Friday, May 29, 2009

Quotable Quotes: Faith

As equities close in on a third up month in a row, a few words on investors' faith that better times lay ahead.

“Faith means not wanting to know what is true”
Friedrich Nietzsche

“Skepticism is the beginning of Faith.”
Oscar Wilde

“I know God will not give me anything I can't handle. I just wish He didn't trust me so much.”
Mother Teresa

“Faith is taking the first step even when you don't see the whole staircase.”
Martin Luther King, Jr

" the beginning of new bull markets investors are driven more by faith than fundamentals, as they seem to prefer Billy Graham over Ben Graham."
Sam Stovall

Have a good weekend.

Thursday, May 28, 2009

Minyanville article: Small Cap Strategy - Lose the Weight

My Minyanville article this week discusses the merits of underweighting small caps.

"Throughout the credit-enhanced era, small-cap issues were one area where investors were well-advised to overweight in their portfolios. As history informs us, small-cap stocks outperform large caps due to their (on average) higher growth rates and (generally) greater risk. Greater risk equals greater rewards. Recently, however, circumstances have changed, and small caps look to bear the brunt of..."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

Wednesday, May 27, 2009

When To Ring The Bullish Bell

Driven largely by short covering and a portion of the mountain of cash sitting on the sidelines, stocks have been on a tear since the beginning of March. Many investors have, in the process, bought into the idea of the reflation trade as sectors and countries associated with it (e.g. emerging markets, basic materials) have led the parade thus far*. In the process, valuation levels have become quite stretched on the concern that the next 12 months will produce sub par earnings that do not justify currently lofty P/Es.

For the bears, there is high skepticism that S&P 500 operating earnings will reach a $70 number, which would justify not just where the market is today but be supportive of a run above 1000 (S&P 500). The bulls, on the other hand, argue that corporate profits are on the cusp of a major rebound mainly due to recession-necessitated cost cutting. Accordingly, any economic rebound in our globalized economy will produce the $70 number – and then some. Who will be right?

To gain insight into who will win this fundamental analysis debate, a peek at the technical analysis side of the equation can be most enlightening.


Many of the technical analysis patterns and indicators that I follow are flashing very constructive longer-term signals. Mega Trend bullish reversals are on the horizon for just about every index tracked**, along with chart patterns that bear more than a glancing resemblance to head and shoulder reversals.

On a short and near term basis, however, equities are faltering as momentum – the lifeblood of near term market power – is eroding (see second and third indicators in the above chart). On the surface, the fundamental analysis debate appears to playing out in the technical analysis space as well – longer-term things look promising, short and near term not so much. So, where’s the enlightenment?

The missing ingredient is the completed bottom – that point at which stocks have built a sustainable base from which higher prices have a greater chance of becoming an actuality.

Such a bottom has been formed in leadership areas, such as emerging markets (see above chart). Breaks above previous tops formed in multi month trading ranges signal a (mostly) completed bottom. This is not quite the case, however, with developed economy markets, as they have not made such a move. Yet, as constructive as the emerging markets patterns are, only when a mega trend reversal has occurred (which looks like it needs only a few more weeks of positive trading action) can the bell be rung.

Investment Strategy Implications

Old school market technicians will tell you that it is always better to wait until a major pattern has been completed and give up x% of the early move just to be sure that you are on the right side of the trade. Given the fluid nature of the real economy environment, this piece of advice will produce more than its value in peace of mind.

The bullish bell looks like it only needs a few more weeks of positive action. Then again, the Cavs were a slam dunk to make it to the NBA finals.

And Now, Another Soapbox Moment

By blending both fundamental and technical analysis, an investor can see how market participants are interpreting the fundamental stories in the real economy. This occurs on both a macro and micro level, with sectors and industries reflecting the prospects on an individual company level. This also involves Soros’ reflexivity, the feedback loop from the markets to the real economy in which changes in market values help produce the very outcomes they measure.

Fundamental analysis tells you what should be. Technical analysis tells you what is.

*While the stats do show Financials as having the sharpest rally since the early March lows, it is arguable that the profound changes the sector will undergo (to profitability and growth) does not auger for a leadership role on a sustainable basis. Therefore, the powerful rally come from a deep oversold condition that will likely dissolve into mediocrity once the bull phase gets underway in earnest.

**Price above moving averages, 50 day above 200 day, both 50 and 200 day upwardly sloped. See chart above for an example, as well as numerous previous blog postings.

