Archive for Uncategorized

Brain Droppings – Markets In Turmoil

I’m told by several people much younger and wiser than me that the bottom is most certainly in. Perhaps – but being old and slow I tend to ponder these things. Alas, to have the certainty of youth is greatly missed after one’s long term memory fades and while one’s arteries become sclerotic with age.

It’s no surprise to me that the market has come off the highs as I have said repeatedly that I think the market is “expensive.” I was, however, surprised by speed of which it all happened this week. It’s not often we see 3% down days these last few years.

It makes sense we see a relief rally – perhaps as early as Monday. The $SPX RSI(14) closed in oversold territory at 24.84 and a host of other technical indicators support a bounce.

Still, after the carnage we haven’t made a lot of progress on getting valuations in line.

PEs_082145

I’m very aware that paying attention to valuation is an activity reserved for only the old and infirm. I’m also really sure that when the market abandons valuation metrics they seem to all-of-a-sudden matter one day.

I don’t want to make an aggregation error here either. After all, it’s a market of stocks. The good news is that finally we’re seeing value in sectors that everyone seems to hate.

I was scolded today because I’m building a position in $MU. I think it’s cheap. Maybe it’s a value trap. That’s the problem with being old. You just can’t keep your wits about you. Still, there are more stocks I like today than I did a week ago.

The tone seems to have turned in this market. The reaction to the rather benign Fed minutes would have sent the market up 1% plus 3 months ago. For the record I don’t think this downdraft has anything to do with Fed policy. I think it’s a pure fundamental story – slowing growth, commodity deflation, earnings growth deceleration, etc.  Crazy growth stocks have been pummeled this week as well. I had the temerity to sell $NFLX call spreads after the stock hit $127. My only regret so far is that I didn’t do it in size. Oh well, you can’t hit ’em all.

It’s also noteworthy that the more times BTFD fails the less previous practitioners believe in it.

A fellow (a really old fellow) for whom I have great regard thinks that what we’re witnessing is a “time correction.” I’m not so sure. Usually a sideways correction happens when stocks trade in a range and wait for earnings to catch up. I’m not seeing that at all.  As always, I reserve the right to be wrong.

Anyhow, I’m thinking we have more work to do on the downside. Market moves are never in a straight line and the most violent rallies usually come in corrections or bear markets. We’ll see. In the mean time I’m nibbling on stuff many of you would think horrible. I’m looking to do more of it.

That’s how I do.

 

$AMZN – Back of the Bar Napkin Valuation

Of course it will be wrong but let’s take (generous) go at it.

Assumptions

Revenue CAGR for 10 years 17% (matches 2015 H1)

Net Margin in year 10 (up from the current .5% and otherwise completely pulled out of my ass) 3%

P/E at Year 10 30X

NPV discount rate 8%

2025 Estimated Net Income $9.87B

Market Cap at 30X $296.1B

NPV of Market Cap $137.2B

Present Fair Value of Stock $294.

 

Market Cycle Reflexivity Poll for 11/21/14 – 11/28/14

Last week’s poll results are here.

Here’s the poll covering the coming week. Remember that you need to vote each week for a good baseline to be developed to establish trend. Please forward this to as many people you know that are market participants. If you came here via a Twitter or Stocktwits link it would be a big help if you RT’s those to help us get the sample size up.

Also, this is specific to the U.S. equities market so please keep that in mind as you’re casting your vote.

Updates are periodically available on my Twitter feed @davebudge

Thanks for voting.

web polls

Market Cycle Reflexivity Poll Results for 11/20/14

The bears increased their lead this week. Here are the stats:

Poll ending 11/20 – Mean = 4.02 Median = 4.5 Mode = 5.

Poll ending 11/14 – Mean = 3.75 Median = 3.5 Mode = 5.

The sample size is still small with the N = 120 but  roughly a 47% increase in participation from last week.

I’m not sure what to make of the numbers and probably need several more weeks of data. Progress with participation needs to improve as well so tell your friends. I’ll have the new poll up sometime today.

