In my last posting I discussed confirmation bias, which according to Wikipedia is "a tendency for people to confirm their preconceptions or hypotheses, independently of whether or not they are true.". I sometimes ask myself how much I've fallen for the stock market's doom and gloom scenario and if indeed I do tend to confirm my preconceptions by reading only those authors that fit my hypothesis of a double dip recession or worse. The problem with the books I read is that bear market meltdowns are about the only subjects available in the economic sections of your local booksellers these days, either at the mall or in cyberspace. However, I did find one this past week that is very upbeat in its outlook on the economy and that book is It's Not as Bad as You Think by Brian Wesbury. Wesbury has very impressive credentials in that the Wall Street Journal named him the nation's number one U.S. economic forecaster in 2001, and USA Today ranked him as one of the nation's top 10 forecasters in 2004. I've seen Mr. Wesbury numerous times on CNBC so I took a flier on his book and I'm glad that I did.
Wesbury never comes out and states that he's from the Austrian School of economics, only a supply-sider, but clearly his roots are there. He quotes Ludwig von Mises and Joseph Schumpeter numerous times and I found it ironic that in the past month I've read three authors that are from the Austrian School or highly influenced by it and all three have different outlooks on the market: Charles Goyette in The Dollar Meltdown believes we are headed for hyperinflation and depression, Robert Prechter in Conquer the Crash sees depression and deflation while Wesbury is very positive and has an outlook of growth for the next 18 months. In fact, Wesbury is so positive on the economy, he thinks the Dow Jones Industrial Average can rise above 14,000 in a few years time.
The implosion of the financial markets the last two years has been referred to as 'Depression 2.0' and 'The Great Recession' in the popular press, but Wesbury calls it "The Panic of 2008". A common theme throughout It's Not as Bad as You Think is that government intervention is to blame for the cratering of the markets. As Wesbury states in the beginning of the book: "What caused the crisis to spread and turn into a full-blown panic was mark-to-market accounting.". According the Wikipedia, "mark-to-market or fair value accounting refers to the accounting standards of assigning a value to a position held in a financial instrument based on the current fair market price for the instrument or similar instruments.". Mark-to-market accounting standards were reinstated by the government at the outset of the financial crisis. They hadn't been in use since the Great Depression of the 1930's. When the stock market started to rally in March of 2009, mark-to-market accounting standards were altered and Wesbury believes this is no coincidence.
Could mark-to-market accounting standards be the cause of the collapse in the financial system? Of course it could be a contributing factor, but I do not believe it is the sole reason for the panic. Wesbury takes a hard stance in his beliefs and writes: "To be absolutely, 100 percent clear, I do not believe that greed, capitalism, high levels of debt, subprime loans, credit default swaps, derivatives, criminal activity, or leverage were the root problems that caused the panic of 2008.". This is where he and I differ. Wall Street always seems to be gaming the system and I feel it was no different this time. Bankers took a lot of speculative risks and used predatory lending practices. Some banks were leveraged 40:1. Wesbury also writes about the panic: "...the interconnected nature of the financial system began to crack.". He is absolutely correct with that one. We needed government intervention in the Fall of 2008. We were on the cusp of global contagion and financial collapse.
I liked It's Not as Bad as You Think. I didn't agree with anything Mr. Wesbury said, but it was well written and gave me pause to think about my current short positions. Although the author backed up his arguments with clear and concise documentation, it didn't sway me to change my mind about my portfolio allocations. To me, the short-term damage has already been done to The Ithaca Experiment. The subtitle for the book is Why Capitalism Trumps Fear and the Economy Will Thrive and I do agree with him that capitalism will survive and the economy will prosper, but not for a few years.
Tuesday, December 15, 2009
Sunday, December 13, 2009
The January Effect
According to Jeffery and Yale Hirsch who publish the Stock Trader's Almanac 2010, the January Effect now starts in mid December based on data going back to 1979. If you are not familiar with the January Effect, it is a Wall Street term that states small cap stocks outperform big cap stocks from January until June and the launch date is now around December 15th. Since we are nearing that date and because I have a sizable stake in small caps with the Direxion Small Cap Bear 3X Shares (TZA), I wanted to bring it to your attention. In the two months that I have owned the Direxion Small Cap Bear 3X Shares (TZA), the ETF is down 30 cents or 2.61% and if history proves correct, it may take another hit here in the short-term. However, the January Effect does not always materialize as small cap stocks underperformed large cap stocks in January 1982, 1987, 1989, 1990 and 2008, but it is a pretty good indicator as Jeremy Siegel writes in Stocks for the Long Run. This does not mean that small caps won't go down in January if the market goes down. It just means that small caps will do better than the larger cap securities the majority of the time.
