Felix Salmon

Algorithms vs retail investors

Felix Salmon
Jan 10, 2011 22:25 UTC

Anand Iyer, after reading the article I wrote in Wired with Jon Stokes, emails with a couple of questions:

The age of analysing a company’s stats, looking at its balance sheets, researching the market the company operates in, and looking at the people running the company seems to be gone. It’s all bots (highly sophisticated ones) who operate the financial world.

What I wanted to ask was would it make sense for a single person to be doing investing the good old fashioned way in this scenario (I do and I guess I will even if your answer tends to suggest in the negative, but I would be VERY interested in your answer).

Finally it would be very helpful if you were to recommend me some books on this algorithmic approach of investing and advise if it is indeed possible for one individual to do the very same thing.

My answer, I fear, won’t make Mr Iyer very happy.

Firstly, there are millions of individual investors doing diligent homework on companies and trying to invest intelligently in the stock market. When they finally arrive at a conclusion and the time comes to buy or sell, their collective decisions are known politely as “retail order flow,” and less politely as “dumb money”; high-frequency trading shops make lots of money by paying for the privilege of filling those orders and taking the opposite side of those trades.

It’s possible that one individual investor—Mr Iyer himself, perhaps—can beat the odds and make more money on his own than he would do simply investing in an index fund. If he does, then it might be due to luck, and it might be due to skill. But if I know nothing about Mr Iyer except for the fact that he’s a retail investor looking at corporate fundamentals, I wouldn’t give him much of a chance of beating the market. Fundamentals-based investing is (still) a very crowded trade, and most people who try it fail—they get picked off by faster, smarter, more sophisticated players in the market.

On the other hand, fundamentals-based investing is vastly more sensible than an individual investor even thinking about entering the shark-infested waters of high-frequency algorithmic trading. You can’t do it, don’t even try. If you do give it a go with real money, expect to lose all that money, very quickly.

The good news is that for the time being it’s not even possible for individual investors to enter this market: the barriers to entry are just too high. But if it ever does become possible, stay very far away. Unless you want to know what it feels like to lose years worth of savings in a matter of hours.


China already there:
http://pipelineandgasjournal.com/petrobr as-china-sign-10-billion-deal

Politics… it’s been fascinating watching the politics on this, and they may be opaque, but they are hugely covered. These is one of those cases where China is buying the assets of a continent. I did a foot-loose-retiree trip south in late ’09. In Buenos Aires you probably can’t go anywhere in the city and not see some form of PetroBras sign at least every 5 minutes; Soccer teams, bus stops, empanada stands, t-shirts on kids. And that’s in Argentina. In Brazil, it’s total.

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What will replace unions?

Felix Salmon
Jan 10, 2011 21:21 UTC

Jim Surowiecki has an excellent column this week on the declining influence, and increasing unpopularity, of labor unions:

The advantages that union workers enjoy when it comes to pay and benefits are nothing new, while the resentment about these things is. There are a couple of reasons for this. In the past, a sizable percentage of American workers belonged to unions, or had family members who did. Then, too, even people who didn’t belong to unions often reaped some benefit from them, because of what economists call the “threat effect”: in heavily unionized industries, non-union employers had to pay their workers better in order to fend off unionization. Finally, benefits that union members won for themselves—like the eight-hour day, or weekends off—often ended up percolating down to other workers. These days, none of those things are true…

Labor may be caught in a vicious cycle, becoming progressively less influential and more unpopular. The Great Depression invigorated the modern American labor movement. The Great Recession has crippled it.

I can’t envisage unions ever getting their mojo back in the US private sector. At the same time, however, I can envisage a world in which the pendulum of power starts swinging back towards labor and away from capital. What I’m very unclear about is how that’s going to happen. Unions have lost their power, and Marxian rhetoric in general, about class or rent extraction or the balance of power between capital and labor, is treated with great suspicion by the broad mass of the population.

Meanwhile, of course, as Chrystia demonstrates, the people who control capital are willing and even eager to take money they would otherwise use employing middle-class Americans, and spend it on cheaper and equally productive workers abroad.

If the era of the union is over, as it seems to be, what other countervailing force will work to preserve the value of labor? Somehow I doubt that an epic shift to a new human age will manage to do the trick.


I’m so late to this thread that few will probably read this but my two cents on who will replace Labor unions in the fight vs capitol is AARP.

