Wednesday, July 31, 2013
Investing for Survival
Why You Never Learn From Your Investment Mistakes
Study successful investors, and you'll notice a common denominator: They are masters of psychologyThey can't control the market, but they have complete control over the gray matter between their ears.
And lucky them. Most of us, on the other hand, are mental catastrophes. As investor Barry Ritholtz once put it:
You're a monkey. It all comes down to that. You are a slightly clever, pants-wearing primate. If you forget that you're nothing more than a monkey who has been fashioned by eons on the plains, being chased by tigers, you shouldn't invest. You have to be aware of how your own psychology affects what you do.
Take one of the most powerful theories in behavior psychology: cognitive dissonance. It's the term psychologists use for the uncomfortable feeling you get when having two conflicting thoughts at the same time. "Smoking is bad for me. I'm going to go smoke." That's cognitive dissonance.
We cognitive dissonance, and jump through hoops to reduce it. The easiest way to reduce it is to engage in mental gymnastics that justifies behavior we know is wrong. "I had a stressful day and I deserve a cigarette." Now you can smoke guilt-free. Problem solved.
Humans are one of the only creatures that engage in this self-deluding behavior. In their excellent book , Carol Tavris and Elliot Aronson write:
A dog may appear contrite for having been caught peeing on the carpet, but she will not try to think up justifications for her misbehavior. Humans think; and because we think, dissonance theory demonstrated that our behavior transcends the effects of rewards and punishment and often contradicts them.
Yes, when it comes to learning from bad behavior, you are at a disadvantage to an incontinent puppy.
Cognitive dissonance is especially toxic in the emotional cesspool that is managing money. Raise your hand if this is you:
· You criticize Wall Street for being a casino while checking your portfolio twice a day.
· You sold your stocks in 2009 because the Fed was printing money. When stocks doubled in value soon after, you blamed it on the Fed printing money.
· You put $1,000 on a hyped penny stock your brother convinced you is the next Facebook. After losing everything, you tell yourself you were just investing for the entertainment.
· You call the government irresponsible for running a deficit while simultaneously saddling yourself with an unaffordable mortgage.
· You buy a stock only because you think it's cheap. When you realize you were wrong, you decide to hold it because you like the company's customer service.
Almost all of us do something similar with our money. We have to believe our decisions make sense. So when faced with a situation that doesn't make sense, we fool ourselves into believing something else.
Worse, another bias -- confirmation bias -- causes us to bond with people whose self-delusions look like our own. Those who missed the rally of the last four years are more likely to listen to analysts who forecast another crash. Investors who feel burned by the Fed visit websites that share the same view. Bears listen to fellow bears; bulls listen to fellow bulls.
Before long, you've got a trifecta of failure: You make a bad decision, rationalize it by fighting cognitive dissonance, and reinforce it with confirmation bias. No wonder the average investor does so poorly.
Great investors are different. They are practically allergic to these biases.
Value investor Mohnish Pabrai has an outstanding long-term track record, but he spends an inordinate amount of time analyzing his mistakes.
In an interview last year, Pabrai told me about his response to 2008, when he (and nearly everyone else) lost a lot of money. Rather than rationalizing his poor performance by blaming Wall Street, he set out to learn from what were, after all, his investment decisions. "I clearly studied my own mistakes, and I went back systematically and documented why we lost money on these different investments," he said. Studying his mistakes eventually led to a checklist Pabrai now consults before making new investments. "The checklist significantly brought down the error rate," he said.
Most investors don't think like this. Which is why Pabrai outperforms most investors.
Billionaire Ray Dalio is similar. His hedge fund, Bridgewater Associates, has a policy that every employee must always speak their mind, even if it means telling a superior they're wrong.
"Successful people ask for the criticism of others and consider its merit," Dalio in his employee handbook. "Remember that your goal is to find the best answer, not to give the best one you have."
Most investors don't do this. They assume their opinion (or the opinion of those who agree with them) must be right, and will delude themselves into justifying a belief when shown opposing facts. Dalio doesn't put up with this behavior -- which is part of why he's a billionaire, and you and I are not.
