Dancing in the Dark: S&P 500 Edition

In early July of 2007, Citigroup CEO Chuck Price told the Financial Times: "As long as the music is playing, you’ve got to get up and dance. We’re still dancing.". Didn't work out too well for him as he was out of a job a few months later. I am not going to go into detail about the "Great Recession" of 2008-2009, but Mr. Prince and his company were an integral part of the financial collapse. Citigroup wasn't a lone actor, either. Jump cut ten years later and investors are back on the dance floor. This is the second longest Bull Market in history.

S&P 500 Bull Markets Since 1928

Tough Date	Peak Date	Percent Gain	Number of Days
6/12/1928	9/7/1929	74.0	452
11/13/1929	4/10/1930	46.8	148
6/1/1932	9/7/1932	111.6	98
2/27/1933	7/18/1933	120.6	141
10/21/1933	2/6/1934	37.9	108
3/14/1935	4/6/1936	92.4	389
4/29/1936	3/6/1937	38.1	311
3/31/1938	11/9/1938	62.2	223
4/8/1939	10/25/1939	29.8	200
6/10/1940	11/9/1940	26.8	152
4/28/1942	7/14/1943	69.2	442
11/29/1943	5/29/1946	75.2	912
10/9/1946	6/15/1948	20.8	615
6/13/1949	8/2/1956	267.1	2607
10/22/1957	12/12/1961	86.4	1512
6/26/1962	2/9/1966	79.8	1324
10/7/1966	11/29/1968	48.0	784
5/26/1970	1/11/1973	73.5	961
10/3/1974	11/28/1980	125.6	2248
8/12/1982	8/25/1987	228.8	1839
12/4/1987	3/24/2000	582.1	4494
10/9/2002	10/9/2007	101.5	1826
3/9/2009	1/26/2018	324.6	3245

Yardeni Research provided the statistics for the above table aided by Standard & Poor's Corporation and Haver Analytics.

It's important to remember, this run began at an extremely low level thanks to Chuck Prince and his fellow investment bankers. Although a decade removed from the financial collapse, Main Street investors have long memories of the losses incurred. Those losses were realized if you sold at the bottom. Easy to do because it was not a normal correction. People were scared. The entire global financial system was at risk of annihilation. However, according to Bloomberg, if you bought equities at the previous market peak on October 9th, 2007, you would have doubled your money in ten years if you owned an S&P 500 index fund such as (SPY), (IVV), or (VOO), and reinvested your dividends.

To buttress this phenomenon, go no further than the J.P. Morgan Asset Management Retirement Guide and view the chart on the impact of being out of the market. When examining the 20 year performance of the S&P 500 between 1/1/1997 and 12/31/2016, money invested in the index had a total return of 7.68% annually. This time period includes two major market meltdowns which is probably why it returned less than the historic average of 9.5%. In contrast, if you would have tried to time the market and failed (as most do), your annualized returns would have been only 4% provided you missed the ten best trading days. Total returns decrease to 1.57% if you missed the 20 best trading days, and so on and so forth. At 1.57%, you might as well have been in a savings account to reduce your volatility.

The current acronym investment mangers utilize to underscore the importance of being long equities is TINA (There is no Alternative). Savings accounts and long duration Certificates of Deposit pay muted interest, somewhere around the one percent range give or take a few basis points. Ten Year Treasury Notes are climbing towards 3% yields, but this still pales in comparison to long-term stock returns. This is not very comforting if you are a retiree and require a steady flow of dependable income. My personal preference remains S&P 500, or Total Market index funds. Although subject to volatility, yields of these financial instruments are close to 1.8%, and if the market continues its ascent, you benefit from price appreciation.

Many investors remain concerned about the fast and loose machinations of computerized stock market exchanges. However, automated exchanges have been in existence for 50 years. Some of the increased volatility in the market can be attributed to retail investors themselves, not just the High Frequency Trading and Quant Funds with their unrestrained algorithms. Reduced commissions at discount brokers and tax deferred retirement accounts invite more trading, too. They've turned the market into a big casino. Derivatives only acerbate the matter.

Average Holding Time for Stocks by Decade:

• 1960, eight years, four months
• 1970, five years, three months
• 1980, two years, nine months
• 1990, two years, two months
• 2000, one year, two months
• 2010, six months

Source: Forbes

The data above stops at 2010, but from the trend, you can surmise holding periods are only getting shorter. I've seen some data that suggests three months is the most recent holding period for individual equities, and ETFs aren't immune from the short-term horizon. Those boring, plain vanilla S&P 500 index funds such as SPDR S&P 500 ETF Trust (SPY) are the preferred trading instruments of speculators globally.

ETF Average Holding Period

ETF	Ticker	AUM ($Bil)	Average Holding Period (Days)
SPDR S&P 500 ETF Trust	SPY	259.9	31
iShares S&P 500 Index	IVV	147.0	313
Vanguard Total Stock Market	VTI	90.2	679
Vanguard 500 Index Fund	VOO	84.4	376
PowerShares QQQ Trust	QQQ	56.1	27
iShares MSCI Emerging Markets	EEM	41.2	33
iShares Russell 2000 Index	IWM	40.4	23

Source: Morningstar Direct

All of these Exchange Traded Funds have ample volume and abundant assets under management. The iShares Russell 2000 Index which follows small caps has a scant holding period of just 23 days - a little over three weeks. In contrast, Vanguard Total Stock Market has a holding period of almost two years. Both are excellent investments, but my personal preference is with the more diversified fund which is the total domestic market index. Although some of these ETFs have high turnover ratios, you're not going to get burned if you invest for the long haul.

Addendum

The Musical Chairs game we're continuously playing in the market may have a ways to go because records are made to be broken. We have approximately three and half years of rising stock prices to surpass the previous enduring bull market of 1987-2000. With the advent of Artificial Intelligence, blockchain, 5G, video and audio steaming, plus new technologies such as Quantum Computing, this market has room to run. It won't be smooth sailing, but even with increased volatility, you're probably going to make money.

5G: The Full Tilt Boogie Band

Faster than a speeding bullet. More powerful than a locomotive. Able to leap tall buildings in a single bound. That's the buzz surrounding 5G, the next generation wireless network projected to roll out nationally by 2020. Connected Home devices, virtual reality goggles, sensors, driverless cars, and anything else wireless are supposed to benefit from the speedy, low latency technology. As an example, to download a two hour movie with 4G, it takes six minutes, but with 5G, that same film will take about 16 seconds.

Although the mainstream press have just begun touting the benefits of 5G technology to the masses, financial writers got on the bandwagon well over a year ago. Investment publications such as Investor's Business Daily and Barron's published pieces with suggestions as to where investors could go to get ahead of the curve. The problem I discovered, is that it's a roundup of the usual subjects. AT&T (T), Verizon (VZ), T-Mobile (TMUS) and Sprint (S) for the network providers. Nokia (NOK) and Ericsson (ERIC) for the network infrastructure buildout. A laundry list of semiconductor manufacturers and software service companies includes Cisco (CSCO), Broadcom (AVGO) and Intel (INTC) to round out the docket.

Despite the fanfare, the sector hasn't done well in the last two years with the SPDR S&P Telecom ETF (XTL) and its peers relatively flat since early 2016. Don't forget that 5G is just another word for telecommunications, and telecom stocks are usually purchased for their dividends, not price appreciation. These widow and orphan stocks may produce income, but not necessarily generate alpha. There are small caps that reside in the telecom sector if you're looking for potential ten baggers, but investing in individual securities is dangerous these days. Most of the time you think you're buying an expensive Cabernet Sauvignon, but end up with a bottle of Two Buck Chuck.

Exhibit A is Ceragon Networks (CRNT). The wireless backhaul specialist has languished the past five years diving from $5 to $2.50. Investor's Business Daily won't cover stocks unless they are above $10, so you can tell it's radioactive. Nevertheless, traders are recommending the company in the hopes it's a home run. Can it happen? Absolutely, but the chances are slim. Right now you are sitting on dead money and it's very difficult to buy at the bottom and sell at the top. Ceragon Networks is a pipe dream if you are looking to increase assets.

Another pure play is Zayo Group Holdings (ZAYO), which provides bandwidth infrastructure solutions to communications companies in North America and Europe. It's had a nice run the past two years going from $25 to $37, a 48% gain which outpaced the S&P 500. A diamond in the rough. However, with the recent purchase of Electric Lightwave and an upcoming deal for Spread Networks, it may trade sideways to digest the acquisitions. Investing in individual equities after significant runs can burn you, especially for a company projected to grow only 10% per year.

Right now, the rising stars of 5G may very well be the startups looking to dethrone telecommunications royalty. According to ABI Research, Athonet, CellWize, CellMining, AirHop Communications, Core Network Dynamics, Blue Danube, and Vasona Networks are some of the privately held firms being trumpeted. The operative expression here is 'privately held', which means Venture Capitalists, Investment Banks and Hedge Funds are the entities able to invest in these pioneering organizations. Retail investors are left out of the process. Nevertheless, even for the experienced and deep pocketed money managers, it's still a crap shoot, but they're usually playing with other people's money.

My belief is that the best way to play 5G is through Telecom ETFs because in 3 years from now, 5G will be synonymous with the traditional telecom companies. Although the deployment of 5G networks will slowly roll out in the next 24 months, investors usually bid up equities in advance of the implementation of a technology. The timing may be right for you to add one of these subsector ETFs to your portfolio, not only because they will benefit from 5G, but because they've been market laggards of late. You also receive dividends while waiting for the ascension.

