Stock Exchange: Oscar loves airlines, but Consider FAST and SLCA

Each week Felix and Oscar host a poker game. We listen in on current trading ideas in the few minutes before the game starts. They like to call this their “Stock Exchange.” I am the only human present, and the only one using fundamental analysis. Their methods are excellent, as you will learn if you join us for a few weeks. Since the time frames and risk profiles differ, so do the stock ideas.

This is the only place you can get several great technical ideas each week along with a response based upon the fundamentals. I have placed more background at the end of the article. Each week features a different expert. The names help you pick a favorite trading style. Comments, dissent, and specific stock questions are welcome!

This Week’s Ideas—Focus on Oscar

Our featured expert is Oscar. Vince (our modeling guru) designed Oscar to be an aggressive sector trader. The time horizon is about three weeks. Oscar’s trading universe is over 30 sectors. Unlike most other sector models, Oscar uses baskets of stocks chosen through a statistical analysis of actual trading. If there are important gaps, we use an ETF instead. Oscar takes more chances than the other models, but employs two elements of risk control:

  1. Using a basket eliminates single stock risk, where something surprising happens to a single company.
  2. Oscar goes to cash or bonds when market conditions are poor.

Even if you do not trade market sectors, Oscar’s top choices are a good place to begin your own research.

Here are the ideas for this week, beginning with Oscar, our featured expert.

Oscar

I still like the Energy and Utilities sectors we’ve been discussing lately, but JETS (a U.S. Global ETF) is my pick for this week. This is a sector that’s underperformed for the past 6 months, but has still shown some overall steady growth. This would be an example of the “sleeper” everyone wants to pick up for their weekly fantasy football team.

You can see the same below with American Airlines (AAL). It is one of the major holdings in JETS – and it’s not hard to see why. If you’re looking for a stock like the overall industry AAL is likely your best bet.

J: Is this another pick you got from your bookie? The football Jets are playing someone they can beat this week.

O: No! I found this one on my own. And I don’t care for the Jets, no matter who is at quarterback.

J: Richard Branson said that you can become a millionaire by starting with a billion dollars and buying an airline.

O: Who is Richard Branson? I am going by the chart.

J: At least you picked a company that has earnings, although we only have three years of history since the last bankruptcy.

O: You are so negative! I said it was a sleeper.

J: Right. Fantasy football. You are not even playing in the office fantasy pool.

O: That is child’s play. I am in a league with some of those Chicago models. Any of us could win your league.

Holmes

As people should know by now, I love to buy the dips. (See last week’s Stock Exchange for more information about Holmes). This week Fastenal, (FAST) is on my buy list. This wholesale distributer of industrial and construction supplies has suffered mightily since April, but it looks to me like it’s ready for a bounce and I’m ready pounce. I’ll be very cautious and get out below 37, but I’m looking for a rebound to 41.25 or better.

J: I think this could lose another 30% or so.

O: That is why I use stops.

Felix

I have studiously selected Basic Materials: Metals and Minerals this week. SLCA is a prime textbook example of what a chart should be. It has great momentum and should be around for a long time.

J: I also like basic materials, but you have picked another company with no earnings! I keep trying to teach you all what NMF means when you look at the P/E ratio.

F: Look at the chart.

J: Look at this chart from Chuck Carnevale. Only losses this year.

F: Look at the price momentum. The market is sending you a message.

Questions for Felix

anpere of SeekingAlpha says:

Great article, like the energy trade, I am long RXNRP and REXX, MEMP, EVEP, and LGCY, knowing will lose 100% in one of them, but will make 1000% in at least one of them, been using this style over 40 years and the math works. Appreciate thoughts? Thanks

Felix: Hi Anpere, you’ve a long list of energy stocks and my opinion is not specific to those, but of energy. I, too, have a long list of energy holdings and I hope that they are all winners! Good luck with your picks, they should coincide with mine!

Phil at “A Dash of Insight” asks:
A couple of stocks for analysis by Felix, and/or others – DIS; SPWR

Felix: I rate DIS near the bottom of the 700-stock universe.

Jeff: I think it is OK — reasonable value now and projected earnings increases.

Felix: SPWR is not in my current trading universe. They are asking me to expand the universe for questions, but have not yet agreed to raise my pay.

Jeff: I prefer either a solid record of earnings. If I am choosing to speculate, I need a very good story. I don’t see either one in SPWR.

Felix: And to my many fans: Please keep your questions coming. I could use the overtime pay! Ask about a specific stock, or perhaps an ETF. I am interested in sectors, but need a representative ETF to help.

 

Athena

I do not have a new idea this week. Most of my choices are from April and they are all doing well.

J: No new idea? What do you think we are paying you for?

A: Wisdom. Sometimes the smartest course is to do nothing. I like my current positions. The only soft one is Carter (CRI) which just did well on earnings.

J: You do not do any earnings forecasts.

A: The chart tells all…. you just need to pay attention.

 

Background on the Stock Exchange

What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.

  1. The model characters are fun, but please tell me more about what they do.

    I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.

  2. Why don’t you show a track record on performance?

    I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is easy to spot the amateurs.

     

  3. Why should I care about these model picks?

    You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not know about. At the Stock Exchange, you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.

 

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Stock Exchange: Featuring Holmes and NKE — Energy and SCHW worth a look

Each week Felix and Oscar host a poker game. We listen in on current trading ideas in the few minutes before the game starts. They like to call this their “Stock Exchange.” I am the only human present, and the only one using fundamental analysis. Their methods are excellent, as you will learn if you join us for a few weeks. Since the time frames and risk profiles differ, so do the stock ideas.

Background on the Stock Exchange

What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.

  1. The model characters are fun, but please tell me more about what they do.

    I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.

  2. Why don’t you show a track record on performance?

    I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is pretty easy to spot the amateurs.

    This is a brief answer, and I promise to follow up with a longer post. Meanwhile, here is our model developer, my partner Vince Castelli, in his Popular Science feature from 2002. It is one of the few projects he worked on that are now in the public record. He has applied his scientific knowledge to finance for decades.

     

  3. Why should I care about these model picks?

    You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not really know about. At the Stock Exchange you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.

 

This Week’s Ideas—Focus on Holmes

This week’s featured expert is Holmes. Vince designed Holmes to be a trader, but one that would be safe enough for average investors. It is not a crazy, day-trading program. Holmes looks for stocks that have sold off, formed a base, and have promising rebound potential. The criteria are strictly technical, so the stocks may not be appealing for long-term investors. Holmes is very cautious in making new picks and aggressively dumps losers. Like most traders, Holmes also includes profit-taking and trailing stops. The average holding period is a few weeks. There may be as many as sixteen positions at one time – all from our universe of 700 liquid stocks.

Holmes reduces risk in three ways:

  1. Going completely to cash when market conditions are poor;
  2. Reducing the number of positions when indicated;
  3. Using stops and trailing stops on individual holdings.

I analyze the risk of each of our strategies. While it is partly subjective, I rate Holmes as lower risk than buy-and-hold for the overall market.

Here are the ideas for this week, beginning with Holmes.

Holmes

I am the rebounding specialist. I love great stocks that investors/traders have bailed on. My Bounce Play of the Week is NIKE, (NKE), This mega sports apparel and sneaker maker just keeps running a marathon while investors treat it like a sprinter. Coming off its highs of 67 in early 2016, this stock has been consolidating, digesting, and hanging out at the bottom of its channel. I see a good chance to power back up a few percent or more. I also love the risk/reward aspects of this trade. I would use 48 as hard stop, so I’m risking 3.8 to make 10 or more points. Like Nike says: “Just Do It.”

