So Long, Farewell My Loyal Readers!

Thursday, January 06, 2011

After 2.5 years of writing, my participation in the Trading Wall Street Investments blog is now officially ended. My career has taken a very exciting turn and my blogging days are finished for the foreseeable future.

Thank you to all my loyal readers over the last few years reading along as I've developed and honed my understanding of financial markets. I've been right sometimes, wrong plenty of times but always striving to deepen my knowledge of how markets really work.

I would recommend anyone that is capable of writing a blog to do just such. This blog has been an unbelievable tool for creating accountability to myself and building a written narrative over time. I cannot stress enough how important this blog has been to my professional growth.

Again, thank you everyone and good luck!

Brandon R. Rowley
"Chance favors the prepared mind."

Recap of 2010 Market Performance & ETF Tracking Error

Monday, January 03, 2011

After a couple weeks off from posting through Christmas and the end of the year, I'm back to recap the year. Santa Claus showed up at the end of 2010 to add to the gains while the economic calendar and geopolitical environment presented no impactful news to derail the advance. The primary US index, the S&P 500, mounted a solid 13% advance for 2010 closing a volatile year that included a 17.1% correction from high to low mid-year. The last four months of the year alone offered a 19.85% return as fears of a double dip recession and a meltdown in Europe abated and stocks recouped the drawdown.

I have had many conversations recently about the advantages and disadvantages of ETFs so I thought it would be worthwhile not only to look back at last year's performance in various markets but to compare these markets to their primary respective ETFs. I am wholly convinced that ETFs are the best bet for the vast majority of investors who control their own accounts, easily topping individual stock-picking and mutual funds.

Market Benchmark
ETF Benchmark
ETF Tracking
Dow Jones$DJIDIA11.02%11.11%(0.09%)
S&P 500SPXSPY12.78%12.84%(0.06%)
Nasdaq 100NDXQQQQ19.22%19.04%0.18%
Russell 2000RUTIWM25.31%25.30%0.01%
Crude Oil/CLUSO15.17%(0.71%)15.88%
Natural Gas/NGUNG(21.18%)(40.58%)19.40%
US Dollar$DXYUUP1.42%(1.60%)3.02%
Data based on thinkorswim closing prices.

The equity market ETFs do an excellent job of tracking their benchmarks with the SPY and DIA actually outperforming marginally after fees during the year. As has been reported across the financial world, the commodity ETFs that trade in futures contracts, JJC, USO and UNG, have large tracking errors. These ETFs are crushed by the rollover costs associated with contango, a concept far too many retail investors do not understand. GLD, which holds the physical metal, must only pay storage costs. It is not surprising then to learn that a new ETF backed by the physical metal for copper will debut in 2011 but will carry a hefty storage fee of 1.5% as copper's equivalent weight to gold results in much larger volume.

I think copper and crude oil are best used as indicators for equity markets. The relevant ETFs are garbage and without a substantial education in futures trading, these markets are simply out-of-reach for most non-professionals. Equity ETFs, on the other hand, are excellent vehicles for achieving low-cost diversification. While investors may be giving up some of their opportunity to achieve alpha it is often best to accept beta and to just worry about the front-end of consistently depositing money into the account. Yet, the game is fun, that's for sure, and active investors can always put most money aside and play with the rest in search of alpha.

Overall, the economy is improving, companies are making more money and stocks are pushing higher. The elephant in the room is clearly the US jobs picture which will likely improve in 2011 as productivity growth slows and firms look to improve the top line by hiring. Here's to a prosperous 2011!

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: No relevant position

Greatest Jeopardy! Champions vs. Watson the IBM Supercomputer

Thursday, December 16, 2010

On February 14th-16th next year, Jeopardy! will hold a contest between an IBM supercomputer dubbed Watson and two of the show's greatest winners of all-time, Ken Jennings and Brad Rutter. This is the first man vs. machine contest in Jeopardy! history and after 4 years of development, Watson promises to showcase man's most sophisticated computer programming to date. This match comes 13 years after the world chess champion was successfully defeated by an IBM computer. Yet, "analyzing subtle meaning, irony, riddles, and other complexities" makes this challenge markedly more difficult than the game of chess.

