Peter Bernstein Interview in Bloomberg Magazine, by Andrew McCauley

Peter Bernstein, in the June 2008 edition of Bloomberg Markets page 172, comments on what he believes the stock market is about.

For most of history, in terms of business decisions, the world was agricultural and risk was in the weather. And we can’t do anything about the weather. But when we get into the 17th and 18th centuries, and capitalism is beginning, and markets are beginning to function, the risk is not in the weather, but what will the other guy do? That’s what the whole stock market is about. What’s somebody going to pay for this stock I buy today, or if I sell it, what’s going to happen to it? …  It’s the other guy that is the risk in our system. So it’s important to learn about game theory and learn how people respond to one another.

I would suggest that observing how market participants respond to conditional price fluctuations may contribute to our knowledge of what will the other guy do.

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Anchoring & Adjustment, by Andrew McCauley

An article in the April 2008 edition of Scientific America titled “Why Things Cost $19.95”, highlights research on our numerical judgements of price discovery. The research by University of Florida marketing professors Chris Janiszewski and Dan Uy may have practical applications for financial markets. The article suggests that the price adjustment deviation is less when the anchor price is precise than if it is rounded.

Why would this happen? As Janiszewski and Uy explain in the February issue of Psychological Science, people appear to create mental measuring sticks that run in increments away from any opening bid, and the size of the increments depends on the opening bid. That is, if we see a $20 toaster, we might wonder whether it is worth $19 or $18 or $21; we are thinking in round numbers. But if the starting point is $19.95, the mental measuring stick would look different. We might still think it is wrongly priced, but in our minds we are thinking about nickels and dimes instead of dollars, so a fair comeback might be $19.75 or $19.50.

With regard to Australian Equities it may be a worthwhile endeavour to observe, Opening Price at Round Numbers, to see whether the intraday range does expand. If expansion does occur, then perhaps hedgers & over the day order fillers, can make the appropriate adjustment to the trading process.

Macquarie Bank Result & Volatility Clustering, by Andrew McCauley

Yesterday marked the 28th occasion since July 1996 that Macquarie Bank (MQG) recorded a 1 day decline of more than negative 5%. I guess the result or more likely the commentary did not impress market participants. The decline of 7% marks the largest one day fall, on release of the half or full year result, since listing.

I observe that MQG has fallen by more than negative 2.5%, on earnings release day, on 6 occasions (including yesterday). The data, post this condition, points to an average absolute gain of 5.32% over the next 20 trading days with a win rate of 4 out of 5. However, the data is not statistically significant.

A one day fall of 5% for MQG is in the bottom 1% of all daily returns. It does appear that a falls of this magnitude have historically provided no directional clues but have provided deviational clues. Benoit Mandelbrot & Richard L. Hudson express this point nicely in the book The (MIS) Behavior of Markets;

Speaking mathematically, markets can exhibit dependence without correlation. The key to this paradox lies in the distinction between the size & the direction of price changes. Suppose that the direction is uncorrelated with the past: The fact that prices fell yesterday does not make them more likely to fall today. It remains possible for absolute changes to be dependent: A 10 percent fall yesterday may well increase the odds of another 10 percent move today – but provide no advance way of telling whether it will be up or down. If so, the correlation vanishes, in spite of the strong dependence. Large price changes tend to followed by more large changes, positive or negative. Small changes tend to be followed by more small changes. Volatility clusters.

This rings true for MQG. The average absolute 7 day change (close to close) for MQG post a daily decline of 5% plus is 9.07% versus 3.51% for all other 7 day periods. The difference is statically significant. A 7 day interval is used due to this being the number of trading days till the May 2008 options expiry. Yesterday afternoon, this particular series in implied volatility terms, was being offered in some strikes in the high 30’s to low 40’s. Would seem a little under priced to me.

I would also note that the last 5 declines of 5% plus produced an average absolute 7 day change of 16.51%. A long volatility strategy with implied volatility purchased in the low 40% region, utilising the May 2008 series with the appropriate hedge, should produce low risk profits.

