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?

http://www.scribd.com/doc/18599532/Avi-Presentation

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
  

"Dear Ann Landers"

I received an email from a fellow participant on KaChing.com. The trader was seeking advice on how to become a better trader. This entry will have an "Ann Landers" feel to it. For visitors who are not on this SEC-registered soon-to-combine-fantasy-with-reality community, here is my post about all that.

Note that what was missing from my entry is how KaChing has changed my mindset and attitude. It has, in effect, and so far, made me a more focused investor.

I'm a newbie on Kaching and am eager to learn a lot more about trading. I've reset my portfolio a few times in the past two months (my first two) because I got cocky after a first month of 40% and lost basically all my gains and then some by betting the farm and getting it wrong. In hindsight, I think it's likely my 40% gain was just as lucky as my 50% fall. But I want to move beyond luck and start trading skillfully. I'm a bright guy but don't really know the best place to learn. I'm intrigued by Elliott Wave theory but some of the arguments against it make sense to me as well. I don't know much about technical analysis but am also interested to learn more. At root, I'm a fundamentals guy, but I've been burned both ways using fundamentals: some companies that seem to be financial nightmares (low cash, high debt, declining sales, high p/s, high peg, low roi, low roe, etc.) just keep going up while others that seem so sound and promising just plummet. I've fallen victim to the value trap as well. Other times, I've been right but not patient enough...I short at 20, it rises to 24, I take the loss and then it drops to 15 the next week. :)

The best success I seem to be having at present is riding momentum and getting out quickly. Yesterday and this morning I saw the severe uptick in C and BAC and figured the fundamentals haven't changed and they're basically insolvent so they HAVE to come down. I waited for the ticker to start dropping, shorted them heavily and made a killing before getting out. Now I see they're up nicely since then...and I don't understand why.

Anyhow, I write to you in admiration of your slow, steady gains, similar to those I see in Daniel Carroll's portfolio. I'd like to learn how to gain slowly and steadily and would love to ask you for a recommendation for how I might learn more. I'm curious how you pick stocks (technical, fundamental, value?) Any books or sites you'd recommend? Any advise would be much appreciated.

Thanks, [User's Name - protected for anonymity]

You are probably frustrated, both your inconsistency in trading and in trying to make sense in the market. You will be surprised to learn that YOU ARE NOT ALONE.

In fact, I created two groups on KaChing. One is called “Beginner's Guide to kaChing Trading“ (75 members). It serves to give back to the group, and to find users like you. That’s right. I’m looking out for newbies because you may have some fresh insight to bring to people like me. I often get direct questions or posts from the beginner’s group from users who express the same frustration.

The path to trading success was recently dominated by lucky traders (look up the tech bubble, 1999-2000). Trading based on fundamentals is almost irrelevant right now, but I believe that this phenomenon is temporary. It turns out that investors who want to “study” fundamentals will need to understand government policy. The Fed and the central banks around the world are applying Keynesian economic theory on a problem that requires more thought and foresight. I won’t get into the details of what solution will work, but I still agree that some kind of monetary policy is needed to save key institutions like AIG. Just last week, Citigroup and Bank of America were trading like insolvent banks. Even though they are technically insolvent, so are the global banks. This week, the CEO’s for both companies said they generated profits in January and February!

Why do I yammer on about economics (the economics text books were top sellers on Amazon recently, by the way!)? You are trying to rationalize the market when traditional accounting and fundamental laws do not apply….insolvent banks aren’t technically insolvent if there is someone ready to save them at all costs. It is my belief that fundamental analysis will not apply to as large a degree as you would want. Until the banking system is fixed (it will take longer than people realize) lending won’t resume to normal levels. Earnings will shrink for companies because of this, and such things as P/E will not be a reliable measure for security analysis.

Still, there are other figures you will need to look at for a company before you buy them. For example, I would suggest you look at debt/equity, book value excluding goodwill, and cash flow.

I won’t lie. This will take a lot of work.