This is definitely a “bounce” play.  It is close to the lower edge of the channel.  I’ll be happy with a few percent.

J: Valuation is reasonable, but it is not exciting based upon the fundamentals.

H: The chart shows the rebound potential. Most of my ideas are quick winners. I’ll cut bait and move on if this does not work.

Felix

I still like energy and have added a new position last week. Some current holdings are dipping dramatically and some are rising out of those dips, but the long-term strength appeals to me. You can see the sector strength in VanEck’s CRAK.

J: Oil prices are still in a trading range. I think that it is the sweet spot for the economy. I agree with the long-term potential.

F: Oil appears to be making a slow bullish move going into Winter in the Northern Hemisphere.  There have already been a number of long range weather forecasters who are calling for a severe Winter in the US this year.

J: Since when do you pay any attention to weather forecasts?

F: My selections are always based upon the charts, but I also am interested in the message of the market.

And to my many fans: Please keep your questions coming. I could use the overtime pay! Ask about a specific stock, or perhaps an ETF. I am interested in sectors, but need a representative ETF to help.

Oscar

This week I like Oil & Gas exploration, illustrated below by XEC. Sure, the stock’s been hanging around yearly highs for a while now. But would you have bet against World Heavyweight Champ Joe Louis? I see at least a couple months of progress hanging around here.

This is a wonderful textbook example of momentum!  It looks like a real long-term winner in the making.

J: That seems crazy. The PE multiple is over 300. Where did you get such an idea?

O: My turf accountant also has stock picks.

J: You take stock advice from your bookie??

O: He is better than one of those robo-advisors. He says that 2017 earnings will be a lot better.

J: Sixty-eight cents this year, but 3.34 in 2017. I still think it is expensive.

O: As usual, I’ll either cash or go for a small loss.

 

Athena

Following some steep losses in January and June, Charles Schwab (SCHW) has spent the last few months on a rebound. The forward average suggests it’s leveling off, but I think there’s room to catch a few points just before the peak here.

What a great recovery from a major pullback.  Very strong!  This could have a long run.

J: This is trading around the long-term P/E ratio and earnings are rising. In that sense it is fairly valued. Here is Chuck Carnevale’s FastGraph, which shows why I still think it is expensive.

A: You and Chuck are just too cautious. If you want a big reward, you have to take some chances.

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You are allowed to choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Stock Exchange: Great Chart Ideas Include WB, DDD, DXCM, and APD

Each week Felix and Oscar host a poker game. We listen in on current trading ideas in the few minutes before the game starts. They like to call this their “Stock Exchange.” I am the only human present, and the only one using fundamental analysis. Their methods are excellent, as you will learn if you join us for a few weeks. Since the time frames and risk profiles differ, so do the stock ideas.

Do the markets predict future events? Or should you use fundamentals to predict the markets?

That is an ongoing debate at the Stock Exchange.

This Week’s Ideas

Our technical experts have some very aggressive ideas this week.

Felix

I look for long-term themes, and I have a great one this week. This week I am revisiting technology, specifically Weibo Corp. There are not too many social media platforms that are available for trading, but this is one that is (we hear) popular in China. It sounds pretty interesting and maybe (if not, already) will show up here soon.

Just look at the chart. What a strong momentum play!!

Our question for this week’s post is from Sedona7 of SeekingAlpha, as follows:

I really appreciate your work Jeff (and group).
Felix (and Jeff), I am wrestling with my current position in BMY … should I stay or should I go?

Felix responds:

BMY is on my sell list (a negative rating). There are many better choices.

[Jeff] The 20 multiple is pretty rich for the stodgy recent growth rate. 3% dividend is OK. If the expected earnings growth for 2016-17 comes through, it is probably fairly valued. I agree with Felix that there are better choices.

[Felix] Please keep your questions coming. I could use the overtime pay!

Oscar

It seems like every week that we have some crashing, dynamic stock that we can liken to a pinch hitter or an offensive lineman. My choice for this week is a change of pace. Take a look at the moving averages on DDD below. This reminds me of the long, smooth strokes you see from the US Olympic Rowing team. Sure, it may not be as exciting as the MLB Division series – but it sure is pretty. Here we’ve got steady, sustainable growth from a major name in the broader sector of 3D printing. What’s not to like? The chart is very encouraging. Breakout coming?

[Jeff] With a PE over 40, this might be breaking hearts rather than breaking out. This makes sense only as a speculation.

[Oscar] I am good at speculating.

Holmes

I am the rebounding specialist. Here is a “fetching” opportunity, Dexcom (DXCM) hit an all-time high around 97 in September of 2015, sold off to a low of 53 before rebounding back to 95, this most recent sell-off gives us a nice technical entry into this name looking for a run back to 95, with a stop around the 200d MA (75.17).

[Jeff] Do you know what it means when you look for the multiple on a stock and see “NMF?”

[Holmes] What’s a multiple?

[Jeff] It stands for “not meaningful.” You see it when a stock has no earnings. It is important for determining value.

[Holmes] I get paid nicely for stock rebounds whether there are earnings or not. The chart tells the story.

Athena

I have a very interesting choice this week, Air Products and Chemicals (APD).

[Jeff] That has a familiar sound. Didn’t we just discuss that pick?

[Holmes] Yes! It was my choice last week. She is copying. I was stopped out with a small loss.

[Jeff] I did not care for it last week, and I still don’t. The price is a bit lower, but not low enough for me.

[Athena] I need not copy from humans and dogs. The Holmes rebound play did not work. APD fits my style just fine. My average holding period is about four months. We can revisit this after some time. Here is the updated chart.

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You are allowed to choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

An Important Note to Readers – from Jeff

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. I humanize them to make it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, and that is especially true here. While we are trading based upon all four models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us (info at newarc dot com) and we will provide more information.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Finding great stock picks need not be boring. Please enjoy the banter and join in.

 

Stock Exchange: Technical or Fundamental?

Market participants split sharply on whether it is better to use technical or fundamental analysis. The question rivals “Ginger or Mary Ann” in popularity.

Technical experts are a rich source of new stock ideas. Our trading models each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their “Stock Exchange.” I am the only human and the only one using fundamental analysis.

The group had a winning call on energy two weeks ago, without clear support from the fundamentals. Just luck? Temporary? Time will tell.

The key difference between the approaches: The technical analyst thinks the market is describing the world. The fundamental analyst looks to the world, and then for mispricing in markets. This series expands upon this story, with interesting new ideas each week, as well as answers to reader questions.

This Week’s Ideas

Our technical experts have varying ideas this week. As usual, I disagree with most of them. Let us have a word from each.

Felix

I look for long-term themes, and I have already shared several. Another good one is technology. One of my favorites is Hewlett Packard Enterprises (HPE).

[Jeff] Ahh! That is the portion Meg Whitman chose to run after the company split into two parts.

[Felix] Who is Meg Whitman?

[Jeff] She is the CEO of the original Hewlett Packard and now HPE.

[Felix] I only know that the market approves! Investors are applauding her. This is an excellent example of momentum in action. I expect more gains to come.

[Felix] We had some questions for this week’s post! I thank my fans, and I am happy to answer.

Seeking Alpha’s poorman#whocares asks: What does Felix think about RIO?

 

My response (via Jeff Miller):

I rank RIO in the top third of our stock universe, with a pretty solid hold/buy rating. In our own trading we stick to the top 20, so it is pretty exclusive.

