Dec

20

CountingEverywhere I go, everywhere I turn, I am beset by people who believe this is the time to get out of the market because it looks bad. They have many reasons for feeling things are bad. The latest is a spate of forecasts based on inefficacies of the central banks, solar spots, and likely changes in pessimism. I would urge those who have given up the quantitative approach to come back to their roots, realizing the following:

 1. When the market looks bad, it is more bullish than when it looks good, e.g. after a series of down weeks.

 2. When there is a 10% a year drift, you have to overcome above a 1/2 point a day drift for each day that you're out of the market. If on average, you're out of the market for 60 days, while things look bad, that's 2% you're giving up.

 3. In order to time the market you have to find a time to sell and a time to get out. If you time it by getting out when the market moves X% below a Y day moving average, and get in on the reverse, you'll have the worst of all worlds quantitatively.

 4. When the market is down, of course the news is going to be bad. But is that good or bad for the future? I don't believe the news is worse now than it has been on other occasions where the market is down 5% in two weeks or so, and if it were worse, I don't know if that's bullish or bearish, except for what happens when such occasions occur without regard to any Monday morning quarterbacking.

 5. The forecasts by the big houses of up 10% to 15% based on the differential of the earnings yield and bond yield have been extraordinarily accurate on a prospective basis over the last 15 years as witnessed by the work of the Spec Duo and Mr. Downing on this front.

 6. If you return 14% a year for 10 years you'll end up with 2.5 times as much money as if you grow by 4% a year, and five times as much after 20 years, And that's the underlying compound interest factor that makes the differential return models work. That kind of difference is impossible to beat on a 20 years (or a one day) basis with consistent trading. Keep that in mind as you consider stocks versus bonds.

 7. Especially toward the end of the year, reversals are most prevalent and predictive, with work on individual stocks often showing that those down the most in the last quarter are up significant double digits in the first part of the next year. Is it time to get them now, or to wait until things look good?

 8. After years like 1907, which this year is so reminiscent of for some sectors, what happens the next year?

 9. When considering the hornet's net of worries that the stock market has been exposed to each year over the last 100 as we have documented on Daily Spec, are these troubles that much more significant? And if they are, have they been discounted, and what happens when troubles are more or less than usual relative to the market move? A quantitative approach here would be apt.

10. The market's been more volatile during the last two months in terms of ranges and big moves in an hour than ever before. Is that good or bad?

Before giving up the quantitative approach for a cyclical view of bull and bear markets and hoping that you can time them, I would encourage a little counting.

Alan Millhone remarks:

MoneyIn 2008 I will come into some money (not exactly sure how much) and plan on opening a growth fund for my two younger grandsons (ages 8 & 11). This is money I would not normally have on hand. I have been reading all the Daily Spec postings and learning about the Market Mistress. There is no better place in the world to live than America. Yes, this country has a lot of problems, but what country doesn't? If you have no faith in our economy then you need to crawl into a hole. American has always recovered and rebounded and opportunities will always abound for making money in the land of milk and honey. What other country can change Presidents and keep going strong without missing a beat? Victor's posting makes a lot of sense and is excellent food for thought. Currently bank CDs pay around 4.75% to 5%. There is a lot of turmoil at present and likely always will be. We all know that a new President won't be able to change all that much. So we forge ahead and work with the tools at hand. I am a dyed-in-the-wool optimist with respect to investing in America.

Anatoly Veltman extends:

GoldI am a die-hard value seeker myself and Victor makes a point dear to my heart. There is one caveat, that I feel is applicable to the current environment. We (more to the point: equity markets) have enjoyed the longest period in modern history, of (at least, we were told) subdued inflation. What if that changed? Then operating margins would suffer.

I got the hint that something is going amiss when my indicators on XAU, GDX, ABX, NEM all flipped into down-trend a week ago, while the same Gold Cash and Futures gauges remained in up-trend.

I scretched my head; then PPI and CPI came out and it dawned on me: traders in-the-know held on to the bullion, while getting rid of their ownership in operating concerns! And the Fed will have a job cut out for them, to reign in inflation's ugly head.

Now, since I feel a lot of the Gold Stock move has occured (gosh, GDX is down 21% in a month!), I'm trying to get short stocks that haven't fallen as much yet. Also, Gold should correct somewhat. And Platinum traded $1,529/oz record this morning, not far off my calculated $1,552 target — it should technically correct $300 for starters. Beyond that, I wouldn’t be surprised if it eventually dropped two-thirds of its current price.


