GOLDMAN'S STOCK FORECAST FOR 2011

Jeremy Grantham's Letter for January 2011

Once again, Mr. Grantham has issued his letter to clients. I really enjoy his writings. Mr. Grantham's advice for the current market is that we are likely to reach 1500 SP500 and to be careful in October. Most of his analysis assumes that the third year in the Presidential cycle is the best year to be in the market. Nonetheless, be aware, or beware, that Mr. Grantham's valuation of the market is approximately 900 SP500.

How to Get Investment Ideas from the Pros

Here is a good way to get an idea of what the well-known investors are holding in their portfolios and funds. By searching 13F filings on this site, one can get some insights into industries and companies that investors like Mr. Paulson, Mr. Klarman, or Mr. Soros are holding. Periodic searches also allow one to see where they are reducing their positions. Hope this is helpful.

The Seven Habits of Highly Effective People

Stephen R. Covey, the author of The Seven Habits of Highly Effective People, first published this bestseller in 1990. Here is a nice summary of the ideas in this book. The seven habits concern personal change and how one can become more effective. One of the parts I find interesting is the “win/win” situation. One should seek agreements, situations, and relationships where there is win/win. This is what we are creating at TradingXYZ. The second is that we see things not as they are, but as we are conditioned to seeing them. This principle is helpful to remember when we look at the market and try to make sense of it. Viktor Frankl’s attitude towards a horrific situation is a great lesson for all people. Humans have the freedom to choose. Frankl’s book, Man’s Search for Meaning, is another that I have on my list of things to read in the near future.

THE BEST STOCK SCREENER

In the quest for information on stocks one will scour the web for hours. Lately I came across what I believe is the best stock screener out there. It is the FINVIZ stock screener. This stock screener allows easy downloading to Excel and a variety of variables that can be used to screen stocks. Hope it is helpful to you all.

The Battle that Changed Western Civilization

I like to read, especially during the winter, when it is difficult to do things outside. Recently I have been reading the book, Marathon: How One Battle Changed Western Civilization, by Mr. Richard A. Billows. This book makes a compelling and convincing case that the course of world history was indeed changed by the Greeks defeating the Persians at the Battle of Marathon. I found the book to be exciting, informative, and fun to read.

Mr. Billows is a professor at Columbia University specializing in Greek and Roman history. He specifically discusses the role of democracy, which he states began with the Kleisthenes in Athens, as one of the primary reasons leading to the Athenian resistance. The defeat of the Persians in Greece halted the westward expansion of the Persian empire. This eventually led to the decline of the Persian empire and to the rise of the Greek empire. As the Greek empire expanded it influenced western culture with its arts, architecture, philosophy, history, and theatrical drama and comedies.

The movie 300 popularized Leonidas and the Spartans who held off the Persians in a different battle, the Battle of Thermopylai. But it was really the Athenians, led by Miltiades, that changed the western world and made popular what we today take for granted.

Meatstick and Phish - Happy New Year !!

Correlations and Comparative Statistics - Stocks

There are many stock screening websites that may be useful, for example MSN Money and Google Finance, but I also like these two. The first is Wolfram, which allows the user to input a variety of stocks and make comparisons in different ways. The second is the Select SPDR site which calculates correlations. Although these things can be done in Excel, sometimes it is helpful to get quick information. I hope you find them useful.

ZZJoke.com - Jokes

One day a blond who had no past experience in horseback riding, decided to try.

She mounted the horse, and it started to gallop, the horse kept going faster, and faster. The blond lost control and started to slide down the side of the horse. So she made a grab for the horse's tail, but couldn't get a good grip.

She then reached for the horse's mane, still she couldn't get a good grip. Now she was at the mercy of the horse's pounding hooves.

Fortunately, Dave the Wal-Mart manager, came and unplugged the horse...

Mr. Stephen Schwarzman’s lecture at Yale

I really enjoyed listening and watching Mr. Stephen Schwarzman’s lecture at Yale. Mr.Schwarzman discussed many topics such as the nature of private equity, real estate, successful and failed deals, and how the financial crisis occurred and evolved. I have read and heard so much of the financial crises by now, that I thought there was nothing new that I could learn. I was wrong.

