The swarming of AAPL.

Understanding how the shares of Apple Inc. managed to get squashed so badly has much to do with knowing a bit about investor psychology and modern market dynamics. It wasn’t very long ago that shares in AAPL were universally loved – about a year ago now, CNN made it known that Poland, Belgium, Sweden, Saudi Arabia, and Taiwan all had GDPs that were less that Apple’s market value (around $500 billion at the time).

It’s all about probabilities. If absolutely everything is going well, encouraging publicity abounds and everyone you know has both the iPhone and owns the stock, then the only thing that is left to occur is suddenly something (sentiment, earnings disappointments, hurricanes) not-so good-happens which cools investor enthusiasm. When a stock is widely held, the subsequent selling can prove disastrous for all shareholders.

In September of 2012 AAPL traded a tiny bit north of $700 per share and is now in the neighborhood of $420 give or take. Losing 40% of one’s investment in a bull market is painful.

On business television you’ll hear lots of Apple pundits (who still own the stock in their portfolios) say the company is worth far more than the share price would suggest. This may or may not be true, but the fact of the matter is that the share price does represent what it is worth to investors right now! Doesn’t it?

The answer used to be yes, but with the increase in the popularity of short-selling it is difficult to determine nowadays what a company is really worth. In many instances there is absolutely no connection between the actual economic value of a business and its stock price.

Swarming is the term now applied to the crime where an unsuspecting innocent bystander is attacked by several culprits at once, with no known motive. Because swarming at street level involves violence, it is criminal. However in financial markets it is perfectly legal and different because there definitely is a motive. The motive is to rob shareholders of their invested dollars.

In a recent (April 6th, Thomson Reuters: Reuters Insider) interview Bill Ackerman, founder of Pershing Square Capital Management and who is described as an ‘activist’ investor, admitted “There is something inherently shadowy or evil about short-sellers.” Ackerman gained notoriety when he publicly claimed the company Herbalife was nothing more than a pyramid scheme, suggested the stock was worth zero and admitted his company had an enormous short position.

When any company today stumbles (or is perceived to have stumbled) it ignites something akin to a swarming. For example, this quote is from CNBC.com on November 10th, 2012:

“The question has been asked by nearly every Apple watcher following a brutal two-week stretch that began with a worse than expected earnings report, quickened after the ouster of a high-profile executive and culminated with news this week that it had fallen behind competitor Samsung in the smartphone wars.”

Although one might expect the stock to decline under the circumstances, the subsequent pummeling of the share price seems a bit cruel. What happened? Have a gander at this graph of the short interest (the total number of shares that were sold short) since about a year ago. To gain perspective, in April of 2013 the short interest has grown to 20,497,880 shares. The dollar value of this is about the same as the Gross Domestic Product of the entire country of Malta.

In English, short-sellers detected vulnerability, and swarmed AAPL. The irony is that short-sellers borrow the stock from real shareholders (via third parties) in order to sell it on the market. After the selling pressure wreaks havoc on the stock price, the short-seller then buys shares at a much lower price, returns the ‘borrowed’ shares to those real shareholders and keeps the profits.

The irony is that short-sellers claim to be providing a public service. Bill Ackerman was simply exposing a company that he believed (discovered) was misleading its shareholders. He even went so far as to say he didn’t even want the profits – they would be donated to charity. The problem is that it isn’t just some big bad corporation that is punished, but its shareholders and in due course even its employees.

I’ve never claimed to be all that smart, but I just can’t figure out how aggressively attacking a company’s share price, selling stock that the seller doesn’t even own, for the sole purpose of transferring the savings of innocent investors into one’s own coffers (whether it goes to charity of not) is a noble thing. Isn’t it kind of like a bunch of thugs beating someone up and stealing his/her cellphone declaring it was the loner’s own fault for being vulnerable?

How can you stay clear of being a victim?

  • Avoid owning stocks that have become darlings. When it seems nothing at all can go wrong, it will ,and when it does there’s sure to be a swarming.
  • If there’s evidence of a growing short interest in a company, best not own the stock.
  • Instruct your financial institution that your shares are not to be available for securities lending purposes.
Mal Spooner

 

 

Finding an investment adviser is no easy task!

 

When RRSP season rolls around, it’s not unusual for dissatisfied clients to consider firing their investment adviser and finding a new one.  Even though most of the time it’s the client who’s the problem and not the adviser (more about this later), once the decision is made the question is how to select a new adviser?

