RocketCap Stock Indexes,
3 Months Ending 3-31-13

RocketCap Stock Indexes,
12 Months Ending 3-31-13

It looks like the returns for the cyberwar index, RCWSI, jumped dramatically over the past three months. This may well correlate with the announcements by the USA government that China has been directly attacking USA with various cyber-actions, and that USA plans to directly attack back…ie, to defend itself via offensive cyberattacks of its own.

The correlation matrices are:

The Cyber and IP indexes became less correlated for the 3 months ending 3-28-13 compared to the three months ending 2-28-13.

Here is the graph of gross returns for the 12-month period ending on 2-28-13:

This return graph shows superior returns from the S&P 500 compared to our two indexes. However, for the previous three trailing months, RIPSI returns beat S&P 500, while RCWSI returns are lower.

Here are the correlations of daily returns over the same time horizon:

The correlations of both RIPSI and RCWSI with S&P 500 substantially increased over the last  3 months compared to the previous 12 months. Usually when groups of stocks become highly correlated, they all are reacting to the same information in the same way. We note again that in the last 3 months, Chinese cyber war activity was well publicized and this awareness may have spooked the markets similarly.

The companies are listed here:

There are many other important firms providing web security, such as Lockheed Martin and Northrop, but they derive most of their sales from non-web security products. Some important pure play firms are not publicly traded, such as Bitdefender and Kaspersky Labs. For each of these firms, their security products and services account for essentially all of their sales. They are thus “pure play” web security firms.

As usual, we illustrate our indexes with a combination of plots of gross returns, and correlations.

Recall that gross return (GR) between two dates Date1 and Date2  is simply defined as:

GR= (Price_Date2  - Price_Date1)/Price_Date1

Thus, we can compare stock prices starting from the same relative value of 1, and see how they all return value over time. We choose Date2 as 1-31-13, and Date1 either 3 months or 12 months earlier. These plots are shown here:

Over the last 12-months, RIPSI and RCWSI bracketed the S&P 500 returns, but over the last 3 months, the S&P 500 return fell below both indexes.

The correlation matrixes over these time periods are here:

RIPSI is moderately correlated with RCWSI over both time intervals, which is not too surprising since the anti-cyber war firms all support companies that leverage IP. The S&P 500 correlates more with RIPSI than with RCWSI over both periods.

We also have created another index. This one tracks stocks that all offer pure plays among firms that provide products (software) and services for clients to protect against and recover from cyber attacks on them via malefactors on the internet. See our next post.

“China has been the tremendous beneficiary of globalization and now is at the end of the road as far as the growth model they have employed, which is based on exports and investment,” he said in our interview, in comments that are more bearish about the world’s second-largest economy than Wall Street conventional wisdom.

“The share of consumption is just one-third of GDP, and that is now reaching the limits of what is sustainable,” he said. “So they have to change that. But it will be rocky. It involves a hard landing. To increase consumption, you need to increase household incomes. But the economic slowdown is creating unemployment and people are scared, so their propensity to save increases. So all three segments are falling: exports, investment, and consumption.”

In Freeland’s article, he continues:

“The great gimmick that was helpful in maintaining economic growth was having an undervalued currency, which was the equivalent of a tax imposed on Chinese labor,” he said. “But people did not feel taxed. Since the economy was growing so rapidly, even though the share which accrued to labor was less than appropriate, during this period of rapid growth everyone was satisfied.”

At the time, the winners were the Communist Party’s elite, whose members personally benefited and saw the economy take off. This political dynamic, however, is breaking down along with the slowdown, he says, as “the willingness of people to accept a regime which is a dictatorship is greatly diminished.”

The result, Soros predicts, will be conflict and crisis in China.

As for his ideas expressed in the same interview about the fact that humans have a finite capacity to understand the world, it appears he has not embraced the ideas associated with the Black Swan, nor those of Prof. Herb Simon.

What we don’t know we don’t know yields Black Swans, events that are exceptionally rare, have huge impact, and are not imaginable in advance. N. Taleb, the strongest advocate of the Black Swan concept of knowledge, has made some recent distinctions that begin to help us defend against that which we cannot, by definition, specifically anticipate. See this article in Wall St. Journal for a good exposition on the concepts of fragile, stable/robust, and antifragile systems.

The fact that human cognition is finite (“bounded rationality”) was first analyzed by economist Herb Simon. He pointed out that humans “satisfice“…they accept good enough solutions, and cannot get optimum ones. Simon got a Nobel Prize in economics for his ideas.

George is always interesting in any case.

You can learn much more about our stock market indexes for IP from the site menu above, or you can start here:

http://www.rocketcap.com/rocketcap-ip-indexes-year-end-2011/

RIPSID vs SP500 vs SOXX ending 2012-11-9

Notice that the RIPSID recently sharply exceeds the S&P 500 which has been gradually diving.