IBM's Watson vs. Jennings & Rutter

Human #1: Ken Jennings: record-holder for most consecutive wins with 74 games, $2.5 million in total winnings

Human #2: Brad Rutter: record-holder for highest cumulative amount won, $3.255 million in total winnings

Machine: Watson: "the most ambitious foray into deep analytics and natural language processing"

The game of Jeopardy! is an ideal ground for competition against humans because it combines four key elements: 1) A large swath of topics and information, 2) the nuance of human language, 3) the need for rapid processing speed and, 4) a confidence measurement because of point deductions for incorrect answers.

Kasparov vs. Deep Blue

Remember man vs. machine in the chess world? The project of creating a computer to beat the greatest human chess player began with the 1989 match of Deep Thought vs. World Champion Garry Kasparov. Deep Thought was handily defeated. IBM went back to work and developed Deep Blue, a true competitor to Kasparov.

In February 1996, Deep Blue became the first computer to best the world' reigning world chess champion in the first match of a six-match series. But, Kasparov went on to win the next 3 out of 5 matches to win the series and humans were declared the winner.

Back once again to the drawing board, IBM programmers created the next version, nicknamed Deeper Blue, to take on Kasparov in February 1997. Even though Kasparov won the opening match, Deep Blue won the second to even it out. Then, incredibly, the next three games came to a draw. Deep Blue went on to win the sixth match and was declared the winner and the first computer to even defeat the current world champion chess player.

Kasparov accused IBM developers of cheating claiming the programmers must have intervened during the game, which was against the rules for they could only adjust the code between matches. IBM denied the allegations and refused Kasparov when he demanded a rematch. (Source)

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: No relevant position

Slowing Productivity Growth Portends Private Sector Hiring

Tuesday, December 14, 2010

Does your company have you pulling your hair out because they fired all your colleagues and expect you to do all the work? Perhaps relief is on the way.

The latest issue of Bloomberg Businessweek had a great segment titled "Seeking the Number That Explain It All: Four economists discuss their favorite indicators as they try to gauge where the U.S. economy is headed". Dean Maki of Barclay's Capital weighed in citing Real Consumer Spending as his primary tool. Dan Greenhaus of Miller Tabek prefers to watch Nonfarm Payroll data while David Rosenberg of Gluskin Sheff + Associates prefers watching Home Prices.

The most interesting commentary came from James Paulsen of Wells Capital Management. He uses productivity as his leading indicator on the economy. While Greenhaus looks at Nonfarm Payroll data, Paulsen is attempting to see the signs of improvement before they are reflected in the jobs reports. As Paulsen explains, when a recession begins CEOs initially clamp down and look for ways to cut costs. The cost-cutting initiatives seen in the US led to a surge in productivity as employees were forced to maintain output while relying on fewer co-workers.

%Δ in
%Δ in
%Δ in
Q1 2008(0.9%)Q1 20093.5%Q1 20103.5%
Q2 20081.2%Q2 20098.3%Q2 2010(1.8%)
Q3 2008(1.1%)Q3 20097.2%Q3 20102.5% r
Q4 2008(0.3%)Q4 20096.1%
Source: Bureau of Labor Statistics

As the chart above shows, the year 2009 was the year of productivity enhancements. With three quarters registering above 6% growth in productivity, firms were able to accomplish more output with fewer workers. This cost-cutting fueled the surge in corporate earnings even while top-line revenue growth was much less impressive.

Fast forward to 2010 and we now see productivity growth slowing. In order for firms to continue growing they will need to begin hiring much more aggressively. Recessions are often healthy in a broader economic sense squeezing out inefficiencies and redundancies and we are emerging from a very deep one. As these streamlined companies start to add employees again average costs will likely be lower as productivity has been vastly improved. Paulsen boldly predicts that "we're going to have job gains around 225,000 average monthly next year". Let's hope he's right!

