In another case of purely coincidental serendipity, three days ago Zero Hedge informed readers that the “NYSE Boerse [sic] has just announced its purchase of Kingsbury International Ltd., which surveys managers for the Chicago Business Barometer, also known as the company that hosts the Chicago PMI data, in order to bring PMI data direct to feed subscribers. Net result: expect even more market volatility at each PMI release, now that the market is not two but three-tiered, and consisting of regular HFTs, HFTs with access to the Deutsche Boerse feed, and everyone else.” We concluded: “It is unclear if the ultra-speed, HFT friendly feed would be activated before its next release on June 30. That said, we will certainly coordinate with our friends at Nanex for any trading abnormalities, primarily in the critical ES futures, this Thursday at 9:42am, keeping a close eye on the tape, and indicating precisely when the tiered data release hits.” Well, as promised here is the Nanex data. As expected, it’s a stunner.

The shocker, however, resides not in the stock arena, but in what is now becoming the go to place for bulk frontrunning high frequency trading algorithms to chase what little volatility is left in the equity market: options, which, as previously noted, we now are confident will be the cause for the next big market wipe out.

Per Nanex:

Approximately 1/2 second before the 9:42 release of the Chicago PMI report, the option market exploded setting new records in quote rates, saturation, and delays. We have not yet determined why the equity market did not see a record explosion of quote traffic; rather it experienced the normal saturation/delay that happens all too frequently every trading day.

The electronic S&P 500 futures experienced a withdrawal of liquidity beginning about a minute before the release of the PMI number. At approximately 9:41:59.550, 1275 contracts cleared through 4 levels of the offer side of the order book. This coincided with the explosion in OPRA quote traffic.

The first image shows quote message rates for each of the 12 CQS data lines that carry data for NYSE, AMEX, and ARCA equities and ETFs in 2ms intervals. Notice how quickly activity drops after the peak compared to the OPRA images below it. Normally, options activity follows equity activity very closely.

The images that follow, show each of the 48 lines individually along with the total, so that you can clearly see the saturation events and estimate the duration and extent of the delay for each line. The flat-top areas you see on the charts are caused by something gating, or queuing the data. Since OPRA, like CQS, timestamps after data exits the queue — right before it’s transmitted to subscribers — it is impossible to know the exact duration of these hidden delays, but 500ms to well over 1 full second is a conservative estimate. We believe OPRA capacity would have to increase at least 3 times, to 12 million/second, in order to avoid these significant delays. However, at those message rates, a significant number of quotes would have already expired before they even left the exchange networks. (for all source images, please go to the Nanex site)

Several individual OPRA data lines show gaps which we believe are exhaustion events. These quiet periods of no quotes are common, can last 20 milliseconds, and almost always follow a spike in activity. We have verified that there were no drops in the data and that the charts accurately show the quote traffic rates. Several lines, noteably #37, show a period of fluttering between a high rate and zero which seem to appear during times of severe saturation.

While it is impossible to determine if this is indeed a case of broad embargo breach, it is imperative that Kingsbury International and the Deutsche Boerse immediately announce are precisely what moment they releasaed the PMI data to i) subscribers of Alpha Stream, and ii) to subscribers of the PMI service, who up until now thought they were getting a bargin by frontrunning the general population by three minutes courtesy of a public embargo, and now seems are themselves being frontrun by almost 500 milliseconds.

Furthermore, if no advance data release is confirmed, can OPRA please explain what the reason for this bizarro frontrunning activity is as traditionally a massive burst of trading action in advance of news dissemination indicates something is terminally broken with the checks and balances in the system. While we know that is the case, with the aid of Nanex, we will continue exposing each and every act of public data frontrunning going forward until every last retail investor is permanently out of the market and central banks and primary dealers can throw the hot ponzi grenade amongst themselves.

