O. Young Kwon's  Instablog

Netflix (NFLX), Chipotle Mexican Grill (CMG), and Bidu.com (BIDU) have been most volatile through the entire last year. I made frequent trading (33 profit/loss takings), pretty big gains (6.6%) for 14 days, paying a $2.65 two-way commission on average, and still holding them.

 

A 6.6% gain for 14 days was enormous. It was a 168% gain annualized. The win average was 97% (32 out of 33). There was no homerun, but many solid singles. The question is how to fairly evaluate this performance. This question leads the following principle.

 

                                 The SAM Principle

 

Investment results depend upon three things: science (“S” 40%), art (“A” 30%), and market trends (“M” 20%). The principle of S (science), A (art), and M (market) makes the “SAM” principle. The 10% residual is luck.

 

The science part includes (a) rigorous stock selections with market data, (b) careful reading of chart formations, or (c) any own system, which is a simple reliable discipline, rules, guide, or strategies. All decisions made by different institutions and individuals with different methods are interacting in the marketplace every moment.

 

The art part is working in the area where human beings are curing the weakness of a machine (algorism, logic, pattern, number clinching, etc), by adding a sound judgment. The art contributes both ways – positively or negatively. The 30% success is based on our decision making.

 

The market part is important. During market upswings, our performances overstate, and during downswings, they understate. For fair evaluation, investment results should be discounted by the market performance. Last year the S&P 500 went up 12.8%, with a couple of big corrections. After discounting the market trend (13%), the performance of three stocks (BIDU CMG NFLX) last year was an incredible return (155%).

 

 

BIDU seems to recently settle at around the $100 range, which is $1,000 as the prior-split (10 to 1 on 5/12/2010) basis It hit a bottom at $40.67 on 1/29/10 and topped at $115.04 on 11/11/10.

 

CMG is showing a strong recovery from a three week (Dec 27, 2010 to Jan 12, 2011) minor correction. It seems to anchor around $230, showing a strong signal for further advance. Its bottom was $93.81 on 2/5/2010 and its top was $262.77 on 11/30/2010  

 

NFLX has moved upward strongly (almost vertically) all year until heating a top ($209.24) on 12/1/2010. It had enjoyed a great momentum after Blockbuster’s fall. News of Comcast, Time Warner, and Coinstar, and all related firms have continuously generated lots of recommendations, tips, charts, reports, rumors, noises, emotion, hunches, cries, excitement, and even curses. NFLX was the king of tigers last year. It is now flying with a harsh head wind. We simply do not know its journey this year. This week (Jan. 10 - 14) NFLX seems to be ready for its next determined movement, shrugging off stubborn bear attacks for several weeks.

 

What are the main features of these three big winners last year? One is their triple-digits prices, Dominant market players (hedge funds, mutual funds, and sovereign wealth funds) tend to prefer high priced stocks which stir the market much less. The second is dividends do not be considered: Investors concern mainly a huge growth potential.

 

The third is that all three stocks were well growing in a recession environment or in the early stage of upswings. Watching movies, internet connections, and eating out at less expensive restaurants are favorable activities in a stressful time. This year we are still in the “weak” recovery process, forecasting 3% or 4% economic growth. The expected earnings of these three are still bright.

 

The Forth is that these stocks are the leaders in their segments in the long run: BIDU (internet services in China), CMG (food services), and NFLX (innovative movie distribution).

 

As of today (1/14/2011), the prices of BIDU, CMG, and NFLX appreciated 130.3%, 139.5%, and 275.8% for one year, respectively. Therefore, the rates may slow down this year. I classify these three as Group A

 

Six stocks have been selected as the candidates of this year winners, and I classified as Group B and Group C as follow.

 

Group B : Amazon.com (AMZN), Life Technologies (LIFE), and NVR, Inc (NVR). The three companies cover consumer spending, healthcare, and the housing industry. The angle is to focus on the domestic market (AMZN) and the special situations (LIFE and NVR). The prices of AMZN, LIFE, and NVR increased 48.5%, 9.6%, and 11.6% , respectively. All companies do not pay dividends.

 

Group C : CME Group (CME), Freeport-McMoran Copper and Gold (FCX), and International Business Machines (IBM). The three companies are more globalized and paying dividends. The price of CME decreased 6.6%. The prices FCX and IBM rose 40.4% and 13.8%, respectively.

 

Groups A, B & C altogether have four technology stocks (BIDU NFLX AMZN IBM), one financial stock (CME), one commodity stock (FCX), one healthcare stock (LIFE), one home builder stock (NVR), and one restaurant stock (CMG). All nine companies are the distinguished leaders in their market segments.  

 

Since I have a strict rule to commit up to 5% of capital for these three Groups, I have to focus only 3 stocks, by selecting one from each Group during this year. The following table shows the summary of three Groups.

 

 

 

Who are leading and lagging in term of the watch lists on Stock Talks? The TANER watch list started on 12/13/2010. I counted how many times these nine stocks showed on the lists daily and weekly. When we observe the TANER watch list (votes or cards) sequentially, we can get an idea which stocks are gaining and losing a momentum. Everyday new TANER watch lists are added, and the momentum rank of nine stocks is changing continuously. We can monitor the potential champions, by paying attention on TANER watch lists.

