MDCigan

Fundamentals And The Market: Review and Expectations

"Hussman writes long articles attacking the Fed Model and defending his own invention. As a consumer of models, I could have chosen to use his. I did not because I have more confidence in forward-looking earnings estimates than looking backward at "peak earnings." I also cannot find a Hussman analysis that considers simultaneously interest rates and earnings. Surely they are both important."

Shouldn't have been to difficult to find. All the weekly commentaries are archived on the website. In any case, here a few that specifically deal with interest rates and the impact interest rates have on fair valuation multiples. I'm interested in what is valid and not married to any particular viewpoint or model, but I have yet to see anyone do a rigorous quantitative counteranalysis.

David Merkel had what I thought was an excellent analysis, but it was more about determining the ***relative valuation*** between bonds and stocks, and not the absolute valuation of stocks. I think it is important to recognize the possibility that both bonds AND stocks are unattractively valued, and neither is priced for attractive long-term returns (although compelling individual opportunities might exist, I personally think Berkshire Hathaway is undervalued)

www.hussman.net/wmc/wm...
www.hussman.net/wmc/wm...
www.hussman.net/wmc/wm...

"Will's comment suggests that forward earnings estimates are incorrect, given his macro analysis. I read Will's blog regularly and I understand his viewpoint. My own approach is to take advantage of the expertise of others, in this case the hundreds of analysts and macro strategists following companies. If I thought that I could forecast earnings better than they could, then I might use a different approach. We should note that many of those calling the economy weak and predicting lower earnings have been doing so for years. (Not putting Will in this camp -- I haven't checked)."

How many of the hundreds of analysts and macro strategists correctly forecasted the earnings decline in 2001 and 2002? What were consensus earnings forecasts for 2001 and 2002 in late 1999, 2000? When S&P 500 earnings do contract I'll just about guarantee that somewhere between 0 and 1-2 major firms/strategists will correctly anticipate it. At that turning point, valuations based on forward estimates will be way off the mark, and the problem is that by that point it will be too late as the market will probably already have declined because the market anticipates/discounts what is coming, not reacts to what is already obviously known.

Hard To See the Connection Between Country Funds and GDP Growth Rates

Thought-provoking note. Since GDP growth doesn't appear to have much predictive power for country stock markets, do you have any thoughts on how one might select coutnries in a top-down manner. I wonder if some combination of relative valuation and price momentum (maybe 6-month) might be effective?

John Hussman: We May Be Seeing a Phase Transition

"The exact cause of Dr. Hussman's failure in this fund could theoretically be caused simply by *************horrendou... stock picking***************... by Hussman Econometrics, but it would have to have been so bad as to be negligent given the positive returns for equities the past 4 years."

Not sure why I am responding. There is a biblical proverb about not arguing with fools. I guess it is just annoying to see you keep repeating the same erroneous assertion.

I'm not sure if you are just too lazy or too stupid to verify what you are saying above (on the stock-picking). In the annual reports for the fund, Hussman breaks out separately the performance of just the individual stock-picks from overall fund performance. The individual stock-picks have *OUTPERFORMED* the market every single year since inception except 2006. The underperformance of the fund is entirely due to being fully-hedged pretty much 100% of the time over the past 3 years. Therefore, the return of the fund is going to be the difference between the stock-picks and the overall market plus the interest earned on the hedges.

You certainly are an interesting fellow. You seem to be on some sort of mission with your plethora of replies to numerous bloggers. You do seem to be a self-proclaimed expert on the market, with the correct stance on "market action" being obvious to you. So help me out, how would you be positioned here. Are you bullish, neutral, bearish? What is your forecast for the next 12 months? Would you be 100% unhedged here, or fully hedged? I suspect you will not give clear answers to these questions, as you have know idea yourself. I think you know how to throw stones, but have no idea how to build the house yourself.

John Hussman: A Sack O' Potatoes Market

"Any thoughts out there ?"

