Review of The Signal and the Noise: Why So Many Predictions Fail —but Some Don't by Nate Silver

Nate Silver's new(ish) The Signal and the Noise: Why So Many Predictions Fail —but Some Don't opens by crediting the increase in GDP per capita since the industrial revolution to the cumulative effects of the spread of information. And it is true that many measures of information exchange or accumulation have grown in perfect harmony with increases in production and standard of living.

However, this ignores a competing explanation, that the increase in our standard of living has been driven by an increase in available energy, and specifically energy sources that yield a big return (10-100x) on energy invested (EROEI).

In general, Silver has a superficial understanding of the topics he covers. He implies that Nassim Taleb discovered that financial variables have fat-tailed distributions (p368), when really fat tails are pretty old news to everyone in finance. He mentions that the average holding period of common stocks has been getting shorter, but apparently is not aware that this is cyclical, and the previous nadir was in 1929.

Silver misses the opportunity to develop systematic explanations for why people make bad predictions, for example the principal/agent problem. The problem is that Silver is a technocrat so he can't tell you that bureaucrats make bad predictions because of an incentive misalignment wherein they prioritize their careers over the lives and property of those whom their predictions can harm. Taleb always pounds the table about lack of skin in the game.

The worst parts are when the book succumbs to left wing dogma. For example, he preaches global warming with nary a mention that there was a Little Ice Age that ended in 1850.

Nate Silver correctly predicted one presidential election where the losing candidate took a dive and another where the losing candidate correctly predicted that he would lose because there was a winning majority already on the payroll of the incumbent.

2/5

Bruce v. Suntech Power Holdings Co., Ltd et al ($STP)

For those following Suntech, docket number 82 in Bruce v. Suntech Power Holdings Co., Ltd et al. is a must read. That case is the class action lawsuit against Suntech alleging securities fraud in relation to the GSF loan guarantee and missing government bonds.

This entry is the plaintiffs' memorandum of law in opposition to the motions to dismiss. The outline of the argument is worth posting.

I. Plaintiffs’ Allegations Support a Strong Inference of Scienter
A. Defendants’ Deliberate Disregard Of Numerous Red Flags Supports a Strong Inference of Scienter
(1) Defendants Chose Not To Verify The Existence Of The Collateral Which They Claimed To Backstop Suntech’s Guarantee to GSF, and Chose Not To Examine The Documents Referencing The Purported Collateral
(2) Defendants Suntech and Shi Had Actual Knowledge That The Person Claiming To Provide The Collateral Was Not Trustworthy
(3) That Defendants Knew GSF Projects Were Being Investigated For Criminal Misconduct Put Defendants On Notice That GSF Assertions Required Scrutiny
(4) The Fraudulent Nature Of GSF Was Apparent And Was Recognized By Others
B. The Fraudulent Nature Of GSF Was Apparent And Was Recognized By Others
C. The Complaint’s Allegations That Suntech And Shi Had A Motive And Opportunity To Disregard The Truth Supports Scienter
II. The Complaint Alleges Numerous Misrepresentations by Defendants
A. Defendants’ Misrepresentations Regarding Internal Controls are Actionable
B. Defendants’ Misrepresentations Regarding the Fair Value of the Loan
Guarantee are Actionable
C. Defendants’ Concealment of the Loan Guarantee is Actionable
III. Loss Causation is Adequately Pled as to Each Misrepresentation
IV. Plaintiffs Have Standing to Represent Noteholders
V. Plaintiffs Have Adequately Alleged Control Person Claims Against Shi and King

Scienter refers to intent or knowledge of wrongdoing. In order to prevail in a securities fraud claim under Section 10(b) of the Securities Exchange Act of 1934, a plaintiff must allege and prove that the defendant acted with scienter.

Hussman on Valuations

Today:

At its recent high of 24.6, the Shiller P/E (the S&P 500 divided by the 10-year average of inflation-adjusted earnings) matched the level that was observed in September 1929, exceeded the peak of 23 reached in March 1937 (the S&P 500 lost half of its value over the following year), matched the extreme of May 1965, which ushered in a 17-year secular bear market, and significantly exceeded the level of 19.8 seen at the August 1987 peak. [...]

