The least dirty shirt on offer

An article featured in this weeks “The Economist” is about the cyclically adjusted earnings ratio, (CAPE) as calculated by Robert Shiller of Yale University.

The CAPE averages profit over ten years and is now used by many as a vital valuation indicator. The article explains that currently, the indicator shows that American shares have hitherto been more highly valued only in 1929 and the late 1990s, periods that were followed by significant crashes.

But the article is also balanced in explaining that CAPE valuations are for the longer term view, and that over-value can exist for quite some time.

The CAPE is a similar method developed by Nick and me in 2010 on individual equities. More recently, however, we have not traded with this method due to there being few suitable valuations on offer.

The CAPE is for the long-term, but it is, of course, advantageous to purchase, even for the longer term, at particularly good value.

The article concludes with fund managers being nervous about equity valuations, but they (fund managers) find government bonds deeply unattractive. They are therefore stuck with the stock market as the “least dirty shirt” on offer.

“We seem to be living in the riskiest moment of our lives”

Richard Thaler, a behavioural economist, received a Nobel prize. Speaking by phone on Bloomberg TV, he said:

“We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping, I admit to not understanding it.”

From our fund point of view, we have a couple of lightly traded shares awaiting the conclusion. Otherwise, we are 100% short-term (both long and short) trading of a chosen currency pairing.

We have traded GBP/JPY, changed to USD/JPY and currently, we trade GBP/USD. Another consideration for us is AUD/USD.

We moved from GBP during Brexit and for the months after.  About the price, JPY is consistent, a requirement of our strategy; unexpected volatility is not, therefore the decision, for the time being, to move back to GBP.

We do not hold trades overnight, as there is often inadequate liquidity during this period; with an increased probability of a spike in price.

Trading equities can be very different to currencies, specialization is appropriate.

Is it time to worry?

The Economist has an article this week that asks “prices are high across a range of assets. Is it time to worry?”

Before the 2007-08 financial crash, I managed to cash-in early; this, I’m sure, was luck. I was, at the time, financing a business build; fortuitously, I went much further than cashing-in assets required to support the business.

Some lost up to 50% of their worth during the 2007-08 crash. (I learnt recently, that this had happened to someone who I had known very well and who now resides in Australia.)

As the Economist alludes, should we be concerned again?

I spent nearly a year in the development of original formulae based on Benjamin Graham’s ideas. His method principally determined a ‘margin of safety’. As the Economist article explains: “the price paid for a stock or a bond should allow for human error, bad luck or, indeed, many things going wrong at once”.

In my technical trading, which is the only trading I now do, ‘margin of safety’ is everything: (1) I do not carry a trade overnight and probably not over a weekend. (2) The risk of each deal does not exceed a maximum. (3) I cannot multi-task, so I trade only one thing, watch it at the moment and with awareness of what (news) might affect it.

Not many have the will, the time or the inclination to do what I do. I understand that. So we use traditional fund managers.

Graham’s ‘margin of safety’ was buying a share at a 50% discount or better. Can we get that deal today? If not, fund managers may become increasingly incautious in their dealings.

Buffett said this week, as reported by the Economist, “stocks would look cheap in three years’ time if interest rates were one percentage point higher, but not if they were three percentage points higher”.

In the meantime, for my fund investors, I’m pleased to take ‘margin of safety’ into my own hands.

P.S. My articles are few and far between currently as I work on a strategy e-book and of course my trading.

A sucker game

A point from Nassim Taleb from his book “Antifragile: things that gain from disorder”.

Yes, he creates, I think, an appropriate new word to help get his meaning across. In one area Taleb presents his argument on medium risk (referral to a financial portfolio) and how he considers there to be no such thing as “moderate” risk.

His point is that in the event of a “Black Swan”, that is a catastrophic adverse event, then all – low, medium and high – risk is going to get hit. (As an aside, I consider that a negative Black Swan, to an expert intraday trader, can become a positive Black Swan).

Fully committed to a “moderate” risk account is, actually, at full risk; at best, this provides medium upside potential but with all the possible downside. That is because medium risks contain substantial measurement errors.

