Sunday, January 29, 2006

a breadth flip-flop

We witnessed an extreme flip-flop in market breadth late last week that’s worth noting given its historical significance. Days like Friday [1/20/06] are discouraging for investors holding long positions, given the complete reversal of Thursday’s relatively healthy day. Almost 2½ times more stocks rose on Thursday than declined. Then Friday came, and almost 2 ½ times more stocks declined than rose. The last time we saw the discouraging pattern of a 2-to-1 up day followed immediately by a 2-to-1 down day (using NYSE advance/decline figures) was on July 21, 2005. That was a notable day as the S&P had hit a new yearly high the day before on July 20. The market went on to enjoy a couple more weeks of gains before a deeper correction set in. That was the case most times this has happened in the past.

According to SentimenTrader, over the past 30 years, there have been 21 other cases where we saw these types of immediate up-down reversals in breadth. Two weeks later, the S&P was positive 17 times (81%) and posted an average return of 1.2% (it was positive 10 out of 11 times over the past decade). It wasn’t a free ride however—on eight of the instances, the maximum drawdown one would have suffered during that two weeks was more than -2%, including a couple of huge declines in September 1986 and October 1987 (after the crash).

Low Priced Stocks

Perhaps orphan stocks (stocks under $5) should be avoided, but Rick Munarriz has done well in picking low-priced stocks between $5 and $10. And here are Rick's picks for 2006: part 1, part 2

Wednesday, January 25, 2006

Charlie Munger

[1/25/06] “It is occasionally possible for a tortoise, content to assimilate proven insights of his best predecessors, to outrun hares which seek originality or don't wish to be left out of some crowd folly which ignores the best work of the past. This happens as the tortoise stumbles on some particularly effective way to apply the best previous work, or simply avoids standard calamities. We try more to profit by always remembering the obvious than from grasping the esoteric. It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” [from Value Investor Insight, article referenced by Respazz at value_investment_thoughts, page 21]

The value of technical analysis

[2/24/07] Randy Harmelink passes on a few websites on technical analysis

http://stockcharts.com/education/IndicatorAnalysis/index.html
http://www.prophet.net/analyze/popglossary.jsp
http://www.chartfilter.com/education/index.htm
http://www.incrediblecharts.com/technical/candlesticks.htm

[10/21/06] [Dr. Sjuggerud writes] [The] topic of technical analysis is a touchy one. But before we dive into this heated debate, we should probably first come up with some sort of definition of technical analysis. How about this: Stock market technical analysis, at its core, is looking at price action alone to determine some course of action.

That said, there are essentially two heated sides of the debate, both with convincing arguments:

On the "technical analysis is a sham" side, the argument (from guys called "fundamental analysts") goes something like this: "The value of a company is purely determined by the fundamentals of that company's business, not by some silly squiggles on a chart. Therefore, the only worthwhile analysis is analyzing the company's business."

On the "technical analysis is the holy grail" side, the argument goes something like this: "Anyone who only looks at earnings and ignores emotions in the market is an idiot. The market is made up of live human beings, who always bid things up beyond any reasonable value, and sell things below any reasonable value. Sticking your head in the sand and ignoring market action is ridiculous."

Both arguments make some sense when you read them, no? As a rule, these two camps are firmly divided - you either believe stock technical analysis is useful or you don't. Generally, there is no in between. So by picking one side in this debate, I'm bound to outrage the other side. But where I stand on technical analysis actually makes NEITHER side happy...

You see, I'm in the "in between" camp - I believe that both EARNINGS and EMOTIONS matter. And therefore I like to mix and match the two. Here's what I mean...

I like to buy good values - cheap stocks. You find those through fundamental analysis. And I don't like to try to "catch a falling knife" in those stocks - I like to wait until the share price at least starts to recover to give me a margin of safety. I prefer to buy in an uptrend rather than in a downtrend.

The Investors Business Daily newspaper is the most popular example of this. It ranks stocks based on both fundamental indicators (like earnings) and technical indicators, like what's called "relative strength." (Relative strength is just what it suggests - how well a stock is performing relative to the market or its industry. In the case of Investor's Business Daily, this is based heavily on the latest three months action. So if a stock has high relative strength, it's likely beginning an uptrend.

... For one other example of useful stock technical analysis, consider the "moving average" of a stock price. While stocks fluctuate wildly over days and weeks, looking at the movement of the average over a period of time can smooth out the fluctuations and let you grasp the underlying trend. More importantly, moving averages can be a great way to significantly decrease your risk and slightly improve your returns...

Jeremy Siegel, author of Stocks for the Long Run and a noted Finance Professor at the Wharton School (University of Pennsylvania), broke with the tradition of academics and actually tested a simple technical analysis rule - the 200-day moving average - himself. During his test, when a stock's price moved above it's 200-day average, Siegel bought. And if a stock dipped below it's 200-day average, he sold.

