Trade of the Day: The Ninja pairs trade

February 5th, 2013

Today’s trade idea is courtesy of the Japanese government who is “encouraging” its central bank to print money thus devaluing the currency. You can see from the chart of the Yen exchange-traded fund (FXY) how well this policy is working.

Since October, the yen has shed 17% of its value and is looking to sink further. The government’s intention behind devaluing its currency is to stimulate its moribund economy by making Japanese products more globally competitive. Has it worked? Have you checked out the stock charts and read the recent earnings reports of some of the major multi-national Japanese companies lately?

If so, you’ll see that many of them have been soaring. Check out the daily charts of Toyota (TM) and Sony (SNE) below. (I selected these purely because they’re two of the most iconic Japanese brands.) The charts of many other Japanese multi-nationals paint a similar picture.

The trade is based on a simple concept: A falling yen boosts the share prices of Japanese multi-nationals. The idea of the trade is to go long a Japanese multi-national (or a basket of them) and short the Yen. A short position on the Yen can be accomplished by shorting FXY stock or buying FXY put options. Thankfully, FXY options are fairly liquid. While we’re on the subject of options, you could also take the long side of your stock trade by buying a call in place of stock. On the plus side, your cost of entry would be reduced but on the minus side, you’ll have only a fixed amount of time for this trade to mature. The trade-off in time versus money is a decision only you can make.

You will profit on both sides of the trade if the yen keeps falling but should it start to shoot up, be quick about closing out your positions. This pairs trade is double-edged sword.  You’ll have to be ready to pounce and book profits the minute the yen turns up before disappearing into the still of the night, just like a ninja.

To do this, you’ll have to stay on top of your positions. Especially, keep an eagle eye on the driver of the trade–the yen–as it nears support levels (shown in the chart above) and keep an ear out for any changes in the Bank of Japan’s (aka the BOJ) fiscal stance.  This will happen sooner or later as no (responsible) government will let its currency fall too far!

If you want to pick one stock as your long pair component, out of the two shown above I’d choose Toyota. In its most recent earnings statement, the company reported a quarterly profit increase of 23% and a sales increase of 9%. These figures were enough for it to reclaim its title of the world’s number one automaker. Even better, the company raised full year profit guidance from $8.5 billion to $9.3 billion, an increase of 9%.

Now, this pairs trade isn’t for everyone. If you’re a conservative investor who doesn’t have the time nor the inclination to monitor your portfolio on a daily basis, this trade is not for you. However, if you’re one of those folks who likes the concept of the trade but is uncomfortable taking the short side, at least consider taking the long side by adding a high quality Japanese multi-national to your portfolio. After decades of deflation and a declining Nikkei, isn’t about time that people started making money on the Japanese stock market and shouldn’t one of those folks be you?

2012 Asset class performance summary

January 2nd, 2013

The table below shows the overall gains (including dividends) of the more widely held asset classes. The big winners were US and international stocks, real estate investment trusts (REITs), and investment grade corporate bonds (US). Note that gold barely out-performed government bonds which is interesting considering all of the hoopla surrounding it. [Note: Suitable proxies for these asset classes are listed at the end of the article.]

So, how did your portfolio fare against these asset classes? Had your portfolio been equally weighted (dollar-wise) among all ten of these classes, your return would have been close to 10%. Did your broker do that well for you?

A friend of mine told me that as of December 2012, his broker-managed account returned 2% year-to-date after paying a 1% management fee. That’s certainly not an attractive return. However, he’s well into retirement and his main investment goal is preservation of capital so the trade-off in return for reduced risk may be justified.

In conclusion, you can see that stocks and real-estate continue to rebound from the “great recession” of 2008-2009. The question is whether or not the rally will continue through 2013. Looking at the market from a purely fundamental point of view, the current P/E (price to earnings) of the S&P 500 is at 16.8 which is now above its historical average of 15. The upcoming round of earnings reports should be watched to see if earnings continue to rise. A stall in corporate earnings could signal the beginning of a market correction. Should this turn out to be the case, then a move into cash or investment grade bonds would be a wise plan of action for long-term conservative investors.

Note: The above data was compiled via the Portfolio Preserver®. To learn how to maximize your portfolio returns while minimizing risk, please visit our website.

Asset class proxies
Large company stocks: DIA, SPY
Small company stocks: IWM, VB
Investment Grade Corporate bonds: LQD
Long-term Gov’t Bonds: TLT, TLO
Intermediate Gov’t Bonds: IEI, ITE
Treasury Bills: Money market funds
International Stocks: CWI, VT
International Bonds: BWX, IGOV
Gold: GLD, IAU

E-Cigarettes–A Game Changer?

