The bias still seems to be to the upside
Steve Cook on Disciplined Investing


Have You Seen This?


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Have You Seen This?

The Market

    The Averages (DJIA 10415 S&P 1104) had another decent day yesterday.  They remain within their current trading ranges (9645-10725, 1042-1149).  Note that the S&P closed right on the down trend off its April 2010 high.

    Volume continued low; surprisingly, breadth weakened; and the VIX was off but remained within the prevailing pennant formation. 

    Since the S&P closed on its nearest resistance level (1104) and given that our internal indicator is suggesting that the S&P will move higher, last night I ran another study of our Universe versus the S&P ‘right shoulder’ resistance level (1132).  Of the 159 stocks in our Universe: the prices of 75 stocks are currently above the comparable 1132 level, 84 are  not and 12 are too close to call.  While that isn’t a rousing bullish indication, with the S&P still 2.5% below 1132, in my opinion, it gives a positive bias to the Market.

    Bottom line: momentum is currently with the bulls; however, let’s not forget (1) September is historically the poorest performing month of the year, (2) volume has been low and will probably stay so until at least next week and the end of the Jewish holidays.  I would like to see all investors back before I get too enthusiastic about the current up trend, (3) judging by Obama’s speech Wednesday, the political rhetoric seems likely to only get more strident as November 2 approaches.  I am not getting beared up; I am just suggesting the need for balance and caution.  Our Portfolios will be Buyers at the S&P 1042-1068 level.

    Since I mention the VIX almost everyday, I thought that this discussion on the VIX and its options would be beneficial. (medium)

    The bear take on current funds flow (medium):

    Here is a more neutral analysis (medium):


    Yesterday’s economic data was quite positive--jobless claims fell more than anticipated (though we subsequently found out that there was a problem with the data--see below) as did the July trade deficit (remember a narrowing trade gap means an improvement in the GDP number).  Not that these stats portend accelerating economic growth; they don’t.  But they do support the notion that the US will avoid a ‘double dip’ (which has been the bugaboo in investor sentiment of late); and that, of course, bolsters not only our economic forecast (slow, uneven growth; but growth nonetheless) but also the assumptions in our Valuation Model. 

    Here is a skeptic’s take on the jobless claims number (short):

    Bottom line: the recent improvement in the economic data sustains our opinion that stocks are modestly undervalued.  That led to our Portfolios committing some cash last week.  However, given our long term outlook that the US economy will grow at an historically below average rate for the foreseeable future, there is little incentive to chase stocks up.  Accordingly, our strategy remains to Buy stocks on weakness.
    The disconnect between the economy and the stock market (chart):

    The latest from David Rosenberg (short):

    The bear case on why rising stock yields are not a positive (medium):

    A cynic’s guide to higher stock prices in September (medium):

    Interest rate spreads as a measure of risk (short):
     Thoughts on Investing--from the Apprenticed Investor

Want to become a better investor?

Get brain damage.

That's the finding of a rather unusual study by researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa. It was published in Psychological Science in June, and its conclusions were reported in The Wall Street Journal last week.

But don't start playing football without a helmet just yet: It's not any type of brain damage that helped investors in the study, but rather, a very specific form: a site-specific lesion (a kind of tissue damage) in the region of the brain in charge of controlling emotions.

The investors who have these lesions are unable to experience fear or anxiety. It turns out that lacking the emotionality ordinary investors exhibit leads to better investment decisions. It is not at all surprising that the emotionally limited investors outperformed their peers. We know from experience that when investors allow their emotions to unduly influence them, they tend to make foolish -- and expensive -- decisions.

It was not simply a lack of emotions that caused the improvement in performance in the study. When presented with a high risk, higher return possibility, the participants with these site-specific lesions lacked the fear the other investors had. The more emotional participants failed to capitalize on these opportunities. In other words, they were greedy at the right time. That accounted for nearly all the difference in their performances.

But the basic lesson from the study is simple: Investors who learn how their emotions impact their investing -- and can get them under control -- stand to significantly improve their returns.

Emotions Undercut Performance

As discussed previously, human beings just weren't built for capital markets. We have numerous design flaws that work against us in the investment process. But once you become aware of how they impact your thinking, you have a chance at avoiding some of the more damaging behaviors. At the very least, you can try to work around some of these hard-wired foibles.

