Tuesday, December 10, 2013 Zeb’s VUE

General Information and Analysis

"we are all floating around on a sea of artificial liquidity right now. This is not going to last." - Jim Rogers

“For most purposes in daily life, your brain is a superbly functioning machine, steering you away from danger while guiding you towards basic rewards like food, shelter, and love. But that brilliant machine can lead you astray when it comes to investing... your investing brain often drives you to do things that make no logical sense – but make perfect emotional sense. Your brain developed to improve our species’ odds of survival. You, like every other human, are wired to crave what looks rewarding and shun what seems risky. To counteract these impulses your brain has only a thin veneer of modern, analytical circuits that are often no match for the power of the ancient parts of your mind.”  Jason Zwig – Author

What Mr. Zweig is communicating to all investors (professional and retail) is that emotionally investors buy high and sell low.  That is exactly the opposite of what the uber-rich investors do. 

If you have followed Warren Buffet’s career at all, you know that he buys low, holds on for a very long time (sometimes never liquidating), and sells high. 

We do illogical things.  We buy high, we sell low, we hold onto losers, and sell winning investments too early. 

Dear Reader, we are at that high point again in the market.  The stock market is at historical all time highs.  It is very difficult to find an excellent company that is priced at value (low).  At this point in time today, price for stocks are high (not low).  This requires very careful research to buy a stock or any asset for a long term investment.

Last week I wrote about the mind-set of a day-trader.  A day-trader is not an investor.  The mind set required for an investor is way different than a day-trader.  A day-trader will find that their success will be tied to volatility.  A market that is not volatile will not move enough for a day-trader to make profits.  In addition, I suspect (but cannot prove) that most day traders are trend followers and do not (for the most part) look at fundamentals such as P/E ratio.  They are trying to take advantage of a trend in intra-day prices and momentum.

Investors need a way to combine fundamentals (long term valuation) and technical timing (when is the right time to get into a stock or other asset). 

So over the next few days, I will tantalize you with a way to build a portfolio that once investments are made, you rarely ever change the investments.  You will be encouraged NOT to look at prices daily or weekly.  You will be informed how to build a systematic approach.  Diversification will be simple; not a complex academic algorithm. 

You will then be given the opportunity to purchase my e-book – Zeb’s Hitchikers VUE to portfolio management.  Or, as Bullwinkle would say, "How to see the world on $10 per day".  :)

In fact, I am thinking of writing a whole bunch of e-books. However, a complete systematic approach to a long-term portfolio will be one e-book.

US

• ·        December futures prices are down.  Monday was a choppy day, but the S&P 500 Index closed higher on a carry-over support from Friday’s stronger-than-expected Nov. non-farm payroll report. The report seemed to make investors and traders comfortable, that if the Fed tapers, the economy can handle it. (If so that is a major trend in trader psychology over the Fed watch mentality.)
• ·        Overnight, the European market is fairly quiet.  Keep your eye on the Ukraine, but European investors do not seem to be concerned that Ukraine’s battle over becoming a part of Russia or staying free, will affect the Eurozone much.
• ·        China November exports rose +23.7% y/y way more than expectations of 7.% y/y.  This also indicates that the global economy is strengthening, making traders think tapering will not be so bad.
• ·        US Treasuries will go on sale today and the rest of the week.  There will be a $64 billion auction package of which $30 billion is 3 year notes.  On Wednesday they will sell $21 billion 10 year T-notes and $13 billion 30-year bonds on Thursday. 
• ·        There are lots of investor conferences going on with Tue-Wed Goldman Sachs Financial Services Conference being the most interesting because of the potential to move the markets.  
• 
  

To Taper or Not, Is That the Question?

Speculation this week will be centered around tapering, I would guess.  Last week’s economic reports suggest that the Federal Reserve have grounds for minor tapering. 

Return then with me to Japan, December 29, 1989.  Equity prices began to drop, and before long, investors wanted out driving stock prices lower.  This began a deflationary spiral in Japan. 

It has now been 22 years since annual inflation in Japan exceeded 2%.  Imagine the angst if the same scenario played out in the US equity market.  How would institutional investors react if their holdings began to lose value with what would appear to be a deflationary cycle?

Ben Bernanke, Janet Yellen, and most of the Fed officials are very much aware of what happened in Japan.  They will do everything they can to prevent the USA from going down the same deflationary path.  PIMCO’s Mohamed El-Erian:

“The Fed is committed to keeping its foot on the accelerator even though outcomes may well continue to fall short of expectations, and even though the ‘costs and risks' are likely to rise. If it ends up making a mistake, something that it will try very hard to avoid, it would likely be one of excessive accommodation rather than premature tightening."

