Last Minute Craziness

Snork Maiden got the e-mail this morning granting her Australia visa. But it said that the visa needs to be "evidenced" at the Australian Embassy. I phoned them and asked them what that means. They said: "she needs to send the passport in to get a label put in it". "But we're going to Australia on Thursday!" They told me she could do it in person at the Embassy in Washington between 9 and 11 am. So I booked her flight for this afternoon and a hotel for tonight and hopefully she'll get it all sorted out tomorrow morning. I was doing all this while her movers were taking her stuff out of her apartment. She only slept a couple of hours last night in a last minute rush to pack everything. Cost is around $1000 for this trip. It's good we don't live on the West Coast. The flight will be a direct 1 1/4 hours each way.

At my end things are a lot calmer. I'm having a big giveaway on Wednesday afternoon. I invited all the grad students in my former department to come take stuff. Wednesday night I'll be staying at a hotel a few blocks away. My landlord is very laid back. They just told me to leave the keys in the apartment when I'm done....

Weekly Trading Report and Goals

This isn't a regular feature of any sort, just an update on my trading one week into the month. The model is still short but I closed all short positions before the close today, worried about rumors of the Fed making a surprise interest rate cut on Monday morning based on the employment report that came out Friday morning that showed that employment in the US fell for the first time in four years. I doubt they will do this, but you never know what might happen. The 1998 scenario is still playing out perfectly just faster than things happened in that year. If we continue to follow the script there is only about a week to the second bottom of the market paralleling the second dip in October 1998. Unfortunately we are travelling to Australia on Thursday and Friday next week, so I am not sure how to play this. If we are still on the short side for Thursday I may keep my Ameritrade account in a hedged position (short enough SPY to hedge away market risk). This will reduce my overall portfolio beta from 0.5 to 0.4 or so and mitigate the effects of any severe drop in the market.

I ended the week down $167. I was down around $2000 on Tuesday after a stupid NQ trade. I posted that bear picture as I was feeling like a bear getting run over by bulls or maybe by a truck full of bulls. Again I was trading against the model. If I hadn't taken that trade I would be up $1100 on the week. If I'd taken the trade in the direction of the model...

My aim at the moment is very modest - earn $1500 a month from trading for the rest of the year. That would bring my total to $19000 or so which was my original goal for the year. It also means maintaining the same average pace for the rest of the year. My goal for next year - I know it is a bit early to be setting next year's goals - is to double this to $3,000 a month or $36,000 a year. That is only half way still to the real goal of making $75k per year from trading, replacing my previous salary. The $36k goal looks very doable if I reduce the number of very bad trades - all the majorly losing trades against the model for instance - and only slightly increase capital deployed. I'm also setting a goal of adding $100k in net worth next year. Here is a budget - in the same format as my monthly reports that shows how we achieve this:



I know it is silly to include everything down to the last cent but I can't be bothered to round this forecast from my projection spreadsheet.

Current other income is the sum of Snork Maiden's salary and tax payments. I will be paying taxes on investment and trading income and I've deducted these here. Half of the current investment income comes from trading and I'm expecting the Australian Dollar to rise to 87 cents by the end of 2008. The non-trading, non-forex rate of return implied is 10.5%, which does not seem unreasonable. We'll be earning $68k from salary and trading income after paying all taxes and spending $47k. Our savings rate from this active income is therefore 30%. I put this in for Enough Wealth :) Snork Maiden and her employer will be contributing $9000 a year to her superannuation fund. So, if everything goes to plan, it should be doable.

Another Great Bear Picture

Stock Market Participants' Returns are Lower than Index Returns

Just read a very interesting paper in the American Economic Review (here is an earlier version). The author demonstrates that the average stock market participant - we're not talking just individual investors here but all participants - earns less than the index return. This is because companies tend to issue more stock when stock prices are high and make more distributions - dividends and buybacks - when prices are low. For 1926-2002 on the NYSE/AMEX exchanges the buy and hold index return was 9.9% and the dollar weighted actual return experienced was 8.6%. On NASDAQ the respective numbers for 1973-2002 were 9.6% and 4.3%! That's the effect of all those dot.com stocks issued at the height of the 1990s boom. Similar results are found for other countries. In some the effect is larger and some smaller (e.g. Australia). This drag on performance isn't quite the same as that of brokerage and management fees (though those can be reduced too) because at least in theory :) you can avoid buying overpriced IPOs. Though if a stock you own is issuing more shares causing dilution I guess that is part of this effect too. And this is also before the fact that small investors tend to be less knowledgable (but maybe overconfident) and underperform large investors.

Bears in the Road

Poor bears.

I'm still suffering from bearish wishful thinking.

The Rich Have Capital Gains the Middle Class Capital Losses

This table which I derived from a spreadsheet I downloaded from the IRS website * contains stunning data. You have probably heard that most traders lose money in the stockmarket but maybe you didn't know how badly most people lose money and how strongly the propensity to lose is related to income. This data is for 2005 and I am guessing contains loss carryovers from the great 2000-2002 bear market. Looking at short-term capital gains, the only income groups that had a net gain in aggreagte were those earning more than $5 million dollars a year. All other income groups had an aggregate net loss. For the $75,000 to $100,000 bracket for example the returns reporting net losses reported losses around four times greater than the returns reporting net gains. It gets worse for lower income groups. For long-term capital gains all income groups earning more than $100,000 reported an aggregate net gain. Again the ratio of gains on tax returns with net gains to the losses on tax returns with net losses rises directly with income.

I excluded the number of returns from the table to make it more legible. The tendency is for the lower income losing returns to lose far more than the winning returns gained. Not for there to be much larger numbers of losers.

If I've interpreted this data incorrectly, let me know. I'm planning on doing some more posts based on this data.

* The New York Times hid the information about this data deep in this article.

August 2007 Report

All figures are in US Dollars unless otherwise stated. This month again saw negative investment performance in USD terms, though this was due to the sharp fall in the Australian Dollar and underlying performance was positive. Trading results were positive but volatile and spending was very high. At the end of the month I merged my finances with Snork Maiden for purposes of reporting net worth etc. The income and expenditure figures for this month are mine alone, but the final net worth figure is our joint figure. Net worth fell in US Dollar terms and rose in Australian Dollar terms post-merger. Both figures fell on a pre-merger basis.

Income and Expenditure



Expenditure was $7,959. More than half the figure was moving expenses and more than a quarter the cost of my new computer. Other expenses totalled only $1625. Yes, there is a retirement contribution ($901) there though I am no longer employed.

Non-retirement accounts lost $11,332 but would have lost only $2214 if it were not for the sharp decline in the Australian Dollar. Retirement accounts lost $4151 but would have gained $2693 if exchange rates had remained constant. Net worth declined by $23k on a pre-merger basis. At one point in the month it was down around $50k.

Net Worth Performance
Net worth fell by $US5755 to $US439,155 and in Australian Dollars gained $A20817 to $A538,576. Non-retirement accounts were at $US242k. Retirement accounts were close to $US197k.

Investment Performance
Investment return in US Dollars was -3.75% vs. a 0.23% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 1.29% gain in the S&P 500 index. Non-retirement accounts lost 5.13%. Returns in Australian Dollars terms were 1.36% and -0.02% respectively. YTD I'm up 12.9% vs the MSCI with 8.3% and the SPX with 5.1%. My non-retirement accounts are up 17.4%. So I'm not too concerned about this month's performance, especially as we gained in Australian Dollars!

