Tempamatics

In college (1980), I was taking a marketing course that required forming groups of 4 and competing in a game called "Tempamatics". Essentially, the group was the company and the collective groups in the class were the industry--competitors.

It was a simulated game where you made routine decisions about your product to include production volume, sales price, stock buybacks, debt assumed etc. Based on your decisions, (entered on key punch cards I might add--ancient technology), and in relation to the decisions of all others, your group was ranked against all others--in your class in and in all classes. The ranking was based on your score earned on about 5 factors. I don't recall them all but debt to equity, return on assets, return on equity were three of the 5. Not all of them had the same weighting.

The marketing professor was not too keen on accounting students. In fact he warned that the worst group that he ever had was composed of all accounting majors. Our group had 2 accounting majors (including me) and a marketing major and a personnel major. He did allow us to keep our weighting of 50% accounting majors, and we did not feel intimidated.

The very first exercise elicited a lecture from the professor about what variable costs were. Apparently more than one group had elected to sell their product for less than it cost them to produce. Naturally, those of us who had a facile grasp (read: accounting majors) of this concept were left with no sales, lots of inventory and red on the income statement.

After the first blow up, our team determined that we would systematically exploit the ranking system by making decisions that would cause a better outcome for more heavily weighted factors. Return on equity was one such factor. Accordingly, among other things, we bought back stock--including borrowing money to do so as debt factors were not weighted so heavily. We consistently climbed higher and higher in the rankings by maintaining a ruthless commitment to maximizing our scores and testing our decisions that would get us there.

To give you an idea how successful our team was, we finished with a score 97. The second place team had a negative number of like -25. (This was among all classes, not just our class, and I don't recall how these numbers were generated). Our lament, though, was that we were NOT making good long-term decisions, but rather short-term, highly rewarded decisions. This M. O. stood in stark contrast to the Japanese style of business decision making (much discussed at the time).

Businesses have to survive for the long term, and they cannot do it with short term thinking--such as unsustainable debt, declining sales or margins, runaway administrative expenses. So as you look at your investment candidates, make sure that they have a management team and product line that positions them for long term success. It's also a good perspective to apply to your personal finances.

China

Hey, if you are looking for something interesting go here.

You can click on the China map and find all sorts of interesting things. Cocktail party this weekend? (I don't have any, but surely you do). Arm yourself with titillating information.

Short Interest

I mentioned some time ago that I had a major "duh" moment. Specifically, that when the market (or stock) advances more than I would expect it to, look at the short interest. JOYG had a terrific day today. Their short increase had also increased rather markedly from APR - May.

I'm wondering if the juice for the market today was real exuberance or the fact that short interest overall has been increasing across the board by people in the 'money know'. The FOMC minutes were not comforting with respect to the drag of housing on the economy. Now, as you might imagine, I was not surprised by that statement; I doubt that any of you were either. So I did garner some comfort that my thinking was not so out of line in that respect; but was discomfited that there was not a more forthcoming worry earlier.

Thunderstorms and Such

Around 8:30 p.m. Monday evening we had a violent thunderstorm--blinding rain, powerful winds and chip-sized hail, lightening ground strikes. Greta, my orange belton bird dog, is deathly afraid of storms. She shivers like perennially jiggled jello. I put her in the utility room and turned the dry on to mute the thunder. She also does not like flash cameras--she knows that a flash is the precedent of thunder.

That trick worked until we lost power. Luckily our dinner, courtesy of my son, was on the table (yeah, we eat late!). He grilled bratwurst and onions. So we ate by candlelight and with the wonder of when power would be restored. My neighbor said that the power company said by 11:30 p.m. With that information, we elected not to go down to the woodshed to get the generator.

Tuesday a.m.. Still no power. So yesterday I was sans internet, though I could connect through my Open Wave through Verizon to see what the market was doing. Good, bad, then good it seemed! Power/cable was restored around 5:00 p.m.
-------------------------------------------------------------------
It looks like today there may be a market thunderstorm with the Chinese govt's tripling of the stamp duty. You can read the story here on Bloomberg. One half of the Shanhai's stocks dropped the daily drop limit of 10%. Naturally, analysts are not concerned. I'm not suggesting that they need to be, for I truly do not know. But we can always be assured that no matter how dire the news, MOST analysts will not be concerned. I at least believe that it is a correction. Whether a healthy one or not remains to be seen. Watch FXI today. It will open at least $2 down.

