The Morning Call
5/8/15
The Market
Technical
The indices
(DJIA 17924, S&P 2088) rallied yesterday off of an oversold reading. Both remained above its 100 day moving
average (the Dow bounced off its average, demonstrating its continuing strength)
and below the trends of lower highs.
Longer term, the
indices continue to trade well within their uptrends across all timeframes:
short term (17123-19920, 2007-2988), intermediate term (17251-22366, 1812-2585
and long term (5369-18873, 797-2129).
Volume declined;
breadth rebounded. The VIX fell
fractionally, finishing below its 100 day moving average, below the upper
boundary of a very short term downtrend and within a short trading range. It continued to be less volatile than I
expected; but given its recent rally, its portfolio insurance value is less
impressive.
What the recent
selling pressure is telling us (short):
The long
Treasury rallied but remained below its 100 day moving average, within a short
term downtrend and well below the lower boundary of its former intermediate
term uptrend. I remained concern about
the current weakness and what it may mean for the underlying fundamentals. On the other hand, it would be a stretch to
assume at this early date that the thirty year bond bull market is over,
especially when it is not clear exactly what the cause of the selloff is. That said, if it continues, stocks will very
likely follow suit.
Is the air
coming out of the bond bubble? (medium):
Warning
signs in the bond market (medium):
What
is the ‘smart money’ doing? (medium):
The
implications of a rate hike in a faltering economy (medium):
GLD fell again,
closing below its 100 day moving average and continuing to build a head and
shoulders formation.
Oil fell back
below the upper boundary of its recent trading range, voiding the recent break
and leaving it within that trading range.
Bottom line: the
100 day moving average once again demonstrated the strength of its support,
leaving the Averages in a narrowing trading range between their 100 day moving
averages on the downside and the trend in lower highs on the upside. I have no opinion on which way prices will
break; but the longer this process goes on, the more powerful the move in the
direction of the break is likely to be.
To be clear, that is a short judgment.
Longer term, the Averages are solidly within uptrends across all
timeframes.
The rapid
decline in bond prices has been unsettling all the more so because it is not
clear what prompted it. It doesn’t mean
that the long term bull market in bonds is over; but given the technical
damage, TLT has little visible support for another 10-12 points to the
downside.
Fundamental
Headlines
The
only US datapoint yesterday was weekly jobless claims which rose less than
anticipated. I don’t think anyone cared
because their focus was on today’s April nonfarm payrolls report. The media spent most of yesterday speculating
on that number and the Market reaction to it.
To summarize: there was little consensus on whether the payrolls report
would be below or above expectations and there was general confusion about the
Market’s reaction whatever the number; that is, there was no conviction about
what is a good news or bad news.
It
is likely that much of this uncertainty is the result of the recent bond market
pin action as well as Yellen’s comment about stock valuations. We will know both by the time that this note
is read today.
Not
much news overseas, though we did get another bit of good news (sort of) from
Europe: the April retail PMI was better than March’s reading but still in
negative territory. Here again, investor
attention was elsewhere: the UK elections and Greece.
***overnight,
the Australian central bank lowered its forecast for economic growth; Japanese
national debt hit an all-time high; and the UK conservative party scored a
major victory in last night’s elections.
What the
conservative victory in the UK means (medium and a must read):
Bottom line: my attention is on (1) today’s nonfarm payroll
number and, perhaps more important, how the Market interprets that stat, (2) interest
rates and whether or not they can stabilize, and (3) the rapidly approaching
endgame in the Greek/Troika bailout standoff.
We will know a
great deal more about each in the short term; but all have potential long term
implications both economic and for security valuation. At the moment, no sense speculating on what
could happen, we will know soon enough.
That said, if the news is good, then I believe that it is likely already
well discounted at current prices; if it is bad, our Portfolios have a large
cash position.
I
can’t emphasize strongly enough that I believe that the key investment strategy
today is to take advantage of the current high prices to sell any stock that
has been a disappointment or no longer fits your investment criteria and to
trim the holding of any stock that has doubled or more in price.
Bear
in mind, this is not a recommendation to run for the hills. Our Portfolios are still 55-60% invested and
their cash position is a function of individual stocks either hitting their Sell
Half Prices or their underlying company failing to meet the requisite minimum
financial criteria needed for inclusion in our Universe.
There
is no margin of safety left (medium):
Are
corporate managements changing their time horizon for success (medium)?
Who
was buying US stocks in the first quarter? (short):
Three warning flags
(medium):
The Fed and the bubble
(medium and a must read):
Thoughts on
Investing from Morgan Housel
Predicting the quality of a fine wine has long relied on
the sniff-swish-and-spit taste method. Critics use palettes and noses honed
over years to assess a wine's future value. Results, unsurprisingly, can be
mixed. Two vintages once deemed equal quality can end up varying in price by
tenfold or more.
Princeton economist Orley Ashenfelter looked at this and
shook his head. "I had never known if [fine wine] was all a bunch of B.S.,
[so my wife and I] tried some older Bordeaux wines, and they were
fantastic," he once told BusinessWeek. Still, the price differences
were astounding. "I would say: Now wait a minute, 1961 Chateau Lafite
costs, say, $5,000 a case, and '62 costs $2,000 a case, and '63 costs $500. So
what's the difference? What's going on here?"
"It
was mainly the weather," he said.
