Tag Archives: investment

6 Weekly Sentiment Charts – SPY Plunging With Deteriorating Sentiment

Summary The time to buy stocks is when there is “blood in the streets”. In late August through early September, my sentiment charts were screaming BUY. Charts 1a & 1b suggest we had a major market low. The Market & Sentiment Recovered. SPY is plunging today following deteriorating sentiment. The time to buy stocks is when there is “blood in the streets” when others are fearful and selling. In late August through early September, my investor sentiment charts were screaming BUY and I added to many positions during this time. Since then, investor sentiment recovered quickly and I took some profits. Now I wait for extreme levels to buy back or take more profits. Every week I review my sentiment charts of the weekly data. In this article, I compare the sentiment levels from various surveys in my table to get an idea of overall investor sentiment. After making his fortune buying during the panic that after Napoleon’s Battle of Waterloo, 18th century British nobleman and member of the Rothschild banking family, Baron Nathan Rothschild, is often credited for telling his clients that “The time to buy is when there’s blood in the streets.” (See ” When There’s Blood In The Streets “) I’ve explained in past articles such as ” SPY 8% Off Record High While WLI Rises To 6-Week High ” why I like SPY as an investment for the long-term. I use fundamentals to pick individual stocks and SPY for my portfolio, but I seldom buy as they are making new 52-week highs. I try to buy when they are on sale and when the blood is running in the streets. To get better prices, I start with my list of “Explore Portfolio” stock picks then wait for market pullbacks and extreme negative sentiment levels to buy if they haven’t quite reached the “low ball” prices I set ahead of time to buy during market panics and other periods of market inefficiency. Said another way, I like to take profits as markets make new highs then buy back shares when my sentiment charts loudly shout at once “Buy” as most investors are afraid and selling. On August 25, 2015, when the S&P500 made its closing low for the year, most of my sentiment indicators were at screaming buy levels not seen since the 21% bear market correction in 2011. Below is a market summary for the closing prices showing four major indexes were down double digits from record highs. Some of the sentiment indicators I track are still improving and have yet to reach extreme levels. Others, like the ten day moving average of the put to call ratio. CPC-MA(10), shown below fell enough that along with the recent market recovery, I took some profits in my stocks. Now the CPC-MA(10) is rising which indicates the short-term path of least resistance for SPY is lower until this turns down again. The extent of the pullback from here is unknown but we get a large enough decline to buy back some of what I took profits in earlier, they I will be a buyer again. Chart 1a: Put-to-Call Ratio – 10 & 66 day moving averages – 10-Years : Chart courtesy of Stockcharts.com Chart shows the ten day moving average, MA(10), of the Put-to-Call ratio was above its 1.25 peak value at the bottom of the 2011 mini bear market correction. (click to enlarge) If you have other favorite sentiment indicators you want tracked in my table, then let me know in the comments and I will consider adding them to future articles. What follows are the charts and brief explanations for the measures of sentiment I follow, in no particular order of importance. Chart 1b: Put-to-Call Ratio – 10 day moving average – 3-Years chart courtesy of Stockcharts.com (click to enlarge) Chart 2: AAII American Association of Individual Investors Sentiment Survey Numbers posted weekly here on Seeking Alpha From AAII Sentiment Indicator , “The sentiment survey, taken once a week on the AAII web site, measures the percentage of individual investors who take the survey who are bullish, neutral and bearish.” (click to enlarge) Chart 3: II: Investor’s Intelligence Survey From Investors’ Intelligence Sentiment Indicator : The “Investors Intelligence Survey” or IIS questions stock-market newsletter writers once a week to see if they were bullish or bearish on the stock markets in the near-term. Newsletter writers have a large following as a group and are thus considered “market experts.” Investor’s Intelligence web site (click to enlarge) (click to enlarge) Chart 4: Ticker Sense Blogger Sentiment vs. S&P500 From Ticker Sense Blogger Sentiment Poll : “The Ticker Sense Blogger Sentiment Poll is a survey of the web’s most prominent investment bloggers, asking “What is your outlook on the S&P 500 for the next 30 days?” Conducted on a weekly basis, the poll is sent to participants each Thursday, and the results are released on Ticker Sense each Monday. The goal of this poll is to gain a consensus view on the market from the top investment bloggers — a community that continues to grow as a valued source of investment insight. © Copyright 2015 Ticker Sense Blogger Sentiment Poll.” (click to enlarge) Chart 5: NAAIM Exposure Index From NAAIM Exposure Index – National Association of Active Investment Managers, “The NAAIM Exposure Index represents the average exposure to US Equity markets reported by our members.” Screenshot courtesy of NAAIM Chart 6: CNN Money Fear & Greed Index The CNN Money Fear & Greed Index is derived from seven indicators explained