AARP is already fighting hard to defend social security which for the first time is a negative income stream for uncle Sam. Keeping that promise was easy when it meant billions coming in for congress to steal for other uses… during the recession it meant that briefly billions were going out as so many were unemployed and so many filed for early retirement benefits.

The number crunchers think that negative cash flow will temporarily reverse back to positive… but only for a couple years at most. Soon the outflows will exceed inflows permanently. Then each budget battle in congress will include a fight over social security and Medicare.

AARP will organize an army in the tens of millions to fight for the benefits they have been promised. There will be rallies, marches, town hall meetings, all of it. In the end I think they will succeed in keeping social security largely untouched… taxes will be raised on the affluent.

Medicare as it is currently structured is toast. My wife’s grandfather, a war hero, a 45 year contributor in the work force and a great guy all around was life-flighted 3 times (this at 77 and twice at 79 years old)from the rural hospital near his home to a major hospital. He probably spent 3 months in an ICU at what $2,500/day?

That math can never scale as the population of seniors skyrockets.

Preventive care will be covered, generic drugs covered,
but helicopter rides to the ICU for a 4 week stay that buy you another 4 months of a low quality life won’t last the fiscal reckoning that has already begun.

The old (retired, semi-retired and retired) will join hands with younger workers demanding that corporations and their affluent shareholders support those who have less.

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Fed profitability datapoint of the day

Felix Salmon
Jan 10, 2011 19:25 UTC

At the end of 2010, the Federal Reserve system had $2.423 trillion in assets and $2.367 trillion in liabilities, which means that the simplest measure of its total equity — assets minus liabilities — comes to $56.6 billion. The Fed also managed to earn net income of $80.9 billion in 2010. Which means that its return on assets was incredibly high at 3.3%, while its return on equity was an astonishing 143%.

I think it’s fair to say that no bank in the history of the world has ever had income of anywhere near $80 billion in one year: that’s over $700 per US household. Somehow, the Fed is making roughly $60 per household per month, and remitting that money straight to the Treasury. Of course, its cost of funds is ridiculously low, and in any event the Fed can simply print new money any time it wants. But still, $80 billion is enormous — more than four times the Fed’s profit in 2004, for instance. And it’s a useful reminder of just how massive the Fed’s balance sheet has become — and also of how monetary policy can make a serious dent in the funding-need side of fiscal policy.


When you control the money is it any wonder that you make a profit?

Of course the truth is that they win even if all those assets on their book vaporize because the American people would be the one’s on the hook then.

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Davos: Where epic shifts are converging

Felix Salmon
Jan 10, 2011 18:21 UTC

Chrystia and I differ on whether Davos is actually important. I say it isn’t, and Exhibit A is this invitation, which I received today. There will be many, many more like it arriving over the next couple of weeks:


The whole thing, obviously, is [sic]. But Davos does tend to attract the kind of people who can straight-facedly pretend to believe that entering the human age, or the New Reality, or unleash and leverage human potential as the key competitive differentiator to win, or entering a new era, or epic shifts are converging, or talent is the new ‘it’ actually mean something.

The panel that these people have put together is prototypical Davos: dean of this, best-selling author of that, general secretary of the other, plus a CEO and a corporate president. There’s no shared expertise here, and there won’t be any real debate. Instead, they’ll all intone sonorously in an attempt to appear visionary and important, as jet-lagged delegates ask themselves why on earth they dragged themselves out of bed at 7am Swiss time (which is 1am New York time) to listen to such pablum.

The main purpose of these panels is to make their sponsors—in this case, CNBC and Manpower—feel important, as they splash their logos around in front of a select group of the most important people in the world. They either don’t know or, more likely, don’t care that their panel discussions look utterly ridiculous. Just about everything in Davos is ridiculous in its own way. It’s like Disneyland. So long as you suspend your disbelief, you’re fine.


Perhaps the world is ready for “Debbie Does Davos”, with various interesting personas from Russia, Saudi Arabia, USA, Italy, France, Germany, …
Might end up with more enemies than Julian A.

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FT Tilt: A blog behind a paywall

Felix Salmon
Jan 10, 2011 15:56 UTC

FT Tilt has now officially launched. Calling itself “a premium online financial news and analysis service focused exclusively on the emerging world,” it has a total staff of 12, including 8 reporters scattered around the world. Founded by Paul Murphy and Stacy-Marie Ishmael of FT Alphaville fame, it has so much blog in its look and feel and its DNA that it’s probably fair to call this the most ambitious paywalled blog in the world.