"The brain is designed with blind spots," Tavris and Aronson write, "and one of its cleverest tricks is to confer on us the comforting delusion that we, personally, do not have any." Alas, you do. And they're preventing you from becoming a better investor. Fight them as hard as you can.
News on Stocks in Our Portfolios
ADT beats by $0.09, beats on revenue
ONEOK Partners beats by $0.06.
Ecolab beats by $0.02, misses on revenue
This Week’s Data
The International Council of Shopping Centers reported weekly sales of major retailers down 1.6% versus the prior week but up 2.2% versus the comparable period a year ago; Redbook Research reported month to date retail chain store sales up 3.2% versus the similar timeframe lat month and up 2.9% on a year over year basis.
The Case Shiller home price index rose 1.0% month over month in May versus estimates of +1.3%
The July Conference Board’s index of consumer confidence came in at 80.3 versus forecasts of 81.0
Weekly mortgage applications fell 3.7% while purchase applications declined 3.0%.
ADP private payroll report showed a 200,000
gain in employment versus estimates of up 179,000.
A confusing second quarter
GDP report: it came
in +1.7% versus expectations of +1.1; however, first quarter GDP
was revised down from +1.8% to +1.1%.
Truck tonnage remains strong (short):
record debt (short):
***over night, EU employment data improved while German retail sales were short of forecasts.
James Galbraith on the social breakdown and financial stress in
(a bit long, but a must read):
Al Qaeda reborn (medium):
The indices (DJIA 15520, S&P 1685) meandered another day, awaiting the data/news flow that will start today with the release of the statement from the current FOMC meeting and the second quarter
number. The Dow remained within its
short term trading range (14190-15550).
The S&P finished within its short term uptrend (1603-1759), although
it once again closed below the upper boundary of its former short term trading
range (1687). The Averages remain out of
sync on their short term trends.
However, they finished within their intermediate term (14476-19476, 1536-2124) and long term uptrends (4918-17000, 715-1800).
Volume was up fractionally; breadth was mixed. The VIX was unchanged, remaining within its short term trading range and its intermediate term downtrend.
GLD declined, closing below the lower boundary of that developing very short term uptrend (not good) and within its short and intermediate term downtrends.
Bottom line: the challenge of the 15550/1687 went nowhere again yesterday. I am sure that Monday and Tuesday’s directionless market was largely a function of investors sitting on the sidelines awaiting the statement from the FOMC meeting as well as the latest readings on second quarter
GDP, the ISM
manufacturing index and nonfarm payrolls.
It would surprise me if, by the close Friday, the technical picture was
as uncertain as it currently is.
If stocks move to the upside, my focus will shift to the upper boundaries of the three major trends (S&P short term---1757, intermediate term---2124, long term ---1800).
If stocks release to the downside, I will likely invalidate the S&P’s re-set to a short term uptrend. That will leave both of the indices in trading range and back in sync.
Sentiment survey (medium):
Yesterday’s economic news was again inconclusive: weekly retail sales were mixed, the May Case Shiller home price index was a little below consensus on a month over month basis but were quite strong year over year, the July consumer confidence index was weaker than expected.
The Case Shiller numbers got most of the attention; and if you watched the video I posted of the interview with Robert Shiller, you know most of the chatter was around the issue of ‘bubbles’. You also know that I am very sympathetic to this point of view---which, all other things being equal, would not be a plus for equities except perhaps in the very short term.
Bubbles and market crashes forever (medium):
In other news,
industrial production was down 3.3% and household spending also declined. Barclay’s ‘discovered’ a L12 billion ‘hole’ in
its balance sheet and JP Morgan (our fortress bank), was accused of gaming
Banks, once again too big to fail (short):
Fed policy mainly benefits foreign banks (medium):
Bottom line: all eyes will be on the FOMC meeting and three primary macroeconomic indicators that will be released between now and Friday. If the Fed states its intention of maintaining QEInfinity into the foreseeable future, that will likely be positively received by investors---though I consider it a negative for the simple reason that the further the Fed gets out on the QE limb, the worse the outcome will be.
The economic numbers could potentially have an impact on our Models---if for example, the
ISM and nonfarm payroll numbers were all blow outs, suggesting that the economy
may be strengthening more than I expect.