Click the graph below to enlarge.

soros_cycle_11_20_14

 

Soros Market Reflexivity Cycle

George Soros developed theory on market cycles and sentiment where he describes what he calls “reflexivity.” I’m interested in understanding the trend of where traders and investors think we are on this scale regardless of their trade discipline. I plan to run a new poll every week starting on Fridays and ending on Thursdays of each week. Then I’ll plot the results against the $SPX.

It may take a few months to get the sample sizes meaningful so early results might be weak gauges. But I plan to keep doing it for a while to see if it catches on.

So, regardless of the the folly you might think of this. Please vote. I’m looking to establish a long term trend to gauge shifts in market sentiment.

I’ll put out a reminder on Twitter and Stockstwits.

A few things about the poll

1 – The system tries to let only one vote per poll (but this can be gamed.) Please don’t vote more than once.

2 – The poll is completely anonymous if you’re worried about trolls on Twitter, etc. giving you crap about your views.

3 – Don’t kill yourselves trying to come up with a correct answer. There isn’t one.

4 – Would love for you to share this with your friends.

5 – Thanks for voting.

Below are the market stages as Soros describes them. I have included a few in between levels for those how can’t quite decide. Please select one.


polls

Extemporaneous Random Brain Seepage

I worry about shit.

Domestic Macro

I keep hearing that the US economy is on a solid growth trajectory but, frankly, I see a mixed picture at best. Yes, unemployment claims are down and (shitty) job creation looks good. Industrial capacity utilization is up and so is sentiment. So we have that.

On the other hand, CapEx is still not doing much except in commercial RE and, so far, the oil patch. But with pressure on oil prices the latter might fade off quite a bit. That needs to be watched pretty closely since YTD it has been about $200B and 1/3 of total domestic CapEx.

Wage growth still is crap and I don’t see reason to think it’s going up in any meaningful way. We seem to have become an economy selling each other burgers. I don’t think this is a permanent condition, yet I don’t see the corner we need to turn on in the immediate horizon.

Still, good economic news tends to come out of the penumbra (edge of shadows for the unfamiliar) of the economy so I might be surprised to the upside. For now I give the domestic outlook a big “meh”.

Global Macro

I’ve been saying since its inception that the Euro has a fatal design flaw. Nothing has changed my mind on that.  The lack of political unity of the EZ will continue to cause member nations to be at odds with each other. The clown candidate Grillo is pushing for the reinstatement of the Lira (let’s hope they divide the old currency by 10,000 if it ever comes back). Not that the joker pol has any real clout but it certainly speaks to the social mood that A) this guy is taken seriously and B) Italy’s re-adoption of a sovereign currency actually makes sense on some level.

And then there’s the Germans with the constant teutonic refrain of “No” to the ECB.

I can’t predict the outcome of if/when the whole EU experiment fails but I’m inclined to think it comes with a shit storm if it does. Just something to keep an eye on.

In the mean time almost the entire EU economy could be headed into a triple-dip recession. I can’t image that there’s not some significant spill-over into the US economy.

While all this is going on the Abe economy continues to suck. Sure, like everywhere else in the world, it’s a mixed picture. But putting up a big tax increase while trying to QE your way into lift-off velocity seems deeply conflicted. And the BOJ’s Kuroda is starting to worry about the hammering of the Yen even though he has more than a large hand in making it. Once a bolder starts rolling downhill it can be hard to stop.

China has been telling us that they have a handle on defusing the trigger on their shadow banking debt bomb. Reminds me a lot of “the sub-prime crises is largely contained” kind of talk. The good thing is that the Chinese don’t need Congress to approve any bail-out.  The Chinese government is the greatest Keynesian machine in the history of the world (if you know me you’ll understand that’s not a complement) insofar as they figure out ways to build unproductive assets on a magnificent scale. Off the top of my head I can’t remember the hedgie who said (Chanos?) that China is the only country in the world that knows their annual GDP on January 1st. At some point, though, it shows up as a dead weight loss and kills productivity. I think Chinese debt is a bigger issue than the market has discounted for. Time will tell.

Please Shut the Fuck Up!