SRS is the 2x inverse of IYR. IYR was up about 3% due to buyout news and speculation. SRS was down 6%. I'm sure that there were many investors in SRS thinking that REITS had rolled over and more was to come. It was a beautiful H&S pattern--THAT FAILED. At least so far. I had exited my position in SRS profitably (because I watched the technical pattern in IYR), and I was glad not be exposed yesterday. Buyouts must release some trader pheromones--they get a whiff of it and go into a buying frenzy for all stocks in a group. I imagine that frenzy will buoy the REITS for a little while--at least through a merger Monday. But the double ETF's can double your pleasure or pain.

I know that some of you dismiss technical indicators, and there are certainly arguments for that. But there are technical indicators that I believe that are separate from the seeming voodoo chart patterns that have increased my transaction success. Most particularly, overbought/oversold as well as RSI have been useful to me. I also watch the Aroon up/down indicators. That has helped me understand whether a price is trending, changing trend or consolidating. Given that I've not wanted to be long this market (call me chicken), I have found that these tools have helped me find some attractive short-term positions, so that I'm earning some return without feeling too exposed on the long side. Stated another way, I feel like I'm making an 'informed gamble'.

May your portfolios persevere today.

Bird-Doggin':

Yes, this is a bird-dog post! I wanted to introduce you to the following study which I believe has interesting implications for those of you who are regular readers of research reports. I found this paper, "Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations" (September 2005), at Brad Barber's research page.

Here's a citation for the work. If you are interested in this subject, I would recommend your reading the paper.

Barber, Brad M., Lehavy, Reuven, McNichols, Maureen F. and Trueman, Brett, "Buys, Holds, and Sells: The Distribution of Investment Banks' Stock Ratings and the Implications for the Profitability of Analysts' Recommendations" (September 2005). Available at SSRN: http://ssrn.com/abstract=495882

I've not paid much attention to the % of buy/hold/sell recommendations, but I will now having read this paper. The premise of the paper follows:

"This paper analyzes the distribution of stock ratings at investment banks and brokerage firms and examines whether these distributions can be used to predict the profitability of analysts’ recommendations."

The study has a comprehensive methodology which I'll skip in this post. But the result was this:

"Upgrades to buy issued by brokers with the smallest percentage of buy
recommendations significantly outperformed those of brokers with the greatest percentage of buys, by an average of 50 basis points per month. Further, downgrades to hold or sell coming from brokers issuing the most buy recommendations significantly outperformed those of brokers issuing the fewest, by an average of 46 basis points per month."

The study dovetails with NASD Rule 2711 which required greater disclosure on the part of investment firms relative to the market peak of 2000 (height of bullishness) and the subsequent market decline. Rule 2711 had to be adopted no later than 09.09.02 for member members. It is this regulation that requires each investment research report (among other things) to list the % of buys/sells/holds in its research universe. The authors have many tables, but I constructed this very simple table to show you the differences in the breakdown among all firms over the pre/post adoption period:

The redistribution is remarkable, is it not?

I will also selectively lift some points that I think are interesting (and I really encourage your reading the paper--it is very accessible to lay (that means me) readership:

• While a literature view conducted by the authors show, "banking activity has not been found to be associated with either less accurate or more optimistic earnings forecasts." (p. 7). They also note some contrasting studies that show that (1) lead underwriter recommendations are more optimistic than that of others; and (2) "the buy recommendations of independent research firms outperform those of investment banks, especially subsequent to equity offerings." (p. 8). That is something to be mindful of when reading a prospectus--and fits with Russell's (and my) prognostication skepticism!
  

• During the height of bullishness (pre 2000), "buy recommendations outnumbered their sell recommendations by more than 35-1.(p. 8)

• Post 2001, the number of companies in the coverage universe dropped due to (1) smaller universe of organizations due to business failure at the time; (2) brokers declining to cover organization's whose prospects are dimly viewed; and (3) cut back in research resources. (p. 11)

The paper provides an interesting historical view useful to a post-2000 investment recommendation view as well as empiricism regarding the value of upgrades and downgrades RELATIVE to the issuing organization's recommendation universe.

Unskilled and Unware--Follow Up

In my former job, I was part of an executive team in a nascent, but fast growing industry. You could consider it the health care equivalent of the dot com era. Each one of us was unskilled but we were fully aware of it. In fact, the entire industry was unskilled--some aware and some unaware. I will tell you that being in such a position produces the highest degree of stress imaginable, because lots of money was on the line and everyone (industry-wide) was flying by the seat of their pants with their hair on fire!

We would actively challenge ourselves by vetting the following about our industry:

• Unknown and unknowable (these are the things that peg the sphinctometer)
  
• Knowable, but currently unknown (because of lack of studies/outcomes)
  
• Known

I would suggest that vetting these three items about any risk undertaking is important. It wasn't until reading through the comments section of the last post that I was reminded of these things. And, in being reminded of them, I thought that they have great applicability for investing.