August 29th, 2012

You walk into a crowded bar where half of the patrons are smoking. You spin around quickly heading out of the place lest it be raided by the anti-smoking police only to realize that although there appeared to be smoke in the air there was no scent of tobacco. What’s going on? You return to the bar and ask the blonde at the end what type of crazy cigarette she’s smoking. After giving you the “See what just fell from the turnip truck” look, she tells you that it’s an electronic cigarette that has none of the dangerous tars and chemicals found in ordinary cigarette smoke.

If you’ve never heard of an e-cigarette, don’t despair. Neither had I until I stumbled across an interesting chart that we’ll get to later. For now, suffice it to say that the chart opened up a new product that could be a game-changer not only in the tobacco space but also in the pharmaceutical arena.

The e-cigarette sounds like a new creation but it was invented nearly 50 years in the US with the aim of being used as a nicotine replacement therapy. The product disappeared and it wasn’t until 2000 when a Chinese pharmacist resurrected the concept along with a few technological improvements. Fast forward: The e-cigarette in its current incarnation is being sold worldwide (to countries that allow it).

What is an e-cigarette?
The e-cig (for short) is a device that vaporizes the liquid placed in it for the purpose of being inhaled, much like a vaporizer or a nebulizer. It consists of three essential components: a cartridge that holds the liquid and acts as the mouthpiece, an atomizer that is the heating element that vaporizes the liquid, and the power supply– a battery in portable models.

The liquid can be anything that’s easily vaporized. Currently, the liquid consists of either propylene glycol or glycerin with (or without) the addition of varying amounts of pharmaceutical grade nicotine along with flavoring that includes tobacco, menthol, as well as many others—vanilla, chocolate, and even Boston cream pie!

There are two forms of e-cigs—disposable and reusable. The disposable version comes with something called a cartomizer, a device that takes the place of the cartridge and the atomizer and is the disposable element of the product. Disposable e-cigs are generally much less expensive than their reusable counterparts.

Why is this a desirable device?
The beauty of this device is that there are no dangerous tars or other toxins that can cause many smoking-related diseases, in either the smoker or the second-hand smoker (although there is some dispute over this point). In terms of public and individual health safety, the e-cigarette a pretty much a non-issue. Can you see the possibilities this opens up?

In the US, the e-cigarette is classified by the courts as a tobacco product and is regulated as such. It is not being marketed as a smoking cessation device because the courts struck down the FDA’s claim that it is a medical device. (The FDA’s real motive was to prevent product importation from China.) Even so, it’s not far-fetched to believe that many people could be using the e-cigarette to help them kick the smoking habit.

Regardless, the e-cigarette is making a statement which will, I’m sure, be addressed as soon as the device reaches a certain level of popularity. Certainly, this will affect the bottom line of not only cigarette manufacturers (MO, LO), but also those of big pharma who make nicotine replacement devices like Johnson & Johnson (JNJ) and GlaxoSmithKline (GSK).

Of course, all of these threatened companies are huge with giant PAC machines that could possibly crush a start-up that threatens their systems. On the other hand, they could possibly buy out one of them, dissolve it, and then spit out the remains under the company banner with a newly formed health spin. It’s reprehensible, but it seems like the easiest scenario.

The Poster Child
What got me started in the first place (see Introduction) was a chart of a defiant upward trending juggernaut, XRMB, aka MYEZSmokes. I’ve been looking at this chart for a while and everything about it reeks synthetic. It sure appears as if the stock is being artificially buoyed up, especially since there’s no volume to support the rally.  My opinion:  Someone wants this stock to go up and then they’ll sell out.

The MYEZSmoke website doesn’t offer much other than how to order their cigarettes (menthol or regular). Their cartomizer (the disposable form) offers a pack of cigarette puffs being the cost equivalent of less than $2 a pack. NOW I’ve got the attention of you smokers!

According to its press release, the company’s marketing plan is focusing on providing tribal gaming casinos with their product in an effort to reduce second-hand smoke. This is a great strategy (in my opinion) that provides a win-win scenario for those folks who like to smoke while they gamble and for those who can’t or won’t suffer the effects of second-hand smoke.  It’s also a winning situation for the casinos as they’ll be able to attract those gamblers who shy away from places where smoking is allowed.

There are few laws on the books right now regarding where people can light up their e-cigs. Should they be ruled safe in regards to public health and allowed back into public places (especially bars and restaurants),  then I’m sure their popularity will increase significantly.

The goal in writing this article is to educate and alert those interested in game-changers, and I do believe that the smokeless e-cigarette is one of them. There are many manufacturers, most not in this country, that import their products all over the world. Before you take any action, please do your own due diligence. This is a really new field that is full of possibilities.

