Posts filed under ‘Trading’
Bin Laden Killing Overshadows Royal Rally
Excerpt from No-Cost May Sidoxia Monthly Newsletter (Subscribe on right-side of page)
Before the announcement of the killing of the most wanted terrorist in the world, Osama bin Laden, the royal wedding of Prince William Arthur Philip Louis and Catherine Middleton (Duke and Duchess of Cambridge) grabbed the hearts, headlines, and minds of people around the world. As we exited the month, a less conspicuous royal rally in the U.S. stock market has continued into May, with the S&P 500 index climbing +2.8% last month as the economic recovery gained firmer footing from the recession of 2008 and early 2009. As always, there is no shortage of issues to worry about as traders and speculators (investors not included) have an itchy sell-trigger finger, anxiously fretting over the possibility of losing gains accumulated over the last two years.
Here are some of the attention-grabbing issues that occurred last month:
Powerful Profits: According to Thomson Reuters, first quarter profit growth as measured by S&P 500 companies is estimated at a very handsome +18% thus far. At this point, approximately 84% of companies are exceeding or meeting expectations by a margin of 7%, which is above the long-term average of a 2% surprise factor.
Debt Anchor Front & Center: Budget battles remain over record deficits and debt levels anchoring our economy, but clashes over the extension of our debt ceiling will occur first in the coming weeks. Skepticism and concern were so high on this issue of our fiscal situation that the Standard & Poor’s rating agency reduced its outlook on the sovereign debt rating of U.S. Treasury securities to “negative,” meaning there is a one-in-three chance our country’s debt rating could be reduced in the next two years. Democrats and Republicans have put forth various plans on the negotiating table that would cut the national debt by $4 – $6 trillion over the next 10-12 years, but a chasm still remains between both sides with regard to how these cuts will be best achieved.
Inflation Heating Up: The global economic recovery, fueled by loose global central bank monetary policies, has resulted in fanning of the inflation flames. Crude oil prices have jumped to $113 per barrel and gasoline has spiked to over $4 per gallon. Commodity prices have jumped up across the board, as measured by the CRB (Commodity Research Bureau) BLS Index, which measures the price movements of a basket of 22 different commodities. The CRB Index has risen over +28% from a year ago. Although the topic of inflation is dominating the airwaves, this problem is not only a domestic phenomenon. Inflation in emerging markets, like China and Brazil, has also expanded into a dangerous range of 6-7%, and many of these governments are doing their best to slow-down or reverse loose monetary policies from a few years ago.
Expansion Continues but Slows: Economic expansion continued in the first quarter, but slowed to a snail’s pace. The initial GDP (Gross Domestic Product) reading for Q1 slowed down to +1.8% growth. Brakes on government stimulus and spending subtracted from growth, and high fuel costs are pinching consumer spending.
Ben Holds the Course: One person who is not overly eager to reverse loose monetary policies is Federal Reserve Chairman, Ben Bernanke. The Chairman vowed to keep interest rates low for an “extended period,” and he committed the Federal Reserve to complete his $600 billion QE2 (Quantitative Easing) bond buying program through the end of June. If that wasn’t enough news, Bernanke held a historic, first-ever news conference. He fielded a broad range of questions and felt the first quarter GDP slowdown and inflation uptick would be transitory.
Skyrocketing Silver Prices: Silver surged ahead +28% in April, the largest monthly gain since April 1987, and reached a 30-year high in price before closing at around $49 per ounce at the end of the month. Speculators and investors have been piling into silver as evidenced by activity in the SLV (iShares Silver Trust) exchange traded fund, which on occasion has seen its daily April volume exceed that of the SPY (iShares SPDR S&P 500) exchange traded fund.
Obama-Trump Birth Certificate Faceoff: Real estate magnate and TV personality Donald Trump broached the birther issue again, questioning whether President Barack Obama was indeed born in the United States. President Obama produced his full Hawaiian birth certificate in hopes of putting the question behind him. If somehow Trump can be selected as the Republican presidential candidate for 2012, he will certainly try to get President Obama “fired!”
Charlie Sheen…Losing! The Charlie Sheen soap opera continues. Ever since Sheen has gotten kicked off the show Two and a Half Men, speculation has percolated as to whether someone would replace Sheen to act next to co-star John Cryer. Names traveling through the gossip circles include everyone from Woody Harrelson to Jeremy Piven to Rob Lowe. Time will tell whether the audience will laugh or cry, but regardless, Sheen will be laughing to the bank if he wins his $100 million lawsuit against Warner Brothers (TWX).
