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I have a PhD in Finance (ABD), a Masters in Economics, and a B.S. in Industrial Engineering. All three of my degrees have largely been focused on data analysis, and that’s what most of my work experience has dealt with. I’m a professor at a major US university now where I teach classes on data... More
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  • A Note Of Caution:

    Today's unemployment numbers were pretty good; remarkably good in fact given the concerns about the fiscal cliff, the sequester, and the weather. And while everyone should be cheering for stronger employment numbers to continue going forward, it is worth noting that the January numbers, which had been for 157,000 new jobs were revised down to only 119,000 new jobs. That's about a 24% fall. Assuming that this month's numbers are also revised down 24% or so, that would put the February jobs number around 179K which is only slightly better than what the street was looking for.

    It's also worth noting that the payroll numbers are a fairly volatile measure. They have averaged about +170K or so over the last couple of years, but even taking out the recession, they have bounced around from about +100K to about +250K each month. To put some specifics on it, the last 4 months payroll numbers prior to today's were (after all revisions to date):

    October +160K

    November + 247K

    December +219K

    January +119K

    Hopefully my concerns are misguided and we will continue to get 200K+ numbers for a long time to come, but I'm wary of reading too much into any one data point. Don't get me wrong, I'm all for bigger payroll numbers, but let's hold the champagne for a bit.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Tags: economy
    Mar 08 6:40 PM | Link | Comment!
  • Last Week's Markets And This Week's Outlook

    Last Week's Markets and this Week's Outlook

    Overview of Markets

    After a pretty wild ride that saw a frigid Italian political climate get heated, significant testimony and clarification the Federal Reserve's intentions from Ben Bernanke, and earnings numbers from most of the big retailers, the week is finally over. The DJIA finished the week up 35.17, the Nasdaq was up 9.55, and the S&P was higher by 3.52. The tepid gains belie the wild gyrations in the markets though as this week saw up and down movements from -1.8% on Monday to +1.2% on Wednesday. These moves were about 2 standard deviations from normal - meaning historically they only happen on average perhaps 10-15 times a year.

    Reflecting expectations for increased volatility going forward, the VIX spiked this week to about 19, before settling in to close the week at 15.36 still markedly ahead of where it has been for most of the last 2 months. The VIX has averaged about 16 for the last 12 months suggesting that the markets have been unusually optimistic and stable since the start of the year, a situation that is unlikely to be maintained indefinitely. Despite increased concerns about future instability though, the Dow sits near its all time high.

    Last Week's Economic Numbers

    New Homes sales for the week came in better than expected on Tuesday, as did Consumer Confidence. The housing figures suggest that the housing recovery continues (albeit the real estate market is still far below its 2006 peak), with sales likely to continue increasing going forward. Sales prices continue to increase as well. However, construction spending numbers later in the week indicated the recovery may not be as strong as it has been in the past few months, and that there is a small possibility the recovery may decelerate going forward.

    The Consumer Confidence numbers also came in well ahead of expectations and combined with the Michigan Consumer Sentiment figures of Friday, suggest that overall the country is not particularly worried about the sequester. While it's likely that the sequester will do some minimal damage to the economy, for now no one seems to be concerned about it driving the economy back into a recession.

    Wednesday's Durable Goods Orders for the month of January were very noisy as usual, but two key points stood out aircraft sales were way down in January but other than that, the numbers were better, and second, demand for business capital stock picked up more than expected which suggests businesses may be looking to gear up later in the year.

    Thursday's revision to last quarter GDP contained both good news and bad news. The good news was that the economy did not actually contract in the 4th quarter of last year. The GDP number was revised from -0.1% to +0.1%. However, this is still an anemic rate of growth compared with the ~3% growth seen in earlier quarter last year. Driving this anemic growth was a fall in exports and a decline in government spending, in part driven by the fiscal cliff and the sequester. Growth in the private sector actually looked fairly strong reflecting an improving economic picture. Increases in non-residential investment, residential investment, and equipment and software, all support this view.

    Initial unemployment claims last week fell to 344,000 for the week ending Feb 23. This was a notable move for two reasons. First, for the past several months unemployment claims have been bouncing around between 350K and 400K - this marks the first time they have fallen below 350K in a long time. Second, the Department of Labor did not issue any special guidance or explanation that would suggest these numbers were a one-off phenomenon. If the initial unemployment claims stay below 350K going forward, that would be definite evidence that the economy is starting to pick up steam.

    Historically, one of the most important predictors of whether stocks rise or fall over the next 12 months is what the average initial unemployment claims are over the past 4 weeks. Read about my Decline Probability Index for more on this subject.

    Finally, just as the US economy looks like it might begin picking up steam, things have gotten grim in Europe again. Friday brought downbeat economic news out of Europe including disappointing UK manufacturing data. Frankly it will be a small miracle if the UK manages to avoid a recession this year. Collectively across Europe, only the German economy can be described as anything close to healthy, while most countries look very likely to enter a recession later this year.

