Wednesday, June 23, 2010
Uncertainty means Profits
I constantly hear that "The Street hates uncertainty". This has always bothered me, maybe because I have never been to Wall and Broad or even New York for that matter. However, it is a fallacy to think anything is certain. Politicians, natural disasters, human emotion, trends, fads, sentiment, which one of these can be predicted with any accuracy. I was listen to a popular CNBC show when it was announced BP was trying to bring to market some new debt issues. One panel member mentioned they would not purchase the debt if maturities were longer than 9 months. Then they turned around and mentioned a company they liked as a long term buy for 5 to 10 years. We are all delusional, trying to predict that anyone or anything will continually be profitable 5 to 10 years. So, I went through all this ranting to mention my new strategy. Step one, take cheap directional bets and step two is to diversify. The risk reward ratio has to be at least 3 to 1, because I plan to be wrong a great deal. I will check back to give an update on my status.
Wednesday, March 31, 2010
Long Term Investing
Below is a chart, I will add any commentary so you can interpret it for yourself. You will have to use the full screen view.
Noninal_Real
Noninal_Real
Wednesday, March 24, 2010
Maximizing Profits
It is difficult to avoid trying to capture short term gains while still pursing a long term strategy. A 15 day chart is noise against the backdrop of a 5 or 10 year trend. A sound investment policy can help avoid that pitfall, which eventually leads to over trading or high turnover. High turnover only means that your initial decision was either unsound or not thoroughly worked through. A sound policy will help minimize emotionally impulses and allow your strategy or system to work. While reading "Winning the Loser's Game", Charles Ellis mentioned that investors get jubilant when stocks are rising and depressed during a fall, but who among us, reacts that way in the mall. When prices rises we shun items and when they fall we buy more than we need, however securities are treated completely contrary. Again a sound policy will aid in quelling the urge to push prices up with the rest of the market. A word of caution, I am not advising buying on dips or averaging losses. If you like the actually enterprise at a market cap of $3 billion and it falls to $1.5 billion because of systematic market movement, you should buy twice as much. If you are trading, cut your losses promptly and move on.
Wednesday, March 17, 2010
I wonder if he got fired?
Great clip to watch, especially 5:15. This is a great argument against my free rider problem, but David Einhorn had a short position so he was putting his money where is mouth was. I doubt analyst buy individual stocks yet alone buy what they recommend.
Sun Valley 1999
This is an excerpt from The Snowball: Warren Buffett and the Business of Life' by Alice Schroeder. This post is quite long but I recommend it to everyone and believe it should be read out loud in trading firms twice a year. Enjoy
"To all you fellow ring-kissers, I would like to talk today about the stock market," he said. "I will be talking about pricing stocks, but I will not be talking about predicting their course of action next month or next year. Valuing is not the same as predicting.
"In the short run, the market is a voting machine. In the long run, it's a weighing machine.
"Weight counts eventually. But votes count in the short term. And it's a very undemocratic way of voting. Unfortunately, they have no literacy tests in terms of voting qualifications, as you've all learned."
Buffett clicked a button, which illuminated a PowerPoint slide on a huge screen to his right. [17] Bill Gates, sitting in the audience, caught his breath for a second, until the notoriously fumble-fingered Buffett managed to get the first slide up. [18]
DOW JONES
INDUSTRIAL AVERAGE
December 31, 1964 — 874.12
December 31, 1981 — 875.00
He walked over to the screen and started explaining.
"During these seventeen years, the size of the economy grew fivefold. The sales of the Fortune five hundred companies grew more than fivefold. [33] Yet, during these seventeen years, the stock market went exactly nowhere."
He backed up a step or two. "What you're doing when you invest is deferring consumption and laying money out now to get more money back at a later time. And there are really only two questions. One is how much you're going to get back, and the other is when.
"Now, Aesop was not much of a finance major, because he said something like, 'A bird in the hand is worth two in the bush.' But he doesn't say when." Interest rates–the cost of borrowing–Buffett explained, are the price of "when." They are to finance as gravity is to physics. As interest rates vary, the value of all financial assets–houses, stocks, bonds–changes, as if the price of birds had fluctuated. "And that's why sometimes a bird in the hand is better than two birds in the bush and sometimes two in the bush are better than one in the hand."