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What Happens to BHP post a 1 Day Gain of 5% Plus? by Andrew McCauley

Yesterday marked the 10th occasion since June 2006 that BHP Billiton (BHP) recorded a 1 day gain of 5% plus. A myriad of explanations have been cited as the cause of this strong performance (post narrative). However, I’m more concerned with what potentially happens next.

Recent evidence suggests that over the next 5 & 20 day periods BHP should continue its upward trajectory in both absolute & relative terms.

The average 5 day absolute return for BHP post a 1 day gain of 5% plus is 3.32% (sample 2006 – 2008, n=9), t stat 1.762, standard deviation 3.87%, win rate 88.89%, max 9.32% & min -2.40%. The average 5 day relative return for BHP post a 1 day gain of 5% plus is 2.63% (sample 2006 – 2008, n=9), t stat 2.020, standard deviation 3.34%, win rate 88.89%, max 7.74% & min -2.62%.

The average 20 day absolute return for BHP post a 1 day gain of 5% plus is 6.35% (sample 2006 – 2008, n=9), t stat 1.287, standard deviation 6.21%, win rate 77.78%, max 15.08% & min -3.13%. The average 20 day relative return for BHP post a 1 day gain of 5% plus is 5.05% (sample 2006 – 2008, n=9), t stat 1.412, standard deviation 5.30%, win rate 77.78%, max 11.92% & min -4.31%.

I note that results from the recent sample are contrary to a prior sample from 1986 to 2006. That sample suggested a retreat in prices post a 1 day gain of 5%. Perhaps this difference is due to the current positive backdrop of consistently firm commodity prices & market talk that the Chinese are interested in acquiring a stake in BHP.

Intuitively I would suggest that this backdrop is unlikely to dissipate in the next 5 to 20 days. Consequently, albeit recognizing the markets ability to change, BHP should outperform over the coming weeks.

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Post Budget Equity Index Returns, by Andrew McCauley

Yesterday treasurer Wayne Swan presided over his 1st Federal Budget. I note that the Australian Financial Review dedicated 32 pages to a thorough analysis of the Budget. However not one article mentioned the historical performance of the Australian Equity Market post the Budget release. I will attempt to fill this void.

The average 5 day return for the S&P ASX 200 post the Budget is -0.43% (sample 1998 – 2007, n=10), t stat -1.036, standard deviation 1.21%, win rate 40%, max 1.89% & min -2.03%.

The average 20 day return for the S&P ASX 200 post the Budget is 0.23% (sample 1998 – 2007, n=10), t stat -0.394, standard deviation 3.90%, win rate 60%, max 5.34% & min -7.06%.

Given that the average 5 & 20 day drift is 0.17% & 0.66% respectively, it does appear that returns post budget are sub standard. However, the data is not statistically significant & results are largely random.

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What Happens to NAB post a 3 Day Gain of 10% Plus? by Andrew McCauley

Yesterday marked only the 10th occasion since 1986 that National Australia Bank (NAB) recorded a gain of 10% plus in a 3 day period. This rally was probably induced by a perceived solid half year result on Friday & the recent machinations between WBC & SGB.

So what happens next? To be honest I don’t know. However evidence suggests that over the next 5 days NAB should retreat from current levels.

The average 5 day return for NAB post a 3 day gain of 10% plus is -4.30% (sample 1986 – 2008, n=9), t stat -4.547, standard deviation 2.57%, win rate 0%, max -0.81% & min -7.45%.

The average 20 day return for NAB post a 3 day gain of 10% plus is -3.21% (sample 1986 – 2008, n=9), t stat -2.303, standard deviation 8.22%, win rate 33.3%, max 7.72% & min -20.20%.

As an aside I would also point out that Suncorp Metway (SUN) has just recorded its 2nd largest 3 day rally since listing, gaining 19.49%. The other rally of this magnitude resulted in a 5 day return of -4.43%.

Short term, the evidence suggests that the heat may come out of this sector.

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A Large 1 Day Decline in US Equities & A Positive Day in Australia, by Andrew McCauley

I’m fairly sure that more than a few market pundits will take more information out of market movements in Australia today than is justified. I can just hear the promoters of confusion saying that a strong day in Australia after a weak lead in the US has positive implications.

