How The Portugal Telecom Mispricing Went And Other Musings

Aug.11.14 | About: Portugal Telecom (PT)


This article summarizes the outcome of the Portugal Telecom mispricing I warned about a couple of days ago.

And then goes on a wild tagent about the issues pertaining to your investment life which the taking of the Portugal Telecom opportunity brought to the fore.

So, basically, you can't miss it and I can't summarize it cleanly here.

First, I'll leave a few words regarding how our "Buy Portugal Telecom Right Away" thesis went.

It went perfectly. But not because it made money. It went perfectly because of how ultimately the market traded the next day. This is what happened to Portugal's main index, PSI20 (Source:

So on a day the main index fell 0.80% and the second best stock was up 0.45% while most stocks were down meaningfully, Portugal Telecom (NYSE:PT) rose a massively non-random 7.28%. This, as expected, was not noise. This was us trading on material information which was not yet in the share price, and doing so successfully.

Why could it have gone wrong and still be the right call?

Imagine that the PSI20 pictured above depicted the index being down 2.5% with everything down 3-5% or more and PT down 1%. We would have lost money. Yet, would we have been wrong? No, we wouldn't. We had correctly predicted what the impact would be from this piece of information. Unfortunately, the impact from this piece of information would have been overwhelmed by the impact from many other pieces of information floating about that day.

We'd still need to take the same trade over and over again in the future. Because in the end, like the roulette dealer pushing the wheel, the odds would be with us.

On omniscient market makers

One of the recurring themes in this instance, was how if the news was material, the market maker would have reacted to it. This was today's version of a well-known quote which goes like this:

Two economists are walking down the street and one of them notices what appears to be a $20 bill on the sidewalk. "It's not a real $20 bill," the other economist declares. "If it were a real $20 bill, someone would have picked it up off the sidewalk already."

People have a strange notion about how efficient markets are supposed to work. Even for those believing in efficient markets, it is the actions of the multitude of buyers and sellers that produce the efficient market. But these buyers and sellers have to drag the market to efficiency kicking and screaming by having informed traders relieving uninformed traders wanting to trade out of their positions. In this case we were simply the informed traders, the smart money, dragging that market to efficiency.

Which brings us back to the market makers. The market makers dread trading against informed traders. They'd rather you be as dumb as possible. They'd rather you be buying a $150 billion stock that's saying it will post a $0.5 billion loss soon, versus past expectations of it already making more than $1 billion in the same period. They'd rather you do this on the words of some analyst which says such powerhouse stock will soon be earning the moon in the next four years, even though the same analyst would have been entirely wrong over the past four. This is for illustration purposes only - such extreme kind of dumb doesn't really exist (or does it?). That's how they rather you be, when approaching that buy or sell button.

But there are no miracles. Sometimes when you press that button you're the informed party. And here, you were the informed party. You had material information that was not yet reflected on the share price, and the market maker along with everyone else was sitting on a stale opinion and trading on it. So, as you saw at the end of the day, you and others had to drag this brute uninformed throng to the light - though trading, through buying everything they had to sell and then some more.

So again, the market is only efficient after you drag it there through buying and selling which is profitable for the informed parties. And in this process, which can happen quickly, the informed parties mint excess returns. Alas, by being here reading Seeking Alpha, you're already a bit closer to being part of the "informed parties".

Not the first time, not the last

I should also add something which I left out of the original article. That this wasn't the first time I saw this kind of inefficiency take place. I've seen the same happen over and over again. Indeed, I've seen the same happen right in Portugal Telecom and to a much more incredible extent:

Once, it was reported that Portugal Telecom was subjected to a buyout offer by Sonae Investimentos. And yet, the PT ADR took at least half an hour or so to react to the news after them being posted! Knowing this, you have to understand that there might be a delay even in news events that are more straightforward than those we traded.

OMG! He's turned into a sinful daytrader!

That one was a constant. People miffed that we were daytrading. That we were not Warren Buffetting our way through life as our parents would have wanted us to (never mind that our parents were trading partners back and forth like they were surplus baseball cards back in the 70s).

Alas, this is the wrong way to think about it. There are only two ways to go through this investment life, and they are:

  • Either you are allocating investment resources to asset classes and waiting for the economic returns of those asset classes to provide you with your portfolio returns. Here, you'd do best to simply allocate among several ETFs;
  • Or you're actively trying to trade your way around it. That is, you are actively trying to find mispricings in the market, and to act on them before the overall market does and to thus reap returns in excess of a "normal" return for the asset in question. This is what we were trying to do.

If you're trying to trade mispricings, then the answer to the question "how soon do I want the mispricing to go away" is "as soon as possible". There is no shame in buying or selling something wanting it to reflect reality the very next day. Most of times, of course, you won't have any indication that tomorrow the mispricing will be gone. But here, you had.

Even those trading on squiggles in a chart are doing this. They're trading on the diffuse notion that trends hold more often than not (and more often than randomness would dictate). But after they buy they wouldn't be pissed to see a buyout. After they sell they would be happy to see the thing bankrupt as soon as possible. There would be no additional value in seeing the asset going where it should in a lengthy Brownian motion.

So be glad that in this instance we had reasons to believe the mispricing wouldn't last more than a single session - most of it, anyway. In truth there is research which says the most likely outcome would now be for PT to continue up in the short term because surprises are not fully discounted in the session they produce themselves in. But that's one of those effects which works like the wind, with most particles going randomly every each way but with a slight bias towards a given destination. Not the kind of thing we can trade easily like we did here.

In this situation, we were on similar shoes to someone handed the next day's earnings report by a filthy CFO. Only for us it was legal since the news were already plastered in the media, but the stock had not reacted yet. Should we be sorry that we would be making money too quickly? That the mispricing wouldn't last enough for us to have a return AFTER a bit of wholesome Brownian motion and anguish? No.


One of the things this situation highlighted, is the importance of liquidity. Why were we able to trade on material information that was already public but not yet reflected on the share price? Because the PT ADR in the U.S. Markets trades around 1/5 to 1/10 of what it does in the Portuguese market.

That is, the opportunity was available to us because the U.S. markets in this stock are less liquid. Let that fall into place. How many times have you complained, on small cap stocks, that the situations are too illiquid for you to dabble in them? And yet, the lack of liquidity is your friend. The lack of liquidity is the most powerful indicator of a possible mispricing. If you're on the business of finding mispricings, you might actually need it. And conversely, if you trade only the most liquid of stocks, you'd setting up for the precise opposite - to find no (favorable) mispricings at all.


The trade worked because it was very likely to work. It worked quickly because intrinsically it had to. It's not a shame for it to have worked quickly, we're not less worthy for it. If we are trying to find mispricings, this is what we have to do and the quicker the mispricing goes away after we position ourselves, the better. If we are not trying to find mispricings, then we'd better off simply allocating to a diversified set of ETFs and keeping the money there through thick and thin.

In the mean time, keep reading Seeking Alpha. Tell your friends to do the same if you really like them, lest they end up following Goldman Sachs or someone similar into some kind of "the profits are coming!" slaughterhouse at a gazillion times earnings.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.