Stop Loss Trades Entered

Update – since the market has kept going up, none of these stop / loss orders has been triggered. This is a good thing. We will leave the orders out there and may re-calibrate them based on the new highs. We only put stop losses on stocks where we thought that either they were near a top or a stock that we’ve had a long term issue with and I wasn’t going to sink all the way back down once it had gotten to break even.

The market has been on a nice rally. Some of the stocks that we’ve held on to for years we’ve given up on (Alcoa, and Exelon a while back) while others we are now putting on “watch” and have a “stop loss” price where they will automatically be sold when the market hits a certain price.

In general, these portfolios are managed as if they have a long time horizon. We will stay invested in the stock market over the entire haul. However, we will watch for stocks that have either stagnated for a long time or may be entering a period of secular decline. Finally, some stocks we’ve nurtured back from earlier lows and I won’t be able to take watching them fall back again.

The last time we put this strategy in play was before the stock crash in 2007-8. We did sell some high flying Chinese stocks that never recovered those high prices again. However, you have to re-invest the money so even selling at a high doesn’t mean that you won’t necessarily lose money; it means you took the gain off the table (or avoided the loss) and then started with a NEW stock that was possibly over-valued at the time of your initial purchase. There is no free lunch, and that is why we employ this strategy sparingly.

How a “stop loss” works is that if a stock hits a certain price, a sell order is immediately issued. It doesn’t mean that it will sell exactly at that price (for instance if your stop loss is at $34 then that is when the order is triggered but it could get filled at $33 or any other price in that range depending on how quickly it is moving down). There is a variant with a “limit”, where you stop at $34 but say something like you don’t want it selling below $33. In that case, if the stock plunges on past your stop and the only offers are at $32, nothing at all happens. In my case I went for the simpler “stop loss” order.

These orders are outstanding for 60 days. After that time they expire, unless renewed. The hope is that the stock market continues to rise and we never trigger ANY of these orders. At that point I will review the market again and determine if I want new stop loss orders for these or different stocks and how to proceed next based on conditions and my specific stocks.

Stop Loss Trades Entered

Portfolio 1

URBN 28 shares at $34 good til December 6

Portfolio 2

ORCL 30 shares at $30 good til Dec 6

WYNN 6 shares at $150 good til Dec 6

URBN 23 shares at $34 good til Dec 6

Portfolio 3

WYNN 6 shares at $150 good til Dec 6

URBN 28 shares at $34 good til Dec 6

CLF 44 shares at $17 good til Dec 6 (updated)

Portfolio 4

ORCL 26 shares at $30 good til Dec 6

NUE 14 shares at $45 good til Dec 6

Portfolio 5

RVBD 30 shares at $13 good til Dec 6

No stop loss orders were entered for Portfolio 6

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Stock Discipline

When I started the trust funds I was pretty much in “Buy and Hold” mode.  Since each of the owners of the trust funds has a very long time horizon (their whole life ahead of them), there is a lot of time to recover from a short-term event such as a market downturn and I wanted to encourage thrift and savings rather than a short term attempt to profit from immediate market conditions.

This article shows a graph that the average time a stock is held has dropped from 8-9 years in the 1940’s down to less than half a year in 2010.  While all averages are subject to skew, if you are holding stocks longer than 1/2 a year in your portfolio, you are likely a long term thinker (of sorts).

Thus I have been forced to change my thinking, too.  If a stock is selected in the group because it is a potential takeover target, when that event occurs, you ought to sell.  The prospect of a stock that is part of a larger company is much different than a stock that is an acquisition candidate.  Thus when there was a run up of approximately 40% on Metro PCS the pre-paid wireless carrier, I put in an order to sell this morning for Portfolios 2 and 3.  We will take these winnings and then decide what to do with the remaining funds.

Difficult (short-term) Time for Stocks

The markets have been selling off lately. Since these portfolios are a mix of US and non-US companies there aren’t “simple” indexes that I can use to compare them. But in general, the US markets which by various measures had been up in the 10-20% range are mostly back down to where they were in the beginning of the year and European and Asian markets are about the same or mostly worse.

These portfolios are meant to be long equity-only vehicles for young individuals with a very long time horizon in front of them (50+ years). They are “part” of a total portfolio and meant for a specific purpose; no one should just put all their wealth into a long-only stock fund.

Thus based on these elements I am loathe to do specific buys and sells based on total market conditions, because you are often selling off one stock for another stock with similar characteristics. Our markets today have very high “correlation”, meaning that almost all of the stocks tend to go up or down on a single day, especially when big market events occur. Correlation has been increasing over the years, meaning that even if you have a diversified fund (a rule of thumb is that you have 10 or more instruments that aren’t similar to one another) that doesn’t necessarily “save” you if they all move together.