The design of Tilt is very clean and very modern—all Ajax and HTML5 and CSS3, in austere black-and-white reminiscent of Khoi Vinh’s Subtraction. It clearly needs work, especially on navigation from article pages, which feel like dead ends right now; even bylines aren’t linked to anything. And the site is far too prone to opening not only external but even internal links in a new tab. But that’s all fine: if you’re not embarrassed by the first version of your Web site, you’re doing something wrong. The trick is to get something up, and then iterate continuously.

One thing is clear, however: the paywall will stay, with all the problems that implies in terms of sharing tools, commenting, and other central parts of any bloggy enterprise. Tilt is designed to provide valuable information to bankers and other financial professionals; the business model is to sell subscriptions on an enterprise level for thousands of dollars a year and up. Eventually, the content could even be rebranded and provided by those financial institutions as a perk for their buy-side clients.

The result can feel a little odd. Tilt behaves in many ways like any number of premium news and analysis services which distribute their content over terminals—except it’s distributed on a website instead. That makes it much easier to build a community: Tilt is built to allow clients to republish their own work and to talk to each other and comment on stories. But because Tilt isn’t available on Reuters or Bloomberg machines, traders aren’t going to see its stories effortlessly shuffled in to their main feed of news and analysis—they’ll have to make a specific trip to the site to find them. Similarly, all the headlines on Tilt are its own: while it will link to outside stories from within its own posts, it doesn’t aggregate external headlines and drop them into its main headline feed.

All of this makes the task facing the Tilt team a very tough one. They don’t want to be one more source of news and analysis for financial professionals who already have dozens of such sources; they want to change the way those professionals consume media on a day in and day out basis—adding an extra site where those professionals feel they must spend valuable time.

The Tilt team is at pains to note that they’ve built one community already—the Long Room, a by-invitation extension of FT Alphaville which has proved very popular. And the community areas of Tilt are going to be free, just as the Long Room is: they’re outside the paywall. Still, I’ll believe it when I see it. One of the key parts of the Tilt architecture is that it doesn’t have an edited front page, since every client is going to be interested in different asset classes and regions. And a necessary corollary of the heterogeneity of its audience is that it’s going to be hard to spark interesting discussions among communities of interest.

What’s more, even if the community areas do prove popular, that’s not going to drive subscriptions. Some institutions are doubtless going to prove willing to pay for access to what Tilt’s handful of journalists are writing; others won’t be.

Murphy explains that he’s filling a gap in the coverage provided by most media organizations based in London or New York, which tend to give much more weight to local deals in their own towns than they do to big deals in countries like Colombia or South Africa. “Western business media is so fixated on London and New York: it just can’t get over itself,” he tells me. “The quality of the journalism tends to deteriorate, the further you move away. It’s a parochialism we’re trying to overcome.”

It’s a very fair criticism. But Murphy’s not really competing with the FT and the WSJ here: he’s competing with expensive news wires and free daily brokerage reports. Many of those are very strong in emerging markets. Murphy is asking his overstretched journalists (just one person for all of Latin America, for instance) to tell financial professionals something they don’t already know: that’s a tall order.

The big picture here, to me, is not that the FT is making an ambitious move into becoming a genuinely global financial-news organization, but rather that it isn’t. Important news about what’s going on in crucial global markets should be a core competency of the FT, a key part of why people read it rather than, say, the WSJ, which seems to be more interested in building up its New York City coverage. Instead, the big Tilt project is being ghettoized behind its own high paywall, is being forced to pay for itself through high-priced subscriptions, and is being deliberately withheld from the broader FT audience.

I’ve said before that the FT is retreating to a newsletter model; I called that “a sad and narrow fate for what should be a proud and global newspaper.” Tilt only reinforces that diagnosis, and seems to be based on the idea that the FT won’t invest in ambitious new projects which are central to what its target audience wants, unless it can wall those projects off and get them to pay for themselves on a narrow, self-standing basis.

I’m friendly with both Paul and Stacy, and I wish them success with Tilt. But both they and the FT would surely have found success much easier to come by if they’d simply made Tilt freely accessible to all FT subscribers.


I agree with you view that paywalls in general limit flow of information. But FT and Tilt in particular may be using paywalls to create an impression of exclusivity the same way luxury goods are priced out of proportion with their usability.