Thanks for joining in!

 

Our second question comes from Seeking Alpha’s 03FOSTER: How does Felix feel about UNH? It would seem to fit his personal presences.

 

My response:

I rate UNH in the middle of the rankings — still a reasonable, positive rating. I do like the company, but I am not overly excited about the stock. Some human once said that a good company is not necessarily a good stock. This intelligent reader raised a very good question.

 

Oscar

I like the Diversified Utility sector (XLU). It is March Madness in action. It’s been on a breakaway since the early spring, and it’s still an easy layup. We may be off the yearly highs, but to me that seems like a buying opportunity more than anything else.

Looking closer, holding EXC (a part of XLU) is a near mirror image of that wider sector. You’d be opening yourself up to a bit more volatility there, though that may carry some extra upside along with it.

[Jeff] You got your nose out of the sports section long enough to spot EXC. I do not care for most of the sector, but Exelon is a good dividend stock especially if you write calls against it as I do for our Enhanced Yield program. The valuation is reasonable and the yield is 3.7%.

[Oscar] Thank you – I think…

Holmes

I like DuPont (DD) This giant Chemical company sold off pretty hard in the last 6 weeks, seems to have rested and consolidated, and is now ready to resume its long term bullish move. I expect new highs pretty soon.

[Jeff] I like a lot of industrial stocks, but this one is significantly overvalued.

[Holmes] I sniff out opportunities, deduce the risk and reward, and swiftly change course when I am occasionally mistaken. This pick fits my approach.

Athena

I have a great choice this week, but before I share it, what is this Ginger or Mary Ann question? Why not ask “Gilligan or the Professor?”

[Jeff] Hmm. That question has not caught on yet.

[Athena] Perhaps it will as wisdom improves. Turning to my excellent choice this week, if you had ever wondered what a textbook definition of “momentum” would look like, here it is. Intel (INTC). After climbing out of lows early in 2016, this stock has been red hot. Of course, I expect the gains to continue for some time. If something goes wrong with that plan, I’ll drop the stock and find a stronger and wiser warrior.

[Jeff] This is a reasonable choice, but I do not see the explosive upside from current valuations. It is another stodgy holding suitable for writing calls.

[Athena] Are you going to fight with me every week? You shall learn my wisdom!

Questions

If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a special expertise. Who is your favorite? (You are allowed to choose me, although my feelings will not be hurt very much if you prefer one of the models).

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

An Important Note to Readers – from Jeff

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them to make it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, and that is especially true here. While we are trading based upon all four models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us and I will see if you qualify for one of the programs.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Finding great stock picks can be fun! I hope readers will join in making it so.

Weighing the Week Ahead: Will Election News Change the Course of Markets?

The calendar has a lot of data, but the FOMC meeting is over. The market waits for the next big event. We will soon have another jobs report, but Monday’s presidential debate overshadows the other news. The news cycles this week will be all about the election, and the financial press will be no different. Should investors use this news to change course?

Last WeekThere was plenty of economic news, and it was another mixed picture. The FOMC decision dominated.

Theme RecapIn my last WTWA, I predicted a focus on bonds, especially at the long end. That proved to be one of my worst theme forecasts. While interest rates figured prominently in the discussions, the Fed commentary quashed the selloff in the long bond. The ten-year note rates finished a bit lower than last week.

The Story in One ChartI always start my personal review of the week by looking at this great chart from Doug Short. Stocks had a good, three-day rally. Doug attributes this to central bank policy – no rate increase from the Fed and the B of J.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis grounded in data and several more charts providing long-term perspective.

The NewsEach week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • FOMC held rates constant with a hint of increases to come. Whether or not you agree with the decision, the market seemed to celebrate. This is despite the reduction by the Fed in estimates for the long-term growth rate. The market continues to applaud stimulus over results.

(click to enlarge)

  • Building permits increased by 3.7%. This is a good leading indicator for housing.
  • Global steel production is again positive.

(click to enlarge)

The Bad

(click to enlarge)

The Ugly

More violence. Talks have broken down in Syria, leaving the two million residents of Aleppo without water (The Guardian). Continuing incidents, tensions, and protests involving U.S. police and assorted bombings. It is not as if leaders were not trying. The U.S. and Russia have joined to back talks in Syria.

Chicago’s homicide rate is much higher.

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The TSA, much maligned last summer, collects hundreds of weapons each week, before they get into the aircraft cabin. Here is a typical haul of firearms. Read the entire post to see the other creative weapons.

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The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. No award this week. Nominations are always welcome.

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a big week for economic data, setting up for some important reports at the start of October. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • Personal income and spending (NYSE:F). Can the recent strength continue?
  • New home sales (NYSE:M). A decrease is expected, but how much?
  • Michigan sentiment . An important concurrent indicator for employment and spending. Is there an election effect?
  • Consumer confidence . See Michigan sentiment. This is almost as good and usually correlated.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Pending home sales (Th). Not as important for the economy as new homes, but still a good read on the market.
  • Chicago PMI . The most important of the regional indexes, especially when released on the Friday before the ISM index.
  • Durable goods orders (NYSE:W). Highly volatile August data with a big monthly decline expected. Any chance of an upside surprise?
  • Core PCE prices . The Fed’s favorite inflation indicator, so it is worth watching.
  • GDP third estimate (Th). Few are interested in the final revision (before later benchmarking) of Q2 GDP, but this is what goes into the books.
  • Crude inventories . Often has a significant impact on oil markets, a focal point for traders of everything.

The first Presidential debate will be a news highlight with markets paying attention. FedSpeak is back in full swing. Chair Yellen testifies on Wednesday before a House committee on bank supervision.

Next Week’s Theme

Most investors would prefer to tune this out, but we can no longer avoid it. The polls have tightened. We are on the eve of the first of three Presidential debates. It is expected to attract more viewers than the Super Bowl. Debates are always important, but this time is really special. The debate will provide a focus for the news cycle, including the financial media. I expect that everyone will be asking: Should the election news cause investors to change course?

Please note that this is not a post with political advocacy. Everyone should vote as they choose, and for whatever reason. That said, it is important for investors to understand what is anticipated by markets, and the likely result if things change. I have worked to find articles that reflect a mainstream viewpoint. As always, I welcome alternative suggestions.

We have three key questions. Out of hundreds of posts on these topics, here are a few that are good. Think of it as a starting point.

  1. Who will win? Nate Silver, whose methods have done well, gives Clinton a chance of about 60%. Larry J. Sabato now has Trump leading in the Electoral College.
  2. What actions might result?
    1. Paul Ryan should know. He sees changes in tax policy, regulation, entitlements, and anti-poverty programs.
    2. Economist Mark Thoma warns about problems in taxes, spending and economic growth.
    3. Niall McCarthy (via GEI and Statista) has something of a mainstream viewpoint, citing Moody’s. Whether you agree with these conclusions or not, it probably reflects the current street expectations. Also see Nanette Jacobson of the Hartford Funds.
  3. Will Congress agree? Important, but little good work.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

The Featured Sources:

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation. This week Dwaine does a detailed indicator review, concluding:

These are just a few indicators in a battery of twenty-one that we examine, and whilst there are no alarm bells yet, the aggregate composite of all 21 indicators shows the US economy the most vulnerable to exogenous shock since this expansion started:

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions. What scares you?)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” This is the place to get some ideas from the best technical analysis – and you can ask questions!