Profiting from the “Pre-FOMC Drift”

July 23rd, 2012

A very interesting article appeared on the popular financial counter-cultural website Zerohedge recently. In it, the authors noted a statistically significant rise in equities before the FOMC interest rate decision announcement that’s been occurring since 1994, precisely when the Fed began announcing their après meeting rate decisions. They dubbed this phenomenon pre-FOMC drift.  Their analysis led to two observations:

“1. Since 1994, there has been a large and statistically significant excess return on equities on days of scheduled FOMC announcements.

2. This return is earned ahead of the announcement, so it is not related to the immediate realization of monetary policy actions.”

The article gives statistical proof that the pre-FOMC drift is a real phenomenon. Being the eternal skeptic, I wanted to see if this was, indeed, the case.

The findings of the original article
In the original article, a regression analysis was performed on the S&P 500 index to determine the pre-FOMC drift while accounting for dividends and excess return over the risk free rate. It was found that the FOMC’s rate decision day’s close (Day 0) minus the close of the previous day (Day -1) was 33 basis points above the typically observed 1 basis point advance. That’s huge!

Not only that, but if one looks at data collected at 2pm ET on the day before to 2pm ET on the date of the rate decision (Fed rate decisions were scheduled for 2:15pm ET until very recently), a 49 basis point gain was realized. That’s even more impressive.

My test set-up
The original article showed statistically significant data going back to 1994. In the interest of (my) time, I decided to limit the analysis to the past 5 years of regularly scheduled FOMC meetings (of which there are eight per year) beginning in 2007 and extending through the present for a total of 44 dates.1

I’ll be taking the simple approach meaning that I’ll not be doing a regression analysis nor will I consider dividends or transaction fees. Basically, what I want to show is how a trader could (or could not) have profited from directly buying an S&P 500 vehicle (the SPY or SPX futures) in the one to three day time frame surrounding the FOMC meetings.

I gathered data from the SPX (the S&P 500 index) on the following dates:
1. The opening price from the day before the FOMC announcement (Day -1)
2. The opening price from the day of the FOMC announcement (Day 0)
3. The closing price from the day of the FOMC announcement (Day 0)
4. The closing price from the following day of the FOMC announcement (Day +1)

Note that data was not collected for the 2pm-2pm (Day -1 to Day 0) scenario  because of time limitations (that would have been an extra 88 data points). Also, I was  curious to see which of the possible time frames using the above data points would be the most profitable.  The table below shows the average total gain for each of the following scenarios:

1. Day 0 open less Day -1 open
2. Day 0 close less Day -1 open
3. Day 0 close less Day 0 open
4. Day +1 close less Day -1 open
5. Day +1 close less Day 0 open
6. Day +1 close less Day 0 close

The results
The above table shows that scenarios #2 and #3 are the most profitable. Since the statistics are nearly identical, I’ll be looking at only scenario #3 (buying on the opening day of the Fed rate decision and selling on the close) because as a trader, if I can make the same profit over one day rather than two, I’ll definitely take the one day approach. Further, you can see that had you bought the S&P 500 using this approach from 2007, you would have benefited to the tune of 394 points with an average gain of 9 points per announcement, although you’d have to assume a standard deviation (a measure of risk) of 18 points.2

The below yearly chart seems to indicate that the effect is heightened during periods of increased market volatility. You can see that returns are amplified during times of stress (late 2007 through mid 2009), although a more rigorous analysis should be performed to prove this observation.  It may be that in times of crisis, investors are counting on the Fed to take decisive action.

    Day 0 Close Day 0 Open
Date Volatility % Points
01/31/07 10 0.67% 9.59
03/21/07 12 1.71% 24.12
05/09/07 13 0.35% 5.26
06/28/07 16 -0.04% -0.61
08/07/07 22 0.62% 9.09
09/18/07 20 2.92% 43.05
10/31/07 19 1.12% 17.23
12/11/07 24 -2.57% -39.03
Total Points   0.60% 68.70
01/30/08 28 1.97% 26.57
03/18/08 26 4.20% 53.58
04/30/08 21 -0.40% -5.63
06/25/08 21 0.57% 7.43
08/05/08 21 2.39% 30.01
09/16/08 30 2.13% 25.29
10/29/08 70 -1.00% -9.42
12/16/08 52 4.78% 41.65
Total Points   1.83% 169.48
01/28/09 40 3.35% 28.36
03/18/09 40 2.36% 18.34
04/29/09 36 1.96% 16.79
06/24/09 29 0.52% 4.63
08/12/09 25 1.19% 11.81
09/23/09 24 -1.10% -11.82
11/04/09 28 -0.06% -0.64
12/16/09 21 0.05% 0.57
Total Points   1.03% 68.04
01/27/10 23 0.51% 5.56
03/16/10 18 0.75% 8.63
04/28/10 21 0.57% 6.77
06/23/10 27 -0.32% -3.53
08/10/10 22 -0.17% -1.86
09/21/10 22 -0.27% -3.04
11/03/10 20 0.35% 4.17
12/14/10 18 -0.02% -0.25
Total Points   0.18% 16.45
01/26/11 17 0.36% 4.66
03/15/11 24 -0.51% -6.59
04/27/11 15 0.54% 7.23
06/22/11 19 -0.64% -8.34
08/09/11 35 4.67 52.30
09/21/11 37 -3.06% -36.87
11/02/11 33 1.50% 18.29
12/13/11 25 -0.90% -11.10
Total Points   0.24% 19.58

