Thursday, 22 October 2015

Wave counters, chart readers, cheerleaders, and the importance of planning

I've been around long enough and (hopefully) I've learned enough along the way to have developed an appreciation for the market.  When I started becoming interested in investing, I was glossy eyed and young (and dumb) enough to be corrupted by the daily swings.  Easy enough to do when all I had observed over my short experience back in 98/99 was "up" and "euphoria" (unlike now).  It didn't help that I was in the thick of it all working on the institutional trading floor as a clerk situated one row behind the institutional sales traders who's only job was to, you guessed it, sell.

Fast forward 17 years and hopefully, I've managed to collect some experience, grounding and wisdom along the way, although to tell the truth, I have had no shortage of dumb moves.  I hope to continue learning from my mistakes along the way.

I've been thinking along the lines of what I should be doing with the long term registered accounts I manage. Currently, these are comprised of my RRSP, my wife's RRSP, my TFSA, and my kids RESP.  In total, there's about $126K in assets among these accounts.  The asset class distributions are:

  • 10% short term fixed income, consisting of a couple of short term Vanguard bond etf's, and short term zero coupons maturing in one year yielding 3%.
  • 4% equities, consisting of all of three stocks, Bancorp of New Jersey, Staples, and Acasta Enterprises, with the remainder in low cost index funds (Canadian dollar hedged versions of SPY, DIA, MSCI Europe, MSCI International and Canadian Index)
  • 86% short term cash, split between one year GIC's yielding between 1.60% and 1.85%, and money market funds which give me the liquidity and flexibility to act on any situation if it meets my exceedingly stringent analytical criteria.
I also run a number of non-registered accounts where I'm a little bit more aggressive.  The total assets here about $18K.  I will do another post on these at some point later.

As much as I love to analyze possible situations, I have not found much to act on.  I bought Bancorp of New Jersey back in late September because it hit my new low list and I believed after researching it, that it met my criteria for having an adequate margin of safety at the time.

I bought Staples a week ago as I analyzed the Office Depot / Staples deal and believed that this risk arbitrage opportunity provided a quantifiable reward to risk ratio on deal approval.  My thoughts were that should Staples divest whatever assets it needs to in order to get FTC approval, my risk was about $1 vs. reward equivalent to market recognition of synergies on approval of about $3.  

I have also developed a thorough appreciation for chartists who are a breed apart.  It's one thing to look at a chart and make a statement or an observation.  It's another thing to be able to turn those observations into profits consistently.

I follow one technical blog maintained by a hedge fund manager, which I find to be superb.  It likely will not appeal to most DGI's because a) it's a trading blog first and foremost, and b) it's got a very bearish slant to it.  It's hard not to read the blog and not want to be bearish, so the answer to this conundrum is either, a) don't read the blog, or b) if you have to read the blog, don't read it while the market's open lest reading it leads you to do something stupid (it's like DiCaprio in Inception, planting an idea in the victim's subconscious).

Here’s a quick example of one guest blogger who posts his wave counts and chart analysis daily.  He’s been calling for a top at a certain level in $SPX over the last couple of weeks, complete with very fancy charts and very fancy trendlines.  He could be very well right overall, but he could still be early (or he could be wrong). And based on today's prices not conforming to his counts, tomorrow's counts will likely change.

"After the close yesterday I had a very careful look at the declining resistance trendline from 2132 using very thin trendlines. The high yesterday tested that trendline twice, and the obvious rally target has therefore been hit. Looking at NDX and RUT there are quality trendline highs on all three indices, with a daily RSI 5 sell signal now fixed on RUT, and close to an RSI5_NYMO sell signal on SPX. If this has just been a rally, which seems very likely, the top should now be in. Even in the event that this hasn’t been a rally the short term high should now be in, though in the latter case the resistance trendlines established yesterday would obviously be less strong."

Honestly, why even bother?  I think I’ve figured something out.  There are always two sides to the market (at least).  Participants trying to fade the move, and participants who’s only job is to be 100% invested.  The guys trying to fade the move hate the guys who’s only job is to be 100% invested.  There’s a constant tug of war between the two sides.  The 100% invested guys for the most part are gawkers.  They must be 100% invested at all times, so they cheerlead when the market goes up and bury their heads in the sand when the market goes down.  The problem is, these guys are bonused based on beating the benchmark, so they chase price higher as price rises.  If they don’t, they don’t make their bonus.  The guys who try and fade the move are also gawkers to a degree.  The faders with the biggest cohones take contrarian bets against the 100% invested guys and hold on while they get squeezed.  If they’re really good at what they do, they may be early but they manage to fade a rising market in little increments and catch the turns.  I put guys like my trading blogger in this box.  For the most part though, the little contrarian guys get squeezed, stop themselves out, and then short again into price moving higher in disbelief until they give up.

There are even more sides I haven’t mentioned.  The "right" side for example.  These are the Peter Brandt’s or the John Boorman’s of the universe (professional trend followers).  The guys who ride the waves and step aside when they need to.  I'd put DGI's into the passive, not really giving a rats a-- side.  I'd imagine that in order to be in this box, one needs to have a very good sense of humour and have the ability to look at the glass half full perennially.

I don’t know where I am in all of this, but at least I’m cognizant of everyone else's existence (if this is at all relevant).  I think this is an important step.

Back to my "proposed" plan.

I’ve stopped bothering myself with trying to understand what the major indices will or won’t do.  I find it much easier to turn it all off and stick to a plan.  For me, the plan in the long term deferred accounts is as follows (drumroll please):
  • Average into 4 index funds at the end of each month (on the last day of every month), $100 per fund, so $400 per month, but, with a caveat, only commit new capital if I am getting a lower price for the index relative to last month’s purchase (i.e., if the current month is lower than the previous month).  If the index is up +x%? vs. previous month’s purchase, do nothing and sit in cash.  Wait til I get a lower monthly price before committing fresh capital.  There will be months where I do nothing.  I am fine with this.  The goal is to get the market return, but I don’t have to chase the market in order to get there.  I am also balancing equity off with a ¼ allocation to the Cdn bond index each month.
  • Continue to screen for select situations where a possible margin of safety exists.  Look at small cap names trading at -30% of my estimated DCF’s using the highest possible discount rates.  I do not find many of these, so I am sitting on my hands most of the time.  I’m ok with this.
  • Continue to look for select opportunities in fixed income.  Two days ago, I managed to find a strip coupon maturing in December 2016, Fairfax Financial zero coupon, yielding 3.16%, which is 2.5 x risk free maturing in one year.  Bought $10K in the accounts.  The entire inventory of this strip is now gone.  I was prepared to act and I did. 

Let's see if I can adhere to this plan for one year...

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