Top Trading Advice

Brett Steenbarger continues to provide a great piece of trading advice every day. Do you have a regular performance review? What does it include? Dr. Brett explains how to improve your trading from this process. He also has a great post on why creativity is important for traders. My guess is that most traders have not even thought about this question. Here’s why you should:

I recall speaking with a successful trader who told me that he was excited about the opportunity in the marketplace. I responded by saying that he was the first person I’d spoken with to tell me that. Everyone else was lamenting the lack of opportunity in markets. He said, “That’s right. I’ve always made my money going against the consensus!” That was shortly before the events of Brexit. That trader was able to capitalize on opportunity because he not only saw the world differently, but experienced it differently.

Adam H. Grimes also takes up the need for creativity and how to accomplish it. He draws upon his experience as a musician, and includes some other great examples for his proposed five steps.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be this analysis of risk by Michael Kitces. His informative blog is aimed at financial advisors and most of us read it religiously. A look at what your advisor is (or should be) thinking about is information you might not normally see. If you manage your own investments, it will give you some helpful ideas. Michael explains the difference between risk tolerance, risk capacity, and risk perceptions. Many people do not understand how much risk is needed to achieve their performance goals. Good planning is essential. He also notes:

The key point is that if perceptions are (or become) misaligned with reality, investors may engage in “surprising” behavior that seems inconsistent with their risk tolerance. For instance, an individual who is highly risk tolerant, but has the (mis-)perception that a calamitous economic event will cause the market to crash to zero, might still want to sell everything and go to cash. Even though he/she is tolerant of risk, no one wants to own an investment going to zero! In addition, the research suggests that some people may have better risk composure than others; in other words, some investors can keep their composure and maintain a consistent perception of the potential risks around them, while others have risk perceptions that are more likely to move wildly.

Another good treatment of risk comes from Seeking Alpha Senior Editor Gil Weinreich. He regularly raises good questions affecting both advisors and individual investors. His discussion of investment goals and risks highlights Eric Nelson, who cites the current fixed income risk to retirees:

Unfortunately, many people still invest as if bonds are priced to return 6% to 8% per year or more going forward. We continue to see significant inflows into bond funds and ETFs as well as balanced funds with a considerable allocation to longer-term bonds. These decisions are especially risky for retirees, whose greatest investment risk entails holding too much of their portfolio in assets that won’t produce an acceptable long-term return, such as low-returning bonds.

Stock Ideas

Chuck Carnevale continues his analysis of high-quality dividend stocks, searching for those that are fairly valued. His discussion of Flowers Foods, Inc. analyzes the stock and also provides an important lesson.

David Van Knapp analyzes which of the “dividend contenders” might be at risk.

Eddy Elfenbein has a great annual stock list and frequent updates about those stocks and the overall market. His clever commentary is appreciated by all, including those who follow him on Twitter. This week he launched an ETF (CWS after the name of his blog, Crossing Wall Street). The ETF will hold his recommended stocks, which you can buy without making twenty different trades. The news is explained in this interview with Abnormal Returns. I also enjoyed this Bloomberg interview, which also includes some of Eddy’s stock picks.

Peter F. Way’s approach measures the hedging used by big-money players. This week he calls attention to biotech stocks finding 70 that are attractive to institutional investors.

Infrastructure stocks are poised to gain no matter who wins the election. Barron’s interviews Jamie Cook, a top-ranked CSFB analyst. Knowledgeable investors can probably guess some of her key picks.

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Our newest trading model, Holmes, has been contributing an idea each week, something we bought for clients a few days ago. I will mention it here, but you can see it sooner (along with other interesting ideas) if you read my new weekly column, the Stock Exchange. I have a “conversation” with disciples of our four trading models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a good starting point for your own research. Holmes may exit a position at any time. If you want more information about the exits, just sign up via holmes at newarc dot com. You will get an email update whenever we sell an announced position. This week Holmes added several stocks, including CVS. See the Stock Exchange for a more complete analysis and ideas from the other experts.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. There are several great choices worth reading. My personal favorite is (once again) our winner of the “best of the week” honor (see above). I also liked the “secret to a good marriage” from Suzanne Woolley. Hint: This is a financial secret. How much is it OK to spend without talking with your partner? Answer for yourself before reading the article, which is both entertaining and quite important. (For guys, I advise not learning the cost of salons and something called a Mani Pedi. Mrs. Old Prof informs me that men also get Mani Pedi’s and I am hopelessly out of date. She does, however have ideas about the appropriate spending limits. The ratio is about 5:1).

Market Outlook

Josh Brown, who expertly helps individual investors by revealing behavior of some pros, highlights the importance of the “career risk trade.” Many managers are chasing the returns from the last twelve months.

Watch out for…

A bond bubble? Jim Cielinski looks at persistent buying despite valuations. He identifies four elements and produces this interesting graphic.

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Final Thoughts

I have an answer for each of the three questions. On a personal note, this is a sweet spot for me. Given my combination of skills – top college debater, coach of the Michigan team, political scientist, and student of presidential debates — this is a good topic for me. For most of these debates the expert commentators on TV were my colleagues as coaches and judges, from back in the day. Mrs. OldProf was originally amazed that they echoed my comments. Then she came to expect it!

  1. Who will win remains in doubt, but the first debate will be crucial. It could represent a change in what is important. Most presidential debates have emphasized short sound bites to convey a message, regardless of the question. That is what the coaches teach: Get your message in there! Incorrect statements of fact have been pounced upon as gaffes. There is a long history. There is also an equalizing effect. Both candidates are on the same platform. The visual and emotional impact may be as important as the substance. One observer even suggested that we should watch with the sound off. (That would facilitate watching Monday Night Football at the same time).
  2. Both candidates want to spend on infrastructure, which will be an economic stimulus. This will require compromise with Congress. Ostensibly a Republican would have an advantage, but there is dissension in the ranks. Initial decisions will include some executive orders, so there could be an immediate effect on health care and immigration.
  3. The dynamic with Congress will be crucial. A new president needs to forge some compromises on spending, tax reform, trade, foreign policy, health care, and defense. Without knowing the Congressional results this is nearly impossible to predict.

Not on the list of question — I expect a progression of reduced uncertainty.

  1. This week we’ll have more definition of the outcome.
  2. After the election we’ll know more about Congress.
  3. After a few months we’ll have more sense of the dynamics and the potential for compromise.

Political uncertainty has limited economic growth, earnings and stock prices. As the uncertainty is resolved, all will improve.

Stock Exchange: How much risk is right?

Technical experts are a rich source of new stock ideas. Our trading models each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their “Stock Exchange.” I am the only human and the only one using fundamental analysis. This week we welcome Athena, whose wisdom helps her to know both when to hold ’em and when to fold ’em.

The group had a consensus on energy last week, but now has sharp divisions.

This Week’s Ideas

Both trading and investing offer many ways to profit. Differing approaches, all sound in themselves, often lead to disparate conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term — all make a difference. Disciples of each become passionate. The Stock Exchange demonstrates that all might be winners in their own time frame.

Our experts are sharply divided this week. Some favor taking on risk, while our newest member, Athena, advocates a utility stock. Here are this week’s top picks.

Felix

While I never boast about my careful and precise method, I hope everyone saw that my pick of gold (and especially RGLD) is off to a great start. I am a long term investor, and it is not too late for others to join me in gold. I see similar potential in mining, the sector I am featuring this week. I like many individual stocks in this group, including one that is owned by some famous activist investor. You can get the long-term picture by looking at the XME ETF.

[Jeff] Why do you like basic materials and gold? Do you think that the Fed and Chair Yellen are leading us into another round of hyperinflation?

