Tuesday, June 28, 2022

Tacking

 Tacking


Tacking allows a sailboat to indirectly sail to a desired waypoint against the wind; investors should take note of this timeless method of sailing. In many ways investors are also often fighting a wind on the way to their waypoint, but in their case the "wind" is a confluence of macro economic events and that waypoint is a financial goal(s).

Although no sailboat can sail against the wind, almost every sailor can tack in a zig zag pattern to reach their waypoint. The Absolute Alpha strategy was developed with this goal in mind, to harness ANY wind to reach a waypoint. Tacking of course is highly dependent on positioning the sails, but it is also a self-correcting mechanical maneuver which will quickly indicate if you're on a bad wind.

Investor need to consider not only their financial waypoint(s), but also the method in which they arrive. It is often said that life is "about the journey, not the destination." While that may largely be true, a destination of effervescent passive cash flow sounds quite lovely indeed...and the journey is the means of reaching that destination.

As previously posted in Sneaker Waves, it is extremely difficult to get to get where you want in a reasonable amount of time without having to deploy the lifeboats occasionally being long-only. Investors need to seriously consider an approach that is all-weather capable of tacking.

As always, it is important to look before you leap. What are the downsides to a tacking strategy? I believe the primary risk is signal risk. What signals will you use? How accurate are they? Are they dependable and repeatable? The secondary risk is the efficiency of using a strategy that may or may not trade frequently.

It has been knocked into our collective consciousness that frequent trading is a recipe for disaster. That is actually debatable...as Ray Dalio (amongst many others) is quoted as saying "Timing is everything." If the signals are good and the tacks made accordingly, then trading more is actually far, far more advantageous. 

Consider dear readers the investor who tacked successfully this year. Would she be down on par with the S&P 500 some 20%? I think not. Assuming successful signal utilization, she would have been short for most of the year and also most likely tacking into several Bull spikes.

Tacking requires accurate signals and trust in the proverbial "wind" that is pushing all of our sailboats around...a waypoint is nearly impossible to reach fighting against the wind. Since we're on the water today, my friend Bruce Lee had an excellent analogy about water that is applicable I think to investing as well. It highlights the importance of harnessing signals and changing a position accordingly. If your sailboat needs help tacking, consider throwing us a line.

"Empty your mind, be formless, shapeless like water
put water into a cup, it becomes the cup;
you put water into a bottle, it becomes the bottle;
you put it in a teapot, it becomes the teapot.
Now water can flow or it can crash. 
Be water my friend."


Monday, June 27, 2022

Demand Shock

 Demand Shock


Has the supply of oil suddenly increased? Has a new pipeline from Canada been approved? Has the lease utility rate spiked? No dear reader, none of these things have happened...yet the price of oil has markedly declined in the past several weeks from $130/barrel to a "paltry" $107 today. What gives?

When inflationary prices are out of control Adam Smith's old "Supply & Demand" really comes to light. The supply of oil hasn't increased, but demand sure has experienced what is termed a negative demand shock. Consumers aren't stupid, and the number one rule of game theory is that they act in their own self interest. Hence when oil spiked, consumers began shifting their demand.

This author suspects we are in the midst of a massive negative demand shock right now. Typically in a negative demand shock prices will fall as demand shifts away from the commodity being purchased and/or the quantity purchased also falls. In California for example, many gas stations now limit the amount of gas you can purchase.

As the chart above helps to illustrate, as the demand shock takes hold output falls, employment falls, and prices eventually fall. The question arises, however, how inelastic is the demand for oil? Or in other words, how much can demand truly fall for oil? This author has long suspected it will lead the economy into a recession.

Typically the first things being cut are discretionary items, all of which are touched in some way by the price of oil. Moving along Maslow's Hierarchy of Needs pyramid, the base is made of food and shelter. Nearly everything else is expendable to secure those two fundamental blocks. People don't have to go on vacation. People don't have to drive to the office all the time now. The boat (and its slip) can be let go.

Spending will be reallocated according to priorities in life. Consumers are like water, they seek maximum utility and flow accordingly. Demand started shifting even before the Fed acted to stifle it by raising interest rates. The fear of course is combined with a demand shock, the Fed's policy will tip the economy into a recession. With oil prices already moderating, and the Fed promising to raise rates until they "break inflation," expect a hard landing that skids into a recession.


Tuesday, June 21, 2022

Sneaker Waves

 Sneaker Waves


Sneaker waves. Sleeper waves. Rogue waves. Long-only is a dangerous proposition, especially when destructive financial waves roll in every couple years and destroy everyone's beach picnic. There has to be a better approach to avoid these wipeouts.

