looking for patterns

Yesterday I wrote that the recovery that follows a sharp stock market decline is an important time to look for changes in the kinds of stocks that investors are eager to buy and the ones they’re happy to dump overboard.  I’m not sure why take place at these market inflection points, but the very often do.

Step one in trying to detect new patterns is for each of us to examine our own holding to see what’s happening with them.  We’re not just looking for under performance/outperformance during the downdraft.  We’re basically looking for two kinds of outliers:  stocks that underperformed on the downside and are continuing to underperform (bad!); and for stocks that outperformed on the way down and that are continuing to outperfrom now (very good!).

Step two is to widen our search to try to get a feel for what the overall market is thinking.  The way of doing this that I find most useful is to try to imagine the general economic situation the world is in and what kinds of stocks should be winners/losers if my picture is right.  Then I look at the stocks themselves to see whether their price movements confirm my thoughts or not.  Then I adjust if needed and repeat.

The most difficult situation is one where I’m 100% convinced I’m right but the stocks say otherwise.  This is rarely the case, in my experience.  At least someone has already picked up on a major investment theme before me.  But that’s okay.  A trend may last for years.  If I’ve missed the first three months it’s not a big deal.  Besides, being the only one in the restaurant has a kind of eerie feel to it.  If I’m thoroughly convinced I’m right, I’ll probably take a small position and prepare myself to add more quickly as other diners come through the door.

what I’m looking for now

The world is still in a slow recovery from the Great Recession.  The US is doing fine, given dysfunction in Washington.  China has structural change issues that have it growing at a “mere” 6% – 7% or so.  On the other hand, the warts in Abenomics in Japan are showing themselves and the EU is starting to look a lot like Japan of the 1990s.

Four big macro changes over the past, say, six months:

–China has been much more persistent than I had thought possible in trying to steer its economy away from low value-added export-oriented manufacturing toward higher-end businesses aimed at a domestic audience.  This changes the composition of growth, but is good, in my opinion.

–The EU is flirting with recession again.  The biggest culprit is France.  This is bad.

–Energy prices are falling–a lot.  This is bad for energy producers, great for everyone else.

–I had expected world growth developments to express themselves mostly (exclusively?) through changes in stock prices, with the US going up and the rest going sideways.  Instead, the principal expression has been through changes in currency values. This makes a difference.  A higher dollar slows economic gains in the US in much the way an increase in interest rates would; the fall in the euro acts as a (desperately needed) stimulus for the EU.

So, I expect…

1.  Slow GDP growth means secular growth stocks will do well, cyclical value stocks (much) less so.  Long Millennial/short Baby Boom ideas may be the best.

2.  Companies with costs in euros or yen but revenues in dollars stand to be big winners from recent currency moves.  So too companies with assets in the US.  Assets or earnings in the EU or Japan are now worth less in dollars than they were earlier in the year.

3.  The energy situation has a lot of moving parts (more tomorrow).  The clear winners are energy users.  The clear losers are the oil-producing countries where the deposits are controlled by national oil companies (think: Latin America, Africa).

Once I publish this, I’m going back to see if the markets are running with these ideas or not.




equity portfolio analysis to do now

Investors, even professionals, typically don’t want to look at their equity portfolios during a market downdraft.  It’s too ugly and too painful.  I’ve always thought, however, that if you can keep yourself from becoming too emotionally distraught from viewing what is after all a natural occurrence in equityland, you can get a lot of valuable insight into how the market will unfold as stocks inevitably turn up again.

Just from eyeballing charts–I’m too lazy to go back and do precise calculations–we had a particularly long and deep correction in 2011, two (maybe three, depending on how you count) in 2012, two 5%+ corrections in 2013–all before this one in 2014.

I’m pretty sure this correction has ended.  No one knows for sure until the downturn is clearly in the rear view mirror–and sometimes my native optimism gets the better of me.  I feel better  having made this disclaimer, even though there’s been enough if a reversal of form in stocks previously being pummeled (meaning most of my portfolio) to have me pretty well convinced

In any event, I think we should all do what I’m about to recommend, even if there does turn out to be another leg down.

First, two rules:

– Generally speaking, when the market declines value stocks go down less than the market; growth stocks go down more.  When the market begins to rise again after a correction, the pattern reverses itself.  We want to find stocks that are acting out of character–both good and bad.

