The Other Side: Smart Money, Carving Station and a New Indicator...
It was convenient to point to the problems the sub-prime borrowers would have, but... it looks like the "smart money" was the group with the ticking time bombs on their sheets.
Note From Prof. Krueger: I wanted to share what may be on the other side of both a headline and a stock that you have no doubt read and heard of.
Before anyone disagrees with either crazy notion, let me be the first to join you.
This will be the origin of each "Other Side" column. I am simply sharing the result of work that began by attacking my own ideas (posing as the other side of each of my trades and structural positions and building a case against myself), especially if I can find a mis-priced trade resulting from over-bet assumptions including, at times, my own. Our biggest mistakes can be found in the mirror, not on the screen.
A good friend and Minyan ask me last night why I had done so much mid-day buying yesterday along with taking off a lot of my hedges. He ask what in the world I saw that makes me think the market was going higher (he's short and he's smart).
My answer is actually on the other side of that question: it had a lot less to do with the buying and more to do with the selling. I think the liquidation waves had little to do with the global growth story and less to do with the domestic debt problem than has been reported. This is but one man's opinion. I simply had a feeling yesterday, and my partner will confirm how rare that is, and how little it has to do with any of my work.
Am I the smart money? Hardly. I'm the same guy who walked out of the house without my keys this morning and then had to grope around on hands and knees in complete darkness trying to find the extra key, then drove off with all my mail and lunch safely resting on the top of my car (not the first time that's happened). I have no way to describe a 'feeling' other than it's what you can get when you give up almost every other natural instinct and good skill of a normal person to completely immerse yourself in a trade with unblinking focus. The tradeoff is bittersweet. Somebody will be walking their dog this morning on my street without a worry in the world and find a free lunch. I worry so much I often forget to eat lunch.
It was convenient to point to the problems the sub-prime borrowers would have, but from where I sit it looks like the "smart money" was the group with the ticking time bombs on their sheets. The problem was 10-to-1 (and often much more) leverage on paper more than mortgage leverage on homes. The forced liquidation, from leverage being unwound after a number of wrong bets (many having nothing to do with mortgages) was intense and the reason I opined that the best place to sell or hedge was the source of funds sectors born from huge speculative profits (Energy and Materials and Yen), not the source of the perceived problems. The Materials Sector (XLB) is down almost 16% over the past month, Energy (XLE) is down 10%. Month-to-date, those two are down more than any other sectors (-9% and -6% respectively) while Financials (XLF) are actually now up for the month.
The Carving Station
Using the S&P 500 price action here is the ugly tale of the tape for longs.
- Past 2 days (1%)
- Past week (3%)
- Past 1 month (9%)
- Past 3 months (7%)
I set my carving station to slice off the stocks that not only beat those averages, or lost a lot less, but actually to plate for us stocks that were up in every single one of those time-frames. Not one: they only qualified if they were positive in all of them.
I then set the blade even thinner to leave only the stocks which also produced 15% or better EPS growth over the past four quarters, and 7% or better revenue growth over the same. Each are above S&P 500 averages. Finally, I threw out all the gristle by excluding any micro-cap, stock under $10, or illiquid shares. Here's a handful of interesting names that made the final cut.
- McCormick & Schmick (MSSR), appropriately, is a high-end steak and seafood restaurant chain. I was shocked this came through but that's the point of the process.
- Nestlé (NSRGY), is a global food manufacturer selling into hundreds of countries with a kicker of also owning over half of the shares of Alcon (ACL) specializing in eye care.
- Exponent (EXPO) is a consulting firm for engineering and environmental companies. The majority of its contracts come comes from engineering, which is my single favorite industry.
- Paraxel (PRXL) provides biopharmaceutical clinical research services. Biotech, in general, sets up as one of the two or three groups better poised for a move from my perch.
- Berkshire Hathaway (BRK.A/BRK.B) was a little cotton milling operation until it was taken over by some guy with a few investment ideas. That Buffett joins this buffet intrigues me, less because of what I know he owns and potentially more by what is less widely reported – his trading acumen. Could he have scored in the currency or bond markets?
Three among this group - Nestlé, Exponent, and Berkshire actually sit within 2% or less of their 52-week and all-time highs.
YAAM Indicator hits 12!
I spend less time than any other money manager I know studying economic numbers. I trust very few of them, I don't understand plenty of them, and their streak of predicting precisely what has already happened is unblemished.
Since my trading desk and design is entirely devoted to stock selection instead, any indicator I build outside of that will likely be met with harsh criticism or predict the future – sometimes a little of both. All of my proprietary indicators are built around my long-held and consistently supported belief that I'd rather spend 1 minute with a delivery guy than 1 hour with a delivered speech.
A little over a year ago I unveiled my Jumbo Shrimp Indicator. Today, for the first time and with some hesitation I will share the YAMM, which is much more scientific and actually has been a staple in my economic analysis for many years.
The You-Are-Aware-Meter (YAAM) was based on the fine work of a great trader from the 80's, George Costanza. You may recall his positions in a few key stocks. Petramco was in late stage developments for a robot butcher and Sendrax had an innovative solution for televising opera.
When Costanza wanted a job with a firm called Sanalac, the interview was cut short by a phone call. He was left to wonder what the end of the final sentence was before the boss waved him out. He told George he'd like him to have the job but... "You are aware..." (YAA).
This became a phrase that is unfortunately quoted at least every week in my offices ever since. We adapted it to mean when we have absolutely no idea what happened to the other side of a business contract we were ready to sign. This can include anybody from high-end to low-end jobs (you can perhaps already see how this data is much more rigorous than most other economic analysis) so that it effectively captures the broadest benchmark of mind-boggling apathy we've ever witnessed. I associate most YAA's with pretty full schedules, or remarkably stupid people, and since I'm trying to be positive, not to mention re-write a few economic textbooks, let's stick with full schedules.
The K&C YAAM hit an all-time high of 12 this week. I'm not cherry picking, I shared this with friends on Wednesday, actually. There are no fewer than 12 deals or requests on everything from a few hundred bucks to tens of thousands that I have given more than my OK to, which were met with days, weeks, or months of YAA's. The YAAM would have you long this economy, and pretty short on understanding why.
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