Thursday, May 21, 2009

Minyanville article: A Mega Trend Reversal?

excerpt from this week's article: "Bullish investors who subscribe to chart patterns are getting all lathered up over the prospects of a major head-and-shoulders bottom..."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

Wednesday, May 20, 2009

How to Beat the Market WITHOUT Even/Overweighting Financials

The stock market parade in the US has been led by Financials (see first chart). As a result, many investors with well-diversified portfolios may have struggled to produce alpha since the bull rally began in early March, especially if they were underweight Financials - as many no doubt were. In the process of the rally and in an effort not to fall too far beyond in relative performance, these same underweight Financials investors have been forced to plunge headlong into that sector to try and keep pace.

For investors (as opposed to traders), part of the problem with even or overweighting Financials is the high degree of uncertainty facing the sector. With the US government forging ahead with new legislation and regulation designed to steer the financial services industry toward a more managed future (see recent articles on the credit card legislation, executive pay caps, mortgage regulators, and Gillian Tett’s (Financial Times) excellent article on derivatives) no one can confidently predict the future shape of the sector, let alone its sustainable growth and profitability. Therefore, what investments should/could the well-diversified investor consider that can generate alpha AND avoid the issues and uncertainty even/overweighting Financials bring?

One approach would be to increase the equity exposure in those areas where sustainable growth and profitability appears to be more assured AND will benefit from themes that will likely play out for many years to come. Two such areas are emerging markets and global infrastructure.

As the second chart shows, while not matching Financials in the current rally, having a sufficient amount of money in several attractive emerging markets (EEM, EWZ, FXI) and global infrastructure sectors (IGF, PHO), as well putting some funds in the higher beta small cap growth area (IJT), a well diversified portfolio can produce alpha while simultaneously reducing the aggregate beta in a portfolio AND avoid investing in a sector (Financials) that is fraught with long-term uncertainty. Moreover, by doing so, less money is allocated to the underperforming sectors that drag down the aggregate portfolio performance (see first chart, again).

And Now, For Another Soapbox Moment

For well-diversified portfolios with a longer-term time horizon, it's a relative performance game. This is what "diversification with a tilt" portfolio strategy is all about. The underlying assumption is that stocks have a longer-term upward bias and investors should exercise sound asset allocation and modified market timing principles (along with a healthy dose of patience) to achieve alpha. If this stocks-have-an-upward-bias assumption is correct, even a modest 2% per year outperformance will produce exceptional long-term results.

Note: Walking the talk is what you see in the second chart as it represents most of the larger holdings in a small fund run my firm and in the Model Growth Portfolio, both of which have year to date alpha of 293 and 484 basis points, respectively. Needless to say, past performance is not a guarantee of future results.

Tuesday, May 19, 2009

Welcome to the Emergent Emerging Markets Century

Okay, maybe it’s more than a tad premature to call a good couple of years the start of a century of exceptional economic performance. Nevertheless, if there is one place, from both an economic and investment basis, where investors are well advised to have an above average investment weighting it’s the emerging markets. The following presents a few core elements, both fundamental and technical analysis, which provide a hint as to why having such an exposure is prudent.

From a fundamental valuation perspective, EEM compares quite favorably to the developed economies on both a growth, diversification, and valuation level. As the first table shows, the mix of EEM (emerging markets ETF) is substantially different than that of either the S&P 500 and the EFA. What may be surprising are the large exposure to Info Tech and the relatively low exposure to Industrials. You can also see the favorable comparisons in P/E with beta where you would expect it to be.

From an economic growth perspective, the IMF chart that follows makes it abundantly clear that economic growth over the next few years resides in developing and not developed (advanced) economies.

From a technical analysis perspective, the above positives for emerging markets are reflected in the following charts.

The first chart shows the solid upside breakout from a significantly improving base that is poised to produce an mega trend reversal (regular readers of this blog know what that means), which has further upside potential for something beyond a tradable rally.

And from a comparative performance perspective, the non confirmation in early March has been rewarded with a far superior run thus far.

Investment Strategy Implications

The above provides a very brief description as to why emerging markets have exhibited and will likely continue to exhibit outperformance vis-à-vis developed markets. But don't take just me word for it - Mohammed El-Erian (Mister Bumpy Road to the New Normal himself) seems to think so. And he controls a lot more money (and influence) than little old me.

