I Worry About "The Shot Heard Around The World"

[rkbabang]

OK now I'm getting scared.  This is a quote from a Facebook post from an acquaintance of mine who has never posted anything about investing or finance before (usually posts about 80s rap music and being an unemployed DJ) and is now apparently trying to run an investment advice newsletter on the internet. He's got a 5 week record to brag about. Hell my portfolio is up by 30% in the last 5 weeks and I am not even in short term options.

 

I pick a pair of options (a main play and a more aggressive play) every Tuesday. People pay $200/month to read my picks. Here are my results over the past five weeks:

 

Main Plays

 

1. BA $85 June 2013 calls entered at $3.80 on 4/9; sold at $4.55 on 4/10 for 19.7% gain.

2. MET $38 June 2013 calls entered at $1.10 on 4/16; sold at $1.35 on 4/23 for 22.2% gain.

3. C $50 January 2014 calls entered at $2.75 on 4/23; sold at $3.30 on 5/8 for 20% gain.

4. HPQ $20 June 2013 calls entered at $1.35 on 4/30; sold at $1.60 on 5/3 for 18.5% gain.

5. HD $75 January 2014 calls entered at $4.70 on 5/7; sold at $5.65 on 5/14 for 20.2% gain.

 

Alternative Plays

 

1. BA $90 May 2013 calls entered at $0.90 on 4/9; sold at $1.20 on 4/10 for 33.3% gain.

2. MET $38 May 2013 calls entered at $0.63 on 4/16; sold at $0.85 on 4/23 for 34.9% gain.

3. C $45 May (24) 2013 calls entered at $2.10 on 4/23; sold at $2.70 on 4/24 for 28.5% gain.

4. HPQ $22 June 2013 calls entered at $0.55 on 4/30; sold at $0.70 on 5/9 for 27.2% gain.

5. HD $75 May 2013 calls entered at $0.75 on 5/7; sold at $1.00 on 5/9 for 33.3% gain.

 

[value-is-what-you-get]

Tepper Makes 'Overwhelming' Case For Markets....

 

http://finance.yahoo.com/video/tepper-makes-overwhelming-case-markets-124100765.html

 

That was painful.  One of the things I admire about Buffett and Munger is their ability to simply and clearly make a point.  This guy is the opposite of that.  Then Kernen pipes up and it becomes laughable.  Like an SNL skit or something!

 

[Uccmal]

Really, I have no idea but that is as likely as any scenario.  My guess is if you are sitting on 50% cash right now, you will still be sitting on 50% cash during, before, and after a meltdown.

 

I think it would depend on the investor.  I remember being over 40% cash before the downturn in 2008, yet I was one of the few people on here who was fully invested by October 2008, and then again by March 2009 after the brief rally in late 2008.  I've been invested in the markets for the last three years, but I think investor's are paying far too much for their stocks today. 

 

There are bulls and bears in every market, but my opinion is that one has to focus on the margin of safety in an investment, rather than be categorized as a bull or bear.  This market is making less and less rational sense to me as prices continue to rise.  We're still about 65% invested, but that number will continue to fall and fall if risk premiums continue to shrink.  And that opinion has nothing to do with Warren Buffett or Prem Watsa, because I don't really care what either do...you have to decide for yourself if your own analysis is correct, and if you can't find many undervalued stocks, that should tell you something.  Cheers! 

 

I know Sanj.  The post was directed at those who are clearly basing their decisions on Macro behaviour, not you.  I am neither a bull nor a bear.  We can pull posts of people who were unable to pull the trigger at generational lows.  The same people will be trying to guess the markets when it is at 1300 and AXP is 1/3 the value of today.  I have repeatedly said that I am slowly selling down positions into this rally.  I am also not buying anything now.  But when there is a significant pullback I will be in there like a bad habit.  I can guarantee that those trying to guess if markets are overvalued or not will be still guessing. 

[rkbabang]

I know Sanj.  The post was directed at those who are clearly basing their decisions on Macro behaviour, not you.  I am neither a bull nor a bear.  We can pull posts of people who were unable to pull the trigger at generational lows.  The same people will be trying to guess the markets when it is at 1300 and AXP is 1/3 the value of today.  I have repeatedly said that I am slowly selling down positions into this rally.  I am also not buying anything now.  But when there is a significant pullback I will be in there like a bad habit.  I can guarantee that those trying to guess if markets are overvalued or not will be still guessing. 