What Siegel found is that since 1886, using the 200-day moving average as your indicator, you would have earned 2% points better than someone using a "buy and hold" strategy (11% instead of 9%, I believe), and you would have done so with significantly less risk. You were only in the market about 2/3 of the time. And my own research corroborates Siegel's - I've found that you simply don't make money in stocks when they are below their 200-day moving average.

[after reading discussion at magicformulainvesting]

[8/31/06] Chart your way to Easy Street

[5/9/06] How one contrarian uses charts

[4/24/06] veryearly1 shows an experienced view of technical analysis

[1/28/06] Here's one value investor's view on technical analysis

[1/25/06] I see that Shai has posted a discussion on technical analysis on his blog with interesting viewpoints on both sides.

[1/24/06] Joseph Khattab says technical analysis is not for him. He then proves his case by presenting 12 best-performing stocks of 2004. Four of them went up in 2005 while eight of them went down.

But let me see what these 12 stocks would have returned in total. If you had put in $1000 in each of them, you would have started with $12,000. Crunching the numbers with his data, you would have ended up with $13,500. So despite twice as many losers as winners, there was a profit of $1550 or a return of 13% which would have beaten the market in 2005. Case not so closed.

[11/9/05] Why did Citigroup fire its technical analysis research team?

Saturday, January 21, 2006

mutual fund performance and turnover

[1/21/06] Here's a different study mentioned in Lowenstein's column in the February SmartMoney. Kevin Laughlin, assistant to Vanguard founder Jack Bogle, divided mutual funds into four groups: those with the highest turnover down to the lowest.

Sure enough, as turnover went up, performance went down. Among all domestic equity funds, over 10 years the funds that traded least had an annualized return of 11.49 percent; those that traded most had a return of 9.78 percent.
A possible factor may be that low turnover funds had lower expenses. Sure enough
Again, Laughlin has the numbers: The average expense ratio of high-turnover funds is 1.31 percent a year. At low-turnover funds expenses are only 1.0 percent.

* * *

[8/1/05] A quote from Chris Davis
Our feeling is that if our research process is going to add value, it will do so by identifying companies with competitive advantages. Those advantages rarely manifest themselves in a year or two of the company's results. I don't know how someone could claim to have a research focus and also have 100% turnover. You only get to know a company well when you watch it closely over time. When you know a company well, you know when it gets mispriced and can take advantage of it.

[7/20/05] One would normally suspect that high turnover means low returns. Although funds pay very little in stock-trading commissions, those costs can add up when you rip out trades at a rapid pace. And rapid-fire trading often leads to rapid-fire mistakes.

But your suspicions would be wrong.

A note: One of the funds I own, White Oak Growth, has low turnover, but has been one of the worst performers since 2000. Their problem was holding high growth stocks all the way down even as the bubble popped. Turnover by itself doesn't seem to be an indicator of performance.

The Rules of Trading

Mauldin presents a chapter from his book Just One Thing. It is Dennis Gartman's Rules of Trading

R U L E # 1

Never, ever, under any circumstance, should one add to a losing position ... not EVER!

Averaging down into a losing trade is the only thing that will assuredly take you out of the investment business. This is what took LTCM out. This is what took Barings Brothers out; this is what took Sumitomo Copper out, and this is what takes most losing investors out. The only thing that can happen to you when you average down into a long position (or up into a short position) is that your net worth must decline. Oh, it may turn around eventually and your decision to average down may be proven fortuitous, but for every example of fortune shining we can give an example of fortune turning bleak and deadly.

By contrast, if you buy a stock or a commodity or a currency at progressively higher prices, the only thing that can happen to your net worth is that it shall rise. Eventually, all prices tumble. Eventually, the last position you buy, at progressively higher prices, shall prove to be a loser, and it is at that point that you will have to exit your position. However, as long as you buy at higher prices, the market is telling you that you are correct in your analysis and you should continue to trade accordingly.

[On the other hand, there's investor Bill Miller.]

Friday, January 20, 2006

Morningstar performance

[1/20/06] In this update, Morningstar reports their star rating system is just about matching the equal-weighted S&P 500 for the trailing 3-year period while trouncing the cap-weighted index. Looking at the list, it would seem like the best buys right now are TGIC, WMT, KMX, LEA, PIR, TPX since they are all still rated 5 stars (and all have gone down).

[7/16/05] How well do Morningstar ratings perform? Morningstar started a study on 8/6/01 where they bought five stars stocks and held them until they became one star stocks. It has outperformed the S&P 500, though it's about par for the cash-flow matched equal-weighted S&P 500. That comparison index may be a little unfair because it doesn't sound easy for the individual to replicate. In any case, they're both trouncing the S&P 500. Even the equal-weighted S&P 500 (where each stock is given equal weight in the index) sounds like a good strategy since it's also been beating the plain S&P 500.