In his flat, breathy twang, the words coming so fast that they sometimes ran over one another, Buffett related Aesop to the great bull market of the 1990s, which he described as baloney. Profits had grown much less than in that previous period, but birds in the bush were expensive because interest rates were low.
Fewer people wanted cash–the bird in the hand–at such low rates. So investors were paying unheard-of prices for those birds in the bush. Casually, Buffett referred to this as the "greed factor."
The audience, full of technology gurus who were changing the world while getting rich off the great bull market, sat silent. They were perched atop portfolios that were jam-packed with stocks trading at extravagant valuations. They felt terrific about that. It was a new paradigm, this dawning of the Internet age. Their attitude was that Buffett had no right to call them greedy. Warren–who'd hoarded his money for years and given very little away, who was so cheap his license plate said "Thrifty," who spent most of his time thinking about how to make money, who had blown the technology boom and missed the boat–was spitting in their champagne.
Buffett continued. There were only three ways the stock market could keep rising at ten percent or more a year. One was if interest rates fell and remained below historic levels. The second was if the share of the economy that went to investors, as opposed to employees and government and other things, rose above its already historically high level. [19] Or, he said, the economy could start growing faster than normal. [20] He called it "wishful thinking" to use optimistic assumptions like these.
Some people, he said, were not thinking that the whole market would flourish. They just believed they could pick the winners from the rest. Swinging his arms like an orchestra conductor, he succeeded in putting up another slide while explaining that, although innovation might lift the world out of poverty, people who invest in innovation historically have not been glad afterward.
"This is half of a page which comes from a list seventy pages long of all the auto companies in the United States." He waved the complete list in the air. "There were two thousand auto companies: the most important invention, probably, of the first half of the twentieth century. It had an enormous impact on people's lives. If you had seen at the time of the first cars how this country would develop in connection with autos, you would have said, 'This is the place I must be.' But of the two thousand companies, as of a few years ago, only three car companies survived. [21] And, at one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. So autos had an enormous impact on America, but in the opposite direction on investors."
He put down the list to shove his hand in his pocket. "Now, sometimes it's much easier to figure out the losers. There was, I think, one obvious decision back then. And of course, the thing you should have been doing was shorting horses." [34] Click. A slide about horses popped up.
U.S. HORSE POPULATION
1900 – 17 million
1998 – 5 million
"Frankly, I'm kind of disappointed that the Buffett family was not shorting horses throughout this entire period. There are always losers."
Members of the audience chuckled, albeit faintly. Their companies might be losing money, but in their hearts beat a conviction that they were winners, supernovas blazing at the cusp of a momentous shift in the heavens. Undoubtedly their names would grace the pages of history books someday.
Click. Another slide appeared.
"Now the other great invention of the first half of the century was the airplane. In this period from 1919 to 1939, there were about two hundred companies. Imagine if you could have seen the future of the airline industry back there at Kitty Hawk. You would have seen a world undreamed of. But assume you had the insight, and you saw all of these people wishing to fly and to visit their relatives or run away from their relatives or whatever you do in an airplane, and you decided this was the place to be.
"As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history.
"So I submit to you: I really like to think that if I had been down there at Kitty Hawk, I would have been farsighted enough and public-spirited enough to have shot Orville down. I owed it to future capitalists." [22]
Another light chuckle. Some were getting tired of these musty old examples. But out of respect, they let Buffett get on with it.
Now he was talking about their businesses. "It's wonderful to promote new industries, because they are very promotable. It's very hard to promote investment in a mundane product. It's much easier to promote an esoteric product, even particularly one with losses, because there's no quantitative guideline." This was goring the audience directly, where it hurt. "But people will keep coming back to invest, you know. It reminds me a little of that story of the oil prospector who died and went to heaven. And St. Peter said, 'Well, I checked you out, and you meet all of the qualifications. But there's one problem.' He said, 'We have some tough zoning laws up here, and we keep all of the oil prospectors over in that pen. And as you can see, it is absolutely chock-full. There is no room for you.'
"And the prospector said, 'Do you mind if I just say four words?'
"St. Peter said, 'No harm in that.'
"So the prospector cupped his hands and yells out, 'Oil discovered in hell!'
"And of course, the lock comes off the cage and all of the oil prospectors start heading right straight down.