 

I don't see anyone here saying that they are trying to time the market.  The message I get from this thread is that people are feeling a little uneasy, because finding something to invest in is getting harder and harder with this rally.  I have a watch list of about 50 stocks and it has just been a sea of green lately.  I've never been one to hold cash, I've been fully invested (or nearly so) for the last 12 years or so and I have only about 7% cash right now which isn't that far from typical for me,  if anything a little more than usual.    But I am getting that uneasy feeling that I always feel when things go too good for too long.  I think that is all anyone is saying. I don't see anyone trying to predict a date for a crash.

 

[txitxo]

 

Here are 2 different statements:

 

1.  How can anyone possibly invest right now given the high levels of profit margins, market cap to GNP, unrest in the Middle East, Japan blowing up any day now, etc.?  Further, if you look at a graph of the stock market it mirrors exactly what happened back in 1929!  Therefore, it is obvious that the market will crash very soon.

 

Or,

 

2.  Given that profit margins are at historic highs, the market cap to GNP is high, there is unrest in the Middle East, etc, it is prudent in my view to allocate funds in a more conservative manner.  It is not clear exactly what will happen - it never is - but all I can do is prepare myself in a way that makes sense to me.

 

The first is a prediction.  The second is not.  Any talk of how much we will decline in exact numbers is a prediction.  That's fine if someone wants to do that, but in order to be correct there has to be a time frame on it.  Otherwise, you know, broken clocks and all that.

 

  Kraven, if any prediction about the stock market with attached timing is right, it has to be luck. Markets are intrinsically unpredictable, as the weather, in a chaos-like fashion. So nobody can really predict anything, stricto sensu.

 

  But you can look at numerical estimators and calculate probabilities. If the CAPE is 10, you know that it is more likely that stocks will go up than down. But nothing precludes them going to CAPE=7. If the CAPE is 24, you know that it is more likely that stocks will go down than up. But they can still keep rising, as they have been doing for quite a while already. That's why I talk about Goddess Fortuna. Everything is probabilistic.

 

  I have my own timing indicator, but it has only flared like this 3 times. So how can I know whether it is right? Thrice is not a broad enough sample. But it adds to the probabilities. And an elemental rule is that, the higher the probability, the closer in time the event will be. 

 

 

[Kraven]

 

Here are 2 different statements:

 

1.  How can anyone possibly invest right now given the high levels of profit margins, market cap to GNP, unrest in the Middle East, Japan blowing up any day now, etc.?  Further, if you look at a graph of the stock market it mirrors exactly what happened back in 1929!  Therefore, it is obvious that the market will crash very soon.

 

Or,

 

2.  Given that profit margins are at historic highs, the market cap to GNP is high, there is unrest in the Middle East, etc, it is prudent in my view to allocate funds in a more conservative manner.  It is not clear exactly what will happen - it never is - but all I can do is prepare myself in a way that makes sense to me.

 

The first is a prediction.  The second is not.  Any talk of how much we will decline in exact numbers is a prediction.  That's fine if someone wants to do that, but in order to be correct there has to be a time frame on it.  Otherwise, you know, broken clocks and all that.

 

  Kraven, if any prediction about the stock market with attached timing is right, it has to be luck. Markets are intrinsically unpredictable, as the weather, in a chaos-like fashion. So nobody can really predict anything, stricto sensu.

 

  But you can look at numerical estimators and calculate probabilities. If the CAPE is 10, you know that it is more likely that stocks will go up than down. But nothing precludes them going to CAPE=7. If the CAPE is 24, you know that it is more likely that stocks will go down than up. But they can still keep rising, as they have been doing for quite a while already. That's why I talk about Goddess Fortuna. Everything is probabilistic.

 

  I have my own timing indicator, but it has only flared like this 3 times. So how can I know whether it is right? Thrice is not a broad enough sample. But it adds to the probabilities. And an elemental rule is that, the higher the probability, the closer in time the event will be.

 

That's my point.  There are probabilities and there are predictions.  Plenty of people had been posting essentially saying a crash is imminent.  Not that the the probability of an adverse market had increased, which is fine of course, but that such adverse market is in fact immiment.  I think what you're saying is correct. 

[Cardboard]

I have been thinking a lot about what Tepper said this morning and I am starting to believe that we need a major blow-up top until this market corrects. It can't happen at these relatively low P/E's unless there is a shock and who knows what or when this will happen. You need to reach a point when everyone who "can" invest in the stock market is in. Defining "can" is tough, but I doubt that we will reach something like 1999/2000. Think of an Apple top kind of moment.

 

The Tepper impact today is remarkable and can be seen on the SPY chart. Basically, we have been in a well defined up channel since mid November or exactly 6 months. Today, we are breaching the upper line of this channel. I am not using technical analysis to buy or sell since I am a value investor, but so many are out there that it has an impact on the market. I am afraid that we are now entering some parabolic ascent.

