Jobless claims came in today at 470k, higher than the upper end of the consensus range. This bodes negatively for the labor market and is the second consecutive week the 4-week moving average increased. This, coupled with the lackluster durable goods order, is a worrisome signal about our economy's current rebound trajectory. Unemployment is stalled at 10% while jobless claims have stopped declining. Charts everywhere are showing breaks of major trendlines, from those of the FOREX market to those of the Dow Jones Industrial average.
As I wrote in a previous post, one must track economic and earnings data in order to get a grip on the future direction of the financial markets. Earnings have been fairly resilient across the board, including the strong reports that MSFT and AMZN just posted tonight. However, the economic data is beginning to counter these strong reports. Since last week I have been shedding my positions and currently hold a fair amount of cash. I have also been moving in and out of 3x bear funds, such as EDZ. Frankly, I wouldn't mind a strong correction here because it would create more value plays and some of my favorite stocks, such as ELY, would begin looking cheap again.
In other news, Bernanke was just reappointed to be Fed Chairman after a Senate vote of 77-23. Apple released its new iPad, which didn't convince me its a necessary device to have. I'm not convinced it's a better substitute for the phone or laptop because the Kindle is a better e-reader, the laptop is a better laptop, and the phone and is a better phone than the iPad. I'll save the $500.
I enjoyed when Obama talked of America's need to play for 1st place in last night's State of the Union address. I believe there is a discouraging spirit amongst Americans right now that we are falling behind China and India. America is fighting nation, a nation of innovation and democracy, and most importantly, a nation whose morale may fade but whose fight doesn't stop. As Americans, we will and always have, overcome the hardships that sometimes cloud over our great nation.
Thursday, January 28, 2010
Tuesday, January 26, 2010
Apple's Strategic Intent
Apple's strategic intent in releasing its tablet has hurt competitors in ways you may not have expected. I first recall learning about the tablet device a few months ago, after someone reported seeing truckloads of books being unloaded at Apple's offices. As more information "leaked" about the tablet device, Apple benefited by forcing consumers to wait for their new product release instead of buying a Kindle or Sony E-Reader. Customers are smart. They weigh the benefits and costs and make well-informed decisions. For many, it is worth the wait to see what the innovative engineers at Apple have cooked up in the labs. Thus, even though the product is not yet available for purchase, Apple has potentially stolen market share and at the very least delayed a customer's purchase of a competitor's product.
Announcing the release date of a new innovative product also stalls responses from competitors, who may be forced to drastically change their business model upon release date. Even worse, competitors may unnecessarily ramp up R&D spending or marketing when the new product actually fails to live up to expectations.
The power of Apple is in its perception as an innovative company whose products and services transform the marketplace. Customers know a new product announcement means something that's potentially revolutionary - and that's power that competitors cannot control and power that demands a premium in product price and stock price.
Announcing the release date of a new innovative product also stalls responses from competitors, who may be forced to drastically change their business model upon release date. Even worse, competitors may unnecessarily ramp up R&D spending or marketing when the new product actually fails to live up to expectations.
The power of Apple is in its perception as an innovative company whose products and services transform the marketplace. Customers know a new product announcement means something that's potentially revolutionary - and that's power that competitors cannot control and power that demands a premium in product price and stock price.
Things to Watch for Tommorrow
- Apple unveils its tablet device
- New Homes Sales - 10:00AM
- FOMC Announcement 2:15PM- Interest rates are expected to remain the same
- Notre Dame at Villanova (3) 7:00PM - ESPN - College Basketball :)
- President's State of the Union Address 9:00PM - Follow his discussion on the budget deficit
Monday, January 25, 2010
Analyzing Bernanke's Prospects for Reappointment
If uncertainty and volatility are to decrease in the financial markets, it's imperative for Bernanke to be reappointed as Fed Chairman. Bernanke has performed well in the midst of the "Great Recession", although the long-term ramifications of his policies have yet to be realized. The stock market is in love with his policy of low-interest rates, fueling the economy with cheap borrowing. Over the past few days, the market has reacted negatively to any news of Senators voting against Bernanke.
According to Dow Jones Newswires, 40 Senators have confirmed their support for Bernanke while 17 have opposed it. In order to be reappointed, Bernanke needs 60 votes. With the President and the stock market already supporting his reappointment, and already having the support of a majority of voters, it stands to reason that Bernanke will be reappointed and the stock market will react mildly positive to this news (most of the positivity has been priced in today, in my opinion).
Most likely, more important economic data and earnings releases that come later in the week will trump the news that Bernanke is reappointed.
The final result will likely be this Thursday or Friday.
According to Dow Jones Newswires, 40 Senators have confirmed their support for Bernanke while 17 have opposed it. In order to be reappointed, Bernanke needs 60 votes. With the President and the stock market already supporting his reappointment, and already having the support of a majority of voters, it stands to reason that Bernanke will be reappointed and the stock market will react mildly positive to this news (most of the positivity has been priced in today, in my opinion).
Most likely, more important economic data and earnings releases that come later in the week will trump the news that Bernanke is reappointed.
The final result will likely be this Thursday or Friday.
Sunday, January 24, 2010
The Week Ahead: 1/25 - 1/29
A slew of economic data will be released this week - Existing Home Sales on Monday, Consumer Confidence on Tuesday, Fed meeting on Wednesday, Durable Goods Orders / Jobless Claims on Thursday, and GDP / Consumer Sentiment on Friday.
Whereas last week the earnings reports moved the markets, this week the economic data will assuredly be the driving force. Now is definitely a time to be on your toes and be ready to shift the composition of your portfolio. Last week I took a little off the table as the markets sold off, jobless claims spiked, the VIX jumped, and uncertainty increased around the financials. However, as I wrote in my recent post , the key to accurately gauging the health of the economy and the stock market is to following the economic reports and earnings data.
The uptrend lines on many charts were broken last week and bearish long-term MACD crossovers abound on many charts - from the FOREX market to the DJIA. The U.S. dollar looks poised to strengthen in the coming weeks, though it is due for a pullback after last week's surge.
Whereas last week the earnings reports moved the markets, this week the economic data will assuredly be the driving force. Now is definitely a time to be on your toes and be ready to shift the composition of your portfolio. Last week I took a little off the table as the markets sold off, jobless claims spiked, the VIX jumped, and uncertainty increased around the financials. However, as I wrote in my recent post , the key to accurately gauging the health of the economy and the stock market is to following the economic reports and earnings data.
The uptrend lines on many charts were broken last week and bearish long-term MACD crossovers abound on many charts - from the FOREX market to the DJIA. The U.S. dollar looks poised to strengthen in the coming weeks, though it is due for a pullback after last week's surge.
Thursday, January 21, 2010
Obama's Proposal to Place Restrictions on Banks
From thewhitehouse.gov:
the financial firms themselves taking part in these trading operations in the first place! Of course, there is a lot of uncertainty about how liquidity would be affected, but it's clear this proposal would not increase it by any means.
The second part is a little more tricky. As for limiting the size of banks, the government cannot regulate the leverage, liabilities, and risk-taking of the banks better than the banks can, as long as the banks know they won't receive a bailout. The problem then becomes creating an environment in which no bank is "too big to fail." How do you do this? In this environment, I would like to know. I'd also like to know what the ramifications would have been were the government to let a bigger bank, such as a Citi or BoA fail, and further, whether they actually would have failed had the government not intervened. It's a shame we can't know the results both ways. There is no question that the government's intervention ultimately had a positive impact on the markets in the short-term, but the longer-term consequences have yet to be seen.
Ultimately, it seems like there is little support right now for this proposal and I highly doubt it will get passed.
My take: Limiting the proprietary trading operations, hedge-funds, and private equity funds could subsequently lower liquidity in the markets. The one thing that has irked me throughout this whole crisis is how much bad press trading operations receive. People sometimes lose sight of the vital role traders play in our economy --> they provide a market and they increase liquidity. Higher liquidity levels result in lower costs of borrowing for firms and increase the financial efficiency of our economy. Instead of highlighting these positives, the press focuses on their "excessive risk-taking" and their "risky bets fueled by greed." If this proposal were to pass, and that's a big if, then the subsequent fall in liquidity could pose a larger risk than1. Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.
2. Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.
the financial firms themselves taking part in these trading operations in the first place! Of course, there is a lot of uncertainty about how liquidity would be affected, but it's clear this proposal would not increase it by any means.
The second part is a little more tricky. As for limiting the size of banks, the government cannot regulate the leverage, liabilities, and risk-taking of the banks better than the banks can, as long as the banks know they won't receive a bailout. The problem then becomes creating an environment in which no bank is "too big to fail." How do you do this? In this environment, I would like to know. I'd also like to know what the ramifications would have been were the government to let a bigger bank, such as a Citi or BoA fail, and further, whether they actually would have failed had the government not intervened. It's a shame we can't know the results both ways. There is no question that the government's intervention ultimately had a positive impact on the markets in the short-term, but the longer-term consequences have yet to be seen.
Ultimately, it seems like there is little support right now for this proposal and I highly doubt it will get passed.
Analysis on the Current State of Markets
The past two days in the stock market have been marked by volatility and uneasiness. The VIX is up 16% as I write this and the Dow is down more than 200 points. For those of you who have followed some of my previous posts, I often comment on the jobless claims number. Today, the number came in at 482k, easily surpassing the upper end of the consensus range and pointing to a halt in the improvement in the labor market. In fact, this was the first week (out of the past 19) that the 4-week moving average did not fall.
Earnings have been better than expected across the board, with some uneasiness about the mortgage/credit loan losses that the banks reported. Later tonight I'll have an analysis of Obama's proposal for the banks and limiting risk.
Despite the market sell-off it is IMPERATIVE to continue following the trend in earnings and economic data. This is the best way to gauge the future direction of the market and the health of the economy. No matter what direction the psychological participants push the market, the ultimate, long-run determinant is influenced the most by economic and earnings data. So far, this data has been largely positive, with the exception of today's higher jobless claims numbers and the sticky unemployment rate above 10%.
I'll be following every bit of economic data that's released in the following weeks to determine whether this recent sell-off is representative of a change in the trend of of the economy. My instinct and expectation is that the market is currently pricing in negative economic news that has yet to come. Further, there is no doubt the market is digesting Obama's proposal for banks and is pulling-back after a near 65% recovery from market lows. Below is the jobless claims chart from econoday.
Earnings have been better than expected across the board, with some uneasiness about the mortgage/credit loan losses that the banks reported. Later tonight I'll have an analysis of Obama's proposal for the banks and limiting risk.
Despite the market sell-off it is IMPERATIVE to continue following the trend in earnings and economic data. This is the best way to gauge the future direction of the market and the health of the economy. No matter what direction the psychological participants push the market, the ultimate, long-run determinant is influenced the most by economic and earnings data. So far, this data has been largely positive, with the exception of today's higher jobless claims numbers and the sticky unemployment rate above 10%.
I'll be following every bit of economic data that's released in the following weeks to determine whether this recent sell-off is representative of a change in the trend of of the economy. My instinct and expectation is that the market is currently pricing in negative economic news that has yet to come. Further, there is no doubt the market is digesting Obama's proposal for banks and is pulling-back after a near 65% recovery from market lows. Below is the jobless claims chart from econoday.
Tuesday, January 19, 2010
Euro hits 4-month low
The Euro just hit a 4-month low against the USD on Greece's debt concerns. It looks like it can drop further. Here's the article from Bloomberg.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aTlPpu2CgJsg&pos=2
Recall that on Dec. 8, Fitch downgraded Greece's debt on concerns about an uncontrollable budget deficit. Greece has the 33rd largest GDP in the world.
Here's a chart of the EUR/USD.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aTlPpu2CgJsg&pos=2
Recall that on Dec. 8, Fitch downgraded Greece's debt on concerns about an uncontrollable budget deficit. Greece has the 33rd largest GDP in the world.
Here's a chart of the EUR/USD.
Useful Links
Here are some useful sources that I check frequently in order to grasp an understanding of what's going on in the markets.
Flow of Funds Report - The most undervalued report on economics
http://www.federalreserve.gov/releases/z1/Current/z1.pdf
Federal Reserve of San Francisco Research - Most undervalued website on economics: Provides amazing research.
http://www.frbsf.org/
Global Economic Calendar - Major economic releases in each country, links to those reports, and analysis. This link is useful for FOREX traders.
http://www.forexfactory.com/calendar.php
U.S. Economic Calendar - I check this daily. You should too.
http://fidweek.econoday.com/
World Interest Rate Table
http://www.fxstreet.com/fundamental/interest-rates-table/
Dow Jones Futures - This site contains most of the futures numbers for a variety of indices. The link is to the DJ Futures. Note that futures data can be obtained on a variety of sites, from cnbc.com to wsj.com
http://futuresource.quote.com/markets/market.jsp?id=index&s=QDJ
Bureau of Labor Statistics - The BLS provides many of the major economic reports and has extremely insightful articles.
http://www.bls.gov/
Economist Intelligence Unit - Comparative Country Analysis and Data
http://www.eiu.com/index.asp?rf=0
American Institute for Economic Research - Great analysis on some of the more pressing issues in economics.
http://www.aier.org/
Earnings Calendar - Everything you need to know about upcoming earnings reports, conference calls, and dividends.
http://www.earnings.com/highlight.asp?date=20100120&client=cb
NEWS SOURCES:
I'm an avid reader of both the Wall Street Journal and the Economist. You may need a subscription to access the articles on the sites. I recommend you get one if you don't already have it because they have the best synopses and analyses of market action.
http://www.economist.com/
http://online.wsj.com/home-page
BLOGS:
I follow mainly three blogs, all on economics/finance/politics.
http://krugman.blogs.nytimes.com/
http://mjperry.blogspot.com/
http://www.calculatedriskblog.com/
Hope this helps with your investments.
-dg
Flow of Funds Report - The most undervalued report on economics
http://www.federalreserve.gov/releases/z1/Current/z1.pdf
Federal Reserve of San Francisco Research - Most undervalued website on economics: Provides amazing research.
http://www.frbsf.org/
Global Economic Calendar - Major economic releases in each country, links to those reports, and analysis. This link is useful for FOREX traders.
http://www.forexfactory.com/calendar.php
U.S. Economic Calendar - I check this daily. You should too.
http://fidweek.econoday.com/
World Interest Rate Table
http://www.fxstreet.com/fundamental/interest-rates-table/
Dow Jones Futures - This site contains most of the futures numbers for a variety of indices. The link is to the DJ Futures. Note that futures data can be obtained on a variety of sites, from cnbc.com to wsj.com
http://futuresource.quote.com/markets/market.jsp?id=index&s=QDJ
Bureau of Labor Statistics - The BLS provides many of the major economic reports and has extremely insightful articles.
http://www.bls.gov/
Economist Intelligence Unit - Comparative Country Analysis and Data
http://www.eiu.com/index.asp?rf=0
American Institute for Economic Research - Great analysis on some of the more pressing issues in economics.
http://www.aier.org/
Earnings Calendar - Everything you need to know about upcoming earnings reports, conference calls, and dividends.
http://www.earnings.com/highlight.asp?date=20100120&client=cb
NEWS SOURCES:
I'm an avid reader of both the Wall Street Journal and the Economist. You may need a subscription to access the articles on the sites. I recommend you get one if you don't already have it because they have the best synopses and analyses of market action.
http://www.economist.com/
http://online.wsj.com/home-page
BLOGS:
I follow mainly three blogs, all on economics/finance/politics.
http://krugman.blogs.nytimes.com/
http://mjperry.blogspot.com/
http://www.calculatedriskblog.com/
Hope this helps with your investments.
-dg
Monday, January 18, 2010
The Week Ahead: 1/19 - 1/22
This shortened 4-day trading week will be sure to pack as much volatility and volume as a 5-day week.
For economic news, we have the Bank of Canada rate statement tomorrow morning, U.S. PPI and Housing Starts Wednesday, and Jobless Claims / Philly Fed Survey on Friday.
However, the real focus this week will be on the slew of earnings reports. The following companies report earnings this week. For a full list, visit http://biz.yahoo.com/research/earncal/20100122.html .
Tuesday: Citigroup, IBM
Wednesday: Bank of America (BAC), Ebay, Morgan Stanley (MS), Wells Fargo & Co. (WFC), and US Bancorp (USB).
