You think the market has risen too far too fast and is due a pullback.
The conundrum.
How and when do you decide to get back in?
The Psychological Challenge
The market starts breaking a little. Hope rises. It is moving your direction. You don't want to jump in too soon. After all you have been short and patiently waiting for this for quite a while. You don't want to waste those missed opportunities (now sunk opportunity cost) by blowing your powder too soon and seeing it pan out in the fashion you envisioned all along. On the other hand, you have been in this position before on the run-up, failed to cover or buy the dip, and seen it tear off again, only to have to chase (or worse fight a losing cause).
There is no good answer to the question. Doing your due diligence. Setting price levels and being disciplined. Having a system, a process, and a philosophy. You're not going to win them all. But you do want to have a system or process in place where you put the odds on your side when you go to bat.
Friday, May 24, 2013
Monday, May 20, 2013
Playing With Fire
Central banks of the world really are playing with fire. Their margin for error is much reduced. Their capacity to expand their balance sheets is now more limited. All of which means their options are diminished.
What they really risk is the markets confidence in their ability to manage the process evaporating. If that were to happen, then all bets are off.
Japan looks to be the poster child for so much. First for the demographic shift the developing world will be experiencing over the next 20-40 years, but more presciently for how the market and economy respond to unlimited QE.
Short term, the effects of QE, whether in the US, Europe or Japan, have been impressive - at least from a market perspective. Each successive policy implementation followed by a surging market response only reinforces the belief that you "don't fight the Fed." And it doesn't hurt that there appears to be some causative correlation with economic improvement. In this environment it is easy to be lulled into a simplistic notion of cause & effect which misreads the visible immediate causes against the less visible long term effects. Beware. The longer term effects are still to be tallied.
What they really risk is the markets confidence in their ability to manage the process evaporating. If that were to happen, then all bets are off.
Japan looks to be the poster child for so much. First for the demographic shift the developing world will be experiencing over the next 20-40 years, but more presciently for how the market and economy respond to unlimited QE.
Short term, the effects of QE, whether in the US, Europe or Japan, have been impressive - at least from a market perspective. Each successive policy implementation followed by a surging market response only reinforces the belief that you "don't fight the Fed." And it doesn't hurt that there appears to be some causative correlation with economic improvement. In this environment it is easy to be lulled into a simplistic notion of cause & effect which misreads the visible immediate causes against the less visible long term effects. Beware. The longer term effects are still to be tallied.
Thursday, May 16, 2013
Market Due A Pullback
The market is due a pullback. The odds are in my favor. I know that. x number of up days in a row. x number of days without a 5% pullback. But just because I know the odds are in my favor, doesn't make it any easier to sit on losing positions and watch them drain away.
The market is up 16% YTD. 21% in the last six months. The move has been relentless. 7% in just the last month. There has been little to no respite. A couple of minor pullbacks here and there. Other than that, it has been a tidal surge.
The move is flushing the bears and the laggards out. I feel it. I can feel the sentiment changing. I feel better about the future. I see things differently from what I saw them before. I can see the justifications for valuation levels, expanding multiples and all sundry of related thoughts that go hand in hand with this kind of move. Don't fight the Fed (or is it ABE and don't fight the trends/momentum). I have some short positions on that are getting pretty painful. I shorted for the wrong reason (valuation) and they are names leading the charge. I have gone against this thing for the last couple of months - selling into it, putting on shorts and directionally speccing on market puts. I know that you need to manage your risks. I know there are times to cut and run, take the loss, live to fight another day.
But I have been here before. I felt those same feelings, and I have not held to my conviction or had the patience to hang tough. I have spat the dummy and watched as I missed out on the rewards that were there waiting for me. Not this time. I am going to go with my conviction. I am going to have the fortitude to go against the flow. But I am also going to put in some stops that will minimize the damage should it continue to go against me.
The market is up 16% YTD. 21% in the last six months. The move has been relentless. 7% in just the last month. There has been little to no respite. A couple of minor pullbacks here and there. Other than that, it has been a tidal surge.