We've
always known that weather affects the quality of a vintage, but Ashenfelter
doubled-down and showed that just four variables -- the age of the vintage, the
average temperature during growing season, the amount of rain at harvest, and
the amount of rain in the months before harvest -- accurately explains 80% of
the variation of a wine's future price. No swishing or spitting required.
In his paper, "Predicting the
Quality and Prices of Bordeaux Wines," Ashenfelter notes that renowned
wine taster Robert Parker ranked the 2000 vintage Bordeaux as one of the
greatest ever produced. "And yet we learned this without tasting a single
drop of wine."
Ashenfelter's system isn't perfect. But just as Michael
Lewis's book Moneyball showed
how baseball manager Billy Beane replaced the traditional, subjective system of
valuing a player with an unemotional numbers-based approached, Ashenfelter
outsmarted wine snobs with a simple formula that stripped the problem down to
the few variables that mattered most. No emotion, no opinion. Just the facts,
thank you very much.
Investors
may be wise to do the same.
There are
no points awarded for difficulty in investing. The investor with the most
complicated model or the most elaborate theory doesn't always win. Indeed,
elaborate theories can often be the fastest route to self-delusion. The Motley
Fool's Seth Jayson put it nicely: "It begins to sound fatalistic, but I
have come full circle on this to the idea that simple rules work far better
than deeper thinking, because most of that deeper thinking is just an exercise
in bias confirmation."
In 1981, Pensions & Investment Age magazine published a list of money
managers with the best track records over the previous decade. One year, a
fellow named Edgerton Welch of Citizens Bank and Trust Company topped the list.
Few had ever heard of Welch. So Forbespaid him a visit and asked him his secret. Welch
pulled out a copy of a Value Line newsletter and told the reporter he bought
all the stocks ranked "1" (the cheapest) that Merrill Lynch or E.F.
Hutton also recommended.
Welch
explained: "It's like owning a computer. When you get the printout, use
the figures to make a decision -- not your own impulse."
I'm not suggesting a similar approach. I couldn't find
what ever happened to Welch's track record. But as Forbes summed it up, "[Welch's] secret
isn't the system but his own consistency."
Simplicity and consistency.
That's the key. It's taking emotion out of the equation and focusing on the few
variables that count. Ashenfelter, Beane, and Welch all believed in this idea.
Study enough successful investors, and I think you'll find it as a common
denominator.
In an
interview just before his death in 1976, Benjamin Graham, Warren
Buffett's early mentor, was asked about investing philosophies:
Q: In selecting the common stock portfolio, do you advise careful
study of and selectivity among different issues?
A: In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors.
Q: What general approach to portfolio formation do you advocate?
A: Essentially, a highly simplified one that applies a single criteria or perhaps two criteria to the price to assure that full value is present and that relies for its results on the performance of the portfolio as a whole -- i.e., on the group results -- rather than on the expectations for individual issues.
A: In general, no. I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook "Graham and Dodd" was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the "efficient market" school of thought now generally accepted by the professors.
Q: What general approach to portfolio formation do you advocate?
A: Essentially, a highly simplified one that applies a single criteria or perhaps two criteria to the price to assure that full value is present and that relies for its results on the performance of the portfolio as a whole -- i.e., on the group results -- rather than on the expectations for individual issues.
Again,
simplicity and consistency.
Some have proposed simple investing rules that have a
good record of success. In his book The Little Book That Beats the
Market, hedge fund manager Joel Greenblatt proposes ranking a broad
group of stocks by two variables: earnings yield (cheap companies) and return
on capital (good companies). Buy a basket -- say, 30 -- of the highest-ranked
stocks. Rinse, repeat. Greenblatt shows this simple formulaic approach has
easily beaten the market over a multi-decade period.
Wharton
professor Jeremy Siegel ranked S&P 500 companies by dividend yield and
showed something similar:
|
Dividend Yield
|
Average Annual Return, 1957-2006
|
|
Highest
|
14.22%
|
|
High
|
13.11%
|
|
Middle
|
10.55%
|
|
Low
|
9.79%
|
|
Lowest
|
9.69%
|
|
S&P 500 average
|
11.13%
|
Source:
Siegel, Stocks for the Long Run.
Other studies show a basic rebalancing of assets -- buy stocks
when they're down, sell bonds when they're up, and vice versa -- every year can
lead to superior returns if done consistently over time.
Past performance is no guarantee of future return. These
strategies may be entirely spurious. The more data you search through, the
higher the odds you'll find what you're looking for, whether it's real or
cherry-picked. And as Einstein put it, "Not everything
that can be counted counts, and not everything that counts can be
counted." Brand loyalty, corporate culture, and trustworthy management are
all things that can't be captured in a formula, but that we know are
characteristics of great investments.
But many
of us are emotional investors. We often make completely different decisions
based on tiny changes in mood or circumstance. Simple, consistent, and
formulaic investment approaches don't suffer from that bias. Any chance to
substitute emotion with unbiased facts is likely a step in the right direction.
News on Stocks in Our Portfolios
·
Revenue of $129.19M (+48.2%
Y/Y) misses by $19.84M.
Economics
This Week’s Data
April
nonfarm payrolls rose by 223,000 versus expectations of 220,000; but March was
revised down from 126,000 to 85,000.
Other
Demographics
are improving (short):
Politics
Domestic
International
Turkey
and Saudi Arabia from alliance to topple Assad (medium):
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