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Noteworthy News – January 31, 2011

Economy:

Speeding up – The Economist

Why You Should Be Afraid Of Japan – NPR

George Soros tells David Cameron: change direction or face recession – Guardian

In U.S., One in Four Unemployed Adults in Financial Distress – Gallup

George Friedman: The China “Miracle” Is a Mirage – Yahoo! Finance

Home Prices Fell 4.3% in November From Year Earlier, FHFA Says – Bloomberg

The poor are not getting poorer – The Philadelphia Inquirer

Markets:

Inflation starts to make unwelcome entrance in world’s economies – The Globe and Mail

Feeling the Heat: Comparing Global Inflation – Wall Street Journal

EXCLUSIVE INTERVIEW WITH ROBERT SHILLER: House Prices Could Fall For Years – Business Insider

Politics:

How to Tax the Rich – Wall Street Journal

Financial crisis of 2008 avoidable, says US inquiry – BBC News

No Clear Strategy to Save the Euro – Dealbook

State pension + debt = big numbers – CNN

Banks:

Secret to Bank’s Comeback: A Rich Uncle Named Sam – Wall Street Journal

Countrywide Accused in Lawsuit of ‘Massive Fraud’ – Bloomberg

Posted in Economics, Markets, Media, Politics.


The Government Has Your DNA

As Big Brother as it sounds, the government probably has your DNA.  If they do not have your DNA directly, then they probably have it from your children.   Newborn babies in the United States are routinely screened for a panel of genetic diseases.  Since the testing is mandated by the government, it’s often done without the parents’ consent and stored indefinitely.  The DNA can be used in the future for criminal forensics, or if private companies get their hands on it, then insurance costs might skyrocket for those whose DNA shows they are predisposed to certain diseases.

Even more insidious than the government mandated storage of your child’s DNA is just how they might and can use it.  In the criminal pursuit of Dennis Rader, they caught him by using his daughter’s DNA without her consent:

“Investigators obtained a court order without the daughter’s knowledge for a Pap smear specimen she had given five years earlier at a university medical clinic in Kansas. A DNA profile of the specimen almost perfectly matched the DNA evidence taken from several BTK crime scenes, leading detectives to conclude she was the child of the killer. That allowed police to secure an arrest warrant in February 2005 and end BTK’s murderous career.”

The usual counter argument from citizens in support of such government invasion of privacy goes like this: “I have nothing to worry about because I would never be in trouble with the police, and by using these extra tools they are keeping me safer…”

There is a reason that our law has stated that citizens are innocent until proven guilty without a questionable doubt.  “Science” makes it seem like DNA testing is an infallible argument of guilt, but in reality things are usually more complicated.

For those making the above argument, I highly suggest you read the research paper by William Thompson from the University of California, Irvine’s Department of Criminology, Law & Society titled [Download not found].  If you do not want to read the whole thing, at least scan through the selections below.

The infallibility of DNA tests has, for most purposes, become an accepted fact-one of the shared assumptions underlying the policy debate.

In this article, I will argue that this shared assumption is wrong. Although generally quite reliable (particularly in comparison with other forms of evidence often used in criminal trials), DNA tests are not now and have never been infallible. Errors in DNA testing occur regularly. DNA evidence has caused false incriminations and false convictions, and will continue to do so. Although DNA tests incriminate the correct person in the great majority of cases, the risk of false incrimination is high enough to deserve serious consideration in debates about expansion of DNA databases. The risk of false incrimination is borne primarily by individuals whose profiles are included in government databases (and perhaps by their relatives)….

In cases I have reviewed over the past few years, evidentiary samples from crime scenes often produce incomplete or partial DNA profiles. Limited quantities of DNA, degradation of the sample, or the presence of inhibitors (contaminants) can make it impossible to determine the genotype at every locus. In some instances the test yields no information about the genotype at a particular locus; in some instances one of the two alleles at a locus will “drop out” (become undetectable). Because partial profiles contain fewer genetic markers (alleles) than complete profiles, they are more likely to match someone by chance (see endnote 1). The probability of a coincidental match is higher for a partial profile than for a full profile.

A further complication is that evidentiary samples are often mixtures. Because it can be difficult to tell which alleles are associated with which contributor in a mixed sample, there often are many different profiles (not just one) that could be consistent with a mixed sample. Because so many different profiles may be consistent with a mixture, the probability that a non-contributor might, by coincidence, be “included” as a possible contributor to the mixture is far higher in a mixture case than a case with a single-source evidentiary sample.

