Tag Archives: Trading

buying a “hot” IPO stock

December 16, 2011 By in Constructing a Portfolio, Industry Analysis, Investment firms, Strategy, Trading Tags: , , , , , , , , Leave a comment

recent new issues

There are three recent or current IPOs that I find potentially interesting:

–Chow Tai Fook Jewelry  (1929: HK), a  Hong Kong-based jewelry chain that specializes in chuk kam (pure gold) gold jewelry, but which is expanding its offerings to include Western-style fine jewelry as well,

–Nexon (3659: JP), the Korean company that started the casual gaming craze with Kart Rider–and who, oddly enough, just listed in Tokyo, and

–Zynga (ZNGA), the creator of the Facebook game Farmville (although my interest is mostly in the fact that it’s going public at close to 100x historic earnings).

how to buy them

Suppose you want to buy one of these–or shares in any “hot” IPO.  How do you go about it?

Let’s take it as given that no ordinary retail investor is going to get an allocation of stock in the IPO itself.

Those shares normally go to the most important customers of the brokers who take the company public, not to retail investors or small institutions.  In fact, unless you’re very close relatives or friends of the top management of the company going public–and they use their influence to direct shares your way (how likely is that?)–being offered shares in an IPO in the US as a retail investor is probably a red flag.  It suggests no one higher up in the food chain wants them.  So, to mix metaphors a bit, the underwriters are forced to reach down to the bottom of the barrel to get the deal sold.  In other markets, Hong Kong, for example, there can be special tranches of stock reserved for retail investors.  But the amount of stock you will receive in a “hot” IPO is likely to be very small.

So, to participate we have to buy shares on the open market.

my rules

While every situation is a little different, I’ve found that the rules I developed for myself while I was running a tiny mutual fund in the 1980s (too tiny to get many IPO allocations) have served me well over the years.  They are:

1.  Read the offering documents carefully and try to calculate the rate of growth of future profits.  this is how you decide what price is reasonable to pay. Like any other kind of investment, understanding valuation is by far the most important factor in success.  For a US investor trying to buy a foreign stock this can be a problem, since the documents won’t be available to you (even on the internet) until after the IPO.

2.  If the stock goes down on day 1 (as ZNGA is doing while I’m writing this), that’s a very bad sign.

3.  First day trading can be very volatile.  Use limit orders, not market orders.

4.  Don’t buy the entire position on day 1.  Three reasons, two relating to attempts by institutions to game the IPO system to get better allocations of future issues:

–retail investors may place market orders, driving up the stock price

–some institutions want to be seen by the underwriters as buying stock on the first day.  They think this establishes them as serious long-term shareholders and not “flippers” (people who only want to make a quick profit on getting an IPO allocation and who dump the stock on the market as fast as they can).  Underwriters generally hate flippers, since a large amount of flipping threatens to depress the stock price on day 1, making the issue seem less successful.  So, rightly or wrongly, buying institutions hope they’ll get larger allocations of future issues as a reward.

—institutions that want to be seen as regular supports of an underwriters IPOs (i.e., they’ll take anything) and as long-term holders of everything may start to sell after a week or two, when they think underwriters won’t notice, thus preserving their A-list status.

3.  A week or two after the initial trading day, after the IPO hoopla is over and when the institutions I describe in my last point above begin to sell, there may well be a chance to buy the stock at a lower price than on day 1.

4.  Keep a list of interesting stocks you might like to buy but think are too expensive now.  Every so often–too often nowadays, in my opinion–stock markets get frightened and sell off in a crazy way.  Everything goes down; small stocks can go down a lot.

I’ve found these to be excellent times to buy the formerly hot IPO stocks.

 

 

 

dark pools and Pipeline Trading Systems

November 8, 2011 By in dark pools, Vocabulary Tags: , , , , , , Leave a comment

dark pools: what they are

the traditional brokerage system

Twenty years ago, virtually all trading between professional investors was conducted through stockbrokers as middlemen.  This traditional system had three big advantages:

–brokers are constantly in touch with a large number of potential buyers and sellers–including other brokers–of a wide variety of securities.  This means that orders can be executed quickly and in large size.

–in some cases, brokers may use their own capital to buy less liquid securities from a customer right away–securities that would otherwise be hard to sell–hoping to trade out of the positions at a profit over a period of time.

–because brokers see lots of orders from very many customers, they may be able to spot trends in the markets faster than an individual investor.  So they may be a source of market intelligence.

Using a broker has one big disadvantage and one smaller one:

–the smaller one is that they’re more expensive than dealing directly with another professional investor would be,

–the larger one is that your broker knows who you are and what securities you’re transacting in.  The more you deal with a given broker, the more insight he will gain about your plans and methods of operation.  In a sense, he gradually comes to “own” them.  He can use this information in his proprietary trading or pass it on to your rival investment managers.