The move is flushing the bears and the laggards out. I feel it. I can feel the sentiment changing. I feel better about the future. I see things differently from what I saw them before. I can see the justifications for valuation levels, expanding multiples and all sundry of related thoughts that go hand in hand with this kind of move. Don't fight the Fed (or is it ABE and don't fight the trends/momentum). I have some short positions on that are getting pretty painful. I shorted for the wrong reason (valuation) and they are names leading the charge. I have gone against this thing for the last couple of months - selling into it, putting on shorts and directionally speccing on market puts. I know that you need to manage your risks. I know there are times to cut and run, take the loss, live to fight another day.
But I have been here before. I felt those same feelings, and I have not held to my conviction or had the patience to hang tough. I have spat the dummy and watched as I missed out on the rewards that were there waiting for me. Not this time. I am going to go with my conviction. I am going to have the fortitude to go against the flow. But I am also going to put in some stops that will minimize the damage should it continue to go against me.
Don't Be Fooled By The Present
A good rule of thumb when modeling firms and valuing equities is not to be fooled by the present. Normalizing growth rates, margins and discount rates attempts to estimate the value of a firm over a cycle.
Here is the problem.
In accord with financial theory, market practitioners are using the 10 yr Treasury bond (or even the 5 yr) as the risk free proxy in their DCF models. When you extrapolate linear topline growth based on the recent past (ie. the recovery out of the pit) throw in a little margin expansion (a lot actually because they are universally optimistic) and then discount the future expected cash flows at basically 1% or 2%, then a lot stocks are going to look awfully attractive. And that is where we are at right now. That is what QE does. It distorts the lens through which value is assessed.
I model with a normalized risk free rate of 5% (that assumes a real return of 3% and 2% inflation). The result is drastically different from the current consensus.
If and when the economy and markets normalize (and I think they are well on their way to doing that now) and analysts start putting higher risk free rates into their weighted average cost of capital calculations, then you are going to see large headwinds for valuations (ie. target prices). That doesn't even take into account the cost of rising interest rates on the actual cash flows of a business funding off shorter term debt.
It has been a free ride for a while, but you want to get off that train before it jumps the tracks. With the Fed on hold until at least 2014 and maybe into 2015 (depending upon economic activity and the level of unemployment), then it might still be a while before that transition takes place. Having said that, the market will in all likelihood anticipate the future rise of rates and begin factoring it into models before we see the actual change.
Here is the problem.
In accord with financial theory, market practitioners are using the 10 yr Treasury bond (or even the 5 yr) as the risk free proxy in their DCF models. When you extrapolate linear topline growth based on the recent past (ie. the recovery out of the pit) throw in a little margin expansion (a lot actually because they are universally optimistic) and then discount the future expected cash flows at basically 1% or 2%, then a lot stocks are going to look awfully attractive. And that is where we are at right now. That is what QE does. It distorts the lens through which value is assessed.
I model with a normalized risk free rate of 5% (that assumes a real return of 3% and 2% inflation). The result is drastically different from the current consensus.
If and when the economy and markets normalize (and I think they are well on their way to doing that now) and analysts start putting higher risk free rates into their weighted average cost of capital calculations, then you are going to see large headwinds for valuations (ie. target prices). That doesn't even take into account the cost of rising interest rates on the actual cash flows of a business funding off shorter term debt.
It has been a free ride for a while, but you want to get off that train before it jumps the tracks. With the Fed on hold until at least 2014 and maybe into 2015 (depending upon economic activity and the level of unemployment), then it might still be a while before that transition takes place. Having said that, the market will in all likelihood anticipate the future rise of rates and begin factoring it into models before we see the actual change.
Wednesday, May 15, 2013
The Crucifixion
One thing at least can be said with certainty about the Crucifixion of Christ; it was manifestly the most famous death in history.
The crucifixion portrays the defeat of goodness by duplicity and power; a meek and broken victim of the kind of human brutality to which we, perhaps more than most generations of men, have had to accustom ourselves.
However unlikely anything of the kind would have seemed at the time! Who among the motley collection of spectators of so obscure an event could possibly have envisaged that there before their eyes another civilization was being born which would last for two thousand years, shining so long and so brightly.
I quite agree that we of the twentieth century are perfectly capable of believing other things intrinsically as improbably as Christ's incarnation. Towards any kind of scientific mumbo-jumbo we display credulity which must be the envy of African witch doctors. I suppose every age has its own particular fantasy. Ours is science. A 17th century man like Pascal, though himself a mathematician and scientist of genius, found it quite ridiculous that anyone should suppose that rational processes could lead to any ultimate conclusions about life, but easily accepted the authority of the Scriptures. With us it is the other way around.
