Trader’s Narrative

Bears are cute and cuddly, until they tear off your head and feast on your carcass. The bear rampaging through Wall Street has taken the poor S&P 500 index down 52% at its deepest level. In case anyone is still keeping track of these sort of things, that’s off the charts.

It is a deeper loss than the bear market we last saw in 2002 in the aftermath of the technology bubble, and it is deeper than the “oil shock” induced bear market of the 1970’s, mercifully ending in less than 2 years from the top in October 1974.

The only bear market that lasted longer and created more devastation was the 1929 aftermath which sliced off 90% off the market’s valuation from its top by the time it was over.

It is the weekend and time to lick your wounds and get ready for duck the swats of this ferocious bear. Don’t forget to check out news.tradersnarrative.com for continous links to articles, breaking stores and analysis. Here are a few examples:

Buffett seems to have been taken off guard like many investors. Way back in 2007, well before the market topped, Berkshire Hathaway (BRK.A) wrote European style put options on the S&P 500 index and 3 other international indices for the next 15+ years. Does that mean that now, more than ever, the market is “cheap”? or did he make a massive blunder?

Fairfax’s Prem Watsa, who many liken to Buffett, recently removed protective hedges and for all intents and purposes went long the stock market after many years of forecasting doom and gloom.

Obama is reported to have tapped Hillary Clinton to be Secretary of State. Hmm…. that strikes a bell. Who was it that mentioned Hillary as the next Secretary of State two months ago?

If the embedded videos don’t work here are the links to them: Hillary Clinton and Recession Watch.

Below is the chart for the brand-new market on whether Sarah Palin’s vice-presidential nomination will be withdrawn:

You can see the complete page at intrade here.

If you think that Palin will be John McCain’s running mate, then you would sell and pocket the difference as the market settles to zero. If you think that she will be replaced, then you would buy and pocket the difference when the market goes to $1.00

So right now this market’s conviction is that there is about a 15% chance for this event. To see what I mean, check out the chart of the market for Palin’s nomination:

As the chart shows, the nomination came out of left field but those who had bought made a lot of money!

Although many call these markets “prediction” markets, they aren’t crystal balls that perfectly foretell the future. They simply reflect all available information at a specific point in time. For example, check out what they were saying during the Democratic and Republican nomination process for president.

The Iowa Electronic Market is another well-known “prediction market”. You can see the graph of the presidential race here.

Speaking of a recession, here’s an interesting graph from Intrade, the prediction market for legal, political, economic events:

The chart shows the contract for a recession in the US economy in 2008. If there is a recession sometime this year, it will pay the holder $100. If there isn’t, it will pay $0. According to this, there is currently a 37% chance of a recession in 2008.

Interestingly enough, the chart seems to be the inverse of the stock market. Notice how in mid October 2007 it bottomed out just as the market was topping. And how earlier this year it topped at 75% while the market was trying to find its footing.

Two caveats though: one, this contract is fairly illiquid; two, while Intrade can be uncanny in predictions borne out of crowd knowledge, it isn’t perfect.

As an example, take the prediction from last year putting Hillary Clinton ahead of Barack Obama.

Intrade, is less of a pure “prediction” mechanism than a way to aggregate all available information in a process of price discovery.

I’m not following the 2008 political race in the US that closely but there is a very cool and capitalistic way to keep up to date without doing any amount of hard work.

Did you know that there are marketplaces where capitalism can be used to predict the outcome of political events?

They are similar to futures markets where a contract can be bought or sold (bid/ask) that will pay a fixed return. So for example, if you thought that Barack Obama would win the Democratic nomination, you could buy or bid on his contract. If he did win, then you would be paid the full amount of the contract (usually 100 points).

The two most popular online marketplaces are intrade.com and the Iowa Electronic Markets. If you are in the US, be careful if you want to participate in these marketplaces. Some states have laws against gambling on political events. The Iowa markets though have received special treatment from the CFTC which allows them to pay out real cash (up to $500) to US citizens.

But you don’t have to participate in these markets to gain insight. Because of the way the contracts are setup, they in effect, act as a measure of probability for an event. Or atleast, what the crowd deems to be the probablity of a future event.

So for example, the contract for Hillary Clinton on intrade gives her a 47% chance of winning the Democratic nomination:

Obama is currently in second place with a 31% chance of winning. Iowa markets are showing very similar probabilities with Hillary Clinton having 42.4% and Barack Obama 33.4%

Recently, Mike Gravel has gotten a lot of attention from the online community (digg, reddit, youtube, etc.). But he’s nowhere to be seen on the prediction markets.

On a different note, I’ve continued to add articles, books and other choice trading related resources to my box.net widget. Make sure to check it out and let me know if you have any special requests.