Day: January 5, 2008

Momentum, Schmomentum

Momentum, Schmomentum

My biggest insecurity when it comes to my investing comes from the concept of momentum.? For the past 7+ years, I’ve been leaning against the wind, buying companies with bad momentum, and for the most part, it worked.? In general, falling stocks have bounced back.? Over the last six months it has not seemed to work so well.? Now, I had a period that was much worse in the middle of 2002.? I even scraped excess money together to invest in late September of 2002.? I am less confident here.

I have a number of ideas that work with respect to momentum:

  • In the short run, momentum persists.
  • In the intermediate-term, momentum reverts.
  • Sharp moves tend to mean revert, slow moves tend to persist.

My own proprietary oscillator indicates that we are very close to a short-term bounce point.? The recent move down has been too rapid, and sellers should be tired.? One more hard down day, and a bounce should occur.

Back to my own portfolio management.? Since I am a value investor, I have leaned toward longer holding periods, which implies to me that I should be playing for the intermediate-term reversal of momentum phenomenon.? But the short-term momentum anomaly is probably stronger.? Consider these two pieces from Crossing Wall Street.? Eddy illustrates the point well.

So, as I head into my next portfolio reshaping, I am scratching my head, and wondering how I should use momentum in my investing.? Suggestions are welcome.

Random Notes

Random Notes

A few random notes:

  1. When I left my prior employer, one of the first things I did was buy a new laptop from Dell. It was much slower than I expected, and I began experimenting to see if I couldn’t speed it up. Now, here are a few tips: a) install sysinternals process explorer — it gives you much more information than task manager, and will show you what programs are hogging system resources. b) shut off or cripple the many little programs that lurk in the background, many of which occupy a decent amount of resources while waiting for program updates to be released over the internet. Do the updates manually, say, once a quarter. c) Reduce the number of programs that load at startup. d) I turned off the advanced graphics that were kind of pretty from Windows Vista. e) all of these helped, but the big bopper was removing McAfee and replacing it with ZoneAlarm Security Suite. McAfee was a real resource hog, and after removing it and installing ZoneAlarm, everything is faster. Everything. There is a limit to security systems; if they are pressed too far, they kill productivity. Productivity and security must be balanced.
  2. QBE’s gain is the Nasdaq’s loss. North Pointe, a not-all-that-well-known property-casualty insurer has sold out to QBE of Australia. Personally, I really liked NPTE’s management team, and thought they were on the right track. I appreciate insurance management teams that can focus on profitable niches, and are willing to let business go if they can’t make an underwriting profit. If QBE is smart, they will give prominent positions in their US operations to James Petcoff (the CEO) and Brian Roney (the CFO).
  3. Just as an aside, I felt like republishing this off topic post from RealMoney:

David Merkel
How to Sell More Popcorn
11/3/2006 2:07 PM EST

When I was in college, I needed to make money, so I got a job working at a convenience store. The young lady who trained me showed me how to operate the popcorn maker. After adding the oil and the popcorn, she reached for the flavoring container and dumped the lot in. Her comment, “Just watch, the extra flavoring really creates sales.” She was right. As people walked in the door, a larger number than I would have expected bought popcorn. But there was a problem. The popcorn didn’t taste good. Too much salt and fake butter flavor. It led to few, if any repeat customers.

About a month later, when I was on the night shift, I tried an experiment where I cleaned out the popcorn maker, cleared out the old popcorn, and the popped a fresh batch using a little less than the instructions would indicate, much less the young lady who trained me. The smell was there, but it wasn’t overpowering. Since popcorn wasn’t usually done on the night shift, though, it would be noticeable.

The surprise: repeat customers for popcorn in the graveyard shift because it tasted good. Word of mouth spread, so I made popcorn regularly.

I believe in UPOD (underpromise, overdeliver) as Jim Cramer often points out. It applies to investing in two ways: first, buy companies whose managements do UPOD, and not OPUD. Positive surprises drive stocks higher, negative ones drive them lower.

That said, there is a second way that UPOD plays into investing. It’s what you tell your investing clients or readers. No strategy works all the time. No strategy is perfect even in the long run. No analyst is always right. Underselling your investment abilities, and demonstrating humility, may not attract as many clients in the short run, but it keeps them in the longer run, with continued diligent work.

And with that, I have to grab lunch; writing about the popcorn has made me hungry.

Position: None

Tickers mentioned: NPTE DELL

Looking Beyond the Three Percent Horizon

Looking Beyond the Three Percent Horizon

Give the Fed some credit. Not literally, of course. Isn’t it their job to give us credit?

