Sunday, April 15, 2012

Machine-Translated Investment Research and the Spanish Debt Crisis

I am not going to make the case that Spain is or isn’t on the brink. My opinion on investment in Spanish public debt is worth exactly a hill of beans in this crazy world, as well it should be. But as a language specialist, I would like to point out a few ways in which this crisis is based on very bad translations that, in practice, could lead to very flawed investment theses.

Spain might or might not default on its debt, I don’t know. I just know that when markets were saying that Spanish debt was almost as good as German debt they were mispricing it. Now, when they say it is worse than Zimbabwean debt, they might be mispricing it again. Focusing a lot on emotional images of pandemonium of Greeks or Spaniards throwing paving stones around is gripping, emotional, and targeted toward the more primitive parts of our brains that are easily moved by that sort of thing. 

Let me provide an example. The general strike in Spain a couple of weeks ago was widely followed. The unions are obviously strong and command a lot of following from even people who are not unionized. But the country is far from close to chaos. The violent incidents in Barcelona were pretty isolated. The strike in Madrid was a very tranquil day, with the streets mostly occupied by German tourists in town to support Hannover against Atlético.

Madrid looks pretty normal and boring, as the weather warms up and springtime is in the air. It is full of tourists doing touristy things and, in the evening, reveling drunks doing drunky things. On Wednesday I was coming back from lunch and I bumped into the vice president of the Spanish government, Soraya Sáenz, chatting with some colleagues outside a restaurant. There was not a bodyguard in sight. 

This is hardly the picture of a country on the verge of the largest sovereign debt defaults in history and massive street battles. Of course, my personal observations are purely anecdotal and worthless as investment intelligence. The bottom line is that the bonfires in Plaza de Catalunya are equally devoid of value for a real investor in a rational market.

Except we know people aren’t rational and markets aren’t always efficient. And right now there are a lot of people fueling the fires of instability to profit on credit default swap bets. And even some of the less emotional gasoline being poured on the fire--which masquerades as cold, analytical number-crunching--is based on appallingly poor translations. Take the example of a PowerPoint presentation that has circulated heavily through the Internet over the past week. It was drawn up by an investment company called Carmel Asset Management. 

The .ppt document was loudly endorsed by ZeroHedgea very popular “investment” blog that has a distinctly nihilistic attitude very typical of the trader mentality: the world is insane; politicians always lie; markets are rigged by Goldman Sachs; there is a huge conspiracy against the little investor; Armageddon is just around the corner; the same guys who killed Kennedy control Apple stock; you have to have a bomb shelter in your backyard; and you basically have to be a paranoid sociopath to make an honest buck in the markets. The main author’s handle is “Tyler Durden,” the co-protagonist of Chuck Palahniuk’s Fight Club. Look at his Twitter account. It features a picture of Brad Pitt with a bare midriff playing Durden. The odds are, of course, that the author is a pale, overweight bald dude called Louie who trades stocks from his living room in “Joysie”. The thing is that, in addition to very analytical blurbs on the problems facing the Spanish economy, ZeroHedge also loves to show images of rioting (viz. “The Spanish RiotCam Has Arrived”). And also of making the parallels between any sort of mayhem in the streets of Madrid or Barcelona with the scenes at Syntagma Square in Athens.

The .ppt makes the bear case for Spain, the absolute worst-case scenario in which the country simply defaults on its debt. It points out factors that are undeniable: high unemployment (23%); unfinished housing crash (perhaps only half over); spendthrift regional governments; and shaky cajas overexposed to the housing bubble. 

One of the key claims in the presentation is that Spanish debt is actually much higher than many realize. The consensus is that Spanish debt is equivalent to 60% of GDP, which is manageable (sixty percent is actually lower than the debt-to-GDP ratio of “serious” countries like Germany [83%], the U.S. [100%], France [87%], the United Kingdom [81%], and Japan [233%]).

“Aha,” reply the ZeroHedgers and Carmels, “but that 60% is deceptive, because it does not include the debt owed by the comunidades autónomas, the regional governments.” The PPT tells us that: “Spain’s national debt is 50% greater than the headline numbers. Spain’s debt-to-GDP balloons from 60% to 90% of GDP with regional and other debts (Slide 2).” When you factor that in, the figure, they claim, is 90%, which is a lot scarier.

