Tag Archives: genius

Who’s Being Naïve, Kay?

All great literature is one of two stories: a man goes on a journey or a stranger comes to town. – Leo Tolstoy (1826 – 1910) Satan: Dream other dreams, and better! – Mark Twain, “The Mysterious Stranger” (c. 1900) Twain spent 11 years writing his final novel, “The Mysterious Stranger”, but never finished it. The book exists in three large fragments and is Twain’s darkest and least funny work. It’s also my personal favorite. Stanley Moon: I thought you were called Lucifer. George Spiggott: I know. “The Bringer of the Light” it used to be. Sounded a bit poofy to me. George Spiggott: Everything I’ve ever told you has been a lie. Including that. Stanley Moon: Including what? George Spiggott: That everything I’ve ever told has been a lie. That’s not true. Stanley Moon: I don’t know WHAT to believe. George Spiggott: Not me, Stanley, believe me! – “Bedazzled” (1967) A must-see movie, and I don’t mean the 2000 abomination with Brendan Fraser, but the genius 1967 version by Peter Cook and Dudley Moore. Plus Raquel Welch as Lust. Yes, please. Harold Hill: Ladies and gentlemen, either you are closing your eyes to a situation you do not wish to acknowledge, or you are not aware of the caliber of disaster indicated by the presence of a pool table in your community! – “The Music Man” (1962) The Pied Piper legend, originally a horrific tale of murder, finds its source in the earliest written records of the German town of Hamelin (1384), reading simply “it is 100 years since our children left.” Wade Wilson: I had another Liam Neeson nightmare. I kidnapped his daughter and he just wasn’t having it. They made three of those movies. At some point you have to wonder if he’s just a bad parent. – “Deadpool” (2016) Shape clay into a vessel; It is the space within that makes it useful. Cut doors and windows for a room; It is the holes which make it useful. Therefore benefit comes from what is there; Usefulness from what is not there. – Lao Tzu (c. 530 BC) It’s like trying to find gold in a silver mine It’s like trying to drink whiskey from a bottle of wine – Elton John and Bernie Taupin, “Honky Cat” (1972) Michael : My father is no different than any powerful man, any man with power, like a president or senator. Kay Adams : Do you know how naïve you sound, Michael? Presidents and senators don’t have men killed. Michael : Oh. Who’s being naïve, Kay? – “The Godfather” (1972) As Tolstoy famously said, there are only two stories in all of literature: either a man goes on a journey, or a stranger comes to town. Of the two, we are far more familiar and comfortable with the first in the world of markets and investing, because it’s the subjectively perceived narrative of our individual lives. We learn. We experience. We overcome adversity. We get better. Or so we tell ourselves. But when the story of our investment age is told many years from now, it won’t be remembered as a Hero’s Journey, but as a classic tale of a Mysterious Stranger. It’s a story as old as humanity itself, and it always ends with the same realization by the Stranger’s foil: what was I thinking when I signed that contract or fell for that line? Why was I so naïve? The Mysterious Stranger today, of course, is not a single person but is the central banking Mafia apparatus in the US, Europe, Japan, and China. The leaders of these central banks may not be as charismatic as Robert Preston in The Music Man , but they hold us investors in equal rapture. The Music Man uses communication policy and forward guidance to get the good folks of River City to buy band instruments. Central bankers use communication policy and forward guidance to get investors large and small to buy financial assets. It’s a difference in degree and scale, not in kind. The Mysterious Stranger is NOT a simple or single-dimensional fraud. No, the Mysterious Stranger is a liar, to be sure, but he’s a proper villain, as the Brits would say, and typically he’s quite upfront about his goals and his use of clever words to accomplish those goals. I mean, it’s not like Kay doesn’t know what she’s getting herself into when she marries into the Corleone family. Michael is crystal clear with her, right from the start. But she wants to believe so badly in what Michael is telling her when he suddenly reappears in her life, that she suspends her disbelief in his words and embraces the Narrative of legitimacy he presents. I think Michael actually believed his own words, too, that he would in fact be able to move the Family out of organized crime entirely, just as I’m sure that Yellen believed her own words of tightening and light-at-the-end-of-the-tunnel in the summer of 2014. Ah, well. Events doth make liars of us all. Draw your own comparisons to this story arc of The Godfather , with investors playing the role of Kay and the Fed playing the role of Michael Corleone. I think it’s a pretty neat fit. It ends poorly for Kay, of course (and not so great for Michael). Let’s see if we can avoid her fate. But like Kay, for now we are married to the Mob … err, I mean, the Fed and competitive monetary policies, as reflected in the relative value of the dollar and other currencies. The cold hard fact is that since the summer of 2014 there has been a powerful negative correlation between the trade-weighted dollar and oil, between the trade-weighted dollar and emerging markets, and between the trade-weighted dollar and