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency losses appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. The biggest positive contribution came from the CFS Conservative Fund which has a 30/70 equity/fixed income mix. Interactive Brokers began to rebound this month. Voltality (of the right sort) should help the stock. The investment in Hudson City Bankcorp also began to pay off as it is seen as a solid bank in a shaky environment. Something similar could be said about Berkshire Hathaway. Trades in IYR, Lehman, Toll Brothers, Beazer, and the S&P 500 made nice contributions. All three of my earnings plays (AAPL, GOOG, DELL) did not work out and neither did NDX trading this month. The quant fund meltdown resulted in a huge loss in the hedge fund of funds management company Everest, Brown and Babcock and to a lesser degree in their fund of funds EBI.AX. The latter is very undervalued at the moment.

Progress on Trading Goal.

Asset Allocation
At the end of the month the portfolio had a beta of 0.50. Allocation was 35% in "passive alpha", 63% in "beta", 4% allocated to trading, 5% to industrial stocks, 10% to liquidity, and we were borrowing 17%. My Australian Dollar exposure fell to 59% partly due to the fall in the Aussie and partly due to the merger which brought in $US17k in US Dollars. The merger also increased "liquidity". We will keep this very high level of cash through the move to Australia. We'll spend quite a lot more in the process and then reallocate our cash when things have settled down in October.

Retirement Account Beneficiaries

Here's a more serious post :) Following on from the "merger" I am updating the beneficiaries on my retirement accounts. This is known in Australia as a "binding death nomination". The U.S. term sounds a lot less gloomy! It is important to do this whenever there is a change in who you would like to receive your retirement money if you were to die before them. Otherwise your money will go to who you previously designated. The money so designated does not go through the same process as your other assets would in case of death (probate) instead it goes directly to who you specify regardless of any laws on who receives the assets of people who die without a will (intestate) or whatever else the will says. The US tax implications are complex but generally it is better to direct the money directly to who you want to receive it rather than to end up paying it to your estate (the default with no beneficiary designated). When the money is paid to an estate it loses its retirement account status - if paid to a specific beneficiary they may be able to retain it as an inherited retirement account.

In Australia there is no estate tax and following the new super legislation I am supposing that there is no income tax on a dependent receiving a death benefit, however large. There used to be income tax above the "reasonable benefit limit". But if the money was paid to the estate much more income tax might be due ("the benefit is taxed as an ordinary eligible termination payment ")? Anyway, it sounds like it is a good idea to designate a beneficiary. It's important to remember that the designation is only valid for three years, after which it must again be renewed (how annoying). At the moment my Australian designation would go to my estate as no-one qualified for the limited categories of beneficiaries allowed.

I changed my US beneficiaries online. The Australian fund (Colonial First State) needs a hard copy form signed in the presence of witnesses that will wait till we get to Australia.

Merger of Moomin Valley and Snorkdale

The merger of Moomin Valley and Snorkdale was announced today. In a stock for stock transaction, Moomin Valley, as the larger of the two enterprises, acquired all outstanding shares in Snorkdale in return for shares in Moomin Valley. Following the merger, the combined organization will move its headquarters to Australia to pursue new opportunities in supplying scientific and research services to the Australian government.

The merger is effective from the close of business on August, 31, 2007. Pre-merger the shareholder equity of Snorkdale was $17,672 and that of Moomin Valley $418,857. The tangible assets of Snorkdale consist of $19,140 in cash and deposits and $1468 in credit card debt. Moom, CEO of Moomin Valley, who will be CFO of the joint venture, was quoted as saying:

"The net financial assets of Snorkdale are obviously much lower than those of Moomin Valley, but we are pursuing this merger to combine the unique and significant human capital of Snorkdale with that of Moomin Valley. The intangible assets of the new organization will certainly be very extraordinary, dare I say peculiar :)"

Commenting on the financial status of Snorkdale, Moom further commented: "Snorkdale is a much younger organization, and as such has developed an amazing financial track record to date. At the equivalent stage of development (in 1994), Moomin Valley had net assets of around -$11k. I believe this bodes well for our combined financial future."

The combined enterprise, which is yet to be named (suggestions?) will be reporting its first accounts for the month of September and despite the move to Australia will still report in US Dollars in order to better inform the worldwide community of PF Bloggers. Moomin Valley's net worth for August, which will be reported soon, will reflect the merger though the August accounts in terms of expenditure and income will be pre-merger.

Dr Yoyo, CEO of Snorkdale, was unavailable for comment at our press deadline.

Congratulations to Snork Maiden a.k.a Dr Yoyo!

Snork Maiden a.k.a. Yoyo successfully defended her PhD dissertation on Friday. You can read all about it here.

Trading Report for August

I gained $1028 in trading in my US accounts. That's 5.6% of the capital allocated to trading. The month started well and then things got worse and worse. By last Friday I was down $1900 for the month. Then on Monday and Tuesday I gained $3400 to be up $1500. Since then the market rallied again and the gains have been gradually bleeding away. I'm sure you can imagine how demoralizing this chart would be:



Obviously, one reason I feel more comfortable trading on the short side is that I am long my investment portfolio. When I trade on the long side I am adding to my risk. When I trade on the short side I am hedging my risk. The latter feels more comfortable. Many of the more bullish people on the internet only invest or only have a small trading account. The former have to feel bullish and the latter don't have as much on the line when they go long. Many famous investors like Buffett or Soros usually sound bearish. A lot of people online who do both investing and trading also tend to sound bearish. I need to be able to separate the activities better in my mind. My trading has a beta of -0.61 to the NASDAQ 100 index. Objective evidence of bearishness. Of course I have an alpha of 5.0% per month or I would have lost money in the last year. The model I am trying to follow is market neutral.

The theoretical model gained an amazing 22.5% this month. The NASDAQ 100 index rose 2.9% in August.

On my annual goal of breaking even on my US trading accounts I am now at $55,972 and have contributed $64,000. US trading has gained $14,839 so far for the year. With this month's data my alpha relative to the model is now -2.1% per month, which is a big improvement. My beta is 0.79, which is lower, showing I am reducing my risk. I think it is good to reduce risk and focus on increasing alpha at the moment.

My overall investment return will be negative for the month in US Dollar terms but probably positive in Australian Dollar terms reported net worth will probably rise in Australian Dollar terms and fall in US Dollar terms. This is because of the steep fall in the Australian Dollar this month. At the worst point, my net worth was down around $US50,000 on last month. The quant fund meltdown also had a very negative effect on underlying returns this month. I'll post a full report in a few days time.

Even though my trading gains were rather meagre this month, the fact that I was in the black gives me a nice psychological boost. Two negative months in a row would have been rather depressing at this point.

New Computer, Google Analytics, Market Direction

The finance person in my former department told me yesterday they want my laptop back (not sure what they plan on doing with a Mac laptop in a PC oriented place - though I have one former colleague who is another big machead who maybe could use it - the forward cursor key doesn't work but otherwise it is a fairly new computer). So I went to buy a computer at the Apple Store at our huge regional mall last night. Cost $2159 including tax the base model MacBook Pro. You can buy one of those white plastic Mac "consumer" laptops with a smaller screen for not much more than half this price. But the MacBook is the most beautiful computer ever built I think and I was using one up till now. If I bought the cheaper model I would be annoyed every time looking at the thing that I didn't get the MacBook Pro :) Besides, for trading, the bigger the screen the better. Maybe I can deduct it as an investment expense in my Australian taxes next year?

I signed up for Google Analytics. This is the first time that I have any analytic capability on my website beyond the Clustermaps application. Expect some geeky reports coming up!

Obviously I was right to close all remaining shorts yesterday morning. The strength of the rally switched the model to long. This is my current Elliott-Wave scenario:



There is a lot more upside coming if this is correct.