here Screenshot courtesy of CNN (click to enlarge) Chart 7: SPY Charts Top (black) is SPY adjusted for dividends Middle (green) is SPY prices not adjusted for dividends Bottom (orange) is the yield of the S&P500 which closely matches the yield of SPY less the small management fee. (click to enlarge) From charting sentiment for nearly 20 years, I’ve observed that major market (S&P500 or SPY) bottoms usually line up well with major spikes in the sentiment charts. The absolute levels are not as important as the relative levels of sentiment. For example, notice how the two biggest declines in SPY since the bottom in 2009 align with the two largest spikes in charts 1a and 1b above. Notes I trade SPY around a core position in my newsletter’s ” Explore Portfolio ” and with my personal account. With dividends reinvested, my explore portfolio holds 137.889 shares of SPY with a “break-even” price, after the 10/30/15 dividend, of $98.83. I also have the index fund version of SPY in both my newsletter’s “core” portfolios. SPY is the exchange traded fund for the S&P 500 Index. VTI is Vanguard’s “Total Stock Market” exchange traded fund. If you want to invest in a single fund, that is my first choice over SPY. I recommend SPY and several others in my core portfolios for more opportunities to rebalance. VOO is Vanguard’s new exchange traded fund that tracks the S&P 500 Index. It is a lower cost alternative to SPY. I own and write about SPY, as I have many years of data for it, but VOO could do slightly better than SPY over time because it has a lower expense ratio. Disclosure : I am long SPY and own the traditional index fund versions of VTI and VOO bought long ago in various taxable and tax deferred accounts. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Concentration: The Age-Old Question

Summary I’ve made the case for concentration before, and while I still advocate concentration, my original “time” argument was misplaced because of diminishing marginal returns on time. Concentration is largely a function of risk tolerance, which makes it far easier to find an appropriate level for an individual investor than it is for a professional. There is a lot of value in thinking about position sizing in terms of “starter” and “core” positions. Concentration is a subject I’ve written on before. In one of my first SA articles , I made the radical argument for a form of hyper-concentrated investing termed “Focus Investing” whereby one holds 3-10 positions… or even just one. Concentration is still a topic I give an inordinate amount of thought too and I wanted to share some of those thoughts here. This post also follows my first post on stock screening in a series communicating my investment process and philosophy. On Time My thoughts on position sizing have definitely evolved since my first article, and in hindsight, some of my arguments, while nice in theory, don’t hold in reality and my use of them demonstrated my inexperience as an investor. For example: Time The responsible investor follows each and every one of his holdings. It takes a constant amount of time per week to stay up on a company. I would advise at least an hour per week. Again this time is constant, whether that company makes up 2% of your portfolio or 100%… He could own 10 companies and still diligently follow them, but he’d have to devote ten hours instead of one. But wait, if he was willing to devote 10 hours total to stock market research when he held 10 companies, why not spend the same time researching, but while only holding one company? He could spend 5 hours per week keeping up on Apple and another 5 researching potential investments, comparing them against Apple, only considering them if they seemed much more attractive. My argument that investments require a constant amount of time and that 50% of an investor’s research time spent on a single investment is a good strategy ignores one very important principle: diminishing marginal returns or, more practically, the 80/20 rule. See one of my favorite Seeking Alpha articles , which discusses this subject, before continuing. The first hour of research yields more information and more valuable information than the 100th hour. The other problem with the time argument is sunk costs. We all know that a sunk cost should not influence decisions, but that they often do and, sadly, this is true even for decisions that we (the same people who are aware of the phenomenon) make. When you spend weeks researching a company and preparing an extensive, tidy investment thesis and article on the stock, it’s just harder not to take a position, independent of the actual prospects of the investment. While my time argument was somewhat off the mark (though it does hold in extreme cases; time is a serious problem for an actively managed portfolio of hundreds of stocks), I’ve still been a proponent of concentration, to a lesser extent, recently. Professional Constraints Concentration is largely a function of risk tolerance. This is not that meaningful if you are only managing your own money. All it means is that you must discover your risk tolerance and volatility tolerance and find a commensurate concentration level. Thing get tricky, however, when you are managing money for others. Introducing clients means more than one brain and in turn, risk tolerance is involved. What is the appropriate level now? If you are a manager like me with one strategy and one portfolio, then you should