The Speculator
More market tricks, trapdoors and tomfoolery

Who knows what danger lurks in the heart of every investing bet? Our readers, who supplied this latest set of market disasters guaranteed to happen when you least expect trouble.

By Victor Niederhoffer and Laurel Kenner

Posted July 10, 2003, on MSN Money

It’s guaranteed to happen that whenever we ask readers for insights, they amaze us with their wisdom, humor and knowledge.

We first began writing together in January 2000 and quickly realized that no pair of columnists, however well prepared, could hope to fathom the market alone.

Friedrich Hayek observed that an economy works best when it is free to rely on the inputs, niches and know-how of the many, instead of being forced to follow the ideas of a central planner. We thought that Hayek’s insight probably applied to the study of markets, and we started inviting readers for contributions.

We appealed in our May 1 column (“Market tricks we fall for again and again”) for “guaranteed to happen” stories about the market, and the response once again proved Hayek had it right. We are delighted to relay some of the entries that gave us belly laughs as we went through our mail.

Many readers said they found the accounts of our mishaps cathartic. “The ‘Guaranteed to Happen’ article was the best thing I've read in a long, long time,” wrote Michael Simpson, of Cary, N.C. “I haven't laughed that hard since I was a little kid.” But at least one reader found our listing of tricks the market plays too painful to read. “It opened wounds that were trying to heal,” wrote Irwin Horowitz. Before memorializing the exquisitely painful Guaranteeds of our readers, whose knowledge of time and place extends our reach immeasurably, we take the liberty of unloading one of our own.

It’s guaranteed to happen. . .
. . . that the market will do the unusual and the unfathomable. During weeks after long weekends -- i.e., those with a previous Friday or Monday holiday like last Friday’s July Fourth break -- a pattern seems to appear. From 1996 on, there have been 12 weeks following a Friday holiday. Typically thereafter, a down Monday has been followed by a serious rise of some 2% during the rest of the week. (After the more common Monday holidays, there appears to be no statistically significant regularity. There is a slight tendency to bearishness of about 6-to-4 in favor of a decline throughout the next several days.)

Of course, it’s guaranteed to happen that after a period of six years when Monday-after-Friday holidays were extraordinarily bearish that the Monday after the most recent July Fourth holiday produced the second-greatest up move of all time for such days.

Along those lines, it’s guaranteed that any seasonal pattern based on 10 observations or such that looks truly great in the test tube, be it the summer slump or the January rise or the January barometer, will turn around and devour you when you apply it in real life.

And now, without further ado, the market twists and gibes that our readers have observed to be guaranteed to happen:

Jim Harper III of Harper Capital Partners, Charlotte, N.C.

• Just when it seems that a troubled stock has turned the corner and is improving, making it safe to finally invest, it will issue a huge convertible offering that will dilute earnings for years to come. Managers who had previously told you how much conditions had improved will now spin how necessary this cash is to the health of the company.
• Three-quarters of the way into a big bear move, an "analyst" who practices some kind of wave or cycle theory will appear for a 10-minute interview with a sycophantic reporter who acts as if the analyst has called every major turn for the past 25 years. He will predict the end of Western Civilization As We Know It, payback for our years of overspending, undersaving, too-strong something, too-weak something, etc. A 70-year cycle chart will appear to have peaked last week and will be due to turn down for at least the next decade.
• If the CEO of an otherwise boring company announces that he is going to sell off the crown jewels because there is better growth in the media area, the stock is a sell. Think Westinghouse or Seagram (VO, news, msgs).
• Warren Buffett has not said anything positive about the stock market (as a whole) since the mid-‘70s. He is not going to tell you where he is putting his money right now, so discount his prognostications accordingly.
• When interviewed on TV, Mr. Broker will insist that you cannot wait for the bottom and must buy before the bottom is in place. He will fail to note that the retail investor with 100k may be able to run his affairs differently than his 700mm mutual fund, which is indeed big enough to scale down into positions.
• You will never hear a mutual fund manager admit that he values relative vs. absolute returns. Yet, if he beats his benchmark and is down 25%, he has done his job well, is a hero, and expects a bonus.
• Once the assets of a hot fund pass a few billion (dollars), it will lose its hot hand and start to mimic the S&P 500 ($INX). A fund named after a famous circumnavigator is a prime example of this.

