Back to a state of cognitive dissonance
Steve Cook on Disciplined Investing


Have You Seen This?


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Have You Seen This?

The Market

    Investors either knew what this morning’s nonfarm payroll number would be (see below--it was a blow out) or they didn’t care; because the recent churning in the Market came to an abrupt halt yesterday.  The indices (DJIA 11434, S&P 1121) didn’t just have a good day, they blasted through the 11257, 1120 resistance level.  Of course, our time and distance discipline prevents me from calling a breakout at this moment.  But the pin action gave every indication that there was more upside to come.  So tentatively, the trend seems to be changing from a trading range (9645-11257, 1042-1220) to my (still) hypothetically re-setting up trend (10505-13811, 1096-1505).  Were the latter to occur the next visible resistance levels appear to be circa 11811, 1309.

    Volume accelerated; breadth was very positive; and the VIX got whacked again, leaving it well within the current down trend.

    Bottom line: another day or two of the kind of action we got yesterday will satisfy our time and distance discipline and put stocks in a technical up trend.  Given my skepticism regarding the election results and the ultimate outcome of QE2, I am back into a state of extreme cognitive dissonance.  However, since I don’t argue with the tape, if our discipline confirms an up trend, I will construct another hedged strategy for committing capital. 

    The latest from Trader Mike (short):

    The missed rally (short):

    An in depth look at the Presidential cycle (charts):


    The economic data was mixed yesterday with the weekly jobless claims coming in worse than expected but productivity beating estimates.  Nonetheless, investors once again ignored the reported data.  Several theories were put forth to explain the stellar day:

(1) the dollar got stomped on; and given the recent solid inverse relationship between the dollar and stocks/gold both rallied hard.  Of course, the dollar took it on the chin because the rest of the world realized the inflationary implications of QE2 and traded accordingly overnight.  Our rally was simply the extension of the global ‘sell the dollar, buy assets’ trade.

    A lecture from the Chinese on QE2 (medium):

    More negative feedback on QE2 (short):

(2) there were big shorts in the Market betting on the ‘sell the news’ [following the elections and the QE2 announcement] thesis; and when it didn’t happen, there was a mad scramble to cover,

(3) Obama hinted that He would accept an extension of the Bush tax cuts for all taxpayers, providing a glimmer of hope that He would tack to the center. [yeah, right]

David Stockman on the deplorable state of fiscal policy, the absence of any likelihood of change and QE2 (long but today’s must read):

It is likely that all the above played a role in yesterday’s equity price moon shot.  Unfortunately, as far as our Valuation Model is concerned, (2) is irrelevant, (1) is a negative and I am siding with David Stockman on (3)--in other words lots of luck. 

Scott Gannis on the Market’s recent performance (short):

Bottom line: I love being a contrarian  when stock prices are dramatically over or undervalued according to our Valuation Model; but it drives me nuts when the Market is plus or minus 5-10% of Fair Value, I have directional bias and prices go the other way.  I have learned the hard way that there is no percentages in being a contrarian in those circumstances.  So I take a Pepsid, grit my teeth, and go with the flow using our Price Disciplines to protect my back side.  This break out still needs to qualify as such under our time and distance discipline; but we are close and I am looking under my sink for the antacid.

    The latest from David Rosenberg (long):
     Thoughts on Investing--from the Apprenticed Investor

The purpose of "Apprenticed Investor" is to teach you to become better investors. Today's lesson is about having a healthy respect -- not fear, but respect -- for your opponents.

I am always surprised at how eager and confident new investors are, entering the fray with hardly any hesitation. The reason for this is fairly simple: Many investors have achieved some level of success in their chosen field. This is how they have amassed their investing capital, and their prior success breeds a healthy self-confidence.

Healthy, that is, in your chosen fields. In the capital markets, that self-confidence is dangerous, even reckless. People tend to forget that once they become investors, they have essentially started a brand-new career -- and started at the very bottom, too.

Transitioning from a newbie to an accomplished pro will present many challenges. The self-confidence that served you so well in your other endeavors can hurt you when trading. Just as 90% of people consider themselves above-average drivers, so too do many people believe they are above-average investors. For the majority of these folks, that belief can be naive -- and potentially self-destructive.

A question I ask people who want to become traders (or even pros who want to become fund managers) is this: Do you have the skill set, discipline, temperament, time horizon, strategy and capitalization to enter into the most competitive gladiator ring on planet Earth?

The market is a zero-sum game. You win, someone else loses, and vice versa. That's certainly true on individual trades, and it's nearly true on the market overall. The only thing that prevents all of investing from being a true zero-sum game is that, over time, the pie gets bigger. At least, it has in the U.S. for the past 100 years.

Competitive Juices Flowing

It's important to understand who your opponents are on the field of battle. Sports and war metaphors abound, because they are consistent with what you are going up against. Yes, you are up against Mr. Market, but your rivals are also other people buying and selling stocks. They, too, are looking to produce positive returns.