Yes, you have way too much time on your hands, and need to get a hobby or some social activity besides the enormous amount of replies you post on this website. You do realize that with Hussman and Ritholtz they aren't likely reading your responses any way. You are just arguing with yourself in an empty room.

I'd spend the time to discuss some of your points (and I actually think you have a legitimate point on the "market action" issue, I too wonder why he was fully hedged most of the last 3 years even if valuations were high), but my time is too valuable to go back and forth with you on this issue.

Best of luck to you in your investing.

Complacency Runs Deep: Time To Sell

"What you should not do is panic, says Jeffrey Kleintop, chief market strategist at Boston's LPL Financial Services via e-mail. His "Five Reasons Not to Panic" include *********"it's just another 5-7% pullback*******, the temporary unwinding of the yen carry trade is nearly over, profit worries are overblown, subprime losses are unlikely to cause a financial crisis, and no one will be left to sell." Keep in mind that "volatility is back," he says."

Interesting comment here from this strategist. In behavioral finance, one of the typical mistakes we humans make in investing decisions is the "recency effect". We tend to overweight more recent experience and discount the distant past. I can't help but wonder if after May-July 06 and Feb 07 the market has "trained" many to assume every quick 5% pullback is absolutely a dip to be bought before a march to new highs. It would be ironic if this particular instance turns out to be trap for all those making that assumption. Be careful.

Premature Return of Equity REITs?

"As a side note, before the purchases were announced, REITs looked the worst from a technical standpoint in the financial space. Now they are the best. So much for the utility of technical analysis."

A few months have passed, so a quick comment on this comment. I'm just not sure what technical analysis tools you were using to make your determination of going from worst to best. Technical picture has been negative since breaking the 200 day moving average, having the 50 day break below the 200 day, and the head and shoulders top:

worldbeta.blogspot.com...

Properly applied technical analysis would have gotten you out and kept you out during the bulk of the recent decline, and indeed did so for my REIT position. I have no issue with the utility of technical analysis.

John Hussman: A Sack O' Potatoes Market

"4. The underperformance is more likely caused by failed short bets"

I'm probably wasting my time even responding to you, but you reveal your ignorance with this statement. It might be a good idea to conduct actual research instead of just random hypothesizing.

The fund does NOT short individual stocks, and is NEVER net short the market. At most, the fund can be market neutral in that it holds a long portfolio of individual stocks that are fully hedged by index options (long puts and short calls).

John Hussman: A Sack O' Potatoes Market

Gembree, Paul, I think you guys pretty much have it right here. Paul, I suspect you are wasting your breath on Mr. Lewing. He seems like a troll who tries to be provocative rather then insightful or rational. I always see his negative attacks on posts by Hussman and Ritholtz and some others.

C meng, you say "Mr. Courtney,

The time period you chose for comparison (July '00 to present) is one that would be most favorable to Hussman. "

I think this is the most logical time frame has cumulatively it encompasses BOTH A BEAR MARKET AND A BULL MARKET. Over the total market history there have been several bull and bear markets. It seems rational to me to assume that at some point the bull market that began in late 2002/early 2003 will end and we will have a bear market. Hussman clearly points out his objective is to outperform the market over a FULL MARKET CYCLE which includes both a bear market and a bull market. The last 4-5 year represents only a bull market. Time will tell, but I suspect that when we get to the trough of the next bear market Hussman will have outperformed starting from the 2003 bull. Now of course, if it's different this time, and bear markets will no longer occur then Hussman will persistently underperform. Is that likely?

Not sure, but your ID looks familiar from the TMF MI board. This should be deja vu for you. Back in 98-00 there were alot of MI momentum guys who were making money hand over fist and thought they were geniuses while the value investors were doing poorly. Of course in the 2000-2002 bear, those MI guys got slaughtered while the value guys did very well.

Look, I am a HSGFX shareholder. I haven't been happy with recent returns, especially 2006, but you have to know why you own what you own. Time will tell whether current stock valuations are "reasonable" or overvalued, but I'd rather err on the side of caution.