Unfortunately, a multiplicity of venues and points of view exists. For each of these (and there may be more than someone could add) you have to be very specific regarding the 'what' (sales, costs, regulatory, etch) and the 'who' --as in whose point of view (yours, management's, the market's, regulator's, etc). Something that is unknown and unknowable may merely be unknown and unknowable TO YOU but others may know it. But you have to adopt an investor point of view. Bill Cara is fond of saying--"if you are not in the room, you are not in the deal".

Unskilled and Unware of It

The above quote is taken from the paper that Russell references in the comments section.

Unskilled and Unaware of It: How Difficulties in Recognizing One's Own
Incompetence Lead to Inflated Self-Assessments
Justin Kruger and David Dunning
Cornell University

I will read the paper, but here is the abstract, and a quote from the 1st paragraph which reminded me of an article I read...I'll tell you why after you read the quote.

Abstract: "People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it. Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd. Several analyses linked this miscalibration to deficits in metacognitive skill, or the capacity to distinguish accuracy from error. Paradoxically, improving the skills of participants, and thus increasing their metacognitive competence, helped them recognize the limitations of their abilities.

(Now you know that I'm wondering if there is a gender breakdown in this assessment--just from having a a fresh dose of that from our last paper. I seldom break down people/issues into categories--liberal/conservative, male/female etc.).


Quote: ""It is one of the essential features of such incompetence that the person
so afflicted is incapable of knowing that he is incompetent. To have
such knowledge would already be to remedy a good portion of the
offense. (Miller, 1993, p. 4)"
--------------------------------------------------------

The beginning quote reminded me of an article that I read (I forget where/when) that stated that depressed people had a more accurate view of themselves than non-depressed people. It had to do with a natural filter that people have (which probably protects them from the mentally scarring cognition of their incompetence. What made me think of that was the quote.....There is a double whammy in the above. First, you are incompetent (and who wants to be labeled as incompetent?) and second, you are so afflicted that you do not realize it.
-------------------------------------------------------

More later. It is early, and no caffeine is coursing through my veins yet.

----------------------------------------------------
9:14 a.m post caffeine, post read and post breakfast:

First: The authors note that gender failed to qualify the results.
Second: The phrase "Unconscious Incompetence" kept resonating in my brain.

Here are some of some first impressions of the article. I certainly have no qualifications for any critical assessment (and Russell, I hope that none of this sounds like I'm dissing your paper) and have sufficient metacognition abilities to recognize such. I have to admit that I have a bit of a bias from a previous life in having to understand study biases related to a very small sliver of the world. But I have NO professional competence in this area.

Before jumping in, let's look at the definition of metacognition. This is from Jennifer Livingston's document that you can find here:

"Metacognition" is one of the latest buzz words in educational psychology, but what exactly is metacognition? The length and abstract nature of the word makes it sound intimidating, yet its not as daunting a concept as it might seem. We engage in metacognitive activities everyday. Metacognition enables us to be successful learners, and has been associated with intelligence (e.g., Borkowski, Carr, & Pressley, 1987; Sternberg, 1984, 1986a, 1986b). Metacognition refers to higher order thinking which involves active control over the cognitive processes engaged in learning. Activities such as planning how to approach a given learning task, monitoring comprehension, and evaluating progress toward the completion of a task are metacognitive in nature. Because metacognition plays a critical role in successful learning, it is important to study metacognitive activity and development to determine how students can be taught to better apply their cognitive resources through metacognitive control.

"Metacognition" is often simply defined as "thinking about thinking." In actuality, defining metacognition is not that simple. Although the term has been part of the vocabulary of educational psychologists for the last couple of decades, and the concept for as long as humans have been able to reflect on their cognitive experiences, there is much debate over exactly what metacognition is. One reason for this confusion is the fact that there are several terms currently used to describe the same basic phenomenon (e.g., self-regulation, executive control), or an aspect of that phenomenon (e.g., meta-memory), and these terms are often used interchangeably in the literature. While there are some distinctions between definitions (see Van Zile-Tamsen, 1994, 1996 for a full discussion), all emphasize the role of executive processes in the overseeing and regulation of cognitive processes.

The term "metacognition" is most often associated with John Flavell, (1979). According to Flavell (1979, 1987), metacognition consists of both metacognitive knowledge and metacognitive experiences or regulation. Metacognitive knowledge refers to acquired knowledge about cognitive processes, knowledge that can be used to control cognitive processes. Flavell further divides metacognitive knowledge into three categories: knowledge of person variables, task variables and strategy variables.

-------------------------------------------------
In reading the study, a few things struck me (I'm sure that Russell will come to my rescue in my mishandling of these!)