Thursday: Google (GOOG), and Goldman Sachs (GS)
Friday: General Electric (GE) and McDonalds (MCD)
Undoubtedly, the market will be focusing on any consumer credit and mortgage losses that the financials report. Since J.P. Morgan's results were overshadowed by negativities in these two areas, the market will be eagerly looking for confirmatory/counter signals from other companies.
Many analysts think credit card loan losses could be the next area in the economy that sees severe losses. This week should shed some light on that hypothesis. Keep your eyes peeled this week because it could illuminate an inflection point that may merit changes in your portfolio.
For economic news, we have the Bank of Canada rate statement tomorrow morning, U.S. PPI and Housing Starts Wednesday, and Jobless Claims / Philly Fed Survey on Friday.
However, the real focus this week will be on the slew of earnings reports. The following companies report earnings this week. For a full list, visit http://biz.yahoo.com/research/earncal/20100122.html .
Tuesday: Citigroup, IBM
Wednesday: Bank of America (BAC), Ebay, Morgan Stanley (MS), Wells Fargo & Co. (WFC), and US Bancorp (USB).
Thursday: Google (GOOG), and Goldman Sachs (GS)
Friday: General Electric (GE) and McDonalds (MCD)
Undoubtedly, the market will be focusing on any consumer credit and mortgage losses that the financials report. Since J.P. Morgan's results were overshadowed by negativities in these two areas, the market will be eagerly looking for confirmatory/counter signals from other companies.
Many analysts think credit card loan losses could be the next area in the economy that sees severe losses. This week should shed some light on that hypothesis. Keep your eyes peeled this week because it could illuminate an inflection point that may merit changes in your portfolio.
Friday, January 15, 2010
Insights from a Value Investment Seminar
Last night I attended a value investment seminar sponsored by our School of Business here at Villanova. Here were some things I picked up on investing from our speaker:
1.) Look for small-cap companies that are unfavored and have little/no analyst coverage. These companies often have wide discrepancies between their stock price and intrinsic value.
2.) Look for companies with significant insider ownership so that the interests of managers are aligned with those shareholders.
3.) One of the most important metrics to look at when evaluating a company is cash flow/share.
4.) Spin-offs are a classic case to find undervalued companies because companies tend to spin-off underperforming businesses. Once this underperforming business is spun-off, however, managers can freely reinvest as much of their earnings as they want into their specific niche segment and control the amount of capital spending. Thus, the economics of the business can completely change. Further, managers are determined to show their previous firm they can be successful.
5.) The best value investors in the world are your mothers. They continuously filter through coupon books, spend time finding the best deals online, and have an innate understanding of the value of an item. Thus, they know a good price when they see one.
1.) Look for small-cap companies that are unfavored and have little/no analyst coverage. These companies often have wide discrepancies between their stock price and intrinsic value.
2.) Look for companies with significant insider ownership so that the interests of managers are aligned with those shareholders.
3.) One of the most important metrics to look at when evaluating a company is cash flow/share.
4.) Spin-offs are a classic case to find undervalued companies because companies tend to spin-off underperforming businesses. Once this underperforming business is spun-off, however, managers can freely reinvest as much of their earnings as they want into their specific niche segment and control the amount of capital spending. Thus, the economics of the business can completely change. Further, managers are determined to show their previous firm they can be successful.
5.) The best value investors in the world are your mothers. They continuously filter through coupon books, spend time finding the best deals online, and have an innate understanding of the value of an item. Thus, they know a good price when they see one.
Sold GBP/USD at 1.6224, for 105 pip profit
I just sold my GBP/USD position for a 105 pip profit. I believe there is more downside in this currency pair in the coming week but I exited mainly because of the oversold conditions of the shorter time-frame charts. I'm expecting a fairly substantial bounce from my selling point and I may consider re-entering sometime early next week. Here's a 15 minute chart.
Thursday, January 14, 2010
Short GBP/USD at 1.6329
I recently established a short GBP / long USD position, mostly based on technical analysis indicators. The MACD indicators in the GBP/USD are overbought on the 4hr, 2hr, and 15 minute charts. Further, the chart is right at the neckline on a head & shoulders pattern on the daily chart. The blue line on the chart below represents my entry point, and coincidently, is the neckline of the head and shoulders. The red line is my stop loss order. Aside from tomorrow's CPI numbers, no relevant economic data is coming out in either country. However, I do expect the CPI to move the currency market tomorrow, so I'll be closely watching it tomorrow. I expect to be out of this position by tomorrow afternoon.
Overbought on the 4hr
Wednesday, January 13, 2010
Stock Market Focus for Tomorrow, 1/13/10
Tomorrow I'll be focusing on Retail Sales and Jobless Claims. Retail Sales are estimated to come in at .4% MoM growth after a 1.3% surge in November. New motor vehicle sales and rising gasoline prices lead me to believe this .4% number will be beat tomorrow.
On the jobless claims side, the consensus estimate is at 437k. Expect the 4-week moving average to continue its downward descent, which would mark the 19th straight decline.
I'll also closely be watching Intel's earnings report which comes out after the bell tomorrow. This report should serve as a good indicator as to what direction the market will be moving in on Friday and specifically how the big-cap tech names will fare.
Here are the two charts for retail sales and jobless claims, both coming from http://fidweek.econoday.com/ .
On the jobless claims side, the consensus estimate is at 437k. Expect the 4-week moving average to continue its downward descent, which would mark the 19th straight decline.
I'll also closely be watching Intel's earnings report which comes out after the bell tomorrow. This report should serve as a good indicator as to what direction the market will be moving in on Friday and specifically how the big-cap tech names will fare.
Here are the two charts for retail sales and jobless claims, both coming from http://fidweek.econoday.com/ .
Tuesday, January 12, 2010
The Power of Compounding
I was playing around with a financial calculator tonight and wanted to shed some light on some pretty neat results about compounding and investing.
A $10,000 investment with a 15% rate of return will grow to $40,455 in 10 years.
If held for 50 years, that $10,000 would grow to $10,836,574.
Now here's the cool part. If you can earn just a 1% higher rate of return per year, the dollar change in your investment becomes increasingly profound over time.
For instance, if held for 50 years, $10,000 with a 16% rate of return will grow to $16,707,038 or about $6 million more than if it was earning 15% per year.
A $10,000 investment with a 15% rate of return will grow to $40,455 in 10 years.
If held for 20 years, that $10,000 would grow to $163,665.
If held for 50 years, that $10,000 would grow to $10,836,574.
Now here's the cool part. If you can earn just a 1% higher rate of return per year, the dollar change in your investment becomes increasingly profound over time.
For instance, if held for 50 years, $10,000 with a 16% rate of return will grow to $16,707,038 or about $6 million more than if it was earning 15% per year.
Moral of the story? Do everything you can to get that extra % point!!
HKX9J4JFKFVD
The Sharpe Ratio
The Sharpe Ratio is a measure of excess return over risk. In a portfolio context, excess return is equal to the return on the portfolio minus the risk-free rate. Risk is measured as the standard deviation of those returns. Thus, the formula is ( Rp - Rf ) / SD, where Rp = return on the portfolio, Rf = risk-free rate, and SD = standard deviation. The risk-free rate is generally the rate on 10-year Treasury bonds.
In my opinion, all investors should track their returns and calculate their Sharpe ratios fairly often. It's an important gauge of whether your returns stem from excessive risk or intelligent investing. In the hedge-fund community, managers are constantly attune to their Sharpe ratios. The best Global Macro funds generally have Sharpe ratios in the range of 1-2, while the S&P is usually below .5, depending on the time-frame. Global Macro funds can generally achieve such high Sharpe ratios because they have the latitude to invest in diverse asset classes, such as commodities, currencies, real estate, stocks, and bonds. Thus, they can achieve low correlation between their investments and minimize their risk. This, in my opinion, is an amazing competitive advantage and it's surprising that only 8% of hedge funds pursue a Global Macro strategy, according to Stefanini's Investment Strategies of Hedge Funds (The Wiley Finance Series)
.