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/article/caught-act-hft-option-algos-observed-frontrunning-todays-pmi-release

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Pat Dorsey of Sanibel Captiva Trust was interviewed on Morningstar yesterday to provide some ideas for sources of alpha.  He cited an old paper by Russell Fuller who notes the “three sources of alpha”.  Fuller’s paper, which can be found here, describes these three sources:

1. Superior (Private) Information: Most traditional investment managers try to generate a better information set.  For example, they may try to generate a superior earnings forecast, or they may try to better understandthe economics underlying a particular industry’s profitability.  These types of managers are frequently referred to as  traditional managers or fundamental managers.

2. Process Information Better: Some investment managers assume that most information is commonly available to all investors and focus their energy on trying to develop better procedures for processing this information.  Managers that try to do this in a formal way are frequentlycalled quantitative managers.

3. Behavioral Biases: Scholars in psychology and the decision makingsciences have documented that in some circumstances investors do not tryto maximize wealth and in other circumstances investors make systematicmental mistakes. Both of these cases can result in mispriced securities andboth are the result of behavioral biases.

This is a good expansion point from the Montier post the other day and his ideas on tail risk (see here for more). Of course, investing isn’t just about reducing risk, but also maximizing rewards. Maximizing those rewards is easier said than done. For most investors it’s easiest to just ignore the whole rat race of the markets. If you’re not willing to put in the time and effort to be a great investor you need to accept the fact that you’re not going to have any of the alpha edges described above. This means you need to accept the old Random Walk approach most likely via a diversified portfolio of ETF’s.

For those of us who pride ourselves on being able to outperform the market you need to find that edge. The behavioral edge, though difficult to overcome, is the easiest of the three to overcome in my opinion. This can generally be achieved through a rules based approach or a systematic approach. Unfortunately, you need to develop the system that generates the alpha. Therefore, the behavioral approach overlaps with discovering the quantitative approach. This is your true competitive advantage and generally overlaps with the information edge. Better information results in a better system which can be perfected within a systematic investment approach. Connecting the dots is easier said than done, but these are the building blocks.

In a future piece, I hope to expand on how to put those building blocks together to “close the loop”.

The full interview is attached:

 This post was published at Pragmatic Capitalism.

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/pOduLIOZD8Y/the-three-sources-of-alpha-2011-6



People are making some noise about the fact that on a non-seasonally adjusted, house prices in April were slightly above where they were in March.

But this is the easiest way to look at it: The year-over-year declines for the broad 20-city Case-Shiller composite index shows things getting worse, not better.

For more details, see here.

chart

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/2SPTiAU5XYY/chart-of-the-day-april-case-shiller-2011-6

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jmeriwether

A while ago, we created a presentation on some of the greatest trades of all time. It featured men who had achieved billions of dollars through their financial aptitude, brilliant investment strategies, and some luck.

John Paulson’s subprime trade, for example, qualifies big time. His Sino Forest trade, on the other hand, not so much. But for all the negative press Paulson’s Sino Forest trade has gotten, he actually only lost $107 million.

That’s nothing compared to the losses these 12 traders saw. This is a story of epic failure.

Robert Citron: The man who brought California to its knees with 292% leverage.

In 1994, Robert Citron was Treasurer-Tax Collector and the only Democrat to hold office in Orange County, California. Through a series of highly-levered deals that included repo agreements and floating rate notes, Citron was able to at one point achieve leverage of 292%. The funds he managed were worth around $8 billion and if interest rates went up, he stood to lose big time due to his collateral which consisted almost primarily of US Treasury bonds.

Well guess what? Interest rates rose and as a result, Citron lost Orange County lost a boatload of money. From Wikipedia:

“The county’s finances were not suspect until February 1994. The Federal Reserve Bank began to raise US interest rates, causing many securities in Orange County’s investment pools to fall in value. As a result, dealers were requesting extra margin payments from Orange County. These extra margin payments were funded in part by another bond issue made by Orange County; the size of that bond issue was $600 million. However, this fix proved to be only temporary. In December 1994, Credit Suisse First Boston (CSFB) realized what was going on and blocked the “rolling over” of $1.25 billion in repos (“rollover” essentially means issuing of another repo when the previous one ends, but, at the new prevailing interest rate).