Consider, every approximately 54 months a -25% wave rolls through...and as a reader can imagine the LONGER you have been investing in the market, the LARGER this wave's impact is on your net worth. The word "catastrophic" is apt, especially if you take a sneaker wave on the cusp of retirement. Both your net worth, and potentially more damaging, your cash flow gets whacked. What is a financial farmer to do?

Consider what the Dutch and other low-plained residents near the ocean do: set-up early warning systems, act when triggered, and have ample ability to handle the inevitable overflow damage a rogue wave can cause. Early alert systems in your portfolio can be similar to Absolute Alpha, or trailing stops, or some type of macro trading which incorporates event-based triggers.

From one of my favorite movies World War Z: "First to know, first to act." There is no escaping the Pareto Principle, namely that these sneaker waves are out there and on average hit every couple years with devastating impact. Investors have several options. Do nothing and watch a long-only portfolio be destroyed like a sand castle. Use an early warning system and move your sand castle. Third, pick up your surfboard and paddle out.

Thursday, June 16, 2022

Investment Code

 Investment Code


A man needs a code. Fellow financial farmers we are in turbulent investment times, and it is good to rehash the importance of having an investment code. What is your code? Is it...ahem...codified? Just like an NFL coach rolling into town to take on the opposing team, investors need a game plan of how they plan to invest, what catalysts spur action, what signals indicate distress, and what their exit strategy is...the old axiom of "if it can be measured it can be managed" rings true.

Consider my Absolute Alpha strategy for example. The goal is straightforward: A positive yearly return regardless of market conditions. How will the goal be accomplished? By utilizing momentum vectors. What is the benchmark? S&P 500. How is it implemented? A standard brokerage account. How are positions added or reduced? Direct buys/sells. This is just one simple example of a codified approach.

The major goal of having an investment code is the desire to manage outcomes within a certain time horizon, risk tolerance, and achieve certain financial results. A process is only as good as the data it is fed and the constructs of its creation. Having an investment code also solidifies the standard deviations which may occur...just how volatile is your process? What does the data say? How do you plan to react to the data? 

Time and information may be the most valuable commodities of all, and having an investment code helps financial farmers glean what is and what may be...we already have a pretty good idea of what was.

June 16th for many Americans is a seminal day. It is the calendar day when you are finally working for yourself after bearing the yoke of excessive taxation and regulation for over half the year. It is a day of freedom. It is the day the Founders had once set to January 1st...obviously there has been some slippage! Nonetheless if you don't have an investment code, create one today. In many ways it will help define your financial success in the future. A man needs a code.

Wednesday, June 15, 2022

Wite-Out

Wite-Out


Today millions of American citizens will dutifully write checks to the IRS, State, and Local governments for billions of their hard-earned dollars. But this quarter their "fair share" will be lower, low enough to warrant a bottle of Wite-Out on the quarterly vouchers. Income destruction has been wrought upon you by politicians who know only a W-2 and an endless gravy train. Free Healthcare. Fat Pensions. Largess.

On this hallowed day, it is worthwhile to recount the introduction to our Declaration of Independence:

"When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation."

"We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed. That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursing invariably the same Object evinces a design to reduct them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. Such has been the patient sufferance of these Colonies; and such is now the necessity which constrains them to alter their former Systems of Government. The history of the present King of Great Britain is a history of repeated injuries and usurpations, all having in direct object the establishment of an absolute Tyranny over the States."

Do you ever feel like you're getting the taxation without the representation? Did you instruct your Congressman to abolish our borders? Did you tell the same "leader" that you want to rely on foreign oil and supply chains for your well-being? Is your "fair share" tossed atop government coffers overflowing with taxpayer remittences...waiting to be squandered on programs and services that benefit only the denizens of corruption? How is your "pursuit of Happiness" going these days?


Tuesday, June 14, 2022

More Cowbell

More Cowbell


Investors often wonder when to add to existing positions. To a large extent the answer to this question depends on their investment philosophy, time horizon, and risk tolerance. Simply put, it depends. 

Active trading is based on the theory that the market is NOT perfectly priced and that there is an opportunity for an investor to purchase something that is mispriced; maybe it will be raising a dividend, maybe new management is taking over, there are a host of potential reasons of "why" that an investor evaluates. At its heart, a trade is in essence a best guess based on available information.

To the quant investor the answer as to when to add more cowbell is simply a function of the charts. What does the chart say? Where is the momentum pointing? Does the data indicate that the trend is strong? Growing? Subsiding? These factors guid the path of a quant trader.