The bigger the institution, the savvier the investment manager, the more valuable this information is–and therefore the more likely it is to be passed on to others.

anonymous trading networks…

Advances in computer technology, both software and hardware, allowed entrepreneurs to create the first anonymous computer trading networks, or “dark pools” for institutional investors about a decade ago.  Investors register with the network operator, but place all their buy and sell orders on the network without revealing their identity.  Nor can they find out who the other side of any transaction is.

The advantages of dark pools are:

–anonymity, and

–very low commission costs.

The main disadvantage is:

–liquidity in a given issue may be low, meaning that execution of a large order may take a considerable amount of time.  An institution can mitigate this problem somewhat by placing orders with a bunch of dark pools at the same time.

…have become very popular

As time has passed and investors have become more accustomed to the concept, the use of dark pools has increased to where some estimates have them accounting for more than one trade in four in the US.  Three reasons:

–more users means better liquidity

–SEC-regulated investors have a positive obligation to seek the lowest-cost executions in their trading.  Using electronic crossing networks demonstrates they’re doing so

–as brokers have deemphasized stock research as a way to cut costs, the need to do enough business with brokers to get full access to research information has diminished.

where Pipeline Trading Systems comes in

Pipeline (PTS) is a broker- dealer who decided to cash in on the dark pool trend by creating one of its own.  It intended to make money, as any dark pool operator would, by charging a fee to anyone using its service.  It opened for business in September 2004.

In its advertising, PTS touted its anonymity and its ability to provide “natural” buyers/sellers for the other side of any trade.  Although, as the SEC notes in its recent cease and desist order, natural doesn’t have a precise legal definition, its use is meant to convey that the other party is another institutional investor, and not a financial intermediary like a broker or short-term trader.

Despite this claim, even before opening, PTS created a wholly-owned trading affiliate to take the other side of trades.  Its idea appears to have been that liquidity in the dark pool would thereby appear bigger than it actually was.

PTS didn’t disclose this to clients.  Quite the opposite.  It continually assured them that this was not the case.

As it turns out, the PTS dark pool was a bust.  In the early years, PTS itself provided well over 90% of the other sides of institutional members’ trades.  And it lost a lot of money doing so.

So PTS decided to put its head trader in charge of the brokerage affiliate, with the task of whittling down the losses.  The in-house broker promptly began to act in a way I see as being against the interests of its institutional clients.  Contrary to what it was telling clients, PTS gave the broker privileged access to the dark pool’s trading data, so it could study customers’ trading patterns; traders were given bonuses for money-making trades; the broker gave suggestions to its parent on how to tweak the dark pool rules in the broker’s favor.

PTS continued to lose money, however, though at a lower rate.  And then it was caught by the SEC.

PTS and two principals were together fined $1.2 million.  They also agreed to stop their illegal behavior.

Although the PTS crew were a hapless bunch, the SEC administrative proceeding against them shows that the agency is finally beginning to examine the operation of dark pools.  At the same time, the case shows that an enterprise like PTS can operate for the better part of a decade without being detected.

supply chain disruptions: first Fukushima, now Thai flooding

October 17, 2011 By in Autos, Current Market Thoughts, emerging markets, Industry Analysis, Recent Market Action, Technology, Trading Tags: , , , , , , , , , Leave a comment

Chao Phraya River flooding

Thailand is suffering extensive flooding because of unusually severe monsoon rains over the past few months.   Several hundred people have been killed and a number of key industrial parks remain underwater.

Although the worst appears to be over, authorities warn that the Chao Phraya River would remain very high for weeks, as more rainwater from the north plus the water accumulated in flooded areas gradually makes its way south to the Gulf of Thailand.

Although the flooding hasn’t received anything close to the media attention outside Thailand that the nuclear plant meltdowns in Fukushima prefecture did outside Japan, it still may have have important investment implications, for two reasons:

–for many years, Thailand has been a big source of automotive components for Japanese auto firms, as well as a jumping-off point for the assemblers into the rest of Asia.

–Thailand produces a lot mechanical and low-end electronic parts that find their way into computers and consumer electronic devices.

effects on industry

Of the accounts I’ve read, the Financial Times has the best overall summary (I was surprised to find that Nikon makes the majority of its digital cameras in Thailand); Forbes has the most company-by-company information.  Nothing is really comprehensive, though.

Few companies have made public announcements about the effect of the flooding on their operations.  That’s partly, I think, because no one knows for sure, partly because the bigger, publicly listed firms are waiting for their subcontractors, who are the ones directly affected, to say something first.

There are two related issues:

–many roads have been knocked out, so people can’t get to work and parts suppliers can’t deliver shipments. Some areas have no electric power.  It sounds like this situation will last for a couple of weeks, at least.