• Overall, the study design seemed to be a bit flawed. Specifically given how the study groups were designed for each of the studies, there appeared to me a heavy selection bias. For example, if you are designing a study and students are being offered extra credit , the study will have selection bias because among all of the population that could participate, only those motivated by extra credit would participate. While such a bias may not affect conclusions about lower quartiles, it would affect the composition of upper quartiles because the better students would have not opted in. In fact, any study that is opt in suffers from selection bias. I found the study design of "Humor" to be particularly flawed (and to be fair, the authors acknowledge some of the deficiencies in that study).

• I couldn't help but being left with the impression that there was a bit of chicken/egg going on--meaning that people who score poorly most likely have poor metacognition skills; accordingly, you'd still expect them to exhibit poor metacognition skills even after training. And, they did, but the gap between actual v. estimated performance lessened.
  

• Study three sets out to determine if incompetents would re-rate themselves relative to others (incompetents tend to overestimate their performance). Specifically: "We reasoned that if the incompetent cannot recognize competence in others, then they will be unable to make use of this social comparison opportunity.) (p 1126). Now, I'm not quite sure how you would parse out lack of skill v. metacognition. Specifically, if you have no skill yourself, particularly in logical problems, how in the heck would you even be able to grade another's paper and recognize that s/he performed better than you? Because of this, how can ANY OTHER conclusion other than the one drawn materialize?
  

• The study and conclusion that training would help the incompetent become more competent (that's fairly obvious). The authors note that it lead to a paradox that by making them more competent they recognized their own incompetence. A logical paradox I think. Now I found some irreconcilable differences. Specifically, the authors conclude that for the bottom quartile, incompetents did better on the tests, but they still lacked the ability to estimate the abilities of others. My quibble is in the study study design to reach this conclusion. The participants only had access to their own tests (before and after). They did not, in so far as I could tell, have the opportunity to look at the tests of others, but rather just made estimates. What I would have preferred to see (hey, and I'm fully incompetent in study design, but I'm just dealing with logic, I think) is that they were both (1) given training and (2) saw his/her test AND the tests of others. It would be interesting to see how replications of this study using a tweaked study design (both in terms of population and test methodology) how differently the ratings would compare.
  

• The most interesting point of this entire study to me was the idea that top quartile folks suffered from false consensus-- From Wikipedia: "The false consensus effect refers to the tendency for people to overestimate the degree to which others agree with them. People readily guess their own opinions, beliefs and predilections to be more prevalent in the general public than they really are."

Regardless of my quibbles, I was certainly left with the following admonition:

If we lack skill/knowledge in any undertaking, we need to be vigilant to ensure that we obtain the necessary knowledge and experience to increase our competence (so that we are not unconscious incompetents) and (b) assess our abilities as objectively as possible.

I leave this post with this hope:

That any of us read and discuss such matter provides us with some immunity from being relegated to the bottom quartile of any such study of competence relative to investing!

Russell--thank you so much for this contribution.

Warning on Market Orders at EOD

If you look at the chart of EEE above (and I encourage you to CTML), you can see that the price rose rather dramatically (by about 50 cents or 7.7%) from 3:39 p.m. through the EOD.

Now you know that I don't have any advice worth following, but I would urge you to be careful if trying to enter a position during this time. I would also urge you to be crafty--if you want to exit a position and there is some buying interest late in the day, you can use that to your advantage.

I remember one time I had a position in GMR. All of a sudden my position of 300 shares was worth $1,000 per share or $300K. I had that brief moment where I thought that I had died and gone to heaven. Some extraordinary news hat catapulted the stock into the stratosphere!! Investing genius!!!

Well, I'm pretty confident somebody wanted 1,000 shares and fumble-fingered their entry. Within a minute (but what a glorified minute that was) the price was back in the trading range.

Investor Behavior: Part II

This is the second installment of Investor Behavior. To remind you of the origin: The purpose of this post is to share with you what I considered some interesting information about individual investors. The paper is from Advances in Behavioral Finance, Vol II, Russell Sage Foundations/Princeton University Press, 2005.

The paper is Chapter 15 of the aforementioned book and is titled, "Individual Investors", its authors, Brad M. Barber and Terrance Odean. If this is a subject that interests you, though the paper is not listed at this following link, several other papers are listed that you might find interesting. In this paper, the authors examine "The Disposition Effect" (explained below) and investors' tendencies to trade to frequently due to overconfidence.