TELECOMMUNICATION ETFs

An important factor to consider before buying a Telecom ETF is that S&P Dow Jones Indicies and MSCI recently announced upcoming changes to the Global Industry Classification Standard. The Global Industry Classification Standard decides what companies go into what indexes. On September 29th of this year, the Telecommunications Services Sector will be expanded and renamed Communication Services. Companies providing Internet access such as Comcast (CMCSA) are to be included. Telecommunications ETFs that mirror an index will be effected by the broadening of the industry group, probably for the better because you're injecting growth into the equation.

• SPDR S&P Telecom ETF (XTL): Introduced in 2011, this equally weighted fund has a fairly high expense ratio of 0.35%. With 48 holdings, it tracks the S&P Select Telecom Index. Industry mainstays such as AT&T and Verizon aren't included in the top 10 holdings which raises a red flag for me because you're looking for dividends in these investments. If you are an investor, you can find a lower expanse ratio. If you are a trader, you can find better volume. Dividend yield is 2%.
• iShares Telecommunications ETF (IYZ): Although IYZ has the highest expense ratio in the group at 0.44%, it's also the most liquid and favored by traders. Founded in 2000, right after the dot com crash, it's the granddaddy of telecom ETFs. I liked the top four holdings of AT&T, Verizon, T-Mobile and Sprint. That's the way it should be in its niche. It tracks the Dow Jones U.S. Select Telecommunications Index. The investment has a hefty dividend yield of 3.38%.
• Vanguard Telecommunication Services ETF (VOX): VOX is a market-cap weighted fund tracking the MSCI U.S. Investable Market Telecommunication Services 25/50 Index. Vanguard is synonymous with minimal expense ratios, and at 0.10%, you only pay $10 for every $10,000 invested. Verizon and AT&T comprise almost half the portfolio. Zayo Group is also included in the top ten holdings. A not so great investment for income seeking buy and hold investors with the dividend yield being a paltry 0.99%

• Fidelity MSCI Telecommunication Services Index ETF (FCOM): FCOM is relatively new to the fold being a shade under five years old, but competes toe to toe with the Vanguard offering. In fact, it has a lower expense ratio than VOX at 0.08%. The stats are almost identical to VOX in that it mirrors the same index and has approximately indistinguishable holdings. The big difference between the two funds is the volume with VOX almost doubling FCOM. Nevertheless, if you are a buy and hold investor, and are watching your expenses, this is another great option for you. The dividend yield is 3.22% which far outpaces VOX.
• ProShares Ultra Telecommunications ETF (LTL): The Wicked Witch of the West from The Wizard of Oz once said: "Do you wanna play with fire, scarecrow?". That's exactly what you're getting with LTL, a financially engineered instrument that delivers two times the profits and losses of securities in the telecom sector. It's been around for ten years, so it's probably not going anywhere. The expense ratio is steep at 0.95% and recommended for professional traders only. If you decide to venture into this option, you shouldn't hold your shares any longer than the trading day.

CONCLUSION

Although laggards to the S&P 500 where price appreciation is concerned, Telecom ETFs should be judged by their dividend yields. This is why I recommend FCOM. Not only does it boast the lowest expense ratio, but it also pays out close to twice the income of the S&P 500 on a percentage basis. In addition, when index alterations are introduced in September, it may get a boost from growth stocks included in FCOM's portfolio. Finally, if infrastructure legislation is passed by the United States Government, you may also see inflated results because 5G buildout should be included in the spending package.

Ten Percent of Nothing

Rock'em Sock'em Robots was a big game when I was a kid. Fast forward over half a century later, the robots are still battling, but this time it's in the inner workings of the stock market exchanges. There's a lot of finger pointing going on about what caused the S&P 500 to correct more than 10% in just a couple of days two weeks ago. With a significant selloff of 4.1% on February 5th that precipitated in minutes, many investors are up in arms because the algos went wild. Although the market had a nice bounce back last week, you can understand why so many are angry.

The main culprit being singled out for the collapse is the Credit Suisse issued VelocityShares Daily Inverse VIX Short-Term ETN (XIV). This is an Exchange Traded Note, not an Exchange Traded Fund. A financially engineered instrument. After much fanfare for over a year, it lost the majority of its value in hours causing great wealth destruction not only for its owners, but market participants globally. In examining the disruptive market tendencies of XIV, we have to go back to high school physics to Newton's First Law:

"Every object will remain at rest or in uniform motion in a straight line unless compelled to change its state by the action of an external force."

With Quant Hedge Funds programming investor sentiment and momentum into their algorithms, investment managers made fortunes as the S&P 500 went up in a straight line with low volatility for almost 15 months. Then that low volatility spiked. The external force occurred in the form of the liquidation of XIV as traders jettisoned the ETN. According to Jim Collins in Forbes:

"While some news outlets are describing XIV as an "obscure" security, the market value of XIV was nearly $2 billion last week, so it is clearly a meaningful name to professional traders...XIV holds no assets; the value of the notes is determined by an underlying index that represents the inverse of futures linked to the VIX volatility index...In two trading days XIV went from hedge fund darling to effectively a defunct security."

XIV lost 80% of its value in one day.

The liquidation of XIV caused an industrial strength chain reaction in the entire global marketplace because of that same foil in The Crash of 1929 - margin calls. In a Washington Post article, Steven Pearlstein gives a succinct explanation concerning the circular trading logic and the margin calls that ensued:

"It apparently created a vicious cycle in which selling begat more selling and wound up wiping out nearly $3 billion in valuation for investors...the amount of trading done with borrowed money is higher than it has ever been...major central banks that allow hedge funds to borrow $4 or $5 for every one of their own they put at risk. When prices start to fall rapidly, the funds are forced to sell their positions to pay back the banks and brokerage houses, driving down the price even further."

Although there is some discrepancy between the two preceding quotes as to how much money investors lost in XIV to the tune of a billion dollars, you can clearly ascertain that a significant amount of assets eroded. To paraphrase an old Wall Street idiom: "A billion here, a billion there, pretty soon, you're talking real money.".

Even though I don't condone or engage in financial engineering, especially after the Great Recession of 2008-2009, I'd like to point a few things out concerning the recent market drop.:

• The market was way over its skis, gaining close to 7.5% since New Year's and in need of a long overdue correction. Ten percent corrections happen annually on a historic basis, and we hadn't had one since early 2016. Additionally, we've had a reduced amount of both 5% and 10% pullbacks since the market bottom in March 2009. Investors got used the the gravy train.
• Things aren't what they used to be. In the recent movie "All the Money in the World", Christopher Plummer playing Jean Paul Getty circa 1973, continuously checks stock quotes via a Ticker Tape Machine. That world is dead and buried. Laymen now get split second access to stock quotes on smartphones from globally connected financial exchanges. In fact, not only did the recent correction effect the domestic markets, but the international markets sold off 10% in concert.
• In the Stock Market Crash of 1929, the DOW fell 20% in two days in an analogue world. Traders were exchanging buy and sell orders manually on pieces of paper, not via bits and bytes through mainframes and servers. Fiscally painful corrections happen, sometimes without the threat of recession during bull markets.

Double Digit S&P 500 Losses With No Recession

YEAR	LOSS
1939-40	(31.9%)
1941	(34.5%)
1943	(13.1%)
1947	(14.7%)
1961-62	(26.4%)
1966	(22.2%)
1967-68	(10.1%)
1971	(13.9%)
1978	(13.6%)
1983-84	(14.4%)
1987	(33.5%)
1998	(19.3%)
2002	(14.7%)
2010	(16%)
2011	(19.4%)
2015	(12.4%)

(source: A Wealth of Common Sense)

If you examine the chart, you can see that some of these double digit corrections occurred during boom times. The one most investors may relate to because it's the most recent excluding the current advance, is the run the S&P 500 had from approximately 1974-2000. I would be remiss if I didn't mention the Crash of 1987 transpired in the middle of the run, but it's included in the chart above. Three other non-recessionary selloffs happened during this period - 1978, 1983-84, and 1998. Those were good times for investors, and these are, too.

You need catalysts to keep the economic engine running and we've got many of them now - artificial intelligence, 5G, and, blockchain just to name a few. Even with interest rates rising, this market has room to run. As I have mentioned before, the hashtag is ten years old, Best Buy will discontinue selling compact discs and The Village Voice no longer has a print edition. We're not quite in Fahrenheit 451 territory, but times have changed. The market should reflect that in an era of rapid technological advancement although there will be bumps along the way.

Conclusion

Credit Suisse is closing VelocityShares Daily Inverse VIX Short-Term ETN. By next month, it will be a footnote in the annals of Wall Street. However, financially engineered instruments are like the city bus - there's always another one coming around the corner. They will make hedge funds and investment bankers a lot of money, but Main Street investors will be left holding the bag. Avoid them. That said, you can't avoid computerized stock exchanges. They're here to stay, so use diversified S&P 500 and Total Market index funds. You will lose principal during market selloffs, but historically you gain close to 10% annually if you reinvest your dividends.

