Saturday, January 29, 2011

Just Another Day at the Office

On September 24th renown hedge fund manager David Tepper made headlines when he was interviewed on CNBC. In that interview he stated that the market would go up no matter what happened because either the economy was going to get better causing stock prices to rise, or the government would intervene by infusing more money into the system to prop up the indexes. Well, he was right on all counts. The economy did get slightly better; the FED also helped the overall markets by issuing QEII, and, since that day in late September, the S&P 500 has continued to percolate higher going from 1149 to 1300 last Thursday. That's a 22% gain which accounts for about all the S&P gains for the past year. It's been a 4 month ride without much of a breather.

This past week I read Vitaly Katsenelson's The Little Book of Sideways Markets, and he claims that we are in a lateral trading pattern that began in 2000 and could go on for another eight years or longer based on historical tendencies. The last decade was not an anomaly but part of a predictable pattern. Katsenelson displays statistics from the past century of boom and bust periods like the bull market we experienced from 1982-2000 and proves that after each successive out-performance of the market which includes P/E expansion, that these cycles are followed by years of P/E contraction and large swings in the indexes that stay within a range.

This is a thesis I've believed in for many years, but it's a concept that's difficult to comprehend because market P/E ratios have been inflated for 30 years so now it's hard to get your arms around the theory. I now fully embrace it. It's tough to say what the actual P/E ratio of the S&P 500 is because different analysts use different metrics to compute the number. Some use operating earnings, some use reported earnings and some follow Robert Shiller's Cyclically Adjusted Price Earnings ratio. I've looked at all three and compared to historical averages for the index, the P/E ratio looks to be overvalued in my humble opinion. Does this mean that the market is ready to crash or correct? No, not necessarily as the bulls point out. Even though the ratio is high, it can still go higher like it did from 1996 to 2000. However, I'm a believer that the P/E ratio for the S&P will trend lower, below the historical averages, so it has the potential to fall significantly.

In the Summer of 2010 I thought I caught a break in my short positions as the market corrected, but during the so called "Tepper Rally", I have been schooled in my asset allocations. Remember that not only am I short the indexes, but I'm leveraged, too. So if the market goes up significantly, I get taken out behind the woodshed to face the music. Although the rally the last four months has tried my patience, I still believe that we are in for a day of reckoning and will hold steady with my Exchange Traded Funds. It may be a foolish move, but like Vitaly Katsenelson, I am still of the school that the overall P/E ratio of the market is going to contract as the sovereign debt gets flushed out of the system somewhere down the line. When will this happen? It's anybody's guess.

I have made proclamations in previous postings that corrections are coming because of macro economic conditions like the European Debt Crisis of last Summer (and is still going on for that matter, but put on the back burner). However, I will not go out on the limb and tell you that the demonstrations and riots in Egypt are the catalyst for the next market downturn. I've been down this road before without any luck, and it only goes to prove that I don't have a crystal ball. Do I believe this is a catalyst of a market downturn? Yes I do, but only because the market has had an outstanding run and 5%-10% corrections are healthy, even in a bull market. This is a market that has legs. If the toppling of the Egyptian government isn't the tipping point of a downward spiral in the S&P 500, then I'll just have to bide my time.

Monday, January 17, 2011

Smarter Than The Street

Street cred goes a long way in establishing a reputation in today's world whether you are on Main Street, Wall Street, or, in some barrio or ghetto. In investing circles, Gary Kaminsky carries a lot of weight, not only for his success as a billion dollar money manager and director at Neuberger Berman, but also because he parlayed a series of guest spots on CNBC into a co-host position on the network with their very influential "Strategy Session" show airing at noon each weekday. Recently, McGraw Hill published Gary's first book "Smarter Than The Street" which gives his take on not only how retail investors should position their portfolios and select stocks, but also some commentary on overall market direction for the next decade.

Kaminsky states right at the beginning of the book that: "One of the key assumptions of this book is that the next ten years will resemble the last ten.". He backs up his thesis with statistics from author Vitaliy Katenelson and makes a compelling argument for a range bound market where: "Stocks will go up, and stocks will go down. There will be periods of exuberance...and similarly periods in which it looks as if the world is coming to an end.". He feels that investors need to be nimble, but not overly trigger happy when it comes to buying and selling securities because he is not a trader, but an investor, and believes that you should hold stocks for a 3-5 year period. This is especially true if you are investing in companies with good organic growth, which he recommends.