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain commodity and S&P 500 exchange traded funds, but at the time of publishing SCM had no direct position in SLV, SPY, TWX, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Reasoning with Investment Confusion
Some things never change, and in the world of investing many of the same principles instituted a century ago are just as important today. So while we are dealing with wars, military conflicts, civil unrest, and natural disasters, today’s process of filtering and discounting all these events into stock prices is very similar to the process that George Selden describes in his 1912 book, “Psychology of the Stock Market.”
Snub the Public
Investing in stocks is nowhere close to a risk-free endeavor, and 2008-2009 was a harsh reminder of that fact. Since a large part of the stock market is based on emotions and public opinion, stock prices can swing wildly. Public opinion may explain why the market is peaking or troughing, but Selden highlights the importance of the silent millionaires (today’s billionaires and institutional investors), and that the true measurement of the stock market is dollars (not opinions of the masses):
“Public opinion in a speculative market is measured in dollars, not in population. One man controlling one million dollars has double the weight of five hundred men with one thousand dollars each. Dollars are the horsepower of the markets–the mere number of men does not signify.”
When the overwhelming consensus of participants is bullish, by definition, the small inexperienced investors and speculators are supplied stock from someone else – the silent, wealthy millionaires.
The newspaper headlines that we get bombarded with on a daily basis are a mirror reflection of the general public’s attitudes and when the euphoria or despondency reaches extreme levels, these points in time have been shown to correlate with market tops and bottoms (see Back to the Future Magazine Covers).
In the short-run, professional traders understand this dynamic and will often take a contrarian approach to news flow. Or as Seldon explains:
“A market which repeatedly refuses to respond to good news after a considerable advance is likelely to be ‘full of stocks.’ Likewise a market which will not go down on bad news is usually ‘bare of stock.’”
This contrarian dynamic in the market makes it virtually impossible for the average investor to trade the market based on the news flow of headlines and commentator. Before the advent of the internet, 98 years ago, Selden prophetically noted that the increasing difficulty of responding to sentiment and tracking market information:
“Public opinion is becoming more volatile and changeable by the year, owing to the quicker spread of information and the rapid multiplication of the reading public.”
Following what the so-called pundits are saying is fruitless, or as Gary Helms says, “If anybody really knew, they wouldn’t tell you.”
Selden’s Sage Advice
If trading was difficult in 1912, it must be more challenging today. Selden’s advice is fairly straightforward:
“Stick to common sense. Maintain a balanced, receptive mind and avoid abstruse deductions…After a prolonged advance, do not call inverted reasoning to your aid in order to prove that prices are going still higher; likewise after a big break do not let your bearish deductions become too complicated.”
The brain is a complex organ, but we humans are limited in the amount and difficulty of information we can assimilate.
“When it comes to so complicated a matter as the price of stocks, our haziness increases in proportion to the difficulty of the subject and our ignorance of it.”
The mental somersault that investors continually manage is due to the practice of “discounting.” Discounting is a process that adjusts today’s price based on future expected news. Handicapping sports “spreads” involves a very similar methodology as discounting stock prices (read What Happens in Vegas). But not all events can be discounted, for instance the recent earthquake and tsunami in Japan. When certain factors are over-discounted or under-discounted, these are the situations to profit from on a purchase or shorting basis.
The Dow Jones Industrial Average traded below a value of 100 versus more than 12,000 today, but over that period some things never change, like the emotional and mental aspects of investing. George Selden makes this point clear in his century old writings – it’s better to focus on the future rather than fall prey to the game of mental somersault we call the stock market.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Playing the Field with Your Investments
For some, casually dating can be fun and exciting. The same goes for trading and speculating – the freedom to make free- wheeling, non-committal purchases can be exhilarating. Unfortunately the costs (fiscally and emotionally) of short-term dating/investing often outweigh the benefits.
Fortunately, in the investment world, you can get to know an investment pretty well through fundamental research that is widely available (e.g., 10Ks, 10Qs, press releases, analyst days, quarterly conference calls, management interviews, trade rags, research reports). Unlike dating, researching stocks can be very cheap, and you do not need to worry about being rejected.
Dating is important early in adulthood because we make many mistakes choosing whom we date, but in the process we learn from our misjudgments and discover the important qualities we value in relationships. The same goes for stocks. Nothing beats experience, and in my long investment career, I can honestly say I’ve dated/traded a lot of pigs and gained valuable lessons that have improved my investing capabilities. Now, however, I don’t just casually date my investments – I factor in a rigorous, disciplined process that requires a serious commitment. I no longer enter positions lightly.