Out of the several thousand investment advisers and financial planners I’ve met over the years, at least a few ‘hundred’ have what I consider to be the savvy to do an excellent job for their clients.  If only 10% of potential advisers are exceptional, finding one will require some work.  Ideally some of what follows will make the job a bit easier for some.

The most important thing to remember is that a capable stockbroker or financial planner doesn’t have to meet the stereotype.  For example, I was looking to hire a new sales rep for my fund company and received a resume from a fellow who was actually an investment adviser looking for a change.   I arranged to meet with him, and just happened to be standing on the street in front of our building when this black BMW pulls up, and a jittery youngster (young compared to me anyway) gets out.  He has his hair gelled straight back like Gordon Gekko, the fictional bigwig from the movie Wall Street, wearing the well-tailored pinstripe suit complete with suspenders that weren’t really necessary.  I didn’t hire him.

Beware of those advisers that are into role-playing.   It is okay I suppose to have a nice car, but a ‘look-at-me’ aura is a warning sign.  When someone deliberately adorns the trappings of success, I believe there’s insecurity in their personality.  Certainly your adviser should exude confidence but shouldn’t need or want to stand out from the crowd by adorning themselves with accoutrements.

You must be realistic.  Your adviser does work for a financial services firm, so expect to be using products and services offered by his company.  However any evidence that he/she is willing to deviate from the company’s party line for your benefit is a very good sign.

Ask him/her what he/she thinks about the market or a mutual fund, or even an individual stock or two.  If he/she simply regurgitates the newspaper headlines or is in love with a top performing mutual fund (you can’t ‘eat’ past performance is one of my favorite expressions), or his/her favourite stocks are everyone else’s favourite stocks too, you might want to avoid this adviser.  On the other hand, if you sense a real independent thinker willing to disagree with conventional wisdom, the adviser is a keeper.

Larger firms are especially good at marketing their wares, and I would recommend that it is infinitely better that you look for the right adviser rather than to just agree to hire the one that lands on your doorstep.  Keep in mind that good investment managers are not always good with people.  A good first impression is not necessarily an indication that the adviser does good work. Ask questions.  For example, ask exactly how they handled themselves in the financial crisis?

Even though it is extremely difficult (likely impossible) to predict market declines, anyone can certainly “do something” about their circumstances once the proverbial poop hits the fan.  Investment professionals often respond differently depending upon depth of experience or temperament:

  • Some are no more experienced (or no smarter) than their clients – they panic and sell at the bottom of markets.
  • Some proclaim a new respect for caution, and hold more cash and bonds….after it’s too late.
  • Some boldly acknowledge they didn’t see the Bear Market coming, apologize and admit that they are buying cheap assets aggressively ‘near’ the bottom (a good sign indeed).

Asking tough questions will enable you to determine whether you’re talking to a pro.  Don’t be afraid to sound stupid – it’s your money we’re talking about here and not your ego.

You may want to stay with the big firm you’re banking with for convenience, or choose to find a smaller firm that is more specialized in managing money for individuals.  It is much easier to learn about what motivates the professionals in a smaller wealth management boutique, learn about their investment philosophy and get personal attention.

Heads up!  When a firm’s performance presented to you seems too good to be true; it probably is.  A prime example was the case of Bernie Madoff.

In March 2009, Madoff pleaded guilty to 11 federal crimes and admitted to turning his wealth management business into a massive Ponzi scheme that defrauded thousands of investors out of billions of dollars. Madoff said he began the Ponzi scheme in the early 1990s. However, federal investigators believe the fraud began as early as the 1980s, and the investment operation may never have been legitimate.

Even small wealth management companies ordinarily have their performance numbers calculated and audited by third party services.  Make sure any performance data you see has been vetted by an independent third party.  Although instances of fraud get volumes of press coverage, they are one in millions.

Most boutique investment firms aren’t gifted marketers, and they rely heavily upon word-of-mouth to get new clients.  Ask friends, your accountant or lawyer for referrals.  There’s no harm calling and arranging to visit a few firms.

Tips:

  1. Never hire a Wealth Management firm based only on past performance.
  2. Don’t complain about investment results.  Ask for an explanation.
  3. Never second guess your adviser.
  4. Pay the fees – sure hey hurt when performance is poor, but you won’t care at all when performance is good.
  5. Be patient. Good things don’t happen overnight or every day.