The analysis here shows that the pre-FOMC drift trading strategy would have been a very profitable one. If implemented as described above, a hypothetical investment beginning in 2007 would have realized a potential gain of 394 points on the SPX. In contrast, had the SPX been bought at the beginning of January of 2007 (at 1418) and held until now, the investor would be down 68 points (as of today’s close at 1350).

The original article showed that more than 80% of the annual equity premium in the S&P 500 has been earned over the 24 hours preceding scheduled FOMC rate announcements. The significance of this conclusion is mind-boggling. For starters, the fact that this effect seems to be amplified during periods of heightened market uncertainty implies that it is based at least partially on hope (too bad Pandora didn’t let that emotion escape, too!) and shows just how much influence the Fed wields. (There are similar effects regarding central bank rate meetings in other countries as well.) The original article also showed that without this pre-FOMC drift boost, the S&P 500 would only be trading around 600, less than half of where it is now.  The implications of this effect are profound.

The aforementioned pre-FOMC drift scenario has been shown to be a viable and profitable trading strategy. One burning question remains: Will the fact that everyone now knows about it render it useless?

1During the sub-prime mortgage crisis, the Fed held many unscheduled meetings which are not considered since I wasn’t sure if I’d be comparing apples to apples.
2This means that 67% of the time you’d have a return ranging between 9 +/- 18, or between a loss of 9 points and a gain of 27 points.

Why averaging down is a bad investment strategy

July 6th, 2012

Whenever some financial “pundit” says that the best way to get into a stock is by averaging down, I cringe. Why? Because at best you’ll be getting into a stock at a lower average price (which can also be accomplished to the very same effect when the stock is rising but more on that later) but more importantly, you can be getting into a stock that’s poised to sink much, much lower–and that’s a risk no one wants to take.

What is “averaging down”?

The concept of “averaging down” is straightforward. Say you buy a hundred shares of a stock at $100. It goes down to $90 and you buy more a hundred more. Your average cost per share has now been lowered to $95. Repeating this action as the stock falls will lower your average cost per share even more. Sounds good, right?

Investing or trading?

It depends. If you’re investing in the stock—that is, you’re viewing this as a trade and not a long-term investment–then averaging down is a strategy that runs counter to your goal of making a profit. Traders use buy and sell indicators to determine when to enter and exit positions. Should a stock fall enough to trigger a stop-loss, they exit the position and take a small loss at the most. Stock traders either don’t care or don’t know enough about the company’s fundamentals to determine whether or not the drop in price is due to a temporary lack of buyers or whether it’s reflecting a more serious problem that they don’t know about or hasn’t yet surfaced.

The situation may be different, though, if you’re investing in the company itself. If, after doing your homework, you are convinced that the company is a good value and you are planning on holding the stock for a long time, then averaging down may work to your advantage. The operative word here is “may.”

Even if you’re convinced that management is on the right track and the fundamentals are solid, I still have a bias against this approach for a couple of good reasons. One is the fact that hype and circumstances can blind even the most judicious, rational investor. Previous Federal Reserve Chairman Alan Greenspan dubbed this condition “irrational exuberance.”

Remember the dot-com bubble in 2000 when internet stocks were bid up to frighteningly high valuations? How many of them are in business now? and were two internet darlings that quickly flamed out once the bubble burst.

Or what about accounting scandals that were kept so hush-hush that even top Wall Street analysts were fooled? Think Enron, Tyco, and WorldCom–companies that wiped out many a retirement account.

If you can’t rely on market hype or trust fundamentals, then what recourse do you have other than using your mattress as a retirement plan? The answer is to follow the technicals because, unlike people, numbers don’t lie.

A case study: It seemed like the perfect candidate

Let’s take a look at a recent example of a market darling that has been experiencing a fall from grace. Last year this company was on everyone’s buy list—Wall Street loved it, Main Street loved it. This is one of those “buy the dips” stocks making it a perfect candidate for the averaging down strategy.