    My European Recession Model has the chances of a European Recession, defined as 2 or more consecutive quarters of negative GDP growth, at 74.2% in the next 12 months. The model indicates that the chances of at least one quarter of negative GDP growth are 84.9%.

    In Asia the Chinese PMI readings were lower last night, but frankly that data is highly suspect given all the dislocations surrounding the Chinese New Year. Given the fairly positive commentary from $JOY global earlier this week about China, it is unlikely that the Chinese economy is heading for a major slowdown.

    Notable Movers

    Best Buy (BBY) advanced at the end of the week following a dramatic improvement in earnings, though the company also now looks unlikely to be taken private. This is roughly a 1 standard deviation move from $BBY meaning that this type of volatility in the stock is to be expected on average once a month.

    Intuitive Surgical (ISRG) spent Friday rebounding more than 8.5% after it plunged 11% in the last 5 minutes of the day on Thursday. The stock collapsed following a report that US regulators were sending surveys to doctors to assess the safety of one of the firm's products. It is rallying back today on the view from several analysts that the concerns are overblown. This is about a 2 standard deviation move for $ISRG and is to be expected on average 3-6 times a year.

    Joy Global (JOY) announced earnings that were ahead of expectations and had good things to say about China. The beaten down equipment maker reaffirmed guidance going forward tamping down fears that its prospects were deteriorating. Nevertheless, the stock fell on Friday after concerns about the health of the Chinese economy. These concerns are probably overdone as I mentioned above.

    (GRPN) and (JCP) battled it out for worst earnings report this week with both stocks seeing dramatic declines following their earnings. Concerns continue to dog Groupon over the viability of its business model, while JC Penny's has chosen to go from an admittedly uninspiring retailer to a trying to adopt business model that virtually no one seems to understand and sales numbers that continue to disappoint. Following earnings $GRPN ousted their CEO Andrew Mason leading to some significant optimism about the stock on Friday.

    Looking Ahead to Next Week

    Monday: No major economic data is due out on Monday, but before the bell 3D printing company Stratasys (SSYS) reports. This sector has been on fire over the last year with expectations of the technology running high. While the growth in the industry continues to be significant, it will take a lot to impress the markets as competitor 3D Systems (DDD) discovered. After the bell, retailer Ascena (ASNA) reports.

    Tuesday: Smith and Wesson (SWHC) and Verifone (PAY) both report on Tuesday. SWHC has been under pressure lately due in part to the possibility of stricter gun control standards, particularly on so-called assault weapons which make up a quarter of the firm's sales. Nevertheless, demand for guns and ammo has been so strong for the last few months that it would be remarkable if SWHC didn't beat earnings estimates. (RGR) beat handily last week, and expectations must be that SWHC will do the same.

    reports on Tuesday after the stock collapsed by almost 50% earlier in February. The fall came after the firm announced that earnings would come in markedly lower than expected. While the firm didn't give a lot of details about why it would miss, it appeared to be largely driven by an effort to shift from making money selling credit card terminals to making money in a stream of service fees on the terminals.

    The firm continues to believe it has a bright future, but analysts are divided on the stocks with some seeing value, and other wary of the uncertainty. In a future post, I will look at the probability of the average firm's turnaround effort succeeding based on past historical data. As an investor, it's important to know what the chances are that you will get your money back after a collapse in stock price like that suffered by . Follow my posts for a detailed analysis on this in the next week or two.

    Wednesday: Wednesday will see a variety of earnings from (AEO), (BIG), (HOV), (TPH), and others. The market moving news will likely come from the ADP numbers, the Fed's Beige book, and the factory orders figures. If these numbers are too good it may scare investors that the Fed will stop stimulating the economy with QE-infinity, while bad numbers may lead to concerns over a slowdown driven by Europe. Either way, Wednesday could be volatile. In fact, historically, Wednesdays and Thursdays have been the most volatile days for stocks.

    Thursday: Initial Claims numbers and earnings from (KR), (NAV), (WSM), (P), (THO), and (WDAY) should give the markets plenty to digest on Thursday. A jobless claims number below 350K would be a very positive sign for the economy's near-term future, especially if there is no indication from the Department of Labor about increasing layoffs around the sequester.

    Friday: Finally, Friday will bring earnings from (ARCO), (CCL), (FL), and (ANN), as well as the monthly employment numbers. A payrolls number between 170K and 210K would probably be ideal for the markets in terms of balancing the need for continued Fed support and avoiding the European mess washing up on our shores.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Mar 05 10:52 AM | Link | Comment!
  • What Are Your Chances Of Making Money In Stocks This Year?

    What Are Your Chances of Making Money Investing In Stocks Over the Next 12 Months? Is the Stock Market Likely to Go Up or Down this Year? Read On to Find Out...

    Research in Behavioral Finance has revealed that people hate losing money a lot more than they like making it. How much the person hates losing money varies, but is closely correlated with the individual's risk aversion. So one important question for most investors is; 'How likely are my investments to lose money?'

    The answer of course depends on which stocks or bonds someone buys and whether they are diversified or not. However given a set of characteristics for a given stock or series of stocks, it's possible to build a statistical model that will tell you how likely those stocks are to go down in any given 12 month period.