A second feature that draws complacency is that the Shiller P/E broke above 27 at the late-2007 market peak, just before the market lost 55%, making present valuations seem not-so-high by comparison (“a Shiller P/E of just 24.6? We spit at your Shiller P/E of 24.6!”)

A third feature that draws complacency is that profit margins are about 70% above their historical norms, making raw P/E ratios (particularly those based on “forward operating earnings”) seem fairly reasonable.

"A Mail Steamship Company in Ruins; Motion for Receiver and Injunction"

A New York Times article from 1860!:

"They aver that the judgment is still unpaid, and that the Company has been insolvent for the last year, and is still incapable of paying its debts. The plaintiffs further state that some of the other creditors of the Company have threatened to bring actions against them for bills outstanding to their credit, and owed to the Company. The prayer of the complaint is that the Company may be declared insolvent; that a Receiver be appointed, and that the assets of the Company be sold and applied to the satisfaction of its debts."

The case was Isaac Grey et. al. vs. The New-York and Liverpool United States Mail Steamship Company et al..

Receivership is old fashioned medicine for insolvent companies.

Why are there so few people over 115 years of age?

A correspondent writes in about Matt Ridley's blog post "Why are there so few people over 115 years of age?" which doesn't actually answer that question,

The human body is a tightly-coupled network with several vital nodes: brain, heart, lungs, liver, pancreas, gut, kidneys, and so on. It has limited redundancy: two lungs and two kidneys. Degradation in one organ indicates degradation in other organs. Past degradation in an organ quickens the pace of future degradation in that organ and in other organs. There is self-repair, but it is limited by the lack of biological usefulness of extremely old people. There is no evolutionary pressure to extend the life of anyone too old to help a mother tend her babies. Given a particular design, the Second Law of Thermodynamics assures that there will be some overall limit to life span. If we were embodied by silicon chips, it would be longer.

"The High Price of Digging Up Dirt in China"

In Barron's:

"China stocks generally haven't done well in the past couple of years, and the flow of Chinese initial public offerings in the U.S. has virtually stopped -- just one company came public here in 2013. Chinese executives were understandably dismayed when American investors turned a cold shoulder, yet Beijing also seems to have taken umbrage. An editorial last year by the state-run news agency Xinhua growled that critiques of Chinese firms by U.S. short sellers were malicious acts seeking to 'poison reputations of Chinese start-ups for profit' and fueling foreign prejudices against Chinese business."

Chinese equities have no margin of safety.

A Chinese company can have its legitimate critics arrested. There is no way to know whether the third parties an investor relies upon for verification (auditors, researchers) are free of undue influence including threats by the government.

There is an epidemic of fraudulent Chinese companies listed in foreign markets, but the country of China is itself a fraud. It has the appearance of institutions: courts, markets, etc., but really everything is decided behind the scenes in a totalitarian fashion.

I would take Russian equities over Chinese any day.

"Post-Judgment Remedies in Reaching Patents, Copyrights and Trademarks in the Enforcement of A Money Judgment"

Excellent article in the Northwestern Journal of Technology and Intellectual Property, "Post-Judgment Remedies in Reaching Patents, Copyrights and Trademarks in the Enforcement of A Money Judgment" [pdf],

"Confronting a recalcitrant debtor, the judgment-creditor should recall Winston Churchill’s description of Russia 'as a riddle wrapped inside a mystery inside an enigma.' To unravel the enigma of a debtor’s inventory of secreted, hidden, and concealed assets, post-judgment remedies compel the judgment-debtor to appear in court and disclose assets and liabilities by testimony and documents through an Order to Appear ('ORAP'). ORAPs are in personam proceedings that compel the judgment-debtor to physically appear for an examination and disclose assets and liabilities. The judgment-creditor has great latitude in compelling the disclosure of information necessary to discover assets available for enforcement. An ORAP also provides the judgment-creditor with the right to compel the judgment-debtor to turn over assets and subject the debtor to direct enforcement under the power of contempt.