What is the company? It’s Deckers Outdoor (NASDAQ: DECK), the maker of outdoor footwear and apparel. Their top brands include Teva and recently acquired Sanuk, but it’s the Ugg brand of sheepskin footwear that makes up at least 80% of their sales and for which they are most known.

Brand popularity raises the stock

Deckers’ stock suffered along with the rest of market during the 2007-2009 sub-prime crisis. In March of 2009 the market turned around. The S&P 500 staged a a two year rally that ended in early May of 2011 when it hit a multi-year high. During that time, the S&P made a spectacular 100% return but as nice as that was it was chump change compared to the 650% return made by Deckers during the same period.

Clearly, investors and consumers were in love with the Ugg brand.

In the months that followed, the market began to slip as debt problems from the Eurozone surfaced. Deckers, however, was marching to a different drum beat. It couldn’t help but fall a bit in August of 2011 when the crisis was at its darkest, but it picked itself right back up. Late that October, the company reported earnings which blew out Wall Street estimates. The next day, the stock jumped over 10% and went on to post an all-time high of $118, tacking another 22% onto its previous gain.

Investors were euphoric.

The stock begins to loose its luster

But the bloom began to fade when the stock quickly reversed course in what would be the start of a major slide. Buying volume dried up reflecting a shift in institutional attitude. Because of the slack in buying pressure, the stock began to fall in tandem with the overall market.

On December 15th, an analyst at Sterne Agee downgraded the company citing slowing sales due to milder weather and rising material costs (mainly sheepskin). The price target on the stock was slashed from $130 to $72. The news triggered a 10% drop in the stock, breaking a major support level at $95 along the way. Many institutions and investors viewed this event as a shift in perception and began exiting their positions. Trading volume on that day was three times normal.

Was this a time to buy the stock? At $87 per share, it must have seemed like a bargain to those who were still enspelled by the Ugg mystique. Even CNBC’s Mad Money maniac, Jim Cramer, named Deckers as one of his top holiday picks on December 27th. But some investors clearly didn’t share his views.

Just two days later, the stock dropped another 8% on heavy volume. There was no news to account for the sell-off, but my guess is that investors and portfolio managers smelled a dog and were looking to shore up their books before the end of the year.

Another nail in the coffin

For the next couple of months the stock languished in a narrow trading range between $80 and $90 until its next earnings report on February 23rd of this year. Although the company beat again on earnings, it guided fiscal year 2012 earnings well below consensus. The reasons that management gave echoed the Stern Agee analyst’s concerns: increasing material costs coupled with unseasonably warm weather. There is another possibility, however, that management would never stake claim to and that is this: Could the consumer’s passion for the Ugg brand be waning?

A company issuing downward guidance is not the news investors care to hear and they responded by pulling out en masse. The stock tanked, losing yet another $10 per share along with 10% of its value, closing under the $80 support level for the second time.

It proceeded to fall from there.  The downward trend came to a halt in mid-April when, with just a little more than a week before its next earnings release, the stock rallied back to $70 resistance on the anticipation of better news.  To die-hard investors, hope springs eternal.

Unfortunately, their hopes were dashed when the company missed estimates–something it hasn’t done in six years. The next day the stock opened down over 18% in yet another mass exodus. You have to hand it to that Stern Agee analyst—he was right on direction but a wee bit off on price target. Not only was his $72 price target violated, the stock broke support at $60.  And it’s been sliding ever since.

The cost of averaging down

There are many ways to construct an averaging down scenario on this stock but let’s just say that you’ve been following the company for months or even years since the 2009 market low. In October of 2011, you witnessed the earnings blowout and were finally convinced that the company was “the real deal” and decided to buy the stock “on the dips.”

The first dip following the earnings release occurred when the stock broke support at $110 on November 9th. If you had gone on to accumulate the stock using the “buy the dip” mentality, you would have bought at the events listed on Chart #1. These events include the break in support, the aforementioned analyst downgrade, and the subsequent disappointing earnings reports.

Chart #1

If you would have stuck with the averaging down philosophy by buying on the dips (using an equal share strategy and not including commissions or fees), your cost basis would now be near $81, as determined from the following table:

Averaging Down
Date Price
11/09/11 $106.39
12/15/11 $86.46
02/24/12 $77.72
04/27/12 $51.83
Average Cost $80.60

(Closing prices are used unless otherwise noted.)

At the time of this writing, Deckers stock is at $44. That’s a 45% discount from the average price of $81. If that statistic doesn’t bum you out, this one will: You’ll need an 84% move to the upside just to get back to your break-even point!

