Monday, September 19, 2011

Hula Hoops

For the past few years, the quant-shop style of stock-picking has been one cutest fads in investing. The general idea is that you base your buy and sell decisions on hard numbers, which supposedly 'takes the emotion out of investing'. A whole new website has been founded to make money from this idea - to make money for the site owners, that is, not investors - and this article is a recent example.

The article's author claims that he has run a value-oriented screen based on the "Graham Number" of a universe of stocks, the universe happening to be "stocks that are rallying above their 20-day, 50-day, and 200-day moving averages". He then compares the performance of his stocks over the past month with the S&P 500, and, lo and behold, his selections have outperformed the index. He would like us to think that this suggests that his supposedly value-based screening method might be worth looking at. Unfortunately, it suggests nothing of the sort. One could just as easily say that by selecting stocks which "are rallying above their 20-day, 50-day, and 200-day moving averages", the author has chosen a group of momentum stocks. Momentum stocks can indeed be expected to outperform over the very short term, because that is what "momentum" means. In other words, his experiment has not one independent variable, but two, and there is no way to un-confound their effects. In plain English, his test comparison says nothing about anything.

There are also a few other problems with this supposed value screen. The author tries to name-bash us from the very beginning by noting that "Benjamin Graham, the 'godfather of value investing' and one-time mentor of Warren Buffett, developed an equation to calculate the fair value of a stock, known as the “Graham Number.” (Notice the name Warren Buffett, which as far as I can tell has nothing to do with anything in the article.) Unfortunately, Ben Graham was also the man who said that value systems should help one pick stocks for the long term, when an undervalued stock should rise in price or otherwise produce a return reflecting a more 'correct' value. He didn't seem to be talking about a scale of one month. (Remember the voting machine and the weighing machine?)

But there's more. Graham's method is based on the assumption, among others, that a stock which you buy when it's undervalued is likely to rise in price, as the market notices the distortion and corrects it. That means it only makes sense to compare two values of a parameter - the value of the screen results, for example, with the value of the members of the S&P 500, if the difference really does represent a distortion, which one can hope will be corrected. Unfortunately, four of the eight stocks produced by the screen are utilities stocks, which have value parameters almost all of the time; therefore their low price should not be seen as a distortion, and there is no reason to expect the market to correct this distortion by raising the price. There is no reason even to assume that current price represents a low price for their income stream. The screen gives us essentially no information about them; it compares them with nothing relevant.

It's no wonder that money management and investing journalism are among those professions where a non-too-talented amateur usually does better than most of the professionals.

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Sunday, May 15, 2011

I'm beginning to wonder about Jim Jubak....

In fact, more than just beginning.

MSN was puffing him for years as "the most read investing columnist on the Web", and he was my favorite as well, both because of his clear, often self-deprecating style and his common-sense approach to the analysis of individual stocks and of economic trends. He also used to display quarterly an almost fudge-proof comparison of the returns on his model portfolio and the S&P 500. However, when I wrote this entry three days ago, the latest performance results posted on his blog were for the third quarter of 2010, and the results posted by the editors of MSN were and are "current through... September 28, 2007".

I was happy when Mr. Jubak became head of his own prefabricated mutual fund, mainly because I figured that its results would be trackable through the usual sources. The fund has existed (or been trackable, at least) for less than six months, but the results have been unimpressive. The results which he did discuss on the blog in the last year or so were also not overwhelming.

I don't have the resources to check out my guess, but it wouldn't surprise me if the "276%... return... on my Jubak’s Picks portfolio since its inception more than 13 years ago" consists mainly of a very high one-time return during the Internet bubble of the late Twentieth Century and losses smaller than those of the benchmarks in the one-time crash that followed it. In any case, the numbers are a little deceptive: It appears that my own portfolio which has existed since late 1998 would be similarly impressive if I were to calculate the returns on stocks alone, but in fact I was not holding a pure stock portfolio, and I don't think that Mr. Jubak was recommending to his readers that they hold only stocks.