Here’s the video of technology’s impact on future crimes, and what’s happening now by technologically advanced criminals and terrorists:

http://www.youtube.com/watch?v=-E97Kgi0sR4

Now Vint Cerf  has called out the U.N. in a major warning to those who love Internet freedom. The situation is described in the 18 JUNE 2012 Wall St. Journal. Author L. Gordon Crovitz says in his piece:

 The failure by U.S. negotiators to stop attacks on the Internet became known only through documents leaked last week. They concern a U.N. agency known as the International Telecommunications Union. Founded in 1865 to regulate the telegraph, the body (now part of the U.N.) is planning a World Conference on International Telecommunications in December, when the 193 U.N. member countries, each of which has a single vote, could use the International Telecommunications Regulations to take control of the Internet. The U.N. process is mind-numbing, but as Vincent Cerf, one of the founders of the Web, recently told Congress, this U.N. involvement means “the open Internet has never been at a higher risk than it is now.”

Oddly enough, the danger is now being better understood by the average voter as a result of a web site created to solicit “leaks” from the secret U.N. deliberations. A trove of documents described how authoritarian regimes, such as China, Russia and Iran, are secretly crafting a document that would give strong controls over Internet content and access to a U.N. body.

According to many writers, including Crovitz, the USA is doing very little to resist this power grab. Crovitz concludes his article with this:

It may be hard for the billions of Web users or the optimists of Silicon Valley to believe that an obscure agency of the U.N. can threaten their Internet, but authoritarian regimes are busy lobbying a majority of the U.N. members to vote their way. The leaked documents disclose a U.S. side that has hardly begun to fight back. That’s no way to win this war.

What is the Obama administration doing to stop this dangerous takeover attempt?

After each mailing, the scammer sends another similar set of predictions, but only to those targets which received what turned out to be the correct prediction. After several rounds, there are a few targets who have received a string of correct predictions. Now, here’s the money shot: the scammer sends one more note, but this time says “We are sure you have enjoyed receiving our great advice so far. But now you have to buy our service get our next prediction.”

This process very cleverly identifies a pool of targets from which some will finally pay.

We assume this process has many illegal components. But mutual fund and hedge fund companies are notorious for using this exact technique in reverse to calculate their overall returns. They exclude funds from the calculation that were previously closed due to losses!

The common characteristic of the scam is that it purposefully misleads people. It now turns out that people will actually buy bad advice even when they know the advice cannot be valid–if it comes from an “expert”! Using a technique similar to the scam above, two academics Nattavudh Powdthavee and Yohanes Riyanto, of the Institute for the Study of Labour, published a paper in May 2012 showed by experiments that people would pay for advice they witnessed in real-time was wrong. We provide their original published paper here.

The authors write in their introduction:

Our paper focuses on a situation in which there is true randomness and predictions are transparently useless. In this setting of non-existent expertise, can an average individual be convinced to switch from having the correct belief that “outcomes are independent and predictions are inherently useless” to the false belief that “predictions provide useful information about the future” – thus leading them to buy subsequent predictions in the future– if they had recently observed a streak of perfect predictions being made in front of them live? We found that the answer is yes and that the size of the error made systematically by people is large.

Here’s the set up. The researchers used undergrads in Thailand and Singapore. They told the students they had to make bets (using tokens) on five rounds of coin flips, and that the coins came from other students. Also, to provide strong assurance to the subjects that the flips and coins were really random, the coins were changed after each flip, the flippers themselves were changed after each round, and the flippers would be participants as well.

At the separate cubical of each participant, there were five envelopes each containing a prediction of the outcome of a future flip. The student had a choice of paying to see an envelope in advance, or waiting for the outcome of the flip and then seeing the prediction for free. The students that paid for the prediction were allowed to see both the outcome and the prediction after the flip.

The key characteristic of all the predictions was that they were randomly generated. Thus, even for a sequence of correct predictions, they were known to be pure luck. The authors write:

Did people who randomly received correct predictions perceive in a hot hand of the nonexistent expert and in turn pay for such useless information later? If so, how long was it before they started buying? The answers are: yes, and not long.

They go on to conclude:

The first is that observations of a short streak of successful predictions of a truly random event are sufficient to generate a significant belief in the hot hand of an agent; the perception which also did not revert even in the final round of coin flip. By contrast, the equally unlikely streak of incorrect predictions also generated a relatively weak belief in the existence of an “unlucky” agent whose luck was perceived to be likely to revert before the game finishes; evidence which was reflected in an increase in the subject’s propensity to buy in the final round of coin flip.

It is well-documented that well over 90% of active fund managers produce returns no better than their target indexes, but people buy services from them anyway. Now we have data indicating people will pay for advice even when they know specifically it will be no better than chance.