I learned from Mr. Schwarzman’s lecture that government policies and laws can lead to unintended negative consequences in our society. Although this was not the main point of his discussion, he did refer to a few government actions that had clear and unintended negative consequences for our society.

The first was the start of the real estate bubble, which began with the US government’s policy to get more people into homes. Although this was a good policy, it wound up turning into a fiasco, with all the unintended consequences to come later. For example, Mr. Schwarzman stated that subprime mortgages at one point were 2-3% of all mortgages; and by the end they had become more than 30%. He also described how 87% of pooled mortgages which were securitized were given AAA ratings. This misled investors into thinking that these securities were safe and could not default. Mr. Schwarzman believes historians will look back at this time and wonder how AAA ratings were given to these securities in the first place. In addition, he wonders how so many investors believed in these ratings and were fooled by them. In my opinion it’s pretty simple; just like there is a fog of war and a fog of panic, there is also the fog of greed.

The second unintended negative consequence came from the passage of the Sarbanes-Oxley law. This law was passed after the Enron scandal and created fair value accounting, also known as FAS 157. Mr. Schwarzman described how FAS 157 forced financial institutions to take losses before defaults actually occurred. These losses, in turn, created a crisis of confidence in financial institutions which eventually morphed into the much bigger financial crisis.

His stories of successful deals, US Steel and Celanese, and unsuccessful ones, an Argentinian cell phone company, were also interesting. One point he stressed was that capital always comes back. Even though there is a credit crunch occurring, he is optimistic that credit and capital will come back. He mentioned the past credit crunches of 1975, 1982, 1987, and 1990-1991.

I also liked his discussion about failure. He stated how he hates failure and when it does occur that he tries to learn from it. Failure can be a blessing in disguise. Mr. Schwarzman is a winner because he does not like to fail. This was worth watching.

60 Minutes and The Day of Reckoning

This past Sunday night, “60 Minutes,” the television show, had a segment on the looming financial crisis of local, municipal, and state governments. The analyst who was interviewed, along with Governor Chris Christie of New Jersey, basically said the same thing. The Day of Reckoning is here and will need to be addressed. What does this mean? It means more catastrophic losses and bailouts by the US taxpayer.

According to the analyst, this will begin to occur within the next 12 months. Mr. Christie says that it is already here. This is serious and no one seems to care. For years I have been hearing of unfunded pension liabilities, creative accounting, and budget deficits-yet no one has done anything about it.

The show also stated how Illinois is effectively bankrupt and a deadbeat. Why have we not heard more about these issues? Are we ostriches with our heads in the sand ? Is our government unwilling to talk about this future crisis? I commend “60 Minutes” for this segment, but it makes me nervous. Just like everything else that is happening…

ZZJoke.com - Joke

A couple of hunters were out in the woods when one of them fell to the ground clutching his chest.

After struggling for a few seconds,he seemed to stop breathing. The other hunter quickly pulls out his cellphone and dials 911.
He gasps to the operator, "My friend is dead! What should I do?"

In a soothing voice, the operator says, "Try to remain calm, sir. I can help you. First, we need to make sure he's dead."

Immediately the operator heard a shot.

The frantic hunter comes back on the line and says, "Okay, now what?"

MBA and the Top Business Schools

Here’s a pretty good site that summarizes a typical MBA program. Also, Bloomberg Businessweek has released what it considers the best business schools in the country.

Confucius Peace Prize - Nobel - China - Liu

China is very unhappy with this year’s Nobel Peace Prize winner; Mr. Liu Xiaobo. Mr. Liu is serving eleven years in a Chinese prison for supporting political reform, human rights, and an independent judicial system. In response, China has created its own peace prize, the Confucius Peace Prize.

