Friday, July 31, 2009

Now comes August

The Dow Jones Industrial Average ($INDU) had its best monthly performance -- up 8.6% -- since October 2002 and its best July since 1989.

The Standard & Poor's 500 Index ($INX) and the Nasdaq Composite Index ($COMPX) were up 7.4% and 7.8%, respectively -- their best July performances since 1997.

Now comes August, which can be a problematic month, which is followed by the always dangerous September. Since 1987, August has been one of the stock market's weakest months of the year, the Stock Trader Almanac says. August also typically sees low volume as many traders and investment professionals go on vacation.

August 2008, however, was benign: The Dow was up 1.5%, with the S&P 500 up 1.2% and the Nasdaq up 1.8%. But the market literally crashed in September 2008.

Thursday, July 30, 2009

The Cheshire Multiple

When a growing number of people buy stocks—and from one another, remember—prices are driven up because buyers outnumber sellers. And as brokerage statements indicate the last selling price of the stock, investor portfolios become inflated.

The economy can get into big trouble this way. You can’t buy the same stock back and forth numerous times, inflating its price, and think that you’re creating real dollars. Yet that’s just how many investors behave.

To illustrate, say that 10 million investors each own 100 shares of stock in a company. Then I pay $1 more than the last fellow for a share. As a result, the stock price goes up by $1, and all 10 million shareholders see their portfolios rise by $100. But did I create $1 billion of wealth, the total of that increase? Of course not.

This apparent $1 billion was generated by what I call the “Cheshire multiple” (after the disappearing cat in Lewis Carroll’s Alice’s Adventures in Wonderland). It exists mostly in the imagination.

Only a small percentage of investors can sell their shares at the price on their brokerage statements. As soon as sellers outnumber buyers, the price will fall and portfolios will shrink due to that same multiple. It works both ways. So most of this so-called money simply vanishes. No one gets it.

Tuesday, July 21, 2009

cash still king

NEW YORK (AP) — That old saying "cash is king" certainly rings true these days. Investors can't seem to get enough of it, which ultimately could be bad news for the stock market and the economy.

In the past, investors would cling to cash until the market's prospects brightened and then money would pour back into stocks. That's just what the bulls today are hoping will drive a surge on Wall Street in the months ahead.

But the shock of the financial crisis — which have made leverage and risk-taking dirty words — may be changing all that. Even with today's minuscule returns, cash seems to have become a sought-after asset class among investors who intend to keep it as a part of their portfolios for the long term.

Historical data he has crunched shows that whenever assets in money market mutual funds — which are low-risk, highly liquid investments — exceeded 25 percent of the market capitalization of the Standard & Poor's 500 index, stocks have rallied over the following two years.

This ratio jumped to an almost-unheard of level of more than 60 percent on March 9, almost triple the median level in the early years of this decade, for two reasons. Money market fund totals have surged 30 percent since the stock market peaked in October 2007, and by early March the S&P 500's market cap had plunged 57 percent from its high point in 2007.

Today, that ratio has narrowed to about 45 percent, primarily because of a recent rebound in stocks. There is $3.7 trillion sitting in money market mutual funds right now, and the market cap of the S&P 500 is about $8 trillion, up from a March low of $5.9 trillion.

Principles of Economics

translated by Yoram Bauman (video)

[via wstr75, 12/31/08]

Monday, July 20, 2009

Q&A with Joel Greenblatt

(GuruFocus, June 30, 2009) Back in early June, when we became aware of Investment Guru, Joel Greenblatt became the strategist for the money management firm FormulaTrading.com, we reached out and requested an opportunity for our users to ask Joel questions. To our delight, the good professor (Joel is also an Adjunct Professor with Columbia University) agreed.

* * *

Comments on the interview

* * *

Steve Forbes interviews Greenblatt

Expanding the Magic Formula

Thursday, July 16, 2009

anchoring bias

In a famous paper from 1974, behavioral scientists Tversky and Kahneman describe this bias in the following manner:
In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient That is, different starting points yield different estimates, which are biased toward the initial values. We call this phenomenon anchoring.
Tversky and Kahneman observed this behavior in a number of experiments conducted in the early 1970s. In the most well-known of these studies, the researchers asked participants to estimate the percentage of African countries in the United Nations. The results indicated that people anchored their answer to completely arbitrary numbers presented by the researchers. For example, the median estimate of people who were given 10% as a starting point was 25% and the median estimate of people who were given 45% as a starting point was 65%. Specifically, people became anchored to the percentage suggested to them by the question even though that number had nothing to do with the actual percentage of African countries in the UN. Having no knowledge of the exact percentage, people subconsciously took their cues from the numbers presented in the questioning despite the fact that those numbers were randomly generated.