industrial, manufacturing, and energy stocks. Here’s an example near and dear to the hearts of any energy investor, the trade-weighted dollar shown in green versus the inverted Alerian MLP index (AMZ), a set of 43 midstream energy companies, principally pipelines and infrastructure, shown in blue. Click to enlarge © Bloomberg Finance L.P. as of 05/02/2016. For illustrative purposes only. Past performance does not guarantee future results. This is a -94% correlation, remarkably strong for any two securities, much less two – pipelines and the dollar – that are not obviously connected in any fundamental or real economy sort of way. But this is always what happens when the Mysterious Stranger comes to town: our traditional behavioral rules (i.e., correlations) go out the window and are replaced with new behavioral rules and correlations as we give ourselves over to his smooth words and promises. Because that’s what a Mysterious Stranger DOES – tell compelling stories, stories that stick fast to whatever it is in our collective brains that craves Narrative and Belief. There’s nothing particularly new about this phenomenon in markets, as there have always been “story stocks”, especially in the technology, media, and telecom (TMT) sector where you have more than your fair share of charismatic management storytellers and valuation multiples that depend on their efforts. My favorite example of a “story stock” is Salesforce.com (NYSE: CRM ), a $55 billion market cap technology company with 19,000 employees and about $6.5 billion in revenues. I’m pretty sure that Salesforce.com has never had a single penny of GAAP earnings in its existence (in FY 2016 the company lost $0.07 per share on a GAAP basis). Instead, the company is valued on the basis of non-GAAP earnings, but even there it trades at about an 80x multiple (!) of FY 2017 company guidance of $1.00 per share. Salesforce.com is blessed with a master story-teller in its CEO, Marc Benioff, who – if you’ve ever heard him speak – puts forth a pretty compelling case for why his company should be valued on the basis of bookings growth and other such metrics. Of course, the skeptic in me might note that it is perhaps no great feat to sell more and more of a software service at a loss, particularly when your salespeople are compensated on bookings growth, and the cynic in me might also note that for the past 10+ years Benioff has sold between 12,500 and 20,000 shares of CRM stock every day through a series of 10b5-1 programs. But hey, that’s why he’s the multi-billionaire (and a liquid multi-billionaire, to boot) and I’m not. Here’s the 5-year chart for CRM: Click to enlarge © Bloomberg Finance L.P. as of 05/20/2016. For illustrative purposes only. Past performance does not guarantee future results. Not bad. Up 138% over the past five years. A few ups and downs, particularly here at the start of 2016, although the stock has certainly come roaring back. But when you dig a little deeper… There are 1,272 trading days that comprise this 5-year chart. 21 of those trading days, less than 2% of the total, represent the Thursday after Salesforce.com reports quarterly earnings (always on a Wednesday after the market close). If you take out those 21 trading days, Salesforce.com stock is up only 35% over the past five years. How does this work? What’s the causal process? Every Wednesday night after the earnings release, for the past umpteen years, Benioff appears on Mad Money , where Cramer’s verdict is always an enthusiastic “Buy, buy, buy!” Every Thursday morning after the earnings release, the two or three sell-side analyst “axes” on the stock publish their glowing assessment of the quarterly results before trading begins. It’s not that every investor on Thursday believes what Cramer or the sell-side analysts are saying, particularly anyone who’s short the stock (CRM always has a high short interest). But in a perfect example of the Common Knowledge Game , if you ARE short the stock, you know that everyone else has heard what Cramer and the sell-side analysts (the Missionaries, in game theory lingo) have said, and you have to assume that everyone else will act on this Common Knowledge (what everyone knows that everyone knows). The only logical thing for you to do is cover your short before everyone else covers their short, resulting in a classic short squeeze and a big up day. Now to be sure, this isn’t the story of every earnings announcement…sometimes even Marc Benioff and his lackeys can’t turn a pig’s ear of a quarter into a silk purse…but it’s an incredibly consistent behavioral result over time and one of the best examples I know of the Common Knowledge Game in action. But wait, there’s more. Now let’s add the Fed’s storytelling and its Common Knowledge Game to Benioff’s storytelling and his Common Knowledge Game. Over the past five years there have been 43 days where the FOMC made a formal statement. If you owned Salesforce.com stock for only the 43 FOMC announcement days and the 21 earnings announcement days over the past five years, you would be UP 167%. If you owned Salesforce.com stock for the other 1,208 trading days, you would be DOWN 8%. Click to enlarge Okay, Ben, how about other stocks? How about entire indices? Well, let’s look again at that Alerian MLP index. Over the past five years, if you had owned the AMZ for only the 43 FOMC announcement days over that span, you would be UP 28%. If you owned it for the other 