Charles Ellis, who oversees the $10 billion endowment fund at Yale University, once observed:
Watch a pro football game, and it's obvious the guys on the field are far faster, stronger and more willing to bear and inflict pain than you are. Surely you would say, 'I don't want to play against those guys!'

Well, 90% of stock market volume is done by institutions, and half of that is done by the world's 50 largest investment firms, deeply committed, vastly well prepared -- the smartest sons of bitches in the world working their tails off all day long. You know what? I don't want to play against those guys either.

That's a brutal and, in my opinion, absolutely spot-on observation. The institutions Ellis refers to are mutual funds, hedge funds, charitable trusts, insiders, program traders -- and all of their professional traders and portfolio managers.

Want to know how fast these guys are? In his recent book, Running Money, Andy Kessler recalls a story about the run-up to the first Gulf War. Then-U.S. Secretary of State James Baker had flown to Geneva to meet with Tariq Aziz, his counterpart from Iraq, to see if a peaceable solution could be worked out: "Baker stepped out of the meeting and said, 'Regrettably...' Before he finished his sentence, oil prices spiked 30% and stock markets sold off," Kessler writes.
That's what you are up against.

Despite this daunting opposition, too many individuals step onto the field of battle with the pros with too little preparation. To carry the sports metaphor further, they end up receiving season-ending injuries to their investment and retirement accounts.
I frequently review these sorts of accounts. What I see causing most of the losses is simply an inadequate skill set. Some of the foolishness I see from the alleged pros is as bad as what the market "dabblers" have done. In the coming weeks, we will look at several things you can do to avoid the most common injuries.

Lawyers, Docs & Money

Consider this: If you have anything more than the simplest of tax forms, what do you do? You pay a professional to do your taxes. If you are accused of a felony, you get the best lawyer you can. Need heart surgery? You go to the very best hospital you can afford.

I put financial management right up there as a profession with medicine, law and accounting. Yet many people never even hesitate to take their hard-earned money, open an account and start trading.

Worse still is how nonchalantly these accounts get treated. Do you ask your friends at cocktail parties what's the best way to crack open a chest cavity, or which rib spreader they like best? No, you find the best heart man you can, and let him try to save your life.

It should be the same in the market, but it's not. People have committed months -- if not years -- of hard-earned income to investments based on cocktail party chatter, chat board rumors or astrologers. That's not what you call extensive due diligence. Idle rumor mongering in an online chat room is not the equivalent of hardcore, in-depth research.

I'm not suggesting that you should throw up your hands in desperation and hand over your accounts to the so-called pros. Rather, I want you to understand exactly what's involved and what you are facing before you plunk down your hard earned do-re-mi. It isn't that you cannot do it yourself -- my point is you darn well better get up to speed before you start doing it yourself.

I'm sure that some people will disregard all of this as self-interested blather. After all, my firm profits by having people pay us a fee to manage their money. And for many people, that's the best route. They are self-aware and realize they lack the time, discipline or interest to do it themselves. If you are reading this, I assume you want to do it yourself. This advice is to help you understand that you best get up to speed.

Still, even the most cynical amongst us must admit the following: It is outrageous folly to imagine that, in just a few hours a week, you can best the world's sharpest, best-equipped, fastest traders.

This is the not-so-secret problem with the online trading business model, i.e., why E*Trade (ET) and Ameritrade (AMTD) are reportedly in merger talks. It's also why Schwab (SCH) set up its "trusted investor advisory." They all know the dirty little secret of the business: All too many frequent online traders eventually grind their assets away. (It also explains why E*Trade has diversified into banking, mortgages and other financial services.)

The most skilled and talented amateur traders eventually go pro (i.e., direct access), while many of the rest hack up their capital, sandpapering away their accounts through poor risk management and over-trading.

Knowledge vs. Wisdom

Just because someone hands you a bat doesn't mean you can hit a home run off of Roger Clemens (yes, another sports metaphor). The explosion of Web-based market data may have given everyone similar tools, but it did not grant them an equal ability to use those tools. There is a huge difference between information and knowledge, and between fact and wisdom.

I believe that many people can compete on the Gladiatorial trading fields. It requires hard work, discipline, intelligence and a willingness to learn things that are counter-intuitive. In coming columns, I hope to show you many of the tools you will need to succeed on that field of battle.


   This Week’s Data

    Third quarter productivity rose 1.9% versus expectations of a 1.1% increase; unit labor costs were down 0.1% versus estimates of up 0.1%

    October nonfarm payrolls blew out forecasts, coming in up 151,000 versus an anticipated up 48,000.


    Here is another depressing analysis on the magnitude of leverage in the system and how difficult it will be to delever (long but worth the read):

    Not a particularly upbeat indicator of the state of the economy (medium):

Posted 11-05-2010 8:27 AM by Steve Cook