The following cube was written in late March of 2009. It was never quite finished and after reading it a couple of times, I thought I should post it as a window to events past (I hope).
These are certainly unprecedented times and so writing about them is more than a necessity, it is a duty. From its height in October of 2007, the market has collapsed to levels not seen in 13 years. In technical terms it means that a dollar invested in 1996 has not changed (without its inflationary erosion) since. A dollar invested at the peak is worth a bit less than 50 cents today. It is hard to comprehend the extent of this decline and it's harder to see the end in sight.
Wall Street must be full of haters and non-believers because the new President has been received with a 20% market drop. It would be unfair to say that the man is to be blamed for the latest bloodbath, but it would be also inaccurate to say he's helped. Then again, it is not the President but his band of cronies in Congress than should carry a lot of the burden. When the public has been desensitized about billions and trillions, who is to say a measly million here and a measly million there for whatever pet project is of any significance? Don't worry about it – we should live for the now and let future generations worry about paying the bill.
Psychology and its best friend the 24/7 media are really the biggest culprits of what is going on. If you hear the horrors reports everywhere you look, all day long, there is nothing else to do but be engulfed and affected by the doom and gloom reported. The vicious cycle is fed constantly and in turn can be attributed for some things not getting better. Absent the media flood, one could argue that things would run their course uninterrupted. Things are pretty bad as they are without the aid of mass psychological trauma.
I have my ideas on how we got in and how we might get out. At the risk of sounding foolish and simplistic, I believe the ebbs and flows of a free economy will flush out the bad and clean out the system from what is rotting the whole economy. I equate this crisis to the body fighting off a bad stomach bug. The body will fight the disease but while the war wages there might be fever and nausea and vomit and diarrhea – all signs of the body trying to rid itself from its ills. Once the "enemy" is beat and has been vanished, the body will slowly recover all it has lost in the war. Help might be needed – some pills, maybe a shot – but nothing should be used that could cause permanent damage to the patient. But what do I know – nothing.
Of course we now live in the era of entitlements, spreading the wealth, and big government. And thus Big Brother should take care of us because alas we're too stupid to take care of ourselves. We're just children of the Tsar. Question is: who will take care of Big Brother once those who carry the load get tired of it? Atlas Shrugged anyone? Anyone? Bueller?
The Perfect Gift for Young Capitalists
I may be tipping my hand here, but I have found the best gift for any young capitalist. This is a gift I intend to give all and any young relatives I will ever have. What is better than the gift of company ownership? Think of how many times you've looked at the explosive growth of a stock and wondered, "If I had invested in that, I'd be rich now"? The goal here is not necessarily to enrich anyone, but it is to teach the valuable lesson of investing in equities.
Companies like Oneshare.com (amongst many others) offer the service to deliver an actual share of a selected company, with the stockholder's name (gift recipient) printed on it. There are many options which include different frames, matting, messages, etc. All these things come at a fee – which of course raises the amount spent on the stock sometimes more than twice its market value. But that's not important. The key here is ownership and growth. That piece of paper will make that child an owner with voting rights and benefits (some companies have great benefits for stock owners). It will also (if the company performs) increase in value over time – something a savings account won't do at a commensurate rate.
The key is to tie the stock with something of interest to the children – a company they would know and grow to love. I am an owner, so as a responsible analyst I must disclose this before I make the following recommendation. An share of Disney (DIS) is the perfect example. This is a company, a brand, which children know and love. Through their parks, movies, and lovable characters, children can quicker bridge the gap between a product, a company, and ownership. As an added bonus, the stock certificate is just plain beautiful – full of color and depicting some of the brand's most recognizable characters, along with the image of their creator Walt Disney. Of course, there are many other stocks that could be just as good such as Coca-Cola (KO), Marvel Enterprises (MVL), etc. Again – more than value the stock and its growth potential, the gift-giver should invest in a company that the gift-recipient would know and appreciate.
