Michael Covel: News & Info.

From “Considering the Last Romantic, Ayn Rand, at 100″ by Edward Rothstein, New York Times, February 2, 2005:

“Rand divided her world - and her characters - in similarly stark fashion into what she wanted and what she didn’t want. Here is what she didn’t want: Ellsworth M. Toohey, “second-handers,” Wesley Mouch, looters, relativists, collectivists, altruists. Here is what she did want: Howard Roark, John Galt, individualism, selfishness, capitalism, creation.”

Man’s mind and his ability to develop his “self”, states John Galt, the protagonist of Atlas Shrugged, is his basic tool of survival. Life is given to him but survival is not. To remain alive, he must act, and before he can act he must know the nature and purpose of his action. In other words, to remain alive, he must think. Thinking is not an automatic process. A man can choose to think or to let his mind stagnate, or he can choose actively to turn against his intelligence, to evade his knowledge, to subvert his reason. If he refuses to think, he courts disaster: he cannot with impunity reject his means of perceiving reality.

The traits Rand wants her protagonists to demonstrate are also those of successful traders. Trading is a zero-sum game. It’s you against the world. It’s not you and your friend or you and your broker fighting together. You are left to objectively use your mind to determine the best course of action in order pull a profit from the other traders in the world who are competing with you at the game. You dig deep to develop a winning course of action. You don’t let fear overwhelm you. Pure fear is why the Nasdaq rose so far and plunged so low. And those who accepted their fear with confidence in their trading decision-making — made a killing.

From “In a Comback, It is Rally Time for the Dollar”, The Wall Street Journal, February 10, 2005:

“Yet unlike other relief rallies during the dollar’s three-year decline, this advance reflects something new: a rare belief that the widening U.S. trade and budget deficits could be coming under control. But can this new optimism be sustained? Some traders certainly think so. They point to a speech last week by Federal Reserve Chairman Alan Greenspan, who suggested that the dollar’s decline should help narrow the trade deficit. Then, on Monday, President Bush proposed a budget plan that calls for sharply cutting the shortfall by 2008. ‘We’ve changed the tone of the debate from one with ever-widening deficits to one where something is going to be done on both accounts,’ says Robert Sinche, head of global foreign-exchange research and strategy for Bank of America. ‘The future for the dollar doesn’t look nearly as scary as it did six weeks ago.’”
Craig Karmin

Why does Wall Street persist in believing that Alan Greenspan has a crystal ball? Is it the need to be optimistic? Patriotic? Or just the unquenchable thirst for fundamentals you can “trust”? And if you can’t trust fundamentals from the Federal Reserve Chairman…but doesn’t this whole debate miss the point?

If you have a trading strategy it must answer these 5 questions regardless of what Greenspan says on some odd day:

• How does the system determine what market to buy or sell at any time?
• How does the system determine how much of a market to buy or sell at any time?
• How does the system determine when you buy or sell a market?
• How does the system determine when you get out of a losing position?
• How does the system determine when you get out of a winning position?

From “The Wild West of Hedge Funds Becomes Tamer” by Gregory Zuckerman and Ian McDonald, The Wall Street Journal, January 24, 2005:

“There are about 8,000 hedge funds, and they pursue many different strategies, from aggressive tactics such as betting on growth stocks and currencies, to capturing small gains from arbitrage plays in the convertible-bond market. Sometimes these moves are more conservative than those of most mutual funds. And lately, hedge funds have turned to “long only” strategies that eschew short selling, or betting that a security will decline.”
The Wall Street Journal

Hedge funds are changing because they are being influenced by today’s investors who have neither the patience nor the tolerance to trade for absolute returns. Adopting mutual fund strategies of “long only” may feel less risky for the fund’s investors but will this conservative (and conventional) approach play well in terms of profits? It’s one thing to blow up using a bad strategy like Long Term Capital Management in 1998, but is the answer to mimic the S&P? I think not and I think any successful trend follower would agree with me.