Seriously, is that what you want or would you rather try a different approach?

The opposite approach: Averaging up

Instead of the “buying the dips” mentality, how about buying the pops? That is, buy when the stock gaps up either due to a compelling technical reason such as breaking through a key resistance level or due to a compelling fundamental reason such beating earnings estimates, raising earnings and/or revenue guidance, making key acquisitions, etc.

Let’s use this “averaging up” approach with our candidate company, Deckers, and see how it compares with the opposite strategy of averaging down.

The market is rising and so is the stock

Let’s say it’s early spring of 2009 and you’ve been making a list of stocks you’d like to buy once the market rallies. You find the Ugg brand appealing and are interested in possibly buying a piece of the company. You research the fundamentals and like what you find.

Next, you turn to the stock chart and see that it’s beginning to rise along with the overall market. You patiently watch it, waiting for a catalyst to give you the buy signal. Finally, you get one in late October of 2009 when the company easily beats Wall Street’s earnings estimates. The next day, the stock gaps up on heavy volume and you jump in.

You keep on doing the same thing—buying the pops–for the next several quarters as the company continues to thrive and beat estimates. Chart #2 below shows the dates of the last three trades that are included in the following table. (There wasn’t room to show all four trades, but suffice it to say that the first one is very similar to the others.). Note the “pop” in the stock and the spike in volume following each earnings report.

Chart #2

If you had bought on each of these earnings “pops”, your stock position would look like this:

Averaging Up
Date Price
10/23/09 $32.36
02/26/10 $40.03
04/23/10 $52.35
10/29/10 $58.10
Average Cost $45.71

Sure, your average cost basis is more than your initial price of $32.36, but you still have the satisfaction of knowing that you’re holding a position that’s profitable down to your break-even point of $45. That’s quite a sizable safety cushion! And isn’t having a safety cushion a lot better than trying to play catch-up?

Deciding when the buying stops and the selling begins

You could keep on accumulating shares as the price rises, but a prudent investor (without a very long investment horizon) would begin selling his or her position at the sign that the company’s fortune is reversing. The first technical indication that Deckers may be in trouble came on 11/9/11 when the stock broke its $110 support level. (This was the date of the first “buy the dips” purchase.)

The “official” tell, though, was the analyst downgrade on 12/15/11 mentioned earlier. You would have seen the stock gap through its $95 support level (see Chart #1) and either have chosen to sell some or all of your position. If you had sold all of it at the closing price of $86.46, you still would have made a profit of $40.75 a share—that’s a gain of 90%! But even if you had steadfastly held onto your entire position throughout the stock’s further decline, you’d just be at the break-even point right now (at the time of this writing). Isn’t it comforting to know that you’re even able to weather such a tough storm?

We’ve seen how averaging down can lead to disaster while the opposite approach, averaging up, can lead to higher profits at lower risk. I can hear your thinking: Why would someone buy a stock on the way down when the fundamentals are indicating a contraction in growth? Don’t forget the power of irrational exuberance–even a seasoned Wall Street professional like Jim Cramer gave Deckers a two thumbs up following a 30% drop in stock price AND a major downgrade. Just remember that investor perception can take much longer to shift than the price of a stock.

So, if you’re ever tempted to buy a stock on the way down, recall this “Ugg-ly” example and resist the urge.  Don’t let it happen to you!

Stock of the Day – (YIPI)

June 7th, 2012

Based in Fort Myers, Florida, Yippy, Inc. (OCTCQX: YIPI) brands itself as “the world’s fastest, family friendly search engine.” This self-censoring site is a boon for parents concerned about their children accessing “morally unacceptable” content and as such has been a darling of Christian websites. The search engine is being embraced by churches, libraries, and schools as well. The Yippy search engine itself is a robust, virtually ad-free interface with the plus of offering a menu bar.

The company has been making strategic acquisitions, the latest being Macte! Labs specifically for its toolbar platfom that bills itself as “the most powerful browser extensions platform in the world with unique abilities to apply monetization solutions such as affiliate commerce, interactive advertising and paid search.”

Management’s main focus is to provide a complete vertical search engine for companies wishing to increase brand awareness via more organic methods. To this end, the company just added two more members to their board whose guidance, industry contacts, and product expertise may provide a big boost to brand awareness and thus the bottom line.

The first board addition is Debbie Sharken who is an expert in direct marketing and digital business. According to her, Yippy is “fulfilling an unmet need in the marketplace by creating custom, vertical consumer search engines for any brand, company or category.” She goes on to say that “Yippy allows brands to maximize their original content over the internet, virtually double their organic online presence and search rankings, and add more value to the brand experience.”