 

 

As of 1/18/2011, the leaders are NVR (28), IBM (26), and CMG (23). IBM has been building a steady momentum and currently accelerating. CMG are following very closely IBM, also speeding up. NVR, however, is loosing its steam a little bit after a strong upward movement. The laggards are LIFE (4) and NFLX (9). The following table shows the scores of nine stocks.

 

 

 

 

In general, short-term traders follow volatile stocks. Option traders and short sellers, in particular, are more sensitive to the volatility of ETFs and equities because of their relatively short period of investing. Relatively longer-term investors also pay due attention on any historical price patterns of stocks.

 

Betas for most securities are available so that we use them as a proxy of the expected volatility. The beta (0.48) of Netflix (NFLX), however, is puzzled. The betas of nine securities – SPY (SPDR S&P as a proxy of the market), AMZN (Amazon.com), BIDU (Baidu.com), NFLX, IBM (International Business Machines), CMG (Chipotle Mexican Grill), KFT (Kraft Foods), MCD (McDonald’s), and YUM (Yum Brands) are:

 

 

The questions are why NFLX has a low beta, which is less than one third of the BIDU‘s beta, and lower than MCD’s, and why the betas of technology stocks (except BIDU).are not much higher than food stocks,

 

The beta (a) measures the volatility of a security relative to the market volatility, and (b) incorporates the correlation of returns between the security and the market. To get some empirical evidence, stock prices of nine securities (9/2/2010 to 1/14/2011) are used.

 

First, to measure the volatility of securities, standard deviations are calculated, and were standardized, as shown in the following table. (Note: STDEV is standard deviation. MEAN is average. S/M is comparable)  

 

 

CMG (0.141) is most volatile, following by NFLX (0.098), AMZN (0.082), and BIDU (0.079), as we expected. IBM (0.045) and YUM (0.041) are moderate. MCD (0.025) and KFT (0.018) are least volatile.

 

 

Second, to capture the correlation components, the correlation coefficients and daily percentage changes are computed. Following two tables are the results (9/2/2010 – 1/14/2011).

   

 

Read the SPY line. AMZN (0.95) and IBM (0.93) are most correlated with the market, following by NFLX (0.79), CMG (0.77), YUM (0.73), and BIDU (0.59). KFT (0.18) and MCD (0.19) are least correlated. The technology stocks are more correlated than food stocks.

 

The correlations among securities : (a) Top 4 – AMZN & IBM (0.91), NFLX & CMG (0.90), AMZN & NFLX (0.88), and NFLX & IBM (0.80). (b) No correlation – YUM & CMG (0.00) and YUM and KFT (0.00). (c) negative correlations – NFLX & KFT (-0.10), CMG & KFT (-0.22), and MCD & KFT (-0.24).

 

Implications:

 

(a)    The stock market is now in the second stage of a bull market. In the early stage, ETF trading was dominated, resulting that the correlations with the market tend to be higher. When a bull market has matured, individual security selections become more popular. As a result, the correlations either with the market or among securities become weaker.

 

(b)   High flyers (NFLX, CMG, and BIDU) made, quite often, huge intraday swings last year. Therefore, the correlations calculated with the closing prices are not accurate for them.

 

 

 

 

                  The Scores of the Against-the-Market Run (12/13/2010 – 1/14/2011)

 

 

This table shows on what day eight securities move to the opposite direction of the market (SPY) and how many times during Dec 13, 2010 to Jan. 14, 2011. The finding is that all stocks are showing a similar pattern, ranging 7 to 11 times. The trend, however, differs. AMZN, NFLX, CMG, and YUM become more often recently while IBM, KFT, and MCD become less frequent.

 

Can we solve the puzzle of the low beta of NFLX, compared with BIDU? The answer is not conclusive.

 

The correlation coefficient is directly and the standard deviation is indirectly related to the numerator (covariance) of beta. The denominator of beta is variance of returns of the market. The following table is a summary of the relationship between NFLX and BIDE, and the relationship between MCD and CMG.

 

Bad decision-making and bad legislation sometime follow any unexpected financial crisis. Any financial crisis is so complex that policymakers are not ready to fight it in the right direction and in a right sequence of employment among available measures. Lawmakers are also reviewing the current laws. They are revising current laws or are enacting new ones to prevent the recurrence of the same crisis in the future.

 

The monetary policy and bank supervisory power of the Fed should not be blamed as a major cause of the unprecedented financial crisis (2007 to 2009). Therefore, it is not relevant to revise the law to beef up the regulatory power. The causes of the world wide financial turmoil are still controversial. The consensus view dwells on (a) global imbalance of spending and saving, (b) lax regulation for derivatives and hedge funds, (c) the Fed’s low interest policy, and (d) subsidies for home ownership. We still debate over which one is the primary one. At any rate, the Fed policy and supervision cannot be singled out as the major cause of the crisis. In a more deep-rooted sense, the Congress itself is responsible for the related laws to support tax benefits and home mortgages, which contributed fundamentally and steadily to the housing bubbles.