Judging Fund Performance: Part 2

"At this point, each investor needs to ask himself or herself whether there is evidence that the managers’ skill has generated the impressive trailing performance or, alternatively, simply an aggressive investment policy, along with a tolerance for taking on some risky positions—such as 10+% in Russian wireless. Is there evidence for sufficient incremental value (beyond asset allocation) to merit the fees that these funds charge and expense that they incur on the basis of their high turnover?"

Good article, and certainly food for thought. My question I would pose to you is what exactly constitutes "manager skill"? Is it just individual stock-picking with basically identical sector weights to the S&P 500, or can manager skill also be part of determining when to have substantial overweights in sectors like utilities, materials, energy, etc.

I think it is fairly easy (as you demonstrate) to do a backwards looking analysis to determine a fund's performance could have been replicated with particular sector and asset class weights using low-cost ETFs. But how would you have known to use that SPECIFIC sector/asset class composition at that point in time? Perhaps the manager skill is knowing when to overweight what sector and when to get out of that sector.

Take your example of CGMFX. I've actually wanted to buy this fund for a long time, but unfortunately my broker does not offer it. I've studied the fund and the manager's investment approach and an integral component of his "skill" is making big sector and industry bets based on top-down analysis. At one point, the fund was loaded with homebuilders, and was responsible for strong performance. You could have done a backwards analysis sometime back demonstrating replicating his performance by purchasing the homebuilder ETF, XHB. But he dumped all the homebuilders before they crashed, and therefore captured the gain and missed the losses. Would a static portfolio based on backwards analysis still be holding XHB?

I think there is more to analyzing a mutual fund then just trying to decompose what sector and asset class are driving returns because you have to also try to understand the manager's thought process behind it. Managing a portfolio is a dynamic and not static process so the sector and asset class weighting could be changing quite frequently.

25 Good Short Candidates

"but your closing sentence: "should not be trading near their 52-week high." is a first line risk control measure that immediately eliminates this as a "good" short candidate for any professional trader I know, including myself. In a general bull market, we do not short stocks at, near or just above their 52-wk high. On the contrary, it's generally a good idea to buy in these situations, although I wouldn't want to own CVS for reasons you mentioned, as well as other internal research we have on the sector and CVS in particular. Remember markets will stay irrational longer than you can stay solvent. "

I completely agree with this sentiment. One ticker comes to mind. CROX. I think at some point this probably becomes a great short, but I am not stepping in front of a freight train to get run over. In my view the valuation is somewhere between absurd and insane in terms of pricing in future growth expectations, but who knows how high the market can build this "castle in the sky".

25 Good Short Candidates

"MDC,
All of the data is fundamental; I update long and short once per month and judge them accordingly, but I think one could extend each hypothetical portfolio 6-12 months and still do fine."

Perhaps I'm missing something here, but I don't follow this. In my view, there is absolutely no connection whatsoever between 1-month stock price performance and fundamental factors. Over a 1-month time frame, stock price behavior is probably some combination of technical factors (I do believe in things like stock price trends and oversold/overbought) or just statistical noise (for those more inclined to random walk theory).

"At the same time, the company just doesn't excite me enough to say I would buy it either - I'd prefer to grab more focused companies in areas I like than get all the diversification that is GE."

I agree one can probably find stocks with more upside then GE, but that is different then saying the stock is an attractive short.

"I can't argue the past with ERTS or ATVI, but I can say that with ERTS, their development seems primarily geared to Sony's platform, followed by Microsoft. Nintendo is far in the distance in terms of product offerings and hence revenues, but with the Wii outselling the PS3 I can't see how that translates positively for ERTS in game sales. PS2 was the dominant console for a long time, and many game developers certainly benefitted from that because Sony wasn't focused on game development and let others control that space. That just isn't the story with Nintendo..."

