John Nyaradi: Hi, everyone. I'm John Nyaradi, Publisher of Wall Street Sector Selector, a financial media site specializing in exchange traded funds and global markets, and today I'm really pleased to welcome our special guest, John Del Vecchio. John, welcome to Wall Street Sector Selector.
John Del Vecchio: Thanks for having me back, John.
John Nyaradi: Great to have you here, John, like always. Whenever I talk to you, I always learn a lot. John Del Vecchio is the co-founder and co-manager of the Active Bear ETF. That's symbol HDGE. Active Bear (NYSEARCA:HDGE) is an ETF dedicated to shorting individual stocks that have fundamental red flags around them. Previously, John was a hedge fund manager for Ranger Alternative Management.
He co-advises a newsletter for Motley Fool and is a chartered financial analyst. Today we're going to talk about John's new book, What's Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. It has been well received and has been named Best Investment Book of 2013 by Stock Trader's Almanac.
So let's start at the top, John, why did you write the book and what can people expect to get out of it?
John Del Vecchio: We wrote the book in order to help people avoid a big loss in their portfolio. So even though I'm a short seller and I trade, it's not really a book about short selling. It gives investors tools to identify companies that they may own that are showing red flags that could be a sign of trouble ahead.
Our view is that avoiding a big loss is really more important than generating a large gain. If you lose 50% of your net worth, for instance, you have to gain 100% just to get back even and we feel like anybody, whether it's a do-it-yourself investor or a more sophisticated professional asset allocator, would do well to learn tools and techniques that will allow them to avoid large losses in their portfolio and that's what we do within the context of the book.
John Nyaradi: Part One talks about the real risk of stock investing. What is the real risk?
John Del Vecchio: Most stocks are actually losers over time. So imagine we were talking in 1970′s and we were talking about Eastman Kodak and Polaroid and General Motors. Those were widows and orphan stocks back then and now fast forward the clock 30 years and they're all dead money. Then in the 1990s, we had Intel, Microsoft, Dell, Cisco, those were the four horsemen of the internet. They've now been essentially dead money for the last 12, 13, 14 years.
So the winners from one generation are generally not the winners of the next and in capitalism, in general, you can't have a lot of winners. For every Wal-Mart, you've got 40 regional retailers that don't exist anymore because Wal-Mart beat them in terms of distribution, technology, pricing, whatever the case may be.
So picking an individual stock is a risky endeavor because you're betting on your ability to identify that one company that's going to be a massive success within a sector or in that particular cycle of the market. So that's where it's very dangerous.
It's also very dangerous in that it depends on really the 20 to 30-year time frame in which you are generating your highest income and your highest savings. If you were investing from 1968 to 1982, chances are you didn't make any money and you probably lost about 70% in real terms just because of inflation. If you were investing during the bull market from '82 to 2000, you probably did pretty well. But the last ten or twelve years haven't been that great.
So while people talk about stocks for the long run, often they're taking about 100 or 200-year time frames. I don't plan on living 200 years so the twenty years in which I'm generating my highest income and savings are the most important for me in terms of securing my future.
And the odds are just against you for being able to identify the companies that are going to be the next Google or Apple. So we talk about certain warning signs that ultimately will be reflected in a lower stock price. We walk through income statements, balance sheets, cash flow to help you spot these trouble signs before they occur. And I think the best thing about the book is that these are real time case studies that were written and published in real time and then show you what occurred, you know, 6 months to 2-years after we had identified these things before the stock actually blew up.
John Nyaradi: You talk about two common investing themes, dollar cost averaging and buy and hold, and it sounds like you don't endorse either of those too much.
John Del Vecchio: No, the problem with dollar cost averaging an individual stock really comes from Bill Miller, the famous mutual fund manager from Legg Mason. His mantra was "Lowest average cost wins."
And so when stocks go against you, you buy more. The problem is when you own Enron, AIG, Fannie Mae, Freddie Mac, WorldCom, all these companies that were basically bankrupt, and he owned them all, it destroys your performance. So dollar cost averaging during a massive meltdown in the market is essentially putting good money after bad, in our view. Conversely, Paul Tudor Jones is probably the greatest trader of our lifetime and he says that the market tells you fairly quickly if you're right or wrong and so don't average losses but actually build on your winning positions.
John Nyaradi: Part 2 of your book is titled "Avoid Huge Losses." How do you do that?
John Del Vecchio: From a long perspective, we want to be value investors. We want to buy a dollar's worth of an asset for fifty cents that has a catalyst that we can foresee that's going to allow that value to be realized. Maybe it's the sale of an asset or the realization that the asset is worth more than it's being carried for on the books. We also show there's real value in having a long/short portfolio that can offer a smoother overall return.
Having some shorts in you portfolio to buffer against the inevitable downturn is really valuable. It seems like the hundred year storm occurs about every three years now.
John Nyaradi: How do you use charts and what's your favorite chart?
John Del Vecchio: We rely quite a bit on price and volume and relative strength. So my view is that the technical usually leads the fundamental. You start to see selling in a stock before everybody catches on to the fact that the fundamentals are questionable. That might be reflected in high volume when the company is selling off and little volume when it's rallying. There might be divergences between the price and the relative strength. So maybe the price is reaching new highs but the relative strength is not and that's because an institution like Fidelity, for instance, can't sell a stock in one day. They unload it over a period of time. So that shows up in the patterns of the stock over time.
It's not just fundamental and not just charts. It's the combination of both that gives you an overall advantage, I think, over most investors.
John Nyaradi: Let's talk just for a minute about the Active Bear ETF, it is symbol is HDGE or (NYSEARCA:HDGE) What are you doing there?
John Del Vecchio: We choose individual stocks that we think have aggressive accounting or some fundamental deterioration in their business and we short them on the expectation that they might miss earnings or have an SEC investigation or other problems what could cause these stocks to go down in price or at least under perform the market over time. And it's a combination of fundamental and technical analysis that's related to what we discuss in the book. The book is not about the fund but it does give you a flavor of how we actually go about analyzing companies and then trading them once they're in the portfolio.
John Nyaradi: We're talking here in October, 2012; the election is coming, the fiscal cliff is just ahead. What's on your mind right now? What should investors be watching out for? What do you see as risks and opportunities here as we head towards the end of 2012?
John Del Vecchio: There's a very high level of bullishness right now among advisers, about 65%, and it has never been positive for stocks when that's the case. Volume is falling off a cliff. It's below where it was in 2007. The cash position of individual investors has been wound down quite a bit. So there's really not a lot of cash on the sidelines. The National Association of Investment Managers is essentially fully invested at 75% equity; there's never been a bull market that started at that level. We're 43 months into this move off the lows in March, 2009, so it's a very old market.
And I think that the big catalyst, probably at the beginning of next year, is going to be Europe. I just don't see them solving their problems in 2013.
John Nyaradi: Folks, we've been talking with John Del Vecchio and about his new book What's Behind the Numbers? It is getting terrific reviews and has been named the best investment book for 2013 by Stock Trader's Almanac.
John is co-founder and the co-manager of the Active Bear ETF (HDGE) and you can learn more about John and his book, What's behind the Numbers ?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio, just by following the link at the bottom of this interview.
John, it has been a great talking with you today and I know we're all looking forward to talking with you again really soon.
John Del Vecchio: Great, thank you very much for having me.
Disclosure: I am long HDGE.