The nature of the stock markets have been changing in the eleven years since I started this effort with Portfolio One, right around 9/11. There are many trends, but here are the key ones in my opinion:

  • Rise in international markets – international markets have always been important, even to US-centric investors, but today they are even more critical.  A stock market is fundamentally about “growth”, and most of the real growth is occurring off US shores.  Thus to not invest internationally, even with all their structural differences from the US market and other risks, is to miss out on the future
  • Reduction in IPO’s – the number of companies listed on exchanges has fallen as the number of IPO’s hasn’t kept pace with companies being acquired either by other companies or “going private”.  Also the IPO’s are later (see FB) meaning that a lot of the “upside” is gone when they launch, or there often is no upside at all if they are being sold out of a private equity fund (they already captured that)
  • Focus on Dividends – some of the dividend focus is due to favorable tax treatment (the limits on double taxation of dividends) and their 15% rate rather than as ordinary income and some is due to the gradual dawning on more investors that a substantial part of the total return is due to dividends and not just share price appreciation (unrealized)
  • Increased government intervention – in order to understand markets today you need to anticipate government moves to a greater degree than in the past.  Our large banks might never have survived the 2008 crisis without government intervention, and today they exist.  Will the government let them survive the next crisis, or will equity holders be wiped out like their were for Fannie Mae and Freddie Mac or Lehman?  Now you need to anticipate government reaction
  • Increasing Currency gyrations – for many years we had currency stability but we may be entering an era of less stability, especially in the key currencies the dollar, Euro, pound, yuan, etc…  This has many effects on competitiveness and immediate valuations
  • Low interest rates – a low interest rate policy has many effects on the market.  It depresses interest earnings (which impacts some equities) but also makes equities more attractive relative to debt instruments, especially when the chance of default rises.
  • The rise of Chinese stocks – while the US market went (mostly) moribund a whole host of Chinese companies came onto US exchanges or were accessible to US investors.  A lot of the “froth” and potential “boiler room” activities went into those stocks instead of US stocks

Here at Trust Funds for Kids we try to look at the long time horizon and make decisions accordingly.  This doesn’t mean that short term gyrations aren’t painful, as well.

Market Moves on a Single Stock RVBD

Riverbed (RVBD) is a stock held by portfolio 5, one of the newer portfolios. In the news I noted that they slightly missed in their revenue guidance for 2012 and their stock value dropped by almost 30%.

This article at Motley Fool asks the question of how such a minor revenue drop drove such a major impact on the stock price.

Clearly the market doesn’t work in very precise ways, but honestly how does a $5M revenue cut in guidance lead to such a dramatic loss of market value? Maybe “fuzzy math” is at work.

Most investors probably saw that Riverbed Technology (RVBD) lost nearly 29% of its market value on Friday. The company reported basically in-line Q112 numbers. Not too bad at this point considering the major product transition going on. Then the wheels started falling off during the conference call. The CFO guided to revenue that at the high end would miss the $202M Q2 estimate by roughly $5M.

Yes, anybody doing the math is probably struggling to understand the stock plunge. It dropped 29% due to a 2% reduction in revenue. All while investors should’ve known that the company was going through a product transition that would muddy up the financials for the 1H of the year.

Since we don’t recommend specific stocks here and everyone should do their own homework I don’t make general recommendations. In the case of my portfolio stocks I watch them and try to assess whether this is a temporary event or a permanent loss of value. It has to be noted that any stock with a high multiple which means that their value is based on looking forward to years of earnings growth is subject to risk when they miss earnings by even a little bit because analysts then tend to “jump off the train”.

In this case after reviewing everything I am going to put the stock on “watch” to see if it comes back next quarter and if the analysts are right or if the stock just hit a minor transition.

Faith vs. Experience and the Young

A recent Wall Street Journal titled “The Young and the Riskless” details how “twentysomethings” are not investing in stocks, but instead are putting their savings into less risky investments.  The tag line on the article is:

Twentysomethings are seeking safety from market volatility at precisely the wrong moment in their investing lives.  Here’s how to get back on track.

From the outset I was struck by the author’s presumptuous and scolding tone. I also like their strategic use of the word “volatility” instead of the more appropriate term of “losses” when describing market events over the twentysomething’s financially sentient lifetime, which would be something like the last 10-15 years.

Per the charts in the article

The percentage of young investors who say they’re willing to take above-average or substantial risk has declined from 52% in 1998 to 31% in 2011. 52% of investors in their 20’s who say they will “never feel comfortable in the stock market”. 33% of 20-somethings’ non-401(k) portfolios held in cash, versus 27% for all investors.