Covered Real Estate Shorts

Kept the Beazer puts though. Thought about putting a hedge on the US portfolio (BRKB, FLIP, HCBK, IBKR, NCT, RICK, SAFT) for the rest of the day but the odds seem in favor of more rallying today so I didn't. Off to a couple of meetings with grad students - the first is trying to sort out one of my students committee going forward after I've left. There is not much enthusiasm to take her on. The other is a farewell lunch with grad students.

Golden Bear Day

Today was a great day for being a bear. However, I closed all my index shorts towards the end of the day. The market closed at the low of the day and near the low of the last five days and so there is a good chance of a bounce tomorrow though the model is still formally short. Also there is a very nice 5 waves down from Friday's top. I did keep my real estate related shorts (LEH, BZH, IYR, TOL). The Case-Shiller house price index reported today - all cities that they cover are now down year on year. The Fed released the minutes of the last FOMC meeting, which essentially said nothing much. There was also a consumer confidence number which just met expectations. Basically the technicals are pointing down and so the market is going down. I don't know if we are immediately heading to a new low or whether this is wave B of a B wave that started with the August 16th low or what. I'd think we need more time before retesting the August 16th low based on the weekly charts, McClellan Summation, and past experience. But you never know. There's also a chance that we won't retest it but I'd rate that pretty low.

Glad I'm not Teaching

Today is the first day of the semester at my former university. I'm glad I don't have to teach today. Maybe some day I'll come back to it. But I need a break from it and academia in general. I've been doing academic research for 20 years since I worked on the project when I was an undergrad that became my first published paper. I'm burnt out. I'll keep doing a little of this at my own pace. For example, right now I'm working on reviewing a paper for a journal. But I'm also rejecting a lot of review requests. That's nothing new for me as I was getting requests to review far more papers than I could.

Sold Ansell

I just sold my 500 shares of Ansell @$A12.59. The stock spiked up 4-5% today and I'd been wondering recently whether to hold onto it. Some people are bullish on the stock but recently it has been negatively affected by fluctuations in the price of latex and the stock price has been pretty volatile. The company has a consistent growth plan and has been acting on it. I first bought the stock six years ago when it was in the middle of restructuring as a value/turnaround play. The company was formerly known as Pacfic Dunlop and produced everything from tires to clothing. The new focus was on gloves - surgical and industrial and condoms. The investment has been very successful yielding a total profit of $A9300 over those six years. Looking at the chart the stock has gone through five major waves a typical Elliott Wave signature of a complete bull run. Today the price was hitting the recent highs from several weeks ago after a dip as low as $A10.85.

When you are using margin as I am you need to evaluate each investment against your margin loan rate, which is currently 9.25%. I'm not certain that this investment can return more than that going forward, I'm bearish in the near term on the general stock market. I've had a great run in the stock and decided it was time to say goodbye. Yes I'll have to pay long-term capital gains tax though that is quite a way off. And because I have bought the stock and sold some now and then, only $A1500 is liable for tax, while I save the interest on all $6250 that I sold. And I received the dividend as the stock just went ex-dividend a couple of days ago.

Trading Psychology

Every time I "blow up" I get to work on both my model and my psychology. I try to find tweaks to the model that would have given me a more definitive signal. For example the problem this time was that at the start of the Friday session the model was saying to be short at the close. But that was based simply on one of the stochastics I follow (slow(5,3)) crossing over (which is one of the sell rules when we are overbought - a state where the stochastics are above 80. But if the market rallies that signal is negated. And that is exactly what happened. So based on that indicator there was no sell on the close signal at the end of the day. But I have other indicators to signal when to sell in the overbought state. One of them is based on the forecast of the stochastic for the next day and its moving average. Direct forecasts of the stochastics are generally poor indicators - not a lot better than a random walk in the one step ahead forecast. But when there is very strong momentum in the market they have enough time to eventually give the correct forecast. Anyway, I tweaked this indicator and backtested it and this seems to work much better. It is saying sell on Friday's close. So overall I would say one could take a short position but cautiously.

But the other half of the story is that no indicator said I should go short before the market close on Friday! My impatience in wanting to be contrarian and bearish as soon as possible is what got me into a classic bear trap when what I saw as a head and shoulders formation over the last three trading days did not play out as expected. So the other half of the work that needs to be done is on my psychology. There are lots of good resources in print and online on trading psychology. These are some of the websites I know about:

The Other 2%
Afraid to Trade
Trader Feed - Brett Steenbarger's website.
Trading Psychology - Bruce Hong's website.

Keep Losing Money

I seem to have developed something like a death wish regarding my trading accounts. I know exactly what to do, and then do the exact opposite. And keep losing money. I don't understand it, but something is emotionally wrong.

I know that I feel most comfortable going against the trend, being outside the mainstream and the consensus. It might come from being an outsider in many ways growing up. But this is a very destructive tendency in trading. Especially, going against the model I created myself! If I could stop this delusion, I could make a lot of money at this.

Closed my Chase/Amazon Credit Card

I hadn't used it at all for a while and think a credit line on my remaining US credit card accounts of $10,500 is perfectly adequate. So why not just leave it open? Well they keep sending bills, many of which include convenience checks which I carefully cut up and throw away. I don't want those to get in the wrong hands. There was no option online to redirect mail to Australia. And what would I want that stuff for in Aus anyway? I might go through all my store cards I've collected and cancel those too. Once I got through the touchtone options it was all over at Chase in a minute. Very painless. I'll still have HSBC and Citibank credit cards.

New Trade

Shorted 100 LEH (Lehman) @ 58.99. Don't know how long I'll hold this one, will see how things develop.

PS 12:38PM

Another new one: Bought 2 Beazer $15 puts in my Roth IRA. I also reshorted IYR.

Craigslist Works - Fast

Snork Maiden advertised her car on Craigslist at 4pm this afternoon and by 6pm she had a buyer! And this is for a ten year old Subaru in a state saturated with Subarus. Agreed price $3300. I think she paid $6000 about three years ago from a dealer.

At my end, I've now worked out all my address changes and did a few already online. Will print the ones requiring hardcopy letters tomorrow and send out. A couple of financial institutions didn't allow a country outside the US on their online interfaces. TIAA-CREF specifically say to phone them about that. Chase credit cards don't mention it, though they do have a link to enter foreign phone numbers! I may close the Chase/Amazon card anyway. I'm not using it a the moment and don't need 3 US credit cards. Also I no longer care about my US FICO score. I plan to keep my HSBC and Citibank credit cards for the moment. Of course, the best address change form was on the website of the Association of American Geographers (it had better be!). It even had the Australian states on the menu together with US ones and Canadian provinces. I probably won't renew my membership though when it comes due...

Otherwise, more stupid trading today (against the model). I don't know how much pain I need to suffer until I learn my lesson.

Clearing Up

Today I did a final clear-up at my old office - erasing all my files off the computer, taking a bunch of files that were still there home, and handing in my keys. They already had the name of the visiting professor who will be teaching in my place on the door, but no sign of him. He got his PhD in our department a few years ago and has been teaching temporarily at various colleges and apparently doing some journalism too. I also helped a faculty member understand a bit about how to maintain our online working paper series which I was in charge of. He's not too computer savvy (in his 60s) but with some help I think he can get on top of it and learn some stuff about servers, using Acrobat, and editing webpages.

Today, exactly 17 years ago, I first came to the United States. Now I am in the process of leaving again (for the third time). I know it is a cliché, but it is amazing how time flies.

