My analysis of 2011 as a whole tomorrow.

I’ve written before about how important it is for us as stock market investors to calculate and analyze the performance of our portfolios on a regular basis.

There are two related reasons for doing this:

1.  We want to identify what ideas/stocks are working for us in the portfolio and which ones aren’t.  Based on this, we decide where to take profits and where to stop the bleeding.

2.  We also want to learn about ourselves, and our strengths and weaknesses in decision-making.  This isn’t like training for the Olympics.  We don’t need to be perfect at everything.  But we want to at least be able to identify situations where we continually shoot ourselves in the foot–and just not do that anymore.

doing it now

On July 7th, the S&P 500 closed at 1353.  On October 3rd, it closed at 1099, for a decline of 18.8%.  On an intraday basis, from 7/7-10/4 the fall was 21%.

The markets appear to be stabilizing now, as politicians in Europe make noises about finally addressing the EU’s Greece/banking crisis.  It’s too soon to say for sure that the worst is over (although I suspect it is).  But whatever the case may be, it’s important to look at your portfolio after a decline of this magnitude and ask yourself how you fared.

how to do it

In all likelihood, you don’t have data from your brokerage account that tells you either what your portfolio as a whole, or any individual security in it, was worth on the beginning and end dates.  So the easiest way to proceed is to use a Google chart to compare the performance of the S&P 500 (or whatever benchmark you measure your portfolio against) with each of the stocks/mutual funds/ETFs you own.  You can find more details toward the end of my post on “method to the madness” a few days ago.

what to look for

1.  One question is whether you’ve outperformed or underperformed the benchmark. But that’s just the start.

2.  Growth investors outperform in up markets and underperform when the market is declining.  Value investors, who have a more defensive bent, do the opposite.  So a second question is whether your portfolio has performed in line with your design.

3.  Is your design really what you wanted?  Is it appropriate for your financial circumstances, or is it too risky–or not risky enough (not the usual problem, but possible)?

4.  What were your strongest and weakest stocks?

5.  Is there a pattern to either the good ideas or the bad ones?  Be careful here.  Over this period, utilities stocks would have been stellar names, capital goods or materials stocks were probably at the bottom of the pile.  That’s not what I mean. You’re looking for behavioral patterns that lead you astray so that you can change them.

Do the weak stock ideas come from names you hear on CNBC?  Are the good names ones where you know the financials backwards and forwards and the bad ones those you know less well?  Are the horrible stocks tips from cousin Fred the broker?  Are the large positions winners and the small positions losers–or the reverse (which would be a more serious issue)?

Some fixes are easy:  turn off the TV; do your homework; don’t act on Fred’s advice; don’t bother with the small positions (or weight each position equally if the small ones are good but the big ones are killing you).

6.  How are your positions doing in the rebound?  Stocks rarely outperform in both up and down markets.  Great if you have one or more of these.  In contrast, in my experience it’s a big red flag if a stock underperforms on the way down and remains an underperformer in a market bounce.  Any like these are ones that need your immediate attention.

7.  Are the reasons you bought each security still valid?

two other thoughts

–Looking at your portfolio decisions with a critical eye is something you need to do regularly.  One time won’t be enough to detect behavior patterns.  But you’ve got to start somewhere.  My experience is that even professionals make mistakes that would be easy to correct–like “don’t listen to Fred”–except that they aren’t aware they’re making them.

–For an analysis like this, don’t use year-to-date numbers.  What you want to see is how your stocks have done in the downturn.  Otherwise, if you have had significant under- or outperformance earlier in the year, that performance difference will just muddy the waters.  An example:

Suppose you have a security/portfolio that was 20 percentage points ahead of the S&P through July 7th.  That would mean you had a gain of 27.7%.  On October 3th, your holdings are down 2.7%, which is ten percentage points better than the market.  How much performance have you lost during the downturn?

The answer isn’t ten percentage points.  It’s five!  During the period we’re considering, the S&P 500 fell by 18.8%.  Your investment went from 127.7 to 97.3.  That’s a fall of 23.8%.  The difference between the fall in the index and in the investment is five percentage points.  The rest of the year-to-date loss comes from the fact that the investment has lost its 18.8% from a starting point that already incorporates a large year-to-date gain.  The gain portion also suffers a loss.

