At least one more day on the sidelines
Steve Cook on Disciplined Investing

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Have You Seen This?


The Market
    
    Technical

    The indices (DJIA 11774, S&P 1273) rallied yesterday.  They remained well below the prior support levels (11985, 1294) which now will act as resistance; however, the DJIA bounced off of the lower boundary of its intermediate term up trend 11616 (an important support level).  Hence both it and the S&P finished safely within their intermediate term up trends (11616, 1220).

    Volume declined; breadth improved; the VIX fell but closed well above the lower boundary of the very short term up trend, a continuing negative for stocks.

    With all the damage to upward momentum, I thought it time to recheck our internal indicator: in a Universe of 162 stocks, 76 remain in solid up trends, 39 have broken their up trend but stayed above the next initial level of support, 11 have broken their up trend but have rallied back above the lower boundary of their up trend, 36 have broken their up trend, the next initial support level and remain below it.  That denotes a fair degree of internal strength; in fact, a lot more than I would have thought; and it suggests that the intermediate term up trend of the Averages is in no present danger of being successfully challenged.

    That said, there is now a very short term but easily definable down trend currently at 11809, 1279; before considering that this down draft is over, I want to see some follow through above the aforementioned level.

    Gold (GLD) inched ahead but because the boundaries of its intermediate term up trend are also rising, it remains fractionally below the lower boundary of that up trend.

    Bottom line: very short term the trend is down; an early indication of its strength will be how the indices handle the 11809, 1279 intersect of the down trend.  On the other hand, intermediate term the Averages remain in an up trend; and importantly, the DJIA touched that trend line on Wednesday and rebounded notably on Thursday.   That makes today another day for patience.  If stocks demonstrate decisive follow through to the upside (above 11809, 1279) on any kind of volume, it might be time to nibble.  Barring that I remain on the sidelines.

    Recent history of 5% pullbacks (chart):
    http://www.ritholtz.com/blog/2011/03/sp-500-5-pullbacks/

    Bullish sentiment has cratered but we are not at bearish extremes (short):
    http://pragcap.com/bullish-sentiment-craters

    Individual investor sentiment has definitely declined (short):
    http://www.bespokeinvest.com/thinkbig/2011/3/17/individual-investor-sentiment-drops-again.html

   Fundamental
      
      Headlines

(1)    the economic news was mixed at best [positives: weekly jobless claims were down, the Philly Fed manufacturing index was a blow out number; negatives: February CPI, industrial production and leading economic indicators]; but investors chose to focus on the positive data points.  That’s fine; but it doesn’t change the fact that overall, the stats pointed at a weak recovery,

(2)    it was a day of little to no news out of Japan, so investors were relieved and that helped fuel the rally.  Late evening yesterday, it was reported that power was being restored to some of the reactor units [p.s. they now say Saturday] which in turn would allow the circulating pumps to get coolant to at least a couple that were at risk.  Let’s hope that this works,


           The impact of the disaster on Japanese stocks (medium):
        http://www.minyanville.com/businessmarkets/articles/japanese-stocks-japan-stocks-japan-earthquake/3/17/2011/id/33413?camp=featuredslidealso&medium=home&from=minyanville

A surprisingly informative and unsarcastic piece from Ann Coulter     (medium):
          http://www.anncoulter.com/
   
(3)    there was no improvement in the Middle East turmoil.  Gaddafi is closing in on Benghazi and loosing the wolves.  Meanwhile back in the magic kingdom, the UN voted to impose a no fly zone over Libya which Angel may sound great metaphysically but once this tar baby is punched, they may not like the outcome [p.s. Libya just declared a cease fire], and Beer may be a day late and a dollar short to have any affect.  I continue to believe that the Middle East crisis poses the greater risk to the global and US economies.

Bottom line: the good news is that stock valuations have been brought down to reasonable levels (and lest we forget, our outlook remains positive, just modestly so).  The bad news is that we still don’t know what we don’t know in Japan and these yahoos in the UN are starting to dick with a manic in Libya without a centrally planned military strategy or a clearly stated end game.  While it may all end well, in my opinion, there are more things that could go wrong than could go right; and that clearly leaves me nervous.  I am sure there will be clarity in both of the above situations in the next couple of days.  Let’s hope that I am too pessimistic and we have to pay up for stocks.

    The latest from Stephen Roach (medium and today’s must read):
    http://www.project-syndicate.org/commentary/roach3/English

     Thoughts on Investing--from John Reese

Ludwig Mies van der Rohe, the great 20th-century architect, famously proclaimed, "Less is more." He was talking about architecture, but Joel Greenblatt has applied this aphorism to stock market investing.

Greenblatt produced a 40% annualized return over more than two decades at the New York City-based hedge fund he founded, Gotham Capital. In 2005, he published The Little Book That Beats the Market, in which he lays out a stunningly simple way to beat the market, using two -- yes, just two -- fundamental variables he called the "Magic Formula." Back-testing his strategy from 1988 to 2004, he found it produced an average annual return of 30.8%, about 2.5 times the S&P 500's 12.4% return during the same period.


I use automated strategies based on the investment approaches of notable market gurus. I have been following Greenblatt's strategy since 2005. Through that period, his strategy is up 56.5% and the S&P 500 is down 3.48%. No doubt, the strategy works.