The procedure to reach the judgment-debtor’s property through an ORAP is straightforward. At the conclusion of the ORAP, the judgment-creditor can seek an order compelling the judgment-debtor to transfer or assign property to the sheriff or receiver under Cal. Civ. Proc. § 708.205(a), who would then take the property into possession and provide for an orderly sale. If the asset is a patent, the court may order the judgment-debtor to execute an assignment of the patent in favor of the receiver but not the sheriff."

Debtors try to stiff their creditors all the time. There are plenty of tools that creditors can use to try to get paid.

Chinese "Naked Officials"

Economist story about Chinese exit strategy,

"THE phrase 'naked official,' or luo guan, was coined in 2008 by a bureaucrat and blogger in Anhui province, Zhou Peng'an, to describe officials who have moved their family abroad, often taking assets with them. Once there, they are beyond the clutches of the Communist Party in case anything, such as a corruption investigation, should befall the official, who is left back at home alone (hence 'naked'). Mr Zhou says the issue has created a crisis of trust within the party, as officials lecture subordinates on patriotism and incorruptibility, but send their own families abroad."

Bullish for San Francisco real estate!

Unpeeling the Suntech Onion ($STP)

What Bernanke Signaled?

One theory,

"What Bernanke signaled this week is that QE is no longer an emergency government measure, but is now a permanent government program. In exactly the same way that retirement and poverty insurance became permanent government programs in the aftermath of the Great Depression, so now is deflation and growth insurance well on its way to becoming a permanent government program in the aftermath of the Great Recession. The rate of asset purchases may wax and wane in the years to come, and might even be negative for short periods of time, but the program itself will never be unwound."

Interesting.

Comment on South Gate Field Trip / Los Angeles Construction Bubble

A correspondent writes in about the Los Angeles real estate field trip and observations about the new construction project in blighted South Gate, CA,

Two points
(1) There is a whole world of subsidized housing, transferable tax credits and tax-free muni financing. The developers will often have a captive (they don't like the term of course) non-profit that runs the properties they buy (sometimes they buy the defaulted loans). Local housing authorities don't like "for profit" entities running the housing sometimes so they have their non-profit run things (very well) and the fund gets the tax-free loan (secured by the property and at very, very attractive rates). So suboptimal location/properties might be very profitable to build. Then you probably have the retailers incentivezed to move there by some politically correct economic development authority. They also get special credits for hiring in certain areas.

(2) Where I was exposed to "good retail" in places where it does not belong was when I was taking the bus from Columbia across 125th street in Harlem over the Triboro to Queens. You probably would not walk on the sidewalk on 125th but there were big national chains all along the strip. Now there's even more coming.

Our financial system (which is not capitalist or free market) seems to be making horrific misallocations of resources.

The city of Cudahy is a mile away from the new 400,000 square foot property in South Gate. There's an LA Weekly article called The Town the Law Forgot,

The cities around the 710 freeway — a gateway from the Port of Long Beach to the rest of the nation — are so small they share freeway exits. Graffiti is scrawled on overpasses, exit signs and the concrete banks of the L.A. River, informing visitors that they are about to enter gangland. The grimy strip malls, auto-body shops and fast-food joints further speak to a loss of prosperity.

Cudahy, the smallest, poorest and most violent of these cities, feels like a place the law has forgotten — a feeling that intensifies along Santa Ana Street, where a large “18” is spray-painted on a telephone-utility box at one end of the block, and another large “18” is tagged at the other end — on a government dumpster, no less, at Cudahy City Hall.

And I'm crazy for thinking you wouldn't want to build a new shopping center here?

Sears Short Interest Update ($SHLD)

Short interest was down to 15,931,810 as of 9/13. That was less than 700,000 shares fewer than at peak two weeks earlier.