The S&P 500 hit a near-term low of 1101, intraday, on August 8th.  It has bounced between 1140, the close on that day, and 1230 since.

what’s going on?

I think(see my dipping a toe in the water posts from early August) that investors are adjusting to the (strong) possibility that economic growth in the developed world will be little changed in 2012 from what it was in 2011.  This contrasts with the prior belief of the consensus (and me, too) that the economic acceleration we saw in 2009 and 2010 wouldn’t peter out completely but would continue to some degree into next year.

The market has alternated between bouts of euphoria and despair–sometimes, like yesterday, both emotions in the same trading session.  On the one hand, corporate profits remain very good; on the other, Greece may default on its debts, messing up the EU, and the Fed has just begun another round of unconventional action to try to restore a stronger pulse to the US.  What the market is taking from the Fed move is that the US needs the stimulation, not that the Fed is riding to the rescue.

testing the lows today?  …probably

Given the sharp selloff in Asia and Europe as I’m writing this on the morning of the 22nd, we appear to be about to see in the US whether the closing low of 1140 will hold.

below the surface, …

Look a bit deeper into the market action, however, and a more complex pattern emerges.  You can look for others yourself, as I’ll explain below.

…big differences among individual stocks,

which means to me that most investors are not as panicky as the index movements might suggest.  This is what I see  (percentage stock price changes since August 9th through Tuesday, with the index up 4.2%):

retail is mixed, with the high end doing well

Tiffany     +15.9%

Dicks Sporting Goods     +13%

Macy     +8.3%

Wal-Mart     +4.9%

JC Penney     +2.7%

Ford     +.4%.

tech–e-commerce, Apple and takeovers

Yahoo     +25.9%

Amazon     +19.7%

E-Bay     +19.6%

AAPL (which it an all-time high two days ago)     +16.7%

Oracle     +13.5%

Intel     +9.0%

Adobe     +4.1%

IBM     +4.0%

Microsfot     +2.5%

Netflix     -43.3%

financials- -ugh!!

GE     +.3%

Bank of America     -2%

Citi     -8.7%

JP Morgan Chase     -10.9%

staples–so-so

P&G     +6.3%

Coca Cola     +1.8%

Pepsi     -3.5%

casinos–high-quality/debt under control

Las Vegas Sands     +29.2%

Wynn     +16%

MGM     -6.3%

no joy in Macau, despite blowout revenue growth

China Sands     -2.8%

Wynn Macau     -6.2%

SJM     -14.7%

MGM China    -15.1%

other random stocks

Catipillar     -3.9%

Exxon Mobil     +2.5%

Intercontinental Hotels     +1.7%

doing this for you portfolio

It’s a worthwhile procedure to do  regularly.

Go to Google Finance and call up a chart for the S&P 500.  The symbol is .inx.  (I normally prefer Yahoo Finance charts, but this is one instance where Google works better.)

Enter a stock symbol into the Compare box just above the chart and hit the Add button.  The chart parameters will change; you’ll see absolute performance numbers for both the S&P and your stock appear.

For checking performance since August 9th, select a 3mo view from the Zoom choices at the top of the chart..

Move the left-hand side of the bar that’s directly under the chart to the right until the chart shrinks to the time period you want.

Type in more symbols.  You’ll see their absolute performances (on a capital changes basis, not that it matters so much) displayed in different colors.

Good luck.

Good or bad, you’ll at least know how your stocks are doing.

The acid test of active management–both of our own efforts and of the professionals we may hire to invest for us–is whether they add value versus an appropriate index.  Picking the benchmark against which to measure results is a pretty straightforward task, though judgment issues do sometimes arise.  (For example, if all a manager’s outperformance of the S&P 500 over the past three years comes from holding a large position in Baidu (BIDU), the Chinese internet company listed on NASDAQ, is the S&P really the right index to be using?  But that’s a story for another post.)

What I want to point out here is a quirk in the way performance calculations are done:

–in a rising market, outperformance tends to look better than it really is;

–in a falling market, outperformance tends to look worse than it really is.

The opposite is true of underperformance.

–in a rising market, underperformance tends to look worse than it really is;

–in a falling market, underperformance tends to look better than it really is.

