Woke up in the morning and wanted to go gym workout that disappointment of not getting CRCT, I notice that there negative divergences in the DOW and SP500. It might be wise to be cautious if you are trading for a short term.
1. Never, Ever, Ever, Under Any Circumstance, Add to a Losing Position… not ever, not never! Adding to losing positions is trading’s carcinogen; it is trading’s driving while intoxicated. It will lead to ruin. Count on it!
2. Trade Like a Wizened Mercenary Soldier: We must fight on the winning side, not on the side we may believe to be correct economically.
3. Mental Capital Trumps Real Capital: Capital comes in two types, mental and real, and the former is far more valuable than the latter. Holding losing positions costs measurable real capital, but it costs immeasurable mental capital.
4. This Is Not a Business of Buying Low and Selling High; it is, however, a business of buying high and selling higher. Strength tends to beget strength, and weakness, weakness.
5. In Bull Markets One Can Only Be Long or Neutral, and in bear markets, one can only be short or neutral. This may seem self-evident; few understand it however, and fewer still embrace it.
6. “Markets Can Remain Illogical Far Longer Than You or I Can Remain Solvent.” These are Keynes’ words, and illogic does often reign, despite what the academics would have us believe.
7. Buy Markets That Show the Greatest Strength; Sell Markets That Show the Greatest Weakness: Metaphorically, when bearish we need to throw rocks into the wettest paper sacks, for they break most easily. When bullish we need to sail the strongest winds, for they carry the farthest.
8. Think Like a Fundamentalist; Trade Like a Simple Technician: The fundamentals may drive a market and we need to understand them, but if the chart is not bullish, why be bullish? Be bullish when the technicals and fundamentals, as you understand them, run in tandem.
9. Trading Runs in Cycles, Some Good, Most Bad: Trade large and aggressively when trading well; trade small and ever smaller when trading poorly. In “good times,” even errors turn to profits; in “bad times,” the most well-researched trade will go awry. This is the nature of trading; accept it and move on.
10. Keep Your Technical Systems Simple: Complicated systems breed confusion; simplicity breeds elegance. The great traders we’ve known have the simplest methods of trading. There is a correlation here!
11. In Trading/Investing, An Understanding of Mass Psychology Is Often More Important Than an Understanding of Economics: Simply put, “When they are cryin’, you should be buyin’! And when they are yellin’, you should be sellin’!”
12. Bear Market Corrections Are More Violent and Far Swifter Than Bull Market Corrections: Why they are is still a mystery to us, but they are; we accept it as fact and we move on.
13. There Is Never Just One Cockroach: The lesson of bad news on most stocks is that more shall follow… usually hard upon and always with detrimental effect upon price, until such time as panic prevails and the weakest hands finally exit their positions.
14. Be Patient with Winning Trades; Be Enormously Impatient with Losing Trades: The older we get, the more small losses we take each year… and our profits grow accordingly.
15. Do More of That Which Is Working and Less of That Which Is Not: This works in life as well as trading. Do the things that have been proven of merit. Add to winning trades; cut back or eliminate losing ones. If there is a “secret” to trading (and of life), this is it.
16. All Rules Are Meant To Be Broken…. but only very, very infrequently. Genius comes in knowing how truly infrequently one can do so and still prosper.
By John Kimelman
As a go-anywhere fund manager, Ron Muhlenkamp has the ability to take on as much cash as he likes.
So it says something that the manager of the $2.9 billon Muhlenkamp Fund (MUHLX) now has 100% of his portfolio in stocks.
“If I saw a depression coming, I would have zero stocks and probably 100% in Treasuries,” he says.
Instead, Muhlenkamp sees the Federal Reserve succeeding in engineering a so-called soft landing, an economy that chugs along at 2% or 3% a year and propels stocks forward.
As passionate a student of macroeconomics as he is of fundamental securities analysis, Muhlenkamp is one of those rare portfolio managers who takes a top-down, macro view of the markets before making stock picks.
