Michael Covel: News & Info.

Capitalism, Happiness, and Beauty by Ludwig von Mises.

From a recent Barrons:

Reading the entrails of animals may not be an infallible method of divining the future. And it holds inherent and obvious drawbacks for the fastidious. But, for all that it’s undeniably primitive and ancient, as a guide to coming events the entrails approach is at least as reliable as most of the contemporary tools of prophecy, and the shamans who employed it were as often on target as are any of the present-day soothsayers and their vaunted computer models. So what else is new? We’re glad you asked that question, because there is something new. And that is solid confirmation of the errant nature of forecasting, especially that genre of the black art that traffics in financial and economic auguries. For such confirmation, we are indebted to Pierre Lussier, proprietor of the Investment Information Provider, who sent to us a neat study he did starkly entitled, “Street’s Track Record.” Using a survey by the Federal Reserve Bank of Philadelphia of a variegated mix of duly anointed economists (they nest in brokerage houses, banks, universities, private firms and consulting outfits), along with securities analysts’ earnings forecasts, Pierre has gone back to 1982 and traced the accuracy — or lack of it — of predictions one and two years out on a clutch of economic variables and corporate profits. What he found, not surprisingly, is that the further out the forecast, the greater the forecasting error. The clairvoyants were relatively — and we stress relatively — successful predicting housing starts, unemployment and long-term interest rates. They were pretty awful on inflation and GDP. In a rare nice-guy mood, we would rate the analysts’ projections on profits as middling. Specifically, on housing, the average gap between what the wannabe Nostradamuses said would happen and what really happened was 5% in one-year forecasts, 11% in two-year predictions. On unemployment, the seers averaged a 5% miss on one-year, and 12% on two-year, forecasts. On long-term interest rates, they were off by 10% in their expectations a year hence and 17% in two-year predictions. Their average error guessing short-term interest rates was 14% when they looked ahead one year, which ballooned to 47%, when they attempted to foretell rates two years out. On inflation, the professional economists were off 29% when reckoning the rate a year in the future; they missed by 41% trying to gauge what the rate would be two years out. They were wildly off the mark in their guesses of nominal GDP: by 102% one year ahead and 109% two years away. Analysts, as intimated, fared so-so doing their clairvoyant shtick. Their forecasts of operating earnings a year ahead went awry by 14%; when they pushed their luck and tried to see two years out, they missed, on average, by 25%. What’s the moral? Well, if you’re a forecaster, never look back and keep forecasting. And if you’re a civilian, at the very first whiff of a forecast, reach for a grain of salt; better yet, go buy a Ouija board of your very own.

There has been a wide cross section of positive endorsements for Trend Following since the late April 2004 release. However, Victor Niederhoffer’s negative review may be the best endorsement yet.

Why is his negative review positive?

1.) Niederhoffer does not believe Trend Following works. He felt this way (and stated so) long before Trend Following hit the shelves. He ignores all performance data of all trend followers for the last 30 years — and continues to draw the conclusion that trend following trading is “horoscope reading”.

2.) Niederhoffer’s review appears to be a response to pages 136-139 of Trend Following. These pages cast a less than positive light on his trading technique.

Government intervention is one of the many root causes of “trends”. This article won’t tell you when to buy and sell or how much to buy or sell, but it does show the forces always there making waves.

Trend Followers do not just “spot trends” or “find trends”. Keep in mind, Trend Followers have less big wins and more small losses. When you enter a market, as a Trend Follower, you do not know whether it will be the “big one” or not. But you still have to enter, follow your rules, and stick with your philosophy. Bottom line: you never know the full extent of a big trend until it is over and a matter of public record. The idea that you can “find a trend” smacks of an ability to predict. Prediction is fools gold.