Maybe the Nobel Peace Prize committee is politically motivated, for example, the choice of President Barack Obama was debatable and raised questions. We all can see this as a politically motivated game, but what I find interesting is the list of countries that have now rejected invitations to the Nobel Peace Prize ceremony. The list includes:

China
Afghanistan
Columbia
Cuba
Egypt
Iran
Iraq
Kazakhstan
Morocco
Pakistan
Philippines
Russia
Saudi Arabia
Serbia
Sudan
Tunisia
Ukraine
Venezuela
Vietnam

Here are some themes these countries represent: opposition to the U.S. and its policies, Arabs, natural resources, and non-Western. I’ll let the reader decide what they think of this, but it does make one wonder why they are not going.

Yes, You Can Time the Market ! - Ben Stein - Phil DeMuth

I have just completed reading the book Yes, You Can Time the Market !, by Mr. Ben Stein and Mr. Phil DeMuth. The book is a well-written, no nonsense book, which gives practical and easy advice to follow for those who have a long term investment horizon. The authors have done their homework and they also discuss other academic studies which support their ideas. The authors make no claim that market timing can be done in the short run. If, however, you have a long term investment horizon (15-20 years), then buying when the market is “low” will generate better returns over other investment strategies.

So, you may ask, what is low? The authors look at a variety of criteria, such as market price, PE ratios, dividend yield, price to book, Tobin’s Q, price to cash flow, etc. In general, they argue that returns for any 5, 10, 15, 20 year period were higher when investors entered the market when it was trading better than the respective long term average of 15 years. For example, buying the SP500 when it was trading below its 15 year moving average price, was generally a good time to enter the market.

The authors are not ignorant that many times you may be sitting on the sideline feeling foolish as markets head to the moon, but they believe you will be rewarded over time because:

“Unlike other stock market anomalies, which disappear the moment they are pointed out, buying low promises to endure. This is because the extra returns it delivers do not come free. Rather they are a payment for assuming the psychological burden of buying stocks when everyone says the sky is falling, and demurring when Wall Street is having a feeding frenzy.”

The authors also believe that markets regress to the mean. This is why groups of stocks with high PE’s tend to underperform in future years, compared to groups of stocks with low PE’s, which outperform going forward. Another example of regressing to the mean was discussed in the performance of stock prices. Stocks that have outperformed (underperformed) over the past few years tend to underperform (outperform) in the future.

This is a good book to read for those who believe in investing for the long run. I enjoyed it and would recommend it.

The authors summarize their work in the following paragraph:

“The point of this book-so simple that a child can grasp it, yet so elusive that your broker will never get it-is that you are better off buying cheap.”

Mr. David Swensen's Lecture - Yale - Shiller

I have always known about the excellent returns generated by the Yale endowment, but have never dug deeper to find out who is responsible for those returns. Since reading Mr. Biggs book, Hedgehogging, I have come to find out the man responsible is Mr. David Swensen. I recently watched a great lecture by Mr. Swensen and would like to share some of the main concepts he discussed.

Mr. Swensen begins his lecture by stating that when he came to Yale he decided to study what other institutions were doing at that time. He found that most institutions were allocating their funds, 50%-40%-10%; 50% US stocks, 40% US Bonds, and 10% cash or other. Mr. Swensen felt that this was inappropriate, and began to change the way Yale invested its endowment money.

Given some academic results of studies done by Mr. Ibbotson, Mr. Swensen decided that equities were the place to be in the long run, given their superior long term returns compared to other alternative asset classes. Mr. Swensen also began to look for investments in alternative asset classes. It was very interesting how he decided on where he should allocate most of his time and effort in search of higher risk-adjusted returns. Mr. Swensen decided that inefficient markets would offer better opportunities and could generate market beating returns. The way he determined this was by looking at long run returns of managers within various asset classes, and what the returns were of the top percentile compared to the bottom percentile within each category. He then also looked at the dispersion of those returns:

Bonds .5%
Large Cap Equities 2%
Small Cap Equities 4.7%
Hedge funds 7.1%
Real estate 9.3%
LBO’s 13.7%
Venture Capital 43.2%

It became clear to him that spending more time in the areas where the dispersion was greatest would pinpoint inefficiently priced markets and better investment opportunities. He stated that there was very little reason to spend a lot of time looking for managers in the bond market, where prices are generally mathematically calculated and pricing is very efficient, compared to other types of markets.