1,229 trading days you would be DOWN 39%. Over the past two years, if you had owned the AMZ for only the 16 FOMC announcement days over that span, you would be UP 18%. If you owned it for the other 487 trading days you would be DOWN 48%. Addition by subtraction to a degree that would make Lao Tzu proud. Click to enlarge I’ll repeat what I wrote in Optical Illusion / Optical Reality …it’s hard to believe that MLP investors should be paying a lot more attention to G-7 meetings and reading the Fed governor tea leaves than to gas field depletion schedules and rig counts, but I gotta call ‘em like I see ‘em. In fact, if there’s a core sub-text to Epsilon Theory it’s this: call things by their proper names . That’s a profoundly subversive act. Maybe the only subversive act that really changes things. So here goes. Today there are vast swaths of the market, like emerging markets and commodity markets and industrial/energy stocks, that we should call by their proper name: a derivative expression of FOMC policy . Used to be that only tech stocks were “story stocks”. Today, almost all stocks are “story stocks”, and the Common Knowledge Game is more applicable to helping us understand market behaviors and price action than ever before. You see this phenomenon clearly in the entire S&P 500, as well, although not as starkly with a complete plus/minus reversal in performance between FOMC announcement days and all other days. Over the past five years, if you had owned the SPX for only the 43 FOMC announcement days over that span, you would be UP 17%. If you owned it for the other 1,229 trading days you would be UP 28%. Over the past two years, if you had owned the SPX for only the 16 FOMC announcement days over that span, you would be UP 5%. If you owned it for the other 487 trading days you would be UP 2%. Click to enlarge What do I take from eyeballing these charts? The Narrative effect and the impact of the Common Knowledge Game have accelerated over the past two years (ever since Draghi and Yellen launched the Great Monetary Policy Schism of June 2014); they’re particularly impactful during periods when stock prices are otherwise declining, and they’re spreading to broader equity indices. That’s what it looks like to me, at least. So what does an investor do with these observations? Two things, I think, one a practical course of action and one a shift in perspective. The former being more fun but the latter more important. First, there really is a viable research program here, and what I’ve tried to show in this brief note is that there really are practical implementations of the Common Knowledge Game that can support investment strategies dealing with story stocks. I want to encourage anyone who’s intrigued by this research program to take the data baton and try this on your favorite stock or mutual fund or index. You can get the FOMC announcement dates straight from the Federal Reserve website . This doesn’t require an advanced degree in econometrics to explore. I don’t know where this research program ends up, but it’s my commitment to do this in plain sight through Epsilon Theory . Think of it as the equivalent of open source software development, just in the investment world. I suspect it’s hard to turn the Common Knowledge Game into a standalone investment strategy because you’re promising that you’ll do absolutely nothing for 98 out of 100 trading days. Good luck raising money on that. But it’s a great perspective to add to our current standalone strategies, especially actively managed funds . Stock-pickers today are being dealt one dull, low-conviction hand after another here in the Grand Central Bank Casino, and the hardest thing in the world for any smart investor, regardless of strategy, is to sit on his hands and do nothing , even though that’s almost always the right thing to do . Incorporating an awareness of the Common Knowledge Game and its highly punctuated impact makes it easier to do the right thing – usually nothing – in our current investment strategies. And that gets us to the second take-away from this note. The most important thing to know about any Mysterious Stranger story is that the Stranger is the protagonist. There is no Hero! When you meet a Mysterious Stranger, your goal should be simple: survive the encounter. This is an insanely difficult perspective to adopt, that we (either individually or collectively) are not the protagonist of the investing age in which we live. It’s difficult because we are creatures of ego. We all star in our own personal movie and we all hear the anthems of our own personal soundtrack. But the Mysterious Stranger is not an obstacle to be heroically overcome, as if we were Liam Neeson setting off (again! and again!) to rescue a kidnapped daughter in yet another “Taken” sequel. At some point this sort of heroism is just a reflection of bad parenting in the case of Liam Neeson, and a reflection of bad investing in the case of stock pickers and other clingers to the correlations and investment meanings of yesterday. The correlations and investment meanings of today are inextricably entwined with central bankers and their storytelling. To be investment survivors in the low-return and policy-controlled world of the Silver Age of the Central Banker , we need to recognize the impact of their words and incorporate that into our existing investment strategies, while never accepting those words naïvely in our hearts.

