To print article, click
Print on your browser's File menu.
Go back
Go back
Posted 10/11/2001
Related Resources
Check out our new StockScouter rating system
Find the top-rated stocks
What are the top-rated funds?
Read the latest market dispatches
Details
 |
Recent Articles
• 3 immutable laws and 12 sober truths, 10/4/01
• 11 dirt-cheap stocks for a scorched-earth market, 9/27/01
• How a NY cop made his mark in life and death, 9/20/01
more...
|
The Speculator
Are home runs bad for stocks?
Of course not -- but you might think so if you looked at the numbers for both over the past 100 years. Perhaps the lesson is that you can win by just hitting singles.
By Victor Niederhoffer and Laurel Kenner
Two of the most quintessentially American activities -- baseball and the stock market – are mirror images of each other these days. Baseball has seen records fall in attendance, franchise sales and home runs this year, while stocks have struck out.
- On the field, Barry Bonds has broken Mark McGwire's single-season home run record with 73 homers as well as Babe Ruth's 81-year-old slugging percentage record. A graying Rickey Henderson beat a record for runs set by Ty Cobb in 1928. And the Seattle Mariners tied a 1906 record for most wins in a season.
- On Wall Street, the market's 20% decline in the 15 trading days leading up to Sept. 21 was probably the greatest in U.S. history. And we won't even mention how many stocks are down by how much from their two-year high.
| New
stock picks from market professionals every day on CNBC. |
We started our study with five-year highs in home runs over the past 100 years and looked to see what happened in the stock market the next year. When home runs weren't at a five-year high, the market went up 12% the next year, on average. When they were at five-year highs, the next year's average move was a 2% gain.
Next, we studied the relation between five-year changes in home runs and the next five years' performance in stocks. The correlation was -0.20, with 20 observations, a level fairly unlikely to have occurred through chance variation alone. Finally, we looked at the correlation of home run changes one year and stock market changes the next year. The correlation was -10%. The bottom line was that every extra 10% increase in home runs knocked 1% off the market the next year. Taken together, the three relations provide confirmation that when home runs get overly numerous, stocks are negatively affected.
Fortuitously, despite Bonds' home run record, the total number of homers is down from 5,693 last year to 5,458 this year. But what, if anything, does the long-term trend toward more numerous homers mean for investors, and why do these relations hold?
The home-run correction
To answer, let's consider the many small ways Major League Baseball acts to restore the balance between offense and defense. If one side prevails all the time, fans get bored. So the balls, bats and gloves change, the surface and size of the fields change, the strike zone changes and the pitching rules change. These things occur gradually, over several years.
For example, at the end of the 19th century, when a manly, swing-for-the-fences style of baseball prevailed, Major League Baseball adopted dead balls, changed the size of the strike zone and allowed the pitchers to use tricks like spitballs and doctored balls. For 20 years, pitchers dominated the game. Earned run averages of 3.00 and season batting averages of .250 were the norm. (And a new form of "scientific" play evolved, replete with bunts, slides, sacrifice flies and stolen bases on offense, and relays, backups and precise double-play positions on defense.)
After World War I, authorities eliminated spitballs and other doctored balls, put cork in the ball to liven it up and changed the balls more frequently. The action was once again in hitting. We were in the Roaring Twenties, and it captured the spirit of the time. The result was Babe Ruth.
During the 1980s, home runs were relatively stagnant. It was a time of "scientific" baseball. Singles and bunts were in, swinging for the fences out.
After a players' strike in 1994 threatened interest in the game, a general move toward immediate gratification came about in the area of sports and, dare we say it, in the offices in Washington.
And the home runs began to climb. Taking the American and National leagues together, here is the record for the 1990s:
| Season | Total homers |
| 1990 | 3,317 |
| 1991 | 3,383 |
| 1992 | 3,038 |
| 1993 | 4,030 |
| 1994 | 3,305 |
| 1995 | 4,081 |
| 1996 | 4,962 |
| 1997 | 4,640 |
| 1998 | 5,064 |
| 1999 | 5,528 |
| 2000 | 5,693 |
This is not a time for spurious correlations. Obviously, we do not believe that baseball home runs cause stock market changes. However, baseball is show biz. The producers provide a product to the fans that gives them the kind of satisfaction they find most appropriate. Fans have always preferred high-scoring games. When home runs are king, perhaps that reflects society's desire to achieve immediate, sensational satisfaction.
Do we stray too far in suggesting that perhaps, during the beginning of the fin de siecle in the naughties, we were eschewing singles in too many other fields, including, perhaps, our desire to become instant millionaires by turning fast profits in the stock market while living as though we already were multimillionaires?
Is the shift predictable?
The question is whether stocks, like baseball, go through cycles where home runs are appropriate and others where one-baggers will win the game. We can only make a dent in that here. We'll leave for another time how this might apply to individual stocks and sectors. Today, we'll limit ourselves to considering whether periods when home runs in the market are expected tend to be followed by a predominance of singles.
In particular, we'll look at whether low levels of the implied volatility of short-term, at-the-money index options trade on the Chicago Board Options Exchange -- captured in the Volatility Index ($VIX.X) -- are predictive of times when singles are appropriate. We'll also see if high VIX levels indicate that a more aggressive stance might be appropriate.