[Felix] Excuse me? What is the Fed and who is this Yellen person? My investment success does not require me to waste time reading news!

[Jeff] Sorry. I forgot about that. 🙂

Oscar

Understanding sports is the key to my pick this week. The best NFL running backs are the ones who can wear down a defensive line. Carry after carry, they bust their way for short gains until they work up the momentum for a big run. In Biotech (IBB), I see a sector lined up in the backfield ready to break the plane for a touchdown. Check this chart of the past year:

 

 

Occasionally stalled, but with explosive potential – biotech looks like a player ready to hop off the bench and play the second half. You can see similar potential in individual Biotech stocks, like RARE.

 

 

All I can say? If I had to stake my fantasy team on that moving average trending back up, it would be a no-brainer.

[Felix] Too aggressive and too speculative. [Jeff] Biotech stocks require a different perspective. A projected earnings multiple is not helpful, since many are “story stocks.” We may not know which will come through, but the sector will be the source of the most important drug developments. Long-term investors can put a little away, but they should not expect regular gains on their quarterly statements. I think we will see a nice gain after the election.

Holmes

CVS has a very good chart! I reject all but 2% of the stocks in the universe I follow. I require plenty of data before reaching a conclusion. CVS rallied for 4 straight years barely touching it’s 200-day MA reaching an all-time high 113. It has been backing and filling for last year. I see a possible double bottom. This is a nice risk reward scenario with a tight stop just below 89. These are the kind of setups one sees from careful sleuthing.

[Jeff] Double bottoms seem to be in the eye of the beholder. The stock has pulled back and it is now almost down to fair value. I agree that It is worth watching.

Athena

Some things are so obvious. You guys should pay attention to what is working! We have a nice stock with an uptrend and strong recent price action. I know a good chart when I see one!

[Jeff] If you absolutely must own a utility, this is not a bad choice. I do not like companies with a multiple of over 18 and an earnings growth rate below 3%.

[Athena] Who cares? Pay attention to what is working. If the market ever starts to reflect your thinking, I will sell and move on.

Questions

Last week’s comments were all about current picks. Feel free to range more widely. If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments and address them to a specific expert if you wish. Each has a special expertise. Who is your favorite?

Cast of Characters

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.

Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.

An Important Note to Readers

All of the characters (except me!) are models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but that is especially true here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors. If you like the approach, reach out to us and I will see if you qualify for one of the programs.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Weighing the Week Ahead: Time for the Bond Correction?

The calendar has very little important data. The highlight is the FOMC announcement and press conference on Wednesday. Even though the Fed is not expected to change course, bonds have gotten much weaker, sending the ten-year note yield higher. This effect is gaining notice. Should we expect a further bond selloff?

Last Week

There was not much news, and it was another mixed picture.

Theme Recap

In my last WTWA, I predicted a week of wondering whether we should start fearing the Fed. That was the Monday theme, but it did not last long. Governor Brainard gave a very dovish speech right at the deadline before the blackout period. Many had expected a significant tone change from her. Perceived odds of a rate increase declined after that and continued with the weaker-than-expected data reports.

The Story in One Chart

I always start my personal review of the week by looking at this great chart from Doug Short. The overall range, once again, is very narrow. Doug emphasizes the early-week volatility and generally soft data.

Doug has a special knack for pulling together all of the relevant information. His charts save more than a thousand words! Read his entire post where he adds analysis and several other charts providing long-term perspective. Here is a sample, showing the regularity of drawdowns since 2009, including 5% or more about twice a year and several over 10%. Keeping perspective is easier when you understand what is normal.

 

The News

Each week I break down events into good and bad. Often there is an “ugly” and on rare occasion something really good. My working definition of “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!

The Good

  • Initial jobless claims were 260K, continuing recent low levels.
  • LA area port traffic increased in August. (Calculated Risk). This indicator may need a “reset” now that the Panama Canal is able to take more traffic. There will also be noise from the bankruptcy of a big shipping firm, leaving some cargo stranded.
  • Inflation – both PPI and CPI remains at benign levels. It is not yet at the point that will attract aggressive Fed action, but is starting to reflect improvement in wages and the economy. Doug Short and Steven Hansen collaborate on the most comprehensive analysis of these data. Check out this deep dive!

  • U.S. households are richer than ever. Scott Grannis reviews the latest updates (June data). While it is 2015 data, incomes also showed a big gain.

  • Frequent indicators are stronger. New Deal Democrat’s update of indicators that most people miss is a regular read for me. One excellent feature is the separation of long-leading, short-leading, and concurrent indicators. This is an excellent check on the more commonly discussed economic indicators. It requires a lot of work to provide information that would be difficult to compile on your own. Here is a key quote from this week’s post:

    Now ALL but one of the long leading indicators are positive.  Interest rates for corporate bonds, treasuries, the yield curve, real money supply, real estate loans, mortgage rates, purchase and refinance mortgage applications are positive. The only negative is that mortgage rates have not made new lows for over 3 years.

     Short leading indicators turned a little more mixed.  Stock prices, jobless claims, oil and gas prices, gas usage, and as of this week the spread between corporates and treasuries, are all positive. Both measures of the US$ are now neutral.  Industrial commodities have joined the volatile regional Fed averages as a negative.

     The coincident indicators remain mixed. For once recently all measures of consumer spending are positive.  The BDI remained barely positive.  Rail, steel, the Harpex shipping index, and bank rates remain negative, with bank rates really spiking. Tax withholding was mixed.  Obviously I do not like a negative YoY tax withholding reading, but I suspect this will resolve next week.

  • Las Vegas visitor traffic has reached a new record high. Bill McBride has the story. And this is even before the new direct flights from Beijing have begun.

The Bad

  • Rail traffic had another bad week. Steven Hansen notes that it is still down 4.9% y-o-y if you remove coal and grain traffic.
  • Industrial production dropped 0.4% missing expectations for a decline of 0.3%.
  • The federal budget deficit is increasing as revenues falter. Scott Grannis has a good discussion. Various sources this week, including Barron’s, noted that the election debate does not pay enough attention to this issue.

  • Election uncertainty is holding back business investment, and it will not stop when the election ends. Duke’s regular survey of CFO’s reports that 1/3 will hold back on investment until there is information about how the new president will govern. Election expert Prof. Larry J. Sabato also expresses concern about the “strange race.” This is a growing concern.
  • Michigan sentiment missed expectations (89.8 v 91.5), but matched last month’s final result.
  • Retail sales declined 0.1% missing expectations of a 0.3% gain. Jill Mislinski covers this thoroughly. The effect on Doug Short’s Big Four indicators is described in the quant section.

 

The Ugly

Corporate misconduct. Deutsche Bank via Bloomberg. “Aside from the U.S. probe into residential mortgage-backed securities, the lender also faces inquiries into matters including currency manipulation, precious metals trading and billions of dollars in transfers out of Russia”. Wells Fargo creating two million phony accounts. (CNN). Exxon accounting issues. (Reuters). Bosch under investigation for possible help to VW in “Dieselgate.” (Bloomberg).

Wells Fargo’s CEO John Stumpf will be before the Senate Banking Committee on Tuesday. The fines and other penalties for corporate offenses sound large, but do not really force accountability. Eddy Elfenbein ponders what a Wells Fargo investor should do. (We also hold stock versus short calls).

Following up on last week’s North Korea story – the Council on Foreign Relations has a collection of papers covering the key issues.

