Posts tagged ‘probabilities’
Trading Obama, Romney and Extraterrestrials
Source: Photobucket
Investors vote on stocks every day by buying shares in favored positions and selling shares in those out-of-favor. But shouldn’t voting on stocks be different from voting for politicians? Actually, no! Now, politicians can be traded just like traditional stocks or other liquid securities. If you don’t believe me, then you should check out www.Intrade.com. Intrade is an online trading platform that is home to various prediction markets that forecast the probability of outcomes of various real-world events, including who will win the 2012 U.S. Presidential election. Just like investors can trade IBM on the New York Stock Exchange (NYSE) or Apple Inc. (AAPL) on the NASDAQ exchange, so too can individuals trade election shares in Barack Obama (ticker: OBMA) and Mitt Romney (ticker: RMNY) on the Intrade platform (see chart below).
Source: Intrade.com
By definition, the trading mechanics of Intrade involve a resolution of a particular event structured as a binary “Yes” or “No” result. Similar to a sports bet, Intrade eventually declares a winning or losing outcome – but there are no ties. For example, by November 6, 2012, we will know whether Obama’s shares will be trading either at $10 per share, if he becomes re-elected, or $0 per share if he loses to Romney. Just like a stock, traders can go long Obama shares, if they think he will win, or short Obama shares, if they think he will lose. Analogous to stocks, holding periods may vary too. Traders can either hold their position until the event expiration, and realize a gain or loss, or instead traders can lock in shorter-term profits/losses by closing a position before the official outcome ends.
Another great thing about Intrade’s prediction markets is that each event share price can be quickly converted to an outcome probability. So as you can see from Obama’s Intrade chart above, the current $5.28 share price signifies a 52.8% probability of Obama winning the 2012 Presidential election. No need to worry about distracting stock-splits, share offerings, or stock buybacks that could distort the true underlying dynamics of the Intrade event fundamentals.
Bizarre Bets and Over-the-Top Trades
Crazy Super Bowl “prop” bets have been around for ages, and the senseless nature of the bets did not disappoint this year, if you consider the following ridiculous Super Bowl XLVI prop bets:
• Will it take Kelly Clarkson longer or shorter than 1 minute 34 seconds to sing the National Anthem?
• Will Madonna’s hair color be blonde when she begins the Super Bowl Halftime show?
• How many times will model Giselle Bundchen be shown on TV during the game?
• What Color will the Gatorade be that is dumped on the Head Coach of the Winning Super Bowl Team?
I think you get the idea from these examples, and I believe Intrade figured out the quirky benefits as well. Betting on unusual or strange outcomes can be a lucrative endeavor.
Here are just a few of the bizarre and remarkable events you can trade on Intrade:
• NASA to announce discovery of extraterrestrial life before midnight Dec. 31, 2012
• Arctic sea ice area for Sep. 2012 to be less than 4.3 million square kilometers?
• Magnitude 9.0 (or higher) earthquake to occur anywhere before midnight Dec. 31, 2012
• The Dark Knight Rises to break the all-time opening weekend box-office record
• The US debt limit to be raised before midnight Dec. 31, 2012
• Bashar al-Assad to no longer be President of Syria before midnight Dec. 31, 2012
• The US Supreme Court to rule individual mandate unconstitutional before midnight Dec. 31, 2012
• Higgs Boson Particle to be observed on/before Dec. 31, 2013
Rules of the Game
You may be asking yourself, “All this betting/trading sounds like fun, but isn’t this Intrade thing illegal gambling?” If your thought process went in this direction, you are not alone – I asked myself the same question. I’m no attorney, but the apparent loophole for Intrade’s business operation appears to be tied to its foreign incorporation in Ireland. Less apparent is how American law applies to Intrade as referenced in a recent New York Times article that states, “It is unclear whether American law applies to Intrade.”
Although U.S. residents may not be able to trade legally on Intrade, roaming the site may provide some quirky entertainment and provide profound answers to critical questions like, “Do extraterrestrials exist?; How much money will the new Batman movie make at the box office?; And which President are we going to get stuck with for the next four years?” Surfing around on Intrade can be a blast, but if it gets too boring, you can always go back to trading regular stocks.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and Wade Slome have no affiliation with Intrade. SCM and some of its clients own certain exchange traded funds and AAPL, but at the time of publishing SCM had no direct position in NYX, IBM any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Art of Weather Forecasting and Investing
Source: Photobucket
I’ve lived across the country and traveled around the world and have experienced everything from triple-digit desert heat to sub-zero wind chill. The financial markets experience the same variability over time.
