Thursday, August 30, 2012

Fisher, Wall Street Women

As a graduate student in anthropology at Columbia, Melissa S. Fisher decided to focus her research on a perhaps unlikely group—the first generation of women to establish themselves as Wall Street professionals. Wall Street Women (Duke University Press, 2012) is a reworking of her dissertation.

The women Fisher studied arrived on the Street in the 1960s, a time when female college grads were often being hired as secretaries and the glass ceiling was a skyscraper away. Women were by and large relegated to the role of support staff; about the most they could hope for, if they were mathematically trained, was to assist in converting the stock exchange’s punch cards to computer data. “Computer programming was, at the time, viewed as a female occupation. Women’s ‘natural’ feminine traits—being patient, detail-minded—were understood to make them ideal computer programmers.” (p. 37)

Almost all of the women who eventually moved up the corporate ladder started off as back-office researchers. (By the way, so did Muriel Siebert.) They were paid significantly less than their male counterparts, and they were not invited to participate in formal training programs. To learn their craft they were largely dependent on the willingness of male mentors. Outside of their firms, however, the women had a support network and an alternate training ground: the Financial Women’s Association of New York City, founded in 1956.

As time passed and Wall Street firms opened their doors to more women and minorities, the original group of women became more visible and successful, although of course none of them broke the ultimate glass ceiling. Nor did the women who followed them. We have only to think of the prominent women who were once considered potential CEO material, only to be summarily fired—Zoe Cruz, Erin Callan, Sally Krawcheck. Ina Drew is a different story, but nonetheless yet another blow to women’s aspirations.

Fisher’s book is not an account of Wall Street careers per se. The women share their often diverse feelings about feminism, politics, affirmative action, and the younger generation of women on the Street. Moreover, Fisher gives theoretical context to their careers by invoking such concepts as corporate neoliberalism and state-market feminism.

Fisher is torn when it comes to gender stereotypes. For instance, she admits that commonly accepted images of women—for instance, that they are risk averse—actually worked to the advantage of this initial cohort of women. When women stepped out of their traditional roles and opted to work in risk-oriented positions, “Wall Street treated them as the ‘anti-mothers’ of the professional-managerial class.” They “threatened the gendered order of firms as well as men’s agency and power.” (p. 98)

If there had been no financial crisis, Fisher would probably have unequivocally defended these “anti-mothers.” But times have changed. There are calls for a “feminization” of markets and for a more “caring” and “softer” capitalism. “Motherly women” have been “touted as the potential rescuers of the global economy.” “The biological system is being directly linked and mapped onto the financial system in strikingly gendered ways.” (p. 172)

Fisher embraces this vision of the future feminization of financial capitalism. I have my doubts, and worries. But then I guess I’m just a skeptical anti-mother.

Monday, August 27, 2012

Brady, Income Investing

I’ve read more than my fair share of books on bonds and have always ended up feeling—well, stupid. Somehow I never seemed to grasp the fundamental structure of bonds. I understood the periphery but not the core. I am happy to report that my stupid days are now behind me, at least on the bond front. Jason Brady’s Income Investing: An Intelligent Approach to Profiting from Bonds, Stocks, and Money Markets (McGraw-Hill, 2012) made all the difference. (And not because it has the word “intelligent” in its subtitle.)

I suspect that Brady might be surprised at my eureka moment. He has, after all, written a practical book for investors who are reaching for yield (something that, as he explains, might be a chimera), not a guide for the perplexed. Nevertheless, when he described bonds in terms of options everything fell into place for me. Bingo!

Brady suggests that we “think about investment in fixed income as selling an option.” (p. 102) Bonds have an asymmetric payout profile, so “both in purchasing a bond and in selling an option the investor takes a small risk of a larger loss in order to receive some small payment.” (p. 106) Not exactly the clich├ęd picking up nickels in front of a steamroller, but certainly more dangerous than many bondholders have been led to believe.

