Science - Shaken, Not Stirred

If you listened closely, you could hear the rumblings. Not those of the devastating earthquake and ensuing tsunami in Southeast Asia, but of the thousands of mice on wheels inside the brains of Wall Street’s delicate geniuses, scurrying to find ways to exploit the devastation.

One notable “winner” was Taylor Devices (TAYD:NASDAQ), a thinly traded microcap, which closed last week a couple cents shy of $2.50 and closed yesterday at a 52-week high of $6.75. As of this writing, shares are currently trading north of $8.50, a 600% return in less than two trading sessions.

Taylor is hands-down the leader in earthquake protection, controlling 95% of the U.S. market for industrial strength seismic dampers, which are employed in such diverse locales as Safeco Field (the Seattle Mariners home), the George Washington Bridge in New York, NASA’s launch pads, and the Petronas Towers in Malaysia. While the 9.0 quake could focus attention on Asia’s inferior building codes, the direct long-term benefit to Taylor is difficult to assess, and the company’s current fundamental picture hardly qualifies it for all this attention. For its first fiscal quarter, Taylor reversed a year-ago loss of $201,129, or 7 cents a share, but revenue declined 18% to $2.5 million, and trailing-twelve-month cash-flow is off 88% year over year, from $3.5 million to under a half-a-million. The revenue decline is a function of cash-strapped California’s construction slowdown, which has compelled Taylor to send in low-ball bids on projects outside the United States, where the firm has much less of a presence.

Earthquake Protection: Earthquake in a Bottle

Clearly, for investors in Taylor, the explosive price action was an instance of catching lightning – or, in this case, an earthquake – in a bottle. If only there were some way of predicting earthquakes and other natural disasters with some level of accuracy…alas, Mother Nature isn’t nearly so amenable.

Earthquakes do have something to teach us about the stock market, at least according to research conducted by a team led by Xavier Gabaix, assistant professor of economics at MIT, and Boston University physicist H. Eugene Stanley, who found that the market, in fact, bumps and grinds fairly predictably, very much like earthquakes (which, a full paragraph later, still can’t be predicted).

The research team reviewed more than 100 million trades from 1994 through 1996 in markets in eleven countries and developed a mathematical model, which, they say, explains the market’s infamous burps and farts, including the recent tech meltdown and the crashes of ’87 and ’29. Who’s responsible for the flatulence – uh, fluctuations? Essentially, Gabaix and his team point the finger of culpability at – or give credit to, depending on your viewpoint – the largest 500 or so players, like institutional investors, mutual funds, hedge funds, and pension funds, whose large-scale buying and selling generates specific mathematical patterns.

Ever keen on misappropriating science to explain the untenable, Wall Street has latched on to call these mathematical patterns, which are unwittingly ironically referred to as “power laws.”

The 9.0 earthquake that shook the earth under the Indian Ocean was an anomaly. There are relatively few examples of this kind of seismic hyperactivity and many more examples of lesser activity, and the relationship between the two follows a precise mathematical model. The same “power-law” math, opines Gabaix, also describes the relationship between large and small fluctuations in the overall market, individual stock prices, daily trading volume, and the number of trades executed.

Earthquake Protection: Eight Times

According to the model, the number of days XYZ stock moves by 1% will be eight times the number of days it moves by 2% percent, which will be eight times the number of days it moves by 4%, which will be eight times the number of days it moves by 8% and so on. The same “power law” describes changes in the number of trades executed.

An inverse “power law” describes daily volume. If, for instance, there are 512 days on which XYZ stock trades 100,000 shares, it can be expected that there will be 64 days when XYZ stock trades 400,000 shares, eight days when 1.6 million shares are traded, and one hyperactive day when the stock sees volume of 6.4 million shares.

Sound interesting? Really? Well, good luck trying to make the science work for you. Even Gabaix admits, “At this point, it’s largely pure science.” Unfortunately, it lacks what good science generally doesn’t: practical application. “Power laws” don’t predict the direction of the price movement, only its size, and while we can expect another crash to hit us, as with an earthquake, we can’t say when, even to within 100 years. And as with an earthquake, “power laws” can’t help prevent market crashes, either. Only excessive regulation can accomplish that.

Gabaix and his team are currently working on identifying the origin of extreme market movements, which he said, could yield a model to help mitigate those extremes.

I can’t wait.


Carl Waynberg
Poitou, France
December 29, 2004


On Monday, we thought – and not for the first time – we saw the door begin to shake. All Hell is going to break loose, we thought. But so often have we thought so…and so often have we been wrong or premature that you have no reason to believe us this time either.

You’ll recall, dear reader, the strange condition of the world economy and U.S. finances.

They (mainly Asians) make. We take. They save. We spend. They lend. We borrow. They sell. We buy. Most observers see a kind of symbiosis in this arrangement. But what we see is parasitism.

We buy…but we have no money. Americans have no savings. And real, actual hourly earnings are going down! That is why what we buy with is object of much wonder. It is the U.S. dollar – a currency that becomes less and less valuable with almost each passing day. A European investor who bought a long-dated Treasury bond on the day of George W. Bush’s re-election, for example, has already seen an entire year’s worth of interest yield lost because of the falling dollar.