There are three broad categories in which emotions work against the investor: ego, flawed analyses and the derailed plan. Let's look at some examples within each category.

The ego issue may be subtler than you would expect; certainly, a prideful trader who is unable to admit he or she is wrong ends up holding losing positions longer than he or she should. That's an expensive flaw, and it's why investors who anticipate being wrong can more quickly -- and therefore less expensively -- cut losses.

But ego has an insidious impact on our analytical abilities as well. It is a subtle form of bias inherent in our thinking process. Ego is why we selectively perceive data, why we emphasize that which confirms our prior views. It helps us ignore new data that may contradict our preconceived notions. It even facilitates our forgetting information that is inapposite to our viewpoint.

That's a pretty powerful analytical flaw hardwired into our brains, damaged or not.

We have other analytical flaws that are emotionally related. Why do we over-emphasize the most recent data point in a series? Each new economic report generates a giddy excitement, almost as breathless as a child the night before Christmas. When we consider the volatility of these data series, and the hedonic adjustments each one must suffer through, it's apparent that they are of more limited individual value. Smart traders focus on the trend of these releases, and not any one data point.

And yet...
We might have enjoyed 10 good GDP reports in a row, but let one bad one slide out and we become fearful and nervous. Or consider the opposite: we've just had over two years of data suggesting that inflation is resurgent, yet the first monthly report (June 2005) showing CPI and PPI as flat caused the Greek chorus to sing that inflation has been defeated in our lifetime. That's hardly the case.

Then, there are fear and greed. These are the best-known market emotions, and they cause all sorts of problems for investors. Our passions have an unfortunate tendency of getting the better of us -- and at exactly the worst possible moment, too. It's not merely chasing hot stocks at the top or getting panicked out at the bottom that's so problematic: It's the impulsive destruction of our investment strategy and long-term plan.

Decisions vs. Decision Making

One of the reasons that emotionally restricted investors have an advantage over everyone else is that they eliminate emotional decisions. It's a battle between impulsive choices, vs. a process for making rational decisions.
Without the tug of adrenaline and dopamine, you can stick to your original investing plan. That's actually the key problem with biochemical or hormonal decision-making: It's not that the decisions are necessarily so bad -- although they often are -- but even more significant, they derail your original investment plan.

As investors, you need a plan that allows you to save an adequate amount of money for retirement. We'll delve into this further in a future column but, suffice to say, the biggest problem with fear and greed is that in the blink of an endorphin, they can derail a well-thought strategy.

Think of this in terms of food: Imagine you are on a carefully crafted diet. You eat only healthful meals from a list of ingredients that have a good balance of carbohydrates and protein, with a limited amount of fat. Now consider an impulsive snack. What are the odds that this cheat will fit into your planned diet?

That's the key problem with emotional decision-making. When carefully designed strategies are supplanted by an impulsive choice, you have a recipe for poor performance.

As Malcolm Gladwell's best-selling book Blink: The Power of Thinking Without Thinking makes clear, unless you are an expert with decades of experience, instantaneous reactions can often have disastrous consequences.

To be sure, the study has an inherent bias in it: The experiment was designed so "risk-taking was the most advantageous behavior." The less-fearful participants made higher return investment decisions. In reality, people have a tendency toward risk-averse economic decision-making.

That aside, there are important lessons to be learned:

•  Do not allow your emotions to derail you from your plan;
•  Learn when risk-taking is an appropriate course of action;
•  It's not just the decisions, but the decision-making process that you can control.

Short of brain damage, there are ways to control the impact our emotions have on us as investors. Investors who do that achieve much better returns.


   This Week’s Data

    The July US trade deficit was reported at $42.8 billion versus expectations of $46.8 billion.  Exports rose, imports declined; even better, the greater part of that decrease came in non-oil related imports.


    More on the European sovereign debt problem (medium):

    Rail traffic continues to improve (short):
    Commodity prices continue to rise (short):



This analysis from ABC news (not exactly the hub of conservatism) on Obama’s plan to end tax cuts on upper income groups suggests that it will constitute a tax hike on small business (2 minute video);

    Now read this guy’s opinion as to the cause of our current plight.  According to him, we need more consumer spending.  So raising taxes on those who spend the most isn’t exactly the answer to our problem (medium):

    More government interference in the free market (short):

    NJ Governor Chris Christie addresses the public employee unions (short and a must read):


Posted 09-10-2010 8:11 AM by Steve Cook