In further discussing portfolio management, Kaminsky also believes that, "There is absolutely no evidence that a 'buy and hold' strategy will work in the future.". This may sound contradictory to his previous advice to keep securities for 3-5 year durations, but later in the book, he goes on to say: "The riskiest form of investing is not buying and holding - it's buying and forgetting.". What Mr. Kaminsky means by that last sentence is that as a retail investor, you need to take charge of your portfolio and do your due diligence if you wish to beat Wall Street money managers which he contends is very possible throughout his book.

According to Mr. Kaminsky, individual investors have an edge because they aren't locked in to any specific investing style the way that most mutual fund managers are, so you don't have to be just investing in large caps, or small caps or a particular theme or sector. You can also be more flexible in buying or selling a position than an institution investor because you don't have to wait for a few weeks to purchase or liquidate a large block of shares. He suggests 3-5 hours a week of doing your homework on the Internet of not only the stocks you own, but the overall condition of the economy. He also talks a lot about portfolio structure and utilizes the concentrated portfolio approach where you own no more than 20-30 securities. Anything less and you increase the risk in your holdings, anything more and you become a closet indexer which doesn't bode well for beating the market.

Throughout the process of reading "Smarter Than The Street", I was in lock step agreement with Kaminsky as each chapter unfolded. However, not all investing books are created equal, and as an experienced investor, I didn't discover anything new while reading this book. Therefore, if you are an experienced investor, I wouldn't recommend it because other authors have covered much of the same material in other investing publications. If you are a beginning investor, this would be a terrific place to start for some overall knowledge of macroeconomic conditions, the stock selection process and portfolio management.

Saturday, January 8, 2011

A Dollar and a Dream

Nothing gets investor's juices flowing like the prospect of getting in on the first day of trading of a hot IPO. At first blush, it would seem that this would be easy money to be had if you pick the right security, and there is a lot to be said for that. In recent history, Google (GOOG) comes to mind. Google (GOOG) launched on August 19th, 2004 at $85/share and closed on Friday just under $620. That's a nice return on your investment if you got in on the ground floor. Back in late 1998 and throughout 1999 during the boom, both institutional and retail investors jockeyed for position to get in on the first day of trading of the IPO's of that era. Fortunes were being made. On the first day of trading alone up 606%, Foundry Networks up 525%, Cobalt Networks up 482%, up 474%, Akamai Technologies up 458% and the list goes on. Those days are over, but IPO's are back in the news.

There's been a lot of buzz about Facebook this past week because Goldman Sachs (GS) "agreed to invest $475 million into Facebook and initiated plans to raise as much as $1.5 billion through a special purpose investment vehicle marketed to private wealth management customers. The private sales would value Facebook at $50 billion.", according to Joseph Giannone and Matthew Goldstein on Reuters. If you are a Main Street investor and want to get in on the action over at Facebook, you're out of luck. At this juncture it's only being offered to Goldman Sachs' clients with a two million dollar minimum.

The probability that Facebook will go public in the next year or two is high, but even when it launches its IPO, as a retail investor you should probably let it trade for a year or two and see if you can catch it on a dip, preferably under it's issuance price. Sounds far fetched, but stranger things have happened and if you chase it, you will probably get burned. As is, "Facebook is now considered to be worth more than Time Warner, DuPont and Goldman's rival Morgan Stanley.", says William Cohan of The New York Times in his article "Friends With Benefits". Goldman Sachs (GS) already values Facebook at 25 times revenues as reported in the Rueters article by Giannone and Goldstein. That's a sky high valuation for a company that may not yet be profitable.

There are numerous academic studies exposing the less than stellar returns of IPO's, most notably 2002's "Pseudo Market Timing and the Long-Run Underperformance of IPO's" by Paul Schultz of the University of Notre Dame, which amalgamates previous scholarly studies on the subject. What Mr. Shultz's study concludes is that IPO's just don't beat the market the majority of the time. If you are an institutional investor, it might make sense to take a flier with a small percentage of your portfolio on some technology upstart like a Twitter, Groupon, Zynga, Linkedin or Facebook. After all, institutional investors have millions, if not billions of dollars to invest with and can afford to gamble a few million bucks on the next big thing. Institutional investors also have the luxury of getting in at the opening bell on the first day of trading.

