Chris Lau - Seeking Alpha

Sunday, August 30, 2009

How To Work So Hard and End Up Where You Started

We all want to be on the right path and on the right direction for an assortment of things. For many readers who visit my site, it is the desire to be a better investor.

The right direction is achieved by asking the right questions. The questions that many investors are asking are:

Are we still in a bear market? Are we in a new bull market? Is the marketing correcting in September and in October?

Vitaliy Katsenelson, a director of research, is author of a finance book, "Active Value Investing." In the following slides below, Katsenelson asks what I believe is the right question: Are we in a sideways market?

If the market is going to move nowhere, then many tools based on "conventional wisdom" such as buy and hold would not an applicable tool to use in today's market.

The paper concludes with the following points:
  • Be a buy-and-sell investor. Buy-and-hold is in a coma
  • Time(price) stocks through a strict buy-and-sell process
  • Time stocks, not the market: Market timing is very difficult
  • Don't buy for the sake of being invested.
  • Don't lose money by making marginal decisions. In the absence of good stocks to buy, be in cash
  • Increase your margin of safety: Fewer (better) stocks will be in your portfolio
  • Favor dividend-paying stocks (Warning: dividends are part of the analytical equation, not the equation)
  • Look overseas - increases return without increasing risk

Sunday, August 23, 2009

Predicting, Forecasting, and Luck (vs. Skill)

Nassim Nicholas Taleb: A Crazier Future

This video found its way via Zerohedge.

Taleb is the author of "Fooled by Randomness" and "The Black Swan." This video summarizes the concepts discussed in his books, in which Taleb comically describes The Black Swan is a re-write of "Fooled by Randomness." (See @1hr 5min)

Most admirably, Taleb (@1hr 15min) reveals how no one wanted to publish his book. Complete with many rejection letters from publishers, the author prevailed by posting his manuscript on the web, gaining attention, and eventually overcoming this set-back.

This video will take 1hr 30min to watch.

In this video, Taleb talks about some of the things we all would want:

  • Predicting the future
  • Illusion of control @46:16
  • Forecasting
  • Moving from Theory to Practice
Some of his Tips:

  • The Best advice comes from those who give you NEGATIVE advice (as opposed to positive advice). (Reference: @57 minutes)
  • Do not use forecasts in a qualitative way or for anxiety relief.
  • Create small Rules of Thumb
  • Do not take advice from people wearing a tie!
  • Respect Tradition and Age (Reference: @1:03)

On Managing Risk:
In the Q&A segment at the 1hr 13min mark, Taleb talks about minimizes risks in the stock market in the maximum way: simply by holding an amount he is willing to lose. For example, he says holding 7% in stock would result in a maximum loss of 7%.

On Applying "Black Swan" to Decision Making
@ the 1hr:22min Taleb is asked:

How does focus on black swans affect quality of decision making? Does it increase paralysis or inaction?

His Response:
(my transcription may have errors)

Being skeptical makes you take more risk in some domains. I take more risks on some domains. If you are aware of black swans, focus your risk taking on some things and not [on] others. This allows you to take more risk in tinkering trial and error, and a lot less risk with when you rely on someone else's opinion who can be full "experts."

Taleb is working on the next book that discusses how we are better at doing things than knowing things. When this book is out, it should make for a very controversial reading from the academic community.

Sunday, August 16, 2009

Countdown: 45 Days

45 Days
In 45 days, kaChing plans to enable the convenience of allowing users to link their trading account to the account activities of its top-performing users.

Many new and existing users on kaChing's virtual trading community have been following my activities over this past year (to the new users, "followers" enables users to receive email alerts when a trade is made or when a research is posted). The site now has 387,598 registered users.

It is not known at this time if followers will decide to do the following:

(1) Open a discount trading account on Interactive Brokers and;

(2) Link a portion of holdings to seamlessly and conveniently have mirrored trades completed based on my actions.