–no one knows for sure how much damage has been done to factory machinery in the flooded industrial parks.  This could be a really serious problem, especially if machines are heavily customized or built entirely in-house.  The Bangkok Post seems to think that companies had enough warning that they could move machines to upper factory floors, where they would presumably be safe from damage.  But in most cases, it looks like no one has been able to get into the factories to check.

investment implications

Under normal circumstances, Japanese car firms would simply switch to alternate production sources inside Japan.  But those are most likely already running flat out to compensate for capacity lost to the Fukushima disaster.  So the Japanese auto firms will probably face production constraints for some time.  Their third-party component customers will, too.  That’s a mild positive for everyone else.

IT is a little bit trickier, since a lot of Thai companies make components that fly way below the radar.  We do know that Thailand is very important for hard disk drives, however.  And they’re in everything from iPods to set-top boxes to corporate and cloud servers.

If you own a tech stock that seems to be resisting the general uptrend that IT is now experiencing, chances are that if you Google your stock’s name + Thai flooding you’ll see that this is what’s holding the issue back.

What you should do with this knowledge depends on valuation and the extent of your stock’s dependence on Thailand (and your risk preferences, of course).  So you’re on your own.  For the one or two that I own, I think a daily trip to the Bangkok Post website is in order.  That will give the fastest indication, I think, that the flooding problem is not going to get any worse–which will probably be the time to decide whether to own more of the affected stocks.

 

what if this is a bear market…and not just a wicked correction?

September 28, 2011 By in Constructing a Portfolio, Current Market Thoughts, economics, major changes in market direction, market bottoms, market tops, Portfolio management, Recent Market Action, Strategy, Trading Tags: , , , , , , , , , , , , Leave a comment

standard definitions

Commentators often use sound-bite definitions for economic and stock market phenomena.  For example,

–a recession is two successive quarters of year-on-year GDP decline.

–a correction is a short, counter-trend, fall in stocks of 5%-10%.

–a bear market is a fall in stock prices of 20% or more.

The virtues of these definitions are that they’re brief and unambiguous.  On the other side of the coin, brief and unambiguous doesn’t represent real life that well.

adding complexity, but also relevance

There’s a time aspect to corrections and bear markets.

A correction typically lasts a few weeks.  That’s because it’s normally a valuation issue–that “animal spirits” have pushed stock prices higher than near-term earnings can comfortably support.  Short-term traders sell, but intend to repurchase in short order, hopefully at somewhat lower prices.

Bear markets, on the other hand, come in two types.  Both anticipate–and ultimately reflect–widespread economic weakness that will last for a year or so.  The garden variety is a consequence of governments’ countercyclical fiscal and money actions when economies are about to overheat (too bad Mr. Greenspan forgot about this part of his job).

The really deep ones come from one-time shocks to the system.  In the past, these have been “external shocks,” like huge oil price rises.  The most recent is the self-inflicted wound of the financial meltdown.  As we experienced in 2007-2009, these ones are deeper and longer.

for the record…

…I don’t think we’re in a bear market–at least not in the world outside the EU (where stocks have already lost over a third of their value since May).

I think we’re in an unusual situation of correction in world markets, complicated by the EU situation.  In brief, the EU hoped to get away with not rebuilding its banks’ strength after the losses they took in the financial crisis, but hiding them instead.  They figured they could free-ride on the economic coattails of China and the US instead and use worldwide growth to mend.

Then the Greek crisis came.  And, instead of addressing the fact their gamble had failed, EU governments have spent the last year with their heads in the sand, letting the problem get worse.

why bring this up now?

EU stocks have lost over a third of their value since May.  US stocks are down by almost 20% (the “magic” bear market line).  Metals prices are crashing.  Stocks have been extremely volatile.

Monday morning I saw a lot of crazy stuff when I turned my computer Monday morning.

–European markets were down 5% intraday.

–Hong Kong-traded Ping An Insurance (I own it–ouch!) had lost another 8%+.  It was down by 25% in three days on rumors that HSBC was about to sell a portion of its holding (so what, I say).

–AAPL lost $10 in early trading in a rising US market on a report out of Taiwan that orders for iPad components from Hon Hai for the December quarter were lower than expected.  It turns out the orders, if they are indeed being lost at Hon Hai, are most likely going to a new iPad factory that’s opening in Brazil in December. It could equally be that AAPL is preparing for iPad3, which would be a bullish sign, I think.  But, noooo. Traders took the most bearish interpretation.