In my opinion, all investors should track their returns and calculate their Sharpe ratios fairly often. It's an important gauge of whether your returns stem from excessive risk or intelligent investing. In the hedge-fund community, managers are constantly attune to their Sharpe ratios. The best Global Macro funds generally have Sharpe ratios in the range of 1-2, while the S&P is usually below .5, depending on the time-frame. Global Macro funds can generally achieve such high Sharpe ratios because they have the latitude to invest in diverse asset classes, such as commodities, currencies, real estate, stocks, and bonds. Thus, they can achieve low correlation between their investments and minimize their risk. This, in my opinion, is an amazing competitive advantage and it's surprising that only 8% of hedge funds pursue a Global Macro strategy, according to Stefanini's Investment Strategies of Hedge Funds (The Wiley Finance Series)
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RSS Feeder
Hey everyone,
I just put up an RSS feeder icon that's located on the right-hand side of the website. The icon is the orange square. By subscribing to my feed, you can organize all my posts into a reader and pick and choose which ones you want to read in a customizable, easy-to-use format.
-dg
I just put up an RSS feeder icon that's located on the right-hand side of the website. The icon is the orange square. By subscribing to my feed, you can organize all my posts into a reader and pick and choose which ones you want to read in a customizable, easy-to-use format.
-dg
Monday, January 11, 2010
ETFs - Diversifying, Arbitraging, and Making Money
This post will outline, in-depth, how you can make money shorting two inverse, levered ETFs. I also propose that left unchanged, institutions that issue these ETFs will come under close scrutiny because of an inherent flaw in the compounding mathematics behind which these ETFs track an index. I can almost guarantee that those of you who read through this whole post will understand ETFs on a much deeper level and understand why levered ETFs represent an incredibly uncovered arbitraging opportunity. The breadth of this post will discuss this arbitrage opportunity, which any investor can achieve if he is able to short-sell securities. First, I'll discuss the major benefit of investing in ETFs and why ultimately, unlevered ETFs are here to stay.
Diversification: An ETF is a basket of securities that give you cheap exposure to a certain industry, country, or index. By only paying one commission fee to own a little bit of multiple companies, ETFs provide a cheap method to get broad exposure. Further, through ETFs, investors are able to expose themselves to countries or asset classes that would have been near impossible otherwise. In this sense, ETFs allow investors to diversify their portfolios more efficiently and effectively. However, investors need to be wary of levered ETFs.
And now FAZ...
Notice how in the long-run, both ETFs are lower than their original price when they first hit market. In other words, both are in a downtrend. How could this be if one is the inverse of the other and they should move in opposite directions? The answer lies in a concept called volatility decay. Volatility decay occurs because these levered ETFs track the daily movement of an index, which means the compounding and ultimately the trend in price, differs drastically than the index over time. This video with an ETF analyst describes this volatility decay process very well.
Diversification: An ETF is a basket of securities that give you cheap exposure to a certain industry, country, or index. By only paying one commission fee to own a little bit of multiple companies, ETFs provide a cheap method to get broad exposure. Further, through ETFs, investors are able to expose themselves to countries or asset classes that would have been near impossible otherwise. In this sense, ETFs allow investors to diversify their portfolios more efficiently and effectively. However, investors need to be wary of levered ETFs.
Arbitraging: Levered ETFs are those that track 2x or 3x the daily movement of a certain index. For instance, many investors may be familiar with FAS or FAZ, which move 3x that of the Russell 1000 Financials Index on a day-to-day basis. FAS is the inverse of FAZ, meaning when the Russell 1000 Financials move up, FAS moves up three times that and FAZ moves down three times that. When the Russell goes up 2% on a particular day, FAS goes up 6% and FAZ goes down 6%.
Let’s start our analysis by looking at two long-term charts – one of FAS and the other of FAZ.
To make money from this phenomenon, you can short both ETFs and profit from the volatility decay. If you’re willing to hold the ETFs long enough, you can reap large gains. I have shorted both the FAS and the FAZ ETFs and have profited greatly, just from the volatility decay. Bearing reverse splits, in the long-run these levered ETFs tend to approach zero. There are a few key risks to be aware of when considering this trade.
1.) ETFs reach zero faster through more leverage and through more volatility in the markets. A 3x ETF reaches zero faster than a 2x ETF. Further, the more up and downs the market experiences, the faster the ETF reaches zero. A good gauge of how volatile the markets are is to observe the trend in the VIX market. If the VIX market spikes up, this ETF trade becomes very attractive.
2.) There is a risk that the long ETF more than doubles in value, which could possibly outweigh any gains you’ve made in shorting the short ETF, depending upon the time frame. To offset this, I would consider using leverage in shorting the short ETF.
3.) There is a risk that the prospectus on these levered ETFs changes and the companies that issue them may decide to track the index in a different manner.
4.) There is a risk that your broker does not allow you to short both ETFs. I’ve tried shorting a few levered ETFs before with my broker, but I was not allowed to.
All in all, this trade seems incredibly easy and profitable. As long as the markets move up and down, this trade should pan out in the long-run. Of course, I could be missing something and as I wrote on my last post, I should seek out facts and opinions that point this trade towards failing. If anyone sees a flaw in this trade, I’d love to hear your thoughts.
I believe firms will continue to issue ETFs because there is a demand for those who are looking to hedge their risks in the short-run. More importantly, the fees from these ETFs are too huge to ignore. At the very least, I foresee many institutions making the prospectus more clear and understandable in order to protect the investor. I wouldn’t be surprised if the government took a role in regulating these ETFs or establishing some standards of behavior.
Whatever happens, as long as these levered ETFs compound daily, take the ride and profit from the volatility decay.
Confirmation Bias and Trading
According to Science Daily, confirmation bias is "a tendency to search for or interpret information in a way that confirms one's preconceptions." This is a dangerous trap to fall into while trading or investing.
When considering an investment or even trying to justify an already-made investment, people often try to seek the opinions and data that confirm their investment thesis. For instance, if one makes an investment in a Chinese Solar company, they may only seek data that confirms how China is growing rapidly, energy prices are rising, and the Chinese government is subsidizing the development of solar farms throughout the country. By focusing only on the positives, they may ignore looming negatives that could change their thesis or give them reason to sell. For instance, the valuations on the company may be exorbitantly high or management may not be acting in the best interest of their shareholders - thus, this may be reason to sell, but the investor has missed it or decided to ignore it completely.
When considering an investment or even trying to justify an already-made investment, people often try to seek the opinions and data that confirm their investment thesis. For instance, if one makes an investment in a Chinese Solar company, they may only seek data that confirms how China is growing rapidly, energy prices are rising, and the Chinese government is subsidizing the development of solar farms throughout the country. By focusing only on the positives, they may ignore looming negatives that could change their thesis or give them reason to sell. For instance, the valuations on the company may be exorbitantly high or management may not be acting in the best interest of their shareholders - thus, this may be reason to sell, but the investor has missed it or decided to ignore it completely.
To weigh the accuracy and strength of one's investment, it's imperative for one to seek both the positives and negatives. By focusing on the negatives, an investor avoids the confirmation bias and can develop into a more independent, confident, and analytical investor. Further, a focus on the negatives can help you zone in on what the company needs to improve upon in the future.
Before implementing his multi-billion dollar trades in the subprime market, John Paulson sought out opinions on WHY his investment thesis would not pan out. He asked analysts all across the country, why will buying insurance on CDS's fail? Why will the housing market bubble not burst? After hearing the opinions of those on the opposite side of his trade, Paulson's original investment thesis was strengthened, he knew what to look for, and he became ever more confident in his wildly successful trade.
Sunday, January 10, 2010
The Production Might of China
Here are some interesting statistics from The Economist's "Pocket World in Figures".
China is the largest producer of meat, vegetables, fruit, cereals, wheat, rice, tea, lead, zinc, aluminum, coal, cotton, and oil in the world.
It leads the world in agricultural output, with twice that of India's.
It is the 4th largest producer of sugar, rubber, and gold. It is the 2nd largest producer of course grains, tin, and raw wool.
The production might of China is real and here to stay. I can only speculate how the diplomatic relations between the U.S. and China will clash and collide as the size of the two economies closely approach each other. However, unless China unleashes the full potential of a free-market capitalist system, the U.S. will always have the upper-hand. Although the size of their economy may one day surpass the U.S. on the backs of a population 4x that of the U.S., our standards of living will always overshadow China's.