What then does the crucifixion signify in an age like ours? I see it in the first place as a sublime mockery of all earthly authority and power. The crown of thorns, the purple robe, the ironical title "King of the Jews" were intended to mock or parody Christ's pretensions to be the Messiah; in fact, they rather hold up to ridicule and contempt all crowns, all robes, all kings that ever were. It was a sick joke that back-fired. No one it seems to me, who has fully grasped the crucifixion can ever again take seriously any expression or instrument of worldly power, however venerable, glittering or seemingly formidable.
What I often ask myself was the Golgotha happening actually like. Clearly in no wise as momentous in the eyes of those who witnessed it as the retrospective attention lavished upon it would seem to imply. Upon history at the time it made absolutely no impact.
In some vague way they expect something to happen, and so it does; the man expires, not with a gesture of defiance befitting a putative King of the Jews, but with a cry of despair. With that cry Christendom comes to pass. We are henceforth to worship defeat, not victory; failure, not success; surrender, not defiance; deprivation, not satiety; weakness, not strength. We are to lose our lives in order to keep them; to die in order to live.
It is true of course that professing Christians and ostensibly Christian societies and institutions have by no means been true to the cross and what it signified, especially today when the nominally Christian part of the world is foremost in worship of the GDP - our Golden Calf - and in pursuit of happiness in the guise of sensual pleasure. Yet there the cross still is, propounding its unmistakable denunciation of this world and of the things of this world.
There had to be a sequel; I quite see that. The man on the cross who has given up the ghost must rise from the dead as a living God; the Resurrection followed the Crucifixion as inevitably as day follows night. And, indeed, in a sense it clearly happened. Otherwise, how should I, a 20th century nihilist, who asks nothing better than to live out his days without any concern for a God, living or dead, be worrying his head about this cross and a man who died on it two thousand years ago? Whether it happened as described in the Gospel narrative, and endlessly repeated by Christian apologists, is another question. In any case, what does it matter?
The crucifixion portrays the defeat of goodness by duplicity and power; a meek and broken victim of the kind of human brutality to which we, perhaps more than most generations of men, have had to accustom ourselves.
However unlikely anything of the kind would have seemed at the time! Who among the motley collection of spectators of so obscure an event could possibly have envisaged that there before their eyes another civilization was being born which would last for two thousand years, shining so long and so brightly.
I quite agree that we of the twentieth century are perfectly capable of believing other things intrinsically as improbably as Christ's incarnation. Towards any kind of scientific mumbo-jumbo we display credulity which must be the envy of African witch doctors. I suppose every age has its own particular fantasy. Ours is science. A 17th century man like Pascal, though himself a mathematician and scientist of genius, found it quite ridiculous that anyone should suppose that rational processes could lead to any ultimate conclusions about life, but easily accepted the authority of the Scriptures. With us it is the other way around.
What then does the crucifixion signify in an age like ours? I see it in the first place as a sublime mockery of all earthly authority and power. The crown of thorns, the purple robe, the ironical title "King of the Jews" were intended to mock or parody Christ's pretensions to be the Messiah; in fact, they rather hold up to ridicule and contempt all crowns, all robes, all kings that ever were. It was a sick joke that back-fired. No one it seems to me, who has fully grasped the crucifixion can ever again take seriously any expression or instrument of worldly power, however venerable, glittering or seemingly formidable.
What I often ask myself was the Golgotha happening actually like. Clearly in no wise as momentous in the eyes of those who witnessed it as the retrospective attention lavished upon it would seem to imply. Upon history at the time it made absolutely no impact.
In some vague way they expect something to happen, and so it does; the man expires, not with a gesture of defiance befitting a putative King of the Jews, but with a cry of despair. With that cry Christendom comes to pass. We are henceforth to worship defeat, not victory; failure, not success; surrender, not defiance; deprivation, not satiety; weakness, not strength. We are to lose our lives in order to keep them; to die in order to live.
It is true of course that professing Christians and ostensibly Christian societies and institutions have by no means been true to the cross and what it signified, especially today when the nominally Christian part of the world is foremost in worship of the GDP - our Golden Calf - and in pursuit of happiness in the guise of sensual pleasure. Yet there the cross still is, propounding its unmistakable denunciation of this world and of the things of this world.