Final Judgments Entered Against Suntech ($STP) For Unpaid Bond Debt

In both the Trondheim/Meixler and Dugaw vs Suntech cases, final judgment has been entered against Suntech, as

"...Defendant has failed to show that a genuine dispute exists as to any material fact of the Plaintiffs' Motion for Summary Judgment in lieu of complaint..."

Let the collections efforts begin!

"Pipes, Not Punting, Explain Commodity Prices and Volatility"

The centrality of steeply rising costs—even for the largest, most well capitalized, most disciplined producers—is easy to illustrate, as data are abundant and transparent. Figure 2, for example, plots the quarterly average price of seamless steel against the quarterly cost of goods sold (COGS) reported by Exxon since 1Q1990.

Seamless steel is a specialty product used in drill pipes. From 1990 to 1998, Exxon’s COGS remained relatively constant around $15 billion per quarter. But as emerging market demand pressed upon marginal sources of supply, even Exxon began to see a significant increase in the costs it incurred to supply its customers with the energy they demanded. By 2Q2008, when oil prices were nearing their cyclical peak,
Exxon’s COGS surpassed $100Bn in a single quarter as the company responded to customer demand. This is 7X the 1990-98 average.

Oil prices did not rise sevenfold because of an increase in index money in futures markets: prices and the value of index positions surged because marginal costs rose sevenfold as producers had to reach into harsher basins to find and deliver oil.

Early 21st Century United States History, Captured in One Story

Entrepreneurs go to skid row in downtown Los Angeles, pick up the homeless and bring them in vans to the Apple store on Colorado Boulevard in Pasadena, so that they can wait in line for the new, slightly better iPhone 5s with its creepy and unnecessary fingerprint reader, which is outselling the other new, less expensive phone without the creepy reader by a huge multiple.

The Toyota Way

Great story about Toyota:

"[T]oyota was similarly extreme in how it exercised kaizen and things like root cause analysis. If an oil puddle is found on the factory floor, most companies would quickly get someone to clean it up before it causes an accident. At Toyota, they would quickly get someone to place warning cones and tape around the puddle, and then they would figure out where the puddle came from. Was a leaky forklift parked here? Does one of the pipes overhead have a leak? Is a nearby robot flinging a few drops of oil from it's joints every minute? The oil puddle is a sign of a problem somewhere else, possibly a more important one, and you don't clean it up until you've figured out where it came from and fixed the cause."

Another Construction Bubble? Evidence from Los Angeles

Driving around Los Angeles, I saw the following collection of retail storefronts along the south side of Firestone Blvd west of Atlantic Avenue.

This is in the city of South Gate, which borders Watts and Compton. It is a zip code (90280) that is much poorer, younger, and less educated than the California or U.S. averages.

Now, I know what you're thinking: this street obviously needs more retail square footage.

Fortunately, the good people at Primestor Development appear to be willing to help out. Their new 400,000 square foot project Azalea is directly across the street from the storefronts above.

Now maybe they are correct that there aren't enough fast casual restaurants within a five mile radius. But with a per capita income of $12,000 - $33/day for food, clothes, housing, transportation, utilities, cell phones (!), etc - is this where you want to place your bets?

As I was writing this, a paper called "The global cycle: A cycle of construction and not business investment" [pdf] happened to come across my desk. They point out that the economic recovery is concentrated in construction and not in capital goods, except those necessary for public infrastructure. Activity is concentrated in real estate because of low interest rates and probably because of the perception that making buildings is "low risk". However, the authors warn,

"An economic recovery due to investment in construction and not productive investment is atypical. It is probably due to the powerful effect of monetary policy on investment in construction. It is likely to be vulnerable [because] it is threatened by more restrictive monetary policy, it creates no additional production capacity, [and] it is not relayed by a pickup in international trade"

It looks as though the Fed has blown another construction bubble, because blowing bubbles is all they know, and the proof is in the sudden explosion of construction projects in very marginal locations.

"Solar panel maker Suntech says Italian court orders seizure of additional solar-power projects" ($STP)

Press release this morning,

"Suntech Power Holdings Co. Ltd. said Monday that an Italian court issued a ruling to seize more solar projects that received investments from Global Solar Fund SCA.