stick to the concentration level that you think is best for total returns, but I don’t think the story ends there. There needs to be some consideration that you are a professional and are managing other people’s money. There is a higher standard. This is one good reason to find like-minded clients. If you can withstand volatility, are long-term oriented, and are okay with concentration, look for clients with the same approach. Good luck- they’re rare! My other insight is that adopting a concentrated strategy as a new manager is tough because it requires credibility, to some extent, to be very concentrated. The base rate in investing is market returns and those are derived from a market portfolio, which is very diversified (500 stocks if we assume S&P 500 = market). Naturally, the more concentrated your portfolio gets, the more different it gets from the market and the further from the base rate its returns. You are going further out on a limb. It’s tough to do that with no professional track record. The logical next step is that if you’re a new manager you should be very diversified, but that’s a dangerous path I don’t want to take because it eliminates my positive optionality of earning extremely good returns and I’m in the investing industry for more than just money. Intellectual stimulation and an interesting, meaningful career is the most important thing I seek and the use of money as a means of keeping score and creating value is a big part of the financial aspect. In short, if I’m to succeed, I want to do so on my own terms and that rules out heavy diversification. If that means a slower ramp for my firm, so be it. “Starter” and “Core” I’m at a point now where my view on concentration is somewhat nuanced. Because I employ both deep research and empirical, systematic methods in my portfolio, not all positions will be sized equally – far from it. Right now, I have some positions that are 15-20% of my portfolio and some that are less than 1%. I think this dual concept of “starter” and “core” positions has been very helpful and is worth discussing. For me a starter position is 1% and a core position is much more than that, but the numbers don’t matter as much as the way of thinking about position sizing it represents. A starter position represents something that should, based on empirical evidence, outperform. That is a firm requirement. I talked about this extensively in a previous post . A starter position is also something I’ve done some research on, find interesting, and can model a good expected return with little to no downside on in an adverse case. But for some reason, it’s not fit to be a core position yet. The most common reasons are: I’m not sure I understand it, i.e. it may not be within my circle of competence The expected return I model is not high enough to exceed my absolute return hurdle, i.e. it’s not quite juicy enough I’ve not done enough research or thinking yet, i.e. I need more time Starter positions are crucial to my investment process because they allow me to slow down. Doing research needs to be a treasure hunt for me. I’m only interested in learning about companies when there is the possibility of it being in my portfolio and making me and my clients money. During the research process, it’s so tempting to act on research and invest. It’s hard to delay gratification. The problem is that good long-term investment decisions are made slowly. Gratification must be delayed. However, I’ve found that taking a small starter position up front helps to hold me over. Of course, I don’t do this for everything I research, but obviously far more than I end up taking core positions in as the chart above shows. It also provides an extra incentive to continue to dig deeper in the research. As Tom Gaynor says : When I buy some of something, I’m buying a library card. One of the reasons I buy some of something is to make myself think more deeply about it, read the reports and be more aware of it. It’s hard to overstate the positive impact starter positions have had for me. Not only have they performed well in aggregate, which is how I look at their performance, but they’ve rejuvenated me as an analyst. There was a rough patch where I only published four articles and made four investment decisions, not all of which were good ones, over a period of almost 8 months. (click to enlarge) I researched more than just four companies over this period, but not at as high a rate as I am now and not as effectively. The lack of gratification in the research process demotivated me. There’s no rule saying research needs to be fun for you to be a good investor, but for me I think it does need to be or I won’t find anything to invest in. It needs to be a treasure hunt and starter positions help a lot on that front. At the same time, when my research does, on rare occasions, generate what I think is a really good idea, I’m not going to only put 1% in it. There are times when the level of conviction and opportunity costs make anything but a big position a bad decision and that is when I am willing to take a core position. That is where concentration is needed. And in aggregate, you still end up with a pretty concentrated portfolio. More than half of my portfolio is in 6 stocks despite the large cash position. So I still advocate concentration, but clearly have a more nuanced view now and recognize that position sizing is a far more difficult issue than I initially had thought.