Thursday, January 19, 2006

Fools vs. Mark Cuban

Munarriz says Mark Cuban (that's billionaire Mark Cuban) is wrong

Seth Jayson pontificates Cuban is not all wrong

The Motley Fool

The fool.com website has a lot to offer. Here's a tour.

2006 Predictions

[2/3/06] Paul Saffo rates 10 different technology trends as buy, sell, or hold over the next decade.

[1/19/06] Munarriz makes five stock predictions

[1/6/06] Mauldin thinks the market will end the year down, going against consensus (and Elaine Garzarelli).

[1/6/06] According to Hulbert, the low volatility of 2005 portends another "calm" market in 2006.

[1/4/06] Sivy is fairly optimistic overall for 2006

[1/1/06] The first half of 2006 could be rough says CNNMoney.

[1/1/06] Forget about 2006, what about 2016?

[1/1/06] Bull vs. Bear: Munarriz and Beyers duel 2006

[12/24/05] Morningstar estimates the Dow's fair value at 11,694, so it's about 8% undervalued. However they estimate the overall market as overvalued by 5%.

[12/23/05] Liz Ann Sonders, Chief Investment Strategist for Charles Schwab looks for outperformance by large-cap growth stocks.

"There’ve been a number of periods in history (like the last two years) when the market had single-digit returns and compressed valuations. The year that followed was typically positive for the market overall, but with multiple expansion particularly pronounced for growth companies."

[12/23/05] Robert Aronen shares his predictions.

Friday, January 13, 2006

The 11000 Barrier

[1/19/06] According to MarketHistory.com, there have been 15 prior occurrences (dating back to May 1999, and omitting repeat occurrences within 10 trading days) where the Dow hit an intra-day high above the 11,000 level. Over the next 27 trading days, the Dow declined in 14 of the 15 cases by an average of -4.1%.

[1/13/06] Dow 11000: Does It Matter?

* * *

[7/28/05] More than six years after the Dow topped 10,000 and then 11,000 for the first time, the index has struggled to leave that trading range behind for good. The Dow has crossed and re-crossed 10,000 at least 49 times in six years.

The Dow's struggles to make a major, long-term move beyond 11,000 aren't unusual by historical standards. Twice in the past century, the markets stagnated for prolonged periods

• After the 1929 stock market crash, the Dow did not permanently move above the pre-crash lows for 25 years.

• More recently, the Dow struggled to top and then move significantly beyond 1,000 during a 16-year period ending in 1982. The high oil prices, inflation jitters and unpopular war (Vietnam) of that era are somewhat similar to the gas price worries, inflation anxieties and another unpopular conflict (Iraq) facing the country today, although the pain may not be as severe this time, said Michael Burke, editor of Investors Intelligence, a newsletter based in New Rochelle.

Can Investors Profit from the Prophets?

[2/25/06] in every single year of the new millennium, stocks rated "sell" by Wall Street have outperformed stocks rated "buy" or "hold." From 2000 to 2004, stocks that the Street told you to sell rose 19% per annum on average. Meanwhile, the "buys" and "holds" rose just 7%.

[1/13/06] On the other hand, John Dorfman relays this. "For eight years, I've been tracking results for the four stocks analysts most adore at the start of each year, and the four they just can't stand. The Adored Stocks have averaged a loss of 4.5 percent. The Despised Stocks have lost 2.8 percent on average. The Standard & Poor's 500 Index has easily beaten both groups, averaging a gain of 6.4 percent."

[9/22/05] Does a portfolio of stocks recommended by analysts outperform the market? A contrarian or skeptic might say no. But this study says yes. [chucks_angels message dated 9/17/05, 4:51 AM]

Selecting Mutual Funds

[from brknews] A new study has taken a big step forward, suggesting a selection method so easy and direct that investors can only wonder why it hasn't received more attention. The idea is to compare each fund's returns with how it would have performed had it simply held, without trading, the stocks it listed in its most recent public disclosure.

The study was done by three finance professors: Marcin Kacperczyk, of the University of British Columbia, and Clemens Sialm and Lu Zheng of the University of Michigan. They focused on what they called the return gap: the difference between a fund's actual returns and what it would have earned had it stuck with its most recently listed holdings. The SEC requires that funds make such disclosures twice a year; the professors report that nearly half of all funds do so at least quarterly.

The study found that, on average, funds with consistently positive return gaps were much better bets for future performance than those that were consistently negative, regardless of the frequency of portfolio disclosures. They analyzed more than 2,500 domestic equity mutual funds over a 20-year period - 1984 through 2003.

Due Diligence

Stephen D. Simpson offers a guide to doing due diligence.

Stocks that go up year after year

Of the 10,000-plus stocks available for purchase today, only 17 have recorded positive total returns in every one of the past 10 years.