Corporate spreads are, for instance, highly correlated to the VIX. “So when volatility spikes during market stress periods like the Asian Financial Crisis, the Enron/WorldCom debacle, or the Global Financial Crisis of 2008/2009, corporate bonds react in a very nonlinear way. To put it another way, bond investors look at the value of their coupon payments when times are good, but look to the value of the assets that they’re going to receive when times are bad. When the overall value of the asset has a chance to move below the strike price because of volatility spikes, the premium on the covered call suddenly becomes a lot less immediate than the claim on the asset itself.” (pp. 113-14)

One point that Brady hammers home is that yield is a terrible measure of return. There is, however, one place where yield can have value—as a downside cushion. “For most fixed-income instruments, the only protection the investor has against loss is the income return of the bond. There are any number of ways to lose money in bonds and not very many ways to get more than yield. But when prices decline for whatever reason, the total return you receive from bonds can still be reasonable if the yield on the bond is high. … The margin of safety in U.S. Treasuries is low.” (pp. 116-17)

Unlike investors in stocks (well, at least during bull markets) corporate bond investors are a gloomy lot, in part because they have sold the upside to stockholders. Bondholders want a low volatility environment; stockholders want stocks to move ever higher.

One way for the income investor to bridge the gap between bonds and stocks is by owning dividend-paying stocks which, when things go reasonably well, provide both income and capital appreciation. Dividend payers, by the way, have a record of outperformance. From January 1992 to June 2011 the DJ Dividend Select Index had a total return of 12.8% whereas the DJ Total Stock Market Index returned 9.8%. The MSCI World High Dividend Yield Index returned 10.7% as opposed to 2.3% for the MSCI World Index. And the MSCI EAFE High Dividend Yield Index returned 11.8%, the MSCI EAFE Index 7.2%. Somewhat counterintuitively, “the outperformance by dividend-paying stocks is not just due to their income properties, but due to the growth of earnings as well.” (p. 152)

Investing in dividend-paying stocks has been something of a fad of late, but the fad may be waning. For a short-term take on rotation out of these stocks, I suggest Bespoke Investment Group’s piece from August 17, "How Rising Rates Make Dividend Stocks Less Attractive."

Brady describes several income-producing vehicles that investors might want to consider. In whatever way investors structure their portfolios, however, they should always exercise due diligence, diversify their holdings, and stay the course.

I’m pretty sure that I’ll be the only slow learner to thank Brady for looking at bonds through the lens of options. Moreover, I apologize to the author for not giving equal time to some of his other ideas. But eureka moments happen rarely these days, and I am very grateful for them.

Wednesday, August 22, 2012

Wildermuth, Wise Money

Wise Money: Using the Endowment Investment Approach to Minimize Volatility and Increase Control (McGraw-Hill, 2012) by Daniel Wildermuth covers a lot of familiar ground. Think back, for instance, to Meb Faber’s The Ivy Portfolio (2009). But I suppose it’s worth going over this ground again.

Wildermuth, the founder and CEO of Kalos Capital and Kalos Management, describes “how the smart money invests”: in domestic and international equities, real assets, private equity, absolute return funds, and fixed income. His discussion of asset allocation is particularly apt for the high net worth individual, but investors with smaller portfolios can make the appropriate adjustments and still mimic the endowments.

One point that Wildermuth stresses and that, I think, merits some space here is the illiquidity advantage. “Liquid investments usually cost more and are worth more than similar illiquid investments because nearly all investors value liquidity.” But liquidity “introduces volatility, which most investors try to avoid. Nearly any asset that can be bought and sold on a daily basis prices according to current demand. Since demand for liquid investments can change markedly and quickly, prices can as well.”