 

The implications are that if you are short that the pain will become unbearable. That is actually exactly what is needed for this market to finally take a breather. You have short/long funds lagging the market, value funds that are raising cash or selling fairly valued holdings also lagging and anyone invested in some bonds also lagging. The pressure to join the crowd and close lagging or losing position will become very strong. Think of the pressure on Berkowitz or Paulson when it gets bad. 

 

The other mechanism as described by Tepper is this incessant buying from the Fed or $85 billion a month. What he failed to mentioned is that the Fed now has its hands tied-up. The Fed is committed to help the economy and to reduce unemployment while keeping inflation below its target. Based on this, it cannot stop. This means that if an equity bubble truly starts that they will not stop QE or raise interest rates. Some economists, analysts and other wise people will ask for the Fed to intervene to cool things down in the stock market, but since it has little impact on the economy or Main Street as we have seen for over 4 years now, the Fed will ignore these calls and be forced to continue QE. It will be like adding dynamite on a magnesium fire. 

 

So I am starting to change my view as to how one should properly hedge this market. I think that it remains fine and perfectly rational to buy and sell individual companies based on valuations. What should happen is that you will find yourself in a growing cash position as the market keeps going up. Some will find comfort getting more cash on their hands, but some will also dislike greatly parting with companies they know well at a fair price to only see them keep going up in price along with Mr. Market. So I think that with very low volatility or very low premium, that one should consider buying index calls to hedge themselves. Yes, I said calls.

 

The cost is very low and it may just prevent you from going insane as the market keeps going higher. I know how it feels being short some names right now and after selling some stocks. While logic should always prevail, we may be getting to a point where things get really out of hand. What I have not figured out yet with the calls approach is when to sell. Defining the "can" as I described above is near impossible. So you may have to "collect" every month or use some other discipline to sell them before reloading.

 

I know it will sound totally stupid to many, but it is not that different than buying puts on the market. You buy puts to hedge yourself or hopefully to get more cash down the road than you spent. You also never know when to cash in your puts. There is no bell that rings or a level that is more rational than another. The problem is with an ever rising market that you are wasting cash instead of accumulating it for the rainy days with puts. If this lasts 6 more months, a year, two years, you are very likely to lose a ton with puts. Buying and selling calls with discipline might instead be a cheaper alternative to stay in the market and to accumulate cash as things get crazier and crazier. And since you are doing this as an hedge, you should be able to detect more easily that the lemmings out there the break point or when the trend gets broken. Just look at AAPL or GLD. A cool head was able to see when it stopped going up or when the up trend got broken, but not the "participants". They kept hoping for it to go back up and stayed invested.

 

I am open for suggestions on this crazy idea...

 

Cardboard

[hyten1]

Cardboard,

 

buyings CALLS! wow hmmm....

 

are you saying swaping out common position gradually as market goes up and replace the common with calls? this way you will take some money off the table and by utilizing calls you can get the same amount of exposure as before (with the common) but at a fraction the cost.

 

in the even market dives you lose on your call, which is finite?

 

is this what you mean?

[Cardboard]

Yes and no.  :)

 

I would not replace your common stocks with their derivatives. If a stock is expensive it should be sold and if cheap bought. I would not change anything that a disciplined value investor does currently.

 

It is more about opportunities vanishing on an absolute intrinsic value basis while the market keeps on rising and the distraction of a growing cash balance earning nothing. It is completely logical to sell your stocks as they become dear, but the psychological impact of seeing them continue to climb makes you regret somewhat your decision. It is just human nature. This whole thread is a bit about this issue I think.

 

I am sure that some people right now may be holding on to stocks or much larger positions relative to their portfolio due to appreciation than they should. This comes with the psychological impact of a rising market. They are afraid to miss out and since their stocks are not very expensive relative to the market or on another basis, they keep overweight positions to get this Alpha. It is not something done consciously, but I think that we all suffer a little bit from it. Continually winning makes you more confident.

 

So if you would be fully exposed to the market, but at a minimal cost, would you still keep your portfolio intact? Would you be in a better mood sitting in cash even if the market goes up like nuts? That is why I am exploring this strategy. It is also to protect from short positions that I thought made some sense, but are now and looking to hurt me even more in the short to medium run.