–Often market leadership–meaning the industries/sectors that do the best–changes during/after a correction.  This change may simply validate ideas we already have  …or it may show us some economic development that we’d overlooked so far.  Either way we want to identify and ride new trends.

use a chart

For me, the simplest way to do this is graphically.  Set up a Google or Yahoo chart that will compare the performance of each stock in your portfolio with the S&P 500 from September 19th until now and look for anomalies.

Throw in some well-known names, stocks you think you might like but don’t own, volume leaders…to get a feel for what’s going on with names you don’t own.

The best case is a stock that has outperformed on the way down and which is rebounding more strongly than the market.

The worst is the opposite   …a stock that underperforms during the downturn and fails to bounce back during the rebound.  These are ones you especially want to detect and investigate.  In my book, you have to have very compelling reasons to hang on to a stock like this.  In my view, you don;t want a stock like this to be your largest position, no matter what reason you come up with.

Do this without having any expectations.  Just see what the numbers say.  Then you can begin to interpret.

Don’t make excuses in advance for stocks.  If a holding has, say, declined by a third during the correction and isn’t rebounding,  chances are that something is wrong.  Facebook (I don’t own it), on the other hand, did better than the market on the way down and continues to outperform.  Other social media stocks appear to be doing the same.

More tomorrow.



3Q14 for Intel (INTC): keeping the faith …or not

INTC reported 3Q14 results after the close on Tuesday.  Earnings per share came in at $.66, which beat the brokerage house analyst consensus by $.02.  The company’s guidance for 4Q14 exceeded analysts’ expectations as well.

The stock gained about 3% in the aftermarket   …but plunged at the open yesterday.

There are two main points at issue, as I see it:


1.  Some analysts think INTC’s outlook is too bullish.

a. Last Thursday, Microchip Technology (MCHP), a maker of a broad range of commodity semiconductors, warned that its 3Q14 would be weaker than it had previously thought.  The reason:  weakness in China in September.  The company also predicted that a general semiconductor industry downturn is now beginning.

MCHP is saying,  in effect, that it is in much better touch with end users of its products than most other semiconductor firms, including INTC.  It records revenue only when an end-user buys a chip from a distributor–not when the chip leaves the factory, which is the common industry practice.  It believes others will soon figure out they have much too much inventory floating around in their distribution systems (already booked as revenue) and will be forced to cut back production to bring them back into line with demand.  If so, MCHP is sort of like the canary in the coal mine for chipmakers.

b.  INTC recorded healthy growth in its PC business.  Third-party research services like IDC say demand was basically flat.  Is INTC inadvertently stuffing the channel?

INTC’s response to this worry is:

–it’s a specialized maker of microprocessors

–corporate demand is strong, partly because Microsoft (MSFT) has stopped supporting Windows XP, but also because corporations are beginning to replace the now-decrepit PCs they’ve been duct taping back together for a decade.  This trend will last for a long time.

–third-party researchers like IDC are fine for tabulating demand in the US and the EU, but can’t easily see the businesses of no-name computer makers in the emerging world who are strong INTC customers.

–yes, inventories are higher today than they were a year ago, but they’ve just returned to normal from extremely low levels.


2.  INTC’s mobile chip business is losing $1 billion a quarter, even as the company has become the second-largest vendor of tablet microprocessors in the world.  Can this end well?

The company has gone from a standing start to having chips in maybe 40 million tablets being made this year.  It is concentrating on low-end tablets in emerging markets, entering into long-term R&D and development arrangements with Chinese firms–and, for now at least, more or less giving its chips away to get them into machines (the reality is more complicated).

The company thinks it can begin to whittle away at those losses, beginning next year.  Profitability in 2016?  My guess is yes, but who knows?

my take

If INTC is ever going to crack the mobile market, the time is now and the company’s strategy is sound (it’s also the only one I see available to it).  Suppose it loses $5 billion on the effort and has to reassess.   Not good   …but then $5 billion represents only about 3% of the firms stock market value.  A risk, yes, but one worth taking, I think.

The cyclical downturn thesis is more worrying. When it comes down to it, though, I’m unwilling to generalize from MCHP’s business softness.  Arguably, the weakness MCHP is seeing comes from the Beijing orienting the economy away from construction and low-end commodity-like activities.  The move to higher value-added business should mean greater demand for microprocessors, not less.  So on this front, too, I’m willing to give INTC the benefit of the doubt.

The stock is trading at 15x earnings (high for it but a discount to the market) and yielding a tad under 3%.  If I had to put numbers to my thinking, I’d say that, in the absence of a serious semiconductor swoon, downside is to $25.  Upside if tablet losses begin to abate in 2015 is maybe to $45.