At that point Orange County was left with no recourse other than to file for bankruptcy.”

Jerome Kerviel: Derivatives arbitrage totaling over $60 billion

Kerviel made headlines last year as the trader at “a french bank,” which ended up being Societe Generale, He lost approximately $6.5 billion just like Leeson and others in this list through arbitrage of equity derivatives. Unauthorized trades totaled as high as $66.7 billion. Kerviel was ultimately charged with creating fraudulent documents and making attacks on an automated system.

Nick Leeson: Wiped out the world’s oldest bank, Barings

Leeson is most likely the most popular guy on the list. He started his career trading derivatives at Barings Bank and was eventually moved to Singapore where he enjoyed a lavish lifestyle and made plenty of money. That is, because he hid mounting losses in a special account known as the “five eights” account. He was eventually caught and sentenced to five years in a Singaporean prison where he acquired cancer and his wife left him.

See the rest of the story at Business Insider

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/wJQ44Cr6fMw/worst-trades-of-all-time-6-2011

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georgesoros

George Soros said at a panel discussion in Vienna today that “We are on the verge of an economic collapse which starts, let’s say, in Greece, but it could easily spread.”

The billionaire hedge fund manager whose huge bet on the collapse of the British pound earned him one billion dollars warned about the severity of the Euro crisis, saying, “The financial system remains extremely vulnerable.”

He also explained how the crisis will probably end, according to Bloomberg: it’s “probably inevitable” that a mechanism will have to be put in place to allow weaker euro-region economies to exit the Euro.

“I think most of us actually agree that [Europe’s crisis] is actually centered around the euro… It’s a kind of financial crisis that is really developing. It’s foreseen. Most people realize it. It’s still developing. The authorities are actually engaged in buying time. And yet time is working against them.”

Of course he’s talking about authorities’ efforts to prevent a Greek default by offering help contingent on a budget overhaul. Preventing a Greek default is important because people worry that it would set off much larger and more damaging defaults in Spain, Portugal, and Ireland.

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/dpA9aSmZqx8/george-soros-explains-how-the-crisis-in-europe-will-end-weaker-economies-will-probably-exit-the-euro-2011-6

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Every time we see another week of declines, our eyes are drawn back to this great chart from Doug Short on the shape of monster bear markets.

Not only are both Japan and 1929 interesting shape-wise, there are real historical analogies between them, what with the establishment of stimulus, and then the cessation of it “prematurely” some would say.

chart

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/euXuGLMEd1w/mega-bears-update-june-26-2011-6

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If you’ve been reading for awhile, we’ve been very bullish on the whole idea of the ongoing “balance sheet recession” characterized by the ongoing need of households to deleverage.

To put it another way: Households are saddled with so much debt from the boom, that even with all the wrenching pain of the bust, they still have a lot of debt to cut.

For proof that this is the deciding factor behind the boom, consider this chart from the Council on Foreign Relations (.pdf).

In past recessions, debt intake never bothered to slowdown. Even in the worst ones, leveraging up continued.

Now? flat. And perhaps worrisome is that it hasn’t gone down more, since that just means the pain drags out longer.

chart

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/-iW99X6VvFM/chart-of-the-day-household-deleveraging-2011-6




If you still believe what’s holding back the U.S. recovery is an unwillingness of banks to lend, this chart from Citi’s Steven Weiting should finally prove to you that you’re wrong.

While banks keep making it easier for borrowers to take on more debt, there simply isn’t a desire to do so.

From Citi’s Steven Weiting:

However, next month’s 3Q survey of senior loan officers should be monitored for potential signs of slippage. As the figures suggested, past improvements in lending sentiment would suggest a stronger outlook. Yet the latest data on loans and leases (“real economy loans”) have not kept up with the sequential improvement in lending sentiment or reported loan demand (see Figure 9).