In my opinion, the innovate spirit of American scientists, engineers, economists, entrepreneurs, businessmen, teachers, and all else cannot be overcome.
China is the largest producer of meat, vegetables, fruit, cereals, wheat, rice, tea, lead, zinc, aluminum, coal, cotton, and oil in the world.
It leads the world in agricultural output, with twice that of India's.
It is the 4th largest producer of sugar, rubber, and gold. It is the 2nd largest producer of course grains, tin, and raw wool.
The production might of China is real and here to stay. I can only speculate how the diplomatic relations between the U.S. and China will clash and collide as the size of the two economies closely approach each other. However, unless China unleashes the full potential of a free-market capitalist system, the U.S. will always have the upper-hand. Although the size of their economy may one day surpass the U.S. on the backs of a population 4x that of the U.S., our standards of living will always overshadow China's.
In my opinion, the innovate spirit of American scientists, engineers, economists, entrepreneurs, businessmen, teachers, and all else cannot be overcome.
The Week Ahead: 1/11 - 1/15/10
This upcoming week doesn't have too many economic or earnings releases, so the market may move on some spurious developments as the week progresses.
For economic releases, International Trade comes out on Tuesday, Retail Sales and Jobless Claims on Thursday, and CPI, Industrial Production, and Consumer Sentiment come out on Friday. For a great economic calendar with upcoming economic releases, analysis, consensus estimates, and reports, go to http://fidweek.econoday.com/ . I have this website bookmarked and visit it daily.
As for important earnings releases, Alcoa (AA) reports Monday, KB Home (KBH) reports Tuesday, Intel (INTC) reports Thursday, and JP Morgan (JPM) reports Friday. Check out www.earnings.com for upcoming earnings releases.
In the FOREX market, I'll be keeping a close watch on the AUD/USD and the USD/CAD. Both the CAD and AUD are close to making one-year highs against the USD and I may establish positions in these two throughout the week.
What are you focusing on next week? Comment below!
For economic releases, International Trade comes out on Tuesday, Retail Sales and Jobless Claims on Thursday, and CPI, Industrial Production, and Consumer Sentiment come out on Friday. For a great economic calendar with upcoming economic releases, analysis, consensus estimates, and reports, go to http://fidweek.econoday.com/ . I have this website bookmarked and visit it daily.
As for important earnings releases, Alcoa (AA) reports Monday, KB Home (KBH) reports Tuesday, Intel (INTC) reports Thursday, and JP Morgan (JPM) reports Friday. Check out www.earnings.com for upcoming earnings releases.
In the FOREX market, I'll be keeping a close watch on the AUD/USD and the USD/CAD. Both the CAD and AUD are close to making one-year highs against the USD and I may establish positions in these two throughout the week.
What are you focusing on next week? Comment below!
Saturday, January 9, 2010
Investing in Australia
Australia is becoming an increasingly attractive investment. Their economy has been boosted in part through rising commodity prices, allowing Australia to reap higher export earnings through shipments of iron ore, coal, and gold. Their economy was hardly impacted by the credit crisis and the Reserve Bank of Australia was one of the first major central banks to raise interest rates, which currently stand at 3.75%.
Australia has also benefited from the rapid growth of China, who is their second largest export-partner only behind Japan, according to the CIA World Factbook. Other major export-partners include South Korea and India. Perhaps the most attractive aspect of investing in Australia, as opposed to China, is the lower political risk factor and the floating exchange rate. The actions of the Chinese government are largely unpredictable and cast a further cloud of risk over Chinese-related investments. Further, the Chinese yuan is tightly pegged to the value of the USD, while the Australian dollar is a floating currency and has appreciated rapidly in recent years. A rising Australian currency will further add to your investment returns when they get reported back to the weaker USD. Chinese investments cannot claim the same advantage.
To get exposure to Australia, look at the ETF, EWA, whose 6-month chart is shown below.
A 1-year chart of the AUD/USD is shown below.
What are your thoughts on foreign investing? Which countries do you think look attractive? Comment below! I'd love to hear your opinions.
Australia has also benefited from the rapid growth of China, who is their second largest export-partner only behind Japan, according to the CIA World Factbook. Other major export-partners include South Korea and India. Perhaps the most attractive aspect of investing in Australia, as opposed to China, is the lower political risk factor and the floating exchange rate. The actions of the Chinese government are largely unpredictable and cast a further cloud of risk over Chinese-related investments. Further, the Chinese yuan is tightly pegged to the value of the USD, while the Australian dollar is a floating currency and has appreciated rapidly in recent years. A rising Australian currency will further add to your investment returns when they get reported back to the weaker USD. Chinese investments cannot claim the same advantage.
To get exposure to Australia, look at the ETF, EWA, whose 6-month chart is shown below.
(Chart taken from BigCharts.com)
A 1-year chart of the AUD/USD is shown below.
(Chart taken from finance.yahoo.com)
What are your thoughts on foreign investing? Which countries do you think look attractive? Comment below! I'd love to hear your opinions.
Friday, January 8, 2010
Failing Unconventionally on Wall Street
In Glen Arnold's book, The Financial Times Guide to Value Investing: How to Become a Disciplined Investor (2nd Edition)
, Arnold discusses how failing unconventionally on Wall Street can cause you to lose your job while the consequences of failing conventionally are minimal. As he put it, "No one will fire you for buying IBM." You get into trouble when you lose money going against the crowd and failing - whether its trading in unfavored small-cap stocks with low liquidity or trading in exotic instruments that few understand.
So how often do you outperform trading in the conventional, popular stocks? Rarely. The bottom line is people can survive on Wall Street through following popular opinion and succumbing to mediocrity. Equity analysts and economists who forecast stock prices or trends in the economy tend to cluster their predictions towards some mean value. It's rare to see the brave analyst who steps outside of that cluster and becomes the outlier, sitting by him or herself. The fate of those who do make extreme calls falls into two categories: stardom or defeat.
Meredith Whitney's career has skyrocketed after accurately upgrading and downgrading financial stocks in the midst of the crisis. The 90% of the other analysts who missed the signs, however, clustered around a mean and were safe in their protective cushion. They all get it wrong and how can you fire all of them? The ones who got fired were the ones who lied on the other extreme, upgrading stocks at exactly the wrong time when the 90% had hold ratings.
Although the equity analysts are just one example that I may have taken it to an extreme, most asset managers know they are at risk of massive withdrawals and possible closure of funds if they fail unconventionally. My question is as follows: Is this the correct type of environment to have in Wall Street's financial firms? Is it acceptable to have mutual fund managers rush in to buying Google at the end of the quarter just so they could claim it was in their portfolio? In my opinion, the threat of losing your job is a big incentive to accept mediocrity but it eliminates the creative spark necessary to take advantage of opportunities in the market. On the other hand, this type of pressure is a form of risk-control to ensure people don't step out of line and recklessly lose client's money. If I'm ever fortunate enough to work in asset management for a financial firm, I'll be forced to wait for the perfect opportunity to make a contrarian move where I know I'm absolutely right but if it that opportunity never presents itself, well, I'll just be a number in the averages.
, Arnold discusses how failing unconventionally on Wall Street can cause you to lose your job while the consequences of failing conventionally are minimal. As he put it, "No one will fire you for buying IBM." You get into trouble when you lose money going against the crowd and failing - whether its trading in unfavored small-cap stocks with low liquidity or trading in exotic instruments that few understand.So how often do you outperform trading in the conventional, popular stocks? Rarely. The bottom line is people can survive on Wall Street through following popular opinion and succumbing to mediocrity. Equity analysts and economists who forecast stock prices or trends in the economy tend to cluster their predictions towards some mean value. It's rare to see the brave analyst who steps outside of that cluster and becomes the outlier, sitting by him or herself. The fate of those who do make extreme calls falls into two categories: stardom or defeat.
Meredith Whitney's career has skyrocketed after accurately upgrading and downgrading financial stocks in the midst of the crisis. The 90% of the other analysts who missed the signs, however, clustered around a mean and were safe in their protective cushion. They all get it wrong and how can you fire all of them? The ones who got fired were the ones who lied on the other extreme, upgrading stocks at exactly the wrong time when the 90% had hold ratings.