In the short term, the economic reports suggest that tapering will begin sooner rather than later.  That will be a minor amount of tapering, and the stock market may react negatively for a small amount of time.  Why would the reaction be only minor?

The only reason Yellen will taper will be if the data says the economy is growing and the labor market is improving.  We are experiencing growth in the USA and globally.

Investors:  NEVER SHORT GROWTH.   Instead take out an insurance policy against a temporary correction.  If you own stocks, you can take out an insurance policy using options:  (A straight buy of PUTS against your stocks; assuming you have stocks that have options available.)  If you do not know how to use options to hedge, then make sure that you know exactly where you will get out in case price against your position.  You can use a stop (liquidate) in order to remove emotions.  I actually do not like to recommend stops, as retail traders do not know at what price they should stop out.

If the market is going to have a violent reaction to tapering, should we not have seen evidence of that already?  That is simply not happening.  You can observe the relative performance of longs (S&P 500) vs. shorts (the inverse S&P 500 ETF) by looking at symbol SH (inverse ETF).  You can also look at the VIX. 

When investors are optimistic about the future performance of stocks, the price of this ratio is above its moving average.  You can use stockcharts.com to graph SH. 

This then suggests another method available to retail traders to hedge.  Use inverse ETFs (buy shares of SH for example).  However, that requires a systematic approach, and the investor must be very actively monitoring their portfolio (which will include SH (or other inverse ETF).  For Investors, Options are more difficult to learn, but are easier and less risky to maintain once the investors learns how to use them.

Would You Like to Tap Into Growth?

“Do Not Short Growth”?  Is that correct or not.  If it is correct, then one would want to measure where growth is.  Even more so, invest where growth is, momentum (fundamentals and price) is on your side, and value is underpriced (meaning price is low). 

 

Go with growth is so simple that everyone understands it.  Why? Because it makes perfect sense.  Companies operating in growth markets (like China) and increasing sales and profits will in valuation.  However, the company’s valuation must be at reasonable valuations. 

 

Why does a company go into business?  Is it not to grow and grow and grow some more?  So where is the growth today?

 

 

 

Believe it or not, growth is in your backyard.  It might be hard to believe the US and Japan is where the projected growth in earnings are. 

 

For those that would like to diversify into Japan, be sure to monitor Japan’s Central Bank and Abeonomics.  Japan Smaller Capitalization Fund (JOF) invests in a diversified portfolio of small-cap Japanese companies.

 

 

Stockcharts.com 

As the chart indicates, JOF has gone nowhere since the middle of October, and has move below its 50 day moving average.  At the moment, Abeonomics has stalled, and so has the stock market. 

Is this an undervalued long-term play?  Look at 8.90 to be a place to go long JOF (just below the 200 MVA) if you believe Japan’s stock market will continue to rise with the stimulus the JCB is providing.  Would I invest in JOF over the next year?  Yes, because I believe that the USA will continue muddling through, and that Japan will continue QE.  I might use Weekly Binary Options, however, rather than straight out purchase.  If you don’t know how to use Binary Options, (or weekly options in general) then ignore my strategy.  If I was buying JOF, I would make it a very small part of country sector portfolio.  Less then 2% of my total funds would be used, and I would use a 25% trailing stop loss in case. I would liquidate ½ of my position at 12% gain, and let the rest of the position take as much profit as possible.  Once I took ½ the profit, I would move the stop to break even and leave it there. 

Well, not a recommendation other than to follow “growth”.   As noted in the chart, the other growth area is US small cap stocks.  Stocks in the US and Japan have stalled since the middle of November.  Last Friday was fun, but outside that, investors are unsure about tapering.

 

Follow the growth, but do so as you determine the market is “oversold” (however you decided to measure oversold).  For example, once the market becomes oversold (probably around the 200 MVA on Dow Jones Average), look to the Internet sector to grow.  Look at Extreme Networks (EXTR) as a short-term (less than 3 months) to make a profitable rise in those conditions.  They will take a hit during a downturn, but overall they are in an explosive growth market.  They offer an open-source scalable platform, which makes them competitive against Cisco.  The open-source flexibility makes gaining market share easier?  Will they replace Cisco?  No, they will not replace Cisco in my lifetime.  Cisco is the biggest bad competitor around in the Internet space.  Price and flexibility will allow Extreme Networks to grow.  So go with growth, and let me know how that works out for you.  J

Please note: The above growth ideas are for investors looking for growth.  It is not the portfolio for the busy non-professional retail trader.  That is coming.