"St. Peter said, 'That's a pretty slick trick. So,' he says, 'go on in, make yourself at home. All the room in the world.'
"The prospector paused for a minute, then said, 'No, I think I'll go along with the rest of the boys. There might be some truth to that rumor after all.' [23]
"Well, that's the way people feel with stocks. It's very easy to believe that there's some truth to that rumor after all."
This got a mild laugh for a half second, which choked off as soon as the audience caught on to Buffett's point, which was that, like the prospectors, they might be mindless enough to follow rumors and drill for oil in hell.
He closed by returning to the proverbial bird in the bush. There was no new paradigm, he said. Ultimately, the value of the stock market could only reflect the output of the economy.
He put up a slide to illustrate how, for several years, the market's valuation had outstripped the economy's growth by an enormous degree. This meant, Buffett said, that the next seventeen years might not look much better than that long stretch from 1964 to 1981 when the Dow had gone exactly nowhere– that is, unless the market plummeted. "If I had to pick the most probable return over that period," he said, "it would probably be six percent." [24] Yet a recent PaineWebber-Gallup poll had shown that investors expected stocks to return thirteen to twenty-two percent. [25]
He walked over to the screen. Waggling his bushy eyebrows, he gestured at the cartoon of a naked man and woman, taken from a legendary book on the stock market, Where Are the Customers' Yachts? [26] "The man said to the woman, 'There are certain things that cannot be adequately explained to a virgin either by words or pictures.' " The audience took his point, which was that people who bought Internet stocks were about to get screwed. They sat in stony silence. Nobody laughed. Nobody chuckled or snickered or guffawed.
Seeming not to notice, Buffett moved back to the podium and told the audience about the goody bag he had brought for them from Berkshire Hathaway. "I just bought a company that sells fractional jets, NetJets," he said. "I thought about giving each of you a quarter share of a Gulfstream IV. But when I went to the airport, I realized that'd be a step down for most of you." At that, they laughed. So, he continued, he was giving each of them a jeweler's loupe instead, which he said they should use to look at one another's wives' rings–the third wives' especially.
That hit its mark. The audience laughed and applauded. Then they stopped. A resentful undercurrent was washing through the room. Sermonizing on the stock market's excesses at Sun Valley in 1999 was like preaching chastity in a house of ill repute. The speech might rivet the audience to its chairs, but that didn't mean that they would go forth and abstain.
Yet some thought they were hearing something important. "This is great; it's the basic tutorial on the stock market, all in one lesson," thought Gates. [27] The money managers, many of whom were hunting for cheaper stocks, found it comforting and even cathartic.
Buffett waved a book in the air. "This book was the intellectual underpinning of the 1929 stock-market mania. Edgar Lawrence Smith's Common Stocks as Long Term Investments proved that stocks always yielded more than bonds. Smith identified five reasons, but the most novel of these was the fact that companies retained some of their earnings, which they could reinvest at the same rate of return. That was the plowback–a novel idea in 1924! But as my mentor, Ben Graham, always used to say, 'You can get in way more trouble with a good idea than a bad idea,' because you forget that the good idea has limits. Lord Keynes, in his preface to this book, said, 'There is a danger of expecting the results of the future to be predicted from the past.' " [28]
He had worked his way back around to the same subject: that one couldn't extrapolate from the past few years of accelerating stock prices. "Now, is there anyone I haven't insulted?" [29] He paused. The question was rhetorical; nobody raised a hand.
"Thank you," he said, and ended.
"To all you fellow ring-kissers, I would like to talk today about the stock market," he said. "I will be talking about pricing stocks, but I will not be talking about predicting their course of action next month or next year. Valuing is not the same as predicting.
"In the short run, the market is a voting machine. In the long run, it's a weighing machine.
"Weight counts eventually. But votes count in the short term. And it's a very undemocratic way of voting. Unfortunately, they have no literacy tests in terms of voting qualifications, as you've all learned."
Buffett clicked a button, which illuminated a PowerPoint slide on a huge screen to his right. [17] Bill Gates, sitting in the audience, caught his breath for a second, until the notoriously fumble-fingered Buffett managed to get the first slide up. [18]
DOW JONES
INDUSTRIAL AVERAGE
December 31, 1964 — 874.12
December 31, 1981 — 875.00
He walked over to the screen and started explaining.