One of my investment heroes, Peter Lynch, appropriately stated, “In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.”
Charles Ellis shared these thoughts on relationships with mutual funds:
“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”
No relationship comes without wild swings, and stocks are no different. If you want to survive the volatile ups and downs of a relationship (or stock ownership), you better do your homework before blindly jumping into bed. The consequences can be punishing.
Buy and Hold is Dead…Unless Stocks Go Up
If you are serious about your investments, I believe you must be mentally willing to commit to a relationship with your stock, not for a day, not for a week, or not for a month, but rather for years. Now, I know this is blasphemy in the age when “buy-and-hold” investing is considered dead, but I refute that basic premise whole-heartedly…with a few caveats.
Sure, buy-and-hold is a stupid strategy when stocks do nothing for a decade – like they have done in the 2000s, but buying and holding was an absolutely brilliant strategy in the 1980s and 1990s. Moreover, even in the miserable 2000s, there have been many buy-and-hold investments that have made owners a fortune (see Questioning Buy & Hold ). So, the moral of the story for me is “buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or down in price. Wow, how deeply profound!
To measure my personal commitment to an investment prospect, a bachelorette investment I am courting must pass another test…a test from another one of my investment idols, Phil Fisher, called the three-year rule. This is what the late Mr. Fisher had to say about this topic:
“While I realized thoroughly that if I were to make the kinds of profits that are made possible by [my] process … it was vital that I have some sort of quantitative check… With this in mind, I established what I called my three-year rule.” Fisher adds, “I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but allow me a three year period.”
Certainly, there will be situations where an investment thesis is wrong, valuation explodes, or there are superior investment opportunities that will trigger a sale before the three-year minimum expires. Nonetheless, I follow Fisher’s rule in principle in hopes of setting the bar high enough to only let the best ideas into both my client and personal portfolios.
As I have written in the past, there are always reasons of why you should not invest for the long-term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) valuation; 6) change in industry regulation; 7) slowing economy; 8 ) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea.
Don Hays summed it up best: “Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.”
Peter Lynch shares similar sympathies when it comes to noise in the marketplace:
“Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.”
Every once in a while there is validity to some of the concerns, but more often than not, the scare campaigns are merely Chicken Little calling for the world to come to an end.
Patience is a Virtue
In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down irrespective of the daily headlines. Explaining this randomness, Peter Lynch said the following:
“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”
Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually date a stock position, perhaps you should commit to a long-term relationship and divorce your field-playing habits. Now that sounds like a sweet kiss of success.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
The Art of Weather Forecasting and Investing
Source: Photobucket
I’ve lived across the country and traveled around the world and have experienced everything from triple-digit desert heat to sub-zero wind chill. The financial markets experience the same variability over time.
Forecasting the weather is a lot like forecasting the stock market. In the short-run, volatility in patterns can be very difficult to predict, but if efforts are energized into analyzing long-term factors, trends can be identified.
For example, I live here in Southern California, and although weather is fairly homogenous, the variability can be significant on a day-to-day basis. I’m much more likely to be accurate in estimating the long-term climate than the forecast seven days from now. I’m not trying to rub salt in the wounds of those people freezing in Antarctica or the upper-Midwest, but forecasting a climate of 72 degrees, sunny, and blue skies is a good fall-back scenario if you are a television weatherman in Southern California.
Charles Ellis, author of the Winning the Loser’s Game – “WTLG” (see Investing Caffeine article #1 and article #2), highlights the weather analogy more convincingly:
“Weather is about the short run; climate is about the long run – and that makes all the difference. In choosing a climate in which to build a home, we would not be deflected by last week’s weather. Similarly, in choosing a long-term investment program, we don’t want to be deflected by temporary market conditions.”
Ellis adds:
“Like the weather, the average long-term experience in investing is never surprising, but the short-term experience is constantly surprising.”
In the financial markets the weather predicting principle applies to long-term economic forecasts as well. Predicting annual GDP growth can often be more accurate than the expected change in Dow Jones Industrial Index points tomorrow or the next day.
Economic Weathermen
As I outlined in Professional Guesses Probably Wrong, economists and strategists use several means of making their guesses.
- One method is to simply not make forecasts at all, but rather use some big words and current news to explain what currently is happening in the economy and financial markets.
- A second approach used by prognosticators is to constantly change forecasts. Consider a person making a weather forecast every minute…his/her forecast would be very accurate, but it would be changing constantly and not provide much more value than what an ordinary person could gather by looking out their own window.