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16 Comments so far

  1. gabe on December 20, 2007 1:59 pm

    with all due respect for everything i learned reading you, maybe you should start by doing some counting yourself? look at the 1, 3, 5 and 10 year returns and you won’t find that 14% compound growth. heck YTD S&P is under performing checking accounts. and no, I don’t think what happened 100 years ago has any relevance to today’s, with the casino landscape so different and such.

    on 9/18/07 S&P was 1,519; since then, ben stagflation dilutes american assets by about half a trillion with his 1% cut in the rate and the S&P darling is 1,450 today, or 4.5% lower. using a 20 year discounting period the price should have been about 21% higher or 1,837. any takers? a worthwhile counting would be to go back and see when and if something like this has happened before and what was the outcome 6 month - 1 year hence. maybe this would explain the volatility levels observed. when the seasons change there’s usually a day or two when the wind blows like crazy.

  2. steve leslie on December 20, 2007 2:34 pm

    I recently reviewed Kudlow and Company for this website and I was attacked by some who were avowed Larry Kudlow haters. It became obvious to me that despite my good intentions to report and then let the reader decide some took it upon themselves to attack Kudlow as a polyanna and describe his outlook on the markets and the economy in general as “goldilocks economy.” They assailed him because his mantra is always positive and went so far as to state that he presents only one side of the discussion. They also stated that he only invites those onto his show who side with him ( this of course is disingenuous and inherently wrong.) But they fail to note the fact that the market has been on a steady climb since 2003 when 7800 was the number and Kudlow has been pounding the table along the way arguing for a dividend tax cut (which was passed) supporting the soldiers in Iraq (which is being financed) and that things are pretty good and getting better. And the market is up over 50% since that fateful day of 911 Yet many want to castigate and crucify him because in their magnificent opinion he is a “blowhard” and “irritating.” They also came out to say that now he only has a jaded corrupt view of the market and politics which is pure sophistry.

    I put in a post on Google and that 3 plus years ago you could have bought it for $80 per share and now it is $700. Again some came out and said that “trees do not grow to the sky!”
    I replied that Apple once was under $20 per share and the Jobs took over and now it is near $200. Again the nattering nabobs of negativism took over with their diatribes and focused on all of the negatives of Apple. Ipods are passe!

    I thought to myself. What is so bad out there in the world. Employment is good, economy is good, interest rates are coming down both on the Fed rate and the discount rate, The Federal Reserve is proactive rather than reactive, European Central Banks are loosening credit, The Iraq fiasco is stabilizing, civilian deaths and military deaths are declining in Iraq, and many other variables are either improving or starting to improve.

    Yet some prefer to focus on one item. The residential housing crisis and the subprime crisis. Bear Stearns had the first down quarter ever. Goldman earnings were down due to writedowns. Toll Bros reported a very rare loss for them. Alan Greenspan mentions in a Sunday evening speech that he fears stagflation. That is it! Stock the pantry with Tuna fish and start building a self-contained bomb shelter in the backyard.

    People are going to believe what they want to believe! Period. In general, they don’t want to read about or hear about other views they want to focus in on those who share their views. Conservatives listen to talk radio because they hear the things that they want to hear.

    What is the point of all of this? A wise and discerning speculator takes advantage of the psychology of the market and the ephemeral extreme fluctuations to exploit and take advantage of. The speculator listens to what the market is telling him/her.
    The very great Lazlo Birinyi said “I never listen to what people say, I watch what they do.”

    I was around in 1990 when Citigroup was priced at $10 and some commented that a China Syndrome was in the making because of all the third world debt that they held on their balance sheets. I could write for hours how many predicted the demise of the Large Banks. Which as we know never happened. Gigantic fortunes were made by speculators who bought up commercial property while the RTC practically gave away real estate to any who could fog a mirror. Large Banks and regional banks and savings and loans were being offered to anyone who wanted to buy them.

    I was around when Michael Milkin, Ivan Boesky, and others were indicted,convicted and ultimately sent to prison and the high yield bond market was sent to hell in a handbasket. Bids? there were none. Drexel filed for bankruptcy. Merrill lost $500 million in Io’s and Po’s. Junk Bonds suffered greatly yet eventuall the market stabilized and many came out and prospered greatly.

    In 1942 during the height of World War II and with the war very much in doubt the stock market slowly but methodically began to turn thus anticipating and predicting an Allied victory and a U.S. success. Almost magically the war ended 3 years later and the U.S. prospered for 20 years after all the way up to 1966.

    History is replete with many more examples and illustrations.