DMO Is The Best Of The Mortgage Bond Funds And It’s Bargain Priced

Summary DMO is a mortgage bond CEF that outclasses its competition and is well priced after a rough few months. I liked DMO in September. I like it more now. I liked DMO in September. I like it more today. When I last wrote about Western Asset Mortgage Defined Opp (NYSE: DMO ) I considered it to be the best of the mortgage-bond closed-end funds. It was selling at a small premium at the time, something I will generally avoid. But that premium was only 0.2%, so I decided to buy it anyway. It has been tracking down since, but that only makes me like it more. I’ve been watching it closely and am likely to add to my position before the end of the year. At the December 1 close, DMO had moved up smartly on the day (1.6%), but since that mid-September article, the fund is down -4.64% at market price and -2.55% at NAV. Why buy into a falling position? Let’s begin answering that question by having a look at how DMO compares to the entire fixed-income CEF category generally and mortgage-bond funds specifically. DMO vs. Its Categories This first chart shows total returns and distribution yields for DMO, along with median values for mortgage-bond CEFs (n=10) and all fixed-income CEFs (n=111). (click to enlarge) First thing to note here is that the past month and year have not been good to fixed-income CEFs across the board. This has been part of a broad trend for high-yield bonds. The large high-yield bond ETFs, iShares iBoxx $ High Yield Corporate Bond (NYSEARCA: HYG ) and SPDR Barclays High Yield Bond (NYSEARCA: JNK ), and the mortgage-bond ETF, iShares Mortgage Real Estate Capped ETF (NYSEARCA: REM ), are down comparable amounts. It doesn’t take intense scrutiny to see that DMO is beating its categories in all recent performance metrics. In the face of these numbers, I’m not terribly concerned about the dip since September. This is particularly evident if we turn our attention to NAV returns. Not that I like it, mind you, but I do not see it as cause for concern. Where everything else is negative, save REM’s meager 0.18% uptick for the past month, DMO’s NAV is solidly in the green. And NAV is what really counts in my view. But most of us look to a mortgage bond fund for income, not necessarily capital gains, right? DMO is yielding over 10% where the median mortgage-bond and fixed-income CEFs are paying 7.0% and 8.4%, respectively; and the high-yield bond ETFs are yielding near 6%. Only REM is paying more, but it is doing so with a consistent erosion of capital as we see in this price chart. (click to enlarge) Income investors will often give lip service to not caring about total return. If you’re investing in the likes of REM, I can see why you’d want to resort to that justification. You can, if you’re so inclined, look at REM in isolation in the total return chart and maybe feel okay about it. It has, after all, returned 35%, or would have done so had you been reinvesting dividends at no transaction costs. But look at that price chart above it. The 34% loss there is, in fact, a 34% loss of your capital if you invested in REM for current income five years ago. Sure, it’s been paying out a ton, but it’s been your own money in large measure, and you’ve had to pay taxes on it. If you had invested in DMO instead, you would have received 10% or so a year income plus your capital would have grown by 18%. Of course if you reinvested the distributions (again, assuming that magical chart-universe where there is no cost for doing so) you’d have more than three times what you would have had from the high-yield bonds or REM. So, as I said about UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ) in September, you can get a better yield than DMO, but with DMO you get to keep your money. I’ll not go into MORL again, other than to note that there are a substantial number of Seeking Alpha income-seekers who will sing its praises, praises that are completely unjustified in my opinion. A more complete look at MORL is on my to-do list, so if you’re interested in my take on it, it should be on your screen soon. I hope I’ve at least begun to convince you that DMO is an outstanding performer in the mortgage-bond space. If you need more, there are additional comparative historical performance data (in particular comparisons to the other mortgage bond CEFs and MORL) in the September article to assist in your due diligence. Why do I like it more as of December 1? Well, I did like it even better the day before, but even with the December 1 gain, DMO is much more attractively priced than it was in September when my only hesitation was that it was priced at that small premium coming off an uncharacteristic discounted period. At that time, I thought the trend would continue and the premium would continue to grow, so I felt it was as good an entry as the fund was going to present for a while. Wrong, obviously; it’s even better now. Premium/Discount Dynamics DMO has moved from a small premium to a decent discount, a move accompanied by that modest decrease in NAV (-2.6%). Distribution yield is up 60bps from mid-September as a consequence. While -1.87% is not a particularly deep discount in the CEF universe, it is, in my view, excellent for a fund of this quality. And the discount is moving in the right direction, according to the Z-scores. (click to enlarge) Where the mortgage-bond and fixed-income categories are, despite their lackluster performances, less discounted than their means (positive Z-scores) over the past 3 and 6 months, DMO is solidly in the other direction. The current discount is almost 1½ standard deviations more negative than the three-month mean. As I noted, one does not expect a fund of this quality to be running a deep discount, so that -1.87% looks pretty good to me right now. If you accept that it is a high-quality fund, and you consider Z-scores to at least suggest a direction for mean reversion, DOM looks good here. Distribution Sustainability Finally, a word about the sustainability of the distribution. This is always a consideration in fixed-income CEFs. Many high yielders maintain their yields by returning investor capital. This cannot continue indefinitely and, all too often, such funds will be forced into making drastic distribution cuts that lead to sharp price drops. One indicator of distribution sustainability is UNII, Undistributed Net Investment Income. DOM reported UNII of $0.62/share at the end of September. Its distribution is $0.21/share monthly, so there is little indication of a problem on that front. Summary I continue to like DMO and think it remains one of the best income opportunities. It has faltered lately, but less so than its peers. It is paying an attractive distribution. And there is no indication that the distribution payment is at risk as the fund is holding a quarter’s distributions worth of UNII. I realize that there is a lot of uncertainty and anxiety regarding a changing interest-rate environment, but I do not see a truly disruptive change on the near horizon. I do not anticipate anything like a devastating blow from a 25 to 75 bps raise from the Fed over the next year, which is what I consider as most likely scenario. My one caution is that it is best accommodated in a tax-deferred account because, as with any bond fund, the distributions are ordinary income and receive no favorable tax treatment.