Thursday, May 14, 2009

Minyanvile article: Executive Pay Caps - Be Careful What You Wish For

excerpt from this week's article: "By all accounts, the concerns expressed in my prior 2 Minyanville articles, Bulls Out of Momentum and Advice for Stressed-Out Bears, as well as several recent blog postings, appear to be working out. Stocks -- fully valued with suspect technical-analysis credentials -- have stalled, and are likely headed toward a range-bound summer, with winners and losers producing a zero-sum period of returns.

If this comes to pass, the decision on what to do over the next few months, how to exploit a mini range-bound/sideways market, becomes a priority for actively managed portfolios. On this matter, I'll have some ideas in next week’s article. What I want to touch on now is something that has far more serious consequences for the market: regulatory overreach by the US government. More specifically, the current attempts by congressional Democrats to dictate pay policy for financial-service firms.

I get this argument, which focuses on the systemic risk posed by..."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

Wednesday, May 13, 2009

Beyond the Sound Bite: An Interview with Dr. Andrew Lo

In a most interesting and insightful conversation with the Director of MIT's Laboratory for Financial Engineering and co-author of "The Heretics of Finance: Conversations with Leading Practitioners of Technical Analysis" we explored the value of technical analysis, the prospects of a standardization and quantitative discipline for technical analysis, the behavioral finance dimensions of stock market analyses, and the theory of the adaptive markets hypothesis.

Beyond the Sound Bite postings can be found at
To listen to this week's podcast interview, click here

Tuesday, May 12, 2009

9 ½ Weeks

For the bulls these past 9 ½ weeks were like the movie of same name – hot. However, the bulls (including many recent converts, especially from the land of momentum lemmings – the hedge fund world) should not forget that in the movie the lovers (Basinger and Rourke), drawn by the heat of the moment, have something as substantive and sustainable as a chimera. In a case where life imitates art, such may also be the story line with stocks.

Using the historical average P/E of 15 times and an optimistic $60 operating earnings number for the S&P 500 for 2009, stocks are projecting a robust earnings rebound into 2010 - a point made by my “Beyond the Sound Bite” guest from last week, Subodh Kumar, with a $75 call for next year. Only if that occurs AND/OR only if one accepts the talk I hear from some institutional investor circles that a P/E above its historical average is fitting for the times courtesy a low inflation rate (18 times is the number I hear), can an investor find fundamental support for the fragile technical analysis base stocks have built. However, it does give one pause when the leadership for this market is the same leadership that existed before the great tumble. Generally that is not how new bull markets get started and sustained, as the more common occurrence is for new leadership to take the helm. Rather, bear market parades are led by those who led before.

Investment Strategy Implications

9 ½ weeks ago I argued that stocks were grossly undervalued. Now, 9 ½ weeks later stocks, while not grossly overvalued, are more than fully valued. Built on the sand of a fragile technical analysis bottom led by those who led before make it more than justifiable to take some money off the table – most conservatively done by maintaining whatever the current equity percent of one's total investible assets at the current level, which in accounts that I manage is in the low 90% range.

In many respects the movie 9 ½ weeks was a study in extreme behavior devoid of real meaning and lasting substance. So, it is interesting to note that the stock market movie of these past 9 ½ weeks has brought out these qualities of extremes, including the expectations of more than a few investors with calls for more upside surges or great plunges. Therefore, allow me to offer an alternative view to this edgy thinking with a reference to another character from Tinseltown – George Costanza. Perhaps what investors will get in the coming months is a stock market movie not about heat but about nothing. A drifting, sideways, mini range-bound market where selectivity matters more than trend following, lemming-like momentum investing as investors digest what has occurred and guesstimate what 2010 has to offer and the appropriate P/E.

In such an environment, you can keep your (slightly bearish) hat on.

Friday, May 8, 2009

WTF? How To Nail An Interview (Tip 17)

The US jobless rate hits 8.9%. So, why is this job applicant admitting to theft from his previous employer?

Have a good weekend.

Thursday, May 7, 2009

Minyanville article: Advice for Stressed-Out Bears

excerpt from this week's article:
"As the stock market continues its unsustainable climb, and portfolio values recover from the depths of their devilishly low point of early March (S&P 500 at 666), there's one group that hasn't been enjoying the merriment of late: the bears. Clinging to the ill-advised belief that the end of capitalism was upon us, the flexibility necessary to successful investing was...

As stocks embrace the pending results of stress tests, it looks as though bears need not stress out for much longer. However, my longer-term advice to the bears is this: One-way, die-hard thinking is always stressful. It may make for entertaining television, but it's not good for your financial health...."