Morton Fink, the second new board addition, is the founding CEO of Warner Home Video. In talking about Yippy, he says that…”[A]s I learned more about the company in my due diligence process, a couple of personal opinions became apparent. First, the company possesses significant intellectual property related to the aggregation and distribution of information over the web. Two, there are certainly competing companies that are going to want these advanced capabilities.”

Taking the liberty of reading between the lines, it’s pretty clear that he regards Yippy as a takeover target. He also notes that because of the creation and acquisition of intellectual property, the company’s “true value is yet to be determined.”

Speaking of value, one can note from its daily chart below that investors are definitely taking an interest. The stock has risen five fold (!) in a little over a month on increasing volume. Its current price of $1.20 is starting to put it outside of the penny stock category. At this level, institutions may begin taking notice. (It’s interesting to note that the stock price has risen as its site traffic has increased according to Alexa traffic stats.)

In short, Yippy distinguishes itself from the rest of the search engine pack by providing a family-friendly search option along with an organic and integrated branding interface between business and consumers.

Risk Level: Speculative
Disclosure: No positions

Apple (AAPL) support/resistance levels

April 24th, 2012

All eyes will be on Apple earnings today after the bell. Should their numbers not meet with expectations, a sell-off appears likely. Below is a daily chart of Apple showing major support/resistance levels. Note that most of them occur at the even $50 marks as well as minor support at $25 intervals. It’s worth noting that selling volume has been increasing (although it’s not shown on this chart) which means that institutions are starting to divest themselves of some of their holdings.

Folks wishing to protect their long positions may wish to buy puts with strikes at support levels. If I owned Apple stock (unfortunately, I don’t), I’d look at a six month to one year $550/$500 put debit spread. (I prefer spreads which lower the cost of entry while also mitigating some of the effects of implied volatility.)

Mobile app review: StockTouch

February 27th, 2012

StockTouch is an app for the iPhone and iPad that provides an easily readable heatmap of the one hundred top stocks (ranked by market cap) in each of nine of the most popular asset classes. This is a nifty tool that shows you in an instant what is happening within each sector and how well the sectors are moving relative to each other.

If you watch CNBC, you’ll know what a heat map is. If you don’t, it’s a graphical display of what’s hot and what’s not: stocks trending up are displayed in increasingly brighter shades of green and those trending in the opposite direction are shown in increasingly brighter shades of red with color brightness defined by the magnitude of the gain or loss.

StockTouch is intuitive and users should have no problem implementing it. But if you can’t figure it out after a few minutes, there’s an online tutorial that can help.

Current features
Handy features include the following:

– Many display choices–by market cap, trade volume, percent price change, alphabetically (handy if you’ve forgotten the stock symbol or conversely, the company’s name), or price change versus the S&P 500.

– Charting time frames from 1 day to 5 years.

– Clickable headline views on any selected stock.

– A stock symbol search feature.

– An optional running ticker of the Dow Industrials, S&P 500, and Nasdaq.

– A “Favorite Stock” feature (touch the star button) that will cause selected stocks to stand out in macro views.

Desired additions
This application is in its infancy and the developer is promising to add more features. “Wants” that many current users hope will be incorporated into future releases include the following:

– An Android version that the company claims is coming soon.

– The addition of lower-cap stocks, ETFs, and commodities.

– A direct connection to online trading platforms.

– The ability to swipe to adjacent stocks in single view mode.

– More charting tools & indicators such as candlesticks, MACD, and RSI.

– The option of creating stock watchlists.

– Price alerts sent via email or text.

The bottom line
Users give this app a thumbs-up based on its graphic design and intuitive nature, but many feel that more bells and whistles are needed. I think the $4.99 nominal fee is well worth the price, and as more of the above changes are incorporated, it will become an even better value. If you’re an active trader and want to see at a glance how stocks, sectors, and markets are trending, then this is the app for you!

Disclosure: I was given the app to review and have no other affiliation with the company.

Themes: mobile applications, stock software, Apple applications, iPhone apps, software reviews

Trade of the Day: Herbalife (HLF)

February 22nd, 2012

Herbalife (HLF) makes weight management and nutritional products and supplies them through its own network of personal distributors worldwide. Today the company reported record fourth quarter sales along with record earnings and free cash flow. FY12 revenues are expected to expand by 9-10% to $3.77B – $3.83B–that’s B for billion, folks. The company is enjoying strong growth especially in the Asia and Central/South America regions with emerging market growth outpacing established markets’. The company boasts an exceptionally high 80% return on equity (ROE) and its P/E of 20 puts it inline with its industry peers. It pays a 1% dividend (which could stand to be raised). One possible negative is that the CEO has been selling a lot of shares in the past couple of months.