“Liquidity premiums can only be approximated and vary across time and asset classes. As an example, a real estate holding that transitions from an illiquid structure to a readily tradable stock has historically increased in value a bit more than 10 percent. With stocks, the premium is usually much greater, oftentimes approaching or even exceeding 100 percent.” (p. 38)

Wildermuth claims that “a very common mistake made by most investors is assuming that their entire portfolio must be liquid.” In fact, since most people have investment time horizons closer to decades than months, “a completely liquid portfolio is usually undesirable for most individuals. The reasons are simple. Performance and diversification possibilities are missed, and the flip side of liquidity for investments with strong return possibilities is virtually always volatility.” (p. 41)

The author suggests that “a significant percentage of a portfolio, possibly even up to 40 to 50 percent, may be prudently invested in assets that have limited or unpredictable liquidity.” (p. 50) Investors with, let’s say, a $500,000 portfolio simply don’t need a supersized emergency fund.

For those investors who are unfamiliar with the endowment model Wise Money provides a good introduction—nothing revolutionary but useful nonetheless.

Monday, August 20, 2012

Chincarini, The Crisis of Crowding

Ludwig B. Chincarini has written a compelling book. The thesis of The Crisis of Crowding: Quant Copycats, Ugly Models, and the New Crash Normal (Bloomberg/Wiley, 2012) may not be a paradigm shift, but the detail with which it is documented makes for fascinating reading.

In the beginning was Long-Term Capital Management and the 1998 crisis. As Chincarini contends, “the 2008 financial crisis really began 10 years earlier.” LTCM had a portfolio of trades, mainly relative value and convergence trades in the fixed-income swap and bond markets of OECD countries, that seemed to be statistically and economically uncorrelated. LTCM had, however, also ventured into “less lovely territory,” including directional bets that made up about 20% of the portfolio. They were short the U.S. swap spread, a position that carried with it an unlimited downside risk in the event of a world crisis when traders would flee to quality and the spread would widen. They were also short long-term volatility.

“LTCM knew these trades weren’t perfect, but may have kept them on in the interest of diversification. But crowds were developing, and that was affecting trades. With every call to a dealer, with every cocktail party between dealers, and with every quant trying desperately to reverse engineer LTCM’s success, word traveled and more investors copied LTCM’s moves. The beautiful trades were getting ugly, with smaller expected profits and a new danger: the danger that copycats might rush for the exit at inopportune moments and cause dramatic changes among trade correlations. That’s just what happened in August and September 1998, when Russia defaulted on its debt, the copycats ran for the exits, and the Titanic of hedge funds sank into the chilling water.” (pp. 68-69)

Chincarini claims that ignoring the broad lessons from LTCM’s failure was, “in part, the cause of a much greater systemic financial collapse in 2008 and 2009.” (p. 101) He thinks that there were twelve lessons to be learned, among them: “1. Understanding saturation and interconnectedness is important for measuring risk and liquidity. 2. There are limitations to any risk management system. Risk measures should include some aspect of valuation. 3. Appropriate leverage depends on underlying volatility, but any amount of leverage with any amount of underlying risk can lead to bankruptcy.” (p. 119)

Before the Bear Stearns collapse, however, came the quant crisis in 2007. It lasted only about ten days but did irreparable damage to many quantitative equity funds. Theories abound as to what (or who) caused the crisis. The author argues that “a shocked, crowded space caused the quant crisis. As quantitative managers began closing positions, they put pressure on other managers to close positions or face margin calls. That pushed prices even lower.” (p. 137)

We know only too well what followed in 2008, at least in its broad strokes. Chincarini, who conducted interviews with many of the players in the various financial crises, again fills in some important details and offers lessons for the future.

Oh, yes, and then there was the flash crash. The author maintains that the Waddell-Reed trade was simply too small to have caused the flash crash. It’s possible that “HFT activity caused data overload in some of the NYSE Arca’s out-of-date systems. Jittery markets combined with a flood of orders and old computers to create a computer glitch at the NYSE Arca. This directly caused the Flash Crash. Chaos ruled those three minutes because faulty data scared off liquidity providers. Amazingly enough, the liquidity providers all ran for the exits at the same time. Crowd behavior erased liquidity just when traders needed it the most, and just as the market saw in the LTCM crisis, the Quant Crisis, and the subprime crisis.” (p. 321)

Chincarini’s analysis should be mandatory reading for anyone who manages money, trades in size or designs those trades, or thinks about financial regulation. And, by the way, even for the rest of us it is a darned good read.