To read the complete Minyanville article, click here
To view all Minayanville postings, click here

Wednesday, May 6, 2009

Beyond the Sound Bite: An Interview Subodh Kumar, CFA

My interview with the Chief Investment Strategist of Subodh Kumar & Associates includes his cautious equity outlook at the top end of the trading range, the low quality aspects of the recent equity markets' rallies, the coming powerful earnings benefits from cost cutting, a 2010 S&P 500 operating earnings view of $75, and the emergent era of managed capitalism.

Beyond the Sound Bite postings can be found at
To listen to this week's podcast interview, click here

Tuesday, May 5, 2009

Sinko de Mayo

For many, today’s date has a special social significance. For prudent investors, however, today is a day that this year marks a point of caution – unless you buy into one of two arguments being passed about: stocks warrant a higher than average P/E or stocks have made their lows as certain trading patterns say the bottom has been formed.

Fundamentals First

For those who favor the first point, the arguments I hear reference inflation and the appropriate P/E for stocks. Historically, when inflation runs in the low single digits P/Es have tended to be in the higher teens – above the long-term average of 15 times. All well and good provided other conditions in the economic and financial arena are balanced - which they are not. What makes the low inflation=higher P/E argument more than a touch suspect is, frankly, a blind faith in the ability of the Fed (and other central banks) to time the withdrawal of monetary stimuli BEFORE inflationary pressures begin to build – which, if unsuccessful, would thereby blow up the low inflation leg of this fundamental stool. More importantly, given the highly fluid nature of the global economic and political environment (can you say "nukes and Pakistan"?), ascribing an above average P/E during above average times of risk (despite whatever may be possible - not probable - in the inflation end of the equation) seems to require an above average degree of faith and a below average degree dispassionate logic.

Now The Technicals

As for the technicals of the market, certain technicians of the chart pattern stripe note the various breakouts as reasons supporting the “bottom has been formed” argument. There are others, however, who are purists in this chart pattern field who would counter argue that only when a completed bottom has been made in the major indices can a bottom-has-been-formed view be agreed to. Since I am not a chart pattern guy, I will leave this debate to those in the two camps. What I will put forth is something readers of this blog are very well aware of – the Mega Trend.

The Mega Trend is the Investor's Friend

Only when price is above both moving averages AND the 50 day has crossed the 200 day AND both the 50 day and 200 day have turned up can an investor confidently declare a Mega Trend change has occurred and a new market cycle is underway. Let’s look at the performance record in this regard using two indices as evidence – SPX (S&P 500) and EFA (Europe and Asia).

As both above charts* show, when a Mega Trend occurs that trend tends to stay in place for years. In this longer-term context, you can see that considerable improvement has occurred recently, HOWEVER, neither index is fulfilled the requisite conditions to warrant a Mega Trend signal change. Price is not above its 200 day moving average and the 50 day has not crossed the 200 day. Therefore, while the 50 day has turned up and the 200 day has begun to flatten all conditions have not been met and should not be anticipated to do so until they do so. (Or as Yogi Berra would say, "It ain't over 'til it's over".)

At present, to achieve all facets of a bullish Mega Trend stocks must build on their 30% plus rally thus far and rise significantly further from here, which, unfortunately, will produce a set of overbought conditions that are unlikely to be sustained. Moreover, any further near term rally would put both indices in a sharp near term uptrend, which is not indicative of the bottoming process that precedes a Mega Trend reversal. In this regard, there are several near and short term technical analysis reasons (momentum and MACD, Slow Stochastics, respectively) that argue against stocks making such a move anytime soon.**

Investment Strategy Implications

To be clear, Sinko de Mayo does not mean Plungo de Mayo. It simply means equities have gotten more than a touch ahead of themselves and some contraction, a healthy contraction, would be best. Since articulating cyclical bullish sentiments in early March, readers of this blog acting on the views expressed have enjoyed a very healthy boost to their portfolios. Now, however, we seem to be at the opposite end of that spectrum for exactly the same reasons - only in reverse. Therefore, when both fundamental and technical analysis flash the yellow caution signal, it is advisable to, at a minimum, maintain the equity percentage of a portfolio through selective selling.

Going forward: Sinko de Mayo will likely be followed by Drifto the Summero leading to Uh Oh the Fallo. Enough with the bad rhymes. Let’s go make some money.

*click images to enlarge
**for more information on this, see yesterday’s complementary report offer. If you have not received such an offer, simply click on the link to your left in the Twitter updates sidebar.