IQ Me Not Smart Enough
To expand on the second point, there are many other users on that site whom have shown not just good results but results that exceeded my own (I am close to, but not currently at the minimum IQ score of 70 to qualify). By that, I mean simulated virtual returns that are consistent with what they say they are going to do ("investment strategy") and what reported statistics (sharpe ratio, turnover, risk index, downside standard deviation to name a few) say they have done ("Investment IQ") against that stated strategy.

Smart users will best allocate, say, $5,000 to one mirrored "signature investor" (as KaChing calls it), $5,000 to another, and say $3,000 to yet another. The rest of the assets can and should be used to purchase other types of assets (like bonds or stocks).

The Price of Convenience

For those who do not have the endurance to manage a portfolio, or want the convenience of the "kaChing mirroring" option, I asked kaChing and was told that it will be a fairly inexpensive alternative (from 0.25% to 3% annually).

The question then becomes: how do you choose an investment manager? On June 25th, kaChing provided its viewpoint on what it thinks is the best way to choose a manager.

Let's just say that in the last month, the virtual community was in a bit of an uproar. Were users hurling accounting figures, ratios, and even philosophy?

Although my enthusiasm is high for statistics, charts, and graphs, a typical user might overlook these measures. What might be worse is that users may not take the time to understand what these measures mean.

I would urge you not to do so, especially when using these measures to distinguish the intelligent investors from the speculative lucky ones.

Take, for example, the Sharpe ratio. It was developed by Nobel laureate William F. Sharpe. A Nobel laureate! Anyone who read Taleb's works might want to take a lesson on skepticism. However, in my reading of Taleb, my interpretation of skepticism is to understand the limitations, risks, and assumptions for any system that attempts to quantify human behavior and action with a numbers. It is this interpretation, not skepticism, that every investor managing his or her own money, must have.

Security Analysis
When I first joined kaChing, I used the site to apply my investment thesis. In that time, though, I stepped up my understanding of uncertainty, random theory, philosophy (the future is far from certain), risk management (quantify risk using a range of values, higher risk does not mean higher reward)...

...I even learned about hedging strategies and macro analysis, both of which are additional tools that investors need to have an edge over everyone else. More importantly, though, I complimented the activity on the site to work on and to apply "bottom-up analysis" based on Security Analysis (Benjamin Graham).

This is not going to be enough. Not for kaChing, and most certainly not for the general unpredictability of the stock market over the next few years.

kaChing's founder, Andy Rachleff, also provided insight in portfolio management that is used by hedge fund managers and by endowment funds. Generally speaking, both performed very well over long periods (15 years or more).

Compare that to various major indexes. Some moved nowhere in 10 or even 20 years.

What will prove valuable from the insights provided in the blog is that the approach is not generally used by the popular mutual funds sold by bank institutions. Note that kaChing's statistical measure for a user's performance return for Ivy League Portfolio managers. It is hardly a walk in the park.

My Strengths Need to Grow from my Weaknesses
From a personal note, my weakness in managing my portfolio was a twofold:

(1) Sticking to a clear strategy (current holdings contain both value and growth) and
(2) Outperforming the S&P 500 since March 2009*

The plan continues to be to learn from point (1). That is, to stick to a uniform strategy so that time is allocated to one strategy. This would provide more time in identifying companies that offer very compelling returns over the long term. As paraphrase what Warren Buffett said, to let lots of pitches go by but to swing hard when the right pitch comes along.

Other Progress - Leveraging the Virtual Trading Social Network
I had the goal of being able to perform a preliminary security analysis assessment for a company in about 20-30 minutes, instead of over several hours. I leveraged the knowledge of other kaChing users to get a second opinion on calculations and assumptions.

Wall Street is like a casino, so one must always remember that odds are, the house always wins. It should then be rationalized that group thinking within a virtual trading environment might be a way to put the odds back in the individual investor's favor (realistically, other quantitative measures like free cash flow, net present value, and discounted cash flow analysis takes time, but it is a next step after performing the quicker company value assessment for a stock).

kaChing's virtual community will thrive as long as users know that the competition against each other is harmless "play time." The true competition is against themselves and against mighty Wall Street.