Taleb points out the following: rather than being fully committed to a “moderate” risk portfolio better to be 90 or 80 percent in a dull, inflation proof, no risk cash account and 10 to 20 percent in a very high-risk account. Moreover,  an adverse Black Swan is a potentially emotionally draining experience. 

The 80/20 example means that we have little downside – assuming that 10 to 20 percent downside is acceptable – whilst still exposed to massive upside.

To finish, Taleb writes: “Someone with 100 percent in so-called ‘medium’ risk securities has a risk of total ruin from the miscomputation of risks”…..”that in fact is a sucker game”.

Longer-term, should we consider North Korea et al

A reminder that we periodically take a look at the US 500 chart (or S&P) to get a feel for what our chosen FTSE 350 companies may do.

We use the US 500 and the FTSE 250 charts as the FTSE 100 is, we feel, more driven by the commodity companies and therefore does not provide us with a platform to judge the non-commodity companies within the index.

Even if this were not so, we’d still consider the US 500 as a good indicator of not only the associated 500 companies but also of companies within the FTSE 350.

The US 500 is at a prominent number position which often affects the chart. Moreover, we have a measured move up to its present location from the 2014-2015 high and low. It would also seem that we are in for a consecutive ‘bear’ month. (The bulls go up, and the bears go down).

The strength of the bulls, however, would, to my mind, not bring the chart too far down at this stage. I would consider any pullback to be a flag rather than a ‘major’ reversal. Possibly the next 2 to 3 months may see a pullback; this, I think, will probably be bought by the bulls and the market pushed back up to the high of the significant number again.

On the daily chart, this will create a more significant double top. And this in itself may be strong enough to create a ‘major’ trend reversal which will start on the daily chart and follow through on the weekly and possibly the monthly chart as a reversal.

Where would the reversal go? Back down to the 1800 position and at the low of 2014 to 2015.

Lets now take a look at the FTSE 250 monthly chart.

The chart has been in a tight bull channel for some time. Of note, I would have bought the December close anticipating a swing target that is at, or almost at, the present high. This high is still short of the top of the channel, but it is at a measured move position and virtually at a significant number. I wouldn’t short at this point, but I wouldn’t take it long from here either. I’m waiting to see what happens.

Finally, do we factor in Trump, North Korea and Syria? Well, yes, these could be a catalyst for at least a small correction and if so this will accelerate the points we’ve made.

Not a good idea to match experts

Each of my faults, the ones that I’m aware, seem to balance themselves out.

For example, my type of dyslexia (probably detectable in many of my spellings) gave me reading problems as a child (I’ve overcompensated as most would now consider me a voracious reader) but seemingly balanced by my skills in mathematics.

Later in my career as a squadron commander, my propensity to change my mind in a flash and go with a different tack was undoubtedly frustrating for my management team.

That same trait is, as it turns out because I wasn’t aware that this oddity of mine could be put to advantage, gives me a traders edge.

That is because in trading, and in particular my chosen method of short-term trading, is based on probability. Where (according to Taleb) probability is about the belief in an alternative outcome; it is not about the odds.

Beliefs (Taleb goes on to say) are said to be path dependent if the sequence of ideas is such that the first one dominates. We may be programmed to build loyalty to plans in which we have invested time – a good salesperson, for example, will take advantage of this principle.

An excellent trader, on the other hand, will change their belief (probability assessment) in an instance. That is why it is not a good idea to attempt to take the same trade of an expert: we know they are long, they said that they are going long, we follow and accept the trade long – the expert went short!

Long-term, what does the S&P chart suggest

The S&P 500 is, I think, a reasonable guide for us when considering our long-term FTSE 350 top ten.

The chart we are considering is the monthly chart, and this snip covers the last few years. The month just gone finished with what is known, technically, as a doji; this is indecision or a trading range bar.

The chart has been steady, having now completed a measured move up from the last pullback at about 1800. Also, the chart is currently at a significant number, being 2400.

