Deep Blue & You

Deep Blue was the first computer system to win a chess game against a reigning world champion (Garry Kasparov) under regular time controls. The computer prevailed in the 1997 six-game match – 3 ½ games to 2 ½ games. Alas, Kasparov’s 1997 task of man versus machine is akin to the task facing the individual investor in a market driven by computer generated trading. Let’s examine this notion and consider outwitting a computer-dependent adversary.

Since the individual investor (read: mutual fund investor) had his proverbial head handed him in the 2002 stock market, many an individual investor has thrown in the towel on the investment markets. Consequently, institutional investors have wrested control of the markets. Circa early 2006, institutional investing is largely a game of giants using computer based program trading. America’s 100 largest money managers now own 58% of all stocks.

Institutional investors show a predilection for employing computers to trade for them. This is corroborated by the fact that computerized program trading now compromises 57% of all volume on the New York Stock Exchange. One can show non-program trading decreasing each year since 2002 when non-program trading totaled just shy of 1 billion shares per day to 2005 when non-programs trading barely exceeded 600 million shares per day.

So by equating the computing power of Deep Blue with that of the computing power of the Program Trades executed daily on the New York Stock Exchange, for one brief moment the mind of Kasparov and the mind of your editor contemplate a similar dilemma: how does one beat the system – the ‘computer system’ that is. In our opinion, poor Kasparov faces a taller task here. Even his powerful mind – a mind by the way that must at a minimum “SEE 10 STEPS IN THE FUTURE” by “envisioning” 5 moves into the future that his opponent will make in addition to the 5 countermoves he will respond with – is bested by a computer that can “see 12 steps in the future.” Wow! Kind of does the Roper poll one better, Huh?  Our “mind” is not necessarily weighed down by the burden of looking 10 steps into the future.

Instead we observe one data set and quickly adjudge that the fuel that keeps those giant money managers going – for the most part large U.S. based companies – is a fuel that has proved less potent than the fuel used by smaller and more diversified money managers – that is small companies and international companies. The data set observed is: since the Wilshire 5000 market peak in March 2000, small companies and mid-sized companies have posted double-digit annual gains through January 6, 2006 while large cap value and large cap growth companies posted approximately 5 % and negative 7% returns, respectively, over an equivalent timeframe1. In addition, excessive relative spending on the part of the U.S. Federal Government is sometimes blamed for the out performance of international investments vis-à-vis their domestic counterparts.

The Largest Money Managers’ computers were ready with lots of money … but looked out onto pools of relatively poor performing investments.

In Hindsight, smaller and international markets have bested some large domestic markets.

The important point is not whether or not this trend continues. The important point IS a nimble strategy of outmaneuvering program trading may lead to excess returns vis-à-vis returns brought about by program trading.

In Foresight, the markets are as prone to erratic and significant instant swings as at any time in the past. By appreciating the repercussions brought on in the wake of massive program trading activity, one may work to seek excess returns. The success or lack thereof of this outmaneuvering may determine who out performs in the investment markets – deep blue or you.

1 “Warning: spin doctors at work”,, January 11, 2006

Let the Data Do the Talking

“Sell in May and Go Away” – a 2005 autopsy

In the hope we have not scared away all but avid chess players and super-computer nerds, one does not need to necessarily understand advanced computer coding to profit in the markets.

Sometimes old-fashioned common sense works too.

In the spring of 2005, the blather that echoed from the media outlets down the corridors of Arlington Hall was: “Sell in May and Go Away”…”Sell in May and Go Away”. This catchy rhyme is put forth by some pundits who lean on data that shows market returns are most favorable from the beginning of the year through April and do not show favor again until later in the autumn. Subsequently, sell your stocks in May as the prevailing market conditions stand athwart your success until autumn winds blow.

Who is Right? Who is Wrong? Who cares! The important point was: as the increasing number of pundits nodded approvingly at the catchy rhyme (perhaps in their haste to summer in The Hamptons), many an investor diligently sold in April as indicated by the market registering a low in early April. What curiously happened next is the markets began to climb after this springtime drop propelling higher for the ensuing three months.

The record (above chart) shows a significant upside awaited investors who avoided the siren call of the catchy slogan: “Sell in May and Go Away”. Only time will tell if the pundits will lean to an unprofitable extend on another one of Wall Street’s age-old aphorisms in 2006.

The Jeweler’s Eye

Quiz: Which organization has a higher credit rating?

In order to prevent Churchill, Stalin, Hitler, Roosevelt, and Charlie Wilson from turning in their graves, we will not provide an outright answer to the aforementioned question. But we will say that the demise of U.S. automobile manufacturers is an on-going glacial slide with potential outcomes that only an egomaniac or a fool would predict consequences of. It is the pink elephant few seem to acknowledge. It combines aspects of the American economy that few other businesses encompass – rising health care costs, antiquated guarantees afforded pensioners, playing to a global consumer market, management versus union match-ups.

We do not know of nor would we predict the date that cancer will be cured.  However, we can gander to say that if and when cancer is cured that it would tend to extend the lifespan of populations the entire world over and perhaps shed light on cures to other related life-threatening diseases.

In a similar vein, we do not know the date that General Motors will cease to exist or merge with an Asian competitor. However, we can say that if and when that would occur:

A bankruptcy effect could be many times that of an airline bankruptcy

US Airways group’s current market capitalization is ~ $2 billion; Delta’s is $124 million (equity only). General Motors’ current market capitalization is ~$12 billion. Ford’s is $16 billion (data: January 11, 2006)

It will be expensive

Someone is going to have to pay for the benefits promised retirees.

The U.S. Taxpayer is a likely end-payor of pensioner’s benefits

If Congress and the Executive’s frivolity shown with the Highway Spending Bill’s passage is any harbinger, is there a politician who would stand in the way of, say, the 2007 American Retirement Act. After all, their playbook has already been written over seventy years ago with the Roosevelt administration’s 1934 Railroad Retirement Act which federalized railroad pensions2.

U.S. Automobile makers will continue divestures away from domestic manufacturing

As the U.S. economy increasing becomes bereft of native science and engineering talent, automakers must either (a) divest operations away from manufacturing or (b) relocate all manufacturing to international locations where science and engineering training thrives.
2 “The Great Train Robbery; how the railroad retirement system swindles taxpayers, robs young workers and derails Amtrak”, Washington Monthly, December 1987

Leave a Reply