Over the past decade, his flagship fund has generated a 13.6% annualized return, beating the Standard & Poor’s 500 index by almost five percentage points. His five- and three-year returns have also outpaced the market.
In recent months, some big bets on economic cyclicals such as home builders and energy got him in trouble. But he’s not backing away from his generally positive view of the economy.
Barron’s Online: Unlike most money managers, you actually have a well-researched view of the economy and it greatly informs your investment choices. Tell me what the economy will be up to?
Muhlenkamp: We’ve been saying for a year that we thought that most likely it was a soft landing as opposed to a recession.
We’ve been saying that the odds of a soft landing were greater than 50%, but we think those odds are now increasing. If I’m wrong and we have a recession, then I don’t own the right stuff. If I’m right and this comes out as a soft landing, we will come out looking pretty good.
Q: In an essay on your Website, you point out that the Fed has been notoriously bad over history in engineering soft landings. At a time likes this, we tend to go into recession. So what is it about the economic circumstances now that makes you so convinced that this is going to be one of those unusual times where the Fed gets it right?
A: Since World War II, we’ve had 10 recessions and one soft landing. Now the trouble with soft landings is you are then vulnerable to something from the outside, [such as a war or oil prices going up]. But the Fed has gotten better at letting people know what it is doing. [Former Fed Chairman Alan] Greenspan pretty much followed interest rates rather then led them, and [current Fed Chairman] Ben Bernanke is kind of doing the same thing. But the fact that they let people know what they were doing is different than the past.
Also, this time around, banks’ balance sheets have been in great shape, corporate balance sheets have been in great shape. The concern is how good are the consumer balance sheets? We made a lot of money the last six years, betting that the consumer was in better shape than people feared and figured. We still think that’s true. So our belief was that with not a lot of financial vulnerability in banks or in corporations and the Fed being open about what it is doing, the odds here were for a soft landing.
Q: What about the consumer side of things, are you not as concerned as a lot of other people that this decline in housing values is going to hurt the consumer.
A: Everybody looks at debt-to-income to judge the consumer, which can get scary. We think if you are going to look at debt, which is a balance sheet item, you should look at assets-to-debt, both of which are balance sheet items. And in fact consumer assets are 5½ times debt. A half century ago, it was 4½ times.
We worried about debt in the ’80s; as long as the economy is growing we can grow our way out of this stuff. In the meantime, we’re three times as prosperous per capita as our grandparents were in 1950. On a percentage basis, what we spend on food and clothing has been cut in half. It has literally gone from 38% of the budget to 18% of the budget. Housing has been flat since the 1960s, except that our new houses are three times what they were then in size.
But the long and short of it is the consumer balance sheet is in pretty good shape. If people have jobs, and keep jobs, which they are, then they generate a lot of discretionary income.
Q: So what kind of economic growth will we have in the next year or so?
A: Our best bet going forward is 2½% to 3%.
Q: Give me an example of a stock that you are buying outright for the first time or adding to?
A: I would be buying Cemex (CX), the Mexican-based cement maker, except I already own a bunch of it. If you came in today, I would buy you Cemex. The company has a free cash flow that is 10% of market cap, so I can either get 5% on the bond or 10% from Cemex. Now if they were taking that free cash flow and pouring it down a rathole, then it doesn’t do me any good. But in fact what they are doing, which is the same thing they’ve been doing for a decade, is borrowing money and buying more cement companies. Running them and generating cash, and paying down the debt, and doing it again.
It is just a good well-run cement company. For a couple of years it did nothing for us, and then last year it doubled, which is why it has become the biggest [holding].
Q: What’s another stock you like right now?
A: Allstate (ALL). The company has had problems, but new management has come along and fixed it. They are at about eight times 2006 earnings, generating a lot of cash, and buying their own stock. But that is a company-specific play; I’m not buying insurance companies across the board.