Thursday, August 16, 2012

Halloran and Thies, The Social Media Handbook for Financial Advisors

I am an antisocial luddite. Well, that’s an overstatement, but I am one of the seemingly handful of people who have assiduously avoided Facebook. I do have a bare-bones LinkedIn listing, but quite frankly I’m not sure why. That said, I realize the extraordinary power of social media as do, of course, Matthew Halloran and Crystal Thies, the authors of The Social Media Handbook for Financial Advisors: How to Use LinkedIn, Facebook, and Twitter to Build and Grow Your Business (Bloomberg/Wiley, 2012). After all, social media has overtaken pornography as the number one activity on the web!

This handbook offers financial advisors who are able to use social media for business purposes (FINRA and the SEC have raised some compliance issues here) but aren’t sure how to get started a step-by-step instruction manual. The authors describe how to set up accounts on the various social media platforms and how to use these platforms to market advisory services. Although most of the marketing can be done at no cost, there are tools such as TwitHawk that make the task less time consuming. The book also includes a chapter on how to advertise on Facebook.

LinkedIn is the authors’ favorite social network because it has the most affluent users. Two LinkedIn studies, one done in partnership with Cogent Research and the other in partnership with FTI Consulting, produced some staggering statistics. Among their findings, 73% of the five million “affluent investors” with $100,000 or more in investable assets use LinkedIn to research investment decisions and 62% of financial advisors actively prospecting on LinkedIn over the previous year gained new clients from that process. (pp. 156-57)

Financial advisors who want to plunge into the world of social media have a lot to learn, and this handbook has a lot to teach, from the nitty-gritty of getting started to the necessary follow-up marketing work. Readers will discover which colors would be best for their Facebook page, how to create events (for instance, a shredding party after April 15th every year), and how to share unique, beneficial information (giving something for nothing). The Social Media Handbook for Financial Advisors is an engaging, instructive guide to a powerful marketing tool.

Tuesday, August 14, 2012

Hirsch, The Little Book of Stock Market Cycles

Jeffrey A. Hirsch is best known as the editor-in-chief of the Stock Trader’s Almanac. He draws on the extensive research behind that yearly publication for The Little Book of Stock Market Cycles: How to Take Advantage of Time-Proven Market Patterns (Wiley, 2012).

Let’s get Hirsch’s most controversial call—that the Dow will reach 38,820 by the year 2025—out of the way right at the beginning. He claims that this “is not a market forecast; it is an expectation that human ingenuity will overcome adversity, just as it has on countless past occasions.” (p. 66) The operative equation is “War and Peace + Inflation + Secular Bull Market + Enabling Technology = 500% Super Boom Move.” (p. 67) But don’t buy that magnificent villa overlooking the Pacific or the Ferrari you’ve been coveting just yet. “[A]fter stalling near 14,000-resistance in 2012-2013, Dow 8,000 is likely to come under fire in 2013-2014 as we withdraw from Afghanistan. Resistance will likely be met in 2015-2017 near 13,000 to 14,000. Another test of 8,000-support in 2017-2018 is expected as inflation begins to level off and the next super boom commences. By 2020, we should be testing 15,000 and after a brief pullback be on our way to 25,000 in 2022. A bear market in midterm 2022 should be followed by a three- to four-year tear toward Dow 40,000.” (pp. 67-68) In brief, if Hirsch’s scenario plays out, we’ve got quite a wait for the market to catch up with our dreams.

The bulk of Hirsch’s book describes the most effective market seasonalities. Take, for instance, the presidential election cycle. Since 1913, from the post-election year high to the midterm low the Dow has lost 20.9% on average. By contrast, from the midterm low to the preelection high, the Dow has gained nearly 50% on average since 1914.