The January Effect is sometimes confused with the January Barometer, but they are not the same. To give a definition of the January Barometer, I will use the Wikepedia free encyclopedia: "The January Barometer is the hypothesis that stock market performance in January predicts the performance of the rest of the year...Historically if the S&P 500 goes up in January, the trend will follow the rest of the year. Conversely if the S&P 500 falls in January, then it will fall for the rest of the year. Since 1969 this trend has been repeated 32 of a possible 39 times.". Ken Fisher in The Only Three Questions That Count calls the January Barometer a myth and "remains wholly unsubstantiated", but this is just his interpretation of the data which is always a problem with investing. You never know who is right when it comes down to data crunching because of confirmation bias. Ken Fisher defines confirmation bias as: "cognitive error causing investors to seek evidence confirming their preset notions and reject contradictory evidence.".
Another Wall Street phenomenon that will supercharge your holdings in the short-term this time of year is the Santa Claus rally otherwise known as the "December Effect". This is a rise in stocks the last week of the year, between Christmas and New Year. Because I am not a trader, I generally don't pay attention to these things, but they will move the needle in your portfolio. I am currently down 43% in the ProShares Ultra Short S&P 500 Exchange Traded Fund (SDS) and this Chris Kringle flurry surely won't do much for my ego if history repeats itself, but as I've been stating right along since the beginning of this blog, we are long overdue for a correction. If the market corrects 15%-20%, I'm back to square one, but that's just wishful thinking right now. You may be wondering how far I will let my losses run in the ProShares Ultra Short S&P 500 Exchange Traded Fund (SDS). Well, indefinitely. It is always best to go with your convictions and since this is a leveraged ETF, it can go up just as fast as it went down.
The January Effect is sometimes confused with the January Barometer, but they are not the same. To give a definition of the January Barometer, I will use the Wikepedia free encyclopedia: "The January Barometer is the hypothesis that stock market performance in January predicts the performance of the rest of the year...Historically if the S&P 500 goes up in January, the trend will follow the rest of the year. Conversely if the S&P 500 falls in January, then it will fall for the rest of the year. Since 1969 this trend has been repeated 32 of a possible 39 times.". Ken Fisher in The Only Three Questions That Count calls the January Barometer a myth and "remains wholly unsubstantiated", but this is just his interpretation of the data which is always a problem with investing. You never know who is right when it comes down to data crunching because of confirmation bias. Ken Fisher defines confirmation bias as: "cognitive error causing investors to seek evidence confirming their preset notions and reject contradictory evidence.".
Another Wall Street phenomenon that will supercharge your holdings in the short-term this time of year is the Santa Claus rally otherwise known as the "December Effect". This is a rise in stocks the last week of the year, between Christmas and New Year. Because I am not a trader, I generally don't pay attention to these things, but they will move the needle in your portfolio. I am currently down 43% in the ProShares Ultra Short S&P 500 Exchange Traded Fund (SDS) and this Chris Kringle flurry surely won't do much for my ego if history repeats itself, but as I've been stating right along since the beginning of this blog, we are long overdue for a correction. If the market corrects 15%-20%, I'm back to square one, but that's just wishful thinking right now. You may be wondering how far I will let my losses run in the ProShares Ultra Short S&P 500 Exchange Traded Fund (SDS). Well, indefinitely. It is always best to go with your convictions and since this is a leveraged ETF, it can go up just as fast as it went down.
Friday, December 11, 2009
Blood From a Stone
Back in 2002-2007, terms like prime, subprime, Alt-A, option ARMs, jumbo prime and second liens became part of the mainstream verbiage as middle class citizens started flipping houses like degenerate gamblers. 2008 was not a pretty picture for the hot real estate money and speculators started singing a different tune as the entire financial system teetered on the edge of the abyss. More Mortgage Meltdown by Whitney Tilson and Glenn Tongue explains the build-up, implosion and future scenarios of the domestic housing situation along with the ramifications on the economy as a whole. The book is divided into two parts, the first half covering the housing bubble and the second half a series of case studies on different companies and how to evaluate them for investing purposes through the eyes of a value investor.
