Wednesday, January 16, 2013

Which Region Will Do Best in 2013?

t’s the New Year, and it’s always a bit of fun to peer into the crystal ball and see bits of refracted images of table cloth below you while a crook asks you for some money. Ernest predictions of your future life follow (usually prompted by a fleeting glance to see if you are wearing a wedding ring or not) and after a few optimistic words, charlatan and dreamer part company. In a similar vein I shall attempt some geographical predictions for 2013!

China's Economy in 2013

Forgive me for not being inclined to forget everything I’ve learned about economics and markets, but the last time I looked at economies under collectivized control they did not have a particularly good track record. In other words, I’m not convinced that China’s attempts to stimulate its economy back to 7.5%+ growth is going to work as many are hoping it will. Moreover, the indications are that this is not going to be like the 2008-09 stimulus plan and this can be taken as a de facto admission that the previous plan was inefficient. So what next?

I think it better to consider China as an odd proposition. On the one hand, continued gains from private sector inspired productivity improvements, while on the other the government’s currency management (buying US dollars, selling yuan) has threatened the creation of a localized asset class bubble in housing. Pencilling in ‘same again’ GDP growth for China seems a sensible policy to me, but who knows? China can always generate growth (but future problems) by throwing money around.

If I am right about China then don’t expect the mining and resources sectors to do particularly well this year. I appreciate that Caterpillar and Joy Global were beaten up in 2012 over this issue, but these things can go on longer than many suspect. I like to invest with a bit more certainty. Things appear to be getting better for them lately, but if China disappoints then their earnings prospects will be downgraded in the future.

US Strengthens

I think the evidence suggests that the US economy is improving but is suffering from near term difficulty engendered by its politicians. I’m not entering a political debate here. Suffice it to show this chart and remark that neither party has a particularly good recent record with either reducing spending or encouraging social cohesion.

The whole ‘fiscal cliff’ debacle is a red herring. It will get resolved and America will go on, but at some point the whole idea of trading off an increasingly unequal society for a larger public sector has to be reconciled. The public sector isn’t very good at doing these things and its growth encourages vested interests to game resources in their favor. Rant over. The US will do okay in 2013.

I think that US consumer focused stocks are still a good way forward. Within retail I favor the high end and some specialty stores. However, the real story lies with the ongoing recovery in housing, employment and credit issuance. When net household wealth rises, it encourages spending and lending. I would look for the financials like Capital One Financial (NYSE: COF) or American Express (NYSE: AXP) to experience improving conditions. There is some more analysis on the issue here. Charge-offs continue to decline in the US and there are signs that the consumer has stopped deleveraging. Financials can start to lend more as consumers spend.

European Economy in 2013

Europe will surprise to the upside. You heard it here first. I’m increasingly becoming less scared of companies with heavy European exposure. Why?

Europe has been weak for a while, and I would expect yearly comparisons to be a lot easier; companies have had plenty of time to adjust to the dictum of North-Good, South- Bad. Moreover, Italian 10 year Government bond yields have come down to around 4.5% and Spain’s are at 5.25% as I write. The EU has made great strides in restoring confidence, and it is making efforts to install systematic rigor to its government's spending. Europe is hopefully heading to the kind of monetary discipline that the Bundesbank enjoyed for so many years. It is still tough, but things are getting better and I'd like to see Greece thrown out of the Euro Zone, though its debt is not such a big issue for Europe provided the markets understand this.  Do not be scared of European exposure.

With this in mind perhaps it’s time to look at some European stocks or at least companies like McDonald's?  It has some issues in China right now but Europe is still its largest profit center and any upside surprise from Europe would drop favorably into its bottom line.

The Bottom Line

Of the three regions, China’s 2013 is likely to be the hardest to predict. I think the risk is on the downside. The US looks set for a slow grinding recovery and it truly is a stock picker's market, but I'm not complaining. I love such conditions. As for Europe, don’t be surprised if we surprise you.

Happy New Year!

Monday, January 14, 2013

Why Follow Investment Gurus?

One of the most seductive things for a private investor is reading an article by an investment guru or pundit that writes or screams about trading a certain stock or asset class. In addition, I frequently see articles that monitor their positions and what they buy and sell. It’s all so easy. You just follow a guru-who has no doubt put in a lot of research--and you make money. It’s so simple and you can just sit back and let them do all the work. Alas, it’s not so easy and here is why.

Why You Shouldn’t Take Gurus Too Seriously

I’m going to summarize the main arguments and then flesh them out.