An aside, thanks to Reuters: “Barack Obama often gets slammed for his stewardship of the U.S. economy, but for stock investors, he's been one of the best presidents since World War Two. At 1,400, the S&P 500 on Friday was closing in on a four-year high and was up 74 percent since January 20, 2009, the day Obama took office. Not since Dwight Eisenhower's first term has a president had such a strong run for their first term.” Will this make any difference to his reelection prospects? It’s hard to tell.

Hirsch provides data on the performance of the Dow in the year in which a sitting president is running for reelection. On average the DJIA gains 9%--10.7% when a sitting president wins reelection and 4.3% when he loses. But the numbers are all over the place—from a gain of 41.7% in 1904 when Teddy Roosevelt was reelected to a loss of 23.1% when Hoover was defeated. The more recent numbers are less telling: 1972 (Nixon won) +14.6%, 1976 (Ford lost) +17.9%, 1980 (Carter lost) +14.9%, 1984 (Reagan won) -3.7%, 1992 (G.H.W. Bush lost) 4.2%, 1996 (Clinton won) 26.0%, 2004 (G.W. Bush won) 3.1%. (p. 89)

Most of the timing strategies described in this book are familiar to long-time readers of the Stock Trader’s Almanac. We have, for instance, the best six months switching strategy and the January indicators. Hirsch also expands on the effect of option expiration dates and trading around holidays. He turns around the old Wall Street adage “Buy Rosh Hashanah, Sell Yom Kippur.” The wiser course of action these days is to “Sell Rosh Hashanah, Buy Yom Kippur, Sell Passover.” He explains that “the basis for the new pattern is that with many traders and investors busy with religious observance and family, positions are closed out and volume fades creating a buying vacuum.” (p. 181) In the last ten years (2002-2011) the percentage change from Rosh Hashanah to Yom Kippur has been -0.6%, 3.0%, -1.8%, -3.0%, 1.4%, 2.9%, -20.9%, -0.3%, 1.8%, and -0.5%. From Yom Kippur to Passover the change has been -0.5%, 10.2%, 1.1%, 9.0%, 7.2%, -7.0%, -5.8%, 11.4%, 15.6%, and 17.6%. (pp. 182-83)

The Little Book of Stock Market Cycles is ideally suited for fans of the Hirsch almanacs as well as for those who have never been exposed to seasonal statistics and who have a hunch that they may have missed something useful.

Friday, August 10, 2012

Book sale reminder

I finally have a bunch of books here for review, so I'll be writing again very soon. In the meantime, don't forget about the half-price book sale. There are still a lot of excellent titles available.

Monday, August 6, 2012

Lawson, Octopus

If you like pulp fiction and bizarre conspiracy theories you’ll love Guy Lawson’s Octopus: Sam Israel, the Secret Market, and Wall Street’s Wildest Con (Crown, 2012). The only problem is that the book is not fiction, or at least it purports not to be fiction. The author worked hard not to be conned by all the con artists he interviewed.

Sam Israel III, you may recall, headed the infamous Bayou Hedge Fund. Convicted of securities fraud, and en route to beginning his twenty-year sentence, he drove his GMC Envoy onto Bear Mountain Bridge in upstate New York, wrote “Suicide Is Painless” in the dust on the hood of the vehicle, and went on the lam. Less than a month later he turned himself in to authorities. He is now serving twenty-two years (the extra two for faking his suicide) in the same facility as Bernie Madoff.

Israel came from a wealthy Louisiana family that made its money from commodities trading. Sam, however, didn’t want to go into the family business; he had his eye on Wall Street. His first job was with Freddy Graber who traded his own account, turning a $400,000 stake in the early seventies into $23 million in less than a decade. Graber, it seems, made his fortune in part by being the broker for such firms as Goldman and Lehman and—knowing what the big players were going to do—front-running the market. He also got inside information from a trader who worked for one of the biggest funds in the market. And he was good at painting the tape. What did Sam Israel learn from Graber? “Under Freddy I learned that Wall Street was an illusion. … There were different magicians using different tricks in different ways. But everyone cheated. It shocked me so much in the beginning. I admired those people. And they cheated.”