Now, how does this bias manifest itself in the investing world? I think the main way in which investors can fall prey to this pitfall is by paying too much attention to the past prices of securities. The two most prevalentnumbers that people seem to anchor to are the 52 week high and 52 week low for a stock. Setting aside technical analysis, in my young career I have observed a marked tendency for people to assume that a stock has potential to get back to its 52 week high but not breach its 52 week low. I think this is a reflection of the eternal optimism that exists in the market. On some level even short sellers believe that the market’s trajectory over the long run is more likely to be up than down. The problem with this thought process is that it assumes that those numbers are an indication of value and are not just random outcomes based on the whims of the market. In the end the value of a stock should be based on its earnings potential, a value that at certain times may have absolutely nothing to do with the current stock price. A quick look at the ride the Nikkei Stock Exchange has had over the past 20 years provides a sobering reminder that previous highs may never be reached again and stocks can stay at low nominal values for a protracted period.

* * *

I dunno. Since anchoring exists, technical analysis must work too. In the sense that people do look at previous levels which must act as some form of resistance and support, regardless of the fundamentals.

The 0% Tax Rate Solution

The federal income tax code is now so mangled that we can probably increase federal revenues with a 0% income tax rate for a majority of Americans.

Long before President Barack Obama took office, the bottom 40% of income earners paid no federal income taxes. Because of refundable income tax credits like the Earned Income Tax Credit (EITC), in 2006 these bottom 40% as a group actually received net payments equal to 3.6% of total income tax revenues, according to the latest Congressional Budget Office data. The actual middle class, the middle 20% of income earners, pay only 4.4% of total federal income tax revenues. That means the bottom 60% together pay less than 1% of income tax revenues.

This actually resulted from Republican tax policy going all the way back to the EITC, which was first proposed by Ronald Reagan in his historic 1972 testimony before the Senate Finance Committee on the success of his welfare reforms as governor of California. Besides calling for workfare, Reagan proposed the EITC to offset the burden of Social Security payroll taxes on the poor. As president, Reagan cut and indexed income tax rates across the board and doubled the personal exemption. The Republican majority Congress, led by former House Speaker Newt Gingrich, adopted a child tax credit that President George W. Bush later expanded and made refundable, while also reducing the bottom tax rate by 33% to 10%.

President Bill Clinton expanded the EITC in 1993. But it was primarily Republicans who abolished federal income taxes for the working class and almost abolished them for the middle class. Now Mr. Obama has led enactment of a refundable $400 per worker income tax credit and other refundable credits, which probably leaves the bottom 60% paying nothing as a group on net.

* * *

I find this hard to believe since everybody I know pays income tax. Since I actually pay income tax, does that mean I make more than 40% of Americans? Or more like I have less exemptions than they.

[Just supposing] I'm trying to look at it as a closed system where money is circulating from producers to consumers back to producers etc. The minority rich become rich because in general they're getting money from the majority poor (or middle-class). In other words, the poor are consuming the products of the rich. That's the way a capitalist society works (in my mind anyway).

But you don't want the poor to become too poor, otherwise they become a burden to society. You want them to be functional so they can continue to circulate money to keep the system running.

The problem is how to do this. How? By taking (taxing) the rich to supplement the poor. Like welfare? Which doesn't seem to be working too well. Or buy lowering taxes on the rich so that they can expand their business and provide jobs to the poor.

But one might ask how making the rich richer can make the poor richer too, when there's only so much money to go around. I think the idea is that it'll increase the velocity of money so it'll circulate better.

I don't know (obviously). But I think most people think of these things on one level and not as a system. If they think about it at all.

Tuesday, July 14, 2009

stocks underperform bonds

As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years.

Still, brokers and financial planners keep reminding us, there's almost never been a 30-year period since 1802 when stocks have underperformed bonds.

These true believers rely on the gospel of "Stocks for the Long Run," the book by finance professor Jeremy Siegel of the Wharton School at the University of Pennsylvania that was first published in 1994.