- Thirdly, some use the “spaghetti approach” – throw enough scenarios out there against the wall and something is bound to stick – regardless of accuracy.
- Lastly, the “extend and pretend” method is often implemented. Forecasters make big bold economic predictions that garner lots of attention, but when the expectations don’t come true, the original forecast is either forgotten by investors or the original forecast just becomes extended further into the future.
Coin Flipping
If the weather analogy doesn’t work for you, how about a coin-flipping analogy? The short-term randomness surrounding the consecutive number of heads and tails may make no sense in the short-run, but will mean revert to an average over time. In other words, it is possible for someone to flip 10 consecutive “tails,” but in the long-run, the number of times a coin will land on “tails” will come close to averaging half of all coin tosses. The same dynamic is observed in the investment world. Often, short-term spikes or declines are short lived and return toward a mean average. IN WTLG, Ellis provides some more color on the topic:
“The manager whose favorable investment performance in the recent past appears to be ‘proving’ that he or she is a better manager is often – not always, but all too often – about to produce below-average results…A large part of the apparently superior performance was not due to superior skill that will continue to produce superior results but was instead due to that particular manager’s sector of the market temporarily enjoying above-average rates of return – or luck.”
Regardless of your interests in weather forecasting or coin-flipping, when it comes to investing you will be better served by following the long-term climate trends and probabilities. Otherwise, the performance outlook for your investment portfolio may be cloudy with a chance of thunderstorms.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Invisible Costs of Trading
Source: Photobucket
You can feel them, but you can’t see them. I’m talking about invisible trading costs. Although some single transaction trading costs can run as high as hundreds of dollars at the large brokerage firms, investors are generally aware of the bottom-basement commissions paid on trades executed at discount brokerage firms like Scottrade, TD Ameritrade (AMTD), E-Trade (ETFC), and Charles Schwab (SCHW) – generally less than $10 per trade. Unfortunately, these commissions are estimated to only account for 20% of total trading costs1. What most investors are unaware of are the host of invisible trading costs and expenses associated with active trading.
Here are some of the invisible costs:
Bid-Ask Spread: Besides the explicit commissions charged, traders must incur the implicit costs of the bid-ask spread. Let’s suppose you have a stock trading at $12.50 per share (ask price) and $12.25 per share (bid price). If you were to immediately buy one share for $12.50 (ask) and sell immediately for $12.25 (ask), then you would be -2% in the hole instantly – more than double the $7.95 commission paid on a $1,000 investment. Effectively, the investor would already be down about -3% the instant the small investment was made.
Impact Costs: The issue of impact costs is a bigger problem for larger institutional investors, although thinly traded stocks (those securities with relatively small trading volume) can even become expensive for retail investors. Suppose the same stock mentioned previously initially traded at $12.50 per share before you transacted, but reached $13.00 per share upon completion (with an average $12.75 price paid). The $.25 cent increase (average price minus initial price) translates into another -2% increase in the costs.
Taxes: It’s not what you make that matters, but rather what you keep that makes the difference. If you make a decent amount of money actively trading, but end up giving Uncle Sam more than potentially 40% of the gains, then your bank account may grow less than expected.
While my examples may shed some light on the costs of trading, an in-depth study using data from Morningstar and NYSE was conducted by three astute professors (Roger Edelen [University of California, Davis], Richard Evans [University of Virginia], and Gregory Kadlec [Virginia Polytechnic Institute]) showing that an average fund’s annual trading costs were estimated to be 1.44%, higher than an average fund’s overall expense ratio of 1.21%.
Unfortunately from an investor’s standpoint, as much as 30% of all trading costs can be attributed to money naturally pouring in and out of funds, due to fund share purchases and redemptions. Therefore, wildly popular or out-of-favor funds will have a detrimental impact on performance. I know firsthand the costs of managing a large fund, much like captaining a supertanker – you create a lot of waves and it can take a while to change directions. Smaller funds, however, can navigate trades more nimbly, much like a speedboat leaving behind smaller cost waves in its wake.
Style can also have an impact on trading costs. Value-based funds that sell into strength or buy into weakness can be considered liquidity providers, and therefore will experience lower trading costs. On the flip side, momentum strategies effectively pour gasoline on hot stocks purchases and pile on damaging sales to cratering losers.