Real House Prices in Australia

Following up from yesterday's post I downloaded data on the Australian consumer price index and computed series for real (inflation adjusted) house price indices:



These series, like those I posted yesterday are for established houses only (not new houses). I used the specific consumer price indices for each city. The next graph shows the real year on year rates of change in hosue prices:



The average growth rates over the entire period for each of the cities is as follows:

Sydney 3.0%
Melbourne3.0%
Brisbane 4.0%
Adelaide 1.3%
Perth 5.0%
Hobart 2.7%
Canberra 2.3%

But as we can see readily from the charts the average rates for 1986 to 1999 were much lower than this:

Sydney 2.3%
Melbourne 0.5%
Brisbane 0.4%
Adelaide -2.7%
Perth 0.6%
Hobart -2.0%
Canberra -1.5%

Only the boom from the beginning of 2000 lifted the real rates of price change into the black for all cities. EnoughWealth's comment that the real rate of increase for Sydney is between 2-3% is accurate, but it's not true of other Australian cities if we assume that the 2000 boom was an anomaly. Based on the 1986-1999 period and what has been seen historically in US housing markets I'd bet that the true long term rate for other Australian cities is less than 1%. In the next few years I'd expect it to be even lower as prices revert to the mean trend. Of course I could be wrong and the other cities might instead continue to perform like Sydney. Theoretical this could happen if the supply of desirable locations is restricted in the future. When supply of land is restricted we should expect land prices to rise at the same rate as the rate of economic growth. This is what appears to be happening in Sydney. But desirable locations are not as restricted in the other capital cities.

Australian House Prices

I put together this chart of house prices for the six Australian State Capitals and Canberra from the official government data:



There is also data available for Darwin but it was too erratic and Darwin is so small that I dropped it. And I also computed the year over year rates of change:



Next, I'll try to come up with the real changes in house prices adjusted for inflation in the prices of other goods and services. That will give a better idea of what we might expect in the future. General inflation was much higher in the late 1980s than recently and so the average rate of house price appreciation over this period is misleading I think.

After the initial subsidence in prices around 1990 there was an "echo boom" that was more noticeable in some cities, particularly the smaller ones. And, again, recently the rate of price increases subsided or prices fell absolutely (in Sydney in particular) but now we are in a new period of house price inflation, especially outside of Sydney. The echo boom in Perth is much greater than the initial boom there. This is entirely related to the boom in the mining industry.

I've noticed that there is a four year cycle in the US housing market, just as there is in the US stock market. It seems this same four year cycle could be present in Australia, superimposed on the longer 16 year cycle. By this interpretation, we are now near the peak of a four year cycle and should see a reduction in the rate of increase in prices over the next couple of years. 2009-10 could be a good time to buy a house.

Quant Fund Meltdown Autopsy

The autopsy of the quant fund meltdown in the last weeks is beginning. In this article, Clifford Asness of AQR is quoted as saying: “We have a new risk factor in our world.” What is that factor? - some stocks are heavily owned by similar funds and others are heavily shorted by the same funds. This is an example of the "fallacy of composition" in economics. Something that works for one player at the microlevel does not neccessarily work for everyone at the macrolevel. For example, some traders have skill and are profitable but not all "traders" can profit (of course, if hedgers lose speculators could all win). Here one small fund could liquidate and exit the market profitably but not all can do this simultaneously.

TFS Capital has been looking at what factors were most responsible for the recent fall in value of quant long-short funds. They have put out a press release on their research. They identify short-covering rather than selling of long positions as the primary factor. And the stocks with the highest "short interest" - the most shorted saw the biggest moves. In other words it was a classic "short squeeze". I guess one could theorize that if a long-short fund liquidates all its positions it would be selling the long positions into relative strength as these are stocks that were identified as being good investments. Long term investors likely wouldn't panic and also sell these stocks due to the price falling a little. On the other hand covering its short positions would cause a scramble by other short-sellers to cover too. The good thing about identifying this factor is that the level of short interest in each stock is published monthly and could be included in a quantitative model. I guess one could try to track the holdings of similar hedge funds on the long side, but these are published quarterly with a lag so that data is less useful.

The bottom line is that many of these funds will rebound in value from this debacle and will have learnt from the experience and improved their strategies. In retrospect this "black swan" looks very predictable. But things are always easier in hindsight. For the individual investor it means that some of these funds are likely good values for investment now and also that if you are shorting stocks yourself monitor very closely any stocks which have high short interests.

Fed Cuts Discount Rate by 1/2 Percent

The Fed made a "surprise" cut in the discount rate - the rate it lends to banks at - of 1/2 percent this morning. The stock futures went crazy to the upside (NDX up 40 points). Interestingly, 10 and 30 year bonds futures fell sharply indicating expectations of higher future inflation. The Fed has not moved their main target the Federal Funds Rate. Yesterday, 90 day T-Bills were trading at yields in the mid 3% range. I think this is due to some money market funds having problems due to investing in short term corporate bonds that have fallen sharply in value or mortgage related instruments. Even those yields are rising today. Interesting that the Fed chose options expiry day to take this action...

Leaving Retirement Account with my Employer

I decided to leave my 403b account with my employer and invested in TIAA-CREF. Often I read about how this is a bad idea. But TIAA-CREF is a good (and cheap) fund manager. And foreign employer sponsored retirement accounts are exempt from Australian taxation as long as distributions are not taken. Distributions are subject to regular income tax just like a 401k or 403b is treated by the US IRS. A US IRA is (mostly) taxed just like a regular taxable account by the ATO (Australian Taxation Office).

The retirement specialist told me that retaining the account with them does not preclude rolling over the account at some later date to an IRA. Also they allow all of the distribution methods that TIAA-CREF facillitate. Not all employers do. And apparently there is no paperwork to complete.

Carry Trade Unwinding

The "carry trade" is where investors borrow in low interest currencies and invest in currencies with high interest rates, pocketing the spread. The main low interest rate currency has been the Japanese Yen and one of the main high interest currencies the Australian Dollar (AUD). In recent months the Australian Dollar soared higher and higher and the Yen mostly lower. In the current financial crisis the process is reversing and the Aussie has fallen around 10 US cents from its peak. It's down 3.5 US cents overnight, which is a massive move in a currency:



This is having a massive impact on my net worth measured in US Dollars as around 2/3 of my net assets are in AUD related investments. At this point in the month my rate of return on investment is -9.7% and net worth has fallen $US 47,000 from last month. In AUD terms, though, the return is -1.6% and net worth is off only $A 12,000. In USD terms this is the worst drawdown since the big bear market in the early part of this decade. But in Australian Dollar terms it is nothing remarkable. I lost more in June 2006 for example: -3.3%.

I am sufferring some big losses on investments, however, especially in the Everest Brown and Babcock Hedge Fund of Funds (EBI.AX) and the management company (EBB.AX). The latter has halved from its peak. I really should have sold some when it was so overvalued. I guess irrational exuberance and a dislike of paying taxes overtook me.



As for the fund of funds itself - it trades as a closed end fund on the Australian Stock Exchange and so the stock price can trade at a discount to NAV which is only announced monthly. Undoubtedly some of the hedge funds in the portfolio have suffered losses in the current market conditions. But I doubt this justifies the steep fall in price relative to the end of July net asset value. NAV was $A4.06 on July 31st. Yesterday, the fund traded as low as $A2.48 before ending up.

Many people claim they wish to emulate Warren Buffett and buy like crazy when prices are below intrinsic values. I have been doing some of that in recent weeks but have been wary that prices could fall lower. So I haven't been "buying like crazy". It's hard in practice to actually put such a plan into action when the time comes.

Wednesday Effect

The model was signalling to go long tomorrow. However, today is Wednesday which tends to be an up day in the markets. I was just searching for the link where I read about that statistically significant effect but I can't find it. Anyway in the last few years the market tends to go up on Wednesday. So I added a rule, that if the model is short on a Wednesday and Thursday is predicted to be long then I should go long on Wednesday. It improves the results. Just going long on Wednesday willy nilly, however, reduces returns. The reason for this is that on about half of all Wednesdays the model will be long anyway and that is a substantial part of the Wednesday effect. On the other half of Wednesday when the underlying model is short it is sometimes right and sometimes wrong. The times it tends to be wrong is when the signal is turning to the long side at the end of Wednesday anyway.