The court also ordered the seizure of tariffs paid to private companies that got investments from Global Solar, Suntech said.

Suntech said that it learned Thursday of the ruling by a court in Brindisi, Italy, which raises to 37 the number of solar projects ordered seized. The projects represent 21 percent of the power-generating capacity of the companies that got investments from Global."

Incredible. The GSF complex of grid solar projects in Italy was leveraged, so to lose 21% of the power generating capacity in a seizure implies that all of Suntech's equity in these projects may have evaporated.

But, who knows? The company certainly doesn't provide financials.

Review: "A Colossal Failure of Common Sense"

A Colossal Failure of Common Sense, about the collapse of Lehman Brothers as told by an employee, Lawrence McDonald. He was a retail broker who saw the value in bonds (especially convertible bonds) twenty years ago. He went on to create an online clearinghouse for bond information, convertbond, before eventually winding up at Lehman.

Oddly, there were many people in Lehman who were all over the housing bubble, and even shorted homebuilder stocks. Apparently, his department even realized the mess the mortgage department was getting in and tried to short builders and lenders as a hedge. They owned New Century puts!

The incompetence seems to have come partially from the mortgage department, because it was on a roll, but even more from the very top of the company, which doubled down on big purchases and on repurchases of its own stock. Here's how out of touch Dick Fuld was, according to the head of distressed debt trading,

“I told them I’d heard a lot about Dick Fuld over the years. He’s a former commercial paper trader, but not once, not one time in all my years here, did I ever see him on the trading floor. Not even on the day me and the guys had the single most profitable day in the history of Lehman’s fixed - income division — two hundred fifty million clams, and the guy’s a no - show.”

If Dick Fuld had never spoken with the head of distressed debt trading, what exactly was he doing all day. (I think you can get a sense from one other must read Lehman article, Lehman’s Desperate Housewives.) And that guy was smart enough that he had bought a billion dollars worth of protection on Countrywide for 18 basis points!

At the moment right before the crash - early 2007 -  one of the really good distressed analysts quit because there were no distressed bonds. Market top.

It's worth noting that even once this ineptly managed firm woke up and started trying to unload assets, the market had plenty of room to fall.
 
There's a disappointing story where the author and the distressed head are in Las Vegas playing blackjack (stupid), and the distressed guy has a big drawdown. He responds by upping his bet size and playing all the spots at the table, which the author mistakenly thinks gives the player an advantage.

4/5

"Will the F-35, the U.S. Military’s Flaw-Filled, Years-Overdue Joint Strike Fighter, Ever Actually Fly?"

Fascinating Vanity Fair article about the F-35 debacle.

"the F-35s that the Marines say they can take into combat in 2015 are not only ill equipped for combat but will likely require airborne protection by the very planes the F-35 is supposed to replace[...]

The political process that keeps the Joint Strike Fighter airborne has never stalled. The program was designed to spread money so far and so wide—at last count, among some 1,400 separate subcontractors, strategically dispersed among key congressional districts—that no matter how many cost overruns, blown deadlines, or serious design flaws, it would be immune to termination."

A correspondent writes in:

"Russia has a 5th generation fighter plane, the Sukhoi T-50. Notice that the T-50 rudders are farther from the center line of the aircraft than those of the F-35. That means they can be smaller, have smaller forces on them and be less of a visual barrier than F-35 rudders.

The US tried to develop a common fighter for the Air Force, Navy and Marines once before. It failed. It may have been the F-111. Anyhow, there seems to be no institutional memory of it.

The problem is that it generally is impossible to maximize more than one variable at once. So an aircraft optimized for carrier takeoff could not be optimized for close ground support or for deep, stealthy penetration.

Russia does not have to optimize an aircraft for carrier takeoff because it is defending a contiguous landmass with land-based planes, not projecting aggression across oceans. Freed of this requirement, Russia can make a superior fighter.