Although the equity analysts are just one example that I may have taken it to an extreme, most asset managers know they are at risk of massive withdrawals and possible closure of funds if they fail unconventionally. My question is as follows: Is this the correct type of environment to have in Wall Street's financial firms? Is it acceptable to have mutual fund managers rush in to buying Google at the end of the quarter just so they could claim it was in their portfolio? In my opinion, the threat of losing your job is a big incentive to accept mediocrity but it eliminates the creative spark necessary to take advantage of opportunities in the market. On the other hand, this type of pressure is a form of risk-control to ensure people don't step out of line and recklessly lose client's money. If I'm ever fortunate enough to work in asset management for a financial firm, I'll be forced to wait for the perfect opportunity to make a contrarian move where I know I'm absolutely right but if it that opportunity never presents itself, well, I'll just be a number in the averages.
Demystifying the Unemployment Report
Today's unemployment report showed the unemployment rate came in at 10.0% for the month of December, unchanged from last month. This report contained a mix of good and bad news. On the bad side, nonfarm payrolls fell 85,000, which was outside the low end of the consensus range, suggesting a pretty big miss. This was largely due to an unexpected decline in government nonfarm payrolls of 21,000. Many economists predicted government hiring to be positive. The worst part about this report, however, was the number of discouraged workers - those who left the labor force because they gave up in looking for a job. This number came in at 929,000, up 44.7% from last year.
These discouraged workers are keeping the unemployment rate down because they are shrinking the labor force. If these workers stay discouraged, it's possible our total labor force will be smaller than before the recession even if the unemployment rate comes down. The chart below (taken from bls.gov) shows how the number of discouraged workers tends to stay elevated for sometime, even after a recession. Including all discouraged workers in the labor force, the unemployment report would have came in at 10.5%
The good news in this report was the 47,000 increase in temp hirings. Temp hirings, like jobless claims, are a leading indicator about the future health of the labor market because firms tend to hire temporary workers coming out of a recession before they offer full-time positions.
Many people seem to believe in the "jobless recovery" idea, in which firms will refrain from hiring this time around because they'll boost productivity instead. From what I've seen in the data, jobless recoveries are fleeting and are just a cyclical effect. In other words, its common for productivity to spike up coming out of a recession and then come down as the recovery takes its course. Firms cannot rely on productivity gains through cost cutting for the long-term. As the economy heats up they'll be forced to hire more workers to meet increases in demand.
These discouraged workers are keeping the unemployment rate down because they are shrinking the labor force. If these workers stay discouraged, it's possible our total labor force will be smaller than before the recession even if the unemployment rate comes down. The chart below (taken from bls.gov) shows how the number of discouraged workers tends to stay elevated for sometime, even after a recession. Including all discouraged workers in the labor force, the unemployment report would have came in at 10.5%
The good news in this report was the 47,000 increase in temp hirings. Temp hirings, like jobless claims, are a leading indicator about the future health of the labor market because firms tend to hire temporary workers coming out of a recession before they offer full-time positions.
Many people seem to believe in the "jobless recovery" idea, in which firms will refrain from hiring this time around because they'll boost productivity instead. From what I've seen in the data, jobless recoveries are fleeting and are just a cyclical effect. In other words, its common for productivity to spike up coming out of a recession and then come down as the recovery takes its course. Firms cannot rely on productivity gains through cost cutting for the long-term. As the economy heats up they'll be forced to hire more workers to meet increases in demand.
Thursday, January 7, 2010
Preservation of Capital and Timing are Everything
It's interesting that the rule, "Never lose money" is so often repeated by Buffet. It's obvious to everyone that the point of investing is to make money, so why does this quote appear in all forms of investment media?
The quote's wisdom lies in the law of percentage changes in stock prices. Very simply, if your portfolio goes from $100 to $50, you have a 50% loss. In order to recuperate this loss, however, you need a $50gain/$50original value = 100% gain, which is an extraordinary achievement no matter how large an amount your investing. The more you lose, the more of a percentage gain you have to obtain to break even. A 75% loss requires a 200% return to get back to your peak portfolio value, or "high-water mark". Thus, the less money you lose, the less of an extraordinary gain you have to achieve to get back to where you started.
Most active investors, in my opinion, intuitively understand this concept. Where traders/investors go wrong however, is by taking on dangerous risks to get back to your peak portfolio value. An extension to this rule is, "Never take on excessive risk in hopes of getting back to even." This is a mistake I've made and I'm sure all active traders have made it at one point in time. If you do this enough times, you'll go from a 50% loss to a 100% loss and be broke. I'd love to hear everyone's thoughts and stories on this, so please comment below if you've ever butted heads or learned to embrace this concept.
The second trading tip I would like to talk about is timing and this one is just as obvious as "never lose money", but it gets complicated very quickly. Simply put, incorrectly calling the top or the bottom can put you out of the game. Renowned hedge fund investors Julian Robertson and George Soros retired after suffering huge losses shorting internet stocks too early in the investment bubble, despite irrationally high P/E ratios for companies with no revenues.
There's a vicious psychological cycle at work here as well, especially if you're a value investor. As the asset price reaches larger and larger extremes, your investment looks more and more attractive, but since you entered the trade too early, you've already incurred a substantial loss. Nevertheless, you decide to put more money to work because the bubble is bound to pop soon or the asset price is bound to rise from its depths of hell. However, unless your timing is perfect, you will continue to lose money and you run a huge risk of going broke. As Keynes once said, "The markets can stay irrational longer than you can stay solvent.".
I'm a firm believer that money is to be made by reversion to the mean, in which assets revert to their mean price from their oversold or overbought categories. However, whenever I put one of these trades on (especially in FOREX market), I'm constantly attune to the fact that the asset may continue to move in a direction against me and I often times have to restrain myself from adding more despite the increased attractiveness of the investment. It's true that most people are damn accurate in their investment thesis but they still lose money because their timing is off.
The quote's wisdom lies in the law of percentage changes in stock prices. Very simply, if your portfolio goes from $100 to $50, you have a 50% loss. In order to recuperate this loss, however, you need a $50gain/$50original value = 100% gain, which is an extraordinary achievement no matter how large an amount your investing. The more you lose, the more of a percentage gain you have to obtain to break even. A 75% loss requires a 200% return to get back to your peak portfolio value, or "high-water mark". Thus, the less money you lose, the less of an extraordinary gain you have to achieve to get back to where you started.
Most active investors, in my opinion, intuitively understand this concept. Where traders/investors go wrong however, is by taking on dangerous risks to get back to your peak portfolio value. An extension to this rule is, "Never take on excessive risk in hopes of getting back to even." This is a mistake I've made and I'm sure all active traders have made it at one point in time. If you do this enough times, you'll go from a 50% loss to a 100% loss and be broke. I'd love to hear everyone's thoughts and stories on this, so please comment below if you've ever butted heads or learned to embrace this concept.
The second trading tip I would like to talk about is timing and this one is just as obvious as "never lose money", but it gets complicated very quickly. Simply put, incorrectly calling the top or the bottom can put you out of the game. Renowned hedge fund investors Julian Robertson and George Soros retired after suffering huge losses shorting internet stocks too early in the investment bubble, despite irrationally high P/E ratios for companies with no revenues.
There's a vicious psychological cycle at work here as well, especially if you're a value investor. As the asset price reaches larger and larger extremes, your investment looks more and more attractive, but since you entered the trade too early, you've already incurred a substantial loss. Nevertheless, you decide to put more money to work because the bubble is bound to pop soon or the asset price is bound to rise from its depths of hell. However, unless your timing is perfect, you will continue to lose money and you run a huge risk of going broke. As Keynes once said, "The markets can stay irrational longer than you can stay solvent.".
I'm a firm believer that money is to be made by reversion to the mean, in which assets revert to their mean price from their oversold or overbought categories. However, whenever I put one of these trades on (especially in FOREX market), I'm constantly attune to the fact that the asset may continue to move in a direction against me and I often times have to restrain myself from adding more despite the increased attractiveness of the investment. It's true that most people are damn accurate in their investment thesis but they still lose money because their timing is off.
