Waiting, waiting for a storm


Annabelle in Audubon Park (New Orleans) pre-Katrina

Absolutely great piece on Katrina’s impact on catastrophic loss insurance, and its underlying market structures.

The author, Michael Lewis, has written a number of great articles and books. Specifically, his book on the economic/statistical theories behind Baseball, Moneyball, did a ton to popularize the sort of layman’s economics that “tipped” with the publication of the inferior (but still entertaining) Freakonomics. Whether you care little or barely at all about either baseball or economics, you should read Moneyball.

Lewis is apparently turning his attention to New Orleans, and has returned to the city where he was born to report on its … uh …. recovery (is that the right word? No).

The fruits of this effort so far that I’m aware of is the above-linked article, which does a fine job of not just explaining insurance markets, but markets in general.

I get asked a lot by my students about the markets, and I always tell them to stay out of them…paper trade, etc. I think, this year, I’ll tell them something else: everything they’ve heard about the markets is wrong. Beginning with the fact that they should do the exact opposite of the hoariest of all Wall St. adages: “buy low, sell high.” While I’m not one to prognosticate, the markets, I believe, are in a more interesting time than usual (no, I’ll not elaborate on this). Because of these interesting times, it’s all the more important to disabuse yourself of such fallacies as “buy low, sell high.” Essentially, you should understand that markets trend, and that – whether trending up or down – you want to ride that trend. You will not be able to pick the exact bottom or top of the trend; thus: buy when a trend is firmly established, and only sell when the trend is broken. In other words, buy high and sell (go short) low. This is very different from the type of value investing that is taught. Value investing is “educated” prognostication, and tends to cause people to get very attached to securities and hold on to them much longer than they should (i.e. after huge losses) in the hopes that they will bounce back, and thus validate their value theorem that led to the purchase in the first place. Trend investing (or, more commonly, “trend following;” closely related to technical analysis) doesn’t care about values-based fundamentals, but rather believes that the only accurate assessment of information is reflected in the price of the stock at the given moment which you look at the stock. Put simply: look at markets that are trending (making higher highs or lower lows), and trust that the trend will continue – until it doesn’t. For example, back when oil was making new highs of 60, 70, 80…100, 110, 130, or when the dollar was falling to new lows against the Euro, there was/is constant chatter that it can’t go higher/lower. Guess what? It can and does.[*]

Any guesses on how this relates to hurricanes?

So, as hurricane season is now upon us I cast my gaze, thoughts, and love to my beautiful city (the city where my daughter learned to walk and talk, the city where my son was born, the city where some of my dearest friends are, the city to which I and my family return every year at the height of hurricane season, the city like no other) and hope against hope for November to arrive with the city as I left it in June: scarred, reeling, but still very much alive.

Some quotes for the article:

Louisiana’s politicians are usually quicker than most to seize upon shrewd politics that generate terrible social policy, but in this case they could not afford to. Louisiana cannot generate and preserve wealth without insurance, and it cannot obtain insurance except at the market price. But that price remains a mystery. Billions of dollars in insurance settlements — received by local businesses and homeowners as payouts on their pre-Katrina policies — bloat New Orleans banks and brokerage houses. The money isn’t moving because the people are paralyzed. It’s as if they have been forced to shoot craps without knowing the odds. Businesses are finding it harder than ever to buy insurance, and homeowners are getting letters from Allstate, State Farm and the others telling them that their long relationship must now come to an end. “I’ve been in the business 45 years,” says a New Orleans insurance broker named Happy Crusel, “and I’ve never seen anything remotely like this.” An entire city is now being reshaped by an invisible force: the price of catastrophic risk. But it’s the wrong price.

New Orleans, as a result, is slower than it otherwise would be to rebuild. “The insurance companies are basically running away from society,” he says. “What they need to do is take the risk and kick it up to us.” They need to spread it as widely as possible across the investment world and, in the process, minimize the cost of insuring potential losses from catastrophes.

And one quote that’s not really related to anything, but one I plan to use often: The devil has come to you as a prostitute and has asked you to lie down with her.

_________

[*]This is not a recommendation to trade. You can and will lose money.

If you are interested, I’d recommend the following:

Trend Following

Ed Seykota’s web site

Once you’ve read the book (it’s about 400 pages), and spent a ton of time digesting Mr. Seykota’s site (it’ll take a year), you should paper trade for another year or so, then – and only then – you should trade only with money you can afford to lose.

Again, not a recommendation to trade. DO NOT TRADE!

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