The requirement for concurrency worsens the problem of commonality. The requirement for commonality means there will be more errors during development. The problem of concurrency means the errors will be propagated through a larger number of aircraft before they are discovered. In effect, the development project has the cost of dozens of different prototypes at once, not just two or three at a time.

Engineering jobs such as aircraft design and production should use established principles. They should not be processes of discovery of unknown principles or limitations.

The F-35's pilot helmet violates this engineering principle. It ties a complex ergonomics research and software development project to the development of an otherwise simple aircraft development. The ergonomics knowledge is not there. The helmet is too complex for the human nervous system. the software is too big and complex to be bug-free. The result is dis-orienting and inferior to the naked eye.

What were the Soviets working on in the years before their empire collapsed?

George Gilder on Central Planning

"GDP growth is fraudulent when it is mostly government spending valued retrospectively at cost and thus shielded from the knowledgeable judgments of consumers oriented toward the future. Whether fueled by debt or seized by taxation, government spending in economic 'stimulus' packages necessarily substitutes state power for knowledge and thus destroys information and slows economic growth"

"Chinese local governments need cash so badly they’re beating, kidnapping and killing to get it" $STP

Chinese local governments need cash so badly they’re beating, kidnapping and killing to get it

"Suntech Arizona Has Shut Down Production" ($STP)

Hopefully there is still collateral inside the building. I suppose there must be if they are still conducting deliveries?

There was a solar panel covered parking area behind the building. Guess what manufacturer the panels were? They were labeled First Solar.

An Australian article this morning about David King resignation makes a good point: "It's a shame that it didn't work out - David had a lot of credibility with U.S. investors".

Building Bubble - Topping Indicator

"Washington reversed a decades-long decline in population, and has for several years been growing as fast as any of the fastest-growing states. Long-neglected neighborhoods have been gentrified, real estate prices are skyrocketing, and the Office of Planning predicts that we could run out of attractive places for developers to build. [...] All of that has made the current conversation about raising the District’s height limits, codified in federal law more than a century ago, different from past efforts."

Washington, DC is running out of office space because of productive enterprises making things? Or because of grifters, lobbyists, regulators, and contractors? Does it matter, since "it all goes in to GDP"?

"In China, the Dangers of Due Diligence"

“Unfortunately, even as due diligence into the integrity of domestic enterprises in China has become more important in the light of perceived widespread fraud and misrepresentation, access to records has become even more difficult,”

We have written about this extensively - China does not have securities with any margin of safety.

Suntech Bondholders Win Motion for Summary Judgment ($STP)

Today:

"Suntech Power Holdings Co. (STP) noteholders won a court ruling on their claim for $550,000 in defaulted debt owed by the Chinese solar-cell maker, a lawyer for the investors said.

U.S. District Judge Robert Patterson Jr. granted the investors’ motion for summary judgment today at a hearing in Manhattan, Jay Teitelbaum, a lawyer for Trondheim Capital Partners LP and Michael Meixler, said in a phone interview."

Suntech Call Spread Trade ($STP)

One interesting way of betting against Suntech would be to short call spreads.

For example, the January 2014 $0.50 call is $0.69 bid, and the $1.50 call same expiry is $0.16.

Shorting a $0.50/$1.50 call spread results in a net credit of $0.69-0.16 which is $0.53. The net credit is the maximum gain; if the spread closed in the money the max net debit would be $0.47.

New Closing High for Sears ($SHLD)

Check out this chart from StockCharts.com for SHLD:

Wow!

More Sears Discussion at CB&F ($SHLD)

Link.

"Sears no longer needs the large retail footprint that it previously held in order to serve its customers. That's the whole anchor padding portion of the presentation. By reducing its retail footprint, Sears will be able to transition portions of any or all of their properties to a better higher use without having to sacrifice much, if any, of their retail operations.

It's telling that the Credit Suisse report does not address any of the conference call transcripts from SPG, GGP, et. al. while focusing only on their own internal numbers."