It is important to understand how “faith” in the market is typically defined in the popular financial press. Faith usually means putting your money in an index fund (or ETF), with low fees, continuing to do so regardless of market conditions, and relying on the belief that “in the long run” it will all turn out alright and you will be able to retire rich. The “financial calculators” have an assumed rate of return that you receive on your money, similar to the same calculators that public pension funds use, and they are typically “set” between 6% and 10%. Due to the “miracle of compounding returns” you can amass large sums of money in the future.

The problem with this mantra is that NO ONE has been winning with this strategy for a LONG time. What you see, instead, is that money put into the market is often battered immediately by volatility and is worth a fraction of what you put in only months prior. If you change jobs regularly (once every 2-3 years, as younger people often do) and are an avid 401(k) saver (which is recommended), many times when you pull out your money it will be valued far less than what you put in, or about even when the company match is taken into effect (depending on vesting). This can be demoralizing. I know that when I left companies in the late nineties and after the dot-com collapse I started putting more of my money into cash-like investment selections (despite warnings from my employers’ 401(k) educational materials) just because I hated moving balances worth a fraction of what I held back out of my pay when I left to start with a new company.

Also, in order to win “in the long run”, you have to stay with it in the short run. This means that when stocks plummet, you need to stay in the market and keep investing. If you decide to cut your losses and run, or stop putting new money in during market troughs, you don’t get the same benefits when the stocks rise later. This post I wrote basically said that no matter what you did in 2007, it turned out to be a loser, but if you bought during the trough in 2008 (or held throughout) you saw big gains later as the market turned back around (to where it was before). BUT if you didn’t stick with the markets, you didn’t benefit from these gains and ended up as a net loser. It is VERY HARD mentally to keep investing when markets are going down, but if you don’t buy low there is no way you can even conceptually win in the “long run”. If you bail, for sure you are going to fail, assuming you are following the mantra (which is what the WSJ article’s author was lamenting).

Kids see their parents’ struggles. Their parents have been believers in the markets, since the bear markets of the 70’s were replaced by the bull markets of the 80’s and 90’s. If you retired in the 90’s, after years of investing in the doldrums, you not only benefited from high interest rates which appeared to “goose” the compounding effect, but you also essentially did some great “market timing”, buying low and selling high. But the parents of today’s twentysomethings didn’t retire in the early 90’s, they kept working, and watched their investments suffer along. Now the parents’ are in a bind.

Not only did the markets get hit, but there isn’t really an underlying foundation of belief in WHY the market should do so great “in the long term”. In the past you could look at the track record of the US and show how we weathered recessions, panics and depressions, wars whether declared or un-declared, and always came out ahead. But today everything seems to be static or declining; our unemployment rate is high, we have high “real” inflation from commodity price increases (oil, food), and the cost of services like a college education or health care (if you can get insurance at all) is very difficult to bear. In order for the market to rise, the country needs to be productive, well run, and growing – does this seem to be today’s perception of American performance? This lack of an underlying narrative in why markets should rise of the long term (other than it has happened in the past), combined with the miserable ACTUAL performance during the last decade and a half, is killing confidence in the “long run” hypothesis that markets go up.

Another element of caution is that not only did stocks crater (or stay flat), but everything else fell apart too, in defiance of what the typical financial media said would occur. Housing became a miserable investment, rather than the guaranteed path to wealth that was painted in the press. Can’t you remember people saying that renting was “throwing your money away”? I remember having many, many people look at me in a dumbfounded fashion when I told them that I rented for over a decade when I could have easily bought. This thinking has obviously changed radically, despite record low interest rates (high rates would have made the housing problems unimaginably worse, at least in the short and medium term).

If kids travel, they can see how the “US Peso” doesn’t go far overseas. The dollars is worth a fraction of what it used to buy vs. the Euro, the Canadian dollar, the Australian dollar, or the Japanese Yen. The devaluation of the US dollar is another signal of our relative decline, along with our equity markets and housing markets.

The popular press’ scolding is going to fall on deaf ears until young adults see something out of their own experience that would convince them that stock investing is a winning strategy. The lack of anything except (comparatively) ancient charts of a world before the cell phone and the internet won’t sway them.

It really comes down to faith vs. experience. And among the young, experience is winning.

Generation X Addendum

This wasn’t mentioned in the article but a parallel trend I personally have noticed is that people of my generation (Gen X) are taking charge of their finances in their own way. Those with means tend to personally select stocks and get involved directly in their investing rather than “passively” investing through indexes (although ETF’s are part of their portfolio). While I am in the finance industry, many of my friends and acquaintances are not, but they have grown tired of bad and counter-intuitive advice and are taking matters into their own hands, in a variety of ways. Their particular strategies aren’t important – what is important is that they don’t believe the common wisdom and are taking responsibility for their own investment outcomes. In my opinion this is another manifestation of what the twentysomethings are doing, except by people with more assets to invest in the first place.