This was why I created “Intelligent Investing” on kaChing. It’s now 180 members strong.
This is a second group I created to share ideas on security analysis.

In terms of your trading, it sounds to me that you are chasing trends, applying various trading “methods” to them to rationalize your positions, only to then get “faked” by the market. You are also day-trading. There are quite a number of day traders on this site, but it was one of the founders/owners of kaChing who posted numerous times that statistically, day traders end up losing in the long run, and that investors with a longer term horizon will last.

Pure technical traders ignore fundamentals. They look at charts alone and ignore fundamentals. The fact you look at them is contradictory to your desire to trade on fundamentals.

I employ technical analysis to a small degree in stock market analysis. I use the basics of this using such things as MACD, moving averages, support and resistance. Again, some swear that technical analysis means nothing, but if the market is efficient (“Efficient Market Theory”) then at the very least, the charts will tell me such things as where things might trade to or whether trends are forming. If everyone else is using charting to trade, then one needs to add this tool to stock market analysis. Note that charting analysis is the weakest form of support for this theory.

You should check out the book "A Random Walk down Wall Street" by Burton G. Malkiel. He discusses Efficient Market Theory. On p.174 the author states that:

Even the legendary Benjamin Graham, heralded as the father of fundamental security analysis, reluctantly came to the conclusion that fundamental security analysis could no longer be counted on to produce superior investment returns.
...the situation has changed...
...investors would be better off in an index fund rather than investing in an actively managed equity mutual fund...

It is my intent to last in both the virtual and real trading world. I have grown a following and I hope that some of those followers will eventually invest in me. That is, the followers will tie a portion of their assets to mirror my investment positions on the site. My advice to you is to keep doing what you are doing: invest in yourself (learn), and then invest in the market. Keep making mistakes. Learn. Reset (after all it is just play money). You will know you reached the next level when you become less emotionally attached to the market and see things for what they are from an objective level.

(Yada yada yada on the usual disclaimers: trade at your own peril, take responsibility and ownership on your own actions...)

Buffett says Economy in Shambles

"The economy will be in shambles throughout 2009 -- and for that matter, probably well beyond." - W. Buffett

This entry is lengthy, because Buffett, and his teacher, Benjamin Graham ("The Intelligent Investor" and "Security Analysis") forms the core fundamentals in my overall investment strategy. Although the market is currently working on a new set of unknown and changing rules, not all of the core fundamentals are applicable at least for the short term. Still, Buffett has returned 362,319% since 1965. In 2008 his company lost 9.6%. The S&P 500 lost 37%. On a relative basis, I would say that Buffett did very well (almost four times better).

Summary of Warren Buffet's Berkshire Hathaway results for 2008:

• Revenue fell 12 percent to $24.59 billion.
• Lost $4.61 billion in junk bonds, derivative contracts
• Profits was $3,224 per share for 2008 against $8,548 in 2007
• Investments fell from $90,343 per share of Berkshire to $77,793

CNN noted that Berkshire's profits stemmed mainly from interest and dividends on its investments and the earnings of its 70 operating subsidiaries. Berkshire has extensive holdings in two industries, insurance and utilities, whose earnings are not closely correlated with those of the general economy."During 2008 I did some dumb things in investments."

Buffett's Investment Strategy

• The paradox of Buffett's investment year will be evident: To put Berkshire's pile of cash to work at prices he considered attractive -- "I like those preferreds," he said recently -- he had to endure a terrible stock market that savaged many of the stocks the company already held. He has always declared, though, that he is perfectly content to see Berkshire's stocks fall in price, because that allows him to buy more of them cheaply.

Buffett's Investment Goals:

"In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of excess liquidity, near-term obligations that are modest, and dozens of sources of earnings and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years, have delivered Berkshire exceptional results."

The Good News:
For objective #4, Buffett is referring to the solid management in their utilities business. In the insurance business, Berkshire made $2.8 billion just to "float" $58.5 billion of insurance.