 

Cardboard

[premfan]

Good thread. Most people make a lot of sense.  Using a quote from the late great jim rohn " Think winter in the summer and  think summer in the winter".  Everyone has their own definition of what summer is and what winter is. But it doesn't matter what YOU think. It only matters what the collective market thinks. The times we should be worried is when EVERYONE thinks its summer. Personally, I don't feel most people think its summer. The truth really is that the fed controls the seasons. Interest rates are the season predictor.

[Eric50]

Interesting thread. Good interview below with Bill Fleckenstein on how/why Japan could derail the current rally.

 

http://finance.yahoo.com/blogs/talking-numbers/fleckenstein-why-japan-easy-money-could-blow-america-213918831.html

[Uccmal]

Very thoughtful Cardboard.  The question remains? 

 

How do you determine when to sell?  The broader markets dont really lend themselves to a value type analysis.  Obviously, we have varied opinions on this, even on this board - imagine that. 

 

I think we could agree that BAC was cheap at < 10 with certain assumptions.  With the general markets there is no simple measure of value. 

 

I am practicing a program of disciplined selling, particularly of BAC and AIG Leaps, as the common reaches new highs.  That being said I still have huge upside potential while trying to minimize the downside exposure.  Its either this or go to cash, wait it out (whatever it is), and give the taxman 20% of my money on Leap profits that have in a few cases tripled. 

 

A little perspective is in order sometimes.  Three yars ago I was buying BAC.ws.a, at prices higher than today, and it seemed to have value.  So were Chou and Berkowitz. 

[fenris]

Any thoughts on why Japanese 10 year rate keeps running up since mid April (now at almost 1% from 0.55% at low) despite the easing? Was the BOJ's QE all priced in?

 

*edit: Oh lol I see Fleckenstein mentioned this as well

[giofranchi]

Tepper Makes 'Overwhelming' Case For Markets....

 

http://finance.yahoo.com/video/tepper-makes-overwhelming-case-markets-124100765.html

 

Wow!! To hear Mr. Tepper's case for markets really makes me feel like I am being cautious and conservative at the worst time possible… basically, it makes me feel like a fool! :(

 

giofranchi

 

Mr. Tepper's chart.

 

giofranchi

tepperchart.pdf

[actuary]

Great thread. I'd be very interested to read any comments from Moore.

 

We can't resist raising cash along and along from the shorter-term bets that have worked out. Trying to be patient about new opportunities. Hey, even if we're looking at 1999... mid-1999 was not a bad time to raise cash on a 3-5 year horizon.

 

Would buy more hard assets if we needed them, but already we have two cars and a 30 year low fixed rate mortgage. We'll take some fun vacations this summer.

 

In longer-term tax-deferred accounts, we buy the indices every two weeks and try not to think about it. What else can we do in this environment? Not looking to retire for >25 years. I guess that is a natural sort of hedge against the seller's remorse Cardboard discussed.

[Cardboard]

They are doing everything they can to push the S&P to bubble levels:

 

1- QE infinity that cannot stop since the economy is just limping.

2- All stock markets are bad, except the U.S. and Japan.

3- The dollar is rising, so you get a boost by just sitting on U.S. assets.

4- Comparison treasuries to earnings yield/dividends that favors stocks as far as the eye can see.

5- A market that remains at the average P/E looking at the past 100 years.

6- Commodity prices that are declining or helping U.S. consumers and profit margins and, shutting off another avenue for capital.

 

A prudent investor would stay away due to artificially low interest rates, bargains that are now just average and massive tail risks. I am more and more convinced that people on this board better be prepared to scratch their heads and maybe pull their hair as this thing evolves. Watsa could not believe that the bubble had reflated after the Internet pop only to reach a new high in 2007. Greenspan had engineered a massive reflation through housing. This time around, they are adding trillions of stimulus in the best self sufficient economy in the world.

 

Cardboard

[Palantir]

They are doing everything they can to push the S&P to bubble levels:

 

1- QE infinity that cannot stop since the economy is just limping.

2- All stock markets are bad, except the U.S. and Japan.

3- The dollar is rising, so you get a boost by just sitting on U.S. assets.

4- Comparison treasuries to earnings yield/dividends that favors stocks as far as the eye can see.

5- A market that remains at the average P/E looking at the past 100 years.

6- Commodity prices that are declining or helping U.S. consumers and profit margins and, shutting off another avenue for capital.

 

 

Sounds like all the more reason to continue holding equities...

[constructive]

When the market appears overextended, another option besides cash or bonds - which are painful because of negative expected real returns - is moving to less cyclical, less leveraged, higher quality stocks. For example, selling F to buy TEVA.