E. Katir, Yuba, Calif.
As a money manager for 20 years, I'd like to add these, all of which happened:

• Your client is a director of Wells Fargo. He says, "buy the stock, massive earnings are going to appear out of reserves after the S&L crisis cools down." Warren Buffett has bought 10% of the company. You don't buy any. The price goes from $40 to $120 in a year. You feel like an idiot.
• The very special deal you put all your good friends in as a favor will sour, while the ordinary deals will perform fabulously.
• A multimillion-dollar discretionary account makes huge returns, in fact, never has a losing trade (hard to believe, but true) but the client sues because he had to pay tax on the gains, and some stocks sold continued to go up so he missed speculative profits.
• Every oil-and-gas partnership salesman has a surefire, insider production well that will return double your money in 18 months, but for some reason he can't find enough investors. Presumably Shell (RD, news, msgs), Chevron (CVX, news, msgs) and Exxon (XOM, news, msgs) have all passed on such puny profits.
• In 1995 you say to yourself, "a company with an idiotic name like Yahoo! will never make it." You try shorting it several times.
• You stay in a market-neutral long/short hedge fund for years, while it underperforms during the '90s bull market. You redeem in disgust. The next year it makes 50%.
• A longtime friend you've loaned money to convinces you to release the collateral "just for a few days;" and then he will collateralize with an equivalent property. His bankruptcy filing arrives in the mail the following week.
• You discover your house mortgage is to be sold at an RTC auction tomorrow afternoon. The bureaucrats are noticeably unhelpful. They try to make you go away. After all, you're just an ordinary consumer citizen. You surprise them by coming up with the $50,000 entrance deposit and try to bid. It's in a $10 million lot, which the bureaucrats refuse to break out, though they admit they could. You helplessly watch a Dean Witter bidder buy the lot for 60 cents on the dollar. You get his card, follow the loan as it is flipped for 70 cents, 80 cents to different bankers. No one will sell you the loan. The message is clear: It's a closed club, and you're not a member. Guaranteed: If you try to get in where the big boys make their money, you'll be shown the door soon enough.

Don't know if you'll use any of these, but I feel a little better.

Michael F Armstrong, Polk City, Fla.
(“That's maybe not quite in the middle of nowhere, but a long way from an affordable squash court.”)

• No matter WHAT the market does, the newsletter publishers will trot out examples of "If you had followed OUR advice and bought MegaMega on Dec. 12, you would have GAINED 237%." They won't mention how they fared overall.
• Our local paper publishes a list of the top 10 and bottom 10 performers on each of the three major exchanges each day. I can't remember a day in the eight years I've been reading this rag that there haven't been gains of 20% or more to be had somewhere. Thus it's guaranteed that even in the market's darkest hour, somebody is making money.

More than a few more
Brian Johnson: The day after you commit yourself to an investment strategy based on asset allocation, the one pocket of strength in your portfolio will promptly plummet.

Charlie Cooper: When somebody finally offers you a good price on the collectible you've been buried in for years, you can't find it. (He adds: I've been in/out of various collectibles businesses over the years. The only people who really make big bucks in collectibles are the insiders and those who can profit from the spreads.)

Dr. Robert J. Jezik: A company reports blowout earnings before the market opens, so you throw in a market order figuring you'll ride the wave up. It's guaranteed to happen that that's the time everyone else wants to take profits, so your stock immediately drops two points from the open. Same situation, but this time you're too cautious to repeat that strategy because you don't want to get burned again. It's guaranteed that the stock will go ballistic after it opens.

Glenn Shaw, Mississauga, Ontario: Re: Cisco Systems (CSCO, news, msgs) and the home stretch of earnings season. The shorts get squeezed at this venue only to be right a week later after a fake-out by sunny J. Chambers. It's like the last race of the night, and the rail position looks guaranteed, but before the race the stock starts giving up odds on favorite. The shorts box the horse and in the last quarter the horse pulls away from the pack by a nose (penny) and it's straight to the winning circle until the next weekend. The only winners are the last-minute ticket holders who bet straight up on the nose and cash ticket within the week, the whip rider who saw it coming and the trainers (fund mangers) who switched around for the next race. The little spectator (long and short guy) enters into another phase of discombobulated dementia.

A Spec Duo test
As our readers know, the Spec Duo is never content to write a column without taking out the pencils and envelopes to perform some counting. The next Guaranteed to Happen, from Joe Granata of Warren, Michigan, seemed not only of susceptible to testing, but potentially useful:

Whenever you are long an option, either a call or put, it is sure to expire worthless and the following trading day on Monday, the stock will make a major move in the direction that would have put you well into the money. Almost never fails.

We tested whether there is an inordinate tendency for stocks to close the day before expiration just out of the money, and then to reverse the next day. We found that 30% of all individual stocks close within 0.75 point of a 5-point strike -- exactly what would be expected to happen by chance. The average move the next day was -0.5 point, regardless of whether the stock was below the strike or above the strike. The study encompassed all S&P 100 ($OEX) stocks during the last 18 months.

Finally, here’s one last Guaranteed from the Spec Duo:

It’s guaranteed to happen that after a series of rises in the market people become bullish, and after a series of declines they become bearish. It’s a manifestation of the availability heuristic, the process by which people estimate the likelihood of future events based on what has happened in the recent past. Our estimates are also swayed by such things as the vividness of past events. For example, some bears have been predicting imminent Armageddon ever since the 1987 crash; since that day fell on a Monday, the predictions tend to show up on particularly trepidatious Mondays. The same thing happened after the 1929 crash. Vic’s Grandpa Martin lived in expectation of an impending decline of comparable magnitude every day for the next 40 years, and some old-hearted gurus have carried on Martin’s tradition.

It’s guaranteed that those who got caught in the tech bubble of the late 1990s will be anticipating Nasdaq 100 for the next 20 years, and this is one reason that the Specs predict Nasdaq 5,000 by 2005.

Final note
We sent official Old Speculators Association canes to eight readers who sent us Guaranteeds for this column. We continue to be interested in fielding readers’ queries and comments. We answer all mail sent to our attention by e-mail, and we’ll be tying all the loose ends together on our Daily Speculations site.