    My feeling is I hope everyone gets negative I hope the Best and the Brightest come out and predict the demise of manking, the implosion of the stock and real estate market, and a Democratic victory in 2008(I cant wait to see the emails on that one!).
    Because that is where value is created. The speculator notes this and takes advantage of it. Is it easy. Hell no! If it were then everybody would do it and nobody would make any money.

    Peter Lynch once said that while during his tenure at the head of Fidelity Magellen the stock market suffered through six major declines and he participated in every one of them.. He also said that he spends about 15 minutes a year worrying over the economy. He prefers to focus on making money and his track record is exemplary for 20 years. Look it up! Better yet read his books.

    But I know that people are people are what they are and crowds are predictable. And in the end, they are going to do what they want to do even if it is losing money and nobody is going to tell them otherwise.

    I leave with one last thought 40 million people visit Las Vegas a year. Many come for the shows,for the food, for a convention, for the water show at the Bellagio, for the legalized prostitution for the mere pageantry of the place. They also come to gamble. Most play slots. Despite the fact that it is a statistical impossibility to win at slots over a long period of time. And the casinos earn less than $100 on ever man, woman and child who visits Las Vegas ever year. That equates to $4 Billion per year most of it guaranteed. Meaning the more slot players, the more predictable their take is.

    Why? Why don’t they just write a check to the casino for $100 per person, have a nice meal, catch Barry Manilow at the MGM or Celine at Caesars or Wayne or Charo or the other innumerable acts on the strip and off the strip?

    I will leave that question up to the reader to decide.

    God bless all this Blessed Christmas. Say a prayer for our soldiers in harms way. hug your child and tell them you love them. Call you family and tell them you miss them.

    Merry Christmas,

    Steve Leslie

  3. MarketBeat Blog - WSJ.com : Blog Roll -- On Charts on December 20, 2007 3:19 pm

    […] On Daily Speculations, Victor Niederhoffer counsels some of those who are worried about how bad the market looks. “When the market looks bad, it is more bullish than when it looks good, e.g. after a series of down weeks,” he writes. […]

  4. Tom on December 20, 2007 9:41 pm

    Allan Millhone writes, “If you have no faith in our economy then you need to crawl into a hole.”

    Whoa, let’s put numbers and facts on the table and not personal attacks.

  5. Mulholland Drive Street Racer on December 20, 2007 9:50 pm

    Yeah, Yeah, Yeah! AMT drama is over. Too early to fret over things like a Democratic sweep and Marxist Re-Distributionists foaming-at-the-mouth to raise tax-rates on everything that even twitches. What? Get negative in here on Dec. 20? No. Buy the shit out of US equities through at least mid-Jan!

  6. jeff on December 20, 2007 10:52 pm

    Reading this blog is like sipping a fine brandy while listening to a nice piece by Mozart.

    Of course, I wouldn’t mind hearing about some good BBQ joints as I’m a world class BBQ chowhound. I have a favorite BBQ place in Arcadia, Florida that is nothing more than a tar paper shack. It has no sign, and I don’t think that they even have a telephone. They are down at the end of a road with a big Budweiser sign, a sign that says BBQ, and another sign that says “Eat.” They use paper plates, and leave a roll of paper towels on each table. Their BBQ pork is fantastic, with a sweet sauce that is very complex in flavor. Combine that with the second best sweet tea in the world(my lovely wife’s is the best), and you have a meal worth driving 1000 miles for.

    I’m just thankful that I found this elegant site, and really appreciate the interesting take y’all have. You turn markets into poetry.

    Jeff

  7. Dan Sturzenbecker on December 21, 2007 10:05 am

    I think caution is advised in making a comparison between the earnings yield on stocks and that solely on treasury bonds. The yields on preferred stocks, muni-bonds, corporate bonds, REITs, and just about everything else that has a significant yield other than treasury bonds have been going sharply higher recently. Since these investments are in competition with stocks for investment dollars, it makes sense that the stock market has been facing a headwind.

  8. Bill aka NO DooDahs! on December 21, 2007 12:13 pm

    Well, Vic is correct, but one has to still have capital (and investors) when the market is down … it doesn't do much good to have a down market and a potentially bullish situation when all your investors are redeeming funds and you're personally out of business.

  9. vniederhoffer on December 21, 2007 1:35 pm

    In response to Dan, I would suggest that there have been hundreds of barbeque posts and sites on this blog and they are available on the search engines including ours. As to Bill, I agree completely that one should never trade in a market where the people on the other side of the market control the exit points and margins required, and thus the scenario that he speaks of might in part evanesce, even if one has made a fortune in total by doing so. It's holding a tiger by the tail. Let us hope all will apply this lesson about not getting in over the head. vic

  10. Marco Loureiro on December 21, 2007 2:02 pm

    I find it particularly interesting the reaction that a few posts tend to generate amongst readers. It only takes a bullish or bearish view to bring a plethora of intelligent opinions (and not so intelligent ones) to counter argue one another. Invariably, the posts turn into an arguing match. This is much like what happens in financial markets on a daily basis as prices oscillate from one level to another.

