The Speculator
10 Dow plays for a
good ol' summertime
We looked at these big-dog stocks and found a
trend: Those that do best through the first half of the year lose ground in
July and August, while the worst first-half performers advance. Here's how
we're playing that trend.
By Victor
Niederhoffer and Laurel Kenner
Summertime, and the tradin’ ain’t easy. Stocks are jumpin’, and the S&P’s high. Victor’s profits in July are usually nothing. But we got some beauties, so readers, don’t you cry.
Summertime, and Vic’s preparing to trek into the
African savanna, where he might be killed by lions and agrarian reformers but
will be far enough away from computer monitors that he can’t overtrade during
his usual July slump. (He may stay there, because the other months aren’t so
easy, either.) Laurel will spread her wings for the gardens of Kyoto, a known
venue for market contemplation. Meanwhile, we’re mulling a move into Dow stocks.
Yes, we are going to short J.P. Morgan (JPM, news, msgs), Home Depot (HD, news, msgs), Intel (INTC, news, msgs), Disney (DIS, news, msgs) and American Express (AXP, news, msgs) around the end of June. And
we’ll buy AT&T (T, news, msgs), Eastman Kodak (EK, news, msgs), SBC Communications (SBC, news, msgs), Microsoft (MSFT, news, msgs) and Boeing (BA, news, msgs). We plan to stay in those
positions, or a basket very close to it, through July and August.
Let us tell you why.
Week after week, we have been coming up with meals for a lifetime, things
like Fed models, interest-rate differentials, the indirect approach, corporate
responsibility, statistical significances and regression forecasts. But no
matter how original our discoveries, no matter how accurate our forecasts, we
continued to bring up the rear in the minds of our readers and our bosses. The
line from "The Music Man" comes to mind, where Marian the Librarian’s
mom tells her, “But darling, when a woman has a husband and you’ve got none,
why should she take advice from you? Even if you can quote Balzac and
Shakespeare and all them other high-falutin’ Greeks.”
It’s true: Our stuff isn’t as catchy as “Mr X, who
manages $50 million, just bought three good tech stocks and we'd like our
readers to know about them if they would like to follow him in an up market.”
The powers that be rightfully put us in the bullpen until we stopped talking
about regression analysis and economic models and started writing about stuff
that readers can buy or sell right now.
Dread of July
The prospect of the bullpen was bad enough. The approach of July made
things worse. Summer’s a difficult time for Vic, you see, because he generally
finds himself on the losing side of some big trend. When he traded for George
Soros, the Sultan of Speculation, the great one would invariably take him aside
at the summer place and ask, “Vic, are you sure you want to continue in this
business?”
Still, the bills have to be paid, and since Vic blew out in ’97, he has
been trading to raise the odd million. He even took on a few clients in places
like South Africa and Zimbabwe, where things are so bad that his own troubles
seem normal. He’ll be visiting those hardy individuals on his way to the wild.
He didn’t want to disappoint them, so in an effort to come up with something
that might reverse the tide of losses that usually engulfs Vic in his trades,
we thought about one of our favorite subjects: baseball. (It is a guiding rule
of the Spec Duo to underline and memorialize all their losses and never admit
to or, worst yet, boast about a profit.)
Now, the one fact that everyone knows about baseball is that batting
averages are streaky. Hitters that do well in the spring often fall in the
summer, and the ones that are doing badly often find themselves standing on the
base paths. We wondered if a similar phenomenon occurs with individual stocks,
and as it turned out we hit on something useful.
We decided to look at Dow stocks, because they’re
big and not very numerous. We went five years back, to 1998, and found that the
best companies in the first half were Wal-Mart (WMT, news, msgs), McDonald’s (MCD, news, msgs), Home Depot, Coca-Cola (KO, news, msgs) and American Express -- with
an average 39% rise. They didn’t perform that well during the summer months. In
fact, they were down 26%, almost twice as big a drop as the five worst
first-half performers suffered in July and August.
OK, that was just one year. When we looked at 1999, imagine our surprise
to find that the first-half best five fell 2% in the second half, while the
worst five rose 5%.
The pattern held in 2000, 2001 and 2002:
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The Dow's summer switch |
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That’s a 14 percentage-point difference in just two months. No way could
that be consistent with chance during that period. It’s 95% that the actual
mean difference for the worst vs. the best during that period was between 4 and
24 percentage points.
We suspect that the effect arises from the
“window-dressing” that mutual fund managers do at the end of the quarter to
pretty up their stock portfolios. By buying the winners and selling the losers,
they look wise. Once the new quarter begins, there’s nobody left to buy the
winners or sell the losers, and a reversal takes place.
Here’s how the Dow stocks are shaping up so far this year.
Final note
Vic to Laurel:We have a problem. One of
the things that sets our work apart is that we like to estimate the strength of
the systems we invent, and to measure the uncertainty of our conclusions. The
results we report above are highly, highly non-random and quite conducive to
some pretty exact estimates of the performance of individual stocks over the
next two months. You start with the stock’s performance in the first six months
relative to the market. For example, J.P. Morgan rose 41% from year-end 2002
through Monday’s close. The market rose 10% in that time. So J.P. Morgan’s
relative performance is 31%.
The best way to calculate J.P. Morgan’s performance over the next two
months is to take one-fifth of that number and subtract it from -7%. That’s -7%
less 6%, i.e., a prediction of -13% for J.P. Morgan’s relative performance for
the next two months. By applying this formula, you can come up with estimates
of the relative performance for July and August for each of the top five
winners and losers.
That simple prediction equation, using nothing fancier than subtraction
and multiplication, turns out to be very accurate. It correlates more than 50%
with the actual performance numbers over the last five years, and it’s well
under 1 in 10,000 by chance alone.
The problem is that if we go into this stuff we're likely to hear, “There
you go again with those fancy equations,” and we’d find ourselves at the bottom
of the barrel. That would be bad for us and our readers because many won’t know
about this great system that has worked for the last five years and is
relatively usable because it applies to big stocks where liquidity is good.
What do you recommend? Vic.
Dear Vic: We promised that we
wouldn’t talk about regression analysis any more. But if it’s just subtracting
and multiplying, maybe we can sneak it in. Laurel
Final, final note: The Spec Duo thanks
Duncan Coker for researching this article. A complete workout of the stocks,
and much more, is available on our Web site, and our book, Practical
Speculation, has a number of extensions of this reversal of fortune system.
Readers are encouraged to write to us at gbuch@bloomberg.net.
Final, final, final note: Any readers who will be
in New York on Sunday, June 29, are cordially invited to stop by the Central
Park Conservatory Garden, 105th Street and Fifth Avenue, for a 1 p.m. gathering
hosted by the Old Speculators Association. Meet Vic and Laurel, and talk about
investments.
At the time of publication, Laurel Kenner and Victor Niederhoffer did not
own any of the equities mentioned in this column.