Brandon R. Rowley
"Chance favors the prepared mind."

Facebook's 'Visualizing Friendships' Maps the World

Tuesday, December 14, 2010

Paul Butler, an intern on Facebook's data infrastructure engineering team, put together a fascinating graphic titled "Visualizing Friendships". With a random sampling of 10 million Facebook users across the world, Butler plotted arcs between friends based on the longitude and latitude of each person.

What emerged from a black canvas background was a captivating replication of the world map. The most advanced technological countries and areas see their borders outlined very clearly while others are lost in the darkness.

Forget Where Stocks Were, The Question is 'Where Are They Going?'

Monday, December 13, 2010

Were you just a spectator to the rally from the bear market lows?

The S&P 500 has rallied 86% off the March 9th intraday lows. The move has been a spectacular opportunity to make money in the stock market if you were smart enough and/or lucky enough to buy near the bottom. But now we come to today, what should an investor do? Does it matter that we've just rallied so much? Absolutely not! An investor cannot make money from past prices, he can only profit from the future.

Stock market investors need to think about the past like businesses look at past investments. Any investment a firm engaged in up until today must always be seen as a sunk cost. The capital has been poured in, it is gone and entirely irrelevant in future decision-making. The choice of which projects to pursue should be made with the goal of maximizing profitability down the road. This judgment is advanced irregardless of the possibly large amount of time and resources poured into previous projects. The downfall of many investors and firms is their commitment to past decisions and their inability to pivot into more profitable options. The rally over the last 21 months is a sunk opportunity cost and should be wholly ignored when making a investment decision today.

Just ignore the charts for now

My contention is that charting is at its best at tops and bottoms in markets, when the whole world is paying attention to price itself. The front pages and headlines ring out during these times informing everyone that prices are making new highs or new lows. Chartists thrive in these irrational environments because investors focus on past price, which is an inherently irrational act. Greed and the fear of missing out drives investors to buy stocks because they are pushing out to new highs and panic fuels selling because stocks are hitting new lows. These behaviors vault the chartist's strategy into favor for short time periods as the breakout and breakdown prophecies are self-fulfilled. In a circular sense, the chartist is the most rational during this time because his strategy is the only one that works as fundamentals and technical oscillators are thrown out the window. Yet, this cannot last for long.

Eventually the herd recogizes the silliness of making investment decisions based on just the price movement itself and slowly recovers its senses. The crowd once again begins to ignore the regular price fluctuations as they diminish in amplitude and rediscovers its confidence in the long-term growth of the economy and its firms, assuming that belief is substantiated. Simply, the rational investor does not care where prices have been, only where they're going. Once the wild emotions calm, prices will revert back to trading inline with long-term earnings expectations.

What does the future look like?

Jeff Miller over at A Dash of Insight penned an excellent post last week about market valuations in the Spring of 2009 compared with current levels. He argues that stocks are priced more attractively on a forward basis when considering the risks to estimates than they were in the late Spring of 2009. He sees the market garnering a higher multiple in 2011.

The S&P 500 in May 2009, a couple of months after the bear market lows were put in, was priced at 15.37 times forward earnings estimates. Yet, at today's prices, the market is priced 13.35 times forward expectations. This is counter to what we would anticipate given the pervasive uncertainty about the future felt in 2009 versus today. The market's fear was reflected in the VIX reading north of 30 at the bottom against the sub-20 range seen today. A more certain future should earn a higher multiple by investors.

There are plenty of possible world events out there to worry investors. What if the euro disintegrates? What if China's property bubble pops? What if California or Illinois defaults? What if terrorists blow up a nuclear facility? What if crazy Kim attacks South Korea? What if a meteor hits Earth? What if the sun blows up? There's always plenty to worry about in the world (and universe I guess), this will never change. But it's important to understand that we have just saved the financial system from flying off a cliff and we're in the mending process. The trend is up, the financial system has stabilized and companies are making more money. Forget that we're up 86% off the bottom, it's irrelevant. There may be plenty of money to be made going forward with the right outlook and some faith in the global growth story.

