Monthly Archives: March 2016

trading your own portfolio: general outline

March 24, 2016 By in Trading, Uncategorized Tags: , , , , 1 Comment

preliminaries

size

Let’s assume I have a $100,000 portfolio.  I probably have a core of 85% in index-like products of some sort, with the remainder in, say, five active positions.  Each would be 3% of the portfolio, or about $3,000 each.   I would probably try to trade one of them.  In other words, this kind of trading should be a side show in investment strategy, not the main event.

trading commissions

If this is the amount I want to trade, I can’t possibly do this in a traditional brokerage arrangement.  I’ll be destroyed by commissions.

what can’t be traded easily

I may not be able to do this with some mutual funds or ETFs, which may limit the frequency with which I can buy or sell shares.  They may simply not honor trade requests, or may put them through and then impose financial penalties.  Either way is unpleasant.  So individual stocks are best.

liquidity

If the portfolio is $1 million, then the amount I’d be trading, using the arithmetic above, is $30,000.  If it’s $10 million, it’s $300,000.  At this last level, there may be some thinly traded stocks where getting in and out immediately will be a problem.  My preference would be to avoid stocks like that.  So the universe I would be willing to trade in narrows as the portfolio becomes larger.

taxable or IRA/401k?

Successful trading will likely produce short-term gains.  Arguably, they’d be best recognized in a non-tax or tax-deferred account.  On the other hand, there’s the tradeoff that doing so loses the benefit of taking a tax loss if a trade ends in tears.

Personally, what little trading I do is in a taxable account.  For me, this reinforces the idea that trading is not a structural pillar of my investing but more like embroidery around the edges.

More tomorrow.

 

trade your portfolio? …why not?

March 23, 2016 By in Trading, Uncategorized Tags: , , , , , 1 Comment

trading your portfolio

Trading your portfolio can be a couple of things.  It can mean finding one or more stocks you own for the long term but that have periodic ups and downs.  You try to add to positions when they’re down, with the intention of selling the extra when prices are unusually high.  Or you can take a stock that is unusually volatile that you have little long-term interest in and try to buy at low points and sell at high.

Professional portfolio managers, with the possible exception of hedge fund managers whose main (only?) skill is trading, usually don’t trade their portfolios.

professionals don’t

How so?

–For a professional manager with, say, a $5 billion portfolio containing fifty positions, average position size is going to be $100 million.  There may not be enough daily trading volume in any given stock for short-term buying and selling to make a meaningful difference in overall results.

–I used to think that truly excellent trading, which I had through the trading room at my last job, could add 100 basis points to my portfolio return in a year.  Certainly no more, maybe less.  My job, on the other hand, was to try to add 300 basis points to the return on the index through good selection of sectors and individual stocks.  It made no sense for me to take my mind off 300 basis points–and risk losing them–when the highest payoff I might get for spending a lot of time on trading would be 1/3 of that.

–The skills are different.

–Pension clients actively dislike portfolio managers (again ex the hedge funds they irrationally adore) who trade a lot.  They monitor turnover ratios, that is, the annual dollar value of buying and selling activity as a percentage of total assets.  They simply won’t consider a new manager whose turnover is much higher than the average, not matter what the long-term record.  So successful trading is a good way to drive clients away.

 

you and me

None of that affects you and me, though.  And the stock market has been crazily volatile in recent times.  Why not try to take advantage of battling trading computers that are creating strange ups and downs?

No, this is not for everyone.  There are risks.  Still…

More tomorrow.

 

 

 

why Wall Street analysts are almost always bullish

March 22, 2016 By in Uncategorized, using research Tags: , , , , 2 Comments

Several days ago, the Financial Times wrote an article about the troubled Canadian pharmaceutical company Valeant (VRX) in which it observed that 21 of 23 professional Wall Street securities analysts had rated VRX a buy just as it was about to lose 50% of its value in a day.  The loss was understandable:  VRX reported weaker than expected earnings figures and said it might soon be in default on some borrowings because of its inability to produce accurate and complete financial statements.

To my mind, that isn’t necessarily the worst part.  VRX shares had fallen by 60% in a flat overall market during the prior year.  Yet very few analysts picked up on the signal that price action was flashing that something might be wrong.  Of course, the CEO of Valeant, no longer with the company, had also called his most favored analysts shortly before the announcement to say that everything was fine.

VRX isn’t a once-in-a-lifetime case.  Comments from readers accompanying the FT article correctly cite Enron and the internet bubble as prior instances of the same phenomenon.  The SEC complaint in the case of Henry Blodget, a former Merrill Lynch internet analyst who was barred from the securities business for publicly recommending stocks he privately believed had no investment merit, spells out the latter situation in detail.  (By the way, Blodget now writes for Yahoo Finance.  Go figure.)

So, why are Wall Street analysts so bullish?

–There’s a saying in commercial banking that no one ever gets promoted for not making a loan.  Same thing for securities analysts.  No one gets rich by warning what stocks not to buy.  Fame and fortune come from introducing clients to stocks that will go up.

–Having a “sell” opinion isn’t a purely intellectual stand.  It entails considerable professional risk.  Institutional/hedge fund customers who own the stock in question may call up the analyst’s boss to complain.  They may intimate, or flat out state, that they will withdraw/reduce the commission business they send the firm unless the analyst changes his opinion …or is fired.

Companies with poor ratings may complain, too, and threaten to take their investment banking business elsewhere.  They can (and do) make the offending analyst’s life miserable.  They can deny access to top management.  They won’t return phone calls. They may not attend industry conferences the analyst arranges.  They’ll ask the analyst’s rivals to set up meetings with important shareholders.  Just ask Mike Mayo, the bank analyst who suffered greatly for years for his negative view of financials.