PS 4:25PM

The Wednesday effect obviously didn't work today though early in the day it looked like it was and I went long and made a profit. Then I went short, ditto. Then I went long near the close and the market kept falling. Then my internet connection went haywire :( I was stuck in the losing position and couldn't get out of it. When things were back to normal I was down more than 10 NQ points. There was a post-close bounce of sorts... deciding what to do now.

Buy: Symbion Health

The ACCC (Australian Competition Commission) approved the merger of Symbion Health (SYB.AX) and Healthscope (HSP.AX) today. Yet Symbion's share price is languishing below the implied value post takeover. Healthscope's price would have to fall considerably to make Symbion's current price a fair value. I guess people are concerned about just that and whether the whole deal will fall through in the current credit constrained environment. Another potentially disturbing factor is the stake that Primary (PRY.AX) has been building in Symbion. Anyway, I decided to do a bit of merger arbitrage and double my position in Symbion. At this point this is shaping up to be my worst month in terms of investment return since April 2005 when I suffered an 8.6% loss. That event got me to be more proactive again in investing in trading after letting things ride for a while. It was a great ride in the two years up to that point but this loss was a reminder that risk hadn't gone away. Apart from the generally negative direction of the markets I am being hit by the fall in the Australian Dollar and by the debacle in quantitative long-short fund strategies which is affecting several of my holdings directly or indirectly. In Australian Dollar terms this month is not particularly bad so far (but still negative).

Tourist Visa

I got my tourist visa or rather "visa waiver" and am back in the US in Snork Maiden's town. They asked me a lot of questions and I showed them my outbound itinerary to Australia, my resignation letter etc. I was the last one back on the bus. That's a relief. When I arrived some Egyptian guy was waiting and he was still waiting when I left. Next step in the moving plan is dealing with all the administrative stuff like changing addresses with financial institutions etc. I'm thinking now to exit my apartment at the end of August (I'll give them some excuse about visas) and fly back here and then on September 12 fly back to my hometown - I have a hotel booked for that night there anyway - and then on September 13th fly out to Australia. The flight would be cheaper than rent and utiltiies for another month. We can't reschedule the flight to leave from here (Snork Maiden town).

On another note, volatility in the stockmarket has now declined to a level where I am much more comfortable trading again. It hasn't been a matter of the daily moves but the intra-hour volatility or intra-5 minute volatility even. Now it is much easier to figure out where the market will be heading in the next few minutes. I am beginning to try more trades and make more money at them again.

Montreal

I'm in Montreal. I took the Greyhound Bus up from Burlington, VT this afternoon. I told the Canadian Immigration agent the whole story - how I was an H1B, quit my job, and was planning on re-entering the US tomorrow. She took my I94 (the little form that gets stuck in foreigners' passports when they enter the US) and let me in to Canada. So, so far, so good. This is actually my first blog post from outside the US. Haven't been out of the US or off the east coast for a while now. Since December 2005 actually. I usually travel more than this. The hotel I'm staying at is called: Hotel Montreal Espace Confort. It is just around the corner from the bus station on Rue St Denis, which is one of the nicer streets in Montreal. I'm not a big fan of Montreal - this is my fourth visit here. I get hung up on the language issue. If I speak English people often seem grumpy and annoyed and if I try to speak French they speak back in English. I can't win. I liked Quebec City more. France itself is a whole other story at least away from Paris. Most people I met there were happy I was trying to speak to them in French. Anyway, the hotel is very new, clean, modern design, and a good price in a good location. If you are happy to share a bathroom you can get it for $C50. I paid $C89 for a better room. There's an even more frugal option for this exercise - do the round trip by bus in one day - it's only 2 1/2 hours each way. But I didn't feel like doing this and thought it best to leave the country on the day I officially quit and then come back the next day in case there were any complications.

Submitted New Resignation Letter

I just now e-mailed in a new resignation letter with a resignation date of 13th August. I also e-mailed HR to ask if there is anything I need to do regarding my H1B. I want to keep it with TIAA-CREF for the moment. I booked a hotel in Canada for Monday night and will take the Greyhound bus up there. Tuesday, I will try to return to the US as a tourist. We will see what will happen.

Back to Visa Issues Again

The HR Department at my university won't approve my leave due to concern that immigration will take a "dim view" of it. The head of HR gave two options: Appoint me to a fixed term appointment from 1 July 2007 to 13 September 2007 or that I resign retroactively from 30 June and do the "B Visa", which practically means leaving the country and trying to re-enter again as a tourist. The problem with the first option is that I might need a new H1B. So now I've e-mailed the lawyer again on that. If it does need a new visa, it's not a practical route. Likely I will end up having to try to go to Montreal and back... At least now all the stuff I want to ship to Australia is on its way and Snork Maiden would "just" have to drive 150 miles each way to pick up the rest of my stuff if I got stuck outside the country. Everything else could be handled from there.

EBI Management Ponder a Buyback

I'm not the only one who thinks this investment is a bargain:

7 August 2007

ASX RELEASE

Everest Babcock & Brown Alternative Investment Trust (EBI)

EBI applies to ASIC for relief to conduct buy-back

Following the announcement of an unaudited net tangible asset backing per unit (NTA) of $4.06 as at 31 July 2007, the responsible entity of EBI announces that it is considering conducting an on-market buy-back of EBI units. It has today applied to ASIC for the appropriate relief.

As at close of 6 August 2007 the market price of an EBI unit was $3.18 being a 22% discount to the July NTA and EBI believes that a buy-back would be an efficient use of capital which would generate unitholder value.

Any buy-back is subject to ASX consultation, ASIC relief and potentially (depending on size) unitholder approval. At the time ASIC relief is obtained, the responsible entity of EBI will review the discount between the EBI unit price and its NTA and will determine its next course of action.

************************************************************************************************

The current undervaluation started with the botched capital raising in April. The capital raising raised the desired funds but resulted in a loss of net asset value to those who did not participate. This included me - I wasn't allowed to participate because I was a foreign investor. The loss of value as a result of the capital raising was very unfair. The stock price plummeted even further. More recently as hedge funds have changed from being the investment du jour to being very out of favor the discount to net tangible assets (NAV) has widened considerably.

Two More Buys

I bought one share of Berkshire Hathaway B (BRKB) @ $3615 and one hundred of Safety Insurance (SAFT) @ $33.26. I thought that Berkshire had another great quarterly report and it was time to double my position. SAFT is a stock I noticed a long time ago and occasionally checked in on but never bought. The negative for this stock is its position as a regulated insurer in the Massachusetts market is coming to an end. The positive is that the P/E is very low and the stock is trading at about book value. The big sell down in recent months has followed other financials and I expect is due to fears that the stated book value is not the true value of net assets when all assets are actually marked to market. It doesn't seem though that this firm's investment portfolio is signifcantly affected by these kind of issues.

Buying at a 28% Discount to NAV

Just bought another 2000 units of EBI - the listed Australian fund of hedge funds - at $A2.92. Today the manager announced that NAV for the end of July was $A4.06 per unit and the fund lost 0.25% in July. They also emphasized that they don't have any investments in mortgage funds. I guess investors might be concerned that the fund is structured using a total return swap. But otherwise this 28% discount to NAV seems a bit overdone.