Using data assembled by other scholars, Prof. Siegel extended the history of U.S. stock returns all the way back to 1802. He came to two conclusions that became articles of faith to millions of investors: Ever since Thomas Jefferson was in the White House, stocks have generated a "remarkably constant" average return of nearly 7% a year after inflation. (Adding inflation at 3% yields the commonly cited 10% annual stock return.) And, declared Prof. Siegel, "the risks of holding stocks decrease over time."

There is just one problem with tracing stock performance all the way back to 1802: It isn't really valid.

* * *

[7/15/09] Jeremy Siegel responds (sort of).

The short answer is that stocks are still the best long-term investments. As bad as the past decade has been, there have been other 10-year periods during which stocks have recorded even bigger losses. Yet over periods of 20 years or longer, stocks have never lost money, even after inflation. Including the latest bear market, stock returns have averaged 7.8% per year over the past 20 years and 11% annually over the past 30.

After periods of sluggish returns, stocks tend to regain their oomph. Stock returns over the past five and 10 years have fallen to the bottom quartile when measured against all five- and 10-year periods since 1871. But history shows that after reaching such a low, stocks' average return for the next five years has been almost 9.5% annually after inflation.

Furthermore, once stocks have plunged 50% from their highs, which they have done during the current bear market, investors have always been rewarded with winners over the next five years -- and that includes the Depression decade of the 1930s. In December 1930, stocks were 50% off their highs of September 1929. Yet, over the next five years -- when the economy was experiencing the greatest contraction in its history -- investors were rewarded with an annual return of 7% after inflation.

Zacks Strategies

[an ad from Zacks]

Zacks Investment Research specializes in the coverage of corporate earnings. And more importantly, how to profit from this information. So, today I'm going to share with you 3 proven strategies to profit from earnings announcements.

Strategy 1: Four Leading Indicators of Positive Earnings Surprises

I figured its best to get the most obvious strategy out of the way first. The 4 leading indicators I refer to are the 4 factors of the Zacks Rank. Before you skip this section, let me share some information with you that you may not have known.

In the mid-1970s, Len Zacks took his mathematical skills to Wall Street, where his job was to discover stock picking strategies that would beat the market. He had a simple theory that was the precursor to what became the Zacks Rank.

Len focused his research on finding stocks that were more likely to have a positive earnings surprise and jumping on the news. The journey led him to what we know as the 4 factors of the Zacks Rank. Each individually increases the odds of owning stocks that will enjoy a positive earnings surprise. However, when you combine them together inside the Zacks Rank, it becomes an almost obscene advantage for investors. (Learn more about 4 Factors of the Zacks Rank, in this video.)

Strategy 2: Stop the Bleeding

This second strategy is so simple, yet so hard for most investors to do. So, I'm going to beat it into your head...for your own good of course ;-)

Sell All Companies with a Negative Earnings Surprise

Yes, sell it immediately. Even after it falls at the open. Even if it is for a substantial loss. Why? Better to take a 10-20% loss in the short run than a 20 to 40% loss in the long run.

Strategy 3: Buy High and Sell Higher - Most Profitable Strategy

I saved the best for last. This strategy has proven to be the most profitable way to harness earnings surprises. This proprietary metric is called the Price Response Indicator, or PRI.

The PRI is amazingly accurate at saying which stocks will rise in the days following an earnings announcement and which won't. Proving the truism "Buy High and Sell Higher."

The scoring system for the PRI correlates the percent earnings surprise and short-term price reaction preceding the announcement. The model scores stocks from A to E with A's and B's being the most likely to increase in price in the days following the surprise. These signals are produced by our systems within hours after the company reports earnings.

At this time, the daily feed of PRI signals is only made available to our institutional clients. However, the Zacks Surprise Trader service filters down all the PRI signals with additional variables to find the 2% that have historically provided the best returns. From there we hand pick the signals, turning down 5 out of every 6 to provide our subscribers with a phenomenal opportunity to beat the market.

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Today is the perfect time to learn more about the Surprise Trader. Why? First, earnings season is coming into full swing. Second, the service has grown so popular that it closed to new members. We've reopened it briefly to give Zacks.com investors one more chance to get in. But we're closing the service again at midnight Saturday, July 11, 2009. This is your chance to avoid the Waiting List and also enjoy a substantial savings.

Learn more about Surprise Trader special offer >>


[closed to new subscribers]

Cap and Trade

Warren Buffett carries plenty of weight in any debate -- even when he gets it wrong.

