Where Is The Froth?

This morning, I saw someone tweeting an interesting observation by legendary investor Peter Lynch:

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than in corrections themselves”.

It is a really good reference to many investors’ natural bias to constantly look for some form of mean-reversion in the midst of strong trends. Blind contrarians are a good thing for trends. Every trend needs doubters and skeptics – otherwise there won’t be anyone left to buy.

The last quarter of each positive year is often marked  by performance chasing by under-invested money managers. So far in Q4, most of the momentum leaders from the first 3 quarters have not only not outperformed, but have experienced sizable corrections. The best performers since October have been breakouts from several months long ranges. I don’t know about you, but I cannot call this a froth. The market has been very level-headed and it has constantly corrected through sector rotations and pullbacks to major moving averages. The fear of missing out has not been that much bigger than the fear of losing.

It is true that at this particular time, the indexes are a bit technically extended and overbought. It won’t be a surprise to see some form of consolidation through time (sideways) or space (price decline) in the near-term perspective. It might have already started on Friday afternoon – nothing to fret about. It is still a bull market of stocks, where dips are likely to be welcomed as buying opportunities.


Is Studying What Hedge Funds Bought Last Quarter Helpful?

There is a whole industry dedicated to studying hedge funds’ past purchases in an attempt to extract some alpha. Once a quarter, all institutional investors with over $100mm under management are required to report their long positions –  the so called Form 13F is filed within 45 days of the end of a calendar quarter. Basically, 13F is a look at what hedge funds bought and sold 45 days or more ago.

This morning, I was going through Josh Brown’s links and clicked on a piece from FactSet, covering hedge funds’ moves from Q3. I saw that the two largest individual stock additions in that quarter were Facebook ($FB) and Baidu ($BIDU) and tweeted the following:


Nov. 22 at 9:28 AM

Reading about what hedge funds bought last quarter has mainly educational value. Price actions tells you what they do in real time.

We certainly did not need to wait a few months to figure out that $FB and $BIDU were under heavy accumulation during the summer.  Price action on those names told use everything we had to know, in real time.

Don’t get me wrong – there are many strategies that try to piggy-back some of the famous money managers positions. Some are doing an exceptional job by copying and following. From my perspective, 13Fs have more educational than actionable value. 13Fs could help you figure out how investors think and when they buy and sell. In the case of $FB and $BIDU in Q3, there are three main observations that could be made:

1) Buying highly shorted stocks after they crush earnings estimates and gap to new all-time highs.

2) Pay attention to industry relative strength – anything related to social media and internet was melting hot during the summer.

3) When institutions buy, they leave traces. They don’t do all their buying in one day, therefore there’s plenty of time for anyone who is watchful enough to jump back with them in real time.

A minute after my tweet, my friend Frank Zorrilla (@zortrades) reminded me that there’s an ETF ($GURU) that buys what select hedge funds bought last quarter and it has been delivering some solid alpha since inception. Look at the chart below

Screen Shot 2013-11-22 at 7.57.13 AM

How is that outperformance possible when the media has constantly bombarded us with proves that cumulatively, hedge funds have not really generated any alpha after fees over the past decade? How is it possible for an ETF that buys weeks and months after the tracked hedge funds bought, to outperform the S&P 500. I have no idea what the actual performance of the tracked hedge funds is, but here’s why this ETF might have done so well lately.

1) it tracks mainly hedge funds, which average holding period is more than a year

2) it charges relatively smaller fee of 75bps. Hedge funds charge 2% and 20%. This is a huge difference. If a hedge fund makes 40% pre-fees, after 2/20 its return will be a little less than 30%.

Take into account that this ETF is relatively young and has only operated in a scorching hot bull market. Typically, the success rate of all market strategies is cyclical.

98 Stocks Went Up Over 1000% In The Past 5 Years

In the Fall of 2008, equity markets were falling apart. Well, the world did not end and 5 years later there are  98 stocks that gained more than 1000%.

Here are the top 10 performers of the past 5 years: biotech and old-media stocks have the most members in top 10. The former, because the market has not idea how to really price them. The latter, because in 2008, they were priced for bankruptcy and it did not happen.

$PCYC +8700%
$JAZZ +7450%
$KERX +6085%
$STRZA +5938%
$NXST +5116%
$RPTP +4864%
$GTN +4684%
$HGSH +4678%
$GENT +4570%
$ATSG +4431%

Study carefully the list of 98. You will notice that they did not become ten-baggers overnight. People like to say that past performance does not guarantee future returns. It is true. It does not guarantee them, but it could help you improve the odds of finding the next big winners. Look at $PCYC for example. It has more than doubled for 3 years in a row.

Here’s the thing about momentum. Stocks that outperformed in the past 3 to 18 months, tend to outperform in the next 3 to 18 months. Longer-term momentum (3-10 years) often leads to mean-reversion.