 

The Fed actually deserves credit for saving the near collapse of the world financial market, which was frozen in 2008. The Fed also has engaged in mitigating the extremely severe downswing of the economy by pumping in liquidity. The Fed haters, however, simply insist that the Fed made this turmoil and bailed out banks with taxpayers’ money. This year (2010) aggressive anti-Fed movements prevailed in the Congress to strip the Fed power without a success. One Congressman even “favors abolishing the Fed.” (Fortune, 2/8/2010, p100). The mid-term election might reinforce the Fed Critic camp. We expect the much tougher blows on the face of the Fed in the coming Congress.

 

A word about the nature of the financial market in general and the banking industry in particular is in order. This kind of financial services area is far much more delicate, innovation-oriented, and rapidly moving, compared to other industries. As a result, regulating financial services including banking is a very challenging job. Early this year the administration suddenly announced that it would rein in the risky practices of banks. It was the so-called Volker Rule. The misstep of this action is twofold. One is they did not consult with other countries. The other one is whether the Volker Rule is implementable. The commodity which the financial services industry is handling is money. Money affects inflation because money is a medium of exchange. Unfortunately, due mainly to globalization and financial-market innovation, money itself has become very hard to measure and less useful as a forecasting tool. As a consequence, interest rates are driving money supply out into the area of central banking and financial markets.

 

Inflation affects every nation, every institution, and every individual and company. Inflation pressure is building up slowly at the beginning, but once it has momentum it accelerates all of sudden. At that stage, it is very hard to slow down. Historically the price control has been proved to be ineffective in many countries. We had a bad experience with Nixon. Do not worry about inflation now? Look back the Carter-Regan era. To prevent inflation, we need a loyal guard to watch any symptom of inflation on a full time basis, not by relatively short-term politically appointed policymakers. It's better to stop stoning the Fed. The Fed is just the lonesome inflation fighter for all of us, including you and me. Read Allan H. Meltzer (A History of the Federal Reserve). (December 29, 2010)

 

Bad decision-making and bad legislation sometime follow any unexpected financial crisis. Any financial crisis is so complex that policymakers are not ready to fight it in the right direction and in a right sequence of employment among available measures. Lawmakers are also reviewing the current laws. They are revising current laws or are enacting new ones to prevent the recurrence of the same crisis in the future.

 

The monetary policy and bank supervisory power of the Fed should not be blamed as a major cause of the unprecedented financial crisis (2007 to 2009). Therefore, it is not relevant to revise the law to beef up the regulatory power. The causes of the world wide financial turmoil are still controversial. The consensus view dwells on (a) global imbalance of spending and saving, (b) lax regulation for derivatives and hedge funds, (c) the Fed’s low interest policy, and (d) subsidies for home ownership. We still debate over which one is the primary one. At any rate, the Fed policy and supervision cannot be singled out as the major cause of the crisis. In a more deep-rooted sense, the Congress itself is responsible for the related laws to support tax benefits and home mortgages, which contributed fundamentally and steadily to the housing bubbles.

 

The Fed actually deserves credit for saving the near collapse of the world financial market, which was frozen in 2008. The Fed also has engaged in mitigating the extremely severe downswing of the economy by pumping in liquidity. The Fed haters, however, simply insist that the Fed made this turmoil and bailed out banks with taxpayers’ money. This year (2010) aggressive anti-Fed movements prevailed in the Congress to strip the Fed power without a success. One Congressman even “favors abolishing the Fed.” (Fortune, 2/8/2010, p100). The mid-term election might reinforce the Fed Critic camp. We expect the much tougher blows on the face of the Fed in the coming Congress.

 

A word about the nature of the financial market in general and the banking industry in particular is in order. This kind of financial services area is far much more delicate, innovation-oriented, and rapidly moving, compared to other industries. As a result, regulating financial services including banking is a very challenging job. Early this year the administration suddenly announced that it would rein in the risky practices of banks. It was the so-called Volker Rule. The misstep of this action is twofold. One is they did not consult with other countries. The other one is whether the Volker Rule is implementable. The commodity which the financial services industry is handling is money. Money affects inflation because money is a medium of exchange. Unfortunately, due mainly to globalization and financial-market innovation, money itself has become very hard to measure and less useful as a forecasting tool. As a consequence, interest rates are driving money supply out into the area of central banking and financial markets.

 

Inflation affects every nation, every institution, and every individual and company. Inflation pressure is building up slowly at the beginning, but once it has momentum it accelerates all of sudden. At that stage, it is very hard to slow down. Historically the price control has been proved to be ineffective in many countries. We had a bad experience with Nixon. Do not worry about inflation now? Look back the Carter-Regan era. To prevent inflation, we need a loyal guard to watch any symptom of inflation on a full time basis, not by relatively short-term politically appointed policymakers. It's better to stop stoning the Fed. The Fed is just the lonesome inflation fighter for all of us, including you and me. Read Allan H. Meltzer (A History of the Federal Reserve). (December 29, 2010)