I spent the better part of Thursday and Friday scraping my brains off the wall as the various central bankers were shooting their mouths off and confusing the market. I wasn’t alone and it’s good to see some actual smart person confirm my outrage. Kevin Ferry at The Contrarian Corner went ape shit on douche-bag Fed backtracking. Read the whole thing but here’s a bit that sums up the mood.

Remarkably, we are to believe that a sudden 100 BP shift in the color coded Eurodollars over a month and a 450k drop in open interest -IN A DAY ! – resulted in no P/L damage to anyone. We are going out on a limb here..Somebody got hurt…BAD. We’ll find out who and how bad over the next few months.

Dysfunctional markets are driven by liquidation and It’s always about the positions. I’d love to see a damaged speculator sue the Fed for following their guidance. Now lets see who wants to come back and play again.

I’d love to see it too but it’s little more than the fanciful thoughts of the angry.

By now the market is starting to learn that the term “Forward guidance” means part “we have no fucking idea what we’re going to do” and part “we think we can jawbone our way out the the structural imbalances we’ve created.”

The problem with the those people talking at all is that their thinking out loud isn’t guidance it’s bullshit and little more than speculation sauced up with a large serving of unearned credibility.  What we’re left with is a market that is confused and makes far too many fucking decisions on the moves of monetary policy instead of plain old supply/demand business modeling.

I’m not smart enough to know what the outcome of this big money experiment will be (and anyone who says they do is quite full of shit.) But I do know that sending conflicting signals to the market is probably the opposite of what they (only?) imagine to be the benefits of “forward guidance.”

As polemics go I’m probably only getting started on this screed. I’ll save you all and stop here. Understand, though, I’m a long-time seasoned Fed watcher and I’ve never seen this type of communication incompetence in my life.

Markets

The question remains whether the markets will go up or down from here. The answer is “yes.” I’ve made my bets to the downside but if I had a nickle for every time I’ve been wrong I’d be rich.

All I can do is what I do best and outline the risks, buy cheap assets and sell expensive ones.

My TA pals are doing yeoman’s work these days trying to find an edge in a market structure we haven’t seen for a couple of years. There are enough on both sides of the trade that I’m forced to pay less attention to technicals here since I get conflicting opinions from people for which I have major respect.   As my friend Andrew Kassen points out, sometimes TA causes apophenia. Too many ink blots does little more than confuse my feeble mind so I’m going back to my (often wrong) big picture stuff.

To sum it all up I have just to quote Hill Street Blues; Be careful out there.

The Power Of Saving

I love that the term YOLO (you only live once) has become part of the modern zeitgeist. Yes, by all means, carpe diem! The problem, of course, is that the one time you live may end up being a very, very long time.

Members of the financial community take for granted time value of money mathematics. My experience, however, informs me that a striking minority of people really understand it’s power.

If you or your kids have a long time horizon, little spending choices can make a huge difference to long term savings.

Here are some examples to play with to show how saving will reflect in the long run with just a wee bit of sacrifice. Plug them into the savings calculator.

1 latte a day at $3.50 = $105/mo
1 pack of cigarettes a day at $6 = $180/mo.
1 cocktail a day at a bar at $5.00 = $150/mo.
A $300/mo reduction on housing expense

You can think of more (lots more) I’m sure. If I had young kids I’d be pounding this stuff into their brains starting at about age 10 (OK, I have but only with limited success.) You should too.

For any time horizon over 20 years I think 7% is a good estimate for a stock portfolio. Play with it. Then forward it to every kid on the planet.

[calc id=2110]

Equity Prices And The Indexing of Everything

I was in graduate school when the Spooz were first approved for trading. The academic argument for the contract was based on the solid premiss of risk arbitrage like other commodities contracts.  The argument holds up today as well as it did then in that regard. At the time, however, academics joked that, if the entire market moved to trading nothing but indexed products, there would be no price signal at the individual  level of public companies to establish value. They joked because they thought this was implausible if not impossible.  Maybe they were right.  But I see the marginal effects of indexing starting to manifest themselves more robustly. That sends me down an intellectual rabbit hole.