Do Stock Spinoffs Still Outperform? A Summary Of The Research

Ever since I read, You Can Be a Stock Market Genius , I’ve been fascinated with stock spinoffs. The book is written by Joel Greenblatt, who is a certified rock star in the value investing community. When he was running his highly concentrated hedge fund, he returned over 50% annually for a decade. Incredibly impressive. In the book, Greenblatt devotes chapter 3 to spinoffs. In that chapter, this line caught my eye: There are plenty of reasons why a company might choose to unload or otherwise separate itself from the fortunes of the business to be spun off. There is really one reason to pay attention when they do: you can make a pile of money investing in spinoffs. The facts are overwhelming. Stocks of spinoff companies, and even shares of the parent companies that do the spinning off, significantly and consistently outperform the market averages . Now this book was written in 1997. Since then, many a hedge fund manager has read the book and the “spinoff anomaly” is relatively well known. You would think that this inefficiency in the market would fade with time as more investors look to exploit it. As such, I wanted to review all studies that are available to see if spinoffs still do, in fact, outperform. Here is what I found: Here are the links to learn more about each study: Restructuring Through Spinoffs: The Stock Market Evidence J.P Morgan Research Report Corporate Spinoffs Beat The Market Credit Suisse: Do Spinoffs Create or Destroy Value The Stock Price Performance of Spinoff Subsidiaries, Their Parents, and the Spinoff ETF Global Spinoffs & The Hidden Value of Corporate Change In short, the answer is “Yes, spinoffs still outperform.” If you want to invest in spinoffs, consider investing in the Guggenheim Spinoff Index (NYSE: CSD ). But if you would prefer to pick your own spinoffs, stay tuned. I will be publishing a series of articles on the stock spinoff market and how to pick the winners. If you would like to read them, follow me on Seeking Alpha and you will be notified when I publish new research. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Are You Trying Too Hard To Beat The Market?