As for the "*"

Memo to: 583 kaChing Followers
Re: Luring Rabbits From Burrows

There is no real excuse to justify an under-performance against the S&P 500. I am staying on the original position: taking a defensive approach to the assets managed. This means being under-invested in comparison to the index.

I am not convinced that the current market value of the index is justified.

The reasons are as follows:
  • Government spending, stimulus packages, tax credits (in housing and in automobiles) is creating one-time events that the market is pricing in as indefinite
  • Growth in the emerging markets is also due in part to government spending
  • American consumers spending much less, are less confident
  • The annual "Back to school" consumer spike that was seen since 1995 is suggested to be weak this year
  • S&P 500's "forward" P/E is over 100
  • Market is pricing in a "V-shaped" recovery but given unemployment levels and lack of job creation, "L" is more likely scenario
  • In real-terms the stock market rally in the S&P relative to other indices (emerging markets) is unimpressive
  • In real-terms the stock market rally in the S&P relative to its own currency is unimpressive
For the latter two points, something will need to give way - this is going to be in the form of a strengthening in the US dollar along with a strengthening in long-term treasury.

Yields in corporate bonds and in U.S. debt securities will provide an indication as to which way the major indexes (and the currency) will move, possibly in the weeks ahead (September or October).

Detailed Notes on Holdings

My investment thesis is that consumers are going to continue to save substantially. Irrational as they are, they will not give up a few luxuries in the area of entertainment. It is for this reason that I have GameStop in the portfolio (my target price is $33).

Family Department Stores
invests on the above investment thesis.

Microsoft is doing everything right with its Windows 7 development and launch. It is fairly valued, but I plan to add a large position in this company. Bing search is impressive.

BCE was simply undervalued after the takeover by Teacher's collapsed due to the credit crisis. Guess what? The crisis is over (by measure of spread, but not necessarily gone for good), and BCE has not traded accordingly. BCE is also focusing on wireless growth.

Biovail deals with generic drugs. Guess what? The U.S. and everyone else wants to cut down the cost of health care and on the cost of prescription drugs. While this does not benefit Biovail directly (from my valuation analysis), Biovail is moving in the right direction to capitalize on this trend.

General Growth Properties trades on the "pink sheets" (meaning it is bankrupt). Its bankruptcy was due to the company unable to roll-over its debt. The valuation of its assets are significantly higher than that assigned by its stock market value.

My position on the 30-year Treasury is bullish. The U.S. dollar should be relatively stronger, and given the change in QE (quantitative easing) by the Federal Reserve, I believe TLT will appreciate in value, especially if or when world stock prices begin to lose confidence in itself.

My bet against FedEx and on the British pound is for hedging purposes. I believe the US dollar will strengthen, and that overall consumption activities are not as strong as the market is predicting.

First Solar's business model is not as solid as everyone thinks, and competitors are adapting to put pressure on this company. Its business model depends on government subsidies. Valuation is too high and needs to come down.

Rio Tinto and Weyerhaeuser are also hedge positions to counter the mis-pricing and valuation given to real estate and to commodities. Rio also has a huge debt which will be a problem should market valuations shrink again.

Furry Rabbit
Rabbits will stay in burrows until carrots are in sight. Since this market is a virtual carrot, this rabbit will stay in cover to wait and will strike with greater decisiveness when the carrot is looking a lot more real.

Thursday, August 06, 2009

How to Start a Hedge Fund with $3 Million

Dan Loeb is someone to learn from. Success is great when you're at the top, but sustaining success is defined by what you do when you are at the losing end of the game.

In the video below, Dan Loeb speaks about the interrelationship between investing and hedge fund management. Loeb started his fund in 1995 with $3.3M. Third Point is now managing over $2B.

This is a great video.

Loeb speaks beyond the need to understand security analysis. He talks about the role of philosophy in money management:
  • To whom does the manager look out for first? For self or for investors?
  • The importance of teamwork
  • Honesty and creativity
A key point I fully connect with is at the 48 minute mark: an investor and manager needs an element of creativity, emotion, analytics, and intuition to tie everything together. For new investors who want book suggestions, a list is provided by Loeb recommends at the 50 minute mark.