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: No relevant position

Insights from High Frequency Trading World

Wednesday, December 08, 2010

Sean Hendelman, CEO of T3Live, was featured on a panel at the High Frequency Trading World Conference in New York yesterday. Sean runs high frequency trading strategies at T3 Capital Management, a separate but affiliated company with T3Live. The event itself was the largest of HFT events that I've attended so far seemingly pointing to the increasing interest in the business and, in particular, the greater awareness of HFT following the May 6th flash crash event. There was even a panel with strictly institutional investors where the broad conclusion seemed to be: we have no idea what HFT is doing to us. I also met a venture capitalist at the event who is looking to break into the business by funding a shop or strategy. Market participants all across the spectrum are recognizing the prevalence and staying-power of HFT and looking to 'get in on the action'.

My takeaway from the event

If I had one key takeaway from the event it would be: computers are faster than humans traders. It is amazing how crystal clear this message has become as I listen to HFT practitioners speak about their businesses. As I have written in the past, the manual side of the business requires more sophistication than ever as HFT has come to dominate the efficiency-creating spectrum, an arena daytraders found profitable in the past. With HFT now driving fantastic efficiency in US equity markets in terms of short-term supply/demand pricing, profitability in scalp-style daytrading has diminished. As a general rule, traders continuing to find success have been expanding their timeframes to profit from inefficiencies over longer time periods. Below is my summary of Sean's panel, let us know what you think!

Volume and Latency Concerns: The Need for Speed

Moderator: John Cogman, VP, Autobahn Sales, Deutsche Bank Securities
Adam Afshar, President and CEO, Hyde Park Global Investments
Chris Bartlett, Director, Nobilis Capital
Sean Hendelman, Chief Executive Officer, Managing Partner, T3 Capital Management
Tim Cox, Director of Execution Services, New York, Bank of America - Merrill Lynch
Feargal O'Sullivan, Head of Trading Solutions, Americas, NYSE Technologies

The motives for latency reduction

The discussion started with participants giving their thoughts on the motives for latency reduction: why do you want to be the fastest and how important is latency? Sean took the lead stating that the lowest latency is a key component of his business and he strives to achieve the lowest possible latency for his strategies. The barriers to entry are quite high with costs that many cannot afford when getting started. Bartlett chimed in to say that latency is a product of the particular strategy employed. For a particular strategy, the relevant question is: can you get the fill you need? How that question is answered will drive your latency needs.

Afshar, CEO of Hyde Park Global, a 100% robotic trading firm based on artificial intelligence, went about re-defininig the goal of HFT. He explains that the purpose is to deal with the non-linearity of price data by splitting up data in chunks and small enough time sets whereby it can be modeled linearly. He believes the limitations for HFT will not be technology as it is falling in price over time, but rather strategies are becoming more intellectually complicated. The real challenge is finding the talent capable of creating profitable strategies.

Bartlett threw some numbers into the debate to define the HFT playing field. The ultralow latency is largely needed for capitalizing on fleeting arbitrage opportunities and typically lives in the 100-200 microsecond land. Normal HFT players, the likes of liquidity providers and rebate traders, are somewhere in the 500 microsecond in latency. The accuracy of these numbers can certainly be debated but for the average daytrader suffice it to say that it's far faster than even the human eye can see and interpret the Level II.

Afshar once again reiterated his belief that, in the end, it will simply be a matter of the smartest people winning the race. He used GETCO as an example, the largest electronic trading firm in the world. Founded by two guys in Chicago just over a decade ago in 1999, the firm quickly became a powerhouse in the liquidity provision space because they had the best ideas. While they're definitely major technology user, their business grew out of nothing to something because of programming ingenuity.