For what it's worth, here are the numbers, though, comparing the performance of "Jubak's Picks" portfolio from May 17, 1997 to September 30, 2010 (from a page which used to be at but which seems to have been deleted today), with that reported by my own portfolio-tracking software for the securities marked "Investment Type - Stocks" from June, 1998 until three days ago.

 Jubak's Picks My Real-World Stocks 
 276% 262% 

Just to show that the methods of computation are comparable, within ballpark limits, his figures for the performance of the S&P 500 and mine - (Mine include dividend reinvestment; I don't know about his.) - are

 Jubak's S&P 500 My S&P 500 
 40% 43.9% 

What all of this seems to mean, within a ballpark range of accuracy, is that Mr. Jubak's impressive-sounding gain of 276% is not much better than the performance of a rank amateur's stock portfolio.

Even if I were to use the 314% number which he seems to have posted today, a comparison with the 54% number which he posted today for the S&P 500 suggests the same. As a matter of fact, if we use his new numbers, my results are a little better than his: His percentage gain equals 579% of the gain on the S&P 500 for the identical period, while mine equals 596% of the benchmark's gain for a period which overlapped his almost completely.

I still read Mr. Jubak's full-length articles more often than I read those of any other Internet source on investing. I just think that we all have to be careful about reading into the numbers more than what's really there.

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Monday, March 21, 2011

When will they ever learn?

I read history for fun. (Sounds like going to autopsies for fun, doesn't it?) Lately I've been struck by the fact that the repeating pattern of market bubble-and-crash which causes suffering for individuals and instability for governments and societies still repeats when looked at up close, in greater detail: There is a first phase in which enormous credit is extended to allow large numbers of borrowers who aren't really credit-worthy, and a second phase when the creditors press on the debtors to pay debts which they just don't have the money to pay. Since each insolvent debtor has several creditors who are themselves overextended debtors, the collapse turns into a chain reaction.

When I first read the late Roger Duchêne's biography of Madame de Sévigné about ten years ago, I hardly noticed the following passage, and it left nary a trace in memory. But when I reread the book a few weeks ago, I was stunned. I had already decided to add it to the Internet's collection of bits and pieces about bubbles and crashes when I read a recent installment of the ongoing argument about how much money it is worthwhile to spend to try to bail out Greece.

From Roger Duchêne, Madame de Sévigné, ou, La chance d'être femme, Fayard, 1982, pp. 431-432. The off-the-cuff translation is my own.

The financial difficulties on which she spent so much time at the end of her life were not hers alone. As she explained in reference to Charles' unrealized intentions, there was a crisis of credit. Mme de Sévigné certainly made a mistake in not renewing the leases of her farmers, La Jarie at Buron and La Maison at Bourbilly; she thought that they weren't paying her enough. These bourgeois, who had been doing well for at least three generations, lived on the income from their farms: by taking their farms away from them, she ruined them, and their possessions were seized. Since she wasn't their only creditor, she ended up losing a lot, and her later tenants ended up paying her no better than their predecessors. The mechanism was similar to the defaults of the treasurers of Brittany and Provence. The king, pressed to obtain the money he needed, started to apply a tight policy and cancelled the large sums which the treasurers habitually invested. Suddenly pushed into deficit, they soon lost their credit-worthiness, and the whole structure collapsed, at the expense of the private investors who had lent to them. If not for the defaults of these complacent investors, the Grignans and Sévignés would have been better positioned.

Monday, December 27, 2010

Gas Pains (Exxon Mobil, XOM)

From the techniclish-momentous point of view, Exxon Mobil (XOM) doesn't look too bad at the moment. The stock price is up about 19% in the last three months, for a relative strength of 67% and steady, their MSN StockScouter Rating is 8/10, and their Motley Fool/MSN Caps Wisdom-of-Crowds/Self-Fulfilling-Prophecy Rating is 4/5. Standard and Poor's gives them five stars. Their trailing P/E, compared with their own last few years, is a little high, but not intolerable. Judging by past patterns, they should be increasing their dividend soon.