Regarding Investor Overconfidence, you must understand that this is a universal phenomena--it's endemic to our humanness (just like all of the children in Lake Wobegon are above average). Studies by several different folks have shown that "people tend to overestimate the precision of their knowledge" and that this has been found in many professional fields: physicians, nurses, investment bankers, engineers, entrepreneurs, lawyers, negotiators, and managers. How is this tested? Through . . . studies of the calibration of subjective probabilities. (p. 554). Here are some of the additional manifestations (in addition to the miscalibration) of that overconfidence as people tend to :

"(All taken from pp 554-555)

• overestimate their ability to do well on tasks, and these overestimates increase with the personal importance of the task (Frank 1935);
• have unrealistically positive self-evaluations;
  
• are unrealistically optimistic about future events;
• expect good things to happen to them more often than to their peers;
• see themselves better than the average person and see them selves better than others see them;
• rate their abilities and their prospects higher than those of their peers;
• overestimate their own contributions to past positive outcomes, recalling information related to their successes more easily than that related to failures;
• 'misremember thier own prediction so as to exaggerate in hindsight what they knew in foresight.' (Fischhof 1982);"

The authors state that "These beliefs can also lead to biased judgments." Now, if you FAIL to see how any of this applies to you then you have only confirmed everything that the these researchers have found through empirism. However, if you see how this applies to you and have a sting of shame upon your cheeks, then you are well on your way to creating better self awareness!

Naturally since this phenomena shows up in every aspect of our life, it is reasonable to expect that it will show up in its full glory in our investing behavior. The authors make a useful distinction regarding "information" that a trader/investor receives. And their emphasis is on "informed" traders. First, let's look at the authors' premise:

"In a market with transaction costs, we would expect informed traders who trade for the purpose of increasing returns to increase returns, on average, by at least enough to cover transaction costs. That is, over the appropriated horizon, the securities these traders buy will outperform the ones they sell by at least enough to pay the costs of trading." (P. 555)

It's worth noting that transaction cost these days are significantly less than those of when many of these studies were conducted. It will be interesting to see additional, more contemporary studies, that perhaps revisit some of these concepts and see if there if transactions cost reduce, magnify or have no effect on these outcomes. Now let's take a look at "information". Traders can be mistaken (overconfident) in

• the precision of the information that they have
• their ability to interpret information

The authors state that overconfidence in the information itself generally does not lead to losses beyond transaction costs. However, if they are overconfident in both the precision of the information and their ability to interpret that information, "they may incur average trading losses beyond transaction costs." (p. 555)

To tie this is with our disposition effect, the authors note "If they unwittingly misinterpret information, they may choose to buy or sell securities that they would not have otherwise bought or sold. They may even buy securities that, on average and before transaction costs, underperform the ones they sell." (p. 555).

I don't know about you, but reading the above gave me substantial pause. What would be helpful to any of us as investors is to know (1) how precise the information is that we know; (2) how uniformly understood is this information--naturally if it is widely understood, then it should already be priced in; and (3) how capable we are to even evaluate such information.

The authors then note that overconfidence leads to overtrading. "Odean (1998b) predicts that the more overconfident investors are, the more they will trade and the more they will thereby lower their expected utilities. . . . we would expect that, on average, those investors who trade most actively will reduce their returns through trading... . we find that this is the case." (p. 559).

Now here is the provocative, gender stuff! "While both men and women exhibit overconfidence, men are generally more overconfident than women". (p. 560). I'm sure that will not surprise any female readers and I say that with apologies to male and female readers alike. This is also an area where the studies are a bit older (1977, 1997), but it appears that it has at least been validated by more contemporary studies. Here are a few of the gender differences that you might find interesting:

"(quoted/paraphrased)from pp 560-561)

• differences in confidence are highly task dependent and are greatest for tasks perceived to be in the masculine domain
• per Deaux/Farris (1977) "overall, men claim moreability than do woemen, but htis dfference emerges most strongly on . . . masculine task(s)".
  
• men are inclined to feel more competent than women do in financial matters
• gender differences in self confidence depend on the lack of clear and unambiguous feedback. When feedback is 'unequivocal and immediately available, women do not make lower ability estimates than men. However, when such feedback is absent or ambiguous, women seem to have lower opinions of their abilities and often do underestimate relative to men." (Lenny 1977)

Based on the literature survey in addition to the authors' original research they posit: "We expect men, the more overconfident group, to trade more atviely than women and, in doing so, to detract from their net return performance more." (p. 561) In fact, they note (p. 561) that

• Men trader 45% more than women
• Men reduce their returns through trady by 0.94 percentage points more than women
• Men underperfom their "buy and hold" portfolios by 2.652 percentage points annually; women underperform by 1.716 percentage points.

{you can read more about gender differences in the following: BOYS WILL BE BOYS: GENDER, OVERCONFIDENCE, AND COMMON STOCK INVESTMENT*
BRAD M. BARBER AND TERRANCE ODEAN}

Buying V. Selling: The authors make an obvious but important distinction about the differences in behavior in buying v. selling stocks. The obvious point is this: When buying a stock, the universe is pretty large, but when selling a stock you can only sell what you own. The authors note that less than 1% of investors sell short--so their analysis is based only on stocks held long and available to sell.