In 1981, in front of a packed lecture hall in Rockford College, Illinois, Dean Williams presented what turned out to be a prophetic talk. Unless you’ve lived under a rock for the past 20 years, you’ve undoubtedly been exposed to one of the most liberating investment philosophies of the past half-century. Going back at least as far as the Dean of Wall Street himself, Benjamin Graham , investors have been told to dig deeply into a company’s financials, it’s operating history, and its record of corporate governance to assess whether a stock would prove to be a good purchase or not. Investors who came after Graham widened the circle of study to include items such as competitive position, product quality, and the dreaded “scuttlebutt,” talking to suppliers and employees to get the inside scoop. The work needed to do a “proper” analysis on a company grew remarkably in size while individual investor returns didn’t. A select group of investors have taken a different approach to their investment projects, however. Rather than plunge neck deep into analysis, they prefer to take a drastically simplified view of their investment choices. Rather than thorough qualitative research, they prefer to leverage statistical anomalies based on simple yet highly profitable financial ratios. These investors have come to be known as Quants. When investment manager Dean Williams gave his talk, the legendary investor David Dreman was still in the infancy of his career. Only a handful of professions, such as John Templeton, Irving Kahn, or the legendary Walter Schloss , came close to falling into the quant category… and they were far from household names. Only as more investors adopted a quantitative strategy was it clear just how valuable Williams’ advice was. Williams’ idea was decisively simple, “We probably are trying to hard at what we do. More than that, no matter how hard we try, we may not be as important to the results as we’d like to think we are.” The thought that an investor could actually try too hard to beat the market is still seen skeptically. Beating the market is hard. Every day we face a tsunami of competition from pros and private investors alike trying to beat us out in what is commonly seen as a zero-sum game. But Williams had good reason to take the position he did. It all started with Isaac Newton. “The foundation of Newtonian physics was that physical events are governed by physical laws. Laws that we could understand rationally. And if we learned enough about those laws, we could extend our knowledge and influence over our environment. That was also the foundation of the security analysis, technical analysis, economic theory, and forecasting methods you and I learned about…” But, as Williams explained, security analysis, like Newtonian physics, proved to be misguided. “In the last fifty years a new physics came along. Quantum, or sub-atomic physics…….. events just didn’t seem subject to rational behavior or prediction……… What I have to tell you tonight is that the investment world I think I know anything about is a lot more like quantum physics than it is like Newtonian physics. There’s just too much evidence that our knowledge of what governs financial and economic events isn’t nearly what we thought it would be.” When added to Williams’ second observation, the combination proves devastating for modern investors. “The second idea …is that most of us spend a lot of our time doing something that human beings just don’t do very well. Predicting things. ……where’s the evidence that it works? I’ve been looking for it. Really. Here are my conclusions: Confidence in a forecast rises with the amount of information that goes into it. But the accuracy of the forecast stays the same. And when it comes to forecasting – as opposed to doing something – a lot of expertise is no better than a little expertise.” The idea that more information does not necessarily make for better predictions drives a stake through the heart of most investment analysis. Consider the mistaken modern day Buffetteers who are basing their investment strategies on discounted cash flow valuations or copper traders that use information from a wealth of different sources to form their purchase decisions. More information does not necessarily mean better judgments. But, investors shouldn’t be so pessimistic about this state of affairs, according to Williams. Instead, investors should see it as liberating. “The consolation prize is pretty consoling, actually. It’s that you can be a successful investor without being a perpetual forecaster.” So how, then, is an investor expected to profit in the stock market? Again, Williams’ thoughts are decidedly simple. “If there is a reliable and helpful principle at work in our markets, my choice would be the one the statisticians call “regression to the mean”. The tendency toward average profitability is a fundamental, if now the fundamental principle of competitive markets. It’s an inevitable force, pushing those profits and their valuations back to the average. It can be a powerful investment tool. It can, almost by itself, select cheap portfolios and avoid expensive ones.” But leveraging investment returns still involves an investment strategy, and an investment strategy still requires human interaction and judgment on some level. Humans, when it comes down to it, are the ones that ultimately still decide which stocks to buy and sell. How are we supposed to invest in Dean Williams’ world? “Simple approaches. Albert Einstein said that “…most of the fundamental ideas of science are essentially simple and may, as a rule, be expressed in a language comprehensible to everyone”. ………as long as there are people out there who can beat us using dart boards, I urge us all to respect the virtues of a simple investment plan.” This is exactly the approach that I’ve taken to invest my own savings. Ultimately, selecting high quality net net stocks is not rocket science. It comes down to selecting stocks that show simple, yet promising, characteristics. Finding these companies does not require hours of time spent talking to suppliers or reading industry profiles. It really comes down to basing your investment decisions off of a few simple balance sheet and income statement calculations. But, while