The Silver Bullet

I occasionally give the Silver Bullet award to someone who takes up an unpopular or thankless cause, doing the real work to demonstrate the facts. This week’s award goes to Chris Ciovacco (See It Market) for his great explanation of the VIX. Featuring a prior piece by Jeff Macke, he emphasizes that the VIX is not really about fear, but expected volatility.

The misunderstanding of this concept is costly for investors who see it is a leading “fear” indicator, as well as traders who misuse it for hedging. The entire post is worth a careful reading, but keep this chart in mind:

See also runner-up Adam H. Grimes with similar conclusions on the same topic.

 

The Week Ahead

We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react. That is the purpose of considering possible themes for the week ahead. You can make your own predictions in the comments.

The Calendar

We have a very light week for economic data, featuring the FOMC decision and Yellen press conference. While personally I watch everything on the calendar, you do not need to! I highlight only the most important items in WTWA. Focus is essential.

The “A” List

  • FOMC decision (W). No policy change is expected. Will the statement and press conference clarify anything?
  • Housing starts and building permits (T). Crucial element for stronger growth.
  • Initial claims (Th). The best concurrent indicator for employment trends.

The “B” List

  • Existing home sales (F). Not as important for the economy as new homes, but still a good read on the market.
  • Crude inventories (W). Often has a significant impact on oil markets, a focal point for traders of everything.

 

FedSpeak will resume after the meeting with several participants on the calendar.

Next Week’s Theme

Last week began with revisionist Fed thinking on Monday and a poorly-explained sell-off on Tuesday. I parsed the explanations which were basically inconsistent. Many relied on the lame “delayed reaction” argument. It is amazing how imagination can be used to make facts fit your favorite scenario. I tweeted a good CNBC sequence where the stock pundits (once again) said that markets were taking a cue from oil. The oil expert then opined that commodity traders were watching stocks!

True enough. Everything declined together on Tuesday, including the interest-rate sensitive names. Pundits were mystified by bond selling even though the FedSpeak was more dovish. Could it be? Regardless (but including) what the Fed does, I expect that everyone will be asking: Is the long-awaited bond correction at hand?

There is a key mistake in most commentary – the idea that the Fed controls all interest rates. “Davidson” (via Todd Sullivan) pursues a theme that I hope will be familiar to my readers.

When I began my career ~35yrs ago everyone talked about “The Credit Spread”. Today, everyone talks about rates as if it is the rate, the short-term rate, and importantly the rate the Fed sets, the Fed Funds Rate. Today’s discussion is universally about the next Fed Funds Rate hike as if the Federal Reserve controls the economy. The extensive economic data we have available has never supported the wide-spread belief repeated ad nauseam in every media that the Federal Reserve controls US economic activity. Actual control lies in the Free Market.

I have not been a fan of Jeff Gundlach on most of his predictions about stocks, but when a “bond guy” gets worried about bonds, we should probably pay attention. Robert Huebscher covers this in an article that has been extremely popular with investment advisors. Here is a key quote:

“This is a big, big moment,” Gundlach said¸ and it won’t pay to “be cute” by trying to benefit from short-term price movements, since the dominant trend will be higher rates.

“It pays not to squeeze the last bit of juice out of the orange,” Gundlach said.

Brett Arends (who also has been no fan of stocks) is sounding a warning about the so-called safe investments.

JP Morganseems to be on the same page.

As always, I’ll have a few ideas of my own in the conclusion.

Quant Corner

We follow some regular great sources and also the best insights from each week.

Risk Analysis

Whether you are a trader or an investor, you need to understand risk. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.

The Indicator Snapshot

 

The Featured Sources:

 

Bob Dieli: The “C Score” which is a weekly estimate of his Enhanced Aggregate Spread (the most accurate real-time recession forecasting method over the last few decades). His subscribers get Monthly reports including both an economic overview of the economy and employment.

The recession odds (in nine months) have nudged closer to 10%.

Holmes: Our cautious and clever watchdog, who sniffs out opportunity like a great detective, but emphasizes guarding assets.

RecessionAlert: Many strong quantitative indicators for both economic and market analysis. While we feature his recession analysis, Dwaine also has a number of interesting approaches to asset allocation.

Georg Vrba: The Business Cycle Indicator, and much more. Check out his site for an array of interesting methods. Georg regularly analyzes Bob Dieli’s enhanced aggregate spread, considering when it might first give a recession signal. Georg thinks it is still a year away. It is interesting to watch this approach along with our weekly monitoring of the C-Score.

Brian Gilmartin: Analysis of expected earnings for the overall market as well as coverage of many individual companies.

Doug Short: The Big Four Update, the World Markets Weekend Update (and much more).

The ECRI has been dropped from our weekly update. It was not so much because of the bad call in 2011, but the stubborn adherence to this position despite plenty of evidence to the contrary. Those interested can still follow them via Doug Short and Jill Mislinski. The ECRI commentary remains relentlessly bearish despite the upturn in their own index.

Quant work on GDP was a key topic this week. The Atlanta Fed’s GDP Now project shows a current forecast of 3%, a lot better than most expect.

Lipper explains why things might be stronger than they feel on the earnings front. This is a theme from Brian Gilmartin that we have been monitoring for months.

Mark Perry has a good idea about GDP measurement. Let’s start by asking whether you think the world’s “music well-being” has ever been better than it is now. Mark explains why it is currently awesome. Next take a look at how it is measured by GDP. Everyone will enjoy this chart, which makes obvious the error in using dollar sales as the main indicator.

 

 

How to Use WTWA

In this series I share my preparation for the coming week. I write each post as if I were speaking directly to one of my clients. Most readers can just “listen in.” If you are unhappy with your current investment approach, we will be happy to talk with you. I start with a specific assessment of your personal situation. There is no rush. Each client is different, so I have six different programs ranging from very conservative bond ladders to very aggressive trading programs. A key question:

Are you preserving wealth, or like most of us, do you need to create more wealth?

My objective is to help all readers, so I provide a number of free resources. Just write to info at newarc dot com. We will send whatever you request. We never share your email address with others, and send only what you seek. (Like you, we hate spam!) Free reports include the following:

  • Understanding Risk – what we all should know.
  • Income investing – better yield than the standard dividend portfolio, and also less risk.
  • Holmes – the top artificial intelligence techniques in action.
  • Why it is a great time to own for Value Stocks – finding cheap stocks based on long-term earnings.

You can also check out my website for Tips for Individual Investors, and a discussion of the biggest market fears. (I welcome questions. What scares you?)

Best Advice for the Week Ahead

The right move often depends on your time horizon. Are you a trader or an investor?

Insight for Traders

We consider both our models and also the best advice from sources we follow.

Felix and Holmes

We continue with a strongly bullish market forecast. Felix is fully invested. Oscar holds several aggressive sectors. The more cautious Holmes also remains fully invested. They now have a regular Thursday night discussion, which they call the “Stock Exchange.” You are welcome to join in with questions or ideas.

Top Trading Advice

Brett Steenbarger is posting great ideas day after day. Traders should read his posts frequently. I sense another book coming! My favorite this week is about what you should do if you are in a drawdown.

Are other people, trading similar strategies, also losing money?

That will tell you quite a bit.  If you were making money and suddenly go cold and others in the same markets, with similar strategies are doing the same, then you know that it isn’t simply a psychological issue.  Everyone did not suddenly lose discipline or become an idiot at the same time.  Rather, the strategy is not working under current market conditions, or it has stopped working altogether.

Simple, but wise and often overlooked by traders who start second-guessing themselves.

I also recommend this post on The Psychology of Dealing with Choppy Markets.