The significant number, completion of a measured move and finishing the month as a doji all point to a pullback at this stage. Albeit a small (in monthly chart terms) pull back; what the technical analyst would call an anticipated bear flag.

Any small pullback will, in all likelihood, trigger on-limit purchases and the chart pushed back up to 2400 or higher. However, if the pullback is stronger than anticipated (the possible government shutdown crisis and the congressional fight over the continuing resolution that expires on April 28 is a factor), then we could see the chart coming back down to the 1800 level. As we’re on the monthly chart, such a scenario would take one to two years.

The bottom line is that the chart is at a measured high with a doji and significant news on the way. I would hold for a time and see where this leads. A pullback to 1800 would provide a good buy point – but, of course, in maintaining we may miss (and possibly the more probable) further move up.

Buffett, an investing dinosaur?

I appreciate that we don’t have much time to read a blog, often on a mobile device and while we’re busy concentrating on something else. Meanings easily misinterpreted. Moreover, accurate longer term ‘value’ investing is not a popular investment method. We want gratification earlier.

Someone close to me this weekend considered me wrong with the longer term investing methodology, suggesting that: (1) the market has changed and a five years investment model is long enough, (2) Buffett is an investing dinosaur and (3) proceeded to tell me why Blackberry failed.

My initial explanation (blog) must have been inadequate, so I hope I can provide more clarification.

The numbers that we provided to back up the top ten shares can be confusing. We are looking for companies that ideally have ten years of reports showing no debt, high consistency in growth and are available at the bargain price of fifty pence on the pound.

The latter refers to the margin of safety (MOS) that Graham coined. That is the same as being able to go to a BMW garage and purchase a £40,000 car for £20,000. A good deal. That is what the MOS is telling us. What it is not showing us is how good the car is.

All the many books available on how to calculate the MOS can be obtained and studied carefully and it would still be tough (and I’m not kidding here) to find a solution for the MOS. That is why what Nick provided us with is a gift.

Because we don’t know how to work out the MOS, many times we are buying shares at £2 or £3 on the pound. That is like going back to that BMW garage and buying that same car, but now for £80,000 or even £120,000. That sounds like a silly thing to do, but we do it when we buy shares!

I was wrong to provide a suggested timeframe for longer-term shares. It seems that some have latched onto that guidance I gave – when it’s an individual interpretation of what is longer. My suggestion allowed for purchase at any point in the market cycle. But I don’t know, and nor does the buyer probably, at what point in a market cycle they are at the time of purchase.

As for Buffett being an investing dinosaur, the methodology comes from Graham, and he was the generation before Buffett. But in any case, it’s nothing to do with either of them. Buying something for fifty cents on the dollar is as good a market trading philosophy today as it was in Babylonian times.

Blackberry is an example. Kodak is another. It doesn’t matter here about these companies. I was merely trying to say that such companies can show up on Nick’s list but are about to crash. That is why Nick has provided the 1st, 2nd and 3rd periods of measured consistency to help us spot such companies. And for those who think it’s easy to see such companies coming, sure it is after the fact, but most of the brightest analysts in the world didn’t at the time.

The market cycle is worth a further mention here. I’m not a doom and gloom thinking guy, quite the opposite. Benjamin Graham gave up at one point because he couldn’t find companies that provided value, a MOS; this was before the great depression. From 350 companies we would expect to see about 10% of a qualifying MOS. On the last run, 3% qualified, and some of those are questionable as they don’t have the ten years of reports.

I don’t recall any of my chart analysis providing a ‘buy me now signal’ either. Moreover, once the daily press has front page news telling us it’s a great time to buy – well, you know what I think about that.

With 5-minute bar charts, I deal with a ‘major’ trend reversal a few times a week. With such a chart it would not be possible without the X/Y values showing to tell the difference between this and, say, the 2008 market crash on a weekly chart. So the short-term trader gets a lot of experience with market reversals.