Chart

There’s also the possibility that, while there is less of a demand for new debt, banks are also on the brink of tightening lending standards again, worried about new capital requirements from the Fed and Basel III. That could slow down the U.S. growth story again, resulting in damages to the recovery.

From Citi’s Steven Weiting:

The U.S. somehow tolerates more than 30,000 fatalities from motor vehicle accidents each year. Speed seems to affect both the incidence of accidents, and most certainly the severity of injury. The most recent data from the National Highway and Traffic Safety Administration shows incidences of fatalities above 55 miles per hour were 3.7x more prevalent than accidents at 40 miles per hour. But the nation seems to value the opportunities afforded by arriving from place to place more swiftly, even with other externalties. If the highway speed were 20 miles or even kilometers per hour, we are quite sure highway fatalities would drop, but so would the nation’s output, given lost productive time. Our point is, a tradeoff that must be acknowledged.

So Weiting believes that, if we increase restrictions on banks, we should also expect a decrease in growth as a result. But if no one wants loans in the first place, the new restrictions might not matter at all.

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/4LGJkgBHaYc/its-official-no-one-wants-any-new-debt-2011-6




The latest reading on Warren Buffett’s favorite valuation metric shows a bit of a decline, but still elevated levels. The latest reading of 105% is still consistent with a market that is overvalued and unattractive from a pure value standpoint.  In the past, Buffett has said that he prefers to see this metric at 70%-80% before buying equities:

“For me, the message of that chart is this: If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%–as it did in 1999 and a part of 2000– you are playing with fire.”

Clearly, we’re far from a level where equities are highly attractive according to this indicator.

chart

See here for more on this metric.

 

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Original source at: Money Game | http://feedproxy.google.com/~r/TheMoneyGame/~3/Ft4g2qYpDX4/a-quick-update-on-warren-buffetts-favorite-market-valuation-metric-2011-6


Last Friday, the CBOE Equity Put/Call Ratio reached the highest level in the past two and a half years, higher not only than May 2010 when the market plunged on the first Greek bankruptcy, but higher than March 2009 when the S&P hit 666, and lower only than the second week of January 2009. Additionally, while this one off event may be discounted, the 10 Day Moving Average, as shown on the chart below, has now lifted to levels not seen since February 2009. A quite note by Stone McCarthy captures the conventional wisdom on the topic: “Where a 1-day rise in this indicator alerts us to investors temporarily seeking protection against a market decline, an extreme high by the 10-day smoothing line reveals a more comprehensive sentiment buildup that typically proves to be a more reliable contrary indication of a meaningful bottom being NEAR.” Perhaps. However, never in the past has the Put/Call ratio been at such levels even despite the multi-trillion backstop of central banks, and worse still, just two weeks in advance of when the Fed will end its daily stimulus program. The is a saying that being contrarian in the face of conventional wisdom is the only sure way to make money. The problem with that saying is that conventional wisdom is quite often actually correct. Furthermore, last time we checked back in January 2009 Greece and Europe were not about to go Chapter 11, nor was a $900 billion asset purchasing program about to end…

More technical observations from SMRA:

The series of recent new highs by this indicator warns that market participants are still in the process of building protection against downside expectations in price. Therefore, the threat of a more cathartic end to the post-05/02/11 price decline remains real. With the benchmark equity index still locked in a C-wave decline (se chart), risk will continue to favor a better test of the all-important 200-day line at 1262.80, the 2011 low (the 03/16 pivot) of 1249.10, rising trend support from the Mar ’09 lows near 1239, and, in a worst-case scenario, a 161.8% extension through 1215 as long as 1311.20 remains resistance.

Are options traders actually correct this time? Next Tuesday, which is when the Greek cabinet vote of confidence takes place, may provide a quick answer.

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Original source at: zero hedge - on a long enough timeline, the survival rate for everyone drops to zero | http://www.zerohedge.com/article/highest-equity-put-call-ratio-sp-666-indication-market-bottom