It's not that easy for the retail investor. Individual investors usually have to wait until the institutional firms have flipped their shares to get a piece of the action, and then it may be too late to make a decent profit. There are exceptions like the previously noted Google (GOOG), but like Jason Zweig said said in his Wall Street Journal column on January, 8th when discussing Facebook and IPO's: "For every Google, there are hundreds of companies like eToys and Lycos; for every Apple, there are countless casualties like Thinking Machines and Network Computing Devices.". If investing in individual securities is a bit like casino gambling, then venturing into the IPO market is like playing the nickel slots. Rarely do you win. We tend to have selective memories and hearken back to those salad days of 1999 when playing the IPO market was like shooting fish in a barrel. If only it were that easy.

Thursday, January 6, 2011

The Last Emperor

Back in 2000, Cisco (CSCO) CEO John Chambers graced the covers of what seemed to be all of the major financial magazines. After an incredible run in the 1990's, Cisco (CSCO) surpassed all other companies in market cap and became number one in the world. I know I have no regrets about owning shares in it. It had 3 for 2 splits in 1997 and 1998, and, 2 for 1 splits in 1999 and 2000. In just 2000 alone it had a low of 35 and a high of 82 and you would have almost tripled your money if you bought at the lows. The press glowed about Cisco's (CSCO) prospects and how it would keep on going up because "it was different this time", we were at a "new normal". There was a cornucopia of riches in the tech sector and the gravy train was nowhere near being derailed, or at least that's what the consensus thought. In the year 2001, less than one year after Cisco's (CSCO) all time high, it was trading at 11 and in 2002, it got down to 8.

Cisco (CSCO) is still a great company. During the last decade it was added to the DOW and still does the majority of the behind the scenes heavy lifting in the Internet. The set-top box for my HDTV is a Cisco (CSCO) and besides the already available movies and television programs, they'll be streaming anything relating to cloud computing right into my living room in the not too distant future. Although Cisco (CSCO) is still king of the jungle in internet infrastructure, it's not a great growth stock anymore. It's price has been hovering in the high teens to high 20's for almost ten years now except for a brief period when it hit 34 in 2007. It doesn't even pay a dividend, so your returns haven't been very good for years.

There's nothing wrong with Cisco (CSCO), it just got to be too big of a company. The high growth period for a security has just so much of a shelf life and Cisco's (CSCO) race is run. ValueLine gives it a high of $40 in 3-5 years and that is their most optimistic projection. Doubling your money in 3-5 years is a good return on investment, but it's nowhere near what investors expect from a stalwart that not too long ago made the expression ten bagger seem like chump change. I believe that what Cisco (CSCO) was to the dot com boom, Apple (AAPL) is to the current euphoria.

Apple (AAPL) is a great company. Has been ever since the mid 1970's when Steve Wozniak and Steve Jobs founded it. Sure, they've had some products bomb, but only because they may have been too early to market like with the Newton. I use and believe in their hand-held computers and don't foresee anybody knocking them off their pedestal despite the success of Google's Android mobile operating system. The problem with Apple's (AAPL) stock is that the company is just getting too big and may not have that much more room to run.

Apple (AAPL) is now the number two largest market cap company on the domestic exchanges, second only to Exxon/Mobil (XOM). You could have picked it up for $6 in 2003 and feathered your nest with the incredible gains it has experienced, trading at around $330 now. However, that's an 8 year run and most stocks don't keep rising that long. If you invest in it now, the probability that you will double your money in the next 5 years is minimal. I could see it climbing to $400 with the momentum that's behind it, especially since they are going to be offering the iPhone on Verizon this quarter and the iPad is relatively new, but the price performance of the last 8 years is now history. If you are a buy and hold investor, I just don't see it being a very good place to put your money.