The world isn’t 5% better one week, 6% worse the next, and 7% better the week after that.  Economic processes don’t change that fast.  Human emotions do, however.  And the extremes of emotion we’re seeing now typically signal significant turning points in market behavior.  Hence the title of this post.

what to do

My best guess is that we continue to move sideways in markets ex the EU until European governments address their banking crisis.  They markets probably rally.  But that may not be for a while, so don’t bank on that.

I think the best strategy is to use days of crazy selling as a chance to buy stocks that are being irrationally sold down.  Be very picky, though.  Look for high quality names where you’re very confident about the fundamentals.  And don’t bet the farm on a single stock.

On September 6-9, for example, I bought INTC, because I saw it was trading at under $20 a share, or less than 9x earnings, and with a dividend yield of 4.3%.  As/when it reaches $24, I have to decide whether I keep it.

if it’s a bear market, then what?

Then markets are not turning up again until maybe next summer.  And, if past form holds true, we’ll see at least one more downdraft in stock prices–maybe another 10% from here, more in economically sensitive stocks and in emerging markets securities (even though the emerging economies themselves may be fine).  That will come as government statistics and company reports show economic activity dipping into negative territory.  Yes, world stock markets may have begun discounting this possibility.  But, ex the EU, they’re barely begun to, in my view.

As much as it cuts against the grain of my growth stock temperament, it seems to me it’s worthwhile thinking about asset allocation and how you’d act if a more ursine mood begins to make itself evident on Wall Street.  My portfolio is betting against this, but it never hurts to think about what happens if you’re wrong.

 

 

 

 

 

more on “discounting”

September 25, 2011 By in Current Market Thoughts, Discounting, Portfolio management, Recent Market Action, Strategy, Technical Analysis, Trading Tags: , , , , , , , , , , , , , Leave a comment

discounting

“Discounting” is the jargon that Wall Street uses to describe the process of factoring changes in consensus beliefs about future happenings into today’s stock prices.  I’ve outlined the basics of discounting in an earlier post.

fundamental vs. technical analysis

Fundamental analysis, the study of company-specific and economy-wide economic and financial information, and technical analysis, the study of charts, can be seen as two approaches to discounting.  In the first case, researchers try to figure out what information is most important for making a security’s price go up or down, and then actively search for relevant data.  In the second, investors study chart patterns as a way of figuring out what fundamental analysts are doing and then riding on their coattails.

the internet

The internet has changed the amount, quality and cost of information in dramatic fashion. For example:

–When I was building an international equity investing organization for a major financial institution in the early 1990s, it cost about $300,000 a year in today’s dollars to get access to all corporate SEC filings.  The data came on microfiche and was available about six weeks after the documents were filed.  Today, the information is free on the SEC’s Edgar website; documents are available the instant they’re filed (companies do this electronically).

–Thanks to regulation FD (Fair Disclosure), company presentations are routinely webcast and are available through the company website.  Typically, they’re archived for at least a year.  True, breakout sessions at conferences, small group meetings or one-on-ones aren’t, but these mostly serve to fill in the blanks for analysts not familiar with a firm.  Companies may sound like they’re revealing new information, but they’re not.

–A Bloomberg terminal still costs $30,000-$50,000 a year, depending on its capabilities.  But discount brokers offer most of what an individual investor needs to their customers on their websites for free.

discounting and Greece

Discounting isn’t a one-time event.  It’s a process.

1.  For one thing, what’s painfully obvious to a seasoned observer or an industry specialist may only dawn on the average investor a considerable time later.

2.  Also, bad news that relates to a specific event is typically not fully discounted until the event occurs–no matter how far in the future that may be.  The financial crisis in Greece is a good example.

A year ago, a new administration in Athens revealed that the country had been falsifying its national accounts for many years.  Greece had taken in less in taxes and also spent a lot more than it had ever revealed.  How so?  Its membership in the EU had allowed it to borrow much more than it could ever repay.

For at least six months, it has been clear that either the rest of the EU will be forced to pick up the tab and let Greece remain in the EU, or that Greece will default and lose its EU membership.  In default, holders of Greek sovereign debt would lose most of their money.  But, since that’s mostly big EU banks which might need government bailouts as a result, the effect is basically the same.  EU taxpayers ultimately foot the bill.

Over recent months, however, EU stock markets–and the financials, in particular–have been subject to periodic waves of selling, driving prices ever lower, as investors express their fears about Greece.  …despite the fact that in general terms everyone has already read the closing chapter of the story.

This pattern of discounting the same news over and over again is typical.  It begins in denial (inadequate discounting) and may end in despair (overdiscounting), the same emotional pattern that shapes a bear market.  While bear markets end in a whimper sometimes, however, discounting that anticipates a discrete event usually involves a final selling bout as the event actually occurs.

Over the weekend, the G-20 seems to have given the EU an ultimatum to resolve the Greek crisis quickly.  We’ll see tomorrow how the markets react.