–Brokerage firms believe that their in-house research loses them money.  They regard investment banking, trading for their own account and acting as a middleman for third-party trades as their major businesses.  Because of this, they have a tendency to think that research should support at least one of these efforts.  In my experience, they also think that the third-party trading business comes in on its own.  So, while they may not say this in public, they view their institutional research as being either an adjunct to investment banking or proprietary trading.

–During the recent recession, very many experienced sell-side securities analysts were laid off.  Their replacements have less experience, and they don’t have the same kind of personal followings with clients that can protect them from external pressure to be bullish.

 

the last bull standing

March 21, 2016 By in last bull standing, Uncategorized Tags: , , , Leave a comment

Being the last bull standing isn’t necessarily a good thing.  The Wall Street cliche is that the bear market doesn’t end until the last bull capitulates.  The complementary, equally hoary, standby is that the bull market isn’t over until the last bear capitulates.

To my mind, both are useful guidelines but not infallible ones.  On the one hand, markets are inherently cyclical.  So if an equity investor has a close to infinite capacity to endure pain–and if his clients don’t fire him in the meantime–persevering with a bad-performing portfolio can eventually pay dividends.

More qualifiers:

–that’s assuming the companies whose stocks the suffering-oriented manager holds are inherently sound, and not barreling down the road to bankruptcy.  They’re just poorly positioned for the current economic environment, which will sooner or later change for the better.

–a surprisingly large number of pension clients love to hire managers who have a recent hot hand and to jettison ones who are cold as ice, no matter what the long-term record.  So my “if his clients don’t fire him” qualification is a much greater risk than one might think.

On the other, there is something to the idea that until the most vociferous and publicity seeking defenders of a given position that’s going wrong give up, the situation rarely changes.  This may be as simple as that when, and only when, the buyers of what short-sellers want to offload disappear, so too does the short-selling–and hence the downward pressure on the stock in question.

…which brings me to Valeant Pharmaceuticals (VRX).

It has caught my eye that William Ackman, a long-time booster (and holder) of VRX, has joined the board of the beleaguered drug firm.  He’s also raised something like $800 million by selling shares of Mondelez, which was reportedly the largest position in his hedge fund.

To the extent that one believes in the last bull theory, and if Mr. Ackman is in fact the last bull, he’s in a no-win situation.

what I find strangest about Valeant Pharmaceuticals(VRX)

March 18, 2016 By in Industry Analysis, pharmaceuticals, Uncategorized Tags: , , , , Leave a comment

Pharma company VRX went from about $20 a share in 2010 to a peak of $263+ last year.  It’s now trading at around $30.

To be clear, I don’t own the stock and never have.  My only acquaintance with the company comes through the financial media and the occasional analyst report–plus a fast look at the stock price history before writing this.

On the surface, the stock screens well.  Its ascent was mainly fueled by rapid earnings growth rather than by price-earnings multiple expansion.  The company seems to have served up continuing positive earnings surprises in a highly visible industry, where such operating performance for large companies is rare.  The only potential red flag I saw from historical data was the rapid build up of long-term debt resulting from VRX’s many acquisitions.

Among other places, I looked at an October 2015 report in Value Line.  I was mostly interested in the past financial reporting data the service provides, but I also happened to glance down at the accompanying commentary, which urges investors to buy.  The fall from $263 to $158 (the price on the date of the report) provided “a prime buying opportunity,”according to VL, with selling related to worries about drug price increases possibly “over done.”  The stock also received VL’s highest rank for Timeliness back then, a rating derived from a statistical analysis of prior financial and trading data.  My point is not to single out VL’s bad call,  but rather to illustrate that there was no obvious sign in historical data of the trouble the stock price was signalling.

What I find worthy of note:

  1.  The main drivers of the stock price seem to have been I’m-the-smartest-one-in-the-room-about-everything hedge fund managers, not traditional portfolio investors.
  2. Holders didn’t seem troubled by the fact that earnings growth was produced in considerable part by large price increases for mature drugs.  That’s OK for things like art works or prime real estate. But history shows Americans have a visceral dislike for companies that make large profits from human misfortune, especially form health problems.  Regulatory changes eliminating the profit “gouging” soon follow.  In my view, then, the whole VRX concept was trouble waiting to happen.  What veteran healthcare analyst wouldn’t know that?
  3. According to a number of media reports the chairman of VRX called select sell-side analysts after returning to the company after an illness last month, apparently to assure them that both he and the company were in robust health.  What’s wrong with that?  The purpose of Regulation FD, published by the SEC in 200, was to outlaw the selective dissemination of important company information (usually to favored brokerage house analysts) that most often occurred in phone calls like this.  Even if no sensitive information was disclosed in the VRX calls, they give the appearance of impropriety.  Why would any intelligent CEO do this?  Especially since…
  4. Last Tuesday, the company had a public conference call in which it sharply revised down its earnings guidance for 2016.  It also said it won’t be able to file its 2015 financials with the SEC on time, which will violate covenants on some of its debt.  That breach will allow the affected lenders to begin a process that could lead to default on those obligations–possibly meaning a demand for immediate repayment of principal.
  5. If media reports are correct, the predominant hedge fund reaction to the rollover in VRX stock has been to buy more rather than reduce their exposure (see point 1 for the reason why).

There may be a time for deep value investors to come in and try to pick up the pieces.  I don’t think we’re anywhere near that point, in time if nothing else, yet.