I haven’t talked a lot about Fed policy in a while, so I thought it was time to do an update. Five months have passed since my 3% sometime in 2008 call was made, and now it is becoming the received orthodoxy. That’s why I have to ask what is wrong with it, or better, what is the next phase beyond it?

Truly, I don’t know for sure, but I will offer out my thinking process. We are seeing rising unemployment and inflation at the same time. The bond market is rallying, anticipating falling Fed funds rates, but not forecasting rising inflation rates. (Buy TIPs!) In the spirit of watch what they do not what they say, let’s review the relevant Fed data.

We are in a period of asset deflation and consumer price inflation, so this is a difficult period to negotiate through. You can listen to facile comments from PIMCO; everyone is focused on economic weakness, and few are focused on rising inflation.

I think we get to a 3% Fed funds rate, but we don’t get much below it, because by that time, a 3% Fed funds rate will imply a negative real interest rate on the short end. Congress will have an implied inflationary bias, because the complaints will come more from asset deflation. They will kick nudge the Fed that way to the extent that they can.

The TED spread is not as wide as it once was, but it is still in a historically high range. Anything above 60 basis points implies stress. To reduce this the Fed has set up an auction facility, called the TAF. The TAF has been expanded, which allows for a greater variety of securities to be lent against. That’s the real novelty of the TAF. Not new liquidity but new collateral. That said, even the discount window is getting greater use. As a result, the Commercial Paper market is showing some life, even for asset backed commercial paper.

So, liquidity is increasing on the short end, to the point where a 1/4% cut in Fed funds has for practical purposes already happened. A formal 1/4% cut at the next FOMC meeting would do little except ratify what has already been done. Now there is weakness in the job market, and the PMI is signaling some weakness as well. The yield curve has moved down, particularly on the short end, to reflect expectations of more cuts from the Fed.

But TIPS yields are quiet, at least for now, and viewing the Fed as quasi-politicians, whose main goal in life is to avoid political pain, the path of least resistance is to loosen policy further. Fed funds futures and options are indicating the most likely outcome in on January 30th is a 50 basis point loosening. Ordinarily, because of the “gradualist” culture that has built up inside the Fed, I am reluctant to argue for loosenings other than 25 basis points. I think at this point, I have to argue for 50 basis points, but with the usual squishy language that pays heed to all potential threats, effectively saying, “But no more after this! Conditions are balanced!” We know better, though. The only real question is when rising consumer price inflation or a deteriorating Dollar (think of 1986) will be a sufficient counterweight to economic weakness.

The US Dollar is weak here, and that reflects the judgment of many actors as to the value of what they get paid back will be. My guess is that foreign investors sense that inflation is higher in the US than is stated in the Government’s statistics. Too many dollar claims (internal and external) chasing too few goods that they want to buy. What will dollar-denominated bonds be worth at maturity? (Judging by current yields, quite valuable for now.) And will the US Government allow significant US companies to be owned by the Chinese, or by Arabs? How free market is the US really? Will foreign governments stop policies that disfavor the purchase of US goods? Perhaps once they import enough inflation, they will.

With gold, crude oil, and a host of agricultural prices high, and with structural reasons for them to remain high, the FOMC won’t feel too happy as they cut rates. But cut they will, and then we get to see where the excess liquidity flows. Some will bail out banks, which will invest in safe instruments in areas of the economy not under threat. Loans in or near default will not be affected. Well, more on that later. Tonight’s post will be on credit issues.

In closing, a return to the problem that I posed at the beginning: So what’s wrong with the 3% Fed funds forecast, or better, what is the next phase beyond it? It could go several ways:

  1. Rising price inflation and a deteriorating dollar lead to an end to the cycle, and the Fed funds rate either stops falling, or has to rise to squeeze out inflation.
  2. Continuing asset deflation, and declining but still positive economic growth (as the government measures it) leads the Fed to continue to loosen, or stand pat in the face of rising consumer price inflation.
  3. Liquidity difficulties in the banking system morph into solvency difficulties, leading pseudo-M3 and credit to contract (after all the banks are doing the heavy lifting here, not the Fed) and the Fed starts to loosen aggressively.
  4. We get a “bolt for the blue” leading to something not currently predictable, but which leaves policymakers in a bind.
  5. We muddle along, get to something near a 3% Fed funds rate, and continue to muddle (think of 1992-1993).


Personally, I favor scenario 2. And, for those that like to invest, TIPS are reasonably priced. Insurance against scenario 2 is inexpensive, and relatively high quality. But be wary, because particularly in a Presidential election year, there could be significant surprises (part of scenario 4).

Long VIPSX

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