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Tom Armistead
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I am a retired accountant, having spent the early years of my career in the insurance industry and the later part in the field of accounting. My insurance experience has given me the willingness to accept investment risk if I feel the return justifies it; also, an interest in applying risk... More
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  • Miscellaneous Musings At A Market Midpoint 7 comments
    Jul 13, 2013 4:13 PM | about stocks: SPY

    Friday while the S&P 500 (NYSEARCA:SPY) was working on a new high, I stuck to my knitting and closed out a position in Bemis (NYSE:BMS), based on valuation. That left an empty slot in my Synthetic DGI Portfolio, which I filled with Darden (NYSE:DRI).

    One of the problems with a portfolio strategy that builds off a screen, and suspends the analysis of individual holdings, is that you do things you wouldn't normally do. Bemis is over-valued by my preferred metric, and while it is optionable, there are no LEAPS and the spreads are too wide.

    Bemis had gone up since I opened the position, but the hedged nature of the diagonal spread, plus a market maker who was intent on collecting his cut in full, reduced my profit. It's too bad, sometimes the training wheels get in the way.

    Running my screen again at Portfolio123, Darden showed up, so I went for it. It's fairly valued by my methods, which is fine, and LEAPS are available. I'm long deep in the money LEAPS and short out of the money calls, the usual diagonal spread.

    Watching CNBC, they were fairly hyper about the new highs. As a practical matter, the market is almost exactly at fair value, by my methods, by Morningstar's methods, or by any other common sense method out there. I'm not talking about Shiller, and CAPE, or Grantham, or Hussman, or Rosenberg, or Roubini, or any of the doomsayers cult leaders.

    My thinking is, that with the market at a midpoint, you can't expect much more than 7% annualized - 2% real growth, 2% inflation, 2% dividends and 1% financial engineering. That 7% comes with the risk of maybe 35% down if something funky comes out of the woodwork.

    Doing the Chuckie Wuckie, the investor can dance while the music's playing. I'm dancing in a corner, with a hoard of cash, and my long-term holdings in S&P 500 type index funds. A part of my play money is in the Synthetic DGI Portfolio, where leverage will help it respond to a rising market, while the defensive nature of the stocks selected and the options strategy employed will help me reduce losses in the event the market tanks. It's kind of a barbell approach.

    The most likely scenario is that the market continues upward, with the occasional dip to suck in any remaining cowards from the sidelines. It could go on for a while. I stopped doing bullish macro analyses when the market got into the fair value area by my calculations, but if it goes up to over-valued you could see 2,000 on the S&P before you see 1,300 again.

    I was rummaging around in my drafts for articles that never where completed and published. One of them caught my eye: it was titled "Stop Buying Cheap Stocks - You'll Make More Money." Apparently I had done some backtesting to support the idea, and developed an impressive chart, for which I am now unable to locate the supporting data.

    Then I started going over my old articles, many of them on value type stocks, comparing my old target prices to current prices, and patting myself on the back, and wishing I hadn't sold out so early, and so on and so forth. The targets were good, very good. Of course two years ago if you had the macro call right you could just throw those targets up there based on common sense and generic projections, there was no rocket science, it was hard to miss with so many tempting targets.

    I dislike holding cash as cash, with interest rates as low as they are. I've resisted the urge to do something with fixed income, which is finally starting to look like a good decision. But when I think back to the depths of the financial crisis, $50,000 was a lot of money then, if you had the courage (or desperation) to put it on the table and lever it up.

    I'm much more risk averse than I was back then. I don't think it's age per se: I have a unique combination of the natural impetuosity of youth with the reduced cognitive functions of old age. It's more about relative well-being. I have enough to cover my retirement now, and I don't want to lose it. Five years ago my retirement was in a smoking crater, and I looked at the rewards for even a mediocre recovery and went risk on and stayed risk on for a long time. That was then, this is now.

    Disclosure: I am long SPY.

    Additional disclosure: I'm long the market, via Vanguard S&P 500 index funds and value funds, also long various dividend growth type stocks by means of diagonal spreads. I have some reservations, expressed by holding above average cash.