"During these seventeen years, the size of the economy grew fivefold. The sales of the Fortune five hundred companies grew more than fivefold. [33] Yet, during these seventeen years, the stock market went exactly nowhere."
He backed up a step or two. "What you're doing when you invest is deferring consumption and laying money out now to get more money back at a later time. And there are really only two questions. One is how much you're going to get back, and the other is when.
"Now, Aesop was not much of a finance major, because he said something like, 'A bird in the hand is worth two in the bush.' But he doesn't say when." Interest rates–the cost of borrowing–Buffett explained, are the price of "when." They are to finance as gravity is to physics. As interest rates vary, the value of all financial assets–houses, stocks, bonds–changes, as if the price of birds had fluctuated. "And that's why sometimes a bird in the hand is better than two birds in the bush and sometimes two in the bush are better than one in the hand."
In his flat, breathy twang, the words coming so fast that they sometimes ran over one another, Buffett related Aesop to the great bull market of the 1990s, which he described as baloney. Profits had grown much less than in that previous period, but birds in the bush were expensive because interest rates were low.
Fewer people wanted cash–the bird in the hand–at such low rates. So investors were paying unheard-of prices for those birds in the bush. Casually, Buffett referred to this as the "greed factor."
The audience, full of technology gurus who were changing the world while getting rich off the great bull market, sat silent. They were perched atop portfolios that were jam-packed with stocks trading at extravagant valuations. They felt terrific about that. It was a new paradigm, this dawning of the Internet age. Their attitude was that Buffett had no right to call them greedy. Warren–who'd hoarded his money for years and given very little away, who was so cheap his license plate said "Thrifty," who spent most of his time thinking about how to make money, who had blown the technology boom and missed the boat–was spitting in their champagne.
Buffett continued. There were only three ways the stock market could keep rising at ten percent or more a year. One was if interest rates fell and remained below historic levels. The second was if the share of the economy that went to investors, as opposed to employees and government and other things, rose above its already historically high level. [19] Or, he said, the economy could start growing faster than normal. [20] He called it "wishful thinking" to use optimistic assumptions like these.
Some people, he said, were not thinking that the whole market would flourish. They just believed they could pick the winners from the rest. Swinging his arms like an orchestra conductor, he succeeded in putting up another slide while explaining that, although innovation might lift the world out of poverty, people who invest in innovation historically have not been glad afterward.
"This is half of a page which comes from a list seventy pages long of all the auto companies in the United States." He waved the complete list in the air. "There were two thousand auto companies: the most important invention, probably, of the first half of the twentieth century. It had an enormous impact on people's lives. If you had seen at the time of the first cars how this country would develop in connection with autos, you would have said, 'This is the place I must be.' But of the two thousand companies, as of a few years ago, only three car companies survived. [21] And, at one time or another, all three were selling for less than book value, which is the amount of money that had been put into the companies and left there. So autos had an enormous impact on America, but in the opposite direction on investors."
He put down the list to shove his hand in his pocket. "Now, sometimes it's much easier to figure out the losers. There was, I think, one obvious decision back then. And of course, the thing you should have been doing was shorting horses." [34] Click. A slide about horses popped up.
U.S. HORSE POPULATION
1900 – 17 million
1998 – 5 million
"Frankly, I'm kind of disappointed that the Buffett family was not shorting horses throughout this entire period. There are always losers."
Members of the audience chuckled, albeit faintly. Their companies might be losing money, but in their hearts beat a conviction that they were winners, supernovas blazing at the cusp of a momentous shift in the heavens. Undoubtedly their names would grace the pages of history books someday.
Click. Another slide appeared.
"Now the other great invention of the first half of the century was the airplane. In this period from 1919 to 1939, there were about two hundred companies. Imagine if you could have seen the future of the airline industry back there at Kitty Hawk. You would have seen a world undreamed of. But assume you had the insight, and you saw all of these people wishing to fly and to visit their relatives or run away from their relatives or whatever you do in an airplane, and you decided this was the place to be.
"As of a couple of years ago, there had been zero money made from the aggregate of all stock investments in the airline industry in history.
