03/02/2013 Playing Games

Sector Model	XLU	40.16%
Large Portfolio	Date	Return	Days
BBRY	7/16/2012	84.28%	229
SEAC	9/25/2012	41.00%	158
CAJ	9/25/2012	5.73%	158
CFI	10/31/2012	32.80%	122
RE	11/26/2012	19.10%	96
NSC	1/28/2013	5.56%	33
BOKF	2/4/2013	6.01%	26
SWM	2/12/2013	2.47%	18
GMCR	2/19/2013	7.57%	11
OKE	2/25/2013	-5.10%	5
S&P	Annualized	6.89%
Sector Model	Annualized	21.21%
Large Portfolio	Annualized	30.67%

 

Rotation: selling NSC; buying TTM (Tata Motors)

Basically we’re moving from a railroad to a car company.

Cars are a consumer cyclical industry, more indicative of a market bottom than of a market top.  My full industry model is NET 100% bullish.

And yet… the sequestration apocalypse happened on Friday.

In light of the stand-off between the two political parties, a few words on game theory:

 

Game Theory.  We see it in movies and TV shows every time two characters pull guns on each other and don’t fire.  If you put the gun down, the other guy will pull the trigger.  If you pull the trigger, the other guy will have just enough time to pull his trigger.  If the other guy pulls his trigger, you’ll have just enough time to pull your trigger.

So no one puts the gun down, and no one pulls the trigger.

Stalemate.

But you only see it on screen.

I used to be a firearms instructor in law enforcement.  You never see these standoffs in real life.   In real life, you pull out a gun in order to pull the trigger as fast and as accurately as you can, hoping to do so before the other guy.  If you see the gun pointed at you, you’ll fire faster.

Game theory, for all its beauty and elegance, doesn’t work in real life, because real life has real people in it.  Most of the books on game theory point out how people do NOT operate in a mathematically optimal way.

When it comes to stocks, here are just SOME of the variables in the game:

Known fundamentals that are correct.

Known fundamentals that are incorrect (and there are plenty).

Technical momentum.

Technical mean reversion.

Right – each set cancels itself out.

Plus, here are just SOME of the players in the game:

Insiders who are operating on unknown information that is correct.

Insiders who are operating on unknown information that is incorrect (a lot of insider traders who have been convicted, were convicted over illegal trades in which they still lost money…).

Fundamental mean reversion players (Warren Buffett).

Fundamental momentum players (David Lynch).

Technical mean reversion players (Tom Dorsey).

Technical momentum players (Sam Weinstein).

And, to make matters worse, two ways to play a stock: up & down.

So, a stock is plummeting and Weinstein is shorting it for all it’s worth.  As it starts getting too cheap Dorsey will look at a bullish percent index under 10 and get the heck out of the short.  He sells to Buffett, who just buys more as it gets cheaper.

The stock starts to turn.  The bullish percent index trips above thirty and Dorsey is now long with Buffett.  The volume picks up and the stock trips above its long term moving average and Weinstein covers his short.  An earnings report shows that earnings are growing faster than price, so Lynch goes long.

Once everyone is in, the last of the Buffett style traders sell to the last of the Weinstein and Lynch traders and the Dorsey traders hang on until the bullish percent index tops 70 and then falls back below it – then the whole thing cycles, over, and over, and over again.

Add in the seasonal traders and you have yet a fifth kind of player.

Add in the inter-market analysis traders – (John Murphy and Sam Stovall), and they’ll be playing wild cards like “Financials are doing great, so let’s pile into Consumer Cyclicals.”

And these are just the strategic traders.

There’s also the full business cycle to consider, the Federal yield ratio, quantitative easing, the exchange rate effect, commodity inflation, etc.

And there are the trading robots stalking prey, piling in more and more variables in an effort to manipulate what is known about technical and behavioral factors.

And there are demographics – young people flooding the marketplace for work in the 1970s created both inflation and unemployment, while the retirement of those same people in the 2010s is creating both deflation and suppressing the unemployment numbers.

Do you REALLY want to trade stocks based on what you THINK they might be worth to someone ELSE?

That’s not investing; that’s speculating.  And there are too many KNOWN variables to even hope to play it correctly.

You’ll never be smart enough, informed enough, sane enough, prescient enough, or fast enough to beat the high frequency trading algorithms out there.

So, there are four choices.  Play your gut and lose money, buy and hold the index, stay out of the market, or…. OR… ask something not covered in game theory.

Instead of asking what the stock might be worth to SOMEONE else, ask instead what the stock is worth to YOU.

No, really.  That’s why you buy a house isn’t it?  Granted, the previous decade was full of people trying to flip houses, but the traditional reason to buy a house is to have a place to sleep at night.

You buy a house to LIVE IN IT.

If real estate gets cheaper you don’t despair; you take advantage of the cheap building prices and add a room.

If the price of a stock is going down, do you cut it for a small loss or buy more of it?  Weinstein will pile on short while Buffett will be snatching it up long.

Here’s the key – you aren’t buying a piece of paper for what it’s worth to someone else; you are buying a company for what it’s worth to you.

Isn’t that was a stock is, after all?  It’s not a blip on a screen or a piece of paper.  It’s a piece of a company, with managers, employees, inventory, brand name, cash flow, debt, and profit.

Would you own the company?

Would you own the product?

Is it at a good price?

Friday morning I texted on a blackberry while I was getting a document from a canon printer.

I even had some coffee.

And I don’t just own those companies – I’m also a client (yes, I stole that from the hair commercial).

What does game theory have to do with all that?

Why, nothing at all.

The people who win the game are not the ones who are playing around, but the ones who mean business.

Do you REALLY want to spend your time trying to second guess how other people second guess your second guesses?  Or would you rather learn a bit about business risk and profits?

I thought so.

Next up – I’ll devote some blog posts to what’s really good in those fundamental details and why value investing is the way to find some sanity in the midst of news driven chaos.

Tim