House Prices and Interest Rates

Mortgage borrowing conditions are getting much tougher and interest rates, especially for large mortgages, seem to be going up. An interesting paper on Irish house prices uses a new approach to model the relation between interest rates and house prices. Most previous macro approaches (including my own published research on house prices - I worked as a real estate market analyst back in 1990) found a small effect for interest rates. They contrast this research with the "finance approach" which takes a very similar approach to my recent blog posts in comparing house prices to rents and alternative investments. The finance approach finds a strong effect for interest rates but can't model the effects of demographics etc. The new approach which combines elements of both finds that if interest rates had been 2% higher in Ireland than they were in fact, then house prices would have been 22% lower. A 25% cut in house prices in high end markets does not seem too extreme. It's already happened in some places like Florida.

Weekly Trading Report

In the first three days of this month the NDX is down 0.7% and my trading accounts down1.1%. The model is up 0.52% because it would have stopped out once the market fell 1.25% this afternoon. I'm losing money at a slower rate than last month, which I guess is a good thing :P

Looking forward to Monday a lot of people seem to expect the market to continue to fall or even crash 1987 style. From my modeling this seems rather unlikely. My best analog for Monday is January 29th this year where the stochastic fell but the market ended up slightly. This is my working E-Wave scenario, which is rather bullish for early next week:



i.e. there should be a "C wave" up following the B down, which would likely exceed the top of the "A wave". On Tuesday the Fed has a chance to say something. This could be a critical juncture for the market. Unfortunately I won't be able to trade at that time.

My Interactive Brokers account was down $603 or 3.53% for the week if I don't count the open position I had over last weekend. If I do count that position then I was up about $400 this week. For the week the market was down 1.9% and the model up 0.2%.

I updated an analysis of the performance in this account relative to the NDX using weekly data:



As you can see from the chart I have a negative beta to the market - actually a beta of -1.6. I'm too bearish - ideally I would have a zero beta as this is meant to be a market neutral strategy. My weekly alpha is 2.6% which is where the regression line crosses the y-axis. This alpha has a t-statistic of 1.59 which is significant in a one-tail test at 5.9%. On average I made 2.1% per week while the NDX went up 0.3% per week. Taking into account volatility the NDX had a Sharpe Ratio of 0.69 while the account had a Sharpe Ratio of 1.37. Here again is the data, which shows why I persist in the face of recent negative performance. I know I can outperform the market with a fairly low probability that my results are just random.

On the net worth front I am down $16,500 already this month. $11k of that is due to investment/trading performance. The rest is mostly the moving bill.

Trying too Hard to Make Money

I'm still trying too hard to make money and end up geting into lower probability trades with too large a position and losing. This week my account has been swinging up and down erratically as I make money and then try to make more and instead lose more. But I feel like things are getting under control. At least I know what I am doing wrong. Alternative investments continue to be hit hard. On a more positive note, the movers came this morning. We had planned on doing a "priority load". First load all my boxes of books and stuff and my custom made desk and then see if another two pieces of furniture would fit in the dimensions of the lift van (the huge crate my stuff will be packed into that will be placed inside the shipping container with other people's lift vans. The guys decided they would and so we are plus one futon on what I thought we'd be taking to Australia. Of course I gave them a tip!

Snork Maiden said that one of her friends was impressed by how easily I walked away from my past - for example quitting my job and giving up on the green card quest. It certainly wasn't easy but I try to rationally decide what is going to make me happiest in the long-run and I think the plan we are now embarking on has more good possible outcomes than not doing it. Maybe my training as an economist helps. Many people seem to do things because that is what everyone else is doing or it is what they have always done up till now. Of course, in many areas of life it makes sense to use "rules of thumb" to make routine decisions. But the big choices in life are worth deeper thought.

Is That a Hedge Fund? Ouch!

Anything that might be a hedge fund, mortgage fund, or have leverage is getting sold. In some cases this is somewhat rational. Case in point: Newcastle. This is a mortgage fund run by a hedge fund company. They do have sub-prime loans and lots of leverage. But subprime loans are a minority of what they have and they have sold off a lot of what they bought in CDOs (but retained some of the worst bits). The majority of their mortgages though are commercial mortgages. Cramer listed NCT in his "dirty dozen" and a Citigroup analyst downgraded the stock yesterday. It's dividend yield has gone up to 16%. Today, the company will report its second quarter earnings. Hopefully, they will give some forward guidance.

Less rational is the selling of the Everest Brown and Babcock fund of hedge funds listed in Australia. This stock is a closed end mutual fund invested in around 20 hedge funds via a total return swap that includes leverage that is equivalent to taking on a one to one margin loan for each dollar invested. The last reported net tangible assets was $A4.07 a share and last night the stock closed at $A3.05. The company has announced that the funds they invest in have no exposure to the subprime market. The yield is 22%.

Roadmap for the Correction

This is my best guess of how to interpret what has happened so far in the SPX and what might happen next, based on my idea that the correction needs to run for a while longer. Until the economy looks really much worse, though, it's hard to see a much steeper decline. I ripped this chart off of Macro Man's blog and then modified it.

PS

I did OK trading today up $300 or so. It all came in the final rally.

July 2007 Report

This is my net worth and investment performance report for July. All figures are in US Dollars unless otherwise stated. This month saw the first negative investment performance in 10 months (in USD terms), bad trading results, and a small decline in net worth.

Income and Expenditure



Expenditure was $2,113 - this month there were no moving expenses. Current non-investment income mainly consisted of a refund from the IRS. I'm no longer receiving a salary or making retirement contributions. Non-retirement accounts lost $1797 but would have lost $3923 if it were not for the continued lift from the Australian Dollar. Retirement accounts gained $288. I've introduced a new entry this month: "retirement tax credits". As I've explained, I measure all investment performance on a pre-tax basis including my Australian supperannuation account. Unlike US retirement accounts the returns on Australian retirement accounts are taxed at source but at a concessional rate. In order to compute the actual gain in my superannuation account after tax to get the change in net worth I need to take out the tax paid. This month the account lost in Australian Dollar terms so the tax adjustment is negative.

Net Worth Performance
Net worth fell by $US356 to $US444,932 and in Australian Dollars lost $A6615 to $A517,784. Non-retirement accounts were at $US244k. Retirement accounts were close to $US201k.

Investment Performance
Investment return in US Dollars was -0.34% vs. a 1.50% loss in the MSCI (Gross) World Index, which I use as my overall benchmark and a 3.17% loss in the S&P 500 index. Non-retirement accounts lost 0.73%. Returns in Australian Dollars terms were -1.48% and -1.91% respectively.



The S&P 500 is barely beating a savings account so far this year.

The contributions of the different investments and trades are as follows:



The returns on all the individual investments are net of foreign exchange movements. Foreign currency gains appear at the bottom of the table together with the sum of all other investment income and expenses - mainly net interest. I can't see any patterns at all in these results - the best gains and worst losses both came from futures trading.

Progress on Trading Goal.

Asset Allocation
At the end of the month the portfolio had a beta of 0.59. Allocation was 34% in "passive alpha", 64% in "beta", 6% allocated to trading, 6% to industrial stocks, 6% to liquidity, and I was borrowing 16%. My Australian Dollar exposure was steady at 62% from 69.5% in January.

Trading Results for July

I lost $3067 in trading in my US accounts. That's 13.61% of the capital allocated to trading. That's the second worst performance since I started recording this data in July 2006. In October 2006 I lost $5952 which was 14.33% at the time. The theoretical model gained 3.22%, which is a weak performance. I tend to perform poorly when the model performs weakly:



The NASDAQ 100 index declined 0.11% in July. The S&P 500 Index feel about 3% and MSCI World Indices fell around 1.5%. Seems like my overall investment return will be only slightly negative for the month in US Dollar terms.