One added feature makes this transaction even better. There is inherent difficulty in the sale of a paper stock – especially just one share (unless it has split). The trading of physical paper stocks is unheard-of. Regular stock trading and holding records are all electronic. This seemingly negative feature deters the child (who grows up to be a money-starved teenager) from trying to cash in the stock for money. Of course, if the stock splits several times and gets to be worth many multiples its original value, it might be worth to do so. With limited knowledge, a young person would most likely need the assistance of an adult to execute the transaction. This is where a responsible parent or guardian would be able to offer sound advice (one would hope).
So there you have it folks – the best gift for a capitalist child. Of course, this is a one-time deal per child. More than one and it begins to lose its effect (unless they are different companies the kid might gain interest in as they grow up – such as moving from cartoons to sports). I cannot imagine a more fitting and long-lasting gift, especially when compared to the alternative: DVDs, books, stuffed animals, and an assortment of lead-painted toys made in China.
Riding the Volatility Rollercoaster for Short-Term Gains
The hot buzzword being thrown around is "recession." Truth about recessions is we won't know until we're in it. Some say we are in it, some don't. Some say it'll be long, some that it will be short. One thing I've learned about economists and experts is that they balance out – for every one claiming one thing, there's another claiming the opposite. When half are proven to be wrong (in hindsight), they cite the reasons for their misfires and assert that they were right in their assumptions – just everything changed and therefore their assumptions were no longer valid.
Truth is what we have been experiencing, at least in the financial markets, is high volatility. Volatility is the best thing that can happen for day-traders (I'm not one in particular). For the long-term investor, volatility is the reason for great joy followed by great fear and heartburn. Ultimately, a good long-term investor should always ignore the day-to-day market activity because in the greater scheme of things it should be inconsequential – especially if their horizon is 20-30 years.
In a volatile environment, fundamentals go out the door and psychology rules the marketplace. News on GDP, jobless claims, consumer sentiment, Fed rates, etc. send the market way up or way down (+/- 1-3% swings). The swings are sometimes momentary – lasting only a few hours. Sometimes it takes a whole day or two for the swings to correct themselves. Although this might not seem huge, these small market swings are caused by greater swings in the underlying companies that are at the root of the good/bad news. I am not taking a huge leap when I say that these days there are two industries almost single-handedly steering the market: housing and financials.
A long-term investor will see the down-swings as great buying opportunities – especially when the future prospects and fundamentals outweigh the risks. A volatile market on average overreacts. Being there to pick up the cheap pieces is the key to profiting off the irrationality. The key is intestinal fortitude and a real understanding of what it means to weather the storm. Buying on a downswing will certainly seem like a great idea, unless the downswing continues way past your entry point. After you buy in at $19, and upon staring at a $14/share market price, things can seem pretty scary. There are only two reasonable things to do: stay the course or buy more. If there's a lack of liquidity to add more funds into the investment, it might just be good to sit tight and hope for an eventual return to normality. This, of course, doesn't apply if the company is going belly up or if newly revealed news indicates worse prospects than you initially took into consideration. The second alternative is definitely the best – benefit of the lower price through the magic of dollar-cost-averaging. Following the previous example: by buying the same amount of shares currently owned at the new $16 level, your average would go down to $17.50/share. Again, this would only be recommended if your initial belief in the market undervaluation of the stock still holds true.
So the long (refers to buying shares only, not short-selling) strategy is to buy until it stops going down and sell when the price reaches a satisfactory level (likely above your average cost plus trading costs). Of course there's risk when investing in companies – especially companies in a distressed industry. To mitigate this risk I like to invest in industry funds – specifically Exchange Traded Funds (ETFs). ETFs are simply openly-traded mutual funds with lower administrative fees and fewer restrictions. There is an explosion of ETFs flooding the market these days. There is one (often many) for as many different industries and strategies as one can imagine. There are index ETFs which track the market such as SPY, an S&P 500 tracker or QQQQ, a Nasdaq tracker. So what an ETF will achieve is the dampened effect of company-specific fluctuations. The highs won't be as high and the lows won't be as low. Still, as long as the industry doesn't collapse completely (highly unlikely), value is not totally lost is something bad happens (which is what would happen if you own stock in a company that goes bankrupt).