All of this is very nice, I suppose, but Warren Buffett says somewhere - What's an investment note without a reference to Warren Buffett? - that one is supposed to look at stock ownership as ownership in a company, and not as squiggles on a graph. And what has this company been doing lately? It's been buying companies which own natural gas rights right and left. (Or they have been buying companies which have natural gas left left and right.) Well, in case you haven't noticed, natural gas is really, really cheap at the moment, and some say that the price could easily start increasing in a year or so. (And I say: Never pay attention to anyone's prediction about any commodity price under any circumstances.) Jim Jubak suggests somewhere that the special talent of XOM's management is finding medium-term ways to make money out of the fossil fuel biz, if not directly out of fossil fuels, in all conditions.

Add to all of that the fact that human beings seem to be taking fossil fuels out of the ground a lot faster than the forces of nature are putting them back, and that the profits of the big oil companies have long shown a tendency to correlate with the price of oil, XOM might be worth buying right now. Or might not. And only as part of your regular program of dental hygiene, including regular professional care.

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Thursday, May 27, 2010

20/20 Hindsight

We are all used to hearing how the big banks caused the Great Crash by creating asset-backed securities of doubtful creditworthiness and then pretending that they could make some subpools safer for some buyers by dividing up the pools into tranches of greater and lesser creditworthiness. The big banks may have told some whopping lies in the runup to Lehman, but that wasn't one of them. It is perfectly reasonable and not at all meretricious to divide an asset pool into tranches some of which are safer than the average of the pool holdings, and some of which are less so. The simplest way to do this would be to schedule both principal and interest payments on the various tranches in such a way that the less safe tranches don't even start receiving any payments until the safer tranches have received most of theirs. That way, to the extent which the underlying debtors become insolvent before the securities are paid off, it is the less safe tranches which absorb the losses, just as the holders of all of the tranches were promised. This is the way the much maligned CMOs actually work, just as their prospectuses and much other written material on them explain. I imagine that many other asset-backed securities work similarly, but I have only studied CMOs because they are the only ABSs which I have held extensively.

The talking heads now hint that this system of tranches is inherently unsafe and inherently dishonest. I have been buying CMOs since July, 2000. Since that time my real-world annualized ROI on them, without reinvestment, as reported by my software, is 5.38%. That same software reports the AROI for SPY, a reasonable benchmark for any portfolio held by a private investor, as 1.28% with reinvestment. Without reinvestment, which would be a better comparison, the S&P 500 would be heavily negative. So far, I have never had any loss of principal (though who knows what tomorrow may bring). So why have I not suffered from the inherent danger?

In fact, everybody, including the talking heads who yell against it, accepts to this very day the principle of tranchification of credit risk. Isn't that what is done when a company sells bonds, preferred stock, and common stock based on the same underlying assets and the same underlying business?

And if the dangers of tranchified asset-backed securities are inherent and obvious, where were the current experts when these securities were being actively marketed, before Lehman? Are you telling me that these experts were approving and recommending complex securities without having read and understood the prospectus, much less the more objective and deeper academic background literature?

There is no inherent danger or dishonesty in tranchifying asset-backed securities in order to change their credit profile for the end consumer. The danger is in a securities industry - in which category I include the supposed regulators - which is run from top to bottom by people who are neither honest nor well educated.

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Friday, April 23, 2010

A Cuirky Recommendation

Today I read an enthusiastic puff-up of a drug company called NeurogesX (NGSX), based on recent approvals for a patch called Qutenza for the treatment of the pain of shingles.

I can't say that I was enthusiastic about the name, but that's not what's going to make or break the company.

What has broken many post-puff-up drug companies in the past is lack of sales, and since one's sales success depends to a certain extent on what one's selling, I decided to look at the prescribing information provided by the company, using it as a reasonably full source of information about the drug. What I saw isn't encouraging.