Of course, the reverse would also be true. That said, in the absence of any great
surprises, my bottom line is unchanged: equities are overvalued; and our
Portfolios will continue to use any price strength (i.e. stocks trading into
their Sell Half Range) to lighten their equity exposure.
A debate on the attractiveness of muni bonds (medium):
Investor funds flows (short):
Market perception versus reality (medium):
Where is ‘tapering’ being priced into the markets? (short/medium):
The latest from Marc Faber (medium):
Tuesday, July 30, 2013
Illinois Tool Works manufactures industrial products and equipment for the transportation, construction, power systems and electronics, industrial packaging, food equipment, polymers and fluids incorporating over 800 businesses in 58 countries. It has generated an 11-20% return of equity and has grown earnings and dividends at a 10-13% rate over the past 10 years. As might be expected for a company serving the housing and automotive markets,
a significant decline in earnings in 2009.
However, this high quality, well managed company witnessed a rebound in 2010 and resumed its prior growth path as a result of:
(1) the company’s aggressive acquisition program,
(2) focus on cost reduction,,
(3) new product development as well as a continual broadening of its product lines,
(4) an ongoing stock buyback program.
(1) it is in a highly competitive industry,
(2) a significant portion of its business is international thereby exposing it to currency risk,
(3) several of its major product lines service cyclical businesses.
Illinois Tool Works is rated A++ by Value Line, has a debt to equity ratio of about 31%, and its stock yields approximately 2.2%.
Stock Dividend Payout # Increases
Yield Growth Rate Ratio Since 2003
Debt/ EPS Down Net Value Line
Equity ROE Since 2003 Margin Rating
ITW stock made great progress off its March
2009 low, surpassing the downtrend off its October 2007 high (red line) and the
November 2008 trading high (green line).
Long term, the stock is in an uptrend (straight blue lines). Intermediate term it is in an uptrend (purple
lines). Short term, it is in an uptrend
(brown line). The wiggly blue line is on
balance volume. The Dividend Growth
Portfolio owns a full position---the result of a purchase, the stock rising
into its Sell Half Range, one half of the stock being Sold and the stock rising
back the value of a full position, The
upper boundary of its Buy Value Range is $36; the lower boundary of its Sell Half
Range is $78.
Thoughts on Investing---from Barry Ritholtz
Mistake #8: Cognitive Errors.These are the errors that are inherent in our wetware – namely, the way your brain has evolved over the millennia. Suffice it to say that capital risk decision-making was not a big issue on the Serengeti plains. On the other hand, avoiding getting eaten by lions was.
Hence, Humans have a number of unfortunate tendencies as a result. These tend to get in our way when it comes to investing:
• We see patterns where none exist;
• We have difficulty conceptualizing long arcs of time;
• We selectively perceive what agrees with our pre-existing expectations, and ignore things that disagree with our beliefs.
• We tend to forget our losers and over-emphasize our winners.
• Our inherent optimism bias turns out to be hard-wired as well — our brains are better at processing good news about the future than bad.
• We actually get a greater thrill from the anticipation of a financial reward than the actual reward itself. (Think what this means in terms of Buy the Rumor, Sell the News)
• We seek stimulus for the dopamine high — regardless of how. Whether you are a Gambler, Alcoholic, Sex Addict, Shopaholic, or Hyper-Active Trader — its all the same buzz.
• Story-telling is how Humans evolved to share information (Pre-writing). Thus, we are vulnerable to anecdotes that mislead or present false conclusions unsupported by data.
In short, we simply are not wired for the required risk analysis inherent in investing.
These cognitive foibles that affect all of us have a significant impact on our decision making, whether we are aware of them or not. We cannot avoid these built-in shortfalls. Its how we are made. But if you at least become aware of these processing issues, you have some hope to avoid their most pernicious impact
News on Stocks in Our Portfolios courtesy of Seeking Alpha
Occidental Petroleum misses by $0.05, misses on revenue
Cummins beats by $0.20, beats on revenue
Coach EPS in-line, misses on revenue
This Week’s Data
The July Dallas Fed manufacturing index came in at 4.4 versus expectations of 6.4.