The risk of obtaining a match by coincidence is far higher when authorities search through thousands or millions of profiles looking for a match than when they compare the evidentiary profile to the profile of a single individual who has been identified as a suspect for other reasons. As an illustration, suppose that a partial DNA profile from a crime scene occurs with a frequency of 1 in 10 million in the general population. If this profile is compared to a single innocent suspect, the probability of a coincidental match is only 1 in 10 million. Consequently, if one finds such a match in a single-suspect case it seems safe to assume the match was no coincidence. By contrast, when searching through a database as large as the FBI’s National DNA Index System, which reportedly contains nearly 6 million profiles, there are literally millions of opportunities to find a match by coincidence. Even if everyone in the database is innocent, there is a substantial probability that one (or more) will have the 1-in-10 million profile. Hence, a match obtained in a database search might very well be coincidental. Consider that among the 6 billion or so people on planet earth we would expect about 600 to have the one-in-10-million DNA profile; among the 300 million or so in the United States we would expect to find about 30 people with the profile. How certain can we be that the one matching profile identified in a database search is really that of the person who committed the crime?

A number of states have recently begun conducting what is known as familial searches.11 In cases where a database search finds no exact match to an evidentiary profile but finds a near match – that is, a profile that shares a large number of alleles but is not identical – authorities seek DNA samples from relatives of the person who nearly matches in the hope that one of the relatives will be an exact match to the evidentiary sample. In several high-profile cases familial searches have identified suspects who were successfully prosecuted.12 The key questions raised by familial searches, from a civil liberties perspective, are how often they lead to testing of innocent people-i.e., people who do not have the matching profile-and how often they might falsely incriminate innocent people through coincidental matches. Familial searching may increase the number of people falsely incriminated by coincidental matches because it increases the effective size of the population subject to genetic monitoring. The larger the effective size of the database, the greater will be the likelihood that one of those innocent people will be identified.

People have been prosecuted based on cold hits to partial profiles. Defendants in cold-hit cases often face a difficult dilemma. In order to explain to the jury that the incriminating DNA match arose from a database search (in which the government had thousands or millions of opportunities to find a matching profile), the defendant must admit that his profile was in the database, which in many states entails admitting to being a felon, a fact that might otherwise be inadmissible. Courts in some cold-hit cases have, at the urging of defense counsel, opted to leave the jury in the dark about the database search in order to avoid the implication of a criminal record. Jurors are told about the DNA match, but are not told how the match was discovered. The danger of this strategy is that jurors may underestimate the probability of a false incrimination because they assume the authorities must have had good reason to test the defendant’s DNA in the first place. In other words, jurors may mistakenly assume the DNA test compared the crime scene sample to the DNA of a single individual who was already the focus of suspicion (a circumstance under which the risk of a coincidental false incrimination is extremely low) and not realize that the defendant was identified through a cold hit (a circumstance under which the risk of a coincidental false incrimination is much higher).

Do innocent people really have nothing to fear from inclusion in government DNA databases? It should now be clear to readers that this claim is overstated.  If your profile is in a DNA database you face higher risk than other citizens of being falsely linked to a crime. You are at higher risk of false incriminations by coincidental DNA matches, by laboratory error, and by intentional planting of DNA. There can be no doubt that database inclusion increases these risks, the only real question is how much. In order to assess these risks, and weigh them against the benefits of database expansion, we need more information.

Some of the most important information for risk assessment is hidden from public view under a shroud of governmental secrecy. For example, the government’s refusal to allow independent experts to examine the (de-identified) DNA profiles in offender databases is a substantial factor in continuing uncertainty about the accuracy of frequency estimates (and hence the probability of coincidental matches). I believe there is no persuasive justification for the government’s insistence on maintaining the secrecy of database profiles, so long as the identity of the contributors is not disclosed. The government’s refusal to open those profiles to independent scientific study is a significant civil liberties issue.

Posted in Conspiracy, Media, Politics.

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Target Date Funds Not a Secret Formula

Institutional Investor just ran a new article suggesting that Target Date Funds Get a Makeover.  If you are not aware, a target date fund targets a specific date in the future, such as retirement.  The idea is to set the investor on a “glide path” in which they start with more equities and then slowly transition to more fixed income as the investor gets closer to retirement.  The problem with the “glide path” is that all funds are not equal and some carry hefty amounts of equities through retirement years which, in 2008, was more akin to putting the investor on a 747’s glide path with one sputtering engine.  Institutional Investor states that the managers, “may not be admitting it, but they are paying much more attention to volatility, inflation, diversification, and ensuring income after retirement“.