Don’t pretend to be smarter than your adviser, you’re not!  Tips number 2 and 3 are very important.  I mentioned earlier that oftentimes the client is the problem, not the adviser.  In times of stress, we have a tendency to let our emotions get the better of us.  It’s kind of like swimming – if you panic then you’re more likely to drown.  Your investment adviser cannot walk on water, but is trained to swim.  There is an infinite number of things that can and do damage investment portfolios. The most damaging crises cannot generally be controlled, but wealth can be salvaged and even restored if level heads prevail.  Click on the picture to watch a funny video I made – are you at all like this client?

 

Mal Spooner

Is it the 1950’s again? The financial war is over!

There is a plethora of articles and blogs out there desperately trying to find a period comparable to now, in order to get some understanding of what markets might have in store for us over the next several years.  After three decades in the investment business, the only thing I can say with certainty is that such comparisons just don’t work.

George Santayana (December 16, 1863 – September 26, 1952) the philosopher and man of letters, is often quoted: “Those who cannot learn from history are doomed to repeat it.

It’s true people will make the same mistakes over and again, but history never actually repeats itself.  Trying to forecast the future is absurd, and so it must be even more ridiculous to expect that the future will be similar to some time period long ago.  Nevertheless, it’s winter and all my friends are on vacation so I’ve nothing else to do.

Post-War Reconstruction: In my simple mind, we’ve just fought a global war against financial corruption.  The weapon of mass destruction?  The ‘derivative!’ These things managed to infiltrate the entire global banking system and almost brought it crumbling down.  Like most wars, it’s difficult to put a pin into when things flipped from a crisis to all out war, but let’s say the seeds were planted when the U.S. Senate tried to introduce a bill in 2005 to forbid Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) from holding mortgage-backed securities (pretend capital) in their portfolios. That first cannonball missed the mark when the bill failed to pass.  By 2007 the two government sponsored entities were responsible for 90% of all U.S. mortgages, and the fly in the ointment was the use of ‘derviatives’ instead of real capital to hedge their interest-rate risk.   Banks did the same thing but much more aggressively. What followed is a long story we’ve been living for years.

Paul Volcker once said, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”  Well, we’ve plenty of evidence now that financial innovation led only to the mass destruction of wealth.

When the foundation fell out from under us (value of the derviatives dropped) we went to war in earnest.  The list of casualties like Lehman Brothers Holdings Inc. (announced September 15, 2008 it was bankrupt) just kept getting longer.

I believe the war ended six years after that failed 2005 Senate bill – in the summer of 2011. You can disagree, but your opinion is as meaningless as this whole exercize. (Laughing out loud.)

Way back when World War II (1939 – 1945) ended, governments around the globe began to print money and spend to rebuild the wealth that had been destroyed.  Isn’t this precisely what we’ve been doing since our financial crisis decimated wealth on a global scale?

So maybe some of what happened in the 1950’s post-war period will happen again?

In 1949 there was a brief struggle with the threat of deflation (and again in 1954) but for most of the decade inflation remained steady between 0% to 3%. We too saw the threat of deflation briefly in 2009.  However since then inflation has been fairly steady:  1.5% (December to December) in 2010 and 3.2% in 2011 in the U.S.  Although T-bills are currently paying a negative real rate of return (yields are below the inflation rate) there will come a time soon when investors insist on earning something or they just won’t hold them.  Short term rates will climb as they did throughout the 1950’s.

Prediction #1:  T-Bills will begin to rise until their returns cover the rate of inflation (see chart).

What happened in the stock market back then?  Government spending to rebuild infrastructure and create jobs had a significant impact, because arguably the 1950’s was one of the best if not the best decade for making money in the stock market.  Unfortunately, we only have reliable data for the Dow Jones Industrial Average dating back that far (okay, there might be more data out there but I’m surely not going to go looking for it). 

At the end of 1949 the Dow was at 200.13 and by the end of 1959 it had climbed to 679.36.  Excluding dividends that equates to a (IRR) return of about 13% per year for a decade.  As always lots of volatility had to be endured in stocks, but in the long run the reward was not shabby!  On the other hand, in Treasury bonds you might have averaged a 2% return, but suffered an actual loss in 5 out of the 10 years.

Prediction #2: Global growth fueled by government initiatives will translate into healthy returns on average in stock markets for several years to come.

Are we doomed to repeat history?  Although the 1950’s turned out okay, a wild ride was to come during the following couple of decades.  Easy money and inflation would eventually get the better of us and although there were some very good years for investors in the stock market (and those invested in shorter term T-bills for sure), inflation mayhem was on its way.