If I thought upside and downside were both equally probable, I should have been a seller at $35.  I wasn’t.  I’m now guessing that upside/downside has deteriorated from 2/1 to each equally probable.  But at $31, I’m still a holder.  I’m not a buyer, though.






SARS and ebola

Two preliminaries:

–Alan Kaplan, a reader, attached an AP article to yesterday’s post that says that 16 staff members of Doctors Without Borders have been infected with ebola and nine have died.  This contradicts information I got from Bloomberg on Monday that none had been infected.  A health expert was using this “fact” to buttress his case that although the protective protocols for health workers were very difficult to carry out they were effective.

Thanks, Alan.

–a second nurse in Dallas who had been caring for ebola victim Thomas Duncan has been diagnosed with the disease.  Reports I’ve heard this morning suggest the hospital was woefully unprepared and that few safety protocols were in place while Mr. Duncan was being treated.


This is my mainly subjective, investment-oriented, account of the SARS period.

–SARS emerged in Guangdong province in southeast China sometime in 2002.

–The disease is spread by coming into contact with respiratory droplets from coughs or sneezes of someone infected.  SARS can also be contracted by touching an object or surface where droplets have landed and then touching the mouth, nose or eyes.

–The World Health Organization says that 8098 people worldwide contracted SARS during the 2002-03 epidemic, of whom 774 died.  In the early days of SARS, however, and for a period of at least several months, Chinese officials suppressed information about the disease.  So it’s not clear how accurate these figures are.  .

–Treatment, as I recall from reports at that time, is long and painful.  Recovery may be far from complete.

–two factors contained the spread of the disease outside China:  at that time is was not as easy as it is today to get official permission to leave the country; and most exit routes led through Hong Kong.  So Hong Kong acted as a choke point for screening and potential quarantine.

–within China, once Beijing began to take preventative measures to contain SARS, factories were quarantined and closed for weeks at a time.  This not only affected the production of Chinese goods, but also foreign production of end products that used Chinese components.

–for a period, port workers in Hong Kong and elsewhere refused to handle shipments of goods from China, reasoning they risked contracting SARS from touching surfaces where infected persons might have coughed or sneezed.

–Travel to Hong Kong dropped sharply.  Business travel from Hong Kong did as well, since clients/colleagues were not eager to schedule meetings.

–Investors closely monitored reports of new cases in Hong Kong, looking for deceleration of the rate at which the disease was spreading.  The time of maximum concern lasted from the initial reports from China in November 2002 until June 2003.

–the S&P 500 dropped by about 10% from mid-November 2002 through early March 2003.  It’s hard to know how much of this decline was due to SARS, since world markets were still working through the aftermath of the implosion of the Internet bubble in 2000.  Markets bottomed in March 2003;  economic revival propelled them sharply higher from that point.

…vs. ebola

–ebola appears to be harder to contract than SARS, but the fatality rate is much higher

–colonial-era ties between Africa and the EU mean there are more routes an infected person might take to other areas of the world

–Africa is not yet the manufacturing powerhouse that China was in 2002.  So the indirect effects of quarantine on the rest of the world will be potentially lower

–as was the case with SARS, the biggest potential stock market losers will likely be travel, tourism and entertainment related.  I think Europe is the area outside Africa most likely to be negatively affected.

–I’d think that, by analogy with SARS, it will take six months of global government effort to contain the outbreak.  If so, we’re still in early days of concern about the disease.


oil? ebola? the dollar?–why stock prices have been falling

In many ways, stock market commentators have an unenviable task.  At any given moment they have to come up with new and interesting reasons why stocks are rising or falling.   The media gurus’ difficulties are compounded by the fact that most are story presenters who have little understanding of investing and are therefore reliant on sources whose statements are many times influenced by their own private agendas.

After peaking in mid-September, US stocks have fallen by about 7% through yesterday/  This has erased most of their year-to-date price gains, although with dividends factored in the S&P is still up about 4% since New Year’s Day.

Among the current “explanations’ for the fall are:

–a falling oil price.  I don’t think this makes sense.  It would be one thing if world GDP were turning negative and demand were sagging as a result.  The current issue, however, is oversupply, being caused by the rise of shale oil/gas production in the US.

Yes, 10% of the S&P 500 consists of oil-related stocks, many of which are hurt by lower prices.  But, to simplify a bit, the other 90% of the index is a beneficiary.  Lower prices are bad for oil-producing nations in the Middle East, for Russia and for the rest of OPEC.  But they’re great for consumers.