Here’s what I mean:

Let’s take an example where the numbers are impossibly large, just to illustrate the point.

outperformance

We’ll suppose that on Day 1 of the measurement period the index is unchanged but our portfolio gains 50%.  At the end of Day 1 we’re 50 percentage points ahead of the index.

a.  rising market.  Suppose that for the rest of the year, our portfolio matches the market performance exactly and that the index doubles from Day 2 through the rest of the year.  How far ahead of the index is our portfolio for the year?

Your first instinct is probably to say “50 percentage points,” since we’ve made no further gains after Day 1  …but that’s wrong.  The actual outperformance is 100 percentage points.

If the index starts the year at 100, its ending value is 200.

If our portfolio starts the year at 100, we’re at 150 at the end of Day 1 and we double from there–meaning we’re at 300 on the final day, or 100 percentage points ahead of the market.  Whatever positive thing we did on Day 1 has been magnified by the rising market.

b.  falling market.  Let’s take the same portfolio, up 50% in a flat market on Day 1.  This time, let’s suppose our portfolio matches the index for the rest of the year, but that the index falls by 50% between Day 2 and the end.  How far ahead are we for the year?

Having seen a., you’re already going to guess that 50 percentage points is wrong.  …and 50 is wrong.  But what’s the right number?

Well, if the index starts at 100 and loses 50%, at the end of the year it’s at 50.  At the end of Day 1, we’re at 150, but we lose half that amount through yearend.  So we end up at 75, or 25 percentage points ahead of the index.

underperformance

Let’s start again with crazy numbers.  Assume Day 1 is the day from hell and we lose half our money in a flat market.  We’re 50 percentage points behind the index.

c.  rising market.  The market doubles from Day 2, going from 100 to 200 by yearend.  We match the market.  Our 50 goes to 100.  We’re 100 percentage points behind the market.

d.  falling market.  The market declines from Day 2 on, and drops from 100 to 50 by yearend.  Our 50 is cut in half to 25.  We’re 25 percentage points behind the market.

implications

There are all sorts of implications for professional investors, who tend to earn most of their compensation based on annual performance vs. an index.  You never want to get behind in a rising market, for instance.  Or, a falling market tends to compress out- and underperformance numbers closer to the index, so that’s the best time to play catch-up.

For the rest of us, the lessons are:

–don’t get too excited about the “phantom” outperformance that a rising market (2009, 2010) brings, and

–more important, a decline of 15% like the one we’ve been in will reduce your under- or outperformance by 15%.  Don’t think your stocks are suddenly doing better/worse than they are.  To see your real performance during the downturn, don’t check the year to date figures, check them from the start of the downturn until now.

NOTE:  If you’ve constructed a portfolio for a rising market, or if you were ahead year to date before the current decline began, you should expect some slippage in relative performance as the market sags.  Similarly, if your holdings are geared for a down market, you should now be seeing a pickup in relative performance.

How much relative gain or loss?  That’s another post-full.  A lot depends on the level of risk you’ve assumed and your skill in picking stocks.  But if you’ve battened down the hatches, you should be seeing at least some benefit.  If you’ve continued to keep a lot of sail let out (which is my usual position), you shouldn’t be surprised/dismayed by a modest relative loss.

When the market makes a decisive change in direction, it’s always good to step back and analyze the composition of the advance.

Why?

When the market changes direction, market leadership often changes as well.  In addition, when the cause of the change is a readily identifiable event like the earthquake/tsunamis in Japan, it’s important to check what you think the market should be doing in response to the development vs. how the market actually is performing.  If you don’t, you may only acknowledge data that’s in line with your presuppositions.  If so, you risk losing performance by sticking too long with yesterday’s winning ideas in tomorrow’s market.

In this case in particular, my impression–before looking at the facts–is that the reaction of the S&P 500 to the earthquake has been too emotional and rather superficial.  In other words, I think that some stocks may be being unduly punished and others irrationally bid up in price in expectation of rewards that are unlikely to materialize.

begin with sectors

Let’s start with S&P sector performance from March 14th, the first day the US market was open after the full impact of the earthquake in Japan was known, through last Friday, April 1st.