All we can hope for is that today’s policy makers have studied their history.  If we allow inflation to get out of control, interest rates will skyrocket like they did through the 60’s and 70’s. Younger folks today will have to suffer rising interest rates (mortgages, car loans) of the sort that created havoc for decision-makers and choked economic growth to a standstill for us older generations back in the day.

It’s true that if we don’t learn from history, we can and will make the same mistakes over again.  But I also said history does not repeat itself.  Although we somehow managed to eventually wrestle the inflation bogieman under control before, this does not mean we will be so lucky next time around.  And it’s a wealthier more technologically advanced world we live in now….which means we’ve so much more to lose if we really screw things up.

Prediction #3:  If governments don’t slow down their spending, bond investors will really get burned.

My instincts tell me that 2013 will be a happy New Year.  And bear in mind that if none, any or all of these predictions come true it will be an unadulterated fluke.

 

 

 

 

Malvin Spooner.

 

 

Invest like you shop and your savings won’t drop!

Huge lineups of shoppers looking for deals on Black Friday and the massive retail sales that occur the weeks after Christmas are testimony to the ability of people to shop wisely.  I know many families that defer buying expensive gifts (for their kids but especially for themselves) until after the Christmas holiday in order to save hundreds of dollars.  So why are people so bad at investing their money?

A recent study by Blackrock, the largest money management firm in the world, confirmed what all of us know already:  The average investor sucks at investing.  Despite the fact that the skills and emotional fortitude necessary for successful shopping are pretty much applicable to the task of investing one’s money, it seems the average person just won’t use these abilities when making important investment decisions.

According the the American Research Group Inc., the average shopper plans to spend $854 on gifts this year. Let’s assume it will be the same next year and the next.  Virtually everyone realizes that since they’ll be spending the money anyway, shopping smartly and getting all gifts at perhaps a 20% lower price leaves them better off.  Wealthier in our example by more than $500 after three shopping seasons in fact!

But when it comes to buying investments, investors prefer to pay a premium.  What proof do I have?  Many years of observation, but the results speak for themselves.

The average investor managed to earn less than virtually all asset classes at his disposal earned over ten years according to the Blackrock study.  To be perfectly honest, I’m surprised the average investor did so well.

I’m not sure about how the study was conducted.  If everyone that participated had a home and kept all their money in a checking account….the result wouldn’t be very surprising would it?  Let’s assume that the sample was comprised of real “investors.”  Some with homes and minimal savings, but others actively investing serious money in both bonds and stocks. Where would they be going wrong?

It’s hard to imagine retail investors trading aggressively in the bond market, but assuredly a significant amount of their long term savings could include fixed income securities.  It’s equally difficult to conceive that the lion’s share of their savings might be in gold or oil.  Likely, the average investor does include stocks in his retirement savings and participates actively in decisions.  He/she would either use an adviser to implement asset allocation decisions or occasionally channel money into or out of funds.

Consider one proxy for stocks, the S&P 500 Index over roughly the same time frame as the study.  It’s certainly been a rollercoaster, but a simple buy and hold strategy would have contributed nicely to the average investor’s nestegg.  In my opinion the only way the average investor could have done so poorly is by losing money making poor investment calls along the way.

Generally, folks wait until the stock market has climbed quite a long way upward before committing their own money – see the “Buy” indicators on the graph?  This decision is made based on the past performance charts and tables that are promoted ad nauseum by the investment industry when the rates of return earned by their funds have been excellent.

Even though past performance means nothing, for some reason impressive historical returns awaken the greed in all of us, just like an extremely large lottery jackpot suddenly inspires many more people to go out and buy lottery tickets.

Unfortunately, great historical performance is very often followed by lousy market environments – evidenced clearly by the graph of the S&P 500 Index over the ten year period.  As anxious as people are are to pile into a market that has been rewarding (after-the-fact), they are just as eager to get out of a losing situation that leaves them feeling they’ve been suckered.  The average investor sells at the worst possible time.  A few of these buy high/sell low episondes is sufficient to reduce the overall return he/she has earned in other assets like bonds or the family home.

Put another way, the shopper in you is always on the lookout for discounts while the investor is more than happy to pay a premium to the list price.  Greediness completely overides any bargain-hunting intuition.

Back to our shopping example.  Imagine that you can shop wisely and get gifts at prices 20% below list.  But also imagine that you and your family can use those gifts for a time and then sell them at a 20% premium to list.  Crazy?  You can actually do this with your investment portfolio.  Apply those shopping skills to your savings and you’ll be surprised how much better off you can be.

 

 

 

Malvin Spooner.