June pending home sales were off 0.4% versus forecasts of a decline of 1.4%.
Fed only putting off the day of reckoning (medium):
More questionable behavior from the banksters (medium):
Are you smarter than an eighth grader in 1912? This is amazing and a must read. (short):
Obamacare and municipal bankruptcies. There goes more of Your Money (medium and a must read):
Inflation in Japan (short):
The indices (DJIA 15521, S&P 1685) drifted lower yesterday. The Dow closed back below the upper boundary of its short term trading range (14190-15550). The move negates the recent break above 15550 and validates (again) the short term trading range.
The S&P finished within its short term uptrend (1601-1757). However, it once again ended the day below the upper boundary of the former short term trading range (1687). I am leaving our call on the re-set to a short term uptrend. However, as I noted last week, 1687 should be acting as support. So further downside will cause me to re-examine that call.
In the meantime, the Averages remain out of sync on their short term trends and hence, the Market is directionless. They finished within their intermediate term (14476-19476, 1536-2124) and long term uptrends (4918-17000, 715-1800)
Volume fell; breadth was weak. The VIX rose, staying within the short and intermediate term downtrends.
GLD declined but closed above that developing very short term uptrend but within its short and intermediate term downtrends.
Bottom line: the challenge of the 15550/1687 level is developing all the characteristics of a Chinese water torture test. The Dow has tried twice to bust through 15550 and couldn’t confirm the break. While the S&P did manage to confirm its break over 1687, it stayed above that level for only one day more than required by our time element and since then has see sawed above and below 1687.
Clearly, this back and forth can go on for as long as it takes for either the bulls or the bears to gain the upper hand. Whenever that occurs, if it is to the upside, my focus will shift to the upper boundaries of the three major trends (S&P short term---1757, intermediate term---2124, long term ---1800).
If stocks release to the downside, I will likely invalidate the S&P’s re-set to a short term uptrend---primarily because it succeeded in confirming by only a single trading day, then couldn’t hold 1687, making it a false break out. That will leave both of the indices in trading range and back in sync.
Yesterday’s economic news was a bit mixed: June pending home sales were down, but not as much as expected; while the July Dallas Fed manufacturing index was up but not as much as anticipated. Both numbers are secondary indicators; so I don’t see this information adding a lot to the discussion on the economy.
Most investor focus was on what is occurring later in the week: the FOMC meeting which ends of Wednesday, plus second quarter
is reported, the ISM manufacturing index on Thursday and nonfarm payrolls on
Friday. Of course, the item generating
most of the discussion was the Fed meeting and what may or may not be said about
‘tapering’. I continue to believe that
Bernanke is as confused as everyone else about what should be done at this
point; and as long as that is the case, we should stay focused on interest
Bottom line: equities are overvalued, as calculated by our Model. That doesn’t mean that the economy is about to roll over, that earnings are going to drop precipitously, that a major sovereign/bank default will occur in Europe or that interest rates are about to soar. It simply means that stock prices are discounting an economic/political scenario far too optimistic for the facts on the ground.
Our Portfolios will continue to use any price strength (i.e. stocks trading into their Sell Half Range) to lighten their equity exposure.
The new game: beat and lower (short):
More on the margin debt problem (medium):
The inevitable ‘taper’ (medium):
The latest from John Hussman (medium):
Morgan Stanley on faith, hope and multiple expansion (medium and a must read):
The latest from Jim Rogers (5 minute video):
Investing for Survival
Nine insights from George Soros:
Monday, July 29, 2013
Monday Morning Chartology
The S&P remains within all major uptrends. Further, the May 22 high (1687) continues to provide support as the S&P has traded several times below that level intraday but bounced to close above it.
GLD is on a very short term uptrend; but remains within its short and intermediate term downtrends.
The VIX is nearing the lower boundary of its short term trading range and remains within its intermediate term downtrend.
If you haven’t been watching the Nikkei (short):
Update on ’the best stock market indicator ever’
Another update on second quarter S&P ‘beat’ rate (short):
News on Stocks in Our Portfolios
This Week’s Data
Lance Roberts on the housing recovery (medium and a must read):
International War Against Radical Islam