As an active portfolio manager I see the effects every day. For example, the spot price of oil has a direct effect on energy ETFs. Thus, when oil is under pressure, most of the $XLE component prices come under pressure regardless of how the spot price of oil effects their operations. And the larger the exposure to an index of an individual name the more pronounced the sympathetic move in price. Thus, I my opinion, this reduces market efficiency in the context of asset values – at least in the short run.

Recently, I’ve seen many economists urge both institutions and individuals to forgo active management for indexing.  Yesterday, in the Wall Street Journal, Jason Zweig wrote:

The debate about whether you should hire an “active” fund manager who tries to beat the market by buying the best stocks and avoiding the worst—or a “passive” index fund that simply matches the market by holding all the stocks—is over.

Whether most know it or not, this is the strongest practical application of the Efficient Markets Hypothesis. And for all the ridicule he’s taken, Eugene Fama must be smiling. And Jack Bogle has a lot of “I told you so” ammo. Economist have a faith in efficient equilibrium. At the macro level they’re mostly right. But on the micro level they know that disequilibrium always exists.

Assuming this trend will continue – at least until active managers learn how to exploit the inefficiencies I mentioned above much better –  the average advisor will look for alpha in sector selection, “smart beta” (more a marketing term than a risk strategy IMO) or minimizing risk via Modern Portfolio Theory (which was pretty useless during the Global Financial Crises.) Financial advisors, in whom the 80/20 rule is obvious, will likely follow the crowd and go all index. Yes, “Dare to be average!” has always been the cri de coeur  of the retail money management business.

For the value manager, however, the inefficiencies created by indexing might be the biggest advantage to gaining long term alpha in many years.  Doing so, however, will not be for the faint of heart and if your clients are sensitive enough to count your performance tick-by-tick you might think of either getting different clients or different work. The focus on long term alpha often means significant periods of under-performance and every money manager knows that “what have you done for me lately” is ever-present. The need to clearly communicate your investment approach is more important than ever. What you have to deal with is this:

Asness and Liew argue that just a few anomalies are robust across time, countries, and asset markets, notably momentum and value. On value, they note that a trading strategy of high minus low, that is long a portfolio of cheap stocks (high book value to price) and short a portfolio of expensive stocks (low book value to price) has generated consistently high returns relative to (CAPM) risk over time, albeit not without occasional terrifying episodes.

[Emphasis mine.] Personally, I’m not changing my investment style. I have always underperfomed in raging bull markets and more than made up for it in other times. But long term alpha should always be the goal of a portfolio manager in my view. And being an index junkie reduces the number of great opportunities in the market that exist.

None of this is to say that long term alpha can not be gained in other approaches. It can. But I’m partial to value because it has a better track record in market draw downs. That’s just me.

On a related note, Twitter is abuzz with all this talk today. In the process I ran across this Cliff Asness piece on Fundamental Indexing. It’s very much worth reading.

 

 

 

 

Investing If Time Were No Object

A few years ago Tyler Cowen penned a little book, The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History, Got Sick, and Will (Eventually) Feel Better (the eBook is on sale today for $3.79 and I recommend you buy it right now.) In usual Cowen style, the premise is highly controversial and has been pooh-poohed by both academics and innovators alike. It’s worthwhile, I think, to look closely to what Cowen sees.

In a nutshell Cowen is saying that our standard of living has not seen the big strides that came from things like the mass migration of people from farming to the industrial economy, the advent of truly life enhancing technology shifts like electrification and its derivatives such as refrigeration, washing machines, central heating, etc. And, I think most importantly, the mass education of the American population. As the book’s description reads:

Median wages have risen only slowly since the 1970s, and this multi-decade stagnation is not yet over. By contrast, the living standards of earlier generations would double every few decades.

Regardless of one’s opinion on that thesis, I think it has important implications; not for the future of the developed world but for everywhere else.

More recently, Marc Andreessen has been tweet-storming the tectonic shift in global economics that will be caused by the advent of the inexpensive smart phone. This is a simple idea; this new technology puts in the hands of everyone access to the sum of human knowledge and the ability to trade goods and services with near frictionless ease. Which brings me back to Cowen.