So given this large universe from which to buy, how do investors do it? The authors note that "investors tend to be net purchasers of attention grabbing stocks, even when it is bad news that catches their attention."

Moreover, the authors note that with the advent of the Internet, and seemingly limitless information, this access to information actually increases investor overconfidence "by providing an illusion of knowledge and an illusion of control" (P. 562) (and let's not forget that systematic bias that some may have in processing that information!!!!). They go on to state supporting studies which distill down to this important point:

"additional information can lead to an illusion of knowledge."


Accordingly, investors think that they have more control and trade to often and more speculatively. (p. 563).

IN conclusion, the authors make this perspicacious observation:

"The investor behaviors discussed in this chapter have the potential to influence asset prices. The tendency to refrain from selling losing investments may, for example, slow the rate at which negative news is translated into price". The obverse is of course that "the tend3ency to buy stocks with recent extreme performance could cause recent winners to overshoot."

I'd like to introduce you to a website that has many of Brad M. Barber's published papers.

I hope that you found this discussion interesting. I would encourage you to study more about investor behavior. People who understand YOUR foibles better than you do can take advantage of that in the marketplace. And shaking our own biases is like trying to change our spots. But at least knowing that we have spots--I call that self-awareness--is a good place to start.

Thank you for taking time to stop by.

Martin Pring Article Index

Martin Pring is a well known technician. Have you ever visited his site?

If you are looking for some free, informative information from a master technician--and this also includes some fundamental information regarding market psychology, may I recommend your taking a tour through this index of information.

Coal Stocks Update

Here's our watch list from 04.06.07. Pretty good, huh? Do click to make larger.

Fan Benno-Caris

I hope that you will take a moment to read about this incredible woman. You can read her story here.

This woman, now 89, inspired me some years ago (probably 6 or so). I was reading an article in Shape Magazine about this woman who started race-walking in her 70's. In fact, she was so competitive, she acquired a heart rate monitor to juice up her speed. Which it did. I did one of those "notes to self". Essentially, if this woman at her age could be physically fit, then I (at 1/2 of her age) could do so as well. So I began serious training to find my inner athlete (having embraced my inner nerd for so many years). I studied about heart rate training, upgraded my Polar monitor to one that I could download my training information. I had XLS spreadsheets that would compile my data in each zone so that I had a weekly pie chart on my time in zones. I was so proud of myself. Unfortunately, a water skiing accident cut my 2 1/2 year training program short. I sprained my back rather badly, and it all went downhill from there. I found it very difficult to become re-inspired to reach that prior level of fitness.

This a.m., I'm reading about her again (the story you see referenced, from a different paper) at age 89. What an extraordinary woman. So, guess what? This woman is back in my life inspiring me. I've cut out the article, enclosed it in a plastic sleeve, and I'm putting it on my wall board at my desk.

Marc Faber is Interviewed

on Bloomberg today (05.22.07). I highly recommend your listening. I made a few notes which may be cryptic, but I'll share them with you:

• Bubble in all assets classes
• Credit bubble in US
  
• US stock market is rising largely due to a falling dollar (more later)
• Though in a bubble, prices could increase more
• If all bubbles burst, and he thinks that we are in the final stage, it will affect the world economy
• He thinks the US will be hit more because it's wealth is based on asset appreciation rather than real industrial production (more later)
• Asian currencies will appreciate with the rembi, and those currencies are undervalued in relative terms. He would not play that, though.
• Distressed assets in Middle East stock market, down 50-70%--some value there
• Distressed assets in Detroit real estate.
• Yen is undervaled--it will strengthen when US stock market decreases
• Euro v. USD--makes US assets relatively inexpensive (though not cheap)--I'm beginning to believe, though I did not believe it before, that this dynamic may continue to drive our markets higher.
• Interest rates are below the "natural" (think real interest rates). Thinks the rate is ~10%
• No real safe place as he feels all assets are correlated.
• All CB's are willing to print money
• Hard to know what the catalyst (to a market decline) might be. Cannot really know the "what" or "when" but rather that there generally is one.
• Thinks that there is illiquidity in the housing market now.
• He likes Vietname. Does not see many opportunities elsewhere.
• One asset class that is 'cheap' is farmland. He said, "Perhaps your Bloomberg readers and portfolio managers should learn to drive a tractor." [I thought that was quite funny]. Should consider owning farmland in
• Argentina
• Brazil
• S. Africa (though not as safe as Brazil)
• N. Zealand
• Australia (NZ and Aus due to proximity to China).

I'm sure that I left some stuff out. I hope that you will take time to listen.

