From Mr. Technology Investor:
"We respond to a squirrelly market by sitting pat — tough it out. Maybe sell a little and raise more cash. We’re tentative. But to turn our head from actively bullish to actively bearish seems traitorous, out of synch with all what we’ve been taught about investing. Yet, the world has turned. The first inkling was in commodities, minerals, and oil. They plummeted."The market has no longer got what momentum investors crave.
A correspondent writes in,
My good friend CP and I spend a great deal of time discussing the problem that we share as two cynical contrarians, namely how to restrain our bearish enthusiasms in the face of investor euphoria and avoid the performance killer of being early. Valuation metrics don't help the timing problem. Witness the plight of that analytical genius John Hussman who keeps losing his clients money in his growth fund as overvaluation continues and increases for years on end. Similarly, the standard sentiment measures like Investors Intelligence, Market Vane and AAII measures of optimism hit extremes many times during a prolonged market rise. They may increase the odds for a short side swing trade for 5 days or perhaps 3 weeks, but the false positives for a full fledged bear market are too numerous. Who can forget the glaring signs of impending doom back in mid 2007 and the painful wait for a year and a half until September of 2008?By the way, last week Prechter put out a one page bulletin saying simply: "THIS IS IT".
What we need is a sentiment indicator that has merit for longer term bear trades – one that keeps us long during periods of delusional optimism and urges us to exit just before the inevitable peak and endure only a several month wait until the bear attacks. We want an indicator that will allow us to gloat and quickly double our fortunes by being short at the right times and then go long and snooze for 4 or 5 years as the selling climax reverses and we go long the new momentum favorites.
CP likes those distressed debt trades where the bonds are selling at 60 cents on the dollar indicating bankruptcy is inevitable while the stock investors think the common stock still has value. These are good trades, and yet I and most other bearish investors have weaker egos that need the satisfaction of seeing the mighty fallen and the massive hordes of hipsters and momentum stock fanboys humbled. And more important, you make the most money staying with momentum stocks long, and shorting at the right time. And for that we need a sentiment indicator that is relevant to the dominant psychological driver of market euphoria. I have a theory that bull markets are created and maintained not by valuation but by momentum and herding.
As a young man and a new associate at the largest law firm in the state in 1974, I began playing tennis (not too aggressively) with some of the partners and discovered that they all had purchased aluminum racquets with the ugly, oversized head and striking surface from a company called Prince Racquet. Being a stock market investor at the time I looked up the company and found that it had an astronomic PE multiple (by 1970s standards) and I knew that the stock would plunge back to earth once sales slowed. Thereafter I noticed that stocks that produced whatever new gadget, fad or thing that filled the yuppie's hands tended to fly to the moon. I called it the Prince Racquet effect, a syndrome which tends to produce momentum surges beyond all reason. It drove Microsoft in 1995 (windows 95) and it now drives Starbucks, Apple, Google, Amazon, Netflix, Facebook, Twitter, Priceline, Chipotle Mexican Grill, and every other provider of things and services that fill hipster and yuppie hands or engages their eyes and fingers, or occasionally exploits their hopes for eco-nirvana as in the case of Tesla motors.
The Prince Racquet effect has always informed my short sale preferences. Thus I am now entirely reliant on my young adult daughters to tell me what is new and hip. And I must say that the Prince Racquet effect has gained considerably more power now than it had pre-1990. Items which fill the hipster-yuppy hand are now not merely fads, but are essential emblems of identity and recognition for the increasingly atomized, anonymous and disconnected individuals of today, herded by what they hold in their hands and use in their lives.
So then here is the candidate for the one reliable sentiment indicator - one which does not involve opinion surveys but relies on actual money flows into the Prince Racquet effect stocks.
I think that when you see momentum loss on the weekly charts of the most talked about moment stocks – the fad stocks and cocktail stocks that are most susceptible to investor herding - you have reason to go to cash and wait for THE TOP. And when I say momentum loss I mean a lower high on the weekly MACD even as price may still be rising. Click on the links for the following momentum favorites that are losing their mojo:
AAPL
GOOG
AMZN
NFLX
SBUX
PCLN
FB
TSLA
and one daily chart of a new entry, TWTR, consistent with the above but lacking the weekly time discipline.
It is one thing for a single company to fall from grace due to a company specific problem, but when you get a cluster of decade long momentum favorites getting tired at the same time the odds on bet is to sell all your long positions and begin nibbling at the short side to make sure you stay awake while stalking the big cahuna to the downside. My suspicion is that the value of or productivity of advertising is beginning to fall and all of the search and social media stocks will fall as ad revenue declines in response to decining productivity of those ads to retail sellers. Also, I think that a company like PCLN will get clobbered from both sides as fewer travel bookings are made by consumers and businesses tightening their belts and by fewer airlines and venues offering discounts as they struggle to maximize full price revenue from those who can still afford to travel. And for all its profitless sex appeal, AMZN is, after all, still just a retailer. For those of you who like busted “redneck” momentum stocks, I would invite you to plug the symbol RGR and SWHC. And for those of you betting on the momentum favorites among the “rising poverty stocks” plug in DLTR and ROST
Skeptics to the ramparts!!