Emotional Costs of Trading
More impactful, but more difficult to quantify, are the emotional trading costs of greed and fear (i.e., chasing extended winners out of greed and panicking out of losing positions due to fear). Constantly hounding winners and capitulating your losers may work in a few instances, but can lead to disastrous results in the long-run. Even if an investor is correct on the sale of a security, the investor must also be right on the subsequent buy transaction (no easy feat).
With that said, there are no hard and fast rules when buying/selling stocks. Buying a stock that has doubled or tripled in and of itself is not necessarily a bad idea, as long as you have credible assumptions and data to support adequate earnings/cash flow growth and/or multiple expansion. Consistent with that thought process, a plummeting stock is not reason enough to buy, and does not automatically mean the price will subsequently rebound. Reversion to the mean can be a powerful force in security selection, but you need a disciplined process to underpin those investment decisions.
Spiritual Savings
As I have stated in the past, investing is like a religion (read more Investing Religion). Most investors stubbornly believe their financial religion is the right way to make money. I personally believe there is more than one way to make money, just as I believe different religions can coexist to achieve their spiritual goals. Through academic research, and a lot of practical experience, my religion believes in the implementation of low-cost, tax efficient products and strategies used over longer-term time horizons. I use a blend of active and passive management that leverages my professional experience (see Sidoxia’s Fusion product), but I would fault nobody for pursuing a purely passive investment strategy. As John Bogle shows, and has proven with the financial success of his company Vanguard, passive investing by and large materially outperforms professional mutual fund managers (see Hammered Investors article).
Investing can be thrilling and exciting, but like a leaky faucet, the relatively small and apparently harmless list of trading costs have a way of collecting over the long-run before sinking long-term performance returns. Sure, there are some high-frequency traders that make a living by amassing a large sums of rebates for providing short-term liquidity, but for most investors, excessive exposure to invisible trading costs will lead to visible underperformance.
Read more about trading cost study here1
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds (including Vanguard funds), but at the time of publishing SCM had no direct position in AMTD, ETFC, SCHW, Scottrade, MORN, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Waiting for the Hundred Minute Flood
Investors have been scarred over the last decade and many retirees have seen massive setbacks to their retirement plans. We have witnessed the proverbial “100 year flood” twice in the 2000s in the shape of a bursting technology and credit bubble in 2000 and 2008, respectively. The instantaneous transmission of data around the globe, facilitated by 24/7 news cycles and non-stop internet access, has only accelerated investor panic attacks – the 100 year flood is now expected every 100 minutes.
If drowning in the 100 year flood of events surrounding Bear Stearns, Lehman Brothers, Washington Mutual, AIG, Fannie Mae, Freddie Mac, TARP bank bailouts, Bernie Madoff’s Ponzi scheme, and Eliot Spitzer’s prostitute appreciation activities were not enough in 2008, investors (and many bearish bloggers) have been left facing the challenge of reconciling an +80% move in the S&P 500 index and +100% move in the NASDAQ index with the following outcomes (through the bulk of 2009 and 2010):
- Flash crash, high frequency traders, and “dark pools”
- GM and Chrysler’s bankruptcies
- Dubai debt crisis
- Goldman Sachs – John Paulson hearings
- Tiger Woods cheating scandal
- Greece bailout
- BP oil spill
- Healthcare reform
- China real estate bubble concerns
- Congressional leadership changes
- European austerity riots
- North Korea – South Korea provocations
- Insider trading raids
- Ireland bailout
- Next: ?????
With all this dreadful news, how in the heck have the equity markets about doubled from the lows of last year? The “Zombie Bears,” as Barry Ritholtz at The Big Picture has affectionately coined, would have you believe this is merely a dead-cat bounce in a longer-term bear-market. Never mind the five consecutive quarters of GDP growth, the 10 consecutive months of private job creation, or the record 2010 projected profits, the Zombie Bears attribute this fleeting rebound to temporary stimulus, short-term inventory rebuild, and unsustainable printing press activity by Federal Reserve Chairman Ben Bernanke.
Perhaps the Zombie Bears will change their mind once the markets advance another 25-30%? Regardless of the market action, individual investors have taken the pessimism bait and continue to hide in their caves. This strategy makes sense for wealthy retirees with adequate resources, but for the vast majority of Americans, earning next to nothing on their nest egg in cash and overpriced Treasuries isn’t going to help much in achieving your retirement goals. Unless of course, you like working as a greeter at Wal-Mart in your 80s and eating mac & cheese for breakfast, lunch, and dinner.
This Time is Different
The Zombies would also have you believe this time is different, or in other words, historical economic cycles do not apply to the recent recession. I’ll stick with French novelist Alphonse Karr (1808-1890) who famously stated, “The more things change, the more things stay the same.”