simplicity is a virtue, it’s not enough to guarantee great returns. Another key characteristic comes into play when building a great track. Williams continues, “Consistent approaches. Look at the best funds for the past ten years or more. …What did they have in common? ………it was that whatever their investment plans were, they had the discipline and good sense to carry them out consistently.” In my experience, nothing destroys an investor’s best chance for outstanding returns over the course of his life like the inability to commit. It’s the failure to stick to a promising strategy due to the inability to stomach short term variance or just the tendency to drift between styles that really sabotages an investor. As I’ve written to those who’ve requested free high quality net net stock picks , sticking with a great strategy is far more important than being the most knowledgeable investor. According to Williams, all of this suggests that investors should be approaching their work from a different orientation. “How are most of us organized? To gather information and use it to make predictions. ……..For all of this to make any sense, we all have to believe we can generate information which is unknown to the market as a whole. There’s an approach which is simpler and probably stands a better chance of working. Spend your time measuring value instead of generating information. Don’t forecast. Buy what’s cheap today.” Talk about liberating! Williams wasn’t kidding. In fact, this has been my approach since adopting Graham’s famous net net stocks strategy. Picking high quality international net nets and leveraging the great statistical returns associated with them has proven to be a much more profitable , and much less strenuous, approach to investing. But there’s another aspect of this type of investing that I didn’t grasp at first. The longer I invested in net nets, however, the more clearly this came into focus. Williams explains, “Like those who study quantum physics, we should be more content with probabilities and admit that we really know very little.” So, how can we leverage these probabilities to earn good returns? He continues, “…if you’re going to manage money mechanically, a good rule is: Buy the stocks with the lowest multiples. Imagine two portfolios. One has stocks we all agree are the “best” companies, with the best prospects for growth. And they’re priced that way. To justify those prices they all have to meet our expectations. But we know that some of them won’t. They’ll disappoint us. The other portfolio has all the companies we don’t like or don’t care about. They’re priced on low expectations. But we know that some of them will surprise us and do well. And since we haven’t paid for the expectation that any will do well, that’s the portfolio with the odds in its favor.” Admitting how little we actually know about the future is a fundamental aspect of good investing. Rather than destroying our chances of earning great returns, admitting our own fallibility sets us up for a different sort of investing – buying a diversified list of stocks with the odds of good returns, as a group, in our favour. Arriving at that group of stocks involves ignoring market, industry, or company forecasts and basing our decisions on hard facts. Those hard facts come down to assessing the firm’s financial position, its current valuation, and the returns on offer from a proven investment strategy. This is essentially the approach I’ve taken for my own portfolio. Proper investing involves getting ‘Meta’. Why would you be content to drift between styles, at worst embracing a haphazard approach to investing or at best using a strategy that’s not optimal for your time, effort, and finances? You really have to take a step back from looking at stocks to assess what it is you’re actually doing as an investor. For me, that amounted to researching many different investing styles before arriving at Graham’s net nets . Probabilities are an interesting thing. You can be right on each one of your picks without all of them working out. After all, you’re not right in the stock market merely because your stock has gone up; and, you’re not necessarily wrong if it hasn’t. Leveraging probabilities means putting together a portfolio of stocks that, as a group, has a better chance than not of working out. It also means recognizing that some of your stocks will disappoint and your portfolio won’t work out each and every year. Williams continues, “The last of the mental qualities we talked about was consistency …and how it seemed to be present in nearly all outstanding investment records. You’re familiar with the periodic rankings of past investment results published in Pensions & Investment Age. You may have missed the news that for the last 10 years the best investment record in the country belonged to the Citizens Bank and Trust Company of Chillicothe, Missouri. Forbes magazine did not miss it, though, and sent a reporter to Chillicothe to find the genius responsible for it. He found a 72 year old man named Edgerton Welch, who said he’d never heard of Benjamin Graham and didn’t have any idea what modern portfolio theory was. “Well, how did you do it,” the reporter wanted to know. Mr. Welch showed the reporter his copy of Value Line and said he brought all the stocks ranked “1” that Merrill Lynch or E.F. Hutton also liked. And when any one of the three changed their ratings, he sold. Mr. Welch said, “It’s like owning a computer. When you get the printout, use the figures to make a decision – not your own impulse.” The Forbes reporter finally concluded, “His secret isn’t the system but his own consistency.” Exactly. That’s what Garfield Drew, the market writer, meant forty years ago when he said, “In fact, simplicity or singleness of approach is a greatly underestimated factor of market success.” And that’s really what it comes down to. Unlike those who have fallen into the Warren Buffett trap , spend time finding a proven strategy that’s simple to use in practice and then stick to it. Doing so will mean shifting your chance of earning great investment returns over the course of your life so that the odds are in your favour. So really, are you trying too hard? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.