Paranoid Android: Artificial Intelligence in your Portfolio

In the 2014 Sci-Fi mystery movie "Ex Machina", Stanley Kubrick's film"A.I.Artificial Intelligence", and the HBO television series "Westworld", humans are having sex with robots. Although we haven't quite reached that juncture in evolution, the proliferation of Artificial Intelligence is everywhere including your stock portfolio. It's so pervasive now that saying you have A.I. in your investments is like saying you've got corn in your Cornflakes. Digirarti guru Mark Cuban believes technological advancement in the next ten years will be swifter than the last thirty years with A.I. being one of the main catalysts.

(click to enlarge)

Since late 2017, financial Websites have been inundated with articles about Artificial Intelligence pureplays, suggesting single stock selections to goose your investment portfolios. Although you will occasionally find a semiconductor equity such as Nvidia (NVDA) included, business writers primarily suggest the FANG stocks. FANG is an acronym CNBC's Jim Cramer coined in the past two years that stands for Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google (GOOG) (now known at Alphabet). The term recently morphed into FAAANG to include Apple (AAPL) and Alibaba (BABA). With the exception of Apple, all are Internet stocks.

I've written ad nauseam about my personal preference of investing in plain vanilla S&P 500 or Total Market index ETFs, but sector ETFs are an option for investors wanting to generate alpha in their portfolios. Even with elevated expense ratios, these niche ETFs can boost your overall returns if, and only if, you catch them at the right time. They primarily come in two flavors, passively managed Internet ETFs issued by mid tier ETF companies and A.I. specific funds from boutique financial firms.

Internet ETFs

Liquidity and longevity are two critical ingredients when selecting subsector ETFs. In the Internet space, First Trust Dow Jones Internet Index Fund (FDN) and PowerShares NASDAQ Internet Portfolio (PNQI) are the two largest with track records going back at least a decade. In fact, since the market crash of 2008-2009, they are two of the best performing ETFs in the financial universe. Domestically focused FDN is the preferred investment vehicle for traders because of its liquidity, but PNQI has performed equally as well with an international leaning. FDN has 9 times the daily volume as PNQI. Expense ratios for both are steep, 0.54% for FDN and 0.60% for PNQI.

Nevertheless, with market-cap-weighted holdings greatly exposed to the FANG stocks, both ETFs have kicked in the afterburners where performance is concerned. Average gains are roughly 23% per year the past five years outpacing the S&P 500. Besides the liquidity, the big difference between the two funds are geographic allocation and number of holdings. PNQI includes overseas equities with a significant exposure to Chinese Internet companies with the exception of Alibaba. The exclusion of Alibaba continues to perplex me, but organizations like Baidu (BIDU) and JD.com (JD) are under its umbrella. Another heavy hitter in the fold is British travel company Priceline Group (PCLN). PNQI holds 88 securities, over double the amount as FDN.

A.I. ETFs

• Global X Robotics & Artificial Intelligence ETF (BOTZ): News travels fast in the financial world. BOTZ had its inception date on 9/12/16, and in a short period of time, it became one of the best non-leveraged ETFs of 2017 gaining 49%. Some of this performance may have to do with an overweight position in Nvidia which constitutes almost 10% of holdings. With only 28 stocks, it's a concentrated portfolio, but that hasn't stopped speculators from bidding it up. Like all of these specialty ETFs, the expense ratio is high, 0.68%. No FANG stocks in its top 10 holdings, so you're getting more of a robotics story here.
• ROBO Global Robotics and Automation Index ETF (ROBO): ROBO has been trading three years longer than BOTZ, but has a much higher expense ratio of 0.95%. You expect some alpha generation with those fees, and although it gained 36% last year, it pales compared to the performance of BOTZ. ROBO holds 89 equities which gives you some global diversification. Like its brother BOTZ, there is not a lot of liquidity with this fund, so you are best suited to use limit orders. The top holding only constitutes 2% of the portfolio.
• ARK Industrial Innovation ETF (ARKQ): ARKQ is another high flyer from 2017 gaining approximately 45%. It's also another low volume, lofty expense ratio ETF charging 0.75% annually. International in scope and actively managed, I found it interesting that Tesla (TSLA) comprised almost 10% of the portfolio of 43 equities. Inception date was 9/30/14, so it's got some history behind it, but don't confuse brains with a bull market. There are thousands of ETFs issued worldwide and any significant downturn in the market could put any of these thematic ETFs in jeopardy.

Conclusion

An oligopoly has formed in the A.I. arena. The same Internet companies we've come to depend on for our everyday technology needs devour smaller startups. The Google and Amazon of 15 years ago are no longer mom and pop shops. They are the IBM and AT&T of the 1950's, if not the Standard Oil of New Jersey in 1900. The Gilded Age redux. That is why if I were to purchase an Artificial Intelligence ETF, I would select either PNQI or FDN with heavier leanings toward the Internet. Unless the European Union or the United States Government breaks them up, there is plenty of room to run.

FDN receives my most favored nation status only because of its relatively high volume. In an up-to-the-second connected world, PNQI, BOTZ, ROBO and ARKQ may frustrate investors or traders with quotes delayed as much as 5-10 minutes. Sometimes as much as a half an hour. That is why I can't stress enough the importance of using limit orders. Although your broker can probably provide you with CFRA reports powered by S&P Global on these smaller exchange traded funds, I find ETF.com is the best source for statistical analytics. It's free. Just go to their Website and register.

I Was Born at Night, But Not Last Night

Last week while surfing Seeking Alpha, I came across Bill Ackman's Pershing Square London Investor Meeting slide deck. What caught my attention wasn't the securities the renown hedge fund was buying or shorting, but the recent performance history of the company as compared the the S&P 500.

Year	Pershing Square	S&P 500
2013	9.6%	32.4%
2014	40.4%	13.7%
2015	(20.5%)	1.4%
2016	(13.5%)	11.9%
2017	(4.0%)	21.8%

Although Pershing Square trounced the S&P 500 by approximately 27% in 2014, the remaining years aren't even close with the S&P 500 shellacking the hedge fund. In fact, while 2013 and 2014 are a wash if you compare the index to Pershing Square, 2015-2017 shows the S&P 500 gaining roughly 35% compared to Bill Ackman's investments losing 38%. It's a 73% difference in performance for those three years. Small sample size? Yes, but we're in a bull market and these are the times when investors make money.

I don't mean to single Pershing Square out, but Bill Ackman puts himself in this position by making frequent television appearances on high profile business networks such as CNBC. His dust up with activist investor Carl Icahn on CNBC's Fast Money over Herbalife (HLF) was all the rage in the business press over a year ago. Mr. Icahn was buying shares of Herbalife while Mr. Ackman took a significant short position, calling the company a pyramid-scheme. The big story here wasn't the overall success or failures of their portfolios, but the pissing match they created on national television.

In a recent CNBC Fast Money segment, money manager Mario Gabelli of GAMCO Investors, defended Bill Ackman's poor performance stating that Ackman's company would be back after a rough patch. Gabelli also stated his own firm has 600 securities under management. That's closet indexing. Being the highest paid money manager on Wall Street, he has a vested interest to promote active management. These guys are thick as thieves.

In reality, when you're dealing with investments, the bottom line should always be performance. The majority of hedge funds have underperformed the market the past decade. Icahn Enterprises (IEP) may be an outlier only because it gained a whopping 154.83% in 2013. However, for the most part, the returns have been lackluster to negative for the past decade. If you put your money in Icahn Enterprises beginning in 2014, you're behind the eightball. According to multiple reports, hedge funds in total gained 8.5% in 2017 as opposed to 21.8% for the S&P 500, and that was the best performance year since 2013.

Anecdotally, in 2007 Warren Buffett bet one million dollars with asset managers Protégé Partners LLC that over a 10 year period, an index fund would outperform a basket of hedge funds, otherwise known as a fund of funds. Over the decade, the S&P 500 returned 7.1% compounded annually while Protégé Partners selections averaged 2.2%. Protégé Partners ponied up. Although the wager was for charity, you get my point. Mr. Buffett has long promoted the use of index funds for individual investors. In his 2013 annual Letter to Shareholders, he stated that he would allocate 90% of his fortune bestowed to his wife in S&P 500 index investments. That's a big time endorsement.

I expect more from the high costs associated with these well heeled money managers. Hedge Fund Research reports the average hedge fund management fee is 1.45% of assets. Pershing Square charges clients 1.5%. I'd rather be in an S&P 500 index fund such as the iShares Core S&P 500 ETF (IVV) which charges 0.04%. That's $4 for every $10,000 invested. SPDR S&P 500 ETF Trust (SPY) has an expense ratio 5 basis points higher than the lowest priced S&P 500 index trackers, but you're paying for liquidity and it's still much less expensive than an actively managed fund.

With the expense wars heating up between ETF providers, you can find ETFs with smaller expense ratios than iShares Core S&P 500 ETF. The SPDR Portfolio Total Market ETF (SPTM), which includes over 3,000 domestic equities, has an expense ratio of 0.03%. Many sources in the business press have reported about the ongoing ETF expense ratio reductions. Some are speculating that some index funds holding fees will drop to zero within the next few years to enable management firms such as Vanguard, Blackrock and State Street Global Investors to commandeer your assets.

Standing in the Shadows of Love

Damon Runyon once said: "The race is not always to the swift, nor the battle to the strong, but that's the way to bet.". That pearl of wisdom may have been true in an era before the proliferation of high frequency trading and computer algorithms, but now that we are in the age of artificial intelligence, the turtle, not the hare appears to be the smarter way to wager - at least in the long run. Don't take my word for it, just examine the statistics. Sabermetrics is not only confined to baseball. Big Data in the investing industry is current and prevalent. There are many excellent books up-to-date and available that prove this thesis.