    It also reminds me of my days in the competitive sport of track. It was not unusual before a race to see your opponents engaging in a psychological warfare in telling you how their training was going well and that they had improved their racing time in the past few months. Occasionally you would hear from other coaches how Mr. X or Mr. Y was ready to win the race that you were just about to run. So I learned at a very young age to completely shut down all the noise and to focus in one thing only: the starting gun. In the end, words did not matter much… it was all about endurance, stamina and strategy. Bottom line, being bullish or bearish is in my opinion just that… an opinion. It is when the opening bell rings where the real battle starts as the market takes no prisoners and it crushes those that hold too dearly to their opinions.

  11. Bill aka NO DooDahs! on December 21, 2007 3:06 pm

    "They" only control the exit points and margins required if you let them. Leverage is a Faustian bargain. This is a scientific approach to speculation with leverage: You know what the S&P 500 futures were at the day you took your first trade in the first fund you managed. You know what the S&P 500 futures are at today. Pull up a table of the S&P 500 futures daily transactions from then 'til now, and calculate how much margin you could have applied (3:1? 2:1? I dunno, I haven't done it) without going belly-up. Whatever that number is, perhaps it's too much to use, on a going-forward basis? You probably have a pretty fair idea what size of capital drawdown will cause widespread redemptions in a fund! Assuming you were to trade according to a systemized set of rules (instead of discretionary trading according to no systemized set of rules), you could apply that same thought to your system's tested equity curve results. What amount of leverage would, in backtesting, have drawn your equity below the amount where redemptions would hit? Whatever that number is, perhaps it's too much to use, on a going-forward basis?

  12. Mulholland Drive Street Racer on December 21, 2007 4:00 pm

    When power-sliding on Mulholland Drive, you always have to keep an eye on signals from your look-out’s posted at Laurel Canyon and Coldwater Canyon. In the old days, you always could elect to duck down Bowmont Drive and get lost in the streets above BH, sort of an escape hatch from either humiliation or defeat or to ditch the LAPD. But the thing is to always be loose. Can’t hold on to tight. Have to feel the car and the granularity of the pavement. Can’t over think or you’re dead. Too many here seem to be over thinking.

    Hey, have fun. Make good dough in ‘08. Don’t hang on too tight. And above all else, be nimble and know where your escape hatchs are. We have some sublime markets to trade for ‘08.

    rock and roll.

  13. GiverOfUnwantedAdvice on December 21, 2007 4:44 pm

    As an immigrant, I can only agree with Mr. Millhone's enthusiasm for investing in the U.S.. As a CFA (sorry, I mean as a holder of a CFA designation), I think diversification is important and I would suggest an allocation of 75% US, 20% Europe and 5% Emerging Markets. That would still represent a strong bet on the U.S.. To reduce costs you should use index funds; three suitable names: Vanguard Total Stock Market Fund, Vanguard European Index and Vanguard Emerging Markets Index. Since the beneficiaries are minors you could open UTMA accounts with you as the custodian; alternatively if the funds are going to be used for college, it might be better to open "529 savings plan" accounts. Whatever you decide (100% US or some other allocation), good luck!

  14. Tom on December 21, 2007 5:18 pm

    Allan Millhone said "What other country can change Presidents and keep going strong without missing a beat?" In France they have peacefully transitioned rulers without incident for over 200 years. Also, it is possible that unstable countries give better returns because the instability is fully discounted.

  15. AlB on December 22, 2007 6:56 pm

    First of all, it is a pleasure, both intellectually and, I hope, financially, to read this blog. Second, re Victor’s Point 9. I believe that someone published a chart years ago that showed the reason for not investing every year since 1929. As a background, it showed the growth of the Dow. Anyone know where that chart might be found.
    Further: re BBQ, I believe you have to be in western/central North Carolina to understand good BBQ.

  16. steve on December 23, 2007 6:50 pm

    If you want a chart on the market and the reasons to not invest check out the Capital Guardian and Trust Co. which manages the American Funds group. In it their oldest fund is the ICA the Investment Company of America. It goes back to the 1920's, far enough to make the argument. It is a mountain chart that shows the major reasons not to invest and the performance of the fund.

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