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Tuesday links: anomalies have no soul
In light of the holidays why don?t you check out: David and Goliath: Underdogs, Misfits, and the Art of Battling Giants by Malcolm Gladwell.
Quote of the day
Matt Levine, ?No matter how long the anomalies have persisted, if they?re just brute statistical facts they could always go away tomorrow. Your anomalies have no soul.? (Bloomberg)
Chart of the day
Billionaire Portfolios: They?re Just Like Ours!
Had some fun playing with the Bloomberg Billionaire tool this morning, located here.
Some of the data I was able to pull about YTD dollar and percentage gains in billionaire net worth tells an interesting story about what?s worked this year (tech and activism) and what has not (emerging markets and commodities). It?s amazing how this mirrors what?s worked and not worked in a typical investor?s portfolio.
Some tidbits:
Tech has been great in 2013, especially old tech like Microsoft:
Bill Gates, retired, is the biggest winner of 2013 in dollar terms. His net worth is up 23% YTD to $77.7billion, reclaiming the top spot.
? Downtown Josh Brown (@ReformedBroker) December 3, 2013
Emerging markets like Latin America, not so much:
Carlos Slim, the world?s #2 billionaire, actually managed to lose money this year, net worth down $3.7 billion YTD (too much EM exposure).
? Downtown Josh Brown (@ReformedBroker) December 3, 2013
And don?t even get me started on metals and other commodities:
The biggest billionaire loser is Chilean copper heiress Iris Fontbona, who lost $6 billion or 20% of her fortune in 2013. Commodities.
? Downtown Josh Brown (@ReformedBroker) December 3, 2013
And the year?s big Wall Street winner was Carl Icahn ? everything this guy touched turned to gold:
Carl Icahn surpassed George Soros this year in net worth. $23.7 billion vs $22.9 billion. Carl made 8 billion dollars this year, OMG.
? Downtown Josh Brown (@ReformedBroker) December 3, 2013
Have some fun with the data on your own, click below:
Bloomberg Billionaires Ranking
This Stock Soared 6,000% This Spring -- And Still Has Triple-Digit Upside
Just as every fisherman has stories about the big one that got away, every investor has "woulda, coulda, shoulda" tales of investments that would have been wildly profited wildly if they had only purchased.
I myself have one such tale from the past year. It gnaws at my insides to think about the massive profits that I missed out on, even though I felt a strong conviction to buy. The good news is that it's not too late to jump on board.
This stock was trading near $65 in 2007 before the financial crisis knocked it down below $5. The price wallowed in the nowhere zone under $5 for several years before slipping into penny-stock territory below $1. Although this company was (and is) majority owned and controlled by the U.S. government, most investors had written it off as not viable. At one point, the stock price fell to less than a dime a share. The price collapse caused the company to be delisted from the New York Stock Exchange, relegating its shares to the over-the-counter market.
I considered buying shares in the $0.15 area, thinking that there was no place for this once-mighty quasi-government agency to go but up. All the bad news was already reflected in the price, the housing market had improved, and there was no longer chatter about the government shutting down the company. I noticed the volume picking up and the price rising -- but fear and doubt kept me from buying.
Between late March and late May, this stock rocketed from a low of $0.09 to nearly $5.50. I watched the entire 6,000% moonshot in amazement. Every $100 investment near the lows would have skyrocketed to more than $6,000 in around 60 days, an incredible return by anyone's standards. The price has since dropped back to about $2.70, but it could easily double or even triple from here.
If you haven't guessed, I am talking about the Federal National Mortgage Association, commonly known as Fannie Mae (OTC: FNMA). A $15 billion-plus company by market cap, Fannie Mae provides liquidity and stability services in the secondary U.S. mortgage market. In other words, it guarantees and securitizes mortgage loans originated by lenders in the primary mortgage market.
Fannie Mae's financial condition has improved dramatically since the housing crisis. Over the past five years, Fannie Mae has facilitated $3.9 trillion in mortgage credit, supported 3.4 million home loans, 12 million mortgage refinances, and 2 million units of rental properties. By the end of this year, it will have paid back $114 billion to taxpayers.