Forecasting the weather is a lot like forecasting the stock market. In the short-run, volatility in patterns can be very difficult to predict, but if efforts are energized into analyzing long-term factors, trends can be identified.
For example, I live here in Southern California, and although weather is fairly homogenous, the variability can be significant on a day-to-day basis. I’m much more likely to be accurate in estimating the long-term climate than the forecast seven days from now. I’m not trying to rub salt in the wounds of those people freezing in Antarctica or the upper-Midwest, but forecasting a climate of 72 degrees, sunny, and blue skies is a good fall-back scenario if you are a television weatherman in Southern California.
Charles Ellis, author of the Winning the Loser’s Game – “WTLG” (see Investing Caffeine article #1 and article #2), highlights the weather analogy more convincingly:
“Weather is about the short run; climate is about the long run – and that makes all the difference. In choosing a climate in which to build a home, we would not be deflected by last week’s weather. Similarly, in choosing a long-term investment program, we don’t want to be deflected by temporary market conditions.”
Ellis adds:
“Like the weather, the average long-term experience in investing is never surprising, but the short-term experience is constantly surprising.”
In the financial markets the weather predicting principle applies to long-term economic forecasts as well. Predicting annual GDP growth can often be more accurate than the expected change in Dow Jones Industrial Index points tomorrow or the next day.
Economic Weathermen
As I outlined in Professional Guesses Probably Wrong, economists and strategists use several means of making their guesses.
- One method is to simply not make forecasts at all, but rather use some big words and current news to explain what currently is happening in the economy and financial markets.
- A second approach used by prognosticators is to constantly change forecasts. Consider a person making a weather forecast every minute…his/her forecast would be very accurate, but it would be changing constantly and not provide much more value than what an ordinary person could gather by looking out their own window.
- Thirdly, some use the “spaghetti approach” – throw enough scenarios out there against the wall and something is bound to stick – regardless of accuracy.
- Lastly, the “extend and pretend” method is often implemented. Forecasters make big bold economic predictions that garner lots of attention, but when the expectations don’t come true, the original forecast is either forgotten by investors or the original forecast just becomes extended further into the future.
Coin Flipping
If the weather analogy doesn’t work for you, how about a coin-flipping analogy? The short-term randomness surrounding the consecutive number of heads and tails may make no sense in the short-run, but will mean revert to an average over time. In other words, it is possible for someone to flip 10 consecutive “tails,” but in the long-run, the number of times a coin will land on “tails” will come close to averaging half of all coin tosses. The same dynamic is observed in the investment world. Often, short-term spikes or declines are short lived and return toward a mean average. IN WTLG, Ellis provides some more color on the topic:
“The manager whose favorable investment performance in the recent past appears to be ‘proving’ that he or she is a better manager is often – not always, but all too often – about to produce below-average results…A large part of the apparently superior performance was not due to superior skill that will continue to produce superior results but was instead due to that particular manager’s sector of the market temporarily enjoying above-average rates of return – or luck.”
Regardless of your interests in weather forecasting or coin-flipping, when it comes to investing you will be better served by following the long-term climate trends and probabilities. Otherwise, the performance outlook for your investment portfolio may be cloudy with a chance of thunderstorms.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Professional Double-Dip Guesses are “Probably” Wrong
As you may have noticed from previous articles, I take a significant grain (or pound) of salt when listening to economists and strategists like Peter Schiff, Nouriel Roubini, Meredith Whitney, John Mauldin, et.al. Typically, these financial astrologists weave together convincing, elaborate, grand guesses that extrapolate every short-term, fleeting economic data point into an imposing (or magnificent) long-term secular trend.
With all this talk of “double-dip” recession, I cannot help but notice the latest verbal tool implemented by every Tom, Dick, and Harry economist when discussing this topic… the word “probability”. Rather than honestly saying I have no clue on what the economy will do, many strategists place a squishy numerical “probability” around the possibility of a “double-dip” recession consistent with the news du jour. Over recent weeks, unstable U.S. economic data have been coming in softer than expectations. So, guess what? Economists have become more pessimistic about the economy and raised the “probability” of a double dip recession. Thanks Mr. Professor “Obvious!” I’m going to go out on a limb, and say the probability of a double-dip recession will likely go down if economic data improves. Geez…thanks.
Here is a partial list of double-dip “probabilities” spouted out by some well-known and relatively unknown economists:
- Robert Shiller (Professor at Yale University): “The probability of that kind of double-dip is more than 50 percent.”