    Stocks: SPY
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Comments (7)
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  • Russell Lane
    , contributor
    Comments (307) | Send Message
    Tom, very interesting article. You're a good analyst and good stockpicker, so if you can't find any great investments, probably few can. But the market remains very inefficient. For instance, when the REITs dropped anywhere from 15 to 30% last month, I jumped on it, and they've come back a long way. I'm invested, but still have a lot of cash, which I'd like to put to work. In addition, I'm kind of tired of the schtick. For the first time in a long while, I'm just tired of following the market every day. Don't know why. In three weeks, I'll be 70. Maybe that explains it. But I'm still hanging in there waiting for those little (or big) inefficiences in the market.
    13 Jul 2013, 07:27 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (6216) | Send Message
    Author’s reply » Russ, I think you picked up on it, that I'm kind of at loose ends, sort of rummaging around to find an area of the market where stockpicking will be fruitful.


    One idea is to set up a separate account for speculation or second guessing big moves on news. What you did on the mREITs would be an example, although I don't follow that sector. Another would be to start looking for some less well known stocks where you can trace steady growth of some basic metric, sometimes moderate but consistent growth doesn't get enough respect.


    I took a couple of months off to hike the Appalachian Trail, that cleared my head for a while. my current portfolio is like watching paint dry, so I keep chugging along, doing one analysis a week until I have them all covered.


    I'm 66, maybe with age it gets harder to believe the daily bs of the market is that important.
    13 Jul 2013, 08:15 PM Reply Like
  • Economic Analyst
    , contributor
    Comments (3723) | Send Message
    Thanks Tom, for taking the time to provide insight into not only the sophisticated methodology behind your thought process, but how it applies to the end game, especially the pragmatic approach of balancing the prospect of continued 7% gains versus the potential risk of 35% losses.
    14 Jul 2013, 08:10 PM Reply Like
  • wrocnrob
    , contributor
    Comments (271) | Send Message
    I have a miscellaneous question Tom. With 10 yr UST rates equivalent to a p/e of 40, the investment-grade corporate rates must be low for many organizations. Why wouldn't a company, with a p/e of less than their cost of capital, borrow to purchase their shares?


    Shouldn't it follow that: price / earnings = 100 / annual interest
    price = earnings * 100 / annual interest
    Using BRK.B for example, 6.6 (earnings) * 100 / 4 (Berkshire cost of debt, estimate) = $165 price. Why is current market price so much less?


    BTW, if you are looking for a new career, I've heard at Berkshire, 66 is a youngstar.
    15 Jul 2013, 01:28 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (6216) | Send Message
    Author’s reply » wrocnrob, you're talking about the Fed rule, which assumes it works along the lines you suggest, with the addition of a risk premium. Stocks haven't behaved that way for a long time, because when 10 year rates are very low, investor fear is high, and they demand a higher risk premium. As a result, the relationship of market P/E and the 10 year is curvilinear.


    I did some articles directed at the topic, with Shiller's CAPE included, here's a link to one of them:


    The most likely scenario is, that as the 10 year rate increases toward 5%, risk premiums will go down and perhaps even go negative. That is, with the 10 year at 5%, you might see a market P/E of like 25 or 30. If and when that happens, you will hear roars of indignation from the bears.


    SA contributor Jeff Miller did some articles on the phenomenon, it was a while ago, but he arrived at the same conclusion, because that's what the facts show.


    That is very relevant to tapering. Those who are fearful of rising 10 year rates, at least in the 2.5% to 5% range, are wrong.


    Thanks for the thoughts on me working at BRK, if I were the type of kid that plays well with others I'd give Warren a buzz.
    15 Jul 2013, 02:02 PM Reply Like
  • Tom Armistead
    , contributor
    Comments (6216) | Send Message
    Author’s reply » I also should say, as far as borrowing money to buy back shares, that's been done, it's financial engineering 101.


    The problem arises when a company pays too much for the shares, and gets a debt burden greater than they can carry. Interest rates go up, earnings falter, the notes come due....


    Sometimes it ends badly, with shareholders diluted by the issurance of new equity at a fraction of the buyback prices.
    15 Jul 2013, 02:14 PM Reply Like
  • wrocnrob
    , contributor
    Comments (271) | Send Message
    Holy Macro! Shareholders desire liquidity. Liquidity requires markets. Markets imply a risk premium based on the chances of the Fed Model becoming the BOJ Model. Whew!
    Governments, like companies, can buy their own equity - as they grow or Zimbabwe. Good reading, thanks.


    "Understanding The Disconnect Between Treasury Yields And The S&P 500 Earnings Yield"
    "Equity Multiples And Interest Rates: Is The Current Risk Premium Sufficient?"
    "What Happened The Last Time The Fed Owned All Outstanding Treasuries"
    16 Jul 2013, 12:02 AM Reply Like
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