While Greenblatt may call his approach the "Magic Formula," there's nothing really magical about it. The two variables used, return on total capital and earnings yield, combine to target solid companies that are selling at reasonable prices. Greenblatt is basically saying that buying good companies at bargain prices makes sense. This does not differ from the number of other guru strategies I follow, including those of Benjamin Graham and his one-time student, Warren Buffett.


Greenblatt's first variable, return on capital (ROC), addresses the issue of buying good companies. ROC is a way to see how much money a company is making by using its assets, which is similar to the return on assets variable used by Buffett. Greenblatt found that companies with high returns on capital were able to generate such returns because they had an advantage over the competition. The advantage might be a brand name that allows the company to charge more than its competitors, or a strong competitive position that makes it difficult for competitors to muscle in on the company's turf.
To calculate ROC, Greenblatt uses earnings before interest and taxes (EBIT) so that debt payments and taxes don't obscure how well the firm's actual operating business is doing. He divides the ea
rnings portion of the equation by tangible capital employed, which is equal to net working capital plus net fixed assets.


The second variable is earnings yield, which shows, according to Greenblatt, "how much a business earns relative to the purchase price of the business." Again, he uses EBIT to calculate this figure. EBIT is divided by "enterprise value," which includes not only the price of the company's shares, but also the amount of debt used to generate earnings. Thus, Greenblatt is measuring how much of a return one could expect if they were to buy the entire company, including all of its debt.
Greenblatt considers the 3,500 largest U.S. publicly-traded companies and ranks them according to ROC and earnings yield. Then he combines the rankings and picks the stocks with the lowest numerical combined ranking (the highest ranked company is number 1, which is why the lowest combined rankings are most desirable).
than two decades at the New York City-based hedge fund he founded, Gotham Capital. In 2005, he published The Little Book That Beats the Market, in which he lays out a stunningly simple way to beat the market, using two -- yes, just two -- fundamental variables he called the "Magic Formula." Back-testing his strategy from 1988 to 2004, he found it produced an average annual return of 30.8%, about 2.5 times the S&P 500's 12.4% return during the same period.


I use automated strategies based on the investment approaches of notable market gurus. I have been following Greenblatt's strategy since 2005. Through that period, his strategy is up 56.5% and the S&P 500 is down 3.48%. No doubt, the strategy works.


While Greenblatt may call his approach the "Magic Formula," there's nothing really magical about it. The two variables used, return on total capital and earnings yield, combine to target solid companies that are selling at reasonable prices. Greenblatt is basically saying that buying good companies at bargain prices makes sense. This does not differ from the number of other guru strategies I follow, including those of Benjamin Graham and his one-time student, Warren Buffett.


Greenblatt's first variable, return on capital (ROC), addresses the issue of buying good companies. ROC is a way to see how much money a company is making by using its assets, which is similar to the return on assets variable used by Buffett. Greenblatt found that companies with high returns on capital were able to generate such returns because they had an advantage over the competition. The advantage might be a brand name that allows the company to charge more than its competitors, or a strong competitive position that makes it difficult for competitors to muscle in on the company's turf.
To calculate ROC, Greenblatt uses earnings before interest and taxes (EBIT) so that debt payments and taxes don't obscure how well the firm's actual operating business is doing. He divides the earnings portion of the equation by tangible capital employed, which is equal to net working capital plus net fixed assets.


The second variable is earnings yield, which shows, according to Greenblatt, "how much a business earns relative to the purchase price of the business." Again, he uses EBIT to calculate this figure. EBIT is divided by "enterprise value," which includes not only the price of the company's shares, but also the amount of debt used to generate earnings. Thus, Greenblatt is measuring how much of a return one could expect if they were to buy the entire company, including all of its debt.
Greenblatt considers the 3,500 largest U.S. publicly-traded companies and ranks them according to ROC and earnings yield. Then he combines the rankings and picks the stocks with the lowest numerical combined ranking (the highest ranked company is number 1, which is why the lowest combined rankings are most desirable).


  News on Stocks in Our Portfolios

  
    Nike reported its third fiscal quarter earnings per share of $1.08 versus expectations of $1.12.  It stated that the short fall was a result of higher cotton, labor and transportation costs.  Note to the Bern-ank: it’s coming.  Note to self: review the inflation and profit margin assumptions in our Model.

    On the other hand (short):
    http://mjperry.blogspot.com/2011/03/cleveland-fed-median-cpi-inflation-only.html

Economics

   This Week’s Data

    February industrial production fell 0.1% versus expectations of a 0.6% rise; capacity utilization came in at 76.3 versus estimates of 76.5.
    http://scottgrannis.blogspot.com/2011/03/manufacturing-production-continues.html

    The February leading economic indicators increased 0.8% versus forecasts of +1.1%.

    The March Philadelphia Fed business outlook survey was reported up 43.4 versus expectations of up 26.5 and February’s reading of 35.9.
    http://scottgrannis.blogspot.com/2011/03/philly-fed-index-soars.html

   Other

    More on who is funding US Treasury debt (short):
    http://www.ritholtz.com/blog/2011/03/is-this-why-bill-gross-dumped-treasuries/

    C&I loans are up (short):
    http://scottgrannis.blogspot.com/2011/03/c-loans-continue-to-grow.html

Politics

  Domestic

  International War Against Radical Islam

    This is mainstream Islam (long):
    http://www.nationalreview.com/articles/262229/why-they-celebrate-murdering-children-andrew-c-mccarthy










Posted 03-18-2011 8:16 AM by Steve Cook