Far from the hunter-gathering, trading demands that your brain hunts, but physically you’re only gathering. There’s a huge disconnect and as a result, Wall Streeters are excessively aggressive and obnoxious. If any of these guys were in a real work crew or infantry platoon, their strutting behavior would quickly stop.

Is Krugman Now Pro-EMH?
Posted by Eddy Elfenbein on March 22nd, 2010 at 1:13 pm

Paul Krugman writes:

Andrew Leonard has a good point: if Obamacare is such a disaster for the economy, where’s the market reaction?
More broadly: the perceived probability of passage, as indicated by Intrade, was only around 30 percent a month ago (which is why I’m still rubbing my eyes). So the expectations of what we’re told would be a great disaster have risen dramatically. And the market has yawned.

I’m confused. Is Krugman is now praising efficient markets? I thought he was against all that.
Also, if the market falls from here, would that be enough for Krugman to support repealing healthcare reform? If there’s an Intrade contract for that, I’d be short.

Friday the Thirteenth and the Stock Market
Posted by Eddy Elfenbein on March 22nd, 2010 at 11:21 am

An academic study:

In this study, we investigate whether Friday the thirteenth has an effect on the stock market returns. We report the following findings: (1) The returns prior Friday the thirteenth are lower than normally prior the year 1981. (2) The returns after Friday the thirteenth are higher than normally after the year 1980. (3) Serial correlation in stock indexes is positive prior the year 1981 and negative after the year 1980. (4) Serial correlation between Friday and the following day is significantly lower after Friday the thirteenth. Thus, we conclude that the Monday anomaly is not more evident than Friday the thirteenth anomaly, and the anomalies may be interrelated.

Market Rallies after HCR
Posted by Eddy Elfenbein on March 22nd, 2010 at 9:48 am

Despite the healthcare bill passing last night or perhaps due to its passing, the stock market is up modestly this morning. I’m especially pleased to see our healthcare stocks rallying. One of my concerns about this year’s Buy List has been our heavy exposure to the healthcare sector.
Fortunately, those stocks have done fairly well so far. Medtronic (MDT), for example, is up over 3% today and is close to taking out its 52-week high. Gilead Sciences (GILD) is a 12% winner for the year and I think it has more room to run. Becton Dickinson (BDX), which is a medical device maker, is inches away from a new high.
Outside our healthcare stocks, Joey Banks (JOSB) is at another new high and Bed Bath & Beyond (BBBY) is up thanks to a very nice earnings report from Williams Sonoma (WSM).
Here’s the CEO of Stryker (SYK) discussing the impact of HCR on CNBC:

Looking at Bracketology
Posted by Eddy Elfenbein on March 18th, 2010 at 10:28 am

Today is the beginning of the NCAA Basketball Tournament and I wanted to discuss an aspect of bracketology that’s somewhat related to investing. (Yes, it’s one of those posts.)
Most pools following the linear scoring method (i.e. you get 10 points if a #10 seed wins), but the key to understanding the game is that the quality of teams are not spread out linearly.
Generally speaking, the better the teams are, the greater the gap between them and the next seed. The teams are really spread out exponentially. If I had to guess, I’d say that the difference between a #12 seed and a #5 seed is probably about the same as the difference between a #3 seed and a #1 seed.
Here’s something what it looks like:

The black line shows how the teams really are while the blue line shows you how points are awarded. (Note: This isn’t drawn to scale. I’m just trying to show you the principle.)
As a result of this mismatch between exponential reality and linear price, there’s an inefficiency to exploit.
I’ll show you what I mean.
The tournament expanded to 64 teams in 1985 so we now have 25 years of data. Here’s how many Sweet 16 appearances each seed has had over the last 25 years.
Seed…………….Sweet 16……………..Points
#1……………………88…………………… 88
#2……………………64…………………… 128
#3……………………52 ……………………156
#4……………………43 ……………………172
#5……………………36 ……………………180
#6……………………35…………………… 210
#7……………………18 ……………………126
#8……………………9………………………..72
#9……………………3………………………..27
#10………………….18……………………..180
#11………………….11……………………..121
#12………………….17……………………..204
#13………………….4……………………….52
#14………………….2……………………….28
#15………………….0……………………….0
#16………………….0……………………….0
I’ve also included a point total. As you can see, there’s an advantage in picking teams at the optimal spread between quality and points like the #10 and #12 seeds.
The invaluable Abnormal Returns guided us to the Geek’s Guide to NCAA Tournament Pools at Wired. The magazine looked at the bracket picks done by thousands of people at ESPN. They then compared the crowd’s picks with some statistical predictions by two college basketball analysts.
Sure enough, the crowd has responded to incentives. You can see that the crowd has tended to overpick the #10, #11 and #12 seeds (those are the cells in green on Wired’s chart). The process is repeated in the later rounds with the #4 and #5 seeds. (Wired notes that the crowd’s consensus bracket usually finishes in the 80th percentile.)
This is interesting because the crowd is doing two things. One, they can be overruling what the bracket committee did. Also, they seem to be paying close attention to seeding and acting accordingly.
This behavior illustrates an aspect of why CAPM doesn’t work. Historical research has shown that the most volatile stocks aren’t the best performers as they should be according to the model. Instead, they’re among the worst. This makes sense since people are probably willing to overpay for a long shot of a big payoff, and this leaves the “sure-things” underrepresented.
Selecting the #10 and #12 seeds is a good strategy in the early rounds, but just like momentum investing, it quickly turns against you. After the first two rounds, the most logical way to play the brackets is to select the favorite. Yes, it’s boring but it works—just like value investing.
In the basketball tournament, you can see how unloved the #1 seeds are (note the red cells). The key fact of investing is that the most conservative and ignored stocks are often the best investments.

Inflation Continues to Be Tame
Posted by Eddy Elfenbein on March 18th, 2010 at 9:37 am

Today’s CPI report shows that consumer prices were flat last month. Wall Street was expecting an increase of 0.1%. The core rate, which excludes volatile food and energy prices, rose just 0.05%.
Last month’s report was noteworthy since it was the first time since 1982 that the seasonally adjusted core rate had a meaningful decline. The core rate has now had its smallest year-over-year increase since 2004. Over the last four months, core inflation is running at just 0.66% annualized.