Dimon Loses Sparkle or “It’s not a hedge if you are the bar”

The news about Jamie Dimon’s JP Morgan losing over $2B has caused quite a debate. The point I’d like to address, is whether or not JPM was “gambling”. You see, on CNBC this week, Maria Bartiromo tried to make fun of Senator Harry Reid who intimated that JPM was gambling and should just move to Nevada. During her comments she also tried to make the point that (and I’m paraphrasing) “do we want to outlaw risk taking?” JPM’s misteps are being debated in entirely the wrong context.

To the question at hand, was JPM “gambling” or was this merely “hedging” gone awry? It helps to understand what a hedge is and why it might be used. Any business faces a variety of risks. Banks, in particular, face risks associated with the credit quality of the general economy. For an institution of JPM’s size, if the economy weakens, defaults are likely to rise or the bank is likely to need to increase reserves against potential losses. It’s obvious why a bank might attempt to hedge such risks.

Too many metaphors

I have to admit, I’m stuck at a literary crossroads. There are simply too many metaphors to draw upon! Where to start? As Yogi said, when you come to a fork in the road, take it. Consider that it is now 2012, the year which the Mayans supposedly predicted the world will end. It also happens to be the 100th anniversary of the sinking of the Titanic. And almost as if on cue, a cruise ship just sank under mysterious circumstances in Europe. Yet it gets better: Europe is all too similar to a slowly sinking ship, listing feebly in the cold night, while the band plays and the crew runs about helplessly (cluelessly?) Greece was just the tip of the iceberg afterall. Will the captain (Germany) abandon ship or order the water tight compartments to close? Will the water tight compartments hold or does the water spill over into neighboring holds, causing the ship to slip deeper and deeper into the sea? Will le passagers in first class survive? The lowly steerage passengers will almost certainly absorb the brunt of the losses. Or will the HMS Eurozone sink suddenly, like the Lucitania (coincidentally torpedoed by the Germans)? If Europe does sink fast, will it bring the end of the [financial] world? Is this what the Mayans predicted, “Eurogeddon”? What will happen to the survivors and what of the wreckage is salvagable? About the only thing I can predict with certainty is that there will be a bull market in metaphors this year- hopefully by writers who will have a more eloquent and creative time with them than me!

It’s January – you know what that means

I was saving this post for the end of the month, but the tea leaf-reading, fortune-telling, divining rod, hocus-pocus is starting early this year, so I’ll post it today.

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You guessed it, it is prediction time! Along with the new year, the pundits will come out and make confident, bold predictions about the year to come. They’ll hardly ever revisit last year’s forecast and how wrong it was, but no matter, they will confidently predict this year’s path anyway. Of course, this annual exercise tends to hit the press in January and January is the month that supposedly predicts the stock market for the rest of the year. (Recaps of this topic here and here.) I’m going to pre-empt the February 1st or 2nd headlines right now.

For 2011, the January Barometer was wrong, again. January 2011 was an up month and the rest of the year was down, albeit slightly. That makes the miss three-in a row, 50% on the last decade and only 64% since 1926. No doubt pundits that will choose a time period with more favorable statistics which to cite as evidence (you get 69% by choosing just 1940 onward).

Let’s play a game, shall we? Please post in the comments links to any January Barometer articles you find, so we can chuckle at their ignorance of statistics and logic. I expect them to start appearing in early February.

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And here are the TWO instances of nonsense I’ve already seen:

In this article from CNBC.com, we learn that “Since 1945, a positive January in an election year has never missed in predicting a full-year gain for the Standard & Poor’s 500, going 8-for-8″. Wow, a whole 8 data points, conveniently ignoring pre-1945 data (why?) 8 data points is not statistically significant for, well, anything. But go ahead and peruse the article anyway, it’s laughable. It includes gems like “Whatever the S&P 500 doesn’t provide in absolute return this year, it will likely make up for in predictability”. What the heck does that even mean? I’m floored.

And then we have this little interview on the otherwise good ‘Breakout’ on Yahoo!Finance. At about 2:10 into the interview, the guest disclaims “even with a few errors”, the January Barometer is still “pretty good”. Uh huh.

Please use the comments to share other incidences of magical thinking.

Hedge Fund Manipulation

Happy New Year, everyone! What better way to start the year than highlight rampant fraud?

Hedge funds seem to make all the headlines. Rarely do we hear about plain old mutual funds much anymore. ETFs, derivatives and hedge funds are the investments du jour (or perhaps, “du la decennie” or “of the decade”?) There is a tremendous misunderstanding of what “hedge funds” are, how they invest and what to expect from them. The category is as broad and diverse as the “mutual fund” category is.

Technical Nonsense

I read as much as I can about the world of finance and economics. And though I consider technical analysis to be fortune telling, it shows up everywhere. So I often skim it anyway, just to see what the witch doctors are saying and observe whether some of them are actually right with any consistency. The last few months have been rather amuzing in how the technical analysts spun the reading of tea leaves. Here’s how it went:

European Follies

In case you were inclined to believe the rumors that Eurocrats have solved their problems, consider this quote from today’s WSJ:

After a day marked by a brawl among Italian lawmakers, debating cutbacks in the country’s pension system, Italian Prime Minister Silvia Berlusconi took time out from the Brussels summit to call into a popular television show shortly after midnight, criticizing the European Central Bank and dismissing reports he plans to call for early elections.

Circular Logic- “Because the market says so”

One thing you see rampant in financial commentary is the plague of circular reasoning. Circular reasoning or circular logic is when, citing Wikipedia:

“Only an untrustworthy person would run for office. The fact that politicians are untrustworthy is proof of this.“

Such an argument is fallacious, because it relies upon its own proposition — “politicians are untrustworthy” — in order to support its central premise. Essentially, the argument assumes that its central point is already proven, and uses this in support of itself.

Stocks “Plunge” and “New Questions” Really?

Take a look at today’s Yahoo! Finance page:

New questions? The real question to non-speculators is why did it take so long for the market to come to this conclusion? The lesson here is that if you are getting your bullish or bearish opinions from the front page, you are WAY behind the curve.

Mutual Fund Performance – A Case Study

As a professional investor, I’ve read quite a few annual reports. If you include quarterly reports, they number well over ten thousand. Early in my career this activity was limited to reports from companies, but now I research mutual funds of all types too. One section you see in every fund report is a discussion about past performance. While “past performance is no guarantee of future results” as the boilerplate legal language says, it can give you clues as to how a fund invests. Past performance should also raise certain questions in every portfolio manager’s mind. Namely, why do we own (or want to own) this fund?

Something seems wrong- European bank leverage COTD

Europe’s economic troubles seem to be fading recently. The Euro has strengthened somewhat and fears about a European banking crisis courtesy of Greece (and Portugal,  Italy, Ireland, and Spain too- “PIIGS” as they are collectively called) have subsided.