"So I submit to you: I really like to think that if I had been down there at Kitty Hawk, I would have been farsighted enough and public-spirited enough to have shot Orville down. I owed it to future capitalists." [22]
Another light chuckle. Some were getting tired of these musty old examples. But out of respect, they let Buffett get on with it.
Now he was talking about their businesses. "It's wonderful to promote new industries, because they are very promotable. It's very hard to promote investment in a mundane product. It's much easier to promote an esoteric product, even particularly one with losses, because there's no quantitative guideline." This was goring the audience directly, where it hurt. "But people will keep coming back to invest, you know. It reminds me a little of that story of the oil prospector who died and went to heaven. And St. Peter said, 'Well, I checked you out, and you meet all of the qualifications. But there's one problem.' He said, 'We have some tough zoning laws up here, and we keep all of the oil prospectors over in that pen. And as you can see, it is absolutely chock-full. There is no room for you.'
"And the prospector said, 'Do you mind if I just say four words?'
"St. Peter said, 'No harm in that.'
"So the prospector cupped his hands and yells out, 'Oil discovered in hell!'
"And of course, the lock comes off the cage and all of the oil prospectors start heading right straight down.
"St. Peter said, 'That's a pretty slick trick. So,' he says, 'go on in, make yourself at home. All the room in the world.'
"The prospector paused for a minute, then said, 'No, I think I'll go along with the rest of the boys. There might be some truth to that rumor after all.' [23]
"Well, that's the way people feel with stocks. It's very easy to believe that there's some truth to that rumor after all."
This got a mild laugh for a half second, which choked off as soon as the audience caught on to Buffett's point, which was that, like the prospectors, they might be mindless enough to follow rumors and drill for oil in hell.
He closed by returning to the proverbial bird in the bush. There was no new paradigm, he said. Ultimately, the value of the stock market could only reflect the output of the economy.
He put up a slide to illustrate how, for several years, the market's valuation had outstripped the economy's growth by an enormous degree. This meant, Buffett said, that the next seventeen years might not look much better than that long stretch from 1964 to 1981 when the Dow had gone exactly nowhere– that is, unless the market plummeted. "If I had to pick the most probable return over that period," he said, "it would probably be six percent." [24] Yet a recent PaineWebber-Gallup poll had shown that investors expected stocks to return thirteen to twenty-two percent. [25]
He walked over to the screen. Waggling his bushy eyebrows, he gestured at the cartoon of a naked man and woman, taken from a legendary book on the stock market, Where Are the Customers' Yachts? [26] "The man said to the woman, 'There are certain things that cannot be adequately explained to a virgin either by words or pictures.' " The audience took his point, which was that people who bought Internet stocks were about to get screwed. They sat in stony silence. Nobody laughed. Nobody chuckled or snickered or guffawed.
Seeming not to notice, Buffett moved back to the podium and told the audience about the goody bag he had brought for them from Berkshire Hathaway. "I just bought a company that sells fractional jets, NetJets," he said. "I thought about giving each of you a quarter share of a Gulfstream IV. But when I went to the airport, I realized that'd be a step down for most of you." At that, they laughed. So, he continued, he was giving each of them a jeweler's loupe instead, which he said they should use to look at one another's wives' rings–the third wives' especially.
That hit its mark. The audience laughed and applauded. Then they stopped. A resentful undercurrent was washing through the room. Sermonizing on the stock market's excesses at Sun Valley in 1999 was like preaching chastity in a house of ill repute. The speech might rivet the audience to its chairs, but that didn't mean that they would go forth and abstain.
Yet some thought they were hearing something important. "This is great; it's the basic tutorial on the stock market, all in one lesson," thought Gates. [27] The money managers, many of whom were hunting for cheaper stocks, found it comforting and even cathartic.
Buffett waved a book in the air. "This book was the intellectual underpinning of the 1929 stock-market mania. Edgar Lawrence Smith's Common Stocks as Long Term Investments proved that stocks always yielded more than bonds. Smith identified five reasons, but the most novel of these was the fact that companies retained some of their earnings, which they could reinvest at the same rate of return. That was the plowback–a novel idea in 1924! But as my mentor, Ben Graham, always used to say, 'You can get in way more trouble with a good idea than a bad idea,' because you forget that the good idea has limits. Lord Keynes, in his preface to this book, said, 'There is a danger of expecting the results of the future to be predicted from the past.' " [28]
He had worked his way back around to the same subject: that one couldn't extrapolate from the past few years of accelerating stock prices. "Now, is there anyone I haven't insulted?" [29] He paused. The question was rhetorical; nobody raised a hand.