Mr. Swenson discussed three large topics in his lecture; asset allocation, market timing, and security selection. He concluded that asset allocation is the number one driver of returns. He discouraged market timing, and he felt that the system is not a zero sum game. Excessive fees charged by hedge funds, commissions, and consultant fees, have turned a zero sum game into a negative sum game.

Mr. Swensen also warned the students to be very careful when evaluating historical performance results. He stressed that data can be skewed by survivorship bias and back-fill bias. Survivorship bias removes the bad performance of managers who have folded and back-fill bias adds in good performance of managers.
At the time of the lecture the Yale endowment was allocated:

11% US Stocks
15% Foreign stocks
4% Bonds
23% Hedge Funds
28% Timber, Oil and gas, real estate
19% Private equity, LBO’s, Venture Capital

This is an excellent lecture and I highly recommend watching it. LINK Mr. Swensen’s long term performance has been exceptional. He did it by becoming equity-oriented, finding great managers who did well in efficiently priced markets, by changing the asset allocation of the total portfolio, and by diversifying the risks. Really quite simple...)

From ZZJoke.com

Dear Abby,

My husband is not happy with my mood swings.

The other day, he bought me a mood ring so he would be able to monitor my moods.
When I'm in a good mood it turns green.
When I'm in a bad mood it leaves a big red mark on his forehead.
Maybe next time he'll buy me a diamond.

Sincerely,

Moody in Buffalo

Stoicism and Trading - Stoics

Stoicism was a philosophy towards life that evolved in ancient Greece. Stoicism was founded by Zeno of Citium around 300 B.C. and was later popularized by Chrysippus, Seneca, Epictetus, and Marcus Aurelius.

The philosophy that stoics lived by was to be indifferent to pain or pleasure. They were not easily excited or upset. In a way they were like Zen Buddhists who follow “The Way,” the Tao, by taking the middle road. Stoic philosophy can be useful for traders. Don’t get too thrilled when you hit winners, don’t get too bummed out when you have losses, don’t get really bummed out when you are in long, painful drawdowns, and keeping your head level is philosophically stoic.

I consider myself emotional and sensitive. I like to live life. I emotionally exaggerate life’s highs and lows. It is in my nature. As I am becoming and getting older, I get better in managing my feelings, thoughts, and emotions. It is not easy, and I am sure some people are better in managing their states than others. Nonetheless, we all need to do it. Knowing what I am like as a person helped me in deciding how I would approach trading. I realized pretty quickly that discretionary trading was too difficult and emotional for me. System trading, however, gave me some “emotional separation” from the market. It also helped me be more stoic about my trading performance. Being a systematic trader helps me better manage my emotional states.

Perhaps we cannot live stoically in all aspects of our lives, but we can, however, benefit from its ideas in our trading.

Mr. Taleb and Mr. Mandelbrot

Here is a gentleman that is fighting ingrained thoughts, the status quo, and money interests. Mr. Taleb is challenging fundamental concepts that are being used by bankers and financiers. There really is no credible theory to replace what has been used and established on Wall Street over many years. He does mention in this video that VAR (Value at Risk) analysis should be immediately discarded. The question I have is what replaces it? No bank or risk manager can go out there today and justify what they are doing, because there is no “standard model” that they can stand on.

I agree with Mr. Taleb’s views, but throwing out old theories and replacing them with theories that use power laws, etc. is what Mr. Taleb argues for in his books. It’s going to take a long time to change the way things are done. In fact, what is upsetting is that it seems to me that the bankers and financiers have “won.” Nothing has changed and the system is more fragile than ever. Maybe the whole thing just has to implode before things change. I hope not, but it sure feels like that is the way things are moving.

What can we say about Benoit Mandelbrot? He is a visionary. His insights have been brushed aside by the establishment, but someday, if not already, he will eventually be proven right.

Mr. Warren Buffett’s two rules for making money

Mr. Warren Buffett has been quoted as saying the first rule of making money is not to lose money. The second rule is to remember the first rule.

This is a simple philosophy that is difficult to do. The point is that an investor cannot dig a hole in their capital. Preserving capital, limiting loss, and having a disciplined money management approach are some of the keys to successful investing and trading.