Grahamite Investing and Callaway Golf (ELY)
Ben Graham's style of investing focused on a company's net current assets, or current assets - total liabilities. If the total market cap is less than net current assets, you may have a potential bargain because it signifies that the company's ongoing business is selling for nothing. I sometimes view net current assets as a company's minimum liquidation value because it subtracts out all debts and other liabilities and leaves you with the current assets left over. As an example, let's look at Callaway Golf - ticker ELY.
Looking at ELY's Q3 2009 balance sheet, ELY has 518mil in current assets and 169mil in total liabilities, giving you a net current asset value of 518-169 = $349mil. At the current price of $8.00, ELY has a market value of $520mil, slightly higher than its net current asset value. At this point, Graham would not be an investor unless some other factor significantly outweighed the high market value. However, back in July, ELY had a stock price of $4.80, providing a market value of $310 million which is less than $349mil. Thus, this would indicate a stock in which further research is required for an investment but from just isolating this data, the stock seems to be priced at a bargain level.
An excellent way of comparing companies is to take what I call the net current asset (NCA) ratio. Simply divide the market value by the NCA to get your NCA ratio. The NCA ratio for ELY is currently $520/$349, or 1.49. Thus, ELY is trading at 1.49x its net current assets. Other competitors of ELY are trading at 5x NCA, meaning ELY is priced at a significant discount to that of its competitors.
I've noticed that different industries have very different NCA ratios. For instance, the average technology company is trading at 8x NCA. You'd be hard-pressed to find a Grahamite investment in the tech space :)
I've read a lot about comparing NCA to market value, but I've never seen it expressed as a ratio. By turning it into a ratio, you streamline the process and can then compare companies and industries that have different values for their net current assets and market caps. (As a full disclosure, I currently own ELY)
Looking at ELY's Q3 2009 balance sheet, ELY has 518mil in current assets and 169mil in total liabilities, giving you a net current asset value of 518-169 = $349mil. At the current price of $8.00, ELY has a market value of $520mil, slightly higher than its net current asset value. At this point, Graham would not be an investor unless some other factor significantly outweighed the high market value. However, back in July, ELY had a stock price of $4.80, providing a market value of $310 million which is less than $349mil. Thus, this would indicate a stock in which further research is required for an investment but from just isolating this data, the stock seems to be priced at a bargain level.
An excellent way of comparing companies is to take what I call the net current asset (NCA) ratio. Simply divide the market value by the NCA to get your NCA ratio. The NCA ratio for ELY is currently $520/$349, or 1.49. Thus, ELY is trading at 1.49x its net current assets. Other competitors of ELY are trading at 5x NCA, meaning ELY is priced at a significant discount to that of its competitors.
I've noticed that different industries have very different NCA ratios. For instance, the average technology company is trading at 8x NCA. You'd be hard-pressed to find a Grahamite investment in the tech space :)
I've read a lot about comparing NCA to market value, but I've never seen it expressed as a ratio. By turning it into a ratio, you streamline the process and can then compare companies and industries that have different values for their net current assets and market caps. (As a full disclosure, I currently own ELY)
Jobless Claims Analysis
Jobless claims came in at the lower end of the consensus range, at 434,000. This is a very encouraging sign that the labor market is improving. In fact, it is the 18th consecutive week in which the 4-week moving average has fallen. I've read 2 articles so far that claim the market is down today because of this number, which is strikingly incorrect. This was an encouraging number and I'd argue the market is down due to other reasons, such as the overnight stock market movement in the overseas market.
Wednesday, January 6, 2010
Jobless Claims - Stock Market Focus for Tomorrow
Tomorrow I'll be focusing on the jobless claims number that comes out at 8:30AM. Jobless claims are the number of people who file for unemployment insurance for the first time. It's often viewed as a leading indicator and an improving trend in the statistic usually translates into an improvement in the unemployment number, which is next released this Friday.
Lately, the jobless claims number has been better than expected. The 4-week moving average has dropped considerably from its peak, as the chart below shows. The consensus estimate for tomorrow is 450,000 claims with a range of 420,000-470,000. Although the number tomorrow won't have any impact on Friday's jobs numbers, the continuing improvement in the claims leads me to believe the unemployment number will come in at the low end of the range, at 9.9%. The jobless claims number surprisingly doesn't have too much of an impact on market movement but it provides an invaluable insight into the condition of the labor market and can give you an edge in your trading.
Lately, the jobless claims number has been better than expected. The 4-week moving average has dropped considerably from its peak, as the chart below shows. The consensus estimate for tomorrow is 450,000 claims with a range of 420,000-470,000. Although the number tomorrow won't have any impact on Friday's jobs numbers, the continuing improvement in the claims leads me to believe the unemployment number will come in at the low end of the range, at 9.9%. The jobless claims number surprisingly doesn't have too much of an impact on market movement but it provides an invaluable insight into the condition of the labor market and can give you an edge in your trading.
The above image was taken from http://fidweek.econoday.com/.
The Weakening Correlation between the USD and the Stock Market
Throughout most of the credit-crisis, the value of the U.S. dollar and the U.S. stock market had a very strong, negative correlation. When the U.S. stock market went down (up), investors would flee to the safe-haven greenback and the value of the USD would rise (fall). This correlation became extremely tight with each passing day, but recent Fed announcements and better-than-expected improvement in the U.S. economy have unraveled the strength of the correlation.
The unraveling began with the unemployment rate dropping from 10.2% to 10.0%, which spooked the markets into thinking that the Fed may raise rates sooner than expected. The dollar appreciated considerably, while the stock market was up slightly on the news. I expect this unraveling to continue and a shift of focus to take place, from the FOREX market focusing on the movement of the stock market to the FOREX market focusing on when and by how much interest rates will change. Perceptions of changes in rates have always moved the FOREX markets, but because interest rates have been zero for so long, investors started to focus on stock market movements. As noted above, I speculate the correlation between USD and stocks will break down.
The unraveling began with the unemployment rate dropping from 10.2% to 10.0%, which spooked the markets into thinking that the Fed may raise rates sooner than expected. The dollar appreciated considerably, while the stock market was up slightly on the news. I expect this unraveling to continue and a shift of focus to take place, from the FOREX market focusing on the movement of the stock market to the FOREX market focusing on when and by how much interest rates will change. Perceptions of changes in rates have always moved the FOREX markets, but because interest rates have been zero for so long, investors started to focus on stock market movements. As noted above, I speculate the correlation between USD and stocks will break down.
Tuesday, January 5, 2010
Two Important but Overlooked Economic Indicators
1.) The Baltic Dry Index
The Baltic Dry Index (BDI) is an index that measures the daily average price of shipping raw materials by sea. The index indirectly measures the supply and demand for commodities such as coal, grain, and building materials. Since it takes years to build a ship, the supply of ships at any point in time is fixed and only through a change in prices can the market reach equilibrium in response to a change in demand. Thus, a rise in the index signifies an increase in the demand for cargo relative to the supply of ships.
The Baltic Dry Index (BDI) is an index that measures the daily average price of shipping raw materials by sea. The index indirectly measures the supply and demand for commodities such as coal, grain, and building materials. Since it takes years to build a ship, the supply of ships at any point in time is fixed and only through a change in prices can the market reach equilibrium in response to a change in demand. Thus, a rise in the index signifies an increase in the demand for cargo relative to the supply of ships.
Investors also use it as a leading economic indicator and to gauge the volume of global trade. It is viewed as a leading indicator because the goods shipped are usually intermediate goods to be used in the final production of other goods. Thus, most goods currently in transport are not intended for sale, but rather for production which would subsequently increase economic activity.
By following the BDI, an investor can get a sense of the future direction of the global economy. To get a daily quote and historic price chart, you can visit the Bloomberg BDI page here.
2.) Cross-Border Deposits
Cross-Border Deposits are those made across borders to other countries. Intuitively, a country with a surplus of capital is viewed to be in a more healthy economic state than one who has a deficit of capital. Additionally, a positive indicator to the health of an economy is when the country is receiving an influx of money. One probable cause of this might be higher interest-rates whereby investors can earn a higher rate of return in that country. For instance, Australia, with interest rates at 3.75%, attracts more foreign investment than countries with lower interest rates such as Japan, with an official rate set at 0.1%. To check out the statistics on cross-border deposits, click here.