After posting this type of performance and rebound, why are there lingering concerns about Fannie Mae? The U.S. government still owns nearly 80% of both Fannie Mae and its sibling firm, Freddie Mac, and most of Washington's Republicans and Democrats want the firms dismantled (and their shareholders wiped out) as part of a broader overhaul of the housing finance industry.
But at least two large hedge funds disagree with Washington's assessment and are fighting to keep Fannie Mae a viable, ongoing concern: Fairholme Capital Management (Nasdaq: FAIRX), led by Bruce Berkowitz, and Bill Ackman's Pershing Square Capital Management.
Currently Fannie's largest stockholder outside the U.S. government, Berkowitz wants to restructure Fannie and Freddie through negotiations with their stakeholders, with the goal of freeing them from government control. Ackman's firm owns a nearly 10% stake in Fannie Mae's common stock and has earned a return of 44%.
Put simply, Berkowitz wants to design a new mortgage insurer by jettisoning the old mortgages, including those in foreclosure. This book of old business would be transferred to common shareholders such as Ackman, who doesn't seem concerned by this possibility. He has said the mortgage insurers should keep the foreclosed assets, rehabilitate the homes and rent them out -- basically, become a large residential REIT.
Judging by Ackman's statement, I expect that should Berkowitz's plan be instituted, Ackman will lead the charge in turning what's left of the common shareholders' holdings into a gigantic REIT. This would be a win-win for everyone involved. Ackman has gone as far as saying that it would instantly stabilize the housing market.
Risks to Consider: The hedge funds fighting for Fannie Mae's survival are no match for the powers of the U.S. government. Although I firmly think that a proposal similar to Berkowitz's will prevail, there remains a high risk of Fannie and Freddie being dismantled, leaving the common shareholders with nothing. Always diversify and use stop-loss orders when investing.
Action to Take --> I am convinced that Fannie Mae will reach $8 within the next 12 months. Dismantling Fannie and Freddie would be too much of a headache for Washington, not to mention the shareholder blowback should such an idea become reality. Politicians usually take the path of least resistance, and that path is to maintain Fannie Mae by following a Berkowitz-type proposal. Buying the stock between $3 and $2.25 with a 12-month target of $8 and an initial stop-loss just below $1.75 makes solid investment sense.
- David Goodboy
Related Articles
December 3, 2013 ? Quote of the Day
Steve Jobs offered me one third of Apple for $50,000 and I was so smart that I turned it down. It?s funny when you think about it now, except when I?m crying,? said Nolan Bushnell, the founder of game company Atari and Jobs? first employer.
Buy Flood Insurance With the VIX
I am one of those cheapskates who buys Christmas ornaments by the bucket load from Costco in January for ten cents on the dollar because my eleven month return on capital comes close to 1,000%. I also like buying flood insurance in the middle of the summer when the forecast here in California is for endless days of sunshine.
That is what we are facing now with the volatility index (VIX) where premiums have been hugging the 12%-14%% range for the last several months. Get this one right, and the profits you can realize are spectacular.
The CBOE Volatility Index (VIX) is a measure of the implied volatility of the S&P 500 stock index, which has been melting since the ?RISK OFF? died a horrible death. You may know of this from the talking heads, beginners, and newbies who call this the ?Fear Index?. Long-term followers of my Trade Alert Service profited handsomely after I urged them to sell short this index two years ago with the heady altitude of 47%.
For those of you who have a PhD in higher mathematics from MIT, the (VIX) is simply a weighted blend of prices for a range of options on the S&P 500 index. The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front month and second month expirations.
The (VIX) is the square root of the par variance swap rate for a 30 day term initiated today. To get into the pricing of the individual options, please go look up your handy dandy and ever useful Black-Scholes equation. You will recall that this is the equation that derives from the Brownian motion of heat transference in metals. Got all that?