The keys to the technology itself

Sean took hold of the discussion centered around the technology angle and used O'Sullivan's clarifying remarks about the pyramid of HFT players. The top of the pyramid is a very small, select group that engages in ultra-high frequency trading while just below and lower are the vast majority of traders that do not strive to be the absolute fastest in the market. Sean argued that while technology costs may be falling over time, maintaining a place in the top of the pyramid continues to require substantial investment costs. The goal with designing a architectural system is to keep it light and flexible. Large institutions often struggle with dinosaur technology because changing one piece requires the updating of many other pieces. In order to remain adaptable, technology must be kept as light as possible. O'Sullivan added that not only does complexity drive the need for technology but also the efficiency of the code itself in executing the operations.

Regulatory impact on HFT operation

Afshar explained how he thinks about the goal of technology: reducing friction costs. He contended that lowering transaction costs and the time in which money is tied up are the key purposes of buying new technologies. Regulations, in effect, impose arbitrary friction costs on traders.

Sean jumped in to say that regulation isn't really a major problem at the current time. Most HFT firms are already going through the process of pre and post-trade checks through brokerages. The checks on the order side are extremely rapid and nothing to worry about. Yet, the quote side has significant room for improvement. As Bartlett added, there is just a ton of data to receive and interpret on the quote side slowing processing capabilities down.

Measuring latency

Some very intriguing discussions on measuring the latency ensued. Bartlett spoke about the ineffectiveness of using the Windows clock because it is only precise down to about 15 microseconds. If one uses the exchange timestamps, they're all different and simply don't match up because there's no universal clock that can be synched to efficiently.

Sean changed the discussion a bit and gave HFT participants the easiest way to measure latencies of various vendors and exchanges. Build two of the exact same strategies and run them simultaneously with the one variable being a particular vendor. Whichever strategy gets the print is the fastest, no more discussion needed.

Brandon R. Rowley
"Chance favors the prepared mind."

McDowell Bests Woods, Bernanke Explains Monetary Policy

Monday, December 06, 2010

Tiger Woods Graeme McDowellGolf is fun to watch again

Tiger Woods is back...almost. For the first time in 2010, Tiger looked like the competitive, hungry player of the past. Granted, he was playing in the Chevron World Challenge, an 18-player event sponsored by the Tiger Woods Foundation and not an official PGA tournament, but he looked good. He took Graeme McDowell to a play-off after letting his 4-shot lead to start the day disintegrate by missing a couple key putts early. McDowell eventually bested Woods showing iron resolve by sinking two long putts on the 18th green to finish the round and on the playoff hole.

Woods' struggles this year are clearly the result of the incredible psychological damage he did to himself. Yet, his psyche seems near repaired after a year of wreckage in his personal life. He has also spent the year working on a new swing which looks to be coming together nicely. The results are a fitting end to each player's season with it being Tiger's worst year and McDowell's best as professionals. McDowell climbed 32 spots in the world ranking, from 39th to 7th, while Woods slipped from 1st to 2nd as Lee Westwood nabbed #1. I think the event sets the stage for a much brighter 2011 for Woods and I loved feeling the thrill of a dead-heat finish to a tournament that only Tiger is able to create.

Strong week after Monday reversal

The S&P climbed 3% last week with futures trading at new highs for the year pre-market on Friday prior to the release of the dismal jobs report. Monday's significant reversal off the lows of November's pullback set the stage for the massive buying that stepped in on Wednesday and Thursday. The reaction to Friday's jobs number can really only be perceived as bullish as equity buyers used the weakness to snatch up shares.

It's tough to spin a report of 39,000 jobs added when economists expected 150,000 and private payroll increases only came in at 50,000 versus 158,000 expected. Even the unemployment rate ticked up from 9.6% to 9.8%. There just really wasn't anything positive in this report.

Yet, stocks reversed and closed strong with the excuse seeming to be that QE2 makes for a heads-we-win, tails-we-win scenario. I think though that the market is staying somewhat optimistic as companies continue to increase profits. Adding 39,000 isn't great; in fact, it doesn't even meet the ~110,000 needed to compensate for new workers entering the labor market, but it is still job growth. The recovery is a slow slog but we're still adding jobs, we're still growing, we're still on the right track, modest as it may currently be.