Volatility

I was doing well trading this morning and was up about $400 and then for some dumb reason tried to trade again this afternoon. Things went crazy when American Home Mortgage imploded and I lost About $1000. Bad day to end a bad month of trading. I don't have the final figure yet but it's probably going to be the second worst in the last 13 in both dollar and percent terms and ends a run of 6 profitable months. The only consolation is that it was worse even a few days ago and I did manage to claw some back. These latest losses also were at least when I was trying to trade according to the model more or less. The less is because I really shouldn't try to position myself according to the model in a new position till near or after the close of trading as the model has only been tested based on placing trades at the close (and overnight trades).

Investment returns for the month will also be negative. That's not surprising as the stock market has gone down. And, therefore, net worth is down too.

Some good news today, is that Snork Maiden got her Australian visa approved. It has been such a pleasure working with Australian immigration compared to dealing with US immigration. No lawyers required. Everything can be done online. There are online updates on the state of your application etc. Last night though we got a message that the visa was approved but would be granted on September 25th. We are flying to Australia on the 13th and arriving there on the 15th. So we e-mailed the person who had e-mailed us to inform us of the approval. It probably helped that Snork Maiden's employer had checked with immigration earlier that this entry date would be OK and we attached that e-mail. The same day the message came back that the visa would be valid from the 11th instead. This is just another planet from the experience of people applying for US visas. On the other hand, Australia is extremely tough on illegal immigrants of which there are not many.

Recovery

I fixed the damage caused to my futures account on Friday and then some. HIgh volatility in today's session was very useful for this purpose. I traded NQ and ES on and off. My US stock account is also doing fine mainly due to a rebound in Interactive Brokers. I expected a bounce today based on my modeling, examining historical parallels, and reading blogs etc. The question is whether this is the beginning of a corrective wave that does not exceed the July high in the indices and then there is another wave down in the correction (or more) or whether we now rally to new highs. Based on E-Wave, other chart analysis, and my model output I am leaning to this being a corrective wave followed by a similar size second corrective wave. It's possible to view the action in the SPX and Dow in June and July as an E-Wave "flat correction". This could be a complete correction labeled iv here:



But looking at the stochastics it seems more likely that there is more of iv to come. Wave ii lasted a long time but didn't result in much downmovement. The "Law of Alternation" suggests that there should be more downmovement in this correction. One possibility is a complex correction with 3 waves down complete, 3 waves up to come and then another 3 down (WXY). After that we would need to rally to new highs to complete the bull market since 2002.

Of course since E-Wave is so subjective lots of other scenarios could be equally valid. In the longer term E-Wave often seems more useful after the fact.

This scenario explains why bearishly oriented traders and investors have been wrong for so long. Wave 5, the final wave of the bullmarket, extended tremendously after getting started in late 2004. Every time the bull market has seemed ready to come to an end another wave has appeared. Of course, the most bearish forecasters, such as Robert Prechter, have assumed for most of this period that we were not in a bull market at all. Action in non-US markets such as Australia convinced me that that was incorrect fairly early on.

That Was a Bad Idea

It was a very bad idea to put so much reliance on an essentially untested or minimally tested model. The progress in winning back some profits in the last few days has been reversed. I have now done some more testing of this new idea and while the results are interesting it is far from a panacea. I don't understand why I trusted this model today to the point that I lost a pile of money in the final collapse of the market at the end of the day. Up to that point things were going well, but I was convinced the bounce should continue. And then I guess I froze in disbelief. Very bad behavior. The Australian Dollar has also been falling in the last couple of days. I now have a negative return overall for the month and not just for trading which was a given. The only consolation is I'm not doing as bad as the market is. It's been a good run in the last several months up till now.

Trying a New Way of Using the "Model"

Just thought of a new way of using my model results and so am going to make a bold prediction for tomorrow.

Direction: Up

Predicted rise in the NDX: 7 points IF today's low of 1955 is not taken out.

But if today's low is taken out then still expect a big bounce before the close.

My modeling approach forecasts the stochastic oscillator which measures where price is relative to the recent range. Today I would have been able to forecast where the stochastic ended up pretty precisely. But because the range extended dramatically to the downside the price could be much lower and still above the bottom of the range. There was a 31 point bounce off the bottom to the close. I am thinking that that is not too hard to forecast but where the bottom will be is not possible...

Five Years Ago Today

I moved back to the US from Australia and now we are on the verge of moving back to Australia again. I produced a NetWorthIQ style snapshot of where things were at then and now:



Apart from the sevenfold increase the big difference is how levered I was back then. My debt was 242% of my non-retirement net worth, which was only $22,597. Non-retirement net worth has risen much more than the retirement accounts. Apart from credit card debt I had $38,540 in a margin loan and $12,502 I owed to my mother. I took on the debt to avoid selling all my shares and funds at the bottom of the market. I just about made it through with a positive net worth.

The Australian Dollar was only worth 54 US Cents back then and now it is at 87 US Cents.

The Model Missed This One

But Oscar was calling for an up day too, so I wasn't the only one. I made some money on the long side and then just when I realized that the market was going to really go down hard I had a bad trade losing just over $200 a contract. Could have been a lot worse today. The model is still predicting up for tomorrow and for a few days after that. Anyway, by the end of the day NDX was only down 1.22% which is slightly less than the model's 1.25% stop. So it wasn't that wrong in the end. Was looking to see if there was some way to predict what happened today, but I only found one past instance when the model "failed" in the exact same way - predicting up when the stochastic was above 20 but instead the stochastic fell the next day below 20 which is the oversold zone. So there wasn't anything I really could learn from that. And by the end of the day the model hadn't actually failed - the stochastic ended the day above 20.

I've tried to avoid making any bigger predictions about the market recently as the market has generally confounded any bearish predictions in recent years. Still the move down from the recent highs is a very nice impulse wave in Elliott Wave theory - a five wave move. If there is any validity in E-Wave theory then that won't be the entirety of the decline. After an upside correction we should expect to see at least another five waves down again.

The Returns from Housing

Following up from my recent posts I thought it would be useful to write down a simple equation that really sums up a lot about the decision of whether to buy a house or not: Rate of Return = Rent Yield - Costs/House Price + Rate of Appreciation The return from owning a house is the rent you would otherwise have to pay minus costs that include insurance, maintenance, and property taxes plus the gains in the price of the property. I'm not including mortgage interest here so I can compare the return on a house with the return on other unlevered investments. The investment decision comes down to whether this rate of return is higher or lower than the return on other investments with similar levels of risk (yeah it is more complicated than that as I'm ignoring the correlation with other assets etc.). Rates of return in bubble areas such as most of California, the coastal Northeast US, Sydney Australia, and probably the UK among many others can only be high enough to pass the investment hurdle if the rate of expected price appreciation is high enough. Enough Wealth pointed out in a comment on one of my posts that high end real estate can appreciate in the long-run faster than the rate of economic growth, but it is hard to imagine that the average house can. In fact Robert Shiller's research has shown that the average house in the US has appreciated slower than the rate of economic growth in the long-run. It is very likely that prices have overshot and that future rates of appreciation will not be as high as in the recent past. In order to restore equilibrium house prices have to fall in order to raise the expected future rate of return. This is the housing bubble argument in a nutshell. So what about mortgage interest? It makes sense to borrow money to buy a house if the expected rate of return (assuming no uncertainty in this return) is greater than the interest rate on the mortgage. And this only if you have passed the investment return hurdle. I think this makes sense though I'm kind of thinking out loud :)

Wednesdays

Maybe I should add this to my model? That is a huge effect not to be arbitraged away already. Weird.