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Felix Salmon
Jan 10, 2011 07:30 UTC

Peter Lattman on the market in “so-called gourmet cupcake shops” — NYT

The income of the top 1% of the US population = the total annual expenditures of the US government — Quiggin

We’re too quick to use “mental illness” as an explanation for violence — Slate

Matt Miller’s massive unpublished profile of Gene Sperling from 1999 — Miller

Larry Summers is the keynote speaker at the 17th Annual Global Hedge Fund Summit in Bermuda — Marhedge


My grandmother said, “everybody is their own kind of crazy”

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Housing: The see-no-evil muddle-through approach

Felix Salmon
Jan 10, 2011 07:27 UTC

David Streitfeld reckons that if mortgage delinquencies continue to pile up without turning into foreclosure actions, that could be good for the economy as a whole:

Foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period…

If the slowdown continued through this month and into the spring, it could be a boost for the economy. Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy’s most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing.

“Anything that buys time, that reduces the supply of houses coming onto the market, is helpful,” said Karl Guntermann, a professor of real estate finance at Arizona State University.

I think he’s probably right. Consumer confidence is a key factor in the health of the housing market and there’s an obvious connection from lower supply to higher prices, to higher confidence in housing as an asset class. That confidence might well turn out to be misplaced, of course. But a warm occupied home is a much happier thing, economically speaking, than a cold and empty one, even if the occupiers haven’t made a mortgage payment in years. Foreclosures carry a large economic cost and all things being equal, the less of them there are the better.

There’s something conceptually attractive, especially to small-government libertarians, about ripping the bandage off the patient harshly. Foreclose on anybody who’s delinquent, stop providing massive government subsidies to the mortgage sector and let the market find the true market-clearing level for house prices. But we simply can’t do that — it would mean a financial crisis much larger than the last one, with substantially the entire banking system becoming insolvent; the resulting plunge in stock prices and global economic growth could make the last recession look positively tame.

The realistic alternative is to muddle through — to artificially support the housing sector and mortgage valuations for however long it takes, which might well be forever. As Bethany McLean notes, “federal involvement in housing has been a constant since the 1930s” and it’s hard to see any politically-acceptable way of changing that.

The big winners in all this will be the delinquent homeowners who continue to live in their houses without making their mortgage payments. The losses, meanwhile, will be spread around a large number of banks and investors, all of whom can cope with — and even fully expect — smaller streams of cash flowing from their mortgage portfolios.

Some potential buyers, worried about the shadow inventory of homes which could be foreclosed upon at any minute, will choose to rent rather than buy — that’s fine, and indeed is probably a good thing. We want the homeownership rate to fall. Other buyers, seeing rising prices and a shrinking supply of houses coming on the market, will jump in regardless. And so long as there’s enough government support and buying interest to keep prices from falling further, everybody will be more or less content. The tail risk will still be there, of course. But merely running the risk of a catastrophic outcome is surely a better idea than actually triggering that outcome.


@y2kurtus: “What else would you have them do? ”

What I would have them do: Not lie to the courts, not forge documents, and present the best fact-based legal case they can – and all while not simultaneously committing felonies and violating the entire spirit of civil procedure and legal ethics.

That’s not too much to ask, is it?

Chris said it well: “I would have have them obey the law just as the rest of us are expected to do. I am appalled but no longer shocked at banker’s constant assertions that they should be exempted from the rules that the rest of us must follow.”

Outside of that, I have no concerns.

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How much is a law degree worth?

Felix Salmon
Jan 10, 2011 05:33 UTC

David Segal is the best writer on the NYT’s business desk, so it’s a good thing that he was chosen to pen today’s 5,000-word disquisition on the economics of law degrees. He’s taken a particularly dry subject and turned it into a compelling and accessible read; that’s no mean feat.

At the heart of the article is law schools’ bait-and-switch operation: universities rake in millions of dollars in tuition fees from students who are given to understand that a well-paid job lies waiting for them upon graduation. But such jobs are hard to find and precious few law graduates will ever waltz straight into a $160,000-a-year Biglaw job, especially if they graduate from a non-top-tier school.

The connection between well-paid jobs and top-tier universities is well known and as a result, there’s something of a statistical arms race going on between universities, all of which want to improve their rankings. Segal doesn’t quite accuse the colleges of outright lies, but he comes very close: at one point, for instance, he talks about the “several different explanations” which Georgetown Law provided to explain a suspicious-looking offer of temporary work to unemployed graduates, one of which claimed that the university — which was also the graduates’ employer — didn’t know where those alums were.