Also:

"The deals where they 'right size' the location like the anecdote in my town (and a number of the examples in the Baker street report), where they subdivide and throw in a Wholefoods (or other "growth" retailer) probably don't correlate at all to a decrease in SHLD retail EBITDA generated the location. In fact, it is probably more likely it would have a positive impact in terms of traffic and overall value of the parcel, even if it doesn't result in increased retail EBITDA generation by the SHLD retail ops remaining in place on the property."

Great discussion over there. Go read it.

Short interest numbers for the end of August were reported after the close today: 16.6 million shares, which was an increase of 862,173 from the middle August.

So it could be that this recent up move was from longs adding to their positions and not even short covering yet!

A Plea for Caution From Russia

"No one doubts that poison gas was used in Syria. But there is every reason to believe it was used not by the Syrian Army, but by opposition forces, to provoke intervention by their powerful foreign patrons, who would be siding with the fundamentalists."

When Was the Last Good Market Corner? Volkswagen?

We've written about corners before: Joseph Leiter, the Hunt brothers, K-V Pharma's drug Makena, and Malaysian tin. Corners seldom happen now, perhaps because ownership disclosure requirements (e.g. 13D/G) have taken away the element of surprise.

It could happen again with Sears. Posters at CB&F have figured out that almost all the shares of Sears Holdings are owned by true believers with more than the remaining float sold short. (Between 85 and 95% "locked up", depending on how you define, and somewhere around 15% sold short.)

Baker Street Capital today released a very thorough report on Sears valuation, which also showed their calculations of short interest and float. They believe that 93.5% of shares are held by "committed shareholders," leaving 6.5% as the effective float, versus 14.8% sold short.

That would be 200% of the float sold short, about the same ratio (and absolute level) that was sold short at the start of the infamous Volkswagen squeeze. Which, by the way, was a thought that had occurred to people in advance. From a Risk.net article in 2008:

"Before the short squeeze occurred, various analysts had published research warning investors of the perils of trading VW stock. Adam Jonas, an analyst at Morgan Stanley in London, had cautioned clients of the dangers of playing 'billionaire's poker' in his research note on October 8, and suggested the size of short positions on VW far outweighed the true economic free float of the company. He added that Porsche needs VW to ensure its long-term survival, noting the company would not develop or manufacture a car in the future without significant resource sharing with VW or Audi (a car brand owned by VW). 'This 'need' for Porsche to control VW, combined with Porsche's long-term horizon, can create shorter-term share price anomalies that could take investors by surprise,' Jonas wrote."

Even though shorts are systematically smarter than many other types of investors, that academic research is more applicable in situations where institutional ownership is small and declining. In this case Sears is practically a private company.

Shorts can be wrong sometimes.



We've seen it from both sides now.

Ed Thorp on Arbitrage

"It all depends on how confident you are about your edge. If you have a really strong conviction about your edge, then the best thing to do is sit there and take your lumps. If, however, you believe there is a reasonable chance that you might not have an edge, then you better have a safety mechanism that constrains your losses on drawdowns. My view on trend-following was that I could never be sure that I had an edge, so I wanted a safety mechanism. Whereas for a strategy like convertible arbitrage, I had a high degree of confidence as to the payoff probabilities, so reducing exposure on drawdowns was unnecessary."

95 Suntech Power Posts ($STP)

This will be the 96th Suntech post, which makes it the most posted about company in the 6.5 year history of this blog. The ten other most posted about companies are:

• Conrad Industries, with 89 posts. Our first post was at $10 in January 2011 - it's now at $30 plus a $2 special dividend. That has been an internal rate of return of 57%. It's amazing how good of an idea it was when we first wrote it up. You were only paying $3 for the business (excluding net current assets) - which then paid a $2 dividend in December 2012! There are no longs anywhere near this cheap anymore, a sign that it is much later in the bull market than people think.
• GMXR with 88 posts. Our capital structure writeup was April 2012. The stock went to zero and the bonds were repaid. Remember in November 2012 when the company had to give away 20% of the company just to raise money for a debt maturity at 15% interest? The stock doubled... but the company was gone six months later.
• Treasuries. We have consistently nailed the Treasury market, with an edge that almost no one else in the market has: the Federal Reserve is driving long bond prices down, not up, by terrifying everyone about monetization and inflation. Nominal bond yields would be lower if investors were not afraid of inflation. It looks like pretty soon it will be time to buy bond call options again.
• MGM with 59 posts. This is our only miss in the top ten most posted. The casinos have diversified from gambling into very profitable nightclubs (and day pool parties) which are good for degenerates with attention spans too short for card games. Rather than repair the overleveraged financial institutions, fraudulent reserve banking system, etc, our "elites" decided to just double down. [MGM will be exciting in the next recession. Tangible book value -$3 billion, long term debt $13.6 billion, EBIT less than interest over the past twelve months.]
• Chesapeake with 43 posts. Both the equity and the preferred stock have done quite well. This one is not really actionable any more, but the bear raid in 2012 was nuts.
• Evergreen Solar with 40 posts. This obviously went to zero.
• A123 Systems. Also went to zero and the bonds were a big win.
• Grubb & Ellis. Went to zero.
• Downey Savings. Looking back on it, I think that people in 2007 refused to believe that a bank could ever fail. After a very brief "panic", which was actually entirely justified, and the suspension of mark to market accounting, people are back to believing that banks can't fail.

In investing, the price will not always move in your direction but the facts should. The Suntech facts have continually moved in our direction. Remember, the bull thesis was first that money in the GSF subsidiary would pay off the bonds [never existed], then that there would be a bailout by the Chinese before maturity [nope], then that some sucker would sink more money into this thing. Instead, no bailouts, no plans, just board member resignations and hopeful announcements of restructuring deals that would crush the equity even if they worked.

Computer Poker

I've had some notes in the can for a while about computer poker research. There's an NYT article today about it.

"Dahl recalls staring at his computer screen, watching his neural nets compete, when he saw one of them make a fairly sophisticated bluff known as floating. You do this by playing passively, initiating no bets and matching the ones that your opponent makes. If, after the turn card is played, your opponent does not bet, you do. His slowing down usually means that he had been overplaying his cards with the hope that you would fold or his hand would improve. Your bet here signals that you’ve just made a strong hand or that you have been inducing him to put as much money as possible in the pot because you have had a superior hand from the start. 'At first, I wasn’t even familiar with that strategy,' Dahl says. 'Later, I thought it was amazing that the neural net could come up with a known, successful strategy on its own.'"

Poker is won or lost before the game is even started.

Worthless Stock Inefficiency: Eastman Kodak ($EKDKQ)

Today, Eastman Kodak emerged from bankruptcy. The confirmed plan wiped out the existing common stock, which was cancelled.

"On September 3, 2013, the Plan became effective pursuant to its terms and the Debtors emerged from their chapter 11 cases.

Upon the effectiveness of the Plan, all previously issued and outstanding shares of the Company's common stock were cancelled as were all other previously issued and outstanding Equity Interests."

What is amazing is that everyone knew that the plan had been confirmed and that the shares were going to be cancelled. Yes, the company market cap was $35 million earlier in the month and was $16 million earlier today. Even in the final seconds before the stock was extinguished, the market cap was $8 million.

Note that there was no options related reason to be buying the shares. Here is how the OCC adjusted the Kodak options contracts:

Effective September 4, 2013, existing EKDKQ options will be adjusted to no longer call for the delivery of Eastman Kodak Company Common Shares upon exercise.

In settlement of EKDKQ exercise/assignment activity, an EKDKQ put exerciser (or call assignee) will receive a cash payment of the full aggregate strike price amount on the exercise settlement date. An EKDKQ put assignee (or call exerciser) will pay this amount on the exercise settlement date. Settlement will take place through OCC’s cash settlement system on the third business day after exercise.

Full strike!

It is analogous to Suntech, which is defaulted and has announced that shareholders will be "severely diluted" if they can even make a restructuring plan work. 

Something similar happened with GMX Resources as well. When the company borrowed money at 15% with 20% of the equity thrown in to the lender, the stock doubled.