Four words of advice

Bill Barker comments on investment advice that can be given in four words. Actually he presents three of them, so that's twelve words.

Wednesday, January 04, 2006

Bill Miller

[1/4/06] Bill Miller has done it again, but it was a close call. Miller's Legg Mason Value LMVTX extended its winning streak against the S&P 500 Index to 15 straight years, with a 2005 return of 5.32%. The S&P 500 returned 4.91% for the year.

[12/21/05 brknews] It looks like Miller is about to make it 15 years in a row.

[6/23/05] Tilson's interview with Bill Miller (actually birge writing of said interview)

Meet Mr. Market

Tuesday, January 03, 2006

But What About Tomorrow?

[12/27/05] Looking in Zweig's Winning On Wall Street (page 159), "if the market does not do what it's supposed to do prior to the holidays (or immediately after Thanksgiving and Christmans), then that in itself is a negative sign and increases the probability that stocks will fall in the short run. Thus, the general trading strategy is to observe prices during the pre-holiday period, and if, at the close of the day, the market is unchanged or down -- defying the normal tendency -- then one should sell short the market for the day after the holiday."

So by this rule, one should have shorted today. And should short tomorrow. It would have worked out for today because the market was down. In fact, "The Standard & Poor's 500 Index, after rallying in early trading, dropped 12.12, or 1 percent, to 1256.54, its worst performance for the first trading day after Christmas since 1987." The Dow lost 105 to 10778. The Nasdaq lost 23 to 2227. What happened on the next day in 1987? The S&P dropped from 245.57 to 244.59. The Dow dropped from 1942.97 to 1926.89. The Nasdaq dropped from 325.60 to 325.50. However the day after that was positive.

So based on 1987, expect the market to be mildly down tomorrow, but the bulk of the move was today. In fact, based on 1987, one might look to buy tomorrow since the day after was positive. And 1988 was positive. The only slight flaw to this discussion is that this ain't 1987. Who really knows?

Chart of Dow Jones Industrial Average 1987-1989

[1/1/06] So what happened? Instead of going down Wednesday, the market finished barely positive. So while the Tuesday prediction was correct, the Wednesday prediction was barely incorrect. The market was down on Friday, normally an up day. So Zweig would say to short the market Monday (is it open Monday?)

[1/3/06] The market was closed Monday. And was up big today on the opening day of the year. In other words, the Zweig indicator was wrong big-time.

Sunday, January 01, 2006

Peter Bernstein

Peter Bernstein is the Yoda of investing.

- from wstr75 at chucks_angels

Goodbye 2005

[1/14/06] Munarriz was right on his 2005 predictions -- about half of the time

For the year, the Dow lost 0.6 percent, the Nasdaq gained 1.4 percent, the S&P 500 gained 3 percent and the Russell 2000 small cap index gained 3.4 percent.

Munarriz looks back at 2005

[1/7/06] Tech's top stories of 2005

Another Magic Formula?

This Scrooge screen reminds me of Greenblatt's Magic Formula but is easier to implement with the common screening tools. Basically the screen looks for "cheap stocks possessing a high degree of earnings quality".

The screen produced a return of 17.5% for 2005 (outperforming the SPYDR's 7.7%). There are seven stocks (that Tim Beyers) picked from the screen this year. Returning is Taiwan Semiconductor (TSM). Another stock is Posco (PKX) that Warren Buffett is said to have bought. This one looks dirt cheap with a p/e of 3.5 and an ROE of 30.2. Another one that's dirt cheap is Southern Copper (PCU) with a p/e of 5.7 and an ROE of 40.8.

(Disclaimer: I own none of these stocks -- yet.)

Scoffing at Fortune

TMF Selena is scoffing at Fortune's "10 Stocks for the Next Decade" which were picked in 1999. Following are the stocks and their performance since 7/19/00. (Don't know why they picked that starting date when the stocks were picked in 1999.)

Broadcom (BRCM) -80%
Charles Schwab (SCH) -58%
Enron -100%
Genentech (DNA) +157%
Morgan Stanley (MWD) -36%
Nokia (NOK) -67%
Nortel Networks -96%
Oracle -66%
Univision -46%
Viacom -49%
Average -44%
S&P 500 -18%

I'm not really super-bullish on any of these stocks (though I actually own three of them in varying amounts), but I'd bet overall they'll be up five years from now. Well maybe not Enron. Stay tuned.

Foolish Fundamentals

The fool.com explains some fundamental concepts

The significance of book value

Income Statement

Enterprise Value

Meet the P/E Ratio

Stock Dilution

The Price-to-Sales (P/S) Ratio

The Balance Sheet

Payout Ratios

Cash Flow Statement

Return on Invested Capital

Inventory

Cash Conversion Cycle

Free Cash Flow

Stocks

Bonds

GAAP

Margin