Tilson and Tongue demonstrate that although subprime loans were the brunt of much populist anger after the housing bubble burst, they only accounted for 20% of all mortgages issued at the peak of the bubble, and it is the other 80% of mortgages we really have to worry about now. The height of the real estate frenzy was in 2006 and since subprime loans reset after 2 years, they were the catalyst for the collapse in 2008. However, the equally toxic Alt-A and option ARMs reset after five years so in 2010, we will begin to feel the effects of another round of defaulting mortgages and these defaults will continue until 2012. In essence, we are in the eye of the hurricane right now, the calm before the storm.
More Mortgage Meltdown was published in May of 2009, three months after the market lows reached in March and although the authors didn't predict the current surge in security prices, they do acknowledge that stock prices are cheap at the time of publication: "Based on data from Yale economist Robert Shiller, U.S. stocks on March 3, 2009, were trading at a cyclical price-earnings (P/E) ratio of 12.3, their lowest level since 1986 and well below their historical average dating back to 1870, of 16.3. (The cyclical P/E compares stock prices to average earnings over the past ten years in an attempt to smooth out booms and busts.)". Well, that was in May and now it's December and Barron's reports that the P/E for the S&P 500 is 85 after a 9 month run up. We are in nose bleed territory where valuations are concerned and this market is ready to roll over like Beethoven. In fact, at the time of printing Tilson and Tongue argue that "the cyclical P/E ratio, while below its historical average, is well above previous bear market lows of 6 - meaning stocks could almost get cut in half again.".
I have been reading Whitney Tilson's column he writes with John Heins in Kiplinger's for a couple of years now and have always enjoyed his long-term value investing perspective in a market where traders live in the moment. I also enjoyed it in this book, but all in all, I was disappointed in More Mortgage Meltdown. Granted, the first half of the book was brimming with valuable statistics and insights on the housing crisis, but the second half of the book wasn't up to par. The last 150 pages of the book is filled with case studies on individual stocks to both the long and the short side and I thought that these studies were too technical for the beginning investor. For the experienced investor, the case studies were not that interesting and tended to get tedious which bogged down a potentially good book.
Tilson and Tongue demonstrate that although subprime loans were the brunt of much populist anger after the housing bubble burst, they only accounted for 20% of all mortgages issued at the peak of the bubble, and it is the other 80% of mortgages we really have to worry about now. The height of the real estate frenzy was in 2006 and since subprime loans reset after 2 years, they were the catalyst for the collapse in 2008. However, the equally toxic Alt-A and option ARMs reset after five years so in 2010, we will begin to feel the effects of another round of defaulting mortgages and these defaults will continue until 2012. In essence, we are in the eye of the hurricane right now, the calm before the storm.
More Mortgage Meltdown was published in May of 2009, three months after the market lows reached in March and although the authors didn't predict the current surge in security prices, they do acknowledge that stock prices are cheap at the time of publication: "Based on data from Yale economist Robert Shiller, U.S. stocks on March 3, 2009, were trading at a cyclical price-earnings (P/E) ratio of 12.3, their lowest level since 1986 and well below their historical average dating back to 1870, of 16.3. (The cyclical P/E compares stock prices to average earnings over the past ten years in an attempt to smooth out booms and busts.)". Well, that was in May and now it's December and Barron's reports that the P/E for the S&P 500 is 85 after a 9 month run up. We are in nose bleed territory where valuations are concerned and this market is ready to roll over like Beethoven. In fact, at the time of printing Tilson and Tongue argue that "the cyclical P/E ratio, while below its historical average, is well above previous bear market lows of 6 - meaning stocks could almost get cut in half again.".
I have been reading Whitney Tilson's column he writes with John Heins in Kiplinger's for a couple of years now and have always enjoyed his long-term value investing perspective in a market where traders live in the moment. I also enjoyed it in this book, but all in all, I was disappointed in More Mortgage Meltdown. Granted, the first half of the book was brimming with valuable statistics and insights on the housing crisis, but the second half of the book wasn't up to par. The last 150 pages of the book is filled with case studies on individual stocks to both the long and the short side and I thought that these studies were too technical for the beginning investor. For the experienced investor, the case studies were not that interesting and tended to get tedious which bogged down a potentially good book.
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