    This is exactly what my Decline Probability Index does for the S&P 500 as well as the major sectors of the markets (see my blog at: InvestmentQuant.com for more details on this). In this post though, I'm going to go over what returns have been like for an individual stock over the last 13 years to try and give you an idea of what risks and rewards you face in picking individual stocks.

    First let's make sure we're on the same page though with some basic definitions: the mean is just a basic average. If we have returns of 10%, 13%, and 20%, then the mean is 11% (10% + 13% + 20%/3 = 11%). The median refers to the 50th percentile or the middle return if we sort the returns from highest to lowest. So again if we have returns of 10%, 13%, and 20%, then the median is 13%. Finally, other percentiles like the 25th or 80th just refer to the return at that level after have sorted all returns. In other words, if the 80th percentile is 12%, then that means that 80% of stocks have a return below 12%, and 20% of stocks have a return above 12%.

    OK, so here are the returns for all publicly traded firms from January 2000 to December 2012:

    Mean: 4.90%

    20th Percentile: -35.24%

    33rd Percentile: -16.23%

    40nd Percentile: -6.62%

    47th Percentile: 0.32%

    50th Percentile: 1.87%

    60th Percentile: 10.43%

    66th Percentile: 18.04%

    80th Percentile: 38.3%

    Yes, I know I picked some weird percentiles there. You will see why in a minute. First, what is this telling us? Well to begin with, we can see that over the last 13 years, if we hold a basket of lots of stocks so that our risk with any specific stock (a.k.a. idiosyncratic risk) is very small, then we will have returns of about 4.9% per year.

    Further, if we just throw a dartboard at a list of stocks, about 47% of the time the stock we hit will have gone down, and 53% of the time, it will have gone up. If we had picked one stock at random in 2000 and held it to 2013, we would have earned just under 2% per year on average.

    This tells us two things. First that diversification was very important over the last decade. second, since the mean is above the median, there were a large number of bankruptcies from 2000-2013. Essentially then, this implies that outperformance in stocks over the last 13 years came from avoiding bankruptcies. In fact, losses in the last decade have had a lot of variation over time as the chart below shows. (Percentages are in decimal terms, so the 20th percentile of stocks in the year 2000 had a return of -58.2%.)

    Year

    20th

    35th

    40th

    45th

    47th

    50th

    55th

    60th

    2000

    -0.582

    -0.298

    -0.214

    -0.136

    -0.107

    -0.064

    0.005

    0.072

    2001

    -0.462

    -0.214

    -0.148

    -0.088

    -0.065

    -0.032

    0.021

    0.073

    2002

    -0.290

    -0.090

    -0.037

    0.011

    0.032

    0.062

    0.116

    0.170

    2003

    -0.055

    0.099

    0.143

    0.188

    0.205

    0.233

    0.281

    0.332

    2004

    -0.213

    -0.063

    -0.026

    0.010

    0.024

    0.045

    0.084

    0.128

    2005

    -0.166

    -0.032

    0.003

    0.038

    0.052

    0.073

    0.109

    0.148

    2006

    -0.231

    -0.090

    -0.051

    -0.015

    -0.001

    0.019

    0.055

    0.096

    2007

    -0.576

    -0.416

    -0.367

    -0.321

    -0.302

    -0.276

    -0.231

    -0.188

    2008

    -0.583

    -0.411

    -0.359

    -0.308

    -0.288

    -0.258

    -0.208

    -0.154

    2009

    -0.110

    0.054

    0.099

    0.146

    0.166

    0.195

    0.246

    0.300

    2010

    -0.195

    -0.035

    0.008

    0.050

    0.066

    0.091

    0.132

    0.175

    2011

    -0.189

    -0.104

    -0.086

    -0.053

    -0.046

    -0.044

    -0.027

    0.004

    2012

    -0.141

    -0.072

    -0.054

    0.016

    0.040

    0.071

    0.104

    0.139

    The take-away here if you aren't a statistics person is that the percentage of stocks that have lost money varies from year to year, but it's usually between 40-45%. Basically, if you want to avoid losing money in stocks and you don't like the risk of the stock market, trying to pick individual stocks is a terrible idea.

    Instead you should buy an ETF, or buy at least 5-10 individual stocks so you have some diversification (and even this is more risky than the ETF). Remember, for more than 200 years, the stock market has gone up in fits and starts. If you hold a basket of the market, you will come out ahead in the medium term. If you buy an individual stock, your odds are much riskier.

    If you are OK with taking on risk and potentially losing a large amount of money, then go ahead, but you really should have some kind of model backing up your investment decisions. At a minimum, a good DCF model is useful, but preferably you should really have a couple of regression models backing your choices. (Logit/probit models, a time-to-failure model, OLS, whatever.)

    Now assuming you don't know anything about regression or DCF models, but you are worried about your individual stock choices, what should you do? In that case, just follow my posts and wait for my next entry in a day or two. I will be telling you all about these models and how to use them to predict returns for various firms.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Mar 05 10:47 AM | Link | Comment!
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