A rare, profound essay on Zero Hedge:
"The role of financial markets is to evaluate in real time the marginal return on capital of different assets. This is done through a ‘price discovery mechanism’, with the ‘right price’ found out through a system of constant trial and error. To discover this price calls for a community of active money managers, each doing his or her due diligence before buying and selling. This price is a function of the return on capital and of the expected growth rate of this return. It has nothing at all to do with the size of the investment under consideration. What’s more, if the price of an asset has been going down for the ‘wrong’ reasons, then active money managers should buy more of it. Over time this process will help to stabilize the system.
Active money management is essentially a ‘mean reversion’ strategy. That’s not so for indexation. In the indexation process, there is no attempt at price discovery. The only thing that matters is the relative size of the asset: the bigger the market capitalization, the more an investor should own. This means if the price of a large asset goes up more than the market as a whole, indexers have to buy even more of it.
Thus indexation is a momentum-based strategy."
For example, if the CEO of Yelp, Jeremy Stoppelman, went on Shark Tank and asked Mr. Wonderful for a bridge loan, Mr. Wonderful would ask “how much money do you make?” Jeremy would reply “zero.” After hearing those words, Mr. Wonderful would say “you have a good website, but a bad business. It’s worth zero. I am out.”
There is a guy whose investment commentary I follow, call him Mr. Upper East Side. A baby boomer entrepreneur who sold his company for ~ eight figures some time ago and has managed the proceeds himself. When rates were higher, he owned munis and bonds. A good, conservative approach to the nest egg that works as a long term, worry minimizing solution.
Now, the munis bonds steadily mature, but the reinvestment opportunities aren't as good. Dividend yields are low. He is suffering from Baby Boomer Yield Anxiety.
So he trades stocks and invests in real estate partnerships ("syndications") here and there. He doesn't do any original investment research besides the old Peter Lynch method of buying retailers and consumer product marketing companies whose products you like. (A friend calls this the "Prince Racquet" approach because Prince stock was hot in the 70s with yuppies who used the racquets.)
Anyway, because he doesn't have a big information edge that you need for value investing, he prefers to buy what's going up: momentum investing. People who do this watch the lists of stocks trading at new highs. If they are satisfied with their newly released Apple product and AAPL is a new high, then it's a 'go' to purchase.
The problem with low-information momentum investing is that since you don't have a theory of the value of your holdings, you have to put a lot of thought into stop loss rules that get you out of the position when the momentum fades. Mr. UES has a stop loss rule to dump anything that goes down 10 percent from his purchase price or subsequent high price.
I've noticed that when he blows out of a stock that "isn't working" anymore, he'll push most of the proceeds into ideas that are "still working" - going up.
This is what creates narrowing breadth at the end of a rally! Momentum investors are preferentially buying stocks with positive derivatives of price, creating a positive feedback loop concentrated in fewer and fewer stocks. That's how TSLA can go parabolic two years after the price of gold, silver, and commodities have peaked.
Narrowing breadth is a mania concentrated in fewer and fewer speculative vehicles. It's created by momentum investors with stop loss rules who consolidate into their winning positions.
Which stocks peak last? That would be worth a lot to know, because you could predict that a wave of speculative money would come rushing into them when market breadth is narrowing. It could be that these are the companies that resonate the most, psychologically with the current zeitgeist. Or it could be arbitrary, chaotic; a path-dependent result of an accidental blip up in price that attracts buyers and creates a positive feedback loop.
As you know, I think that momentum investing is totally idiotic. Reading a paper called "Managing the Risk of Momentum," which acknowledges the fatal flaw of the method but purports to be able to avoid the big drawdowns.
"[T]he remarkable performance of momentum comes with occasional large crashes. In 1932, the winners-minus-losers strategy delivered a -91.59 percent return in just two months. In 2009 momentum experienced another signi…ficant crash of -73.42 percent over three months. Even the large returns of momentum do not compensate an investor with reasonable risk version for these sudden crashes that take decades to recover from."These guys use "the realized variance in the previous 6 months to scale the exposure to momentum." In other words, they think that they can predict crashes. However, the "auto-regression of monthly realized variances yields an out-of-sample (OOS) R-square of 57.82 percent."
From the comments:
The value "cult" proposes buying $1 of value for less than $1. If you are in fact buying $1 of value, you have made a successful investment in the moment of buying.
The momentum "school" proposes buying $1 of value for more than $1, and then selling that $1 of value for >$1+n to someone else. Your expected profit isn't "locked in" in the buying like it is for the value investor but rather is hoped for in the selling, a proposition which is decidedly more uncertain because you've given yourself no room for error from the get-go by purposefully paying more for something than it's actually worth.
There are so many trend following and momentum strategies out there that when the fire alarm is rung they cannot all fit out the door at the same time. That is why we have seen a 30% crash in silver and and a severe declines in other commodities.I don't think a momentum "investing" strategy works over an entire market cycle.
Monster Worldwide (MWW) was another high flying momentum stock that had doubled since August.
Monster shares tumble 25% on weak outlook.
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