From “How Wall Street Learns to Look the Other Way”, New York Time Op-Ed, Tuesday, February 8, 2005:

“Whatever happens with Mr. Grasso - and with Dennis Kozlowski of Tyco and the other avatars of corporate misconduct in the headlines these days - we should be reminded that ethical behavior for many business people must involve overcoming their learned biases. Perhaps these scandals would be a little less likely, and the rationalizations for them a little less tenable, if more of us professors integrated business education into a broader historical and psychological context. Would our students really fail to understand the economic models if we treated the subject matter not as an arcane specialty, but as part of a larger liberal arts education?”
Robert J. Shiller

Shiller may be a brilliant writer, he authored Irrational Exuberance, as well as professor, he teaches Financial Markets at Yale College, but he’s dreaming if he believes those on Wall Street behave unethically because of what they didn’t learn in business school. Learning to take responsibility for your actions, just like learning to trade properly, has little to do with a graduate degree in business or any other field.

From The Financial Times on February 9, 2005:

“Investors who buy shares in companies in fast growing economies are risking disappointment because there is no clear link between equity returns and GDP growth.”
The Financial Times

More importantly there is no clear link between the fundamentals (however those may be sujectively determined) and the price of the stock, currency, future, etc. You can have the greatest fundamentals in the world and still see a stock tank. Of course, and we should all know this now post bubble, the fundamentals can be terrible and a stock can soar.

One of the goals of Trend Following was to better explain terms like “risk” and “risky” (see p. 89-95). Saying something is “risky” tells you nothing. To those who don’t understand trend following (or for those who refuse to admit the strategy’s success) the easy way to feel good about ignorance is to quickly say, “trend following is risky.”

We have to risk to find opportunity of gain. If you don’t risk, there is no possibility for gain. Risk is not a four-letter word. A good example? Trend followers do not make money each month with their “risks”. They never have. They don’t expect a gain every month. Trend followers see just as many losing months as winning months. That scares you? It should not. At least trend followers understand and acknowledge there will be down months when taking calculated risk. On the other hand, those who promise positive returns every month are the cons.

View trend following performance for January 2005. It was a down month across the board for most trend followers. I hope, “Oh my trend following lost money for a month it must not work!”, was not your reaction. Don’t look at one month in isolation and attempt a judgment — you would be foolish. Look at the decades of trend following performance (month by month) across numerous trend following trading professionals — there is your real insight.

The phrase “buy low and sell high” is so pervasive in our culture that few stop to consider the implications of believing it. It just sounds so good, who could argue with the logic. Right? Wrong. How do you consistently determine what is “low” or what is “high”? What does “low” or “high” mean in practical terms? “Low” or “high” relative to what?

Recent feedback from a top Wall Street Technical Strategist:

“I started and finished your book on the stunning Beaches of Ipanema, Brazil. I have to tell you that I thought it was fascinating, insightful and extremely readable. The format made it very easy to soak up all the information, which I feel is the most important aspect of a any book period. Above all else however, I came away with a much better understanding of my trading paradigm now that I can validate and categorize - giving me a label if you will - my trading style. Reading your work also afforded me a great feeling of comradery and renewed confidence in my understanding of the markets. In fact, I had never know that I was a ‘Trend Follower’.”

Interestingly, many traders who you never would have expected to find a common bond with Trend Following, have written to express similar sentiment.

From Barrons this weekend:

“Everyone, even the little old lady in Peoria, knows about the Super Bowl indicator and its uncanny ability to predict the stock market. But for the benefit of the tourist from Mars who’s just passing through and hasn’t had time to bone up on such exotica, we’ll whistle up a brief exegesis. The National Football League is divided into two parts: the National Football Conference (NFC) and the American Football Conference (AFC). The survivors in each conference of an interminable stretch of playoffs meet in the fabled Super Bowl. Got that so far? (We’re talking to you, the funny-looking green guy with the antenna coming out of the sides of his head.) Okay. If the NFC team wins, the stock market is destined to go up that year. If the AFC team wins, the stock market’s a goner. This indicator has been right 30 out of 38 years, which betters by far the record of any Wall Street strategist or even someone who knows something about the market. We’re deeply indebted to the excellent Richard Bernstein of Merrill Lynch for the revelation that there’s another, little known Super Bowl-stock market indicator (Richard, in turn, says he’s indebted to National Public Radio for the info) that turns on animal versus human mascots. There have been 25 Super Bowls in which teams with human mascots have contested against teams with animal mascots and, we’re pleased to say, the humans have emerged victorious in 18 of those games. (If a team ever called itself the “Traders,” as in brokerage house traders, we’d be at a loss to say which category it fell into.) Richard, obviously a mathematician, used both indicators to gauge the prospects for the stock market this year. The teams vying for supremacy are the New England Patriots, the AFC champs, and their NFC opponents, the Philadelphia Eagles. He figures that based on the human/animal rule, there’s a 72% chance the Patriots beat the Eagles. If that happens there’s a 79% chance, according to the original Super Bowl indicator, that the stock market declines in 2005. Combining both indicators in some mysterious fashion which he does not disclose, Richard divines a 57% chance that the market will wind up the year lower. While we’re at it, we might as well toss in the January indicator, which holds that as goes January, so goes the year as a whole for the stock market. There has been a lot of ink spilled on why that ain’t necessarily so. But a very savvy friend of ours points out that in each of the past 13 post-election years, January has, indeed, been a forerunner of the stock market’s action, up and down. In case you’ve forgotten, January 2005 was a downer.”

These articles are fun, but they serve little purpose. Remember the Washington Redskins indicator for the U.S. Presidential election?

http://www. snopes.com/politics/ballot/redskins.asp

“Our desire to understand and assert some control over the world around us is often manifested by our attempts to find predictive signs that enable us to prognosticate events–even Vote when there is no seeming connection between predictor and event. Sometimes one natural phenomenon supposedly forecasts another, as in the belief that a groundhog’s seeing his shadow on February 2 portends another six weeks of winter. In other instances the linkage is between affairs of mankind, as in the superstition that the winner of football’s Super Bowl augurs that year’s stock market performance (or vice-versa).” Snopes.com

Recent feedback:

“I have been a “lurker” [at the web sites] for some time now. I seem to recall someone writing in one time to defend fundamental analysis as the only way to invest. The answer was that fundamental analysis might tell you when to buy but didn’t tell you how much to buy or when to sell. Somehow, that answer didn’t seem to satisfy me, but I couldn’t put my finger on the reason why. You see, I am a fundamental analyst and portfolio manager. I put myself squarely in the Graham and Dodd camp, along with other such luminaries as Sequoia Fund, Warren Buffett, Longleaf Partners and Tweedy Brown. I just purchased the Michael Covel book Trend Following and have started reading it with much interest. As I was plowing through the first chapter, it began to occur to me that I am a closet trend follower, as are many of my value oriented colleagues. How did I arrive at that conclusion? Let’s go back to the answer that was given about fundamental analysis. That answer would certainly dispel any myths about trend following being better than fundamental analysis if it were truly the case that one ran the numbers, bought a stock and forgot about it. Trouble is, it doesn’t work like that. You get new information about your purchase at least every quarter. At that point, any money manager worth his salt is re-evaluating his holdings in light of this new information. Sometimes you revalue your holdings upwards, other times, downwards. Some change very little. Next look at current price versus the newly calculated valuation. If the risk/reward ratio is sufficient, buy more. If it’s not, hold what you have. If the valuation has gone down enough or the price risen sufficiently, you sell. It is interesting to note that, currently, most of the Graham and Dodd investors are holding a significant portion of their assets in cash (myself included). This is because there is nothing that meets our value criteria to buy and, of the holdings that we held, they have become overvalued enough to take profits on. So trend following and fundamental analysis are not mutually exclusive as some of you might think. If things are done properly, good fundamental analysts will follow a trend. As for your argument on position sizing (’fundamental analysis won’t tell you how much to buy’), you are correct in that statement. But trend following won’t tell you that either. Position sizing is a personal choice and is a necessary part of ANY competent investment program. The decision to add to positions that offer better rewards and sell out of positions with declining or negative rewards is critical. I look forward to finishing Mr. Covel’s book. I am still intrigued by trend following techniques. I do not argue with the successes of those who follow the techniques. I think the polarizing element is the perception that the only way to trend follow is to use technical analysis and technical analysis seems like so much hocus-pocus to so many folks (more often than not, with good reason).”
Alan M., CFA