There had to be a sequel; I quite see that. The man on the cross who has given up the ghost must rise from the dead as a living God; the Resurrection followed the Crucifixion as inevitably as day follows night. And, indeed, in a sense it clearly happened. Otherwise, how should I, a 20th century nihilist, who asks nothing better than to live out his days without any concern for a God, living or dead, be worrying his head about this cross and a man who died on it two thousand years ago? Whether it happened as described in the Gospel narrative, and endlessly repeated by Christian apologists, is another question. In any case, what does it matter?
Is there a God? (contd)
Another defence against God has been utopianism, and the revolutionary fervor that goes therewith. A passion to change the world and make it nearer to the heart's desire automatically excludes God, who represents the principles of changelessness, and confronts each heart's desire with its own nullity. It was confidently believed that a kingdom of heaven on earth coudl be established, with "God, Keep Out" notices prominently displayed at the off-limits.
With the church no longer a sanctuary, and utopianism extinguished, the fugitive from God has nowhere to turn. Even if, as a last resort, he falls back on stupefying his senses with alcohol or drugs or sex, the relief is but short-lived.
There are no adequate words for any of the great absolutes, like life and death, good and evil; only for trivialities like politics and economics and science. One falls back on the meaningless monosyllable, God, Hindu sadhus in their spiritual exercises endlessly repeat the equally meaningless mononsyllable, Oom.
With the church no longer a sanctuary, and utopianism extinguished, the fugitive from God has nowhere to turn. Even if, as a last resort, he falls back on stupefying his senses with alcohol or drugs or sex, the relief is but short-lived.
There are no adequate words for any of the great absolutes, like life and death, good and evil; only for trivialities like politics and economics and science. One falls back on the meaningless monosyllable, God, Hindu sadhus in their spiritual exercises endlessly repeat the equally meaningless mononsyllable, Oom.
Is there a God?
Well, is there? I myself would be very happy to answer with an emphatic negative. Temperamentally, it would suit me well enough to settle for what this world offers, and to write off as wishful thinking, or just the self-importance of the human species, any notion of a divine purpose and a divinity to entertain and execute it. The earth's sounds and smells and colors are very sweet; human love brings golden hours; the mind at work earns delight. I have never wanted a God, or feared a God, or felt under any necessity to invent one. Unfortunately, I am driven to the conclusion that God wants me.
God takes a hand as history's compere, turning it into a soap opera, with ham actors, threadbare lines, tawdry props and faded costumes, and a plot which might have been written by Ted Willis himself. God arranges the lighting - Spark of Sparks - so that all the ravages of time, like parched skin, decaying teeth and rotting flesh, show through the makeup, however lavishly it may be plastered on. Under God's eye, tiny hoarded glories - a little fame, some money...Oh Mr M! how wonderful you are! - fall into dust. In the innermost recesses of vanity one is discovered, as in the last sanctuaries of appetite; on the highest hill of complacency, as in the lowest burrow of despair. One shivers as the divine beast of prey gets ready for the final spring; as the shadow lengthens, reducing to infinite triviality all mortal hopes and desires.
There is no escape. Even so, one twists and turns. Perhaps Nietzsche was right when he said that God had died. Progressive theologians with German names seem to think so: Time magazine turned over one of its precious covers to the notion. If God were dead, and eternity had stopped, what a blessed relief to one and all! Then we could set about making a happy world in our own way - happy in the woods like Mellors and his Lady Chatterley; happiness successfully pursued, along with life and liberty, in accordance with the Philadelphia specification; happy the Wilson way, with only one book to take to the post office - one book, one happiness; happy in the prospect of that great Red Apocalypse when the State has withered away, and the proleteriat reigns for ever more. If only God were D.H. Lawrence, or Franklin D. Roosevelt, or Harold Wilson, or Karl Marx!
Alas, dead or alive, he is still God, and eternity ticks on even though all the clocks have stopped.
One of the most effective defensive systems against God's incursions has hitherto been organized religion. The various churches have provided a refuge for fugitives from God - his voice drowned in the chanting, his smell lost in the incense, high purpose obscured and confused in creeds, dogmas, dissertations and other priestly pronunciamentos. In vast cathedrals, as in little conventicles, or just wrapped in Quaker silence, one could get away from God.