Sam eventually left Graber (who, by the way, eventually ended up broke) and traded his own money, which followed the familiar, repetitive pattern of building up a nest egg and then losing it all. He tried to set up his own hedge fund that would trade the tape, but he didn’t know how to attract money to his fund. He had to get a job.

Leon Cooperman, who’d left Goldman to start a hedge fund called Omega and was looking for a savvy trader, hired Sam. Sam quickly figured out a way to make a lot of money on the side. Every morning he gave a trader in the Carolinas Omega’s positions for the day, “and he knew how to turn that into money on a big scale, for us at least.” And soon Sam had guys all over the country front-running for him. He had “bags and bags of cash arriving at JFK and La Guardia.”

But Sam wasn’t satisfied. He was tired of working for Cooperman and ready to go out on his own with a computer program—Forward Propagation—that he’d tinkered with for years and believed gave winning signals 86 percent of the time. He founded Bayou and, to complement his scalping, brought Jimmy Marquez on board as a “strong hand” investor.

One misfortune followed the next and, if the fund were not to close, the only solution seemed to be to create a fake audit. The fraud had begun.

Sam “found oblivion in booze and cocaine” as the trading disasters began to mount. But Bayou’s investors got glowing reports and the fund continued to grow. With the events of 9/11, however, “trading out of the hole was no longer a realistic option—unless a miracle occurred.”

Enter the Octopus, a fictitious shadow government allegedly run by U.S. intelligence agencies. “Just as Goldman front-ran the market and created fraudulent derivatives, so did the CIA deal drugs and assassinate President Kennedy.”

The con artist Sam met offered him a way out of Bayou’s financial troubles. “There is a secret government operating within the world’s government,” he explained. “They run the secret trading program—the high-yield market. Only a few chosen people participate in the program. The returns are staggering.”

For a mere $100 million Bayou could participate in this elaborate con, a con so labyrinthine and implausible at every turn that it takes about half the book just to describe it. Only the truly desperate or the mentally impaired could have fallen for it. Sam Israel III by this point was presumably both. The con got conned and Bayou collapsed.

“In nearly a decade, the charade of Bayou Funds had transformed from accounting trickery to true-crime thriller to tragedy to parody.” Lawson recounts it all in this fast-paced though depressing tale of cheating gone delusional.

Wednesday, August 1, 2012

Wilson, Visual Guide to Financial Markets

The third volume in Bloomberg’s new “visual guide” series, David Wilson’s Visual Guide to Financial Markets (Bloomberg/Wiley, 2012) targets the beginning investor. It is a well written, ingeniously organized primer.

In a shift from the ordinary, Wilson looks at the basic financial instruments in the context of their issuers. Instead, for instance, of devoting a chapter to bonds, he discusses bonds in two chapters: government and companies.

After his description of each security (currencies, bills, and notes and bonds in the government chapter and money markets, corporate notes and bonds, and stocks in the companies chapter) Wilson turns to the so-called three Rs: returns, risks, and relative value. He packs a lot of useful information into these three R sections.

Hard assets don’t lend themselves to an issuer lens, so Wilson approaches gold, commodities, and real estate head on, once again with a three Rs section after each.

Wilson rounds out his first take on direct investing with a chapter on indexes. He then begins anew, revisiting government, companies, and hard assets—this time describing more complex securities. The government chapter deals with municipal bonds and mortgage-backed securities, the companies chapter with preferred stock, convertible securities, and bank loans, and the hard assets chapter with master limited partnerships and real estate investment trusts. The three Rs structure remains intact.

The second part of the book is devoted to indirect investing—derivatives (futures and forwards, options and warrants, and various kinds of swaps), mutual funds and ETFs, and indexes based on futures, options, swaps, and funds.

Throughout the book are color charts that illustrate key points and the sidebars that I still find annoying in this series.

If, as Bill Gross recently said, “the cult of equity is dying,” investors may want to look around for alternatives. Wilson’s Visual Guide to Financial Markets introduces the reader to a wide range of investing opportunities in an engaging and informative way.