Cross posted at Chicago Boyz

The Long Run

The portfolios that we run on this site coincide with a market that effectively is a “do nothing” market.  We are basically flat over the last 13 years, meaning that there hasn’t been growth in the indexes since 1998.

The money that an index investor would have earned (i.e. if you put $100,000 in the SPY ETF or a mutual fund such as Vanguard’s VFINX) would have come through dividends, which averaged about 2% / year during the period.  Thus every year you received $2,000 in dividends (taxable each year) which means over the 13 year period you made roughly $30,000 (adding in compounding of interest) before taxes or maybe $24,000 after taxes depending on your bracket (and whether or not the 15% dividend received deduction applied during the period).

This is reflected in our results; while valuations fluctuate about 1/2 the total return of portfolio one, our longest lasting portfolio at over 10 years, is due to dividends.  When we look to select stocks a strong (and sustainable) dividend yield is an important, although not the only factor we look for in the “list of six stocks” that we pick from each year.

In the October 24, 2011 issue of Barron’s there is an article titled “It’s Cheaper the Second Time Around” that discusses the fact that indexes have been flat for the last 13 years.

The fact that we are struggling daily to hold above a level first reached nearly 13 years ago is both sobering and, viewed in the proper light, profoundly encouraging for true long-term investors… we are finally returning to a time of ‘stocks for the long run’… anyone who believes in mean-reversion investing has to consider the current starting point for equities at least somewhat attractive…

Jim Paulsen of Wells Capital was kind enough to calculate the 10-year forward return from all points in historry when the market was flat or down over the priod 12 yars.  The result: a 7.2% annual gain, versus 4.7% for all other times, not including dividends.

It is good that this analysis disclaimed the impact of dividends and yet noted that they are important, although if the yield is relatively consistent over time (which isn’t true, since yields go down when stocks go up, and vice versa) the analysis should hold true.

This type of investing approach is also a version of “market timing” – you should buy when items are cheap, and sell when they are expensive.  The most obvious example of this is housing; if you bought in 2007-8 you probably are regretting it right now – that same house probably would cost you a lot less to buy in 2011 then it did back then, for the same exact house.  It isn’t obvious HOW to do market timing, but the effects are real for anyone struggling to pay on an underwater mortgage today.

Like every good investment analogy, there is a counterpoint – Japan.  Japan peaked long ago, in 1989, and still hasn’t recovered to the highs.  In order to be a long-run investor in Japan you apparently have to be very patient, indeed.  Of course at some point investors are entering the market and they don’t care about recovering 1989 highs anyways.

For our portfolios here at the site flat returns mean a few things:

1) we don’t feel so bad at our struggles to raise values since the market has been poised against us

2) we have been right to focus on dividends, since they have been the only reliable source of cash over the period (relative to stock values)

3) while the analysis is more complex many of the overseas indexes weren’t flat over the same time frame; we have been putting up almost 1/2 our picks from overseas companies (US based ADR’s to keep it simple) in that same time frame

4) there is some hope that our patience will be rewarded if values increase in the next decade

Market Timing

In the past I, like many general investors, shied away from the concept of market timing. It was viewed as too difficult, and many investors left the markets when stocks went down and then missed the rally on the way up, essentially “buying high and selling low”. Instead, investors were advised to “stay the course” and keep investing, assuming that, over time, the rising markets would reward continuous faith with high returns.

An article in Sunday’s Chicago Tribune showed in a crystal clear fashion that, in fact, market timing is the ONLY issue for stocks, at least nowadays. This article shows stock performance for the top 50 stocks by market capitalization based in the Chicago region.

EVERY SINGLE STOCK is showing positive performance over the last 12 months! What are the odds of that, assuming that the stock market has its ebbs and flows? Very remote. The ONLY issue in the market over the last few years has been timing; everyone lost in late 2008 when the market cratered, and everyone who bought in at the trough made a lot of money. Likely to see this same article in late 2008 virtually 100% of the top 50 firms would be in negative territory over the prior year.

While I can’t say for certain what is driving stock performance UP (now) or DOWN (2008), I can say that virtually the entire market is extremely correlated with this phenomenon, as indicated by the top 50 stocks all being in positive territory.

Recent articles I have seen point to returns as being closely tied to the P/E level; when you buy into a “cheap” P/E market, you do well; when you buy into an “expensive” P/E market, you do poorly. While no one can say for certain what cheap or expensive really means, that broad theory is one that might be crucial to stock investing post 2000. In modern history (the last 30 years) there hasn’t been a long period where stocks traded in such a narrow range (around the Dow 10,000 level); but we need to decide how to weight the last few decades against the entire history of the stock market.

While I am not a professional stock adviser, the fact that 50 out of 50 of the top Chicago stocks (by market capitalization) are all up has to be a signal of some sort.

Cross posted at Chicago Boyz and LITGM