The data points to a different conclusion. Since 2000, the Australian Equity Market (S&P ASX 500) has recorded a positive move on 17 occasions after a decline of -1.5% or more in the S&P 500. Over the next week the average return for Australian Equities was negative 80 basis points. The win rate was 7 out of 17. No positive implications to be seen.

A conditional sample of an S&P 500 decline of -1.5% or more, versus, an Australian Equity Market gain of more than 0.5% (as was the case today) reveals the same random outcome. The average return over the next week was negative 41 basis points, with 3 observations & a win rate of 1 out of 3.

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SPI Intraday Movement Pre & Post the RBA Monetary Policy Release, by Andrew McCauley

Today will mark the 4th occasion that the RBA has released its decision, on the level of cash rates, during market hours. Our very own Peter Missingham is of the opinion that cash rates will be unchanged when the RBA releases its Monetary Policy Statement at 2.30pm. I have no reason to doubt Peter.

I ponder if the RBA Release during market hours has had any observable impact on the intraday gyrations of the SPI (S&P ASX 200 Index Futures). Breaking the data into 2 samples, Open to 2.30pm & 2.30pm to Close, does not provide any tradeable edge.

I observe that the only up morning session of 0.29% was greeted with a down post 2.30pm session of -0.26%. The 2 down morning sessions of -1.78% & -0.29% were greeted with a post 2.30pm return of 0.99% & -0.13% respectively. The average post 2.30pm session return is 0.20% with a win rate of 1 out of 3. Hardly convincing.

The only consistent pattern (3 out of 3) is that the post 2.30pm range is smaller than the pre 2.30pm range. Again no edge in that observation. I guess with time the paucity of the data will expand & perhaps a couple of economic patterns will emerge.

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An Interest Rate Refrain, by Peter Missingham

We all know that it’s a worry when 23 of 24 market economists agree that there will be no change to official RBA interest rate settings at Tuesday’s board meeting. This no change to rates refrain is in the Reuters poll of 24 market economists.

It does remind me that in a similar survey in January 2007, of the 18 surveyed on their views on where interest rates were going in the next three months of 2007, 3 went for an increase of 0.25%, 1 for a decrease of 0.25%, and 14 of 18 for no change. Some even went as far as prognosticating no change through the whole of 2007! I suspect that Abraham Lincoln was onto something when he once uttered;

the best thing about the future is that it only comes one day at a time (one day at a time is more than enough – editor)

Please keep this in mind when reading my view on Tuesday’s RBA cash rate decision.

My favoured prognosticators are the financial journalists with a good track record at predicting (guessing) these events. One could be forgiven for thinking that they may have the front running on the RBA’s thought processes. Both Terry McCrann and Alan Woods have excellent recent form & are going for no change tomorrow. I’m with them.

Apart from recent mixed economic data (still surprising on the upside) there is anecdotal evidence that consumers are heeding the message that is being sent so unequivocally by the RBA. One economist has apparently said; 

the numbers of supermarket shoppers he has observed using a shopping list, and price comparing, has increased noticeably (an economist doing practical research? – editor)

There are still some worrisome signs on the strength of the economy, hence more rate increases in 2008. Clouding the picture for example was today’s TD Securities – Melbourne Institutes’ Monthly Inflation Gauge. 

Also the ANZ job advertisements index rose strongly, and while I don’t think there is any direct correlation with the employment data to be released later this week, it will ring warning bells. Again, my best guess at the moment is that the RBA will stay on hold until August. All this despite having the Budget ahead (with promises of fiscal rectitude) and signs of a slower economy appearing.

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City versus Country (A Total Points Observation), by Andrew McCauley

Tonight City play Country in what is loosely described as a NSW State of Origin selection trial. The bookmakers have posted the total points market at 38. This does look a little high when analysing total match points under the origin selection criteria introduced in 1987.

The average total from 1987 onwards is 33 points. Interestingly, if we include the data from 1930 to 1986, under the old residency selection criteria the average total was 40 points. Closer to levels set by the bookmakers. The difference in mean between residency & origin is statistically significant at a level of 1 in 40. The level of significance would be higher if I adjusted the 3 points per try during residency criteria to the current 4 points per try.

The decline in total points in this particular game is at odds with the general trend of increasing totals in the NRL regular season.

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