Unfortunately, this defensive system has now proved to be a Maginot Line, easily by-passed by hordes of happiness pursuers, some in clerical collars and even mitres, joyously bearing a cornucopia of affluence, and scattering along their way birth pills, purple hearts and other goodies - a mighty throng whose trampling feet clear a path as wide as a motorway, along which God can come storming in.
God takes a hand as history's compere, turning it into a soap opera, with ham actors, threadbare lines, tawdry props and faded costumes, and a plot which might have been written by Ted Willis himself. God arranges the lighting - Spark of Sparks - so that all the ravages of time, like parched skin, decaying teeth and rotting flesh, show through the makeup, however lavishly it may be plastered on. Under God's eye, tiny hoarded glories - a little fame, some money...Oh Mr M! how wonderful you are! - fall into dust. In the innermost recesses of vanity one is discovered, as in the last sanctuaries of appetite; on the highest hill of complacency, as in the lowest burrow of despair. One shivers as the divine beast of prey gets ready for the final spring; as the shadow lengthens, reducing to infinite triviality all mortal hopes and desires.
There is no escape. Even so, one twists and turns. Perhaps Nietzsche was right when he said that God had died. Progressive theologians with German names seem to think so: Time magazine turned over one of its precious covers to the notion. If God were dead, and eternity had stopped, what a blessed relief to one and all! Then we could set about making a happy world in our own way - happy in the woods like Mellors and his Lady Chatterley; happiness successfully pursued, along with life and liberty, in accordance with the Philadelphia specification; happy the Wilson way, with only one book to take to the post office - one book, one happiness; happy in the prospect of that great Red Apocalypse when the State has withered away, and the proleteriat reigns for ever more. If only God were D.H. Lawrence, or Franklin D. Roosevelt, or Harold Wilson, or Karl Marx!
Alas, dead or alive, he is still God, and eternity ticks on even though all the clocks have stopped.
One of the most effective defensive systems against God's incursions has hitherto been organized religion. The various churches have provided a refuge for fugitives from God - his voice drowned in the chanting, his smell lost in the incense, high purpose obscured and confused in creeds, dogmas, dissertations and other priestly pronunciamentos. In vast cathedrals, as in little conventicles, or just wrapped in Quaker silence, one could get away from God.
Unfortunately, this defensive system has now proved to be a Maginot Line, easily by-passed by hordes of happiness pursuers, some in clerical collars and even mitres, joyously bearing a cornucopia of affluence, and scattering along their way birth pills, purple hearts and other goodies - a mighty throng whose trampling feet clear a path as wide as a motorway, along which God can come storming in.
Friday, May 10, 2013
When Contrarianism Can Hurt You
Contrarianism when things are falling is a slightly safer bet than contrarianism when things are rising.
In both cases, you are following the go against the herd dictate - "buy when they are selling and sell when they are buying."
However if you stick your toe in the water at -10% and it goes to -20%, then to -30%, then that is very painful. But at least there is a floor somewhere, and if history is any guide, the market will eventually recover and sometimes will do so in spectacular fashion. So you are better off sucking it up, waiting for the turn and then letting it flow.
Conversely, when the market is moving up and you dip your toe in to sell, it can be incredibly painful watching it go up another 10%, 20%, 30%, because you have no way to recoup that lost opportunity cost and you have no idea how much further it might rise. Even if you know there is a short term limit, you don't know where it is and you can't be assured you'll be able to get your timing right when the dip comes.
In both cases, you are following the go against the herd dictate - "buy when they are selling and sell when they are buying."
However if you stick your toe in the water at -10% and it goes to -20%, then to -30%, then that is very painful. But at least there is a floor somewhere, and if history is any guide, the market will eventually recover and sometimes will do so in spectacular fashion. So you are better off sucking it up, waiting for the turn and then letting it flow.
Conversely, when the market is moving up and you dip your toe in to sell, it can be incredibly painful watching it go up another 10%, 20%, 30%, because you have no way to recoup that lost opportunity cost and you have no idea how much further it might rise. Even if you know there is a short term limit, you don't know where it is and you can't be assured you'll be able to get your timing right when the dip comes.
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