  • Real time observations: Are you able to monitor exactly when they enter and exit positions? And when they change their minds?
  • Deliberate obfuscation: It’s a nasty zero sum game world out there, and some people deliberately want you to trade opposite to them. Think of Jim Cramer and his infamous ‘moron longs’ observations.
  • Track record: Are these guys actually any good? What do you really know about their track record and do they consistently make money or is it just a year or two of good numbers when the market favors their strategy? Why is it so hard to find a track record for some of these guys?
  • Timing: Are you in the position at the right time or is the guru the only one making money?
  • Portfolio positioning: Do you understand how the position works within their overall portfolio or are you looking at it in isolation?

It’s all very well reading the myriad reasons why someone wants to buy something, but what about when they want to sell? What about when conditions change and a disciplined ‘guru’ then suddenly changes his mind? I doubt he is going to email you personally to let you know. Moreover, let’s say that you learn that one of them has just sold his entire position in, say, Costco. You get all excited and dump your entire holding but what if he sold his because he wanted to shift into Wal-Mart and Target on a relative value basis? This doesn’t mean he’s expressing anything negative about Costco. On the contrary, it could be positive, but it just means he prefers other stocks in the sector.

Moron Longs and Jim Cramer

It should not be lost on investors that there are lots of scurrilous people out there who spread rumors and counter-rumors in order to manipulate investors and sometimes it is in the opposite direction of which way they are actually trading.

In recent years there have been examples of financial institutions setting up products in order to sell investors and then short them or their constituents. Similarly, it’s so easy for an investor who wants to sell a position to try to encourage others to buy it so he can get his exit cleanly. Always ask why someone wants to tell you about his position.

What is Ken Fisher's Track Record?

Okay, I confess I have a bee in my bonnet about this. Investment management lives off numbers, performance and results. There is no end to the metrics that have been devised in order to monitor these things mathematically. Well in that case, why on earth is it so difficult to find a track record for many of these guys? I doubt anyone markets more than, say, Ken Fisher but I suggest Googling around and trying to find a discernible long term track record for the guy. Similarly, some investors are great in certain periods but they may not perform in others.

I learn this lesson to my own regret. Now I respect Warren Buffett more than most investors and have written about his long term track record here, however, there are certain types of stocks that I have learned to avoid with him. A few years ago I recall buying H & R Block (NYSE: HRB) and Iron Mountain (NYSE: IRM) and feeling good because Buffett held position in the stocks. The logic seemed clear. HRB had a natural moat with its tax services and was expanding into Wal-Mart locations. It was cash generative and had obvious long term prospects. Similarly, Iron Mountain’s document storage was a long term recurring revenue generator and a service that certain industries could not do without. It all made sense. Right?

Well HRB turned out to be on the cusp of losing market share to Intuit thanks to its do-it-yourself software and cloud offerings. IRM discovered that electronic storage can replace much of the need for document storage. Lesson learned. Buffett is not that hot in industries susceptible to technological changes. Maybe this is because of his famous aversion to buying technology stocks?

Following Hedge Funds Shorting Herbalife?

This argument is simple. It is all very well to follow a guru ‘with a view’ but you have to be in the position at the right time. For example let’s look at GameStop (NYSE: GME), Herbalife (NYSE: HLF) and Nu Skin Enterprises (NYSE: NUS).  I wouldn’t buy these stocks if you paid me to, but I would be very cautious about shorting them despite the amount of negative feeling that some ‘gurus’ have over them.

Here is why.

HLF data by YCharts

As much as I dislike Nu-Skin and Herbalife, the fact is that until a notable hedge fund manager comes out and states his negative case over the stock you could find yourself losing money. The reason is that so many nervous shorts hold these positions and worried buyers stay away. Therefore any positive news sees them rising and the shorts close out. You can see this with GameStop.

In addition, investors need to be in the position before the guru speaks, but how do you know when he will do that? And why short a stock after the big move down. The few big down moves took place over a few days in the year!

Portfolio Positioning

This is probably the most important aspect. Investors buy stocks for all sorts of reasons, and you need to understand how a stock works in a portfolio. So, for example, what is the point of talking about a short/long position in a stock if a hedge fund manager is long/short another stock in the sector with a relative value pairs trade.  Similarly, some managers buy stocks in order to thematically hedge against overweight positions in their portfolio or they buy them in order to try some form of corporate action. The reasons are myriad and investors should not look at one position in isolation.