A good working hypothesis is that when the VIX is high, sentiment is unusually pessimistic and it's a good time to buy stocks. Conversely, when the VIX is below 25% or 20%, sentiment is unusually optimistic and it's a good time to sell.
First, a rather amazing update on the VIX. The normal level for it is 25. On April 26, after spending the better part of two months above 30, it sank below that level and stayed there, reaching a low of 20.29 on July 2. Guess when it topped 30 again?
| Date | VIX |
| 8/31 | 27.85 |
| 9/4 | 28.66 |
| 9/5 | 28.96 |
| 9/6 | 32.48 |
| 9/7 | 34.46 |
| 9/10 | 33.87 |
A high of 57.31 came during the day on Sept. 21. As of the close on Tuesday, Oct. 9, our day of writing, the VIX is at 35.99.
We note that in our May 3 article, "Make volatility and uncertainty your friend," we suggested a system to take account of cycles. We suggested buying stocks when the VIX first closes above 30; close your position out when VIX closes below 25; go long again only after it rises above 30.
The system showed a profit of 3.1% per trade, capturing the full extent of the S&P's gain from October 1987 to May 2001 without tying up money in stocks for the entire period. It was by no means a perfect system, and many readers wrote to criticize it -- a result guaranteed whenever we write an article with a market view, expose a worthless shibboleth or post a system of our own, with all of its weaknesses and limitations.
Updating the system to the present, on May 18 the system would have closed out a long position initiated Feb. 28, realizing a rather normal profit of 4.3%. Then it would have been out of the market from May 18, when the S&P 500 futures closed at 1,295.50, until Sept. 6, when it would have gone long at 1,103.50. Those 15% drops are good to avoid.
Looking at it a little closer, we find that a slight extension of the baseball home run provides a nice model. Let's take all the 20-day highs in the VIX, where the VIX closes at 30 or higher. Taking out overlapping highs, there were 14 such 20-day highs in the past four years. One week later, the market was higher on 10 of the 14 occasions, with an average gain for better or worse of 1.2% and a variability of 3.5%.
As a special gesture to our loyal readers, and to encourage you to communicate to us your thoughts on baseball and markets and other relations, we will be pleased to send a spreadsheet of that and related studies on the VIX to all readers who request it from dciocca@bloomberg.net. We learn much from you, and most of you know much more about baseball than we do. But in a society where knowledge is diffuse, and where tastes and insights are specialized and ever-changing, this is the best way for us and you to learn.
End note
It's guaranteed that readers will write in to tell us that our column is the craziest piece of trash they've ever seen, and that only ignorant people like us would try to see a relationship between the market and baseball. We've given our feelings as to why excesses in one might show up in excesses in the other, and how one might lead the other. However, we plead guilty to often going out on a limb. As one reader so directly put it:
- Half the stocks you listed would have no
merit in a decent market, let alone the shell-shocked market we
experience now.
- Navigant? A company profiting short-term as they help out Oppenheimer with the World Trade Center recovery
- Culp? A fabric company? Ever notice every furniture store is going out of business right now?
- Novell??? They've been slowly dying for 7 years now. They have no market share, and a fading customer base and nothing attractive on the drawing board. Now add a recession.
- Corel? I'd like to believe that, but they sell pricey niche graphic software in little demand and their office software has been obliterated from the market by Microsoft. Now add a recession.
- Western Digital has been floundering for the last 5 years. They build factories in politically unstable 3rd world countries, and build products with next-to-nothing profit margins.
- OfficeMax? This company loses $100 million a year, and is closing stores nationwide.
- PARKER DRILLING??? You'd actually suggest investing in a company that's building rigs in Kazakhstan??? Right next to where the war is going to be?
| Stock | % Change |
| Culp (CFI, news, msgs) | -10.6% |
| Corel (CORL, news, msgs) | 3.9% |
| Dixie Group (DXYN, news, msgs) | 0.6% |
| Navigant (NCI, news, msgs) | -4.6% |
| Novell (NOVL, news, msgs) | -2.3% |
| OfficeMax (OMX, news, msgs) | -8.0% |
| Parker Drilling (PKD, news, msgs) | -4.6% |
| QAD Inc . (QADI, news, msgs) | 21.2% |
| Read-Rite (RDRT, news, msgs) | 45.0% |
| R.G.Barry (RGB, news, msgs) | -2.5% |
| Western Digital (WDC, news, msgs) | 17.5% |
The system that seems to pick the stocks that appear to be the least likely to succeed often is the most successful. The results we reported in our Sept. 27 column, showing an average 36% September-March return for below-$5 stocks in the highest two Value Line timeliness categories, were based on thousands of observations. We are quite confident that the average stock picked by the system was equally maladroit and looked equally reprehensible and counterintuitive relative to all the great stocks selling at 50 or more rather than 5 or less. We'll stick with the system, and our money is where our mouth is.
At the time of publication, Victor Niederhoffer and Laurel Kenner owned or controlled shares in the following equities listed in this column: Culp, Corel, Dixie Group, Navigant, Novell, OfficeMax, ParkerDrilling, QAD Inc., Read-Rite, R.G.Barry and Western Digital.
MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.