Monthly Archives: August 2011

two tricks of performance calculation arithmetic

August 19, 2011 By in Absolute vs. relative performance, Analyzing performance, Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Trading Tags: , , , , , , , , Leave a comment

measuring performance

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.

 

 

 

I’m updating Current Market Tactics: part 2 of 2 on scenario-building

August 18, 2011 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , , , , Leave a comment

I’ve just updated Current Market Tactics.   If you’re on the blog, you can also click the tab at the top of the page.

Google’s takeover of Motorola Mobility: implications

August 16, 2011 By in Current Market Thoughts, economics, Industry Analysis, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , , , , Leave a comment

the deal

Yesterday morning before the start of trading in New York, Google and Motorola Mobility jointly announced an agreement for GOOG to acquire MMI for $40 a share in cash, or about $12.5 billion.  The takeover price represents a 63% premium over MMI’s closing quote last Friday.  The parties have also agreed to a breakup fee of $2.5 billion, or 20% of the deal price (an unusually large amount)–and that MMI will operate as a separate division of GOOG.  The deal is expected to close late this year or early next.

MMI ended Monday trading at $38.12 a share, a price that I think signals two Wall Street’s beliefs:   that the acquisition is highly likely to occur, and that a rival bidder is probably not going to emerge.  That’s my take as well.

MMI has three main assets:  by far the largest is its massive collection of cellphone-related patents; it also has a set-top box business; and it makes handsets.

why the acquisition?

Look no farther than the competitive situation in the global smartphone market.

In the early stage of any market, the field is wide open.  Entrants focus on building their own market share and ignore everything else.  With smartphones, we’re long past this stage.

As the market matures, the competitive field separates into frontrunners, and also-rans.  Typically, the stronger entrants turn on the smaller, weaker competitors–who fall by the wayside, one by one.  Think NOK and RIMM as being on the losing end.

A further sign of maturity is when the top dogs–in this case, AAPL and GOOG–turn on one another as the only additional sources to fuel further growth.  This phase comes last because the market leaders are typically the most difficult and expensive to wrest customers from.

That last stage is where we are now.

According to ComScore, the Android operating system extended its market share lead in the US during the three months ending June 2011 by 5.4 percentage points from 34.7% to 40.1%.  During the same period, the iPhone added 1.1 percentage point of share, from 25.5% to 26.6%.  The overall situation:  APPL is losing ground to Android, picking up a decreasing share of the customers being shed by RIMM and MSFT (NOK has almost none left to take).

AAPL is fighting with patents

Several reasons for this:

–smartphones are by far AAPL’s largest business, so growth here is important,

–APPL doesn’t want to introduce lower-priced handsets to compete with GOOG’s mid-market offerings, and

–its lack of patents is a potentially severe point of weakness for GOOG.

last week’s EU tablet decision is a case in point

The details can be found in the blog Foss Patents, but the bottom line is that Samsung’s 10.1″ Galaxy Tab has been banned for now from sale in the EU, ex the Netherlands.  What’s interesting is that the design drawings on which the ruling are apparently based are very generic  (look at pp.3-4).  They look kind of like Etch-a-Sketch screens and boxes without the knobs.  In fact, a ZD Net article suggests that the iPad itself isn’t an original idea–it looks amazingly like the prop tablets actors used on Star Trek.

In any event, last week’s ruling suggests that patent litigation can be unpredictable.  It can also have potentially disastrous consequences for the loser.

better safe than sorry

$12.5 billion is about what GOOG generates in cash flow during one year.  It’s also a bit less than a third of the cash the company has on the balance sheet.  The fact that this money is earning very close to zero is a key reason why the acquisition of MMI will likely be “mildly accretive” to earnings from day one.

So the cash is not a real issue, particularly since control of the mobile user is so key to GOOG’s–and APPL’s–future.

is the rising yen an economic problem?

August 15, 2011 By in Asian economic development, Current Market Thoughts, economics, Japanese development, Portfolio management, Recent Market Action Tags: , , , , , , , , Leave a comment

the current situation

As I’m writing this during afternoon trading on Monday in Tokyo, the yen exchange rate is at US$1 = ¥ 76.8.  That is down a bit from the high of US$1 = ¥ 76.5 the Japanese currency achieved last week.  But it’s still about 1% stronger against the greenback than when Tokyo intervened in the currency markets on August 4th trying to stem the yen’s rise against the dollar.

Notably, in contrast to the coordinated intervention by a group of major industrial countries that occurred after the tragic earthquake/tsunamis of last March, Japan acted alone this time.  The show of solidarity in March was enough to buy the yen a month of relative weakness; the difference of opinion implied in last week’s solitary move meant the Japanese currency gained a mere day of respite.

currency realities

Two of them:

1.  Countries, either alone or in groups, have far less firepower in currency markets than the big international banks.  Add to this the fact that governments typically want to defend politically expedient but economically inappropriate currency levels, and it should come as no surprise that countries stand no chance at all to impose their will on today’s currency markets.

2.  A rising currency acts to slow down economic activity, much in the way an increase in interest rates does.  But it also rearranges growth–away from export-oriented industries and toward domestic ones.  It also reduces the local currency price of imported raw materials.

what about Japan today?

I think it’s important to distinguish between the Japanese economy and the Japanese stock market.

economy

In the case of the former, the most pressing current need is to rebuild the Fukushima area after March’s devastation.  The increased government spending that will make up part of that effort will tend to lift GDP growth, negating at least a portion of the high-yen pressure on economic expansion.  To the degree that local companies use dollar-denominated materials in their rebuilding, their costs will be lower, their profits higher, than they would be in a weak-yen situation. Therefore, yen strength probably won’t be a significant negative for Japan’s economy–and may even be a mild positive.  Today’s announcement in Tokyo of better than expected 2Q11 GDP illustrates this point.  Economic news is likely to continue to be surprisingly positive over at least the coming 12 months.

stock market

The Japanese stock market, on the other hand, is in many ways a monument to Japan’s weak-yen, export-oriented economy past.  In fact, if you were to examine the sectoral structure of the Nikkei without knowing it to be the Tokyo index, you’d guess it to be the benchmark for an emerging economy, not a developed one.  Because this is so, although there will be pockets of strength among Japanese stocks, the index will likely be held back considerably by its high weak-yen component.