As you can see from the data below, the recent recession lasted two months longer than the 16 month cycle average from 1854 – 2009. We have had 33 recessions and 33 recoveries, so I am going to go out on a limb and say this time will not be any different. Could we have a double dip recession? Sure, but odds are on our side for an average five year expansion, not the 18 month expansion experienced thus far.
The Grandma Sentiment Indicator
I love all these sentiment indicators, surveys, and various ratios that constantly get thrown around the blogosphere because it is never difficult to choose one matching a specific investment thesis. Strategists urge us to follow the actions of the “smart money” and do the opposite (like George Costanza) when looking at the “dumb money” indicators. The bears would also have you believe the world is coming to an end if you look at the current put/call data (see Smart Money Prepares for Sell Off). Instead, I choose to listen to my grandma, who has wisely reminded me that actions speak louder than words. Right now, those actions are screaming pure, unadulterated fear – a positive contrarian dynamic.
Over the last few years there has been more than $250 billion in equity outflows according to data from the Investment Company Institute (ICI). Bond funds on the other hand have taken in an unprecedented $376 billion in 2009 and about another $216 billion in 2010 through August.
As investment guru Sir John Templeton famously stated, “Bull markets are born on pessimism and they grow on skepticism, mature on optimism, and die on euphoria.” Judging by the asset outflows, I would say we haven’t quite reached the euphoria phase quite yet. I won’t complain though because the more fear out there, the more opportunity for me and my investors.
As I have consistently stated, I have no clue what equity markets are going to do over the next six to twelve months, nor does my bottom-up philosophy rely upon making market forecasts to succeed. Evaluating investor sentiment and timing economic cycles are difficult skills to master, but judging by the panicked actions and bond heavy asset inflows, investors are nervously awaiting another 100 year flood to occur in the next hundred minutes.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, WMT, and AIG derivative security, but at the time of publishing SCM had no direct position in Bear Stearns, Lehman Brothers, JPM, Washington Mutual, Fannie Mae, Freddie Mac, GS, BP, GM, Chrysler, and any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Insider Trading Interview with Sidoxia Capital Management
I am recovering from one too many servings of turkey and pumpkin pie, so perhaps you can enjoy an interview I conducted with CNBC’s Erin Burnett on the subject of insider trading earlier this week (Minute 2:00).
Once I awake from the food-induced coma, I promise to return with a more typical article on Investing Caffeine’s site.
I hope everyone had a wonderful holiday…
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Shrewd Research or Bilking the System?
Information is power and some hedge funds, mutual funds, and investment managers will go to great lengths to obtain the lowdown.
Integrity of the financial markets is key and recently several hedge funds (Level Global Investors LP, Diamondback Capital Management LLC and Loch Capital Management LLC) have been raided by the Federal Bureau of Investigation (FBI). Other large investment players, including SAC Capital Advisors, Janus Capital Group Inc. (JNS) and Wellington Management Co. have also received inquiries as part of what some journalists are calling rampant industry insider trading activity. Even investment bank Goldman Sachs (GS) is allegedly being examined for potential unlawful leakage of merger information. Little is known about the allegations, so it is difficult to decipher whether this is the tip of the iceberg or standard investigative work?
Regardless of the scope of the investigation, there is a fine line between what scoop is considered fair versus illegal. The distinction becomes even more difficult to pinpoint with the evolution of faster and more voluminous trading (i.e., high frequency trading). The internet has accelerated the speed of information transfer faster than a politician’s promise to cut spending. Data is chewed up and spit out so quickly, meaning tradable information has a very short shelf life before it is profitably exploited by someone. In the old days of snail mail and private back-office meetings, security prices would require time for information to be completely reflected.
Expert Networks Questioned
Another ingredient introduced over the last decade is the advent of the “expert network,” which are firms that connect fund managers to industry specialists, in many cases as part of a “channel check” to gauge the health of a particular industry. About 10 years ago Regulation FD (Fair Disclosure) was introduced to prevent selective disclosure of “material non-public” information (tips that will likely cause security prices to go significantly up or down) by senior company officials and investor relation professionals to investor types. Greedy (and/or ingenious) institutional investors are Darwinian and as a result figured out a loophole around the system. Hedge funds and other investment managers figured out if the senior executives won’t cough up the good info, then why not target the junior executives and squeeze the inside story from them like informants? Expert networks (read thorough description here) serve as an informational channel to service this demand. Although I’m sure there have been a minority of cases where mid-level managers or junior executives have leaked material information (intentionally or unintentionally), I’m very confident that it is the exception more than the rule. In many instances when the beans were spilled, Regulation FD protects both the person disseminating the information and the investor receiving the information.