But I’m a wonk and I’d like to have seen a few more numbers in this piece. For instance, when Segal says that only “a small fraction of graduates are winning the Big Law sweepstakes”, I’d like to know what that fraction is: roughly what proportion of the nation’s law graduates, each year, is going to get one of those $160,000-a-year jobs?

And then there’s this:

In the Wonderland of these statistics, a remarkable number of law school grads are not just busy — they are raking it in. Many schools, even those that have failed to break into the U.S. News top 40, state that the median starting salary of graduates in the private sector is $160,000. That seems highly unlikely, given that Harvard and Yale, at the top of the pile, list the exact same figure.

Even at Harvard and Yale I’m suspicious of that $160,000 figure; for the non-top-tier colleges, it’s clearly fictional. No matter how many of your graduates go on to $160,000-a-year jobs, there’s always going to be a significant number who earn a lot less than that and there are going to be almost none who earn more. As a result, the mode might be $160,000, but the median will never be that high. (And in reality the distribution of law-grad salaries is highly bimodal, with the first mode at a much lower level.)

Dean Baker has a more serious criticism of Segal’s piece, noting that “most of the new jobs that are being created are at the top and the bottom of the skills level”. If that’s the case, he says, “then the NYT has seriously misrepresented the state of the legal market”.

I wouldn’t go that far. For one thing, I’m not sure that someone clutching a law degree from Thomas Jefferson School of Law in San Diego really counts as being at the top of the skills level; Segal’s whole point is that lower-tier law schools are churning out graduates who would have been better off not getting a graduate degree at all, partly because they could put their skills to better use in the world of employment rather than racking up hundreds of thousands of dollars in student loans.

But Baker’s point is well taken: “the economy,” he says, “could simply be suffering from a situation in which there are too few jobs in total”. Given the NYT acreage afforded him, Segal could and should have spent a little time looking at how the number of law-school graduates has changed over time and how their employment prospects have changed as well. If the number of graduates is holding roughly constant even as the number of jobs has plunged, then that looks like a problem with the broad economy more than a problem of law school mendacity.


If people knew just how horrendous the employment situation was at my law school, one of the top ten in the nation, they would not even think of going to a 3rd or 4th tier law school, i.e., outside the top 100.

Historically, among those who worked at law firms as summer associates, only 2-3% did not receive job offers — those who seriously screwed up. In contrast, two summers ago, the proportion of no-offers at my school was more like 1/3. Legal employers continue to assume that those who get no-offered are serious screw-ups and ignore their resumes. The no-offers I know are struggling to get any work whatsoever.

Among the fortunate law graduates with jobs, many had to resort to public-interest work that does not pay anywhere near enough to cover $180,000 loans. There is a loan assistance program for public interest and government jobs, but only if you commit to working 10 years outside the private sector. This is a serious problem for people who want to have kids and move out of their tiny apartments in dangerous, urban areas — which is all they can afford on public interest salaries. I especially feel sorry for those who graduated after age 30 or so, only to face the same salary prospects now as they did with bachelors degrees.

What does a ~32-year-old woman with a $180,000 debt and mediocre grades do? I suppose she works public interest for about $30-$40,000 and signs up for the loan assistance program — but good luck having kids on that income, while making even these reduced loan payments. And by the time the 10 years are up, it may be too late. I know people facing this dilemma.

Despite all this, my class caught the last “good year.” The firm where I work has eliminated about 80% of its summer associate positions over the last two years. That is not a typo — 80%, gone. Other firms eliminated their summer programs altogether. Basically, they’ve stopped hiring from law schools. Those who have been hired since the financial crisis have mostly been deferred, forced to wait a year or two before they begin working at their firms, until (hopefully) the economy has recovered. The pyramid model, where law firms hire droves of new associates every year and let them gradually trickle away, is dead.

Again, this is happening at a top ten law school, where, with a lot of luck, I have managed to land the job I wanted. If you can get into a top fourteen law school (fourteen has historically been the magic number), law school is probably still a gamble worth taking. A top-fifty, tier one school might also make sense if you can beat out 75-90% of your peers there. But whomever is thinking of going to a 3rd or 4th tier school, I would seriously advise to reconsider. You will struggle madly for three years, only to realize at graduation that you have just been digging your own financial grave.

If you want a reliable job with decent pay and hours, do yourself a favor and study something health or software related. That’s where the future is.

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