Tuesday, January 1, 2013

How to Be a Better Investor

It’s Christmas shopping time: No doubt us obsessive investors will be thinking about gifts and contemplating buying the latest book designed to convince us that a certain investor or other has the panacea to investment or management problems. Whether it is a book on ‘master investors,’ the latest Buffett biography, ‘Business Secrets of the Pharaohs,’  ‘Why Mayan Civilization Collapsed: A Technical Analysis’ or other such nonsense, you can be sure they will be out in book shops near you. Well, in the spirit of Christmas, it’s time to throw my opinions over for free.

Fooled by Topiary

Any discourse on this subject can’t avoid a reference to Nassim Taleb. In truth, most investors owe a debt to him for his popularization of the idea that most of these tomes are merely selling observations of ‘certainty’ on events which are in fact random in nature. I’m greatly sympathetic to this view. For example, if you want to analyze what makes great investors do you only analyze the traits of ‘the greats’ or do you analyze a huge cross sample and see which traits appear to lead to some of them being great?

Let me put it this way. Assume Buffett, Soros and Chanos love doing topiary on the weekends. Conclusion: doing topiary makes you a great investor! However, you can analyze 1,000 investors (including plenty of losing investors) and discover that doing topiary on the weekends actually causes negative overall performance.

In other words, I don’t think a narrow analysis of a few great investors’ traits is a legitimate pursuit.  It’s a bit like looking at say Exxon Mobil or Chevron and the huge run up they both had from 2003 to 2008 and then concluding that the management was fantastic because they may have all favored topiary when in fact it was largely due to the price of oil. If you buy these stocks, you are de facto taking a position in oil.

And don’t get me started on hindsight or survivorship bias!

Stop Analyzing the Pro’s

The other problem that private investors (and authors for that matter) have is that most of the track record is in the professional arena.  This is an issue because professional investors are necessarily solely focused on generating risk adjusted returns.  I’ll explain.

Private investors can take no solace in the track record of professionals.  Essentially the investment industry works on a couple of working principles which it has learned empirically over the years. It took the work of behavioral psychologists Kahneman & Tversky to rationally express these principles or heuristics, but the investment industry has always lived by them.

  • A loss is psychologically weighted double that of a gain
  • Investors overweight near term performance

The first point plays out because asset managers are terrified to deviate from industry benchmarks on the downside because they will lose their blessed assets under management (AUM), and there is little benefit to be gained in trying to beat their peers because upside is not as strongly rewarded.

The second point is that investors tend to overweight short term performance, and the industry knows this so there is nothing wrong (for the industry) in chasing myriad risky strategies which produce short term outperformance but then blow up when conditions change. After all, the important thing is to get AUM and tie it up.  This is why asset managers tend to have a stable of different types of funds. When one is hot they market it more and then investors duly reward them with AUM. Of course the problem is that that manager may have taken on excess risk to get the numbers. But who cares? Asset managers make money by managing assets after all.

In this sense it is exactly the same principle with what went wrong with the financials. Risk went out the window in many cases and if it wasn’t for the largess of the Government and taxpayers money, the likes of Goldman Sachs (NYSE: GS), JP Morgan (NYSE: JPM) and AIG (NYSE: AIG) wouldn’t be around today. It’s tough to blame them for the whole crisis because so few saw it coming, but then again if conditions collapse for a topiary supply company then they go bust.  Who ever heard of a bank going, errr, bankrupt?  My point here is that these organizations don’t appear to be run with a cognizance that they might fail, therefore the only game in town is (still) to go for profits irrespective of the risk.

I would urge great caution in following professional investors too closely unless they have demonstrable track records of making money over the long term. I would also suggest investors avoid tomes in technical analysis which in fact turn out to be capturing some facet of market conditions that worked for a while only to then fall apart as they changed.

So What to Do?

My only suggestion if you want to be a better investor is to look at your internal thought processes. You will find no end of information, views and data on stocks. In my humble opinion what makes a good investor is the ability to disseminate this mass of information into something coherent and then pick out the salient drivers that are going to guide the stock price. In the end all you want is the stock price to go up while not taking on too much risk. The latter stipulation usually requires a level of humility (diversifying to accept that fact that you might be wrong) that is often missing in professional investors touting for AUM.

No matter, it shouldn’t detract private investors from trying to define clearly what they think is the key driver of the stock price and then analyzing whether they are good at doing this or not over the long term.

As for the Christmas book shopping, I would advise Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay. Any lingering doubt that investing requires humility and the need to avoid selective reasoning should be eradicated after reading that marvelous book.