In the mid 1970's, Charles Ellis wrote a research paper that later morphed into his pioneering passive investing book "Winning the Loser's Game". I read it years ago and recommend the most recent edition as a starting point. However, during the past six months there are two books I've read that are fresher in my memory. The first is "The Incredible Shrinking Alpha" by Larry Swedroe and Larry Berkin. It's like a pamphlet, but well worth the price of admission. The second is the 10th anniversary edition on John Bogle's "The Little Book of Common Sense Investing". If you are new to investing, they are eye openers.

Although the debate over active vs. passive investing rages on, it's passive indexing that trounces active managers once you remove fees and expenses from the equation. That is the overarching theme in the three books I have just recommended. This is especially true in a computerized stock market. Trust me, you're not faster than a bot. "Everyone is entitled to his own opinion, but not his own facts.". That old political chestnut by Daniel P. Moynihan was prescient in a time before being inundated by artificial intelligence from Google, Facebook, Amazon and Apple. Ego has no amigo in the investing world. Just follow the facts.

Kicking the Tires on GoPro

For the past year and a half, the financial blogosphere has been inundated with posts touting the pros and cons of GoPro (GPRO). There's never been too much of an argument as to the quality of their high definition camcorders - very popular with millennial daredevils and outdoor enthusiasts. However, the perception that GoPro is more than a one-trick pony was greatly distorted in its first few months as a public company which caused it to accelerate to the upside.

Originally, traders bid the stock up with the expectation GoPro would build a media company with original content created with GoPro camcorders. You probably remember the catch phrase "content is king" back in the late 90's. Unfortunately, it couldn't supplant the 800 pound gorilla in the space, Alphabet's (GOOG) YouTube. Although GoPro has a very successful channel on YouTube, it doesn't generate enough revenues to command the lofty valuation it once did.

The stock got as high as $100 during its first few months of trading, only to come crashing down to $28, roughly $4 above the IPO price of $24. Almost a round trip ticket.

Examine the chart below:

Source: Stock Charts

The extreme decline in share value may be a tantalizing entry point for some investors, especially if they're familiar with GoPro's products. However, there's a 30% short float on the equity, so many traders believe the stock has more room to go to the downside.

I've read arguments that there is potential for quick profits for GoPro bulls with the advent of a short squeeze, and this may be true, but not at this juncture in my opinion. I tend to side with the shorts and think that although there is a future for this company, whether as a stand alone entity or part of a larger conglomerate, the next quarter will be tepid. The next earnings call is scheduled for October 28th, and I'm waiting for company results at this time before I put any money to work, if at all.

Short Term Bear Thesis

• High Definition semiconductor manufacturer Ambarella (AMBA) warned that Q3 would be flat in their last conference call. Ambarella is GoPro's primary chip supplier. Although this news caused GoPro to sell off significantly, the damage may not be done.
• No wide moat. Although GoPro has great brand recognition in the United States and is doing well internationally, in China it's rival Xiaomi that may have a leg up. Not only are Xiaomi camcorders significantly less expensive than GoPro's products, but there's that old adage "charity begins at home". There's no guarantee GoPro's Hero series of action cameras will supplant Xiaomi products in Asia.
• Oversaturation. GoPro has been around for years. Those that want the cameras probably already own them. Although they make for great stocking stuffers, that's a Q4 phenomenon.
• Smartphone cameras are improving. Although you don't want to take your iPhone or Android device scuba diving, the quality of still and motion pictures on smartphones is improving which may temper sales to mainstream buyers. As an example, the recently released Session model aimed at mainstream users was met with tepid reception, resulting in GoPro reducing the price by $100.
• Government regulation. Quadcopter is GoPro's foray into the drone market, and is scheduled to be released in the first half of 2016. Wall Street is a forward looking mechanism and potential sales of Quadcopter may be buoying current share price of $28. I think the drone market will be regulated in the near term, and may put pressure on sales, which in turn will decrease earnings.
• Virtual reality is an evolution, not a revolution. Odyssey, GoPro's 16 camera array that captures action in 360 degrees will surely be a hit, but not until VR technology becomes more suitable for the mass market. As is, we're still in the pioneering phase of VR rollout. Odyssey will not contribute meaningfully to the top or bottom lines for a few years.
• Analyst downgrades. Piper Jaffray recently cut GoPro's price target from $54 to $25. More brokerage firms may follow suit as the company's financial niche transitions from entertainment entity to hardware manufacturer. Valuation metrics should be in the same ballpark as a Garmin (GRMN) or an Apple (AAPL).

Long Term Bull Thesis

• Quality. GoPro cameras are the best products on the market. The editing software is improving, too.
• Brand recognition. GoPro cameras are synonymous with "must have" with the Millennials. This is true both domestically and in Europe. If they command a certain cachet in Asia, this could propel revenues to the upside.
• Expanding markets. If drone technology doesn't get regulated to extreme levels, and Virtual Reality becomes more user friendly, GoPro will have additional revenue streams to build on.
• Great distribution. Over 40,000 retail outlets sell GoPro camera. If you want to buy one, there shouldn't be a problem.
• Well run company. GoPro is profitable and has very little debt.

Valuation

The sentiment on Wall Street has soured on GoPro because it is no longer considered a media company. Analysts are valuing it as a hardware stock now. Let's compare some statistics between GoPro and Apple, another hardware company and see how it stacks up.

	GoPro	Apple
Price/Sales	2.23	2.84
Price/Book	4.84	5.08
Return on Equity	41.58%	41.15%
Estimated earnings growth this year	28.80%	41.60%
Trailing P/E	25.53	12.84
Estimated earnings growth next year	15.30%	7.30%
Forward P/E	14.55	11.33
Dividend	0%	1.86%

Source: Yahoo! Finance

The two stocks appear to be evenly matched in Price/Sales, Price/Book and Return on Equity. It's when we get to earnings growth and forward P/E Ratios that GoPro seems to be slightly overvalued compared to Apple. Plus, Apple pays a healthy dividend for a Silicon Valley corporation. I believe Q3 will be a tough one for GoPro, and analyst estimates may come down, especially impacting the forward P/E Ratio.

Strategy

I'm a value investor by principal and prefer to purchase my stocks at discounted rates. GoPro doesn't meet that criteria yet. All bets will be off if they report a killer quarter on October 28th, but I'm positioning my bid as a price in the low $20 range, below the original IPO price of $24. I will not chase a stock like GoPro. If I do happen to catch my price, I wouldn't hold my position much past Q4 which is traditionally a strong quarter because of the holidays.

A Clear Plan of Attack

The current market correction we're experiencing has carpet bombed some high flying stocks into submission. Alibaba (BABA), Tableau Software (DATA), and Twitter (TWTR) were all shown the door by short-term investors exiting their positions. Selling pressure has reduced equity valuations to levels that haven't been seen in months, and in some cases years. Although I've done a complete reboot with my investing thesis during the last two years by primarily buying index ETFs, I still dabble in individual equities on a limited basis. Enclosed is my current take on these three securities.

Tableau Software

Tableau Software still remains a category killer. It traded at $131 at the end of July, only to come tumbling down to $82 as of Friday. I got off the sidelines and picked up some shares, although I didn't back up the truck because my belief is that it's much more prudent to be in index funds at this juncture. Nevertheless, I wanted to own a limited number of shares to become an investor in a exciting young company. I thought $82 was a good price for a solid growth company.

My last posting gives you the lowdown on where the company stands, but here's the synopsis - It was a momentum stock for most of 2015, only to be sold off after a very solid quarter because Wall Street deemed the valuation too high. Tableau dropped roughly $50 in 45 days. Some of the depreciation is due to the quarter, some to the overall market correction, and some because on Thursday rival Oracle (ORCL) reported a slowdown in revenues. This, coupled with The Street reconfirming their SELL rating on Tableau citing better valuations among its peers, caused it to drop $6 in one day last week.

This SELL rating by The Street is short sighted in my opinion. Tableau is the proven technology leader in data visualization organizations, whether it's a pure-play, or part of a conglomerate like Oracle. It deserves a premium multiple. Granted, Tableau's technology can be leapfrogged in a heartbeat, but they've maintained pole position for years, and invest heavily in R&D. My bet is that the market sell-off we're experiencing is just a run-of-the-mill correction, and that Tableau accelerates to the upside after the next conference call. It may not become a go-go stock again, but it has the potential to beat the S&P 500 for the next few years.

Twitter

Last week Twitter CFO Anthony Noto made a presentation at the Deutsche Bank 2015 Technology Brokers Conference. Mr. Noto is a candidate for the vacant CEO position, which is now in a state of flux. Company co-founder Jack Dorsey is Twitter's interim CEO and is also in contention for the top spot. The board has yet to make its decision on who will be calling the shots, and Noto declined to make any comments on the CEO process during the presentation. A lack of a permanent leader has been cited as one of the reasons the stock is under considerable pressure.

Another reason for the equity sell-off is that the product is difficult to use, which in turn decreases the number of monthly active users [MAU]. Mr. Noto addressed this concern and went into detail about Project Lightning, an initiative by the company that is set to launch this Fall. In a nutshell, Project Lightning will curate Twitter content to make Twitter simpler and easier to use. The organization is going to make a big media blitz through television advertising and digital video, to make the mass market aware of the product change.