To me the important part of The Great Stagnation is not in the current state here but in the story of prior to 1970. Productivity exploded in the developed world as time was freed from the labor of managing household chores (the biggest economic boon in history by the way), the procurement of food and clothing and the extension of productive hours that came from the light bulb. The developing world, though the advantage of trade (read Recardo re: comparative advantage), is about to increase both productivity and, hence, earnings as a consequence of this rapidly proliferating technology. The smart phone will have similar effects to our history by bringing education to the masses as well. These are like the conditions in place that resulting in the mind-blowing advance in living standards we experienced from the first industrial revolution.

There’s a rub (there’s always a rub.) In the west we have been blessed by (classical) liberal institutions. There is no dismissing that The Enlightenment philosophers had a durable effect on free trade and the capitalistic construct. The developing world has some way to go to change there anachronistic government structures that will allow the type of trade we take for granted in the west. But we can see it changing everywhere – from China’s state capitalism model to the enthusiasm for India’s liberal new reformist prime minister, Narendra Modi. I expect we’ll see it continue everywhere in one form or another as access to knowledge sweeps the world at an increasing rate. But it will take time.

As a portfolio manager I understand the benefits of investing in EMs for both growth and portfolio diversification. That, however, is so pedestrian that it’s not much worth the time to write about.

But, what if time was no object in one’s investing frame? How would you invest then?

I manage my kids IRA’s and help them with their 401(k)s. I also am building accounts for my grandkids. For my kids I’m allocating 50% of their portfolios to EM. For my grandkids it’s the same but half of that I’m putting in Africa – the area where I think there is more potential in both the spread of liberal society and gains from access to knowledge. There is where the growth will be in the next 50 years. Will it be a bumpy ride? Probably. What does that have to do with the long term?

I might wrong and my kids push back a bit (although they don’t pay that much attention.) But if I were starting out today that’s what I’d do with my own money.

I’ll write about what I would do with the other 50% in another post. But investing looks different if one can take the time constraints out of the calculus. It’s an exercise worth doing.

 

 

The Twitter Induced Drift

I saw this exchange this morning between Jon Boorman and Michael Shea.

 

 

I came to the conclusion a while back that too much Twitter, for all of its benefits, was really hurting my performance.  That’s not Twitter’s fault. It’s mine.

I am not a trend follower/RS trader though I know a few of them who do very well and I highly respect their craft. But I started my career as a financial analyst – a skill set that takes decades to learn – and that’s what I know best.  For me, investing is a pretty simple concept: Buy inexpensive assets and sell expensive ones. Not that I don’t make a lot of mistakes. But it has worked for me over the long term and I’m proud of the long term alpha I’ve generated.

Last year I loaded up my twitter stream with people who have significantly different styles than mine. On the one hand it’s good to learn how others approach the market. On the other, it can – and did to me – distract one from one’s core strengths. I found myself seriously over-trading and, as a consequence, ignoring the type of analysis that is bedrock to my investment discipline.

In February I began to cull my follow list and I got rid of about 100 traders whose ideas never resulted in any profit for me. Then, I went through a systematic process of winnowing down my list of technical analysts to a few who do work in sector analysis or whom frequently delivered ideas that conformed with my underlying value strategy.

I also threw out a lot of rather talented people who have a compunction to lecture the world on what makes a successful trader. With all due respect, I have boots older than many of you and the last thing I need is an endless stream stale market bromides that take up space and waste our most precious commodity – time.

I’m not a technician and I need good TA support.  Todd Harrison artfully says that the market is made up of technicals, fundamentals, structure and sentiment. I pay attention to all of these. That, however, doesn’t mean that I should practice my craft by setting my core strengths behind anyone else’s. And I’m glad I caught myself doing just that. Still, I have learned a great deal from the people I still have on my stream and I’m in awe of some of their trading chops. Without them I’d be worse. But finding the ones that really add value is the key.

The only and last best exception I make are people who make me smile regardless of what their market approach is. Trading is an intense lifestyle and we all need a good dose of smiles to offset the constant flipping of the fear an greed switch.

I don’t remember who said it (but I think it was Howard Lindzon) that we don’t suffer from too much data. We suffer from poor filters. For me less has been more and my performance of the last several months is all the proof I need.

Yes, less often is more.