Rigged Game for Individuals?
OK sure…hedge funds and institutional managers may occasionally have privileged access to executive teams and can afford access to industry experts. I should know, since I managed a multi-billion fund and consistently had access to the upper rank of corporate executives. Hearing directly from the horse’s mouth and trying to interpret body language can provide insights and instill confidence in a trade, but these executives are not stupid enough to risk prison time by selectively disclosing material non-public information. This dynamic of privileged access will never change as long as CEOs and CFOs are allowed to communicate with investors. Corporate executives will naturally prioritize their limited investor communications towards the larger players.
So with the big-wig managers gaining access to the big-wig executives, has the game become rigged for the individual investors? The short answer is “no.” Over the last decade individual investors have experienced a tremendous leveling of the playing field versus institutional investors. While institutions have privileged access and have pushed to exploit HFT and expert networks, individual investors have gained access to institutional quality research (e.g., SEC filings, real-time conference calls, Wall Street reports, etc.) for free or affordable prices. With the ubiquity of technology and the internet, I only see that gap narrowing more over time.
There will always be cheaters who stretch themselves beyond legal boundaries and should be prosecuted to the full extent of the law. However, for the vast majority of institutional investors, they are using technology and other tools (i.e., expert networks) as shrewd resources to compete in a difficult game. I will reserve full judgment on the names pasted all over the press until the FBI and SEC reveal all their cards. So far there appears to be more noise than smoke coming from the barrel tip of the insider trading gun.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in GS, SAC Capital Advisors, Janus Capital Group Inc. (JNS), Wellington Management Co., or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Sentiment Indicators: Reading the Tea Leaves
Market commentators and TV pundits are constantly debating whether the market is overbought or oversold. Quantitative measures, often based on valuation measures, are used to support either case. But the debate doesn’t stop there. As a backup, reading the emotional tea leaves of investor attitudes is relied upon as a fortune telling stock market ritual (see alsoTechnical Analysis article). Generally these tools are used on a contrarian basis when deciding about purchase or sale timing. The train of thought follows excessive optimism is tied to being fully invested, therefore the belief is only one future direction left…down. The thought process is also believed to work in reverse.
Actions Louder Than Words
When it comes to investing, I believe actions speak louder than words. For example, words answered in a subjective survey mean much less to me in gauging optimism or pessimism than what investors are really doing with their cool, hard cash. Asset flow data indicates where money is in fact going. Currently the vast majority of money is going into bonds, meaning the public hates stocks. That’s fine, because without pessimism, there would be fewer opportunities.
Most sentiment indicators are an unscientific cobbling of mood surveys designed to check the pulse of investors. How is the data used? As mentioned above, the sentiment indicators are commonly used as a contrarian tool…meaning: sell the market when the mood is hot and buy the market when it is cold.
Here are some of the more popular sentiment indicators:
1) Sentiment Surveys (AAII/NAAIM/Advisors): Each measures different bullish/bearish opinions regarding the stock market.
2) CBOE Volatility Index (VIX): The “fear gauge” developed using implied option volatility (read also VIX article).
3) Breadth Indicators (including Advanced-Decline and High-Low Ratios): Measures the number of up stocks vs. down stocks. Used as measurement device to identify extreme points in a market cycle.
4) NYSE Bullish Percentage: Calculates the percentage of bullish stock price patterns and used as a contrarian indicator.
5) NYSE 50-Day and 200-Day Moving Average: Another technical price indicator that is used to determine overbought and oversold price conditions.
6) Put/Call Ratio: The number of puts purchased relative to calls is used by some to measure the relative optimism/pessimism of investors.
7) Volume Spikes: Optimistic or pessimistic traders will transact more shares, therefore sentiment can be gauged by tracking volume metrics versus historical averages.
Sentiment Shortcomings
From a ten thousand foot level, the contrarian premise of sentiment indicators makes sense, if you believe as Warren Buffett does that it is beneficial to buy fear and sell greed. However, many of these indicators are more akin to reading tea leaves, than utilizing a scientific tool. Investors enjoy black and white simplicity, but regrettably the world and the stock market come in many shades of gray. Even if you believe mood can be accurately measured, that doesn’t account for the ever-changing state of human temperament. For instance, in a restaurant setting, my wife will change her menu choice four times before the waiter/waitress takes her order. Investor sentiment can be just as fickle depending on the Dubai, Greece, Swine Flu, or foreclosure headline du jour.