So long has this strange situation endured…and so strange has it become…that now foreigners hold $10 trillion worth of U.S. dollar assets – and every single day adds about $2 billion more!

Blissfully, the dollar fell…but it did not seem to occur to these foreigners that they were losing money. Mr. Asakawa kept a currency monitor next to his bed so he could be awakened at night. We could not figure out why he bothered to alarm himself, for he never seemed to wake up; though he was losing billions every day…he did nothing.

But sooner or later, the foreigners were bound to catch on. Another 10% drop in the dollar will cost them a trillion in losses. What if the dollar fell 20%? You’d expect them to sell dollars to avoid it. Or at least they would stop buying more.

And when they did so, the U.S. bond market would sense it immediately. That is when the bells would really start to ring – when bond prices fell and yields rose. That is when the door would suddenly give way…and all Hell would break loose.

On Monday, the door rattled and shook. Bonds fell. But yesterday, the door was silent. Bonds held. The dollar held. Hell stayed where it is supposed to be. Stocks even went up! Everything is all right for at least another day. The sun is shining. We’ve got rhythm. We’ve got music. Who could ask for anything more?

Not us.

More news, from our team at The Rude Awakening:


Tom Dyson, reporting from New York…

“Some day bonds will crack, we are nearly certain, but so far, yields have hardly budged. ‘Maybe the current valuations on the U.S. Treasury market are not as crazy as we believe,’ wonder the folks at Gavekal. ‘Maybe the U.S. bond market is already discounting next year’s liquidity crisis and the consequent stampede into U.S. Treasurys?'”


Bill Bonner, with more views from Poitou:

*** We would like to take a minute to acknowledge the disaster that occurred in South and Southeast Asia…

I’m sure you all are aware that on Sunday an earthquake of epic proportions – 9.0 on the Richter scale – shook Indonesia. The earthquake and resulting tsunami has killed over 70,000 people…and has left millions more injured or homeless.

At The Daily Reckoning, our hearts and prayers go out to the victims of this catastrophe…and we urge those of you who have the ability to help to please do so.

*** “The private investor hasn’t got a chance,” said a friend recently. Our friend helps manage a large portfolio for a very rich family. What he notices is that he often gets first crack at the best deals. Not surprisingly, people hoping to raise money give the best terms to those who offer them the most cash.

Even so, it’s hard to come out ahead.

“When you add in all the points and commissions, you’re lucky to break even over time – even when you’re considered an ‘insider’,” he said.

One of the great myths of late, degenerate capitalism is that everyone can be a capitalist. It’s easy, they tell you in the ads, and all you have to do is buy some stocks. Of course, Wall Street is eager to sell stocks to you. And, presto, you’re just like Warren Buffett. See how easy it is to get rich!

But you don’t get rich by buying stocks; you get rich by buying companies at good prices…and holding for a long time…and not spending your money. In this regard, Wall Street is not a friend…it’s an enemy. And so is, by the way, the SEC.

The fraud perpetrated by Wall Street and the SEC is that mom and pop investors are on the same level playing field as real investors. Of course, it is not true. The insiders know vastly more than the average investor. Wall Street knows vastly more too. And do you think Wall Street’s insiders would sell a stock if they thought it was going up? Of course not. They sell stock because they know they make more money on commissions – buying and selling for customers – than they are likely to make from the stocks themselves. They are like the owners of casino. If they wanted to do so, they could pull the levers on slot machines themselves. They don’t. Because they know they will make more money by letting the customers win from time to time…so they keep playing, and keep hoping that they will all come out winners. Ultimately, it’s the House that wins…not the players.

Wall Street’s great humbug is aided and abetted by academic economists who maintain that the market is always correct. Whatever price the market sets, they say, is the right one. So whether you are Warren Buffett or a bus driver…you’ll always buy at the “perfect” price. And since the price will be correct – no matter what it is – you don’t have to worry about how high prices go. Just buy! And then buy some more! Wall Street loves it. The SEC encourages it – with the preposterous bamboozle that all investors are created equal and endowed with the same right to buy stocks at the market price!

Real capitalists do not buy stocks at all. They buy companies. And they buy them only when they understand what the companies do…and how their investment will pay off. Real capitalists do not buy Google, for example. Speculators buy Google. Investors won’t live long enough to get their money back from earnings or dividends. The speculators’ only hope is that the stock will go up in price so they can sell it on to some other sad sack punter.

[Editor’s Note: Wall Street is definitely not looking out for the private investor…and Fleet Street editor, Chris Mayer couldn’t agree more. He says, “Wall Street shows nothing but contempt for the individual investor. And make no mistake: These guys have been cheating us for years. In 2005, things are going to get very ugly… and very personal… for individual investors.” This is just Prediction #1…

*** “I’m sorry that I have not been able to bring you a hare this year,” said old Francois this morning. “They’ve got some disease. I find them dead in the fields. It’s probably best not to kill them. I might be killing one that is sick – in which case we wouldn’t want to eat it…or one that is healthy, in which case I wouldn’t want to kill it.”

“But there are plenty of little deer around. They’re nice and fat…I think they’ve been eating all the trees and bushes you planted.”

“Thank God he didn’t bring us another hare,” said Maria. “That last one we ate was terrible. It tasted like an old shoe.”

The Daily Reckoning