Q: What is the future of property and casualty insurers like Allstate that sell primarily through traditional brokers, given the success of companies such as Geico, which sells direct to consumers?
A: I have no opinion.
Q: You don’t have an opinion, even though you see enough merits to the company to recommend it?
A: If Allstate were 12 or 15 times earnings, those things become relevant. At eight times earnings, I don’t care. It’s a better company than it was; they fixed their problems and they are still selling cheap.
Q: What about a cheap company that’s worth buying?
A: Masco Corp. (MAS). They are the largest supplier to Home Depot and Lowe’s. Now we bought them several years ago because they were selling at half the P/E of Home Depot and Lowe’s. Since then Home Depot and Lowe’s P/E has come down.
Masco has said publicly that they will return a billion shares a year to the shareholders either through dividends or corporate buybacks. The market value of the company is less than $10 billion, so they’re returning 10% to us, that’s not bad.
Now, can I find things that are better, maybe, but that is certainly better than a bond returning 5%. Masco is saying, “If we don’t grow we’ll send the money back to you, or if we do grow, we’ll plow money back into the business.”
By Vitaliy Katsenelson, CFA
“Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.” — Jeremy Grantham
Many investors (including the author) were caught off guard by the economy’s surprising earnings growth over the last several years. Earnings of S&P 500 companies have grown more than 20% during the last two years, and they are expected to climb another 8% in 2006. This astonishing growth has exceeded the Gross Domestic Product (GDP), which topped out at 4.6% in 2004 and has grown at a slower rate since. Contrary to common perceptions, corporate earnings growth historically stays in line with GDP growth.
The source of this earnings growth was profit margin expansion (here we define profit margins as corporate profits / GDP), from 7.0% at the end of the third quarter 2001 to a whopping 10.3% in the latest quarter. As profit margins rise, corporations get to keep more of their sales, leading to improved profitability. To put things in perspective, the average profit margin for corporate America over last 25 years was approximately 8.3%, 200 basis points less than today.
The question comes to mind: Are the billions of dollars dedicated to productivity enhancements over last decade finally paying off? Did the new era of technology-induced corporate efficiency descend upon us? Are we in a “new”-economy, higher-profit margin paradigm? (OK, three questions). The answer is no, no, and definitely no.
Fallacy of composition
Corporate America’s enormous investment in technology did not go to waste. It made companies more efficient, helping them to produce more with less — the definition of productivity. That’s the good news. The bad news is that technology improvements were available to everyone. Oracle(Nasdaq: ORCL) will sell its software to any company that can spell “Oracle” on a multi-million dollar check. This is where the economic concept fallacy of composition (what is true for part may not be true for the whole) kicks into high gear. Though technological investment may help the first adapter to cut costs and get a leg up on the competition, competitors won’t watch their economic pie being eaten by a more efficient company. Those who do sit still will be driven out of business. The others will adapt by writing a big fat check to Oracle, SAP(NYSE: SAP), or Microsoft(Nasdaq: MSFT), eventually catching up and competing the higher margins away. Thus, what was true for one company is not true for the industry.
As much as we would love to believe that productivity improvements brought to us by technological innovations will transform into corporate profitability, historically that has not been the case. Wal-Mart(NYSE: WMT) has changed the retail landscape by installing the most (at the time) revolutionary inventory management and distribution systems, passing the cost savings to the consumer, and driving less efficient competitors out of business.
However, Wal-Mart-like technology is available off the shelf to any retailer aspiring to coexist in today’s competitive landscape. Even companies like Dollar General(NYSE: DG), with stores the size of several Wal-Mart bathrooms put together, wrote sizable checks to Manhattan Associates(Nasdaq: MANH) and installed perpetual inventory and automatic reordering systems. This investment will keep Dollar General in the game by helping it survive in the new competitive environment, but is unlikely to send its margins much higher from today’s level. [Read more…]