Growth in China Lowers U.S. Inflation
By tying the value of the Chinese Yuan to the U.S. Dollar, China is driving asset inflation in their own country and allowing the U.S. to dodge it. As the value of the USD weakens, which it has since 2001, so too does the value of the Chinese Yuan relative to other currencies. So for instance, as the euro strengthens against the USD and the yuan, Europeans begin buying cheaper assets abroad. Since China is currently a more attractive investment than the US because of its astronomical growth rate, most Europeans will invest in China driving asset inflation. The United States, which would have a relatively lower rate of foreigners purchasing domestic goods, dodges asset inflation. Thus, the floating peg policy which ties the value of the yuan to the USD helps lower inflation in the U.S. and may create an asset bubble in China.
It will be interesting to see how this dynamic conflicts with the trillions of dollars the government has pumped into the system, which will surely put pressure on prices to rise in the U.S.
It will be interesting to see how this dynamic conflicts with the trillions of dollars the government has pumped into the system, which will surely put pressure on prices to rise in the U.S.
Winter Readings
I've always been an avid reader and this winter break I've had the opportunity to catch up on some reading on finance, economics, and investing. I believe the absolute best thing one can do to be successful in this industry is to read, read, and read. Absorb as much information as possible, be curious, and discuss what you read with colleagues, friends, professors, and frankly anyone.
In order to generate ideas for investment or learn more about finance/econ in general, I read primarily The Economist
, WSJ, and any book I can get my hands on. Of these, the Economist is by far the best reading material to stay up to date on your business/fin/econ. In fact, Global Macro manager Jim Leitner once said he could still do what he does if all he had was the Economist. He made a bundle investing in Guinness of Nigeria after reading about the country in an Economist article.
Anyway, here are the things I've read over my winter break so far.
I first read The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History by Gregory Zuckerman
. This is the story of Paulson's infamous trade in credit-default swaps during the subprime crisis. I felt it provided a great view of how ideas are generated in a hedge fund and the potential problems that can arise in executing those ideas. I learned a lot about the intricacies of the trade itself as well. I'd recommend it for a quick read.
I next read Reinventing the Bazaar: A Natural History of Markets
by John McMillan which thoroughly described the different types of markets around the world and how a stable, efficient market, is vital to financial success and economic growth. The title is misleading because the book doesn't go into any detail about the history of markets.
I then decided to take up The Financial Times Guide to Value Investing: How to Become a Disciplined Investor (2nd Edition) by Glen Arnold. This is a fantastic book about the different methods of value investing, covering the styles of Peter Lynch, John Neff, Benjamin Graham, and Warren Buffet. The author then takes the best of all worlds and combines them into his "valuegrowth" style of investing, and further adds a detailed analysis on the competitiveness within industries.
Next up was How Countries Compete: Strategy, Structure, and Government in the Global Economy
by Richard Vietor. This book provides a thorough analysis on the different types of economies in each major country, how they have developed over time, and how they compete with each other. The book takes a strong focus on the role of government and how it helps or hinders economic growth.
Finally, I'm currently reading Investing From the Top Down: A Macro Approach to Capital Markets
by Anthony Crescenzi. I'll provide a review when I'm finished.
Hopefully this gives you a sense of what I read. I try to read a mix of finance, economics, and investing since these are inextricably linked to each other and an understanding of one will help you understand the others.
In order to generate ideas for investment or learn more about finance/econ in general, I read primarily The Economist
, WSJ, and any book I can get my hands on. Of these, the Economist is by far the best reading material to stay up to date on your business/fin/econ. In fact, Global Macro manager Jim Leitner once said he could still do what he does if all he had was the Economist. He made a bundle investing in Guinness of Nigeria after reading about the country in an Economist article.Anyway, here are the things I've read over my winter break so far.
I first read The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History by Gregory Zuckerman
. This is the story of Paulson's infamous trade in credit-default swaps during the subprime crisis. I felt it provided a great view of how ideas are generated in a hedge fund and the potential problems that can arise in executing those ideas. I learned a lot about the intricacies of the trade itself as well. I'd recommend it for a quick read.I next read Reinventing the Bazaar: A Natural History of Markets
by John McMillan which thoroughly described the different types of markets around the world and how a stable, efficient market, is vital to financial success and economic growth. The title is misleading because the book doesn't go into any detail about the history of markets.I then decided to take up The Financial Times Guide to Value Investing: How to Become a Disciplined Investor (2nd Edition) by Glen Arnold
. This is a fantastic book about the different methods of value investing, covering the styles of Peter Lynch, John Neff, Benjamin Graham, and Warren Buffet. The author then takes the best of all worlds and combines them into his "valuegrowth" style of investing, and further adds a detailed analysis on the competitiveness within industries.Next up was How Countries Compete: Strategy, Structure, and Government in the Global Economy
by Richard Vietor. This book provides a thorough analysis on the different types of economies in each major country, how they have developed over time, and how they compete with each other. The book takes a strong focus on the role of government and how it helps or hinders economic growth.Finally, I'm currently reading Investing From the Top Down: A Macro Approach to Capital Markets
by Anthony Crescenzi. I'll provide a review when I'm finished.Hopefully this gives you a sense of what I read. I try to read a mix of finance, economics, and investing since these are inextricably linked to each other and an understanding of one will help you understand the others.
Monday, January 4, 2010
My Style of Investing
When it comes to stock investing, I believe the surest way to prosperity is through a long-term focus on value investing. The power of compounding is simply amazing and the greatest way to exploit this is through holding long-term stocks that, in Buffet's words, have a "durable competitive advantage".
However, I am not completely convinced on the value-investing approach and read extensively on other methodologies. In particular, I feel a top-down style of investing has merit, whereby the investor drills his way down from prospective countries all the way to a specific company within a promising industry. This differs from Buffet's thesis, which focuses on bottom-up analysis.
As another note, I do follow Technical Analysis and use it when entering/exiting a trade. However, I believe solely using T/A is not suitable for long-term investing, but I do look at it because it moves the markets in the short-run.
Thus, I am at a crossroads between the various styles of investing and I feel it's going to be a long time before I choose an investment methodology that suits my style and compounds my wealth the quickest.
As a final remark, I believe I have a great advantage investing as a private investor with little to invest as opposed to an institutional firm or other entity with millions to invest. I have the ability to put my money into stocks with low liquidity and whose intrinsic values differ more widely from their current market price than larger-cap stocks. Those who swing a bigger line need to stick with large-cap companies that have ample liquidity. The other aspect of my investing (which in my opinion is advantageous) is the fact that my net worth will rise by more than 5-fold upon receiving a full-time offer at graduation. Since the money I invest is limited to summer money I've made, I have the advantage of learning from my mistakes and failures at a very VERY cheap cost. It's much better to learn about the importance of stop-losses from a $500 dollar loss than from a $500 million loss. Further, since the money I invest now will have little/no impact on my future net worth yet it still hurts greatly when I lose money, I have the great opportunity to experiment with different styles of investing and learn the pros/cons.
About Global Macro..
Global Macro is a style of investment and asset management, whereby managers have the flexibility to invest in any asset class (commodities, stock, bonds, real estate, forex, etc.), in any market in the world (US, Canada, China, Australia, Nigeria, etc.), using any financial instrument (options, futures, swaps, etc.).
By making uncorrelated bets, risk drops dramatically, increasing your return/risk and sharpe ratios. Quite simply, from my research, many global macro investors achieve outsized returns with amazingly less risk. Whereas other funds' investments may be heavily concentrated in one market or asset class, Global Macro's investments are more diversified but that diversification does not translate into mediocre performance as one might expect, mostly due to the heavy directional bets these managers make in their varied markets.
I also love Global Macro because of the challenge of learning new markets and methods of investing. I love stretching my mind past the confines of the US markets and learning how other foreign markets function, as well as other financial markets.
About Me
Hey everyone,
My name is Derek and I'm currently a student at Villanova University majoring in Finance and Economics. The purposes of this blog are to lay out ideas on finance, economics, and investing and hopefully promote an engaging discussion about these topics with you guys. I've been investing for over three years now in the stock market and for about 6 months in the FOREX market.
I follow the markets quite closely and one day hope to work for a Global Macro fund or in Alternative Investments for an institutional financial company.
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