Housing Simulation for Canberra

I plugged the actual numbers for our own situation into my housing simulator. These include a 7% mortgage rate current in Australia, Snork Maiden's salary, and our current net worth. I'm assuming a 10% downpayment, a house price of $A500k and rent of $A400 per week. Buying would cost us all of Snork Maiden's salary at first vs. about 40% on rent. It would only make sense if prices appreciated at 7% per year indefinitely. Maybe prices have historically risen at that rate in the recent past, but can they continue to do so? The average Canberra house would cost $A3.8million in 30 years time and rent would be $2800 a week. Adjusted for inflation at 3% these are $A1.6million and $A1200 per week in today's money. In the long-run real GDP per capita growth has averaged 2% p.a. So we can't really expect wages to increase faster than that. How long can house-prices and rent rise at twice that rate?

Renting vs. Buying Simulation

It seems to me that the best way to address the financial aspects of the renting vs. buying conundrum is to use simulations. There are too many variables and complications for most people including me to get a handle on this problem analytically. Of course you need to make a lot of assumptions but these can be adjusted in a "sensitivity analysis" to see what effect each assumption has. My initial assumptions are as follows:



Both the renter and the homebuyer start off at age 30 with a disposable monthly income of $5000 and savings of $40,000. The homebuyer uses all this as a downpayment on a house with a 30 year mortgage. The renter invests the money in a taxable account with an after tax rate of return of 9% and pays rent of $1500 for an identical house (which isn't too far off for some of the bubble areas). House prices and rents rise at 4% per annum and wages at 5% p.a. Initially I assume that the homebuyer spends the rest of their after tax income and the renter spends an identical amount. The renter saves the remainder in the taxable account. Initially the homebuyer can't save any extra money but as the homebuyer's mortgage payments do not increase (but property taxes etc. do) gradually they can afford to make some additional savings which they also put in a taxable account. Both the renter and homebuyer increase their spending at the same rate as wages increase. I run the simulation till the end of the mortgage:



At age 60 the renter has a net worth of $4.74 million and the homeowner $3.88 million. Obviously there are possible assumptions and scenarios which would result in the homeowner ending up ahead in net worth terms. But these assumptions seem pretty typical to me and result in the renter coming out ahead.

Let me know if there are particular scenarios you want me to check out or I can even e-mail you the spreadsheet.

New Trading Strategy Working So Far/"Subprime Woes"

My new trading strategy is to hold a minimal or small position overnight (currently equivalent to 1100 QQQQ shares) and to increase my position only when I am actively looking at the market. The previous strategy was to hold a larger overnight position and only to hold the minimum position during regular trading hours when I wasn't available to trade. This was the so-called "overnight trading. Recently I haven't been feeling confident enough to do this. Well, I did make money today going short in a mostly up-market. So that's a good start.

Some of my investments are now not looking like such good ideas. Specifically (there are others :)), Newcastle and Hudson City Bankcorp. The idea was that these were two of the better real estate investments and I would hedge them by shorting IYR in a "pair trade". The bottom line is the hedge has been insufficient. The main question concerns NCT. Is it likely to implode like the Bear Stearns funds? Or is the selling overdone? Is it a buy, hold, or sell? I don't know.

How Will Moving to Australia Affect My Investment Choices?

There are two main ways that an international move of this sort should affect investment choices:

1. Differences in tax policy - I don't believe in arranging investments to minimize taxes. Rather one should choose investments that maximize net worth (for a given willingness to bear risk). Taxes will affect the net worth outcome but are only one factor. Nevertheless differences in tax policy are important.

2. Differences in accessible investments - For example, as an Australian resident I will again have access to Australian IPOs and adding new investments to Australian mutual funds. I am likely to do both to some degree.

In this post I'll discuss some more about the influences of tax policy on my future investment choices:

Margin interest I'll probably increase my margin borrowing in the long-run as Australia lets you deduct margin interest at your marginal rate whether your investments made any money that year or not. In the U.S. margin interest is directly deductible against investment income. If you didn't do well that year you have to carry the expense forward to following years. So I've been a bit more cautious on using margin. Still there are often cheaper ways of getting leverage than actually using a margin loan. These included levered (geared) mutual funds, options, and futures. So I won't be overdoing it.

U.S. Dividend Paying Stocks As a U.S. resident most dividends are taxed at the Federal rate of 15%. As an Australian resident I will need to pay a 30% with-holding tax in the U.S. I can claim this as a foreign tax credit in Australia but I'll need to pay tax at my marginal rate on the dividend. That is likely to be 30% at first but could be 40% or higher if my income rises. I'll pay lower or similar rates on long-term capital gains (no U.S. with-holding). So I am more likely to choose a low or non-dividend paying U.S. stock over one that pays a high yield.

Australian Stocks Stocks that pay dividends based on Australian sourced profits are highly tax advantaged in Australia. You receive a credit for the tax paid by the company. The company tax is 30%. So if your marginal rate is 30% you pay no tax on the dividend. If your rate is above 30% you pay the difference between the two rates. Things get more interesting when you lever a portfolio. The interest is effectively deducted against the dividends and you end up with excess credits that can offset other taxes. I'll be more likely to invest in higher yielding Australian stocks either directly or through Australian mutual funds. One interesting twist is that listed investment companies (the equivalent of closed end funds) can invest outside Australia but are deemed as earning Australian profits and the dividends that they issue have franking credits attached. The leading example is Platinum Capital, which I already invest in.

From an economic perspective there really isn't any difference between investing through the listed investment company or a mutual fund which passes all earnings through pre-tax. Actually, there are advantages to the mutual fund structure as long-term capital gains are taxed at a lower rate. The LIC pays 30% tax on its profit and then distributes a dividend with a credit but no other concessional tax rate. So the total tax bill to company and investor combined is higher! With leverage though, the LIC's tax credits can offset taxes on other income the investor earns.

However, it is structured though there is double taxation of foreign dividends but not of dividends from actual economic activity in Australia.

U.S. Mutual Funds I think I can still invest in these but all distributions are subject to U.S. with-holding. I should be able to claim that tax back in Australia. There are very complex rules governing investments in foreign mutual funds. This can include paying tax on unrealized gains at the top marginal rate. Generally if you hold less than $A50k in foreign mutual funds you are exempt from the rules. Most U.S. mutual funds now also appear to be exempt. But it's not clear to me yet whether you can pay the lower long-term CGT rate on capital gains distributions from the funds. Given this, I won't be making extra investments in U.S. mutual funds in the near future. Employer sponsored retirement funds are also exempt. I plan to keep my 403b with TIAA-CREF and my employer to avoid any issues.

Individual Retirement Accounts Australia taxes non-employer sponsored foreign retirement accounts as if they had no retirement status at all. Probably next year I will close my Roth IRA. I will need to pay a 30% with-holding tax (but no penalty) on the profits for doing this. But I should be able to claim this back in Australia while if I just transfer the fund units to a non-retirement account without redeeming them paying no CGT in Australia. Actually, it could make sense to cash out the 403b once I'm a non-resident too - I'd pay a 30% withholding tax that was reclaimable in Australia and then 15-20% capital gains in Australia. We could then maybe make an aftertax contribution to an Australian superannuation fund where earnings would be taxed at 15% in perpetuity or just keep it in a non-retirement account. This will need careful analysis. One thing I would need to understand is how distributions from a 403b would be taxed in Australia. I would think that selling the units should be subject to capital gains rather than ordinary income tax rates?

Futures Trading The U.S. taxes futures trading at a concessional rate, while Australia doesn't. But it is more flexible (24/5) and cheaper than trading ETFs so I probably won't be likely to reduce my futures trading.

So the bottom line is there is a mix of things where I'll be cautious until I understand them better and others where a small change is likely to happen over time. No dramatic moves.

Please let me know if I made a mistake in anything!

Buying vs. Renting Again

A very good article on buying vs. renting.