- Bill Gross (Founder/Managing Director at PIMCO): The New York Times described Gross’s double-dip radar with the following, “He put the probability of a recession — and of an accompanying bout of deflation — at 25 to 35 percent.”
- Mohamed El-Erian (CEO of PIMCO): “If you wonder how meaningful 25 per cent is, ask yourself the following question: if I offered you that I drive you back to work, but there’s a one in four chance that I get into a big accident, would you come with me?”
- David Rosenberg (Chief Economist at Gluskin Chef): In a recent newsletter, Rosenberg has raised the odds of a double-dip recession from 45 per cent a month ago to 67 per cent currently.
- Nouriel Roubini (Professor at New York University): “As early as August 2009 I expressed concern in a Financial Times op-ed about the risk of a double-dip recession, even if my benchmark scenario characterizes the risk of a W as still a low probability event (20% probability) as opposed to a 60% probability for a U-shaped recovery.”
- Robert Reich (Former Secretary of Labor): According to Martin Fridson, Global Credit Strategist at BNP Paribas, Robert Reich has assigned a 50% probability of a double dip, even if Reich believes we are actually in one “Long Dipper.”
- Graeme Leach (Chief Economist at the Institute of Directors): “I would give a 40 per cent probability to what I call ‘one L of a recovery’, in other words a fairly weak flattish cycle over the next 12 months. A double-dip recession would get a 40 per cent probability as well.”
- Ed McKelvey (Sr. U.S. Economist at Goldman Sachs): “We think the probability is unusually high — between 25 percent and 30 percent — but we do not see double dip as the base case.”
- Avery Shenfeld (Chief Economist at CIBC): “The probability estimate is likely more consistent with a slowdown rather than a true double-dip recession but, given the uncertainties, fiscal tightening ahead and the potential for a slow economy to be vulnerable to shocks, we will keep an eye on our new indicator nevertheless.” This guy can’t even be pinned down for a number!
- National Institute for Economic and Social Research (NIESR) : “The probability of seeing a contraction of output in 2011 as compared to 2010 has risen from 14 per cent to 19 per cent.”
- New York Fed Treasury Spread Model (see chart below): Professor Mark J. Perry notes, “For July 2010, the recession probability is only 0.06% and by a year from now in June of next year the recession probability is only slightly higher, at only 0.3137% (less than 1/3 of 1%).”
Listening to these economic armchair quarterbacks predict the direction of the financial markets is as painful as watching Jim Gray’s agonizing hour-long interview of Lebron James’s NBA contract decision (see also Lebron: Buy, Sell, or Hold?). Just what I want to hear – a journalist that probably has never dribbled a ball in his life, inquiring about cutting edge questions like whether Lebron is still biting his nails? Most of these economists are no better than Jim Gray. In many instances these professionals don’t invest in accordance with their recommendations and their probability estimates are about as reliable as an estimate of the volatility index (see chart below) or a prediction about Lindsay Lohan’s legal system status.
I can virtually guarantee you at least one of the previously mentioned economists will be correct on their forecasts. That isn’t much of an achievement, if you consider all the strategists’ guesses effectively cover every and any economic scenario possible. If enough guesses are thrown out there, one is bound to stick. And if they’re wrong, no problem, the economists can simply blame randomness of the lower probability event as the cause of the miscue.
Unlike Wayne Gretzky, who said, “I skate to where the puck is going to be, not where it has been,” economists skate right next to the puck. Because the economic data is constantly changing, this strategy allows every forecaster to constantly change their outlook in lock-step with the current conditions. This phenomenon is like me looking at the dark clouds outside my morning window and predicting a higher probability of rain, or conversely, like me looking at the blue skies outside and predicting a higher chance of sunshine.
Using this “probability” framework is a convenient B.S. means of saving face if a directional guess is wrong. By continually adjusting probability scenarios with the always transforming economic data, the strategist can persistently waffle with the market sentiment vicissitudes.
What would be very refreshing to see is a strategist on CNBC who declares he was dead wrong on his prediction, but acknowledges the world is inherently uncertain and confesses that nobody can predict the market with certainty. Instead, the rent-o-strategists consistently change their predictions in such a manner that it is difficult to measure their accuracy – especially when there is rarely hard numbers to hold these professional guessers accountable for.
Economists and strategists may be well-intentioned people, just as is the schizophrenic trading advice of Jim Cramer of CNBC’s Mad Money, but the “probability” of them being right over relevant investing time horizons is best left to an experienced long-term investor that understands the pitfalls of professional guessing.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
*DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, NYT or any security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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