Much of the cowbell quandary is based on confidence in the underlying investment. What is the truth? And in this matter financial farmers need to evaluate their investment thesis. Otherwise positions are increased simply on emotion ("This stock can't go any lower!" or "I'm gonna double down on this position!") What is your thesis?

There are a host of reasons to add more cowbell, but an investor should have a code. A theory. A blueprint. Some methodology that can be captured, implemented, and evaluated. In this manor the process can help yield maximum success. If you can measure it, you can manage it. 


Monday, June 13, 2022

Tasty Tidbits

 Tasty Tidbits


Edwin Lefevre chronicles the life of legendary stock trader Jesse Livermore in the masterpiece "Reminiscences of a Stock Operator." It is a timeless read for Wall Street aficionados, students of the stock market, and even those with just a cursory interest in finance. If you haven't read it yet, put this book on the top of your summer reading list. Below are some of my favorite tasty tidbits. The wisdom and knowledge gleaned from this book are priceless, but Amazon will sell you a copy for about ten bucks!

1) "It takes a man a long time to learn all the lessons of all his mistakes. They say there are two sides to everything. But there is only one side to the stock market, and it is not the bull side or the bear side, but the right side. It took me longer to get that general principle fixed firmly in my mind than it did most of the more technical phases of the game of stock speculation."

2) "After spending many years on Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who where right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine--that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance."

3) "Another lesson I learned early is that there is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again."

4) "There is nothing like losing all you have in the world for teaching you what not to do. And when you know what not to do in order not to lose money, you begin to learn what to do in order to win. Did you get that? You begin to learn!"

5) "Speculation in stocks will never disappear. It isn't desirable that it should. It cannot be checked by warnings as to its dangers. You cannot prevent people from guessing wrong no matter how able or how experienced they may be. Carefully laid plans will miscarry because the unexpected and even the unexpectable will happen. Disaster may come from a convulsion of nature or from the weather, from your own greed or from some man's vanity; from fear or from uncontrolled hope. But apart from what one might call his natural foes, a speculator in stocks has to contend with certain practices or abuses that are indefensible morally as well as commercially."


Many readers will notice distinct similarities in Livermore's trading philosophy utilizing momentum signals and the Absolute Alpha strategy launched on June 6th.  Absolute Alpha acted on the preponderance of Bearish market signals at launch and has steadily added more cowbell over the ensuing week, including today. Bearish signals remain constant and intact. Livermore would probably LOVE trading in our era.

Investors today have many advantages that Livermore didn't have in his day; nearly real-time quotes and execution with almost universal free trading, nearly limitless data sources, and even the ability to limit risk via index trading rather than speculation in individual stocks or commodities. So although the game may have changed, most (all?) of the behavioral characteristics remain the same; fear & hope drive the investing world. 


Sunday, June 12, 2022

Suffering Fools

Suffering Fools


Dearest fellow Financial Farmers, why do we suffer fools? Investors for too long have been held hostage to economic imbeciles. Why are we gluttons for punishment? If every piece of economic data indicates that the market is POOP, why NOT short it? 

Frequent readers of this amazing blog know that this author is a big fan of "Reminiscences of a Stock Operator" by Edwin Lefevre detailing the life of Jesse Livermore. It reads like an acquired taste, in that fine champagne is an acquired taste. I consider it Gospel for trading. With that said, one of my favorite lines in the book details Livermore's thoughts on selling: "If a stock is good enough to sell, it is good enough to sell short."

Here at ILAF we have an open mind, but it closes like a steel trap when we lose money! The past 7 months have been a painful reminder of what happens when "leadership" runs amok and there is no strategy in place. Chaos ensues. Why as an investor should you be punished for this? Well because you believe in long-term growth and that the economy will "eventually recover," right? 

Recovery often takes longer than we realize, with the Bear Markets often lasting years. In times of listless trading, near-term assets are whipsawed back and forth until investors are green with nausea, not envy. So with that said, there are several options for investors who have little to no confidence in the current market.

First, there is always "do nothing." This involves keeping your current portfolio as is. You're indifferent to near-term volatility and think in decades. Second, there is Dollar Cost Average your existing portfolio during the sell-off with the hope of increasing your positions. Over long periods of time this has generally worked. Third, there is the safety run idea of going all cash until the market subsides and there is some light at the end of the tunnel. The average bear market lasts about 300 days. So cozy up to a umbrella cocktail for about 10 months. A fourth option to consider would be profiting from the downturn. There are several ways to accomplish this, some act more as buffers while others seek Absolute Alpha.

Consider your time