Notable comment about insurance:

"GEICO grows because it saves money for motorists. No one likes to buy auto insurance. But virtually everyone likes to drive. So, sensibly, drivers look for the lowest-cost insurance consistent with first-class service."

The Bad News:

"I made some errors of omission, sucking my thumb when new facts came in that should have caused me to re-examine my thinking and promptly take action."

Comment:
Having little to no reaction is like being a rock that won't change. The economy today needs investors who are more fluid and more reactive to the facts that matter. The challenge, of course, is knowing which facts matter and which ones do not.

On Housing:

Foreclosures take place because borrowers can’t pay the monthly payment that they agreed to pay.

...

Home purchases should involve an honest-to-God down payment of at least 10% and monthly payments that can be comfortably handled by the borrower’s income. That income should be carefully verified.

Comment:
I am a part-time real estate in Toronto. The first thing I do is check and counsel buyers about how much they can and should spend on a home.

On Clayton, the home lending unit for Berkshire:

At the moment, it is much better to be a financial cripple with a government guarantee than a Gibraltar without one.

Comment:
I find this situation troublesome. The government is stepping into the home lending business, and creating a level of competition that hurts healthy lenders.

Buffett Steps It Up a Notch Too:

When forced to choose, I will not trade even a night’s sleep for the chance of extra profits.

Comment:
I do not agree that buying $14.5 billion worth of fixed income from GE, Goldman Sachs, and Wrigley is worth trading in the well-run J&J and P&G. These companies may fall due to declining consumer spending. However, low energy prices will keep costs down, and "recession-proof" items will ensure sales don't fall that much.

...But the U.S. Treasury bond bubble of late 2008 may be regarded as almost
equally extraordinary.

Comment: I am short TLT, long TBT.

On Cash:

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted.

They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.

Comment:
I fit in this category. My investment thesis lies squarely on protecting principle, and acting when there is clear evidence that the economic implosion experienced in Q4/2008 and in the foreseeable future abates. I am sure that Castlemoore Inc. would agree with this thesis, since I have re-modeled my strategy to be "aggressive" than in the past (Castlemoore currently recommends a 30% equity holding and 70% cash).

Admittedly, one thing I am cognizant of is being paralyzed from taking action when the time is right, because there can never really be a way to predict when that time is right.

On being part of the herd:

"Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier. Beware the investment activity that produces applause; the great moves are usually greeted by yawns."

Comment:
I interpret this as an investors need to be objective, separate, and independent in thought from others.

A Red Flag:
Berkshire has $37.1 billion in put contracts. This means that if the major indices are below a certain level in 2019 - 2028, Berkshire could in theory lose $37.1B if the indices were 0. This is unlikely, so a more reasonable target loss would be a 25% decline in the indices (from inception of each contract). This translates to a $9B loss payable between 2018 and 2028.

To-date, Berkshire has a paper loss of $5.1B (loss is reported due to changes in accounting rules).

The Bad News (Results)

Buffett bought large amount of Conoco Phillips stock when oil prices were near their peak and in no way anticipated the dramatic drop in prices that subsequently occurred.

Buffett said he still thinks the odds are good that oil will sell in the future at much higher prices than the $40 to $50 per barrel. Even if prices should rise, he said, "the terrible timing" of the Conoco purchase has cost Berkshire several billion dollars (paraphrased from CNN Money; link is below).

Other Losses:

• American Express (AXP, Fortune 500) shares fell by $5 billion
• Coca-Cola (KO, Fortune 500) stake sank by $3 billion
• Wells Fargo have lost well over half their market value, falling from $9 billion to $3.65 billion.
  
• Holdings in U.S. Bancorp (USB, Fortune 500) is down by around $800 million

Final Comment:
I had thought that Berkshire would reduce or eliminate its holdings in banks, but in doing so the paper losses become real ones.

Links
Full Letter Here
CNN Money's on Berkshire

Other Links
Hedge Fund (Thanks Dan, from KaChing)