My belief is that once the market correction is over, the results of the Project Lightning are in, and the CEO is in place, Twitter will make considerable gains. I've written about the stock numerous times, and thought it was expensive. However, I had a limit order in for $25, and during the recent "flash crash" picked up some shares at $23. I really enjoy using the product, and believe the stock will do well after it gets through the near-term growing pains. This is an investment for me, not a trade, albeit a very small investment.

Alibaba

Most people that follow business news are well aware of the pissing match between Barron's and Alibaba last week. It started with Barron's doing a cover story about the Chinese e-commerce company with a preposterous claim that the stock could fall 50%. This is after a fall from $120 to $65. Alibaba shot back with a rebuttal, stating the article was filled with fallacies. It is difficult to know if any company is a house of cards, but if Alibaba is, it would mean the biggest stock collapse since Enron. I give Alibaba the benefit of the doubt, but must play Devil's Advocate because it is a Chinese company which tend to lack transparency.

Like Twitter, Alibaba also presented at the Deutsche Bank 2015 Technology Brokers Conference last week. Executive Vice Chairman Joseph Tsai made the presentation, but didn't shed much more light on the company then what was already given on the last conference call. He did state that there has been a slowdown in the overall Chinese economy since mid Summer, a psychological effect from the stock market crash in China. White-goods such as washing machines and refrigerators remain steady, but the lower end consumer goods have slowed down. He also discussed logistics, and how "the last mile" isn't as developed in his country as opposed to Europe or the United States. This means there's plenty of room for improvement by Alibaba partners engaged in he transport of goods sold.

Alibaba's stock was priced at $68 for its IPO a year ago. It now trades at $65. A lot of smart people in the investment banking business priced it at $65 for a reason - the underlying business fundamentals. That said, although business is improving for Alibaba, the economy is slowing in the People's Republic of China. That, coupled with a large share lock-up expiration that come to fruition on Monday, make me want to take a wait and see on this equity. I don't believe the stock will be cut in half as Barron's suggests, but if it drops $10, to $55, I would consider taking a flier on it for Asian exposure to my portfolio.

Resistance is Futile: Artificial Intelligence Invades the Markets

Black Monday was Monday, October 19, 1987, when the DOW fell 22.61% in one trading session. Illiquidity and investor psychology have been cited as possible factors for the sell-off, but the brunt of the implosion can be traced to Quant Funds that do all of the program trading. We now have circuit breakers and other mechanisms in place on the major exchanges to prevent another catastrophe, or so this is what we're told. Fast-forward to late August 2015, and the DOW drops almost 1,100 points at the open for no apparent reason other than rogue algorithms. Things could have gotten out of hand.

Omega Advisors Chairman Leon Cooperman, a vocal self-made billionaire, is often on CNBC, and he cites the proliferation of risk-parity funds as the culprit of our recent "flash crash". To use a simplistic definition, risk-parity is an investing strategy some quant funds use to limit risk by over-allocating lower volatility assets. This investing technique usually has a heavy dose of bonds over equities, and is supposed to protect investors such as pension funds in all investing environments. In theory, if stocks sell off, you make money with the bonds, and visa versa.

The problem is that both stocks and bonds are not supposed to depreciate at the same time. Enter the new "flash crash" where both stocks and bonds took a beating. A recent Reuters article gives you more depth about risk-parity funds and the possibility that they did do damage to the overall markets three weeks ago. Mr. Cooperman took exception to funds like this in a CNBC interview because they cause instability in the indexes, plus alter conventional investing tactics:

"In the world I grew up in, and the world Warren Buffett grew up in, when something went down you wanted to own more, and in the world that we're in now, it goes up you want to own more, and it goes down you want to own less, and that's just counter-intuitive. It lacks common sense."

He's absolutely right that it doesn't make sense. You've probably heard stock pickers use the expression, "It's a market of stocks, not a stock market.". That's a dead chestnut in today's era of programmatic portfolio allocations. An old stock picker like Cooperman said it almost correctly:

"I think the machines seem to be taking over."

The machines don't seem to be taking over, they have taken over. That's why it's much more advantageous for individual investors to be in S&P 500 index funds such as SPDR S&P 500 ETF Trust (SPY), iShares S&P 500 Index (IVV), or, Vanguard 500 Index Fund (VOO). Any one will do. This is especially true if you are a domestic investor. It's like John Henry versus the steam drill. John Henry and his hammer won, but only to die at the end of the competition from exhaustion. It's much better to be on the mechanized side of the fight at this juncture. Yes, you can still pick winning individual securities, but what's the probability you'll do it consistently when competing against computers.

The Reuters article cites that the world's largest hedge fund Bridgewater Associates, allegedly lost 4.2% in August. Bridgewater's 'All Weather Fund' is an algorithmic trading vehicle, a risk-parity fund. It's supposed to make money during market sell-offs. Because you need to be a high roller to invest in hedge funds, it's the one percenters that lost money during August investing in Bridgewater's fund. Nevertheless, it's Main Street investors, either through pensions, 401K plans or individual broker accounts, that probably saw shades of the 'Great Recession' of 2008-2009 flash before their eyes due to market instability. It was the lead story on the evening news for a week.

Bridgewater Associates has $165 billion in assets under management, and this is miniscule compared to the net worth of the trillions of dollars invested in the overall markets. I doubt they were the lone wolf that caused such a big market meltdown in the most recent 'flash crash', but they could have contributed to it. However, they were asleep at the wheel during August with their proprietary trading algorithms, which presumably were being monitored and adjusted by a team of human beings. What's going to happen when the machines take over, and all trading is guided by artificial intelligence? The future is closer than you think.

"I'd rather be a hammer than a nail"

High finance is quickly morphing into a machine learning world along with the rest of corporate America. Bridgewater Associates recently formed a new artificial intelligence division spearheaded by David Ferrucci, the mastermind behind the IBM and academic engineers that created the Watson computer system. According to an article by Phoebe Venable:

"The AI unit will devise trading algorithms that make market predictions based upon historical data and statistical probabilities — and like all AI systems, it will adapt to new information and get smarter as it goes."

Warren Buffett also likes to say, "If past history was all there was to the game, the richest people would be librarians.". However, Bridgewater isn't alone in its pursuit of unlimited profits by utilizing machine learning. A blog posting by Robust Tech House lists most of the major players venturing into the new era of AI, plus a brief synopsis of their business models. The firms included are:

• Two Sigma Investments
• Bridgewater Associates
• Clonealgo
• Renaissance Technologies
• Aidyia
• Cerebellum Capital
• Rebellion Research
• Commeq
• Castilium
• Binatix
• Sinai
• KLF Capital

If you have plenty of cash to burn, a closer examination of these organizations will give you a nonstop flood of ideas where to invest if you are inclined to go with machine learning algos. The prevailing orthodoxies on Wall Street would tell you to put your money in firms like these. However, I don't know which ones are flush with cash, or which ones are skating on thin ice. With the exception of companies such as Bridgewater Associates, most hedge funds have short self lives, automated or not.

Aidyia, one of the AI Funds listed above, is thoroughly covered in Quartz by Georgia McCafferty. As she states in her posting about the future of finance:

"Most quantitative trading, as it is currently practiced, relies on a human being to develop a mathematical model to identify trading opportunities. The model is then updated by hand to adapt to new markets or changing conditions. For an AI, conversely, humans develops the initial software, but the AI itself develops the model and changes it over time."

Just like the Bridgewater algo. What I find disturbing is that if the people monitoring Bridgewater's 'All Weather Fund' can't keep from losing money in a "heads I win, tails you lose" environment, what's an algorithm going to do if they aren't programmed correctly? This could put a lot of pressure on the markets and cause a collapse. It almost happened three weeks ago with human interaction. What about on autopilot?

I'm not a Luddite, but am wary of the new era. With the proliferation of personal computers and smartphones, the age of privacy is over. This becomes more evident when you mix machine learning with cloud computing. Artificial Intelligence in all forms is here to stay, especially in finance. It's a leading edge business where technology is concerned. There has to be some government intervention to monitor automated hedge funds or else they're doomed to crash the markets.

Splunk: In No Man's Land

"Big Data is a broad term for data sets so large or complex that traditional data processing applications are inadequate." - From Wikipedia.

If you're in the corporate world, the concept of Big Data is nothing new. Even Main Street is aware of phenomenon, if not by name, then by practice. One example is Sabermetrics, the advanced baseball analytics made popular by the book Moneyball by Michael Lewis, and made even more popular by the movie of the same name starring Brad Pitt. Another is Amazon (AMZN) recommendations. The more you shop, the more they know about you. That's Big Data at work.

Although this mining and massaging of data is here to stay, Big Data as we know it is morphing from static sources to continuous data streams of spontaneous creation. This actionable data is created by HVAC controllers, smart electrical meters, GPS devices, RFID tags, smartphones and electronic wearables like a FitBit. We are now entering into the era of telemetry, the automated communications process by which measurements are made, and other data collected at remote points, then transmitted to receiving equipment for monitoring. This is where Splunk (SPLK) comes into play.

I did a posting about Splunk in early 2014 when it was the flavor of the month along with its entire sector of data mining and analytics securities. For a more detailed look into Splunk's business model, you can find my previous article here. At the time, I thought the equity was overvalued, and still do by a price/sales metric, but valuations have come down significantly in a year and a half.