The weekly chart of the stock (shown below) is compelling because it finally broke out of its 10 month rangebound pattern to hit a new all-time high of $66. Judging just from the technicals, the stock has room to run to well over $100.

Surviving Market Crashes Part 4: The global debt crisis

February 7th, 2012

In the previous articles* on surviving market crashes we demonstrated how a market timing modification to Modern Portfolio Theory (MPT) provided asset allocation recommendations that resulted in the investor avoiding most of the losses during these market crashes. Not only that, but in the case of the dot-com bust, the model actually produced a significant positive return.

What is Modified Modern Portfolio Theory (MMPT)?
MMPT is the application of an optimized market timing strategy to MPT which not only produces superior returns but also does so at much lower risk than MPT. The reader is invited to read these articles* to become familiar with the basics of the approach which we call Modified Modern Portfolio Theory (MMPT).

In this article we will be considering the time of global instability arising from the debt crisis in the Eurozone in which we will show that the MMPT constructed portfolio would have significantly outperformed the classic MPT model portfolio.

Global Debt/Recession Fears
The movement of the market is heavily influenced by the uncertainty in the economic environment, and it is this uncertainty that is measured by the volatility index (VIX). Following a spike in volatility in March of 2011 resulting from the tsunami and nuclear plant meltdown in Japan, the volatility settled back down to stable levels below 20. But it began to rise again as both the domestic and Eurodebt crisis came to the forefront on the heels of sovereign debt downgrades heralded by some of the major ratings agencies.

It wasn’t until the end of July that the volatility began climbing to bearish levels (over 25). July 22nd was the last time the S&P 500 (SPX) hit a relative high of 1346 before the VIX took off, sending the S&P plunging 17% in a few short weeks. Following Standard & Poors downgrade of the US’s credit rating, the SPX hit a low of 1120 on August 8th as the VIX concommitantly hit a high of 48. After two months of extreme choppiness, the VIX hit another relative high on October 4th as the S&P put in an intraday low of 1075, representing an overall loss of 20% from its July high. (See charts below.)

To compare how a modified portfolio would have done compared with a classic one, the reader should understand the underlying methodology. Both portfolios are made up of the same nine asset classes comprised of domestic and international stocks and bonds along with real estate (in the form of REITs). The model portfolios presented here are designed to return a 10% compounded annual return, the same that was used in the previous articles. The analysis rebalances the portfolios monthly as new total return asset class performance data is made available. The portfolio allocation tool used to conduct these studies for both the classic MPT model and the market timing MPT approach is the SMC Analyzer.

The allocations
During this turbulent time period, an MPT portfolio with a 10% required annual compounded return would have been heavily invested in the stocks of large and small companies both domestic and international (see Table 1). But the MMPT equivalent model (see Table 2) was already light in the large and small stock asset class having benefited from the recent experience of the dot-com bubble and subprime mortgage collapse. Despite some optimism for the alternative international stock and real-estate investment trust asset classes the allocations there were comparatively light, instead heavily favoring medium-term government bonds and the safety of Treasury Bills (or an insured money market equivalent).

Table 1. Classic MPT Historical Allocations During the Subject Period for a Target 10% Compounded Annual Return

Table 2. MMPT Historical Allocations During the Subject Period for a Target 10% Compounded Annual Return

Comparing models
During the months of this mostly fear-driven event, the MMPT portfolio lost at a rate of only 4.7% compounded annually (green line) while the classic MPT portfolio lost money at an annual rate of -40.4% (magenta line). Further, the MMPT portfolio was less volatile. It experienced a standard deviation of only 3.9% while the classic MPT investor experienced a standard deviation of 6.2%.

Figure 1. Comparison of results
(green = MMPT)
(magenta = MPT)

We have shown that an MMPT investor during the global debt crisis was able to hold onto almost all of his money while most other investors were getting hammered. The reason is that a considered and properly applied market timing approach injects an element of flexibility and responsiveness to a portfolio while still benefiting from historical experience. This is of tremendous value especially in today’s uncertain markets.

Every day the news concerning the uncertainty of the global economy is increasing volatility across most of the traditional asset classes, and it’s for this reason that market timing approaches should be given their proper due. I believe we have shown once again with this case study that the MMPT approach combines the best of Modern Portfolio Theory with the desirability of a viable market timing strategy

For further information on how you can save your portfolio from the ravages of market crashes please visit our website.

*Previous articles on Surviving Market Crashes:
Part I: “Surviving Market Crashes”, August 23, 2011
Part II: “Surviving Market Crashes, Part 2: The dot-com bust”, September 29, 2011
Part III: “Surviving Market Crashes, Part 3: The subprime mortgage crisis”, November 19, 2011