Of course there are alternative ways to play volatility. The short strategy is to short-sell over-valued stocks benefiting from a psychological run-up. Some that come to mind are Google (GOOG) when it was $700+ (it's already down 40% from those highs), and anything that is highly correlated to commodities such as gold and oil (that bubble will bust eventually). So you'd sell high while the ignorant are buying, and buy low when the true value finally collapses the stock and the frantic are selling. There are huge dangers with this strategy – so much so that I have yet to short-sell a stock in my life. Margin calls are not something I'd like to deal with. While enduring a decline on the long side may be painful, being short on a continued run-up can be absolutely devastating. This is not unlike the average guy buying a $1M house (on 100% leverage/debt) on the hopes that it will quickly go up to $1.5-2M in a hot market, selling it and pocketing the easy money. And there, folks, you have the guy that got burned when the housing bubble popped. He couldn't afford the mortgage payments on a $1M home that the market now valued at $500k. Foreclosure, bankruptcy and financial woes for many years to come are what are left.
So a word to the wise – when you see run-of-the-mill people getting en masse into investments, recommending investments or strategies, it's time to run the other way. Do you remember people who as a side job decided they'd be great at flipping properties? The ones that started the trend made out like bandits. When everyone was talking about doing it, it was time for the smart ones to fold their tents and retrench. What happened to the late-comers? We all know. Likewise, I see the run-up in gold and other commodity-backed investments as the next thing to burn your uninformed investor. When you hear everyone talking about buying gold, this should be the last thing in your mind. Bubbles work the same way every time. By the time something has turned into the "easy money/fail-safe/everybody is doing it" investment, it's time to turn the other way.
One other (less risky than shorts) way to make money off of volatility is an option straddle. By being long (buying) a put and long a call (same amount of contracts) with the same strike price and expiration date, you'd be achieving gains on volatility around the mentioned strike price. The stock would have to move beyond the total cost of the option purchases for you to make any money, but while the upside benefit is infinite, the downside losses are capped at that initial investment. I don't want to get into an option valuation thing - assume market prices are fair. I'm also not going to get into explaining calls or puts. Fact is derivatives as these can be very dangerous – specially the short side. If you're buying (long) an option, the worse you can do is lose your initial investment (option expires worthless – out of the money). I have yet to trade in options although I consider a long strategy a pretty safe bet – just like spending $1 in the lotto: at worse I wasted a dollar; at best I can win a lot of money. A long on a put or call works the same way – it's pure speculative gambling.
Overall the market is unpredictable and run-ups might be followed by greater run-ups and huge sell-offs might only spark even more sell-offs. There's no way of knowing what's around the corner and that's what makes the markets semi-strong efficient. Most information is known, but not all of it. The current volatility can be played for short-term gains. One just has to have the guts to ride what will certainly be a rollercoaster ride. So what do I like? Easy: ITB and XLF. Have owned both and have jumped out to capitalize gains. I am currently looking to jump back in when the dip is right.
First, a Disclaimer
Any financial advise cubed in this website is stated for informational and entertainment purposes only and written for the sole use and consumption of yours truly as a record-keeper of my thoughts. Any use of investment information included herein is done so at your own responsibility and understanding the risks involved.
I'm not a professional investor or market analyst. I do not work for a publicly traded company and my job responsibilities do not include the valuation of exchange-traded equities (that's for you Mr. SEC - Securities and Exchange Commission for those who can't see those words without ridiculously chest-pumping about the greatness of your conference). My sole purpose for investing in the financial markets is being rewarded with higher returns (than the risk-free rate) by the excess risk undertaken (refer to the CAPM).
Remember, when you take free advice, you get what you pay for. The best investor is an informed investor. Carry on.