The active ingredient is capsaicin. Not only is capsaicin a very old treatment, but it already exists as a topical treatment for herpes zoster, and it's not clear that the new patches are in any way superior to the old cream. Reading the warnings to the prescriber suggests that this is not going to be a blockbuster, even if we take into account that shingles aren't all that common:

"Do not use Qutenza on broken skin."

The non-broken lesions are likely to be close to already-broken blisters, and the patches are likely to be less easy to control than the competitor's cream.

"Apply Qutenza for 60 minutes and repeat every 3 months or as warranted by the return of pain (not more frequently than every three months)."

I'm supposed to become a zillionaire investing in a product which cannot be used more than once in three months, whether it's needed or not?

"Use only nitrile (not latex) gloves when handling Qutenza and when
cleaning treatment areas."

Most medical and paramedical professionals have disposable latex examination gloves around somewhere all of the time. Do they also have nitrile gloves? I'm not at all sure

"Apply a topical anesthetic before Qutenza application.... Remove the Qutenza patches by gently and slowly rolling them inward.... After removal of Qutenza, apply Cleansing Gel for one minute and then remove it with a dry wipe.... For those patients who require the use of opioids to treat pain during or following the procedure...."

This is starting to sound complicated.

"Do not use near eyes or mucous membranes.... Inhalation of airborne capsaicin can result in coughing or sneezing."

Shingles are not rare on or near the face.

I'm not saying not to buy NeurogesX; I'm just sayingthat you should look before you leap.

Full disclosure:

  • My prophecies about health-care companies are invariably wrong.

  • With all of the big health-care companies now facing patent-expiration and pipeline dangers, NeurogesX could be bought up or partnered even if their product is not very persuasive.

Tuesday, August 18, 2009

Why the Nitwits Always Win, and the Smarties Always Lose

In his "Jubak's Journal" of August 18, 2009, Jim Jubak writes about the failures of efficient market theory, both it's intellectual failure and it's practical failure in predicting or preventing the great market collapses of the past few years. He concludes the article: "So the strategy I come away with after reading [Justin] Fox is actually very simple: Follow the efficient investing strategies during normal times and invest like a contrarian during the 20% of times that aren't normal. Now if someone will just show me an infallible way to tell the 80% from the 20%."

Obviously, I don't have a way to distinguish between the 80% of normal markets - driven by intelligent and informed self-interest - from the 20% of abnormal markets - driven overwhelmingly by emotion, whether it agrees with reality or not. The difference between myself and Mr. Jubak is that I don't see why I need one, or why I should want one.

At this point, it's quite legitimate to ask why anyone should pay attention to my opinion, the opinion of a nobody, in opposition to that of Jim Jubak, an experienced, well informed investing professional with a lot of expensive technical equipment standing behind him. I will give my usual answer: I am indeed a nobody, but I am a nobody who has been getting an annualized return of roughly 5.8% since I started investing in the middle of 1998, while the S&P 500 has been returning roughly 0.16% since then, and most of the professionals have been doing much worse. And the same basic relationship holds true between my returns and the "market's" return for any reasonable length of time since I have been investing - any period of five years or longer, let's say. Luck? Maybe most of it, but probably not all of it. My brilliance? Certainly not, but Ben Graham's clear-headedness may have something to do with it.

Back to our point of discussion: Why does Jim Jubak regret not being to understand what's driving the market over the short and medium term, while I just don't care? For a reason which Benjamin Graham enunciated in 1949, in the famous concept of "Mr. Market". Mr. Market, the gentleman who prices securities in the short term - and one always buys or sells in the short term; one rarely intends to place a buy or sell order to be executed five years from now - is often wrong, and it is often best to ignore him, buying securities on the basis of one's own estimation of their intrinsic value relative to price. The nobodies always plod along crunching the same old price-to-future-returns numbers, ignoring the "market" - and have tended to be right over the last few decades, while often looking like nitwits over the short term - while the smarties try to understand the market, and often lose.

So not knowing what drives the market isn't the end of the world.

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