Most aspiring traders would save a lot of time and money if they asked Sam Seiden’s question, Are You a Good Fit for Trading? (This was GEI’s Investing Trading Academy’s article of the week).

Adam H. Grimes has another take on psychology, considering how it is linked with experience and methodology.

Insight for Investors

Investors have a longer time horizon. The best moves frequently involve taking advantage of trading volatility!

Best of the Week

If I had to pick a single most important source for investors to read this week it would be Chuck Carnevale’s lesson about how to pick dividend stocks. I almost always suggest that readers take a look at his ideas, but this week’s post is extra special. He provides a wonderful opportunity to test the tools at his wonderful time-saving and profit-building site. Anyone who is a do-it-yourself individual investor should set aside an hour or so to read the article and try out the method.

His example convincingly shows why entry price is important. A given budget permits purchase of more shares. Better value at the time of purchase gives you both extra upside on stock gains and also larger dividends. Take Chuck’s challenge to try it for yourself.

Stock Ideas

 

Eddy Elfenbein’s latest CNBC appearance explains the relationships underlying the gold trade, where someone bought $1 million worth of put options on a single gold stock. The discussion emphasizes the short run, reaching a different conclusion than Felix, who thinks long-term.

Our newest trading model, Holmes, has been contributing an idea each week, a stock we bought for clients a few days ago. I will mention it here, but you can see it a little sooner if you read my new weekly column, the Stock Exchange. I’ll have a “conversation” each week with all three of our models. Since each has a different personality and style, there are often disagreements – especially with me! While we cannot verify the suitability of specific stocks for everyone who is a reader, the ideas may be a starting point for your own research. Holmes may exit a position at any time, and I am not going to do a special post on each occasion. If you want more information about Holmes and exits, just sign up via holmes at newarc dot com and you will get email updates. This week’s Holmes added several stocks, including Solar City (SCTY).

Technology stocks are now favored by value funds. That is no surprise to me or to my readers! Barron’s has the story. A subscription is required, but you can probably get it by putting the title or key phrase into Google.

Barron’s also highlights homebuilder CalAtlantic (CAA). The company has been digesting a merger which helped to place it in some of the fastest growing areas.

The top 10 dividend stocks from Morningstar’s Ultimate Stock pickers.

Peter F. Way uses his unique methodology to highlight Dow stocks with the best risk/reward profile. Here is one of several interesting charts:

OK, here is another….

You can get some great ideas from this approach.

Personal Finance

Professional investors and traders have been making Abnormal Returns a daily stop for over ten years. The average investor should make time (even if not able to read AR every day as I do) for a weekly trip on Wednesday. Tadas always has first-rate links for investors in his weekly special edition. This was a really great post. There are several great choices worth reading, including my pick for best advice of the week. My personal favorite is the Harvard Business Review study of the cost of your inconsistent decisions. Unless you are a regular HBR reader (I listen to a lot of their podcasts) you would never see this story. Tadas does the heavy lifting for you.

Many readers would also enjoy his Saturday post with interesting lifestyle features. Mrs. OldProf liked the item on wine.

Market Outlook

Many people have described current markets as “complacent.” That is not what I see. The fact that the trading range is tight can occur when there are intense feelings in a rough balance. There is plenty of negative market sentiment. Here is a typical popular column listing six worries.

This week I was struck by two excellent posts.

Brian Gilmartin summarized the “Delivering Alpha” conference, where nearly everyone was downbeat. For contrast, here are some notes from Market Folly. It will be interesting to review how well these ideas play out over the next year.

Joe Fahmy explains why the market will not correct when that is what everyone is expecting. His perception of the trading community squares with what I hear.

Watch out for…

Junk bonds. Marc Gerstein has a warning for “yield hogs.”

Final Thoughts

 

Fueled by ill-informed reports from financial media, most investors think only of a single interest rate, controlled by the Fed. This is a costly mistake. It is important to monitor the entire yield curve.

The short end responds mostly to the Fed policy announcements. Most recently the Fed is unsure that their decisions can have the desired impact, so the resulting rate is imprecise.

The long end reflects (at least) five factors:

  1. Expected future rate increases – the term premium;
  2. Inflation, current and expected;
  3. Economic growth;
  4. The Fed balance sheet – estimates are that the current holdings have an effect of 1 – 1.5% on the ten-year note; and
  5. Global interest rates, including policies from other central banks.

Those who attribute the long rate or the slope of the yield curve to a single factor are making a costly mistake. This is especially true for those whose favorite game is to make it all about the Fed.

Investment Implications

The dominant perception holds that the Fed is about to raise interest rates despite economic weakness, probably creating a recession. This is backwards. If rate increases are consistent with economic growth, it would be the “bear steepener” that I have been describing for some weeks. We should embrace short-term rate increases when growth is strengthening and the long rates are also moving higher.

Holdings to reduce or avoid include:

  • Bonds and bond mutual funds. Alliance Bernstein warns that the one statistic you must know is duration of your bond holdings. Do you? That helps you see how much is at risk.
  • Utility stocks and bond proxies.
  • REITs and MLPs that are interest sensitive and without a tie to economic growth. Look for sectors benefiting from demographic changes – health care, senior living.

Holdings to emphasize include:

  • Technology
  • Banks
  • Homebuilders

The consensus, even among the traditional bond advocates, is that the crowded bond trade (bubble?) has reached its end. As investors following the traditional 60-40 formula see absolute losses on their brokerage statements, where do we expect the money to flow?

Stock Exchange: The Experts Like Energy

Technical experts are a rich source of new stock ideas. Our models, Felix, Oscar, and Holmes each specialize in a different time frame and level of risk. Before their weekly poker game, they spend a few minutes trading ideas. They like to call this their “Stock Exchange.” Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

Jeff sometimes joins the discussion with some comments about stock or market fundamentals.

This Week’s Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term — all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Each member of the group, independently, comes up with an idea. To my surprise this week was all about energy.

Felix

I am liking oil and gas this week. I particularly like SM Energy (SM). There is a lot of movement and great long-term opportunity for more growth.

 

Oscar

I’m still holding onto Regional Banks, but my latest sector pick is Refiners. Just a glance at this YTD chart for CRAK and you’ll see a strong element of seasonality in this sector. I don’t think we’re anywhere near this year’s peak just yet.

Most stocks in this area have been quietly jogging through this low volatility period, waiting to break out into a sprint. I know I’ll be watching when they cross the finish line. Will you?

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are still ahead of the humans. Last week’s bumpy ride has not changed my bullish outlook. Here is one I bought this week: Solar City (SCTY).

Jeff

The aptly named CRAK focuses on the key element for refiners, the crack spread. This tracks the difference in price between their input, crude oil, and the refined product they sell. When oil prices fell most people missed the opportunity in refiners. One way to keep an eye on this is to watch the forward curve on crack futures. Yes, there is such a thing. The spread declines seasonally into the end of the year, and looks nicely higher net year. Oscar might be disappointed in how long this takes.

Felix seems to think that SM Energy will return to the good old days when it traded 80. Time will tell. In last week’s question about AAPL he thought the chart was too messy, but I liked the stock. I would point out who is leading on that question, but it is best not to talk trash around Felix.

Holmes picked Solar City, which is showing some volatility. Holmes is quick to exit trades that are not working.

Questions

Each week we will answer questions. Feel free to address any of us.

One reader noted insider selling in CAH. This can be an important fundamental factor, more typically when there is buying. Holmes does not consider it because the information is not released quickly enough to be helpful in his time frame.