More often than not, a beginner trader will trade a reversal too early (this is the case for both short and long-term trading/investing). Only to be stopped out at a higher price – in the case of a bull reversal – and watch from the sidelines as the market eventually drops. On a 5-minute chart, such a reversal can take hours, on a weekly or monthly chart it is years – or at the very least many months.

As a final thought, value investing, or the interpretation of fundamentals is not a suitable methodology for mid-term investing. There are alternatives. For example: taking advantage of IPOs, share splits or runaway news, events, fads and fashions. I particularly like the interpretation of the COT report with commodities for mid-term investment.

I hope this helps.

More on the long-term investment model

My recent blog(s) were regarding long-term investing. By long-term, I’m thinking 15 to 30 years. Nick has given us, from each company past ten years of annual reports, where available, his estimation of a company’s future value (MOS) and measure of consistency as a percentage of growth.

From the FTSE 350 companies, Nick found that only ten companies met his criteria. Of these top ten companies, meant for long-term ISA or SIPP investment, we need to understand the principles of the company and be satisfied that a company has a product, method or brand that will be around after the next ten years.

Nick has provided us with an old 3rd, mid 3rd and latest 3rd consistency to help us determine this. For example, Blackberry would have scored all the way higher to its end on this system; however, the clue would have been in Blackberry’s old, mid and latest consistency which would have shown a significant downslope.

Nick will refresh these calculations every few months. Primarily to capture the most recent annual report – three of which, on our current estimate, were from the end of 2015. To help, or possibly confuse, I’ve provided a brief chart synopsis of each of the top ten companies. I will continue to do this at the release of an updated calculation from Nick.

New readers to this blog, please note that my full-time business is short-term trading. Most of my blogs, therefore, will be focused on the day trading stuff.

Personally, I’m only in favour of short-term and the very long-term trading/investing model. I’m not in favour of the mid-term trading timeframe which constitutes the majority of the trading/investing world – pension funds and the like; this is a timeframe from the near term out to 15 years. I also feel that many pay too much for the services of providing mid-term investing. ‘Tony Robbins, Money Master the Game’ shows how every 1% of charges results in giving the investing company 20% of the final fund. Possibly a reason why a finance company made our top ten!

If we are to invest in the mid-term, Robbins advocates cash, share, commodity and bond mix. There are a few investment companies that provide such a fund – an independent financial advisor could help. Such funds are not exciting when the share market is going up rapidly; but such a fund usually provides a profit  – even when the share market heads south.

The remaining top share picks on a chart

To complete our take on the remaining top ten FTSE 350 shares here’s the final few from last week. As I’ve explained, the primary purpose for these shares is their fundamentals. As we are looking at mainly, long-term holds the chart (even a 10-year weekly bar chart, as shown below) becomes irrelevant. However, it’s always nice not to have to spend the first few years of ownership out of the money. Therefore, please do your due diligence, but these charts may help.

Zoopla has a clear 3-wedge up which could signal a pullback. However, if the pullback is weak, there is a reasonable probability of a measured move up of the whole wedge, to the 600 area. 

There is a 50% probability of a pullback with Wizz to the 1,300 area, as marked below. However, the price is currently centrally located in a possible big trading range (TR), so a push up to the top of the marked TR is a consideration. The big TR will only reveal itself after another touch at the top and bottom.

Shire is a lot at 5,000. However, do not misinterpret this as expensive or overvalued.  Price and value, in this sense, as we know, are not correlated. Pharmaceutical companies are liable to considerable share price movements. Shire, being one of the more stable for reasons that our further due diligence will reveal. Again, we are looking for a break out here from its previous high of about 5,750 or a pullback to cement the bottom of the trading range firmly.

Whatever your thoughts might be about a company such as Playtech – online casinos and the like – it has been a consistent member of our top ten. Since 2012 share price has more than tripled and from our original calculations is still only 50% of its future value. The last annual report for Playtech was at the end of 2015, so I’m waiting to see what the next results provide.

The FTSE 100 is mostly influenced by the big commodity companies, even though weighted by market capitalisation. Therefore I’d be reluctant to use the FTSE 100 as a barometer for our top ten shares.