For the rest of you who do not possess a PhD in higher mathematics from MIT, and maybe scored a 450 on your math SAT test, or who don?t know what an SAT test is, this is what you need to know. When the market goes up, the (VIX) goes down. When the market goes down, the (VIX) goes up. End of story. Class dismissed.
The (VIX) is expressed in terms of the annualized movement in the S&P 500, which today is at 1,800. So a (VIX) of $14 means that the market expects the index to move 4.0%, or 72 S&P 500 points, over the next 30 days. You get this by calculating $14/3.46 = 4.0%, where the square root of 12 months is 3.46. The volatility index doesn?t really care which way the stock index moves. If the S&P 500 moves more than the projected 4.0%, you make a profit on your long (VIX) positions.
Probability statistics suggest that there is a 68% chance (one standard deviation) that the next monthly market move will stay within the 4.0% range. I am going into this detail because I always get a million questions whenever I raise this subject with volatility-deprived investors.
It gets better. Futures contracts began trading on the (VIX) in 2004, and options on the futures since 2006. Since then, these instruments have provided a vital means through which hedge funds control risk in their portfolios, thus providing the ?hedge? in hedge fund.
But wait, there?s more. Now, erase the blackboard and start all over. Why should you care? If you buy the (VIX) here at $14, you are picking up a derivative at a nice oversold level. Only prolonged, ?buy and hold? bull markets see volatility stay under $14 for any appreciable amount of time.
If you are a trader you can buy the (VIX) somewhere under $14 and expect an easy double sometime in the coming year. If we get another 10% correction somewhere along that way, that would do it.
If you are a long-term investor, pick up some (VIX) for downside protection of your long-term core holdings. A bet that euphoria doesn?t go on forever and that someday something bad will happen somewhere in the world seems like a good idea here.
If you don?t want to buy the (VIX) futures or options outright, then you can always buy the iPath S&P 500 VIX Short Term Futures ETN (VXX).
If you lose money on this trade, it will only be because you have made a fortune on everything else you made. No one who buys fire insurance ever complains when their house doesn?t burn down.
Has Gold Reached An Inflection Point?
Market tops and bottoms are always a popular topic of conversation. There are a number of theories about how to forecast key turning points in advance, but, in reality, those theories rarely work.
While it does seem like an exercise in futility to forecast the day and price of tops and bottoms, there is valuable information to learn from studying the general nature of market turning points. This knowledge will help us understand what to look for and how to react to the market as it develops rather than provide a false sense of comfort about what we should see.
In the stock market, we tend to see tops build slowly and bottoms appear unexpectedly. This can be seen in the chart below, which shows the 2007 market top on the left and the March 2009 bottom on the right.
SPDR S&P 500 ETF (NYSE: SPY) built a top slowly, over a period of several months. The bottom, on the other hand, came unexpectedly and was greeted with disbelief.
This pattern has been seen at other significant stock market turning points. The bottom that occurred in 2002 was also unexpected and sudden, while the top in 2000 had been formed over several months. While the top was forming, stocks moved within a relatively narrow range as the transition from bull market to bear market was completed.
This behavior can be explained with investor sentiment. In a bull market, investors become conditioned to buying dips. They respond to price drops by buying, and this is why we see prices trade in a consolidation pattern at a top. Buying the dips shows up as support on a chart, and excessive valuation levels prove to be resistance levels.
Bottoms in stocks begin when sentiment is negative and selling has reached a peak. When the selling pressure is exhausted, prices rebound suddenly.
Gold and other commodities tend to behave differently, as the next chart shows.
Has Gold Reached An Inflection Point?
Market tops and bottoms are always a popular topic of conversation. There are a number of theories about how to forecast key turning points in advance, but, in reality, those theories rarely work.
While it does seem like an exercise in futility to forecast the day and price of tops and bottoms, there is valuable information to learn from studying the general nature of market turning points. This knowledge will help us understand what to look for and how to react to the market as it develops rather than provide a false sense of comfort about what we should see.
In the stock market, we tend to see tops build slowly and bottoms appear unexpectedly. This can be seen in the chart below, which shows the 2007 market top on the left and the March 2009 bottom on the right.