[ERICOPOLY]

Here are some lyrics that speak to the siren song of the markets:

 

 

Dear Prudence, won't you come out to play

Dear Prudence, greet the brand new day

The sun is up, the sky is blue

It's beautiful and so are you

Dear Prudence won't you come out to play

 

Dear Prudence open up your eyes

Dear Prudence see the sunny skies

The wind is low the birds will sing

That you are part of everything

Dear Prudence won't you open up your eyes?

 

Look around round round

Look around round round

Oh look around

 

Dear Prudence let me see you smile

Dear Prudence like a little child

The clouds will be a daisy chain

So let me see you smile again

Dear Prudence won't you let me see you smile?

 

Dear Prudence, won't you come out to play

Dear Prudence, greet the brand new day

The sun is up, the sky is blue

It's beautiful and so are you

Dear Prudence won't you come out to play

[Kraven]

Here are some lyrics that speak to the siren song of the markets:

 

 

Dear Prudence, won't you come out to play

Dear Prudence, greet the brand new day

The sun is up, the sky is blue

It's beautiful and so are you

Dear Prudence won't you come out to play

 

Dear Prudence open up your eyes

Dear Prudence see the sunny skies

The wind is low the birds will sing

That you are part of everything

Dear Prudence won't you open up your eyes?

 

Look around round round

Look around round round

Oh look around

 

Dear Prudence let me see you smile

Dear Prudence like a little child

The clouds will be a daisy chain

So let me see you smile again

Dear Prudence won't you let me see you smile?

 

Dear Prudence, won't you come out to play

Dear Prudence, greet the brand new day

The sun is up, the sky is blue

It's beautiful and so are you

Dear Prudence won't you come out to play

 

Great song.  I actually like the Siouxsie & the Banshees version the best.

[ERICOPOLY]

Just a general question...

 

Why are defaults low?  People have been saying that the stock market is out of sync with the real economy.

 

However, is it really tough out there in the real economy?  Is following default trends on outstanding debt an outmoded means of measuring the real economy?

 

I've heard people say that nothing is really improving out there (except for stock prices and home prices) -- real incomes aren't rising, jobs added are all low quality, etc... etc...  Okay, then where are the defaults?

[Parsad]

Just a general question...

 

Why are defaults low?  People have been saying that the stock market is out of sync with the real economy.

 

However, is it really tough out there in the real economy?  Is following default trends on outstanding debt an outmoded means of measuring the real economy?

 

I've heard people say that nothing is really improving out there -- real incomes aren't rising, jobs added are all low quality, etc... etc...  Okay, then where are the defaults?

 

Defaults are low because interest rates have been low for a prolonged period of time, and corporations, individuals, etc have been able to restructure their debt profile.  They are in much better shape than they have been in a long time.  The question becomes, what happens when rates start to rise...what happens when the government decides to start selling assets...what happens when other parts of the world that have not been able to restructure their debt profile face those circumstances?  Cheers!

[jay21]

Just a general question...

 

Why are defaults low?  People have been saying that the stock market is out of sync with the real economy.

 

However, is it really tough out there in the real economy?  Is following default trends on outstanding debt an outmoded means of measuring the real economy?

 

I've heard people say that nothing is really improving out there (except for stock prices and home prices) -- real incomes aren't rising, jobs added are all low quality, etc... etc...  Okay, then where are the defaults?

 

Credit has been pretty tight until last year and now things are thawing/loosening (mortgages are still probably the tightest).  Defaults usually occur a few years after the debt has been issued so they lag current underwriting standards.

 

You can also think of it as 2007-2009 was a real stress test and almost everyone who was going to default in a stress scenario did default.  All those bad debts were replaced with very good debts so it makes sense that we are in a low default period.

[ERICOPOLY]

A couple of comments based on those replies, and then a question...

 

1)  defaults will remain low because because interest rates will remain low for a long time

2)  defaults will remain low because underwriting standards have improved and the weak credits in legacy books have been culled

 

What constitutes a long-time? 

 

The earnings yield on S&P500 is 7% annually and the thing that threatens it (higher rates) is a long ways off according to Watsa (and the bond market seems to agree with Watsa, so he's not exactly contrarian in saying this).

 

The trouble I see in using the Schiller P/E over the next few years is that if rates stay this low (as Watsa forecasts) for years and years going forward, then the Schiller P/E10 will begin to look a lot more benign even without a market drop.  You will then need a Schiller P/E13, then a P/E 15, etc...

[Packer16]

Eric,

 

You are right in that in a delevering rates stay low for decades (See 1930s, 1870s, Japan 1990s/2000s).  The only difference is with the massive QE how much is this period compressed and the delevering accelerated?

 

Packer