Why I'm Late

Ugh. I had to take an educational detour into dog training. In an attempt to cure Macy of chasing motorcycles, Reade in I managed to do much ill that resulted in her biting him. He's fine, but the situation with her chasing cars, motorcycles, and barking and stuff has become untenable.

I'm on the right road, but one should never let their frustration show teaching dogs or children (or spouses!).

Investor Behavior: Part I

This purpose of this post is to share with you what I considered some interesting information about individual investors. The paper is from Advances in Behavioral Finance, Vol II, Russell Sage Foundations/Princeton University Press, 2005. This post will be in two parts.

The paper is Chapter 15 of the aforementioned book and is titled, "Individual Investors", its authors, Brad M. Barber and Terrance Odean. If this is a subject that interests you, though the paper is not listed at this following link, several other papers are listed that you might find interesting. In this paper, the authors examine "The Disposition Effect" (explained below) and investors' tendencies to trade to frequently due to overconfidence.

Before getting started with some of the concepts of the paper, there are two investor theories that you should understand. First, there is the Disposition Effect. Simply put, the Disposition Effect describes an investor's tendency to sell his/her winner while hanging onto his/her losers. It's the reason of for the aphorism: sell your losers and let your winners runs. Seems like reasonable enough counsel, but it is counter to the behavior that most investors exhibit. The stain of shame is on my cheek for this behavior as well.

Second, is Prospect Theory (PT): You can find a comprehensive explanation here. Essentially, PT serves as a counter to the rational behavioral models that economists build that assume people are rational. PT is observed behavior that is NOT rational, and describes that that "many people are far more willing to engage in risky behavior to avoid potential losses than they are willing to take risks to improve their positions."(cited from link). Do visit the link and read the information. It is not even a page, and it will flesh out this rater meager morsel of an introduction here.

The Disposition Effect:





The above represents the value function. It relates to an investor's perception of expected gains/losses. "Critical to this value function is the reference point from which gains and losses are measured." (p. 544). Here the reference point could be the purchase price, the current price, or some expectation of value. The authors quote Kahneman and Tversky 1979, p. 287): "there are situation in which gains and losses are coded relative to an expectation or aspiration level that differs from the status quot. . . A person who has not made peace with his losses is likely to accept gambes that would be unacceptable to him otherwise."

To sell a stock that has appreciated, the investor has to lower his/her expectation of the stock's ultimate value. Now the stock has declined. The authors state, "Then its price is in the convex, risk-seeking, part of the value function. [L's note: lower left quad] Here the investor will continue to hold the stock even it its expected return falls lower than would have been necessary for her to justify its original purchase. Thus the investor's belief about expected return must fall further to motivate the sale of a stock that has already declined rather than one that has appreciated." (p. 544). If an investor has a liquidity issue and has two stock's--one depreciated, one appreciated--without any new information regarding either stock, the investor "is more likely to sell the stock that is up." (p. 544).

So if you find yourself doing this recalibration of expectations for a stock, and you have a different standard for expectations of continuing gains for your winners vs. expectations of continuing losses for you losers, then you are in good company. Just remember, your expectations have been empirically proved wrong! The authors then go into the study design which I'll summarize briefly:

• Data was gathered from 78K households over a 5 year period (1991-1996). It's worth noting that ease of trading and trading expense has changed dramatically since that time period. It would be interesting to see if the author's original test results still stand in the same proportions as noted in the next bullet.

• Computed Percentage Gain Realized (PGR) on all appreciated stock v. Percentage of Loss Realized (PLR) on all depreciating stock. The authors found that "During this sample period, stocks that hand increased in value were approximately 65 percent more likely to be sold than stocks that had declined in value." (p. 548)The authors point out a number of potential reasons as to why investors were reluctant to sell their losers. They note that other studies fail to denote the distinctions as to why investors sells losers rather than winners. Here's a brief summary:
  

• Anticipations of Changes in Tax Law: The authors found no effect.
  
• Desire to Rebalance: No difference. When study modified to take this into consideration, they still found that investors prefer to sell winners.
• Belief that One's Losers Will Bounce Back: Compared to the sold winners, the investors were mistaken.
• Attempt to Limit Transaction Costs. Nope again.
• Belief that all Stocks Mean Revert. Given the importance of this, I'm going to quote directly from the paper: "The results. . . are not able to distinguish prospect theory and the mistaken belief that losers will bounce back to outperform current winners. Both prospect theory and a belief in mean-reversion predict that investors will hold their losers too long and sell their winners too soon. Both predict that investors will purchase more additional shares of losers than of winners. However, a belief in mean-reversion should apply to stocks that an investor does not already own as well as those she does, but prospect theory applies only to the stocks she owns. Thus, a belief in mean-reversion implies that investors will tend to buy stocks that had previously declined even if they do not already own these stocks, while prospect theory makes no prediction in this case." P 551-552).
• I've elected not to include
• Employee Stock Options
• Finnish Investors
• Real Estate

In Part II, I will share the authors' view of Investor Overconfidence. I'm not even closed to qualified to addressing questions, but I know that Russell is well-read on this stuff and I'm confident he will help in this regard.