Performance ran as follows:

Telecom          +7.2%

Materials          +6.7%

Energy          +5.3%

Industrials           +4.2%

Finance          +2.5%

S&P 500          +2.2%

Staples          +2.1%

Consumer discretionary          +1.9%

Utilities          +1.3%

Healthcare          +1.2%

IT          +.3%.

Full-month sectoral results for March and for the first quarter of 2011 can be found on the Keeping Score page.

post-earthquake differences

The main changes I see are these:

Telecom, Materials and Finance join Energy and Industrials as outperformers.

Healthcare, on the other hand, drops like a stone.  It, Consumer Discretionary and IT join Staples and Utilities as significant laggards.

It makes sense to me that investors would bid up the Materials sector on the idea that reconstruction, whether in Japan or elsewhere, will use lots of extra building materials.  Similarly, uncertainty about component supply might depress IT stocks.

On the other hand, I have no idea why Healthcare should suddenly become less attractive.  How does the Telecom sector benefit from the problems in Japan?  …I think the outperformance there is the result of the consolidation in the wireless arena and has nothing to do with Japan.  After all, the S&P sector only has 9 constituent companies, so changes in one or two names can make a big difference to sector performance.

a closer look:  individual stocks

Some investors, even professionals, try to stay on the level of the “big picture” and shape their portfolios based chiefly on what they consider overarching trends.  Known as “thematic” investors (calling someone that is an insult, though slightly veiled), they may have short-term success, but usually flame out in spectacular fashion.  The only people who can make money while remaining at this low level of sophistication are the talking heads on cable TV. 

Looking a little deeper, then:

currencies, since the earthquake

Korean won/¥          +5.4%

€/¥          +3.7%

$/¥          +2%.

Yen weakness may partly be the result of intervention.  There may be more to it than that, however.

I’ve been thinking that the earthquake may change multinationals’ ideas about where a second source of production should be located.  No manufacturing company wants to rely on a single supplier for key components.  Firms always want a second source.  I think that firms are being forced to the realization that having two Japanese component makers, one two miles down the road from the other, as sources gives you some protection against price gouging.  But it’s no help in a natural disaster.  In fact, the possibility that electricity will be rationed across Japan for some time to come suggests that even having a second source in the same country isn’t good enough.

I suspect multinationals will be trying to develop alternate sources of supply in Korea or Greater China–meaning a long-term net loss of economic activity in Japan.  The weak yen may be telling us this.

Looking at stocks (all percentage changes are calculated in US$):

indices

S&P 500     +2.2%

Topix (the Japanese equivalent of the S&P)     -6%

Japanese utilities

Tokyo Electric Power          -79%

Tokyo Gas          +6%

Tokyo Gas has outperformed the Japanese market by 12%, as investors look for alternate suppliers of utility services.  I no longer know Tokyo Gas well, but the move seems logical to me.

construction machinery

CAT          +13.1%

Hitachi Construction Machinery          +4%

Kubota          -4%

I don’t get it (I say this even though I own CAT).  All three companies do basically the same thing, and 100% of the reconstruction business is going to go to the Japanese firms.  There could be some subtle thinking at work here–maybe that Japanese public opinion or government action will force HCM and Kubota to provide machinery on concessionary terms, using up their productive capacity and leaving higher-margin business elsewhere for CAT.  My guess, although (again) I don’t know the Japanese firms well anymore, is that HCM and Kubota have upside that is generally unappreciated.  CAT has gone up because it’s easier for US investors to buy, even though it’s probably the worst positioned of the three to participate in Japanese rebuilding.

autos

BMW          +8.7%

F          +5.5%

GM          +1.5%

Honda          -3.5%

Toyota         -6%

The luxury brands of Toyota and Honda are the ones whose models have the greatest Japanese content.  The two automakers also have by far the biggest exposure to the Japanese car market.  So I understand why there should be a wide spread between them and luxury car maker, BMW.  If BMW sources its car electronics from European semiconductor companies, then the absolute price performance makes sense to me as well.

semiconductors

Samsung Electronics          +12.5%

MU         +10.5%

ARMH          +8.4%

WFR          +6%

TXN          -.5%

MIPS          -4.5%

INTC          -5.5%

Shinetsu Chemical          -6.5%

Renesas          -20%

Renesas is the product of the merger of semiconductor operations formerly run by NEC, Hitachi and Mitsubishi Electric.  It makes DRAM, and other commodity semiconductors used in cellphones and autos.  Its plants have suffered extensive damage.