Well, it turns out that this is not actually true. The lower consensus 60% figure is accurate, because it includes both the money owed by the central government and all the goodies on which regional authorities splurged throughout the boom of the past decade. Listen to Luis Garicano, a leading Spanish economist, responding in comments on his blog from a reader who is freaking out after visiting ZeroHedge:
Zero HEdge se hace un pequeno lio. La deuda de las CCAA esta incluida YA en el total de la deuda publica. Otra cosa es la deuda bancaria con aval del estado y la “otra deuda avalada”
Which I translate as follows:
ZeroHedge is tying himself into knots. The debt owed by the autonomous regions is ALREADY included in the public debt total. Banking debt guaranteed by the government and “other guaranteed debt” is another issue.
So, who you gonna call? The economics professor who does this for a living (and, incidentally, is not a Spain bull), or the anonymous blogger who masquerades as the Nietzschean, psychopathic alter-ego of an alienated insomniac suffering from multiple personality disorder? I have my answer, but then again I’m an elitist, as some sock puppets mutter under their breath when they read this blog.

And then you start to probe the detail of the .ppt document, and the picture shifts a little more. A Wall Street Journal blog carried a very useful portrait of Carmel, the company making the bearish Spain call. First of all, Carmel manages $50 million. That makes it a very, very tiny player. Second of all, Jonathan Carmel, the head of the asset manager, reveals that he writes his own investment research and that his Spanish is very poor:
While Mr. Carmel has yet to visit Spain for his research, he says he has spent much of the past year combing through as many numbers as he can dig up, speaking with as many people as he can find and reading as much as he can with what he calls “my pretty bad Spanish.” “I’ve been using a lot of Google Translate,” he confesses.
 So, basically, we have a manager from a tiny boutique firm who has never visited Spain and who supplements mediocre language skills with Google Translate. And this is the research that moves the gigantic bond market that decides the rates that govern the lives of millions of people. I am not saying that any of this is evil. After all, Carmel’s PowerPoint very transparently reveals his firm’s interest in the matter:
We began buying Spain CDS in Q4 2011 because the country has significant structural problems within its economy, a debt load that is higher than the headline number, and a banking system with unrealized losses (Slide no. 10)
This means he is betting on a Spanish default (probably using massive leverage). Spain doesn’t have to actually go broke for him to make money. The CDSs only have to go up and his bet will pay off (if he cashes out in time):
Should the Spanish crisis flare up in 2012 as we expect, we can generate a 300% return on the annual premium (Slide no. 10)
Simply put, some of the financial mayhem is being fed by second-rate research based on machine translation. Markets are increasingly fueled by this ever-greater mass of information that is easily available. According to the data worshippers, this will only end up being to our benefit. And language automation will only make the world an even better place by providing approximate translations of this data. But that is a stupid illusion. Seeing grown men spout that silliness is the equivalent of watching those creepy middle-aged men at comic book conventions who still play with Star Wars figures. Because in investment, "close-enough" translation is actually "wrong" translation.

In financial markets, it is increasingly evident that greater information is not providing more rational markets that are better fed with accurate information. On the contrary, what we have is more noise. Noise like the one currently being generated by ZeroHedge and Carmel for their own selfish ends using low quality translations (anonymous blogs don’t have to disclose their positions in the markets, by the way). The Google translations used by Carmel are not capable of providing the fine points of financial data that can be better conveyed by a human translation.

As such, the reams of Spanish-language data translated into mediocre English and consumed by Carmel’s analysts are the equivalent of the stock-trading algorithms that are producing more and more frequent flash crashes.

Miguel Llorens is a freelance financial translator based in Madrid who works from Spanish into English. He is specialized in equity research, economics, accounting, and investment strategy. He has worked as a translator for Goldman Sachs, the US Government's Open Source Center, and H.B.O. International, as well as many small-and-medium-sized brokerages and asset management companies operating in SpainTo contact him, visit his website and write to the address listed there. Feel free to join his LinkedIn network or to follow him on Twitter.


Michael said...

You're only confirming the impression that the markets gave me last year. There are indeed people using serious research, and then there is a vast army of people in spare bedrooms running forex software and trying desperately to scrape a fraction of a percent. They lap up rumours.

Remember, the euro would not survive the New Year. And I can't remember the numbers of times Greece was going to crash and burn and bring the euro with it. Did anyone else get calls from investment companies telling you that they had inside information that Germany was printing Deutschmarks? Nutty.

It's one of these cases where the worst kind of information is a little information. These days, this can be magnified and extrapolated in the blink of an eye.

Having said all that, the economies of Greece, Ireland and Spain are in deep. But it turns out a lot of the doom and gloom was pretty shallow analysis and wishful thinking.

Miguel Llorens M. said...

You are right that markets moving to the beat of bad info is nothing new, nor can most of the volatility experienced now due to the technology. My thesis is simply that more information and more automatic translations are not bringing about a better world. Instead, they are adding to the instability.