Another point:  today’s production contracts with national oil companies provide that virtually all revenue from oil price increases above a certain level goes to the host country, not to the international oil firm that is developing the petroleum deposits.  Although this has been true for decades, my sense is that many investors still don’t get this.  The dynamic is much more consumers gain/emerging countries lose than the consensus thinks.

–ebola.  More about this tomorrow.  Ebola is scary.  The only model we have for what happens to stocks once investors become aware of pandemic possibilities is SARS.  On the other hand, Doctors Without Borders has been handling ebola patients for many years without a single infection of their own.  In my view, stocks would be way lower than they are today if investors viewed ebola a real threat.

–the dollar.  This is an issue, although almost no one is talking about it. The US dollar has risen against the euro by almost 10% since early May.  In back-of-the-envelope terms, 25% of the earnings of the S&P 500 is sourced in euro.  A 10% fall in the dollar value of the euro means that overall S&P earnings–without factoring in current Euroland economic weakness–will be 2.5% lower than previously thought.  Discounting this outcome would explain about half the recent market decline.

my take:

–technicals.  At the peak a few weeks ago, stocks had already discounted all the S&P earnings growth that’s likely for 2014.  In addition, the market had already also factored into prices, let’s say, a third of the expected earnings growth for the index next year. This is normal market behavior, granted, though, that we haven’t seen “normal” for the better part of a decade.

By September, potential short-term buyers couldn’t justify paying higher prices for stocks.  In addition, euro weakness + a lot of other miscellaneous stuff had put 2015 profits under threat.

We’re now in the process of determining how low prices have to go to bring buyers back.

Looking at past levels where lots of buying and selling has taken place ends up being a surprisingly effective tool for figuring out where buying will emerge again.  Don’t ask me why.  If this rule of thumb holds true, as I read the charts the key levels are 1840-80 (i.e., where we are as I’m writing this) and 1800.

ARK Investment Management and its ETFs


I was listening to Bloomberg Radio (again!?!) earlier this month and heard an interview of Cathie Wood, the CEO/CIO of recently formed ARK Investment Management.  I don’t know Ms. Wood, although we both worked at Jennison Associates, a growth-oriented equity manager with a very strong record, during different time periods.  Just before ARK, she had been CIO of Global Thematic Strategies for twelve years at value investor AllianceBernstein.  (As a portfolio manager I was a big fan of Bernstein’s equity research but I’m not familiar with her Bernstein output.)  She’s been  endorsed by Arthur Laffer of Laffer Curve fame, who sits on her board.

ARK is all about finding and benefiting from “disruptive innovation that will change the world.”

Ms. Wood was promoting two actively managed ETFs that ARK launched at the beginning of the month, one focused on industrial innovation (ARKQ) and another the internet (ARKW).  Two more are in the works, one for genomics (ARKG) and the last (ARKK) an umbrella innovation portfolio which will apparently hold what it considers the best of the other three portfolios.

What really caught my ear in the interview was Ms. Wood’s discussion of the domestic automobile market (summary research available on the ARK website).  Most cars lie around doing nothing during the day.  What happens if either ride-sharing services like Uber or the Google self-driven car, which make more constant use of autos, catch on as substitutes?  According to Ms. Wood, until these innovations reach 2.5% of total miles driven (based on the idea that on a per mile basis ride-sharing costs half what owning a car does), there’s little effect.  But at 5% penetration, the bottom falls out of the new car market.  New car sales get cut in half!

Who knows whether this is correct or whether it will happen or not   …but I find this a very interesting idea.

about the ETFs

The top holdings of ARKW are:  athenahealth, Apple, Facebook, Salesforce.com and Twitter.  These comprise just under 25% of the portfolio.

For ARKQ, the top five are:  Google, Autodesk, Tesla, Monsanto and Fanuc.  They make up just over 24% of the portfolio.

Both will likely be high β portfolios.  Both have performed roughly in line with the NASDAQ Composite since their debut.

The perennial question about thematic investors (I consider myself one) is whether the high-level concepts are backed up by meticulous company by company financial research.  This is essential.  In addition, it’s important, to me anyway, that the holdings be arranged so that they’re not all dependent on a single theme–the continuing success of the Apple ecosystem, for instance.

I’m not familiar with Ms. Wood’s work, so I can’t say one way or another (Fanuc and ABB strike me as kind of weird holding for ARKQ, though).  But I think her research is worth reading and her ETFs worth at least monitoring.  For us as investors, the ultimate question will be whether Ms. Wood can outperform an appropriate index.  The NASDAQ Composite would be my initial choice.







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