Another reader suggested that the group needed a female perspective. That is interesting, since there will be a new member of the poker group soon. She is quick-thinking and fast-trading. She knows a good chart when she sees one.

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.

Felix, Oscar, and Holmes Talk Stocks

Fans of the Odd Couple know about Felix and Oscar’s regular poker game. While Holmes is a dog, everyone knows that they play poker as well. They have all agreed to take a few minutes away each week to talk with us about stocks. Here is the cast of characters:

Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not make any picks, but he will answer questions, saying what he thinks about specific stocks.

Oscar is naturally optimistic and a bit excitable. He definitely likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.

Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.

To provide occasional representation for those of the fundamental persuasion, I will sometimes include a human in the discussion.

 

This Week’s Ideas

My purpose is to show how different approaches – all sound methods – often lead to different conclusions. Technical versus fundamental, trader versus investor, short-term versus long-term — all make a difference. I hope you will find the weekly discussion interesting and become a part of it.

Felix

I see good value in precious metals. What to buy? Gold or silver? Metals or mining? Royal Gold (RGLD) is an attractive choice.

Question: Felix, what is your opinion of Apple (AAPL).

Felix: Too messy! It is barely acceptable.

Jeff: Earnings and cash will eventually lead the stock price higher.

 

Oscar

“Felix may be in it for the long haul, but there are plenty of ways to cash in faster! There is a football game tonight, for example. But you want to know about stock sectors. My pick of the week is Regional Banks (KRE). They started with an early slump in January but now there is a hot streak – just check the 50-day moving average! I don’t want a floor for my portfolio; I want to blow the roof off!”

 

Holmes

I do not talk as much as Felix and Oscar, but my stock picks are ahead of the humans. This record market has my tail wagging! Here is one I bought this week: Cardinal Health (CAH).

 

An Important Note to Readers

Felix, Oscar, and Holmes are all models, carefully engineered and tested by one of the leading developers of the last thirty years. They are highly-modified momentum models, with different time frames and features.

I humanize them because it makes it easier to understand the characteristics in their design. I always remind readers that my posts are informational, not investment advice, but special emphasis is needed here. While we are trading based upon all three models, we are always watching and can act quickly when necessary. The models are not suitable for all investors.

The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned (individual banks rather than KRE).

Questions are welcome about both stocks and sectors. I will pass them along.

Why Smart Investors Struggle to Beat the Market: Over-emphasis on Recent Performance

The individual investor does not beat the market, but actually trails by a significant margin. It is not a matter of intelligence.

The habits and skills that help smart people succeed in their jobs and recreational life actually mislead them when it comes to investing!

Preface

I am writing some posts subjects that have great current significance. These are issues where the average investor has a lot of money at stake. There is currently a lot of buzz about 2016 performance. This morning I heard a pundit explain that hedge fund managers had to go into “catch up” mode since so many of them trailed the market. As we enter the last quarter of the year, there is already focus on that annual grade card. Should you care?

Everyone has heard, of course, that past performance does not assure future results. Still, it must provide some kind of indication about the future? Doesn’t it?

Let us investigate further.

As I elaborate, please keep in mind this story about Ken Uston, one of the greatest blackjack players of all time. In his excellent book, Million Dollar Blackjack he describes both his system and the implementation in team play.  Card-counting nerds would signal “the Big Player” who would seem to flit from table to table, cocktail in hand and a woman on both arms.  The Big Player would make large bets, but only when the odds were in his favor. As a result of this team method (no longer effective given casino counter-measures), Uston played exclusively in situations where he had an edge of about 5%.

The Relevance of Past Performance

Suppose that you adopted a system where you took all of your money each day and bought the stocks that did the best the day before. That would be past performance on a one-day time frame. I suspect that most readers will think that is silly.

Suppose that you looked at the stocks and sectors which did best in the past year. Buy them! That may seem reasonable, but it is also a regular loser.

How about choosing the managers that did the best over the past year? Or the ETFs that were strongest? That is simply a closet method for following last year’s top picks. The top investors and managers for last year owned the popular FANG stocks, utilities, and consumer dividend payers. We know that it worked last year, but will it continue?

Warren Buffett, on a monthly basis, beats the market only 51% of the time. He has had multiple losing streaks. None of this has stopped him from being a great investor.

Evaluating performance requires relevant, long-run data.

What is the long run?

 

The average investor thinks of the long run in terms of time. This is a big mistake. The long run relates to the number of decisions, not time. Here are some illustrative examples:

  • High frequency trading firms rarely have a single losing day! This is because they make tens of thousands of trades each day. They reach the “long run” in an hour or two.
  • Single-theme managers may lose for many years. The heroes who called the housing market collapse and were memorialized in The Big Short, endured years of losses and many angry investors –often locked in by contract. The past performance of multiple years was certainly no indication of what was to come.
  • Thematic managers (like me) might have 5 or 6 themes. Even a strong strategy does not get into the long run in a given year. When the theme hits it is a huge winner.

The “long run” should be measured in the number of decisions, not the calendar time. If you try to cut it into arbitrary times, it either fails, or creates the wrong incentives for managers.

Is Performance Even the Correct Test?

Some investments are chosen without the “beating the market” concept in mind. If you make such a decision, it is wrong to revisit the results with a specific market benchmark. Here are some examples:

  • Suppose you choose an income program. If the income meets the target, that should be the test.
  • Suppose you fear a particular threat. One of my concerns is a cyber-attack. I suspect that the frequency is under-reported and bigger cases loom. If it happens, it would be helpful to hold a leading company in the field. I have chosen Palo Alto Networks (PANW) because it is a good company with a strong client base and real earnings. The stock was crushed today because of cautious comments in their outlook. The earnings and revenues were fine. We bought more. Should I be concerned that this hurt my performance? Should my clients? If they are worried, they have the wrong manager. Nothing fundamentally changed. If there is a big cyber event, we’ll win big. We are not trying to beat the market each month or year with this stock.
  • Suppose you want downside protection. If you go with a manager like John Hussman who buys puts to hedge your position, that was your choice. Even if the puts expire worthless, he did his job. You should expect reduced performance when the market does not decline significantly.
  • Suppose you select a portfolio with a large cash or bond component. This is often exactly what you should do. Do not second guess yourself by wondering if you should have taken more risk.
  • Suppose you invest in a “value” program. Buying cheap stocks (on an earnings basis) has been out of favor for the last few years. Should you expect this to continue, or for the pendulum to swing? My approach is to buy regional banks (STI is a favorite), technology, and homebuilders. This will work, but maybe not in the next few months. You should not worry about that.

Conclusion

 

Revisiting Mr. Uston — despite the big percentage advantage, he describes a period of time where they had a losing streak lasting more than a month!  Please note that this includes thousands of hands played. They started questioning error rate, methods, the skill of their counters, theft, etc. I like the example since it is possible to compute a valid benchmark result for what they were doing. Eventually the winnings returned. It shows that you must have confidence in your system, and stick with it through some improbable losing times.

In similar fashion, value investing is a fundamental part of my approach. It may be difficult, even for the smartest investors, to see this. It is a good problem to analyze.

Anthony Fogler (via ValueWalk) explains why value has been treated unkindly, and why sentiment is likely to change. Here is an illustrative chart:

The chart provides some idea of what time frame you should consider to reach the “long run” in value investing. Not one or two years, but more like five.

There are many other traps for the really smart investor. The most intriguing is that most of our reading in our professional life is designed to educate and help us. In the investment world, many are trying to sell us or scare us or both. But that is a subject for another day.