The issues that I have with target date funds are numerous:

  1. The fees are just as high as active management (.68% versus .71%) even though most strategies are simple re-balance strategies with asset allocations shifting over time.
  2. The underlying assumption is that all investors of a certain age have the same risk appetites.  The truth is that one 40 year old can have a drastically different risk appetite than another 40 year old.
  3. Target date funds can vary dramatically from each other even though they target the same date. e.g. Fidelity target date funds have 50% exposure to equities at retirement
  4. There is a belief that target date funds offer a one stop solution for retirement which guarantees enough retirement income when the target date arrives.

In truth, most investors would benefit the greatest from access to a diversified group of low-cost ETF’s, simple programs that show them the best ways to diversify their portfolios and minimize downside risk (mean variance optimization calculators), along with the ability for the account to automatically re-balance monthly, quarterly, or annually.  If the investor does not feel comfortable with the choices that come with educated autonomy, then the investor should find a trustworthy fee only investment advisor who offers ETF investment options and portfolios that are tailored to the investor’s risk appetite.

The sad reality is that the investment companies do not care whether a target date fund maximizes the risk adjusted returns that fit within the investors’ risk appetites, they only care to get the highest assets under management at the highest possible fees.  Why provide ETF’s at 20 bps fees when you can offer a mixture of ETF’s in a “Target Date Fund” package for 70 bps?  I guess the rationale for the higher fee is to build up a reserve to defend against the law suits from those who felt like their retirement was guaranteed.

Posted in Conspiracy, Educational, Markets.

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Markets Defy Gravity

Since the beginning of December, the S&P 500 has yet to meaningfully break down below its 10 day moving average.  We just like to blissfully crank upwards in valuations.  The Dow has hit its momentous 12,000 level and the S&P was inches away from 1,300.  Now that we have touched our psychological targets, maybe it is time we reassess how enthusiastic we have gotten.  Instead of looking at P/E ratios on 2011 earnings forecasts, I have seen more and more analysts consider 2012 and 2013 forecasts…

I guess our 10 day moving average is a fixed positive slope

When it comes to the lesser of investment evils, it certainly still looks like equities are more attractive than bonds.  The issue that I have is that most investors have set aside the significant tail risks that are out there.  Not to belabor the point, but there is still significant risk in the Eurozone.  Equity markets have ignored it, as well as concerns with local municipalities and states.  These risks are real and will take quite a long time to resolve.  While the VIX sits around 16 and realized volatility hovers near six year lows, we need to understand that risk flares come quickly and unexpectedly and there are plenty of issues that could precipitate are run.

The default spreads on the PIGS do not appear resolved to me so why is the Euro rallying?

I do not like to be negative, but it does get tiring when the arguments switch so fiercely from bearish to bullish stances.  It seems to be the psychology of not wanting to be miss out when the market is rallying or not wanting to be the last one in when the market is tanking.  Feast or Famine, no in-between.

Posted in Economics, Markets.

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Gold Diverges From Equity Markets

Since the beginning of the year we have witnessed a divergence between gold and equities.  The question is whether we are entering into a shift between inflationary fears caused by wild printing presses over to the start of fiscal tightening brought on by solid economic growth.

Gold/SPX correlation no longer 1?

In the past few years, the big joke has been that even though equities have rallied significantly, the dow is still down over 57% since 2007 when priced in terms of Gold.

Has the equity market really gained any real value?

The real bet seems to be whether gold has finished its run and my short-term view is that it has not. The market might be underestimating Bernanke’s desire and tenacity with regards to restarting the economy and lowering the unemployment level.  I believe that the Federal Reserve’s continued mandate is that it wants to make absolutely sure that a deflationary Japanese outcome has no probability of occurring.  In addition to the mandate, they probably take solace in a false perception that if inflation spikes they will be able to tame it as Volcker did in the early 80’s.  Inflation and tightening will come, but it is hard to foresee that with over 9.5% of the population unemployed.

What this view implies is that writing out of the money put options on gold might not be such a bad strategy.

Posted in Economics, Markets, Politics, Trading Ideas.

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