Delayed Post

Family time took priority. So my promised post will be delayed.

Market Masters Link

I did find the link for the Market Masters.

I stumbled upon this website by looking up Richard Donchian whom Barry Ritholtz has excised some of his "rules". The website has several profiles, and I know that I found it interesting. I'd like to post Donchian's rules here.

Please do visit this website.

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Donchian’s Trading Guides

Richard Donchian documented his trading guides in 1934. He reviewed them in 1974, noting the ones he felt were the more important, some 40 years after they were first documented. The more important rules are reproduced in bold type.

General Rules:

1. Beware of acting immediately on widespread public opinion. Even if it is correct, it will usually delay the move.
2. From a period of dullness and inactivity, watch for and prepare to follow a move in the direction in which volume decreases.
3. Limit losses and ride profits, irrespective of all other rules.
4. Light commitments are advisable when a market position is not certain. Clearly defined moves are signalled frequently enough to make life interesting, and concentration on these moves to the virtual exclusion of others will prevent unprofitable whipsawing.
5. Seldom take a position in the direction of an immediately proceeding three-day move. Wait for a one-day reversal.
6. Judicious use of stop orders is a valuable aid to profitable trading. Stops may be used to protect profits, limit losses and take positions from certain formations such as triangular foci. Stop orders are apt to be more valuable and less treacherous if used in proper relation to the chart formation.
7. In a market where upswings are likely to equal or exceed downswings, a heavier position should be taken for the upswings for percentage reasons; a decline from 50 to 25 will net only 50% profit, whereas an advance from 25 to 50 will net 100%.
8. In taking a position, price orders are allowable. In closing a position, use “market” orders.
9. Buy strong-acting, strong-background commodities and sell weak ones subject to all other rules.
10. Moves in which rails lead or participate strongly are usually worth following more than moves in which rails lag.
11. A study of the capitalization of a company, the degree of activity of an issue and whether the issue is a lethargic truck horse like Consolidated Edison or a spirited, volatile race horse like Case Threshing Machine is fully as important as a study of statistical reports.

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Be Sure to Check back

Over the weekend I will do my promised post on the "Individual Investor", by Brad Barber and Terrance Odean, and taken from my Advances in Behavioral Finance, edited by Richard H. Thayler.

No original thoughts from me. This will be a bird dog post (under Lucy's watchful eye, now in eternal repose under the forest pansy red bud). But, I think that you guys will find it interesting. There will also be some gender differentiations that will cause some provocation, no doubt.

$1 mil consoloation round

Lots fewer folks, but, that notwithstanding, I'm not doing too badly!

Fire up the Grill!

I'm from the South; accordingly, barbecue is a noun and not a verb. So if someone were to ask me what I did over the weekend, I would never say, "We barbecued". Now, my northern compatriots would say this, and I would look at them in bewilderment. You barbecued what? A dog, a chicken, steaks?

No matter what your longitude/latitude, I'm going to provide a helpful hint on grilling (b'ing) a chicken. First, if your kitchen is devoid a good pair of kitchen shears, then go purchase a pair. It will make your life so much easier. Chicago Cutlery and Kitchen Aid make them. Personally, I prefer the ones that come apart so that you can wash them easily.

The little hens (not the Perdue oven-stuffer roasters) that you can buy at the store make a wonderful grill mate. To save yourself some time do this:

Cut the backbone out of the chicken with your shears. Then turn the chicken over and press on the breast bone to crack it. You could also cut the ribs out--it's easily done, and I think that it works best. It lays flat and you will be so happy with the results.

You can then marinade your chicken in your favorite. I personally love Yoshida's Gourmet Sauce (which you can cut half and half with pineapple juice or orange juice--heck even apricot nectar). Also, if you have an Asian market, seek out the Korean Barbecue sauce.

You needn't marinade very long--even an hour works. Fire up your grill and place the chicken absetn-backside down. Grill until done. If your grill is too hot, you'll burn the skin because the marinades that I mentioned have a fair amount of sugar in them.

If you like chicken and like to grill, I hope that you'll try this technique. You shouldn't have to cook your chicken more than an hour if that. Otherwise you will have a tough bird, which will delight none. And, if you do not have an digital instant thermometer, buy one of those too. It will cut down on over/underdone food.