This is true, but it might prove dangerous from the short side to underestimate just how quickly ERTS might be able to turn the ship around and ramp up development for the Wii and start having success on that platform. In my view, the video game industry is still one of secular growth, and in general I think one of the best investment strategies is to go long companies in long-term growth industries which are experiencing "temporary" problems. The key question is are ERTS' problems "temporary"? Time will tell, but if I were forced to bet, I'd bet on them fixing the issues and developing a strong line-up of titles for the Wii that bring the company back to strong profitability.

I appreciate the discussion.

25 Good Short Candidates

Interesting. Quite a few of your short picks actually look interesting to me from the long side with the top 2 being GE and ATVI. You mention these selections are purely the result of your quantitative model. I can understand if you'd rather not share, but I'd be interested to know what quantitative factors lead to GE and ATVI being short candidates. What is the time frame on your model? Are these selections intended to capture 6-month price movement? 1-year? 3-years?

In GE, you've got an above-average company selling at a market multiple, earnings growth rate that appears to be accelerating, and a pretty hefty dividend yield, and from a technical perspective it appears to be breaking out of a long-term consolidation pattern. We're at 40ish right now. I'd bet we see 50 before 30. It looks a little overbought here, but the entire market looks overbought. Maybe we see a pullback to 35-37, but I just don't see any reason to forecast substantial market underperformance over the next 1-2 years which makes me wonder what specific quantitative factors lead you to that conclusion.

I think your qualitative comments on the video game makers miss the mark. The fact of the matter is if you look at the really long-term performance (past 5-10 years) both ERTS and ATVI have created substantial shareholder value. Historically, the gamemakers have rallied from the summer to late fall/early winter in anticipation of the strong holiday sales. This particular year is likely the sweet spot for this current cycle roll-out and ATVI has a pretty compelling game line-up. From a technical perspective, the stock appears to be consolidating around 18 with some high volume up days (big money accumulating the stock).

Apple Ripe for a Ratio Call Spread

Excellent note. I'm really interested in this sort of thing. Most of the "options" posts are just market and technical analysis with very little actually connected to sophisticated option strategies involving the interplay between price direction, time, and volatility.

I hope you'll continue to post these types of example trades. I checked out your blog after reading this note and subscribed to updates. It appears to me that there is no way to comment on your blog. Is this intentional?

I have an options trade on Chesapeake Energy (CHK) which is a combination of Jan 08 and 09 LEAPs and I am contemplating an adjustment strategy to convert it into a calendar, diagonal, or bull call spread. I'd like to get your feedback and opinion if you have the time. Thanks.

Vanguard's Jack Bogle on Rebalancing: Don't!

"Fact: a 48%S&P 500, 16% small cap, 16% international, and 20% bond index, over the past 20 years, earned a 9.49% annual return without rebalancing and a 9.71% return if rebalanced annually. That’s worth describing as “noise,” and suggests that formulaic rebalancing with precision is not necessary."

I'm not sure this really proves anything against rebalancing. First off, the set of asset classes used isn't very diverse. If you used a more comprehensive set of asset classes with more negative correlation like REITs, commodities and precious metals, emerging markets, etc. in addition to just U.S. large-cap and U.S. small-cap, I'd bet the results would be ALOT DIFFERENT in favor of rebalancing.

Secondly, you would want to test different rebalancing strategies in terms of time frame. There is alot of evidence to suggest there is momentum at the 1-2 year time frame, and mean reversion at the 3-5 year time frame. Perhaps rebalancing less frequently then annually would do even better.

As much as Mr. Bogle is respected in the industry, I think it is important to remember he is biased, and I would not accept anything he says at face value without further investigation of the issues.

Why Bond Yields Are A Sextuple Threat

Timely note from Geoff Gannon:

usmarket.seekingalpha....

"I didn't get into a long discussion of interest rates and normalized P/E ratios before, because I think it's a tricky subject. There is no doubt in my mind that interest rates both matter and matter far less than most people believe."

"Regardless, when buying the entire market, simply looking for low normalized P/E ratios is a much more effective strategy than anything I can come up with involving interest rates. I expected this to be true in the long-term; the fact that it also works pretty well in the short-term surprised me."