“No matter what the models say, traders are not machines guided by silicon chips; they are impressionable and imitative; they run in flocks and retreat in hordes.”
Roger Lowenstein
When Genius Failed: The Rise and Fall of Long-Term Capital Management

John Mauldin of Millennium Wave Investments offered this endorsement of Trend Following:

“Covel has created a very rare thing - a well-documented and thoroughly researched book on trend following that is also well-written and easy to read. It touches on a wide variety of the principles and practices which make for successful trend following. This is one book that traders at all levels will find of real value.”
John Mauldin
Millennium Wave Investments

Author of Bull’s Eye Investing and editor of Thoughts from the Frontline

Alan Farley, of RealMoney.com, offers today at Yahoo Finance:

“Now is a good time to ask yourself whether things are getting more or less bullish than they were a month ago. At this point it’s obvious that things are getting incrementally better. First, traders have already priced in a higher rate environment. Second, the terror influence is losing its fear factor. Third, the key June 30 date for Iraq and the FOMC meeting are approaching quickly. Most analysts think that particular day is very important to the markets, but traders know better. They’re focused squarely on the time period leading up to the date because the markets discount major events before they happen. So we should see buying and selling activity next week based on traders’ assumptions for the rest of the summer. Students of the 1990s may recall that many rallies began just as the Fed announced rate hikes. Those booming markets illustrated the absolute dominance of certainty over speculation when it comes to fiscal policy. In other words, a timely rate hike can put the conjecture and worry behind traders so they can concentrate on something else. The “something else” in this case should be the quality of second-quarter earnings. The news on that front may be outstanding because we’ve seen few negative preannouncements, although we’re right in the middle of confession season. I think the problem is that everyone is so fixated on world events right now, they haven’t noticed that American companies are firing on all cylinders.”

How can one deduce from this writing when to buy, when to sell or how much to buy or sell? How can one measure objectively any of his statements to actually use them as part of a trading system or plan?

James Simons, President of Renaissance Technologies, offered in a roundtable forum:

“I heard this story and I think it’s true. Anyway, it’s a pretty good story. It’s about how the Air Force trains pilots. When a trainee made a good landing, he would be praised. When a trainee made a bad landing, he would be ridiculed. Well, it was perfectly clear to the general that the first approach was lousy and the second approach was good. He had statistics demonstrating that when you praised a pilot who made a perfect landing, his next landing was not likely to be as good. Whereas, if you berated a pilot who made a bad landing, his next landing was likely to be much better. However, if you think about it, it doesn’t matter what you do, because landings are most likely to be average. If a pilot had an exceptional landing, his next landing was likely to be average. If he had a poor landing, his next landing was likely to be average, also. By slicing the data and only looking at what follows good landings and praise, you only see part of the picture. You must consider how data was selected before you can draw conclusions. This example is closer to home. We interview a lot of managers, because we do some asset allocations. Although I haven’t compiled careful statistics on this, it frequently seems that a manager with a marvelous record does not perform as well after I invest with him. Why is that? Well, do managers who lost 35% in the last three years show you their records? No, those guys aren’t showing anyone their records. You are seeing a sample of the best managers, a sample of “good landings.” Going forward, some people do better and some people do worse, but reversion to the mean is probably a persistent phenomenon in both managing money and landing airplanes.”

Excerpts from Wall Street Journal article:

“The conclusion is unavoidable: If you have a good education, you shouldn’t just consider getting rich. Creating and amassing wealth is an outright moral obligation. Do so and you can take comfort not just in financing public services but in knowing that you are giving people what they need or want, generating jobs and underwriting the affluence that makes art, justice, environmental protection and other social goods possible…Of course, making yourself a pile of money is good for you too. You’ll live in a better neighborhood, drive a safer car, get to be more selective in choosing a spouse and enjoy a longer, healthier life. Your kids will get a better education, which in turn will mean more of the same for them, too — and will better equip them to improve the world still more…From a moral standpoint, it is clear that Alex has done his part. With such an eleemosynary career under his belt — and such bulging bank accounts — he has decided to indulge himself and stop making money. The money he already has is busily reproducing itself, of course, and meanwhile he is spending most of his time figuring out how he can use it to make the world a better place. Sounds like fun, no?”

Source: http://online.wsj.com/article/0,,SB108690610119134476,00.html