So as the Senate digs into the climate-change bill that passed the House of Representatives last month, it’s worth taking a hard look at how Buffett’s views on the bill went off course.

[via iluvbabyb]

Wells Fargo sues itself

You can't expect a bank that is dumb enough to sue itself to know why it is suing itself.

Yet I could not resist asking Wells Fargo Bank NA why it filed a civil complaint against itself in a mortgage foreclosure case in Hillsborough County, Fla.

In this particular case, Wells Fargo holds the first and second mortgages on a condominium, according to Sarasota, Fla., attorney Dan McKillop, who represents the condo owner.

As holder of the first, Wells Fargo is suing all other lien holders, including the holder of the second, which is itself.

"The primary reason is to clear title and ownership interest in a property to prepare it for sale," Waetke said in an email exchange. "So it really is not Wells Fargo vs. Wells Fargo."

Yet court documents clearly label "Wells Fargo Bank NA" as the plaintiff and "Wells Fargo Bank NA" as a defendant.

[via chucks_angels]

Wednesday, July 01, 2009

Pompous Prognosticators

1927-1933 Chart of Pompous Prognosticators

[via brknews]

Toyota vs. Ford

A Japanese company (Toyota) and an American company (Ford Motors) decided to have a canoe race on the Missouri River. Both teams practiced long and hard to reach their peak performance before the race.

On the big day, the Japanese won by a mile.

The Americans, very discouraged and depressed, decided to investigate the reason for the crushing defeat. A management team made up of senior management was formed to investigate and recommend appropriate action.

Their conclusion was the Japanese had 8 people rowing and 1 person steering, while the American team had 207 people steering and 2 people rowing.

Feeling a deeper study was in order; American management hired a consulting company and paid them a large amount of money for a second opinion.

They advised, of course, that too many people were steering the boat, while not enough people were rowing.

Not sure of how to utilize that information, but wanting to prevent another loss to the Japanese, the rowing team's management structure was totally reorganized to 4 steering supervisors, 2 area steering superintendents and 1 assistant superintendent steering manager.

They also implemented a new performance system that would give the 2 people rowing the boat greater incentive to work harder. It was called the 'Rowing Team Quality First Program,' with meetings, dinners and free pens for the rowers. There was discussion of getting new paddles, canoes and other equipment, extra vacation days for practices and bonuses. The pension program was trimmed to 'equal the competition' and some of the resultant savings were channeled into morale boosting programs and teamwork posters.


The next year the Japanese won by two miles.

Humiliated, the American management laid-off one rower, halted development of a new canoe, sold all the paddles, and canceled all capital investments for new equipment. The money saved was distributed to the Senior Executives as bonuses.

The next year, try as he might, the lone designated rower was unable to even finish the race (having no paddles,) so he was laid off for unacceptable performance, all canoe equipment was sold and the next year's racing team was out-sourced to India.

Sadly, the End.

Here's something else to think about: Ford has spent the last thirty years moving all its factories out of the US, claiming they can't make money paying American wages.

TOYOTA has spent the last thirty years building more than a dozen plants inside the US. The last quarter's results:

TOYOTA makes 4 billion in profits while Ford racked up 9 billion in losses.

Ford folks are still scratching their heads, and collecting bonuses.

IF THIS WEREN'T SO TRUE IT MIGHT BE FUNNY

[via chucks_angels, 12/3/08]

What Makes Fidelity Tick?

Fidelity's culture is defined by paradox. It invests heavily in its investment capabilities, but it's also a marketing machine. It's a leviathan, yet it encourages individuality. It hires some of the best and brightest analysts and managers, but it too frequently shifts them from fund to fund, making it difficult for investors to benefit from their talents.

Ultimately, Fidelity's greatest strength is its individualistic ethic. It's not a place where you'll find many cookie-cutter personalities. Instead of imposing rigid, one-size-fits-all constraints, Fidelity managers have latitude to implement their own investment strategies. And unlike many overly buttoned-down investment organizations, Fidelity tolerates offbeat, and even eccentric, personalities--so long as they put up the numbers. While more buttoned-down investment organizations might push conformity, Fidelity encourages creativity. It could well be that the reason that great investors like Peter Lynch, Will Danoff, and Joel Tillinghast emerged from Fidelity is because they had the freedom to think and invest differently.