Bernanke explains they're not practicing witchcraft, it's just monetary policy

Ben Bernanke appeared on 60 Minutes last night in his second public interview to explain the FOMC's viewpoint and actions. Bernanke did a great job laying out the mandates of the Federal Reserve and quelling some of the fears surrounding their policy initiatives. Bernanke made the case that with unemployment at ~9.5% much of the year and inflationary pressures very modest, the correct course is to ease monetary conditions further. He points out that the risk of non-action could be far greater. Bernanke also tries to put to rest the warnings of inflation from many pundits by arguing that the Fed has a diverse set of tools to deal with inflationary pressures if and when they crop up. Importantly, he stresses that his policy are not fiscal in nature, they do not add to the national debt.

The FOMC's mandate is to balance the goals of full employment and stable prices. When unemployment is high and inflation is very tame, really the only choice the Fed has is to pursue expansionary policy. The Fed has a long history of fighting inflation and should be able to rein it in if inflation rises above their 2% target. For now, the slack in the system will inhibit producers from passing through costs of rising commodity prices driven by global demand. I applaud Bernanke for his appearance and would like to see more reasoned and rational discussion on the benefits and risks of monetary policy. There is simply far too much hyperbole when it comes to discussing the subject.

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: No relevant position.

Google's (GOOG) Android Flourishing

Friday, December 03, 2010

Android logoThe latest data from comScore was released today on the mobile phone market and shows Google's (GOOG) Android platform flourishing, rapidly gobbling up market share from competitors.

Smartphone ownership overall jumped 14% for the three months ended October 2010 over the previous three-month period with now fully 25% of cell phone users owning a smartphone. While Research In Motion (RIMM) still dominates the market with 35.8% of the market, its share is continuing to erode as Apple (AAPL) and Google (GOOG) steal would-be customers. Microsoft (MSFT) and Palm (HPQ) round out the lowest shares of the market.

Google's (GOOG) Android platform has been well-received by customers with the Android now accounting for almost a quarter of the smartphone market, up an impressive 6.5% over the previous three month period. The Android's initial release was in October 2008, just over two years ago, but the free and open source software was quickly seen as the best choice for many OEMs including Samsung, LG, HTC and others. The momentum is clearly in Google's favor at this point in time.

Smartphone Platform Market Share
July 2010
October 2010
Point Change

Previous posts on Google (GOOG):

Google (GOOG) a Value Play ~ September 17, 2010

Brandon R. Rowley
"Chance favors the prepared mind."


Doctor Copper (JJC) Challenging All-Time Highs

Friday, December 03, 2010

Doctor Copper is one of the best indicators of global growth given its ubiquitous use in products we make all over the world. Copper has the characteristics of malleability and ductility while being one of the most efficient conductors of heat and electricity locking in its spot as a commodity with broad usages. From wiring and circuits to fittings and pipings, copper is useful in a wide variety of products (and let's not forget the Statue of Liberty!).

With emerging economies exploding as the global credit crisis abates, demand for commodities is likewise rising aggressively. This demand has pushed prices back to all-time highs seen in 2006 and re-challenged in mid-2007. The $4.00 level in high grade copper looks likely to be broken in the near future as copper prices charge higher.

I have found Doctor Copper to be a quality leading indicator for stock prices and see it as unquestioningly bullish at the present time. A quick use of Nexalogic's handy correlation tool shows the correlation between the S&P 500 (SPY) and copper (JJC) at a whopping 0.73 for the year 2010. Compare this to the oft-cited explanatory power of the US dollar (UUP) at a -0.36 correlation. In sum, copper continues to lead the way challenging all-time highs; should previous correlations hold up, the stock market is likely to follow it higher.

Previous posts on copper:

Trust this Rally ~ September 1, 2010

Thoughts on the "Bond Bubble", Equity Sentiment & Doctor Copper ~ August 28, 2010

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: Nothing relevant.