Big Trends – How to Find Them, Ride Them and Get Off

At Stocktoberfest, I had the honor to present alongside Howard Lindzon and share how I think about the stock market. There are two major cornerstones to our approach – simple is good and “a glass half full” attitude.

The most important thing to remember is that stock market is an opportunity machine. Times change, gas prices change, fashion changes, presidents change, but there are always companies that find a way to monetize on an undergoing social and business trend and make their investors rich.

One company’s rising costs are another company’s rising revenues and the market usually does a pretty good job of identifying the winners and the losers.

Albert Einstein liked to say that “Any fool can make things bigger, more complex, and more violent. It takes a touch of genius-and a lot of courage-to move in the opposite direction”. No truer words have ever been said when it comes to investing. You could make your investing life as complicated as you want it to be, but the degree of complexity is not positively correlated with market returns.

Most people put the odds against themselves as they fish for stocks in the wrong pond. Guess what? 1 out of 3 publicly traded stocks lose 75% of tgeir IPO price. All of them come from the 52-week low list.

All major stock market winners come from the 52-week high list and better yet – the all-time high list; hence we focus our equity selection efforts there.

Market is a discounting mechanism that looks 6 to 12 months ahead into the future. This is why prices will often change before fundamentals change. By no means, I try to convey the message that the market is always flawless. It is not and there are short periods of time when it acts like a bipolar schizophrenic, but for the most part it is a leading indicator and I want to put the odds in my favor by paying attention to price action.

Prices don’t change when fundamentals change. Prices change when expectations and perceptions change and they could change for various reasons. From a trend follower’s perspective, the main indicator that signals change in expectations is price.

Anybody could buy a stock as the ETrade baby commercials has long tried to convince us. Most people’s investing problems come from not being able to sit on their hands when they are right. Very few hold their winners long enough to make a difference in their returns.

Price is not the only reason we buy, but price is the only reason to sell. It is good to have conviction in your picks, but discipline should always prevail. Sooner or later, all trends end and when they do, it is not pretty. I have accepted that I won’t be right every time and I have learned to live with it. Being wrong is not a choice. Staying wrong is.

Two Key Takeaways from the Flash Crash In 1987

I was 5 and half in October 1987, so apparently the only thing I know about the event is from reading other traders and investors’ stories. Nevertheless, all I need to see is the chart from the period.

1) The tape gave plenty of warning signs to decrease substantially your equity exposure. $SPX made lower low below its 50dma a week before the event. Market volatility measured in daily ATR (average true range) had increased substantially in the weeks before the event. Any time this happens, it is a sign of change of trend and $SPX was in an uptrend for the most part of 1987. Pay attention to price action. It tells you everything you need to know.

2) Any quick pullbacks of 20% or more in the general stock market are usually a good buying opportunity for long-term investors. The market took its sweet time to recover from that flash crash and I am sure that buying the right stocks made a big difference in returns.

Here’s Why Insurance Stocks Have Been Rising Like Crazy Lately

The FED induced zero interest rate environment is affecting our lives in more ways than you can probably imagine. One of the most affected industries is insurance:

The fundamental business of insurance is to collect premiums, invest them for a period of time, and then pay out a portion of the money in claims, while earning a small profit margin along the way. Yet when interest rates are so low, insurance companies are forced to collect more in premiums to fund future benefits (since they can’t bridge the gap with investment growth), and in some cases the prospective return on premiums is so low there isn’t even room left for the company to retain a margin for both risk and profits; the end result is that insurers are changing or eliminating many lines of insurance.

As noted previously in this blog, the low interest rate environment has already helped to drive a number of long-term care insurance companies out of the marketplace entirely, and all of the remaining companies now charge dramatically more to offer what coverage they do. Estimates from the AALTCI suggest that every 1% decline in interest rates has driven up the cost of long-term care insurance premiums by 10%-15% over the past decade. Various policy options have been curtailed as well; it is likely that by the end of the year, lifetime benefits and limited-pay policies will no longer be available at all.

Higher premium will boost insurance companies’ short-term earnings substantially. The market realized that 6-9 months ago, when many of the insurance stocks started to break out to new 52 week highs from good technical bases. Rising expectations for U.S. housing market recovery have also been a factor in this re-pricing process.

You could sit and complain about the increase of your insurance rate or you could pay attention to the 52-week high list to figure out where else the market thinks there will be changes in the economy. There is one basic law in business – one company’s rising costs are another company’s rising revenue and more often than not, the market does a very good job of identifying which the winners and the losers are, long before they become mainstream news.

This is not to say that the market is flawless forecasting indicator. It is not and there are times when it is very wrong and driven by animal instincts, but it is one of the best discounting mechanisms we have.

All the Talk About Potential Inflation And Yet Gold Has Done Worse than the S&P 500 Since the Lows of March 2009

QE1, QE2, QE3 and all other garden variety monetizing efforts have certainly left their mark on the U.S. dollar, which has lost 20% of its value since March 2009 lows. But why is gold underperforming equities then? It turns out that Buffett is right again:

My own choice: Investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.

Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.