Source: This video was originally posted on Market Folley

Investment Performance Highlights
In 2007, the firm had a good year and made over $1B.

In July 2008, Loeb allowed his risk discipline fall apart due to long exposures in financials and energy.

Loeb essentially panicked during those crisis months.

By the end of the year, the firm lost about 32-37% and lost a third of its clients (still losing fewer clients than other firms.

This year, Loeb focused back on the basics. He focused on investing in places where the government was intervening. As the story unfolded, the fund moved from a 7% loss to a 7% gain in a 6-week period.

Disclosure: These are important lessons learned. I currently have about 550 followers on kaChing. If I qualify as a Signature Investor later this year, and that each follower invests an average of about $5,500, it is possible for me to also start with $3 Million in assets under management.

Loeb ends the presentation by stating there is andwill be a massive opportunity on investing on the theme of asset re-structuring over the next few years. Note that Seth Klarman spoke on this idea as well - opportunities that exist outside of the mainstream.

Wednesday, August 05, 2009

The Three Little Pigs and the Fox (1890)

We can only sit back and marvel at how the U.S. government has managed to put the economy back together, but it’s the same problem as the first little pig had in fending off the big bad wolf. Straw will only hold up for so long.

This was how David Rosenberg, former Merrill Lynch chief Economist, began his newsletter today.

It is surprising but not unexpected to marvel at the way the stock market has recovered since March of this year, but I am still on the camp that this is a bear market rally.

It is a belief that this is the mother of all head-fakes of our time. My reasons remain unchanged for why caution is required and why money should not be deployed aggressively on long positions:
  1. "Cash for Clunkers" - this was the difference between keeping an old car replacing it with a new one...getting a government-sponsored $4,500 discount and taking on more debt to finance a new car. No more tax credit, no more sales.
  2. Selling mountains of government-issued debt via U.S. Treasuries, at the expense of a lower U.S. dollar (The U.S. dollar peaked in March at 89.62 and is now 77.80). Will foreigners react to a weaker U.S. dollar?
  3. Home sales improved, reducing inventory. Fair enough. People are taking advantage of low mortgage rates, bat at what terms? 1-year? 5-year? What happens when rates rise and mortgage rates reset to the higher ones? Will government be constrained in raising rates? Will government be forced to maintain low borrowing rates? The housing market "bottom" is inconclusive.
  4. Even when the recession is soon to be declared over (when all import, inventory, and other variables are factored in, GDP figures will necessarily be calculated to be higher than in previous quarters), unemployment will still be over 9.5%. Fewer jobs, less consumption. Source.
  5. U.S. savings rates are rising permanently. Conversely, U.S. consumption is necessarily declining permanently. Sustained unemployment moving into 2010 will be more than likely. The "Recoveryless" recovery is appearing like a likely scenario.

Tuesday, August 04, 2009

Yale economist Robert Shiller on Evaluating Risk

It can be difficult to develop an opinion contrary to that of the behaviour of the market and the mass media. During those times, one might not be focused on listening and watching the opinions of those who express contrary opinions.

Shiller, a Yale Economist does this in his discussion on evaluating risk:

Note: Video was found from Ritholtz' blog site.

...The Good ("Better") News

  • There were 8.8 months of supply in June - significantly below the all time record of 12.4 months of supply set in January (Source, here)

Monday, August 03, 2009

Math Class: Exponential Growth

Below are 8 videos that will help investors correctly interpret news headlines, economic policy and goals. Total class time is about 1 hour.

As an aside, notice the dropoff in views from video 1 to video 2-8. HT (hat tip) to Tom Doser (kaChing).

1. Exponential Growth








No Benefits, No Problem
CalculatedRisk reported that 1.5M unemployed will lose benefits by the end of 2009.

No problem.

The site reported that policies may change to extend benefits.