Shinetsu is the leader in another commodity semiconductor business, making silicon wafers.  These are the main raw material chips are built on.  It too has had a lot of plant damage.  So it makes sense that the stocks of these two companies have gone down (although Shinetsu is an outperformer vs. TOPIX)–and that the shares of rivals Samsung (a world leader in commodity semiconductors), MU and WFR (two middling firms that happen to be in the right place) have gone up.

One anomaly I see is in the relative performance of TXN vs. INTC (I own it) and ARMH vs. MIPS:

TXN is roughly flat, despite having had considerable plant damage in Japan.  INTC is down, despite having had none.

MIPS and ARMH are both intellectual property companies.  They sell their chip blueprints to a wide swath of fabless chip firms who incorporate them in their designs.  The profits of  both are vulnerable to any earthquake-induced materials or components disruptions that slow component manufacture; that slows the flow of royalties customers pay them.  I don’t think there’s any sure way to figure out how their businesses are likely to be affected.  The most reasonable assumption is that the same thing is likely to happen to both.  Yet MIPS (trading on 23x historical earnings) is down and ARMH (trading on 90x) is up strongly.

consumer electronics

Panasonic          -.3%

AAPL          -2%

Sony          -5%.

Two thoughts:

–AAPL is down;  ARMH, which powers AAPL cellphones and tablets, is up a lot.  ???

–Panasonic, a strong company, is flat;  Sony, a bad one with high exposure to Renesas, is only down 5%.  ??

luxury goods

LVMH          +4%

Hermes          +1.3%

TIF          -1%.

The oddity that I see is that, despite all three having significant exposure to Japan, their stock prices have been relatively unaffected by the earthquake and loss of electricity (hard to buy stuff in a store where the lights are out) in this important market. (By the way, I own TIF.)

summary

There has been a market reaction to the Japanese earthquake.  It can be seen in the S&P 500 through relatively good performance by the Materials sector, and though an accelerated underperformance of the IT sector.   Hard to argue with that, though I personally think supply chain disruptions will be far fewer than the market now thinks.

The investor response within sectors is a bit more uneven, though not the crazy level I had anticipated finding.  The company performance relationships seem ok to me in the Japanese utility, auto, consumer electronics and luxury goods industries.

In construction machinery, on the other hand, the Japanese firms that will presumably receive all the rebuilding orders have substantially underperformed CAT, which probably won’t receive anything.

Investor behavior in the semiconductor sector is the most eccentric, in my view.  My guess is that professional portfolio managers have examined their IT holdings with an eye to : 1) reduce weightings, and 2) eliminate holdings that are exposed to plant damage in Japan.  But they’ve ended up doing something different.  In my experience, this often happens.

They’ve ended up selling weaker, or poorer performing, names in a sub-sector, and using part of the money to build up their positions in companies that have shown positive price momentum.  They may also have trimmed huge positions, like AAPL, which just about every professional portfolio manager owns.

Whatever the reason may be, companies whose fortunes are closely linked, like ARMH and AAPL, have performed differently, for no good reason that I can see.  So too have TXN and INTC, and ARMH and MIPS.  My guess is that the relative performance of these pairs will soon reverse themselves.

One other point:  with the punch of a few buttons, a professional can almost instantaneously have a printout of the absolute and relative performance of all of his positions over any time frame–including from March 11-April 1.  If he wants, he can have the report show his portfolio constituents–broken out by individual stocks, industries and sectors–compared with the performance of the corresponding portions of his benchmark index.  He can not only see his performance at a glance, but also what stocks outside the portfolio are doing better or worse than his.

Try getting this info as an individual from your broker.

Why aren’t these data available?  For one thing, you might need some instruction to be able to read a report intelligently.  For another, it would show whether your trading activity is profitable or not.  Your brokerage firm makes most of its money based on the amount of trading you do, not on your success.  So there’s no upside to letting you know you’d be better off trading less, or not at all.