Minyan Mailbag: The Other Side of the Trade
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
One of the things I try to consider when establishing or maintaining a position for an investment (as opposed to a trade) is what the person on the other side of the trade is thinking. Whatever the merits of what I might be thinking when I'm buying/shorting or selling/covering, there's someone else out there with an opposite conviction taking the other side of the transaction.
I find myself pondering this in the context of AIG (and, to a lesser extent, Fannie Mae (FNM)). Anyone who reads The New York Times or the Wall Street Journal would have seen the same articles yesterday that made me think, "You know, this stuff about long-term underpaying into state unemployment compensation funds probably has our friend Elliot Spitzer thinking about ... salivating about ... indicting the whole damn firm as an 'ongoing criminal enterprise.' The stock is going to wind up worthless." There's more bad news today, lots of it.
Instead, the darn common was up most of yesterday before finally closing a bit lower, and it's up again today. So, I'm wondering, from whom is the buying pressure coming? What are they thinking? This is just going to blow over, or Spitzer is going to roll over and play dead, or the stock price already discounts the worst possible news even though there are new revelations daily?
I'm just trying to assimilate the other guy's thought process, and I'm "just not getting it." Any thoughts?
Thank you for hearing me out on this. Hope you're having a great day.
Minyan Ben Richter
Positions in AIG and FNM
Think about this chain of events.
A poll was just conducted trying to ascertain the level of financial acumen of the general public. Two of the responses I think answers this question fairly plainly: "about half of American adults did not know that if they kept their money at home, in cash, they were at greater risk of losing ground to inflation than if they invested it elsewhere" and "one-third of adults were unable to explain how falling interest rates would affect business."
It is these same people that are the source of the $6 trillion invested through mutual funds, without a clear understanding of how mutual funds operate. Mutual funds are free to operate on the dark side: they operate to maximize their fees over a long period of time. A great deal of the time that objective is not congruous with selecting stocks and stock market exposure in the best interest of their clients (this is my opinion based on experience). As long as money flows into mutual funds and markets rise, the objective is based on the relative performance of one fund over another. This normally means being fully invested at all times and buying the same stocks over and over.
Eventually fundamentals play themselves out. But the utter size and control that mutual funds have (and now hedge funds) can delay this process for long periods of time.
Sealed Air (SEE (we are neither long nor short this stock)) reported disappointing earnings this morning and guided down for 2005. This is not a cheap stock by any measure. Why is the stock basically unchanged this morning? Well, it didn't begin that way. After trading down over $2.50, it slowly began to grind back up and is now down only $.28. I would not be surprised to see it up on the day (not advice). A crucial piece of information is that one mutual fund owns 34% of the company. Do you think they can even sell the stock? Do you think maybe because they own so much they have nothing to lose by buying more even into bad news?
So things don't often make sense to fundamentals, especially in the short term. I think people more react to price action than actual information..."oh, the stock is only down small so it must not be bad." Pavlov proved this. People are driven by fear and greed and prices are the biggest variable.
You may be eventually right but the trick is timing and risk control: You have to be there when the funny stuff is overcome by fundamentals. That could take a long time and a lot of price movement.
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