Wednesday, January 5, 2011

Collateral Damage

Author's Note: In my last installment I briefly discussed High-Frequency Trading, Flash Trading and Dark Pools. This article is similar to that posting, but, expounds on the subject with additional facts. If the material sounds similar, it is, but because I feel so strongly about it, I am including it just the same. Consider this an addendum or Part 2.

If you have a job and skim from the cash register or emergency slush fund, you'd get fired and even prosecuted. Do the same crime in a country with more Draconian laws, the authorities cut off your hands. A similar offense if you are a wiseguy in the mafia and they'll whack you. I just don't understand why the high-frequency trading technique known as Flash Trading isn't under more scrutiny by the powers that be because the firms that engage in the practice are just skimming off the top and playing with an advantage, like throwing a spit ball or using steroids if you're a baseball player. They're nothing but shakedown artists in my humble opinion and should be regulated, if not eliminated.

During the past year Flash Trading got a black-eye from Main Street because they were purported to be the cause of the Flash Crash in May of 2010. This is an urban myth. According to Graham Bowley in his recent New York Times article "The New Speed of Money, Reshaping Markets": "In their investigation into the plunge, the S.E.C. and Commodity Futures Trading Commission found that the drop was precipitated not by a rogue high-frequency firm, but by the sale of a single $4.1 billion block of E-Mini Standard & Poor’s 500 futures contracts on the Chicago Mercantile Exchange by a mutual fund company.". I just wanted to clear the air, but I still believe that even though Flash Trading wasn't a direct cause of the Flash Crash, it can make the markets unstable and this is not good for anybody except the anointed few that control the financial grid.

Flash Trading is is a sub-set of High-Frequency Trading and, if you believe that the stock market is primarily comprised of floor brokers on the New York Stock Exchange, you are misinformed. In an article on 1/4/11 by John Melloy, producer of CNBC's Fast Money, he writes: "High frequency trading accounts for 70 percent of market volume on a daily basis, according to several traders' estimates. The average holding period for U.S. stocks is now just 2.8 months, according to the Crosscurrents newsletter. In the 1980's, it was two years.". The article also goes on to talk about dark liquidity: "Another factor jumped into the fray in December: dark pools. Off-exchange trading accounted for more than a third of the trading volume in December, says Raymond James.".

You don't have to be a Rhodes Scholar or a member of MENSA to do a little back of the envelope calculating and come up with a rough estimate of half of all High-Frequency Trading is done via Dark Pools. I don't have facts and figures on this, but I imagine that some Dark Pools also are in the business of Flash Trading. Many of the masters of the universe on Wall Street use every trick in the book to make their meal ticket. They have to to remain king on the hill. The Mom and Pop investor isn't an endangered species, but being a buy and hold investor isn't what it used to be.

Monday, January 3, 2011

Warp Speed

On New Year's Day The New York Times posted a terrific article on their Web site by Graham Bowley titled "The New Speed of Money, Reshaping Markets". The article talks primarily about Direct Edge, "one of the top four stock exchanges in the United States"and the ramifications of all of the high speed trading that has dominated the markets the past decade, accelerated by mainframes and server farms the new exchanges utilize to bring you trades in a nanosecond. I was not aware of Direct Edge, or The BATS Exchange located in Kansas City, another large stock exchange that does all of the back-office work you don't see when you tap your iPod screen or click that mouse to make a trade.

The digerati have clearly taken over and although technological advances in the markets have reduced trading costs (at least if you use a discount broker), there is something ominous about these upstarts that are taking market share away from NASDAQ and the New York Stock Exchange at an alarming rate. In fact, according to Mr. Bowley: "The N.Y.S.E. accounted for more than 70 percent of trading in N.Y.S.E.-listed stocks just five years ago. Now, the Big Board handles only 36 percent of those trades itself. The remaining market share is divided among about 12 other public exchanges, several electronic trading platforms and vast so-called unlit markets, including those known as dark pools.".

I've discussed dark pools before in other postings and are wary of them, especially since they are growing larger by the minute. To refresh your memory, a dark pool is a trading venue that doesn't quote prices publicly. This translates into a lack of transparency and I'm a firm believer in transparency and government regulation because without either one, we tend to get into trouble. It's like some of the institutional investors are playing with a marked deck. You give some of these white shoe firms an inch and they take a yard. Just look at The Goldman Sachs Group (GS) that recently was fined $550 million by the S.E.C. for fraud in the sub-prime meltdown. They were like used car salesmen knowingly selling you lemons.