"Thank you," he said, and ended.
Market Correction?
I am just as bearish as the next guy but there are three reasons why I believe the market will go higher this year. First, let me say I know banks are hoarding, foreclosures are going up, mortgage resets are still occurring and I have not seen job creation in months, so my argument is not that the market "should" go up, my argument is that the factors below outweigh the aforementioned factors.
1) There is waaay too much liquidity in the capital markets. Marginal and mediocre players are given the opportunity to raise capital, refinance and amend liabilities that would be disastrous in a tight market. Even if rates go from 0 to 2%, is the mutual fund manager going to buy cds or stay in equities? Until there are relatively better capital allocation vehicles, the market rise will continue.
2) The cash on the sidelines argument is more factual than I believed. According to Businessweek, there is $3.2 trillion dollars in money market funds. So, 24% of the US GDP is earning less than 50 basis points. Also, the same article stated $369 billion went into bond funds relative to $23.4 billion in equity fund. There is still room to run with that much money sitting on the sidelines. I do not have the numbers but also since the Treasury auctions have been performing well, the risk less trade seems to be in vogue with 3 month T-Bills yielding 15 basis points according to Bloomberg Market Data.
3) The third point is the strongest. There is still fear and pessimism in the market. I gauge markets by book publishing. There are too many books being published about the crash, bailouts, Wall Street hubris and associated topics. When the trend changes to booms, how to make millions in markets or day trade your way to a million then we will see optimism return. There is not blood in the streets and people are still fearful and not greedy.
Personally, I would be cautious even though my argument is caution is not necessary YET. However, I would not go short issues I feel are weak or marginally. The better strategy is to stay flexible and make money. There is no premium on cash right now, I cannot return to my investors and tell them I outperformed cds by 100 basis points when they could have done it themselves. The bull momentum is not as strong as mid 2009 but the bear forces are in retreat.
1) There is waaay too much liquidity in the capital markets. Marginal and mediocre players are given the opportunity to raise capital, refinance and amend liabilities that would be disastrous in a tight market. Even if rates go from 0 to 2%, is the mutual fund manager going to buy cds or stay in equities? Until there are relatively better capital allocation vehicles, the market rise will continue.
2) The cash on the sidelines argument is more factual than I believed. According to Businessweek, there is $3.2 trillion dollars in money market funds. So, 24% of the US GDP is earning less than 50 basis points. Also, the same article stated $369 billion went into bond funds relative to $23.4 billion in equity fund. There is still room to run with that much money sitting on the sidelines. I do not have the numbers but also since the Treasury auctions have been performing well, the risk less trade seems to be in vogue with 3 month T-Bills yielding 15 basis points according to Bloomberg Market Data.
3) The third point is the strongest. There is still fear and pessimism in the market. I gauge markets by book publishing. There are too many books being published about the crash, bailouts, Wall Street hubris and associated topics. When the trend changes to booms, how to make millions in markets or day trade your way to a million then we will see optimism return. There is not blood in the streets and people are still fearful and not greedy.
Personally, I would be cautious even though my argument is caution is not necessary YET. However, I would not go short issues I feel are weak or marginally. The better strategy is to stay flexible and make money. There is no premium on cash right now, I cannot return to my investors and tell them I outperformed cds by 100 basis points when they could have done it themselves. The bull momentum is not as strong as mid 2009 but the bear forces are in retreat.
Monday, March 15, 2010
Investing vs. Savings
I believe there is a popular misconception about saving and investing. The misconception is furthered by the fact the most people are encouraged to own stocks and bonds in their retirement accounts. Saving is a safe passive activity that involves practically no risk. Either you are buying bonds issued by the United States government or buying certificates of deposits which are guaranteed by the United States government. Investing is allocating capital for a possible return on the initial capital. Banks and financial institutions connect both parties so capital markets can function. However, an investor is rewarded for taking risk with their capital, while savers are rewarded for deferring compensation to put their money away for a guaranteed return. The best investment one can make is in themselves and the best savings vehicle in the last 40 years was US T-bonds which have outperformed the S&P 500.
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