Source: Stock Charts

If you examine the above chart, you can see where the stock was extremely overvalued. Stair step pattern on the way up. Elevator on the way down - penthouse to lobby in a matter of a month. However, if you are a long-term investor and bought at the IPO price of about $25 three yeas ago, you doubled your money. That beats the market. I don't want to go over old material from my last posting about Splunk, so I will concentrate on two areas of interest the company has been expanding the past 18 months, Security and Cloud.

Security

Every digital action produces actionable data, and Splunk's predictive analytics puts them at the forefront of Internet security for both corporations and The United States Government. According to CFO David Conte in the most recent conference call:

Security two plus years ago was 20% to 25% of business, and the end of last year, it ended up being not quite 50%, but over 40%.

With so much of the company's revenues devoted to security, I was surprised it didn't get caught in the updraft during the past year of many cyber security equities like partner Palo Alto Networks (PANW), which has had an incredible run, and to a lesser degree the PureFunds ISE Cyber Security ETF (HACK). That hasn't been the case. Perhaps investor sentiment will change once the market gets back in gear because of two recent acquisitions.

The first acquisition is Metafor Software, an anomaly detection and machine learning company. Splunk plans to fold in Metafor's technology into their already existing platform. The second purchase is Caspida, which adds Behavioral Analytics and machine learning to better detect advanced threats and malicious insider penetration. The software uncovers hidden breaches and new attacks out-of-the-box without extensive customization. Splunk will offer this product as a standalone application and bundle it in with their existing product line.

In the last conference call, company chief Godfrey Sullivan commented that security has become the main conduit to gain access into the inner workings of IT departments. For the first time security is serving as a steward for a lot of machine data across an organization. Splunk's sales department now targets security departments of potential clients, then expands across to application development or IT operations. Four years ago, it was the other way around, you'd go through IT operations to get to security. Splunk is the nerve center of security as one executive stated.

Cloud

Another initiative Splunk has recently launched to increase its Total Addressable Market [TAM] is its cloud service. Splunk cloud is now available through nine Amazon Web Services global regions. The results from the international launch look promising, and in the past nine months, clients have tripled their orders. According to a Splunk executive:

Our customers are excited with the speed and ease of Splunk cloud. They are happy to focus their time and attention on analyzing data to achieve their business results rather than procuring and deploying equipment.

Company management also believes they have the only solution in the marketplace that gives clients a true hybrid experience. They can search seamlessly across data stored on premises and in the cloud to get a unified experience with a single Splunk interface. One example is The City of Los Angeles who purchased Splunk cloud and the application for enterprise security to correlate cyber threat information with several other governments. This solution allows Los Angeles to monitor and analyze network traffic to identify discrepancies that indicate malicious attacks.

Offering a cloud or software-as-a-service solution is the way that many enterprise software companies are transitioning. It enables you to reach smaller customers with an out-of-the-box solution, plus takes away implementation headaches for IT departments in larger organizations. However, corporations like Adobe (ADBE) and Nuance (NUAN) made the switch, and found that it put pressure on equity valuations for a number of years. Although Splunk is in the early stages with its cloud offering, it's something potential investors should be aware of.

Some Statistics

Some pertinent points addressed in the conference call:

• Revenues were up 46% over the past year.
• The company can claim 10,000 customers worldwide. Including 79 of the Fortune 100 companies.
• Since they denominate revenue globally in U.S. dollars, they do not have foreign exchange exposure.
• Splunk expects to be profitable on a non-GAAP basis for the balance of the year.

Valuation

When I wrote my initial post about Splunk, trailing twelve month price/sales was 32 with a market cap of 9.8 billion dollars. Now it's much more reasonable with a price/sales of 14 and a market cap of 7.56 billion dollars. Still expensive. This can be reflected by the short float of roughly 11% as of two weeks ago. In addition, after a well executed quarter as reported on August 27th, the stock price went down. I realize there is no cookie cutter answer as to when the current overall stock market correction will be over, but it's taking all the growth with no earnings equities down, Splunk included.

Splunk excels at telemetric data collection with machine-to-machine data mining and analytics. This sounds like science fiction and that's why I like the company. They're using 21st Century technology in a 21st Century world. If you are considering investing in Splunk in anticipation of it regaining its go-go days of two years ago, I believe you will be disappointed. However, if you want a high growth company that appears to be turning profitable, this may be the right stock for you if you temper your expectations on price performance.

Liking a company and liking a stock price are two separate situations. I am not alone in my conclusion. A Barron's assessment of the conference call echoes my beliefs, or perhaps I'm parroting Wall Street consensus. As far as equities go, Splunk reminds me a lot of Acme Packet, a security that was engulfed by Oracle (ORCL) many years ago. Both pure-play companies had big runs, then crashed, although their respective technologies were deemed superior. I don't know what's in store for Splunk, but they'll probably be around for a long time unless a company like IBM has a better idea.

Be Careful What You Wish For

Back in the 1990's, Legg Mason's Bill Miller was synonymous with investing excellence. He ran the Legg Mason Value Trust mutual fund, and his after-fee returns beat the S&P 500 index for 15 consecutive years from 1991 through 2005. He was often mentioned in the same breath as Warren Buffett where money making prowess is concerned. Miller's investing style was utilizing a concentrated portfolio which was in vogue at the time, and he made outsized bets on young technology companies like America Online. You can't argue with his success.

Back when Bill Miller was front page news, I distinctly remember an interview with him, and he was asked what books he was reading to compliment his investing process. He replied he was very much influenced by horse handicapping and betting books. This was before the advent of High Frequency Trading and the proliferation of Quant Funds that are popular in today's investing world. I don't know what Mr. Miller's investing style or track record is in the environment of proprietary trading algorithms, but he may have changed with the times.

Last week I read a book, Smart Sports Betting by Matt Rudinitsky that stated the sports betting market is very much like the stock market. Below are quotes by the author on the parallels of the two, plus my own commentary:

• It incorporates everything that is public knowledge. (Just like the Web bots that scour the Internet for press releases that report investing information such as earnings statistics. By the time the retail investor gets wind of the information, deep-pocket investors have already taken advantage of the price/action.)
• It incorporates the thoughts of all professional bettors, because their money has flown into the market and given oddsmakers information on who they like. (Sounds a lot like the options market. Industry insiders know where the hot money is flowing.)
• It incorporates the thoughts of many ridiculously complicated algorithms that professional bettors have backed up with lots of money. (This parallels with quant hedge funds.)

Statements like this are why I have almost given up investing in individual securities, and have migrated to passive investing in index funds like iShares Core S&P 500 (IVV). All is known...except when you get a flash crash like we did on Monday when the DOW dropped close to 1,100 points at the open. Although we've regained a lot of those losses after a two day rally, the sensory overloading drop spooked both retail and institutional investors.

We haven't experienced a flash crash, or whatever you want to call it, in five years. With the high frequency trading networks and quant funds commandeering the exchanges, selling begets more selling. A vicious cycle as trading triggers kicked in as each technical level was breached. If you didn't have limit orders in place before the market opened on Monday, you were out of luck for a brief period of time. Many brokerage houses shut down for the first fifteen minutes of trading from the overwhelming volume and price depreciation in both equities and ETF's. You would not have ben able to log into your brokerage accounts in some instances.

One piece of carnage on Monday was the drop in the iShares Core S&P 500 ETF, which was down almost 25% in the first few minutes of trading. This did not correlate with the overall decrease in the S&P 500. The decrease in the iShares Core S&P 500 ETF was much more severe. Although the price/action balanced out after about ten minutes, if you sold your shares at market price, you got fleeced. Although high frequency trading makes the markets much more liquid, it is times like these that it is important to always use limit orders.

Nobody really knows what caused the violent sell-off, but speculation is that it was the implosion of the Chinese markets, and the continuing decrease in the price of oil. An infusion of cash by the People's Republic of China in their native exchanges, and a short squeeze in oil have helped boost the overall indexes the past two days. In fact, at this juncture, we're up for the week, but down 6% for the month.

My personal belief is that the correction is healthy for the markets. I had limit orders in and bought a stock and an index ETF early Monday morning - Twitter (TWTR) at $23 and the iShares Core S&P 500 ETF for $188.50. Financial guru Art Cashin who is often on CNBC, stated that historically, these sharp V shaped corrections rarely last. He didn't suggest we'd test the bottom, but that there would be some backing and filling in the next two weeks. That, coupled with the fact September and October tend to be bearish months for the markets, propelled me to raise some cash to take advantage of securities at lower entry points. And yes, I will be using limit orders.

Alibaba Bulls Get Caught Flat-Footed

Last September, Alibaba Holdings (BABA) went public at $68/share, raising approximately $10 billion for the company before expenses. It was the biggest IPO in history. Investors thought it was an ATM stock, generating gain after gain by producing earnings that "beat the street" on a consistent basis based on past performance. For a few months, that was the case, at least on price appreciation when Alibaba reached $120 in November. However, since that time, it's been a slide straight down as it trades very close to the IPO offering. The road to nowhere.

Source: Stock Charts

This is a security that was on practically every conviction buy list from the Wall Street marketing machine. In fact, it still is, and even more so as the price loses steam each passing month. According to Yahoo!Finance, 16 brokers consider the equity a strong buy, 25 a buy, and only 4 a hold. It had almost the same recommendations three months ago when it was considerably higher.