I went to the Direct Edge Web site and on their FAQ page they state that The Goldman Sachs Group (GS), Citadel Securities and Knight Capital Group each own 19.9% of the exchange. You sharpen your pencil and that's 59.7% of the organization. Citadel Securities and Knight Capital Group are both major players in the dark pool arena. You can't tell the players without a scorecard and once the dust settles it's like you're dealing with Skynet, the artificial intelligence network that went haywire in The Terminator movies. If it weren't for the dark pools and flash trading that Direct Edge allows, I wouldn't have a problem with them, but I do because I believe it effects everyone on Main Street. IRA's, 401K's, pension plans and mutual funds that are the lifeblood of your Average Joe on the Street's retirement could be in jeopardy without proper government supervision.

I've got nothing against somebody trying to make a buck. I tip my hat to Direct Edge for coming up with a modern trading concept and padding their coffers, but there seems to be a conflict of interest when they are still dabbling in flash trading and dark pools. Supposedly you get a better price for your trade with dark pools if you are involved with high-frequency trading, but the little guy doesn't have access to Big Iron. Your discount broker may get you a penny more per share when you are buying or selling securities on these exchanges. Big deal. If left unattended, these exchanges may bring down the economy again. That's not good for anybody except for corporations like The Goldman Sachs Group (GS) who seem to make money no matter which way the wind blows.

Saturday, January 1, 2011

Exile on Main Street

The problem with following stock shaman like you see all day on CNBC is that you don't know if they are investors or traders. They never give you a timeline as to how long to hold a security. One day they love a company and if it goes up a meager 2 points in a momentum move, they'll drop it like a bad habit. I don't like to invest that way. I want to be like Warren Buffett and buy a piece of the business. However, there are times to sell. Now may be one of them. I just don't know because I've gotten it wrong with one of the best market rides since the 1940's. I really don't make many market or security calls, but in 2010, I got three wrong: the direction of the market, Apple Computer (AAPL) and Gold (GLD). I still believe that all three of them are overvalued, but they've got the wind at their backs.

Ever since the New York Stock Exchange was founded in 1792 with the Buttonwood Agreement, there has been a rift between Wall Street and Main Street. As you are probably well aware, things haven't changed too much in 200 years. Just look at the returns of the markets in 2010: DOW up 11%, S&P 500 up 12.8%, NASDAQ up 16.9% and the Russell 2000 up a whopping 25.3%. Main Street, on the other hand, has a distinct problem of unemployment hovering around 10%. The lofty unemployment rate coupled with underemployment and individuals who have stopped looking for work, puts the downtrodden closer to 17%. That's a lot of people on the dole.

For the majority of my life, I have been a Main Street guy. Still am and probably always will be. I am currently putting money under the mattress in for form of CD's and savings accounts and have been doing so for almost 2 years. I also have a percentage of my money in short ETF's which you are already aware of if you have been following this blog. I see the economy from the ground level: food stamps, soup kitchens, foreclosures and muggings. The rosy scenario that a majority of Wall Street pundits are promoting isn't what it's like on the front lines. This is why I'm staying out of the market for the time being. However, the "little guy" or Main Street may be getting back into the market with all of the current bullish sentiment after staying on the sidelines since the 'great recession' wiped out a great number of investors. This could be a bad move.

Throughout the years the markets have been very kind to my portfolios and I thank them for that. This includes all of the Wall Street "experts" who can't seem to agree on anything. You've got to parse out the white noise and get to the transmissions that are down in your range. Right now, the sentiment is extremely bullish and I heard this same tune in the late 1990's when there was a "new normal" and stocks were just going to keep going up. I am a subscriber to ValueLine and the majority of the securities I am interested in have very little room for growth in the next 3-5 years according to their reports. In fact, some will have negative returns with no dividends to pay out if you believe in ValueLine. Many of these stocks are in the green technology, mobile computing and cloud computing sectors. Bubbles abound so buyer beware.