Other major problems with these indicators are time horizon and degree of imbalance. Yeah, an index or stock may be oversold, but by how much and over what timeframe? Perhaps a security is oversold on an intraday chart, but dramatically overbought on a monthly basis? Then what?
The sentiment indicators can also become distorted by a changing survey population. Average investors have fled the equity markets and have followed the pied piper Bill Gross to fixed income nirvana. What we have left are a lot of unstable high frequency traders who often change opinions in a matter of seconds. These loose hands are likely to warp the sentiment indicator results.
Strange Breed
Investors are strange and unique animals that continually react to economic noise and emotional headlines in the financial markets. Despite the infinitely complex world we live in, people and investors use everything available at their disposal in an attempt to make sense of our endlessly random financial markets. One day interest rate declines are said to be the cause of market declines because of interest rate concerns. The next day, interest rate declines due to “quantitative easing” comments by Federal Reserve Chairman Ben Bernanke are attributed to the rise in stock prices. So, which one is it? Are rate declines positive or negative for the market?
On a daily basis, the media outlets are arrogant enough to act like they have all the answers to any price movement, rather than chalking up the true reason to random market volatility, sensationalistic noise, or simply more sellers than buyers. Virtually any news event will be handicapped for its market impact. If Ben Bernanke farts, people want to know what he ate and what impact it will have on Fed policy.
Sentiment indicators are some of the many tools used by professionals and non-professionals alike. While these indicators pose some usefulness, overreliance on reading these sentiment tea leaves could prove hazardous to your fortune telling future.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
Doing the Opposite – Slow Frequency Trading
The business of robot trading, or so-called high-frequency trading (HFT) has grabbed a lot of headlines recently. The recent exposé released by 60 Minutes on the subject has only fanned the flames, which have been blazing harder since the May 6th “flash crash” earlier this year. The SEC is still working through proposed rule changes and regulatory reforms in hopes of preventing a similar crash that saw the Dow Jones Industrial Index almost fall 1,000 points in fifteen minutes, only to recover much of those losses minutes later.
The debate will rage on about the fairness of HFT (read more), but let’s not confuse active day-trading with high-frequency trading. In the case of HFT, the traders are actually getting paid to trade with the assistance of “liquidity rebates.” In exchange for the service of providing liquidity, these computer-based trading companies are earning cold, hard cash. Wouldn’t that be nice if individual day traders got paid money too for trading, rather than flushing commissions down the toilet?
Rather than warn unsuspecting working class Americans of the dangers of trading, discount brokerages and other trading firms peddle talking babies, loud music, back-testing voodoo software, and the prospect of discovering a profit elixir. As it turns out, investing is like weight loss…easy to understand, but difficult to execute. There’s no such thing as a miracle drug or chocolate diet that will shed pounds off your frame, just like there is no miracle trading system that will instantaneously generate millions in profits.
Doing the Opposite
Rather than succumb to the vagaries of the market, investors would be better served by following the mantra of character George Costanza from the hit, comedic television show Seinfeld. In the classic episode, astutely captured by Josh Brown (The Reformed Broker) and also cataloged in chapter four of my book, George realizes that all his instincts are wrong and discovers the road to success can be achieved by doing everything in an opposite fashion. George goes on to flaunt his contrarian approach when he runs into a blonde bombshell at the diner. Rather than boast about his accomplishments, George fesses up to his professional shortcomings by revealing his unemployment status and admitting that he lives at home with his parents. No need to worry, this strategy captivates her and results in George immediately getting the girl. George doesn’t stop there; during the same episode he gets his way with New York Yankee owner, George Steinbrenner, by telling him off. Before long, George is generating big bucks and making key decisions for the organization.
The same contrarian instincts of George apply to the investing world. Resisting the urge to follow the herd is key. The grass is greener and the eating more abundant away from animal pack. Investor extraordinaire Warren Buffett encapsulates the idea in the following advice, “Be fearful when others are greedy, and be greedy when others are fearful.”
There will constantly be an urge to trade frequently and chase performance, whether you’re talking about technology stocks during the boom, real estate five years ago, or the perceived safe-haven of Treasuries and gold today. The melody sounds so beautiful, until the music stops and prices come crashing back down to Earth. If you want to win in the losing game of the financial markets, do yourself a favor and become a slow frequency trader – George would be proud of you doing the opposite.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.
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