Not everyone feels as positive about Alibaba as the sell-side analysts. Master of the Universe George Soros sold 98% of his holdings in Q2, leaving him with a meager 59,000 shares. Maybe this is a lesson for the retail investor to learn, that the majority of the time, IPO's should be left to the deep-pocket traders and hedge funds. The mom and pop investor usually gets fleeced by the time shares are available to the general public. Now we're back to square one, almost a year has passed, and the company is in transition. Let's see if you think this is a good place to park some money.

Some Background

Founded in 1999, Alibaba is the largest online and mobile commerce company in the world based on Gross Merchandise Volume [GMV]. GMV is generated from three marketplaces:

• Taobao: China's largest online shopping destination. It works a lot like Ebay. Alibaba provides the platform for merchants to set up digital storefronts, plus assists in logistics and payment processing.
• Tmall: China's largest third-party platform for brands and retailers. Some examples are American retailers like Costco and Macy's who are now setting up shop here for exposure in the People's Republic of China.
• Juhuasuan: China's most popular group buying marketplace.

Alibaba's companies have become synonymous with online and mobile shopping in China. As a result, the twelve months ended March 31st, 2015, these three marketplaces generated a combined GMV of $394 billion. There were 350 million active buyers and over 10 million active sellers at this time. In Internet time, a 16 year old organization is considered a fossil, but that can be good if execution is consistent. Let's look at some numbers provided by the most recent S&P Report:

	2012	2013	2014	2015
Revenues in millions	$3,131	$5,488	$8,579	$12,300
Earnings per ADS	$0.26	$0.57	$1.63	$1.57

As you can decipher, earnings per ADS have been lumpy on a year-to-year basis. However, with almost $400 billion GMV and growing, you can see why investors became excited at the chance to invest in such a solid company, especially when there is still a large untapped market in China. Although Q1 2016 wasn't bad, it wasn't up to Wall Street standards on the revenue front, which put additional pressure on the stock. Management took the foot off the gas in Q1 because of two transitions for Alibaba. One is the transition from desktop computing to mobile. The second is the overall transition of Alibaba from a platform to an Internet conglomerate much like Amazon (AMZN) or Google (GOOG).

Transitioning to Mobile

The overall consumer transition from desktop to mobile is a fairly old phenomenon now. It was only two years ago that Facebook (FB) shares were decimated because they didn't have a concrete mobile strategy, or at least this is what Wall Street thought. Alibaba's mobile strategy appears to be panning out, and this was a problem for the analysts because it decreased desktop growth. Alibaba management takes a different tack. They believe that both mobile and desktop are synergistic because the two platforms compliment each other. The company considers it a unified platform. Mobile users tend to visit Alibaba properties more frequently, but desktop users buy higher ticker items on a more "sticky" application.

In examining the last quarter more closely, mobile GMV reached $60 billion, an increase of 125% year-over-year. This accounted for 55% of total GMV transacted on Alibaba's marketplaces. The company expects mobile GMV as a percentage of total GMV to keep growing as they improve the user experience on their mobile apps. However, as a cautionary note, the company stated improvement in mobile monetization may not always be linear. Management also said that the strength in mobile commerce demonstrates Alibaba's ability to attract mobile users with strong commercial intent on a scale that is unrivaled by any peers in China, as well as globally.

Transitioning to a Technology Juggernaut

Rodney Dangerfield once said, "I found there was only one way to look thin: hang out with fat people.". This is exactly what Alibaba is doing, hanging with the fat technology giants like Amazon and Google. All three companies have expanded their core competencies to include other areas of interest that compliment their bread and butter technologies. For Amazon, it was morphing from an online upstart in e-commerce to cornering the market in cloud computing with Amazon Web Services. Google went from king of search to inventing the Android operating system, and developing robotics just to name a few areas of expertise. Now Alibaba has joined the fray with a big push into logistics and cloud computing.

In 2013, Alibaba formed a joint venture with Cainiao Logistics, taking a 48% equity interest in the operation. According to Alibaba, they have created the largest logistics ecosystem in China. Consumers now enjoy next-day delivery services in 41 major cities, including Beijing, Shanghai, Guangzhou, Shenzhen and Hangzhou, and this will be extended to 50 cities by the end of this year. Same-day delivery of groceries has also been launched in Beijing and Shanghai, taking a page right out of the Amazon playbook.

To buttress and expand Cainiao's logistics network, Alibaba recently formed a partnership with Suning, one of China's largest electronics and home appliance retailers. Now customers in over 150 cities will be able to enjoy two-hour delivery services. Alibaba has been handling approximately 30 million packages a day, 10 times the amount of their competitors, and those numbers just got larger with Suning in the fold. In addition, Suning has brick and mortal retail outlets to enable ease and efficiency in returning big ticket items.

Aliyun, Alibaba's cloud service, is the largest cloud computing business in China. Although the company has grand plans to take it global, I would think they would have difficulty going toe-to-toe with American counterparts such as Amazon Web Services and Microsoft's Azure. Nevertheless, after years of investment, Alibaba is beginning to see positive impact in reliable, cloud service offerings. In Q2, revenue growth from cloud services was 106% year-on-year, accelerating past the 82% growth in the prior quarter. Aliyun is one of the company's core growth strategies in the coming years.

Although Alibaba has its tentacles in many other businesses, according to the Q4 2015 conference call and the Q1 2016 conference call, logistics and cloud services are the areas the company is counting on to boost customer satisfaction and sales growth. However, make no doubt about it, Alibaba has plans to compete internationally with cross-border initiatives and other offerings. Exhibit A is Alipay, a service very similar to PayPal that accounts for about 78% of e-commerce transactions on the Alibaba platform.

Valuation

According to Yahoo! Finance, Price/Sales on a trailing twelve month basis is 14.5, which is high for a mature technology company. This is not an apples to apples comparison, but Amazon comes in at only 2.52, although doesn't produce earnings like Alibaba. In fact, Alibaba's earnings generation is a big selling point for investors. Wall Street is a forward looking mechanism, and we are already past Q1 of fiscal 2016 for the Chinese e-commerce behemoth. Earnings per ADS are projected to be $2.73 for the entire year. This would give us a P/E ratio of 25. Not overly exciting, but when you consider growth projections, the PEG Ratio looks much better. Next year, earnings growth is slated to come in at 27%, which would give us a PEG Ratio of just about one. That's in the wheelhouse of many traditional growth investors.

Caveats

One thing potential investors should not overlook is that Alibaba is a Chinese holding company registered in the Cayman Islands. I'm not suggesting they are going to fudge the numbers, any company has the potential to do that, but they may not have as much transparency as a domestic equity. They are also under the thumb of the People's Republic of China. Last quarter sales came up a bit short because Chinese authorities suspended Alibaba's on-line lottery. The government could interfere again in other areas.

For instance, in the 2015 Q4 conference call, an analyst brought up the point that the Ministry of Commerce recently proposed that all online merchants have to have their businesses registered and issued operating licenses. Alibaba management answered the question stating it was just a proposal, and that the government is encouraging entrepreneurs to modernize. However, Alibaba's Taobao Marketplace is a huge profit generator for the company, and any decrease in profits could place addition pressure on shares, albeit for a short period of time.

Finally, there is the issue of the September 19th share lockup expiration. Sixty three percent, or 1.58 billion ordinary shares may be flooding the market in about a month, if indeed the owners want to sell. Softbank, Yahoo!, company founder Jack Ma and Alibaba Executive Vice Chairman Joseph Tsai all have major stakes that could dilute company valuation metrics if they wish to liquidate. Not highly plausible, especially by company insiders, but could put a crimp in earnings per share if acted upon.

Conclusion

With the Chinese stock markets imploding, the Chinese economy contracting, global stock indexes like the DOW and S&P 500 correcting, there may be a better entry point in Alibaba. That said, this stock may be a good long-term investment for people looking for Asian exposure in their portfolios. Although Alibaba wants to expand globally, I believe that is a tall order, particularly with American rivals such as Google and Amazon which may be perceived to have the better technology. However, charity begins at home. There are over a billion people in China, and Alibaba has only 350 million monthly active customers. There's plenty of room for growth in the PRC, not to mention in the adjacent geographies in the Asia/Pacific region. I'd wait until after the lockup expiration before placing an order.

Tableau Software Takes a Standing Eight

The world has taken a few spins since "Big Data" visualization and analytics company Tableau Software (DATA) reported Q2, 2015 earnings results on July 29th. Although Tableau had an exceptional quarter, the stock failed to maintain orbit at $131/share, and has crashed to near par value at roughly $103 in the past two weeks. The primary reason for the decline is that traders bid the stock up to nosebleed valuations, and it couldn't maintain the upward trajectory based on Q2 sales and earnings.

Source: Stock Charts

I've talked ad nauseam about equities included in the Investor's Business Daily Top 50 List, and how they tend to crash and burn with even the slightest blemish in valuations in the quarter-to-quarter trading environment we're in. The recent price decline in Tableau just illustrates the point. The company graced the upper echelon of the IBD 50 until short-term traders opened the floodgates, and dumped whatever inventory they had on hand. Exhibit A is the right hand side of the above chart. The stock declined close to 20% in one day.

This is not a slight to the IBD 50. Far from it. We're currently in a market that pays up for growth, and holding periods are minimal on a historic basis. This trend will probably continue unless there is some sort of penalty for selling securities held less than a year, such as higher capital gains rates. It hasn't paid to be a value investor, or long-term investor in this market. Now with a shift of mind-set in Tableau as a short-term trade, I want to examine the last two conference calls closer to see if this could be a good buying point.

In March of 2014, I wrote my first post about Tableau. It was a hot IPO at the time, and I thought the equity was expensive, but was in a good position in regards to its technology. Since that posting, revenue valuations have been cut in half, and the company is now profitable, but it is still an expensive security. Trailing 12 month Price/Sales Ratio is currently 14. However, this hasn't stopped traders from piling on, driving the price higher. This may be attributed to impressive execution.

According to Investor's Business Daily:

"Tableau has beaten analyst estimates on earnings and revenue in each of the nine quarters for which it has filed reports since making its IPO in 2013. Revenue gains have been in the double-digit percentages."

In the investing environment we're in, a good growth stock can levitate for years. This is especially true when your computational efficiency is considered to be leading edge. Tableau's specialty of data visualization has been proclaimed pioneering by both company execs, and The Gartner Group. A ringing endorsement by The Gartner Group can go a long way in enterprise software sales. Company chief Christian Chabot noted in the 2015 Q1 Conference Call:

"Gartner is very influential, very well read. And particularly, in regions where we don't have a lot of brand recognition, it is one of our more important awareness vehicles and sources of lead flow."

If we examine some statistics from the past four years, you can see why Wall Street considers Tableau Software a top notch growth stock. Although earnings are minuscule and lumpy on a year-to-year basis, sales and a healthy R&D budget are accelerating. Some of the increase in sales may be from the inclusion in Gartner's Magic Quadrant three years running.

	2014	2013	2012	2011
Revenues (in thousands)	$412,616	$232,440	$127,733	$62,360
R&D (in thousands)	$110,923	$60,769	$33,065	$18,387
Net Income (in thousands)	$5,873	$7,076	$1,427	$3,379

If we extrapolate revenue statistics out to full year 2015, company guidance is for a range of $617 million to $627 million, up from the $600 million to $610 million from Q1. This represents an annual growth rate of approximately 52% at the high end of the range. It should be noted that Tableau, like the majority of enterprise software corporations, lands a considerable amount of large contracts at the end of the fourth quarter. Some of these sales will come from international markets, which now constitutes 25% of business. In fact, Tableau is opening a new Data Center in Paris to make further inroads in overseas opportunities.

Competition in the "Big Data" visualization niche remains fierce. Rivals such as Microsoft (MSFT), Oracle (ORCL) and IBM (IBM) have much larger coffers than Tableau, but Tableau believes they've built the better mousetrap with first mover advantage.

CEO Chabot proclaims:

"And while everyone else is saying they're kind of figuring it out and doing it, Tableau remains the gold standard, and that will remain our main source of competitive advantage."

To maintain that edge, for the past two years the company spent a great portion of its R&D efforts on Tableau's new iteration, Tableau 9.0. It was released in Q1 with version 9.1 currently distributed in beta. It's the company's biggest leap in its history from version to version on server scalability and resiliency. Its strengths versus the competition continue to be incredible ease of use, a pioneering approach to visual analytics, a self-service platform, and a product that is finely tuned with all the world's disparate data.

Tableau now has 32,000 customer accounts worldwide. The company's "Land and Expand" sales strategy is a grassroots endeavor that has paid off handsomely, in both revenues and word of mouth advertising. Once a client signs up for the service, the Tableau Software sales team helps customers upgrade and incorporate the Tableau solution into other departments within large businesses. In Q2, they signed 233 transactions greater than $100,000 as companies continue to deploy Tableau more broadly within their organizations. Q4 should be a barn burner, but that's almost six months away.

Former NFL coach Bill Parcells is known for saying, "You are what your record says you are.". At this moment, Tableau has been a great long-term investment, especially if you bought it at the IPO price of roughly $30/share. Conversely, it's been a not-so-good investment if you bought at the top, only to see traders go into damage-control after the Q2 conference call. I believe for the time being, the selling has been done.

However, the bull market that started in March 2009 is almost six and a half years old. In addition, we haven't had a 10% correction in the S&P 500 since last October (intra-day, the correction was 9.8%). Therefore, although Tableau appears to have the secret sauce, and the digeratti has put it in the top spot in its niche, based on macro conditions, I'm betting Tableau Software trades lower along with the overall market in the next three months. After all, Tableau is expensive on a price/sales metric. P/E ratios aren't really relevant with young growth companies...at least not in this market, but maybe they should be. Companies with limited earnings may be the first to be liquidated if investors get defensive.

My buy point is between $80-$90 a share. An almost 20% decline. This will be especially true if the FED raises interest rates in September.

Twitter: The Grace Period is Over

In a take-no-prisoners trading culture, there was a mass exodus of investors in Twitter (TWTR) after interim CEO Jack Dorsey and CFO Anthony Noto reported anemic user growth in the Q2 2015 Conference Call. Originally, Wall Street liked the results of the second quarter when the earnings press release first hit the Web. According to the document, sales of $502 million for the quarter, up 61% year-over-year, and above the previously forecast range of $470 million to $485 million. The stock shot up over 7% in after hours trading.

However, the equity did an about face a few minutes into the conference call when the executive team discussed user growth, or lack thereof. The gears of capitalism ground to a halt, and the stock not only lost all after hours gains, but descended to near all time lows the next day of trading. Here are some quotes from members of the C-suite from both the prepared statements and Q&A session that accelerated the selling:

• "Specifically, we do not see organic growth."
• "Simply said, the product remains difficult to use."
• "Our growth rate in users is slowing quite dramatically."
• "We will take the necessary time to build the service people love to use every single day. And we realize it will take some time to show results we all want to see."
• "The DAU (daily active users) to MAU (monthly active users) ratio has gone down...because we’ve grown MAUs faster than DAUs, and we have not historically focused on driving daily active user growth."
• "Our organic growth is going to be very low as it was this quarter, and as I think about Q3, it’s marginally better, but I wouldn’t want you to or anyone else to expect a change in our growth rate relative to what you are seeing in this quarter."
• "We have only reached early adopters and technology enthusiasts, and we have not yet reached the next cohort of users known as the mass market."

That assessment is about as succinct as you'll get from high-tech management, or management in any publicly traded company. My hat's off to Jack Dorsey and Anthony Noto for not sugarcoating prospects going forward. However, it wasn't a bad quarter. Besides beating on the revenue front, Q2 adjusted EBITDA was $120 million, up 122% year-over-year. This is above the previous forecast range of $92 million to $102 million.

I believe a big problem with Twitter is perception. Early investors just got seduced by the Wall Street marketing machine. People thought this global brand on the digital frontier would be an instantaneous profit generator. In reality, it was an unprofitable story stock from the get go. If you bought the hype thinking the share price would be in an automatic upward trajectory, you got dealt a cruel hand. The equity may reach it's previous all time high of $75/share again, but that may take some time the way sentiment is going.

Twitter has some new initiatives going for it, which may be why Twitter bulls cling on to lofty price expectations. Most importantly, the company appears to have a growing relationship with Google (GOOG). Tweets are now integrated in the daily search of Google domestically, but only on the desktop. Mobile is a work in progress. In addition, there are other languages they will be expanding into internationally with Google desktop search, specifically within English-speaking countries.

A partnership with Google's DoubleClick will help improve advertising performance measurement. There's been speculation in the business press that Google would be a good suitor for Twitter, and that may be so, but that's just speculation. With Twitter's market cap of $21 billion, it would be an expensive acquisition for Google. Plus, regulators would have to approve the deal.

The acquisition of TellApart in late April is also discussed in the Q&A session. TellApart will remain a standalone business, although under the Twitter family of companies like Periscope and Vine. The marketing technology company provides retailers and e-commerce advertisers with cross-device retargeting capabilities. At this juncture, Twitter has no plans to monetize TellApart. Twitter paid $533 million for the company, so that just adds to the mounting expenses the corporation has accrued recently, including increased headcount and infrastructure build out. Nevertheless, these expenditures are a necessity to stay current in today's social media environment.

Like all companies, Twitter is in a state of perpetual flux. The partnership with Google, and the acquisition of TellApart, helps monetize the rabid base of over 300 million active monthly users. However, if current management plans come to fruition, Twitter may be taking steps backwards by making the service easier to use. In doing so, you take the chance of alienating the current user base, which may dilute end-user participation. Twitter is not a mass market product like Facebook (FB). It's a niche product.

Going toe-to-toe with Facebook would be a big mistake in my opinion. Facebook has 1.5 billion monthly active users, five times the population of Twitter. You need to invest intellectual capital to become well versed in Twitter. Therefore, you may have a more affluent user base. Facebook is basically plug-and-play. Octogenarians posting pictures of their grandchildren and other family members, to stereotype the process. Both demographics are important to advertisers, but followers on the Twitter communication platform may be more qualified, allowing higher advertising rates. After all, it's the Millennials and Gen-Xers that primarily use the communications service.

It was only a few weeks ago that I wrote my previous article about Twitter. To recap, I thought the equity was expensive, and that I wouldn't pay any more than $25/share for the company. With a trailing twelve month price/sales ratio of roughly 15, and very little earnings visibility, it's still expensive despite the recent selling spree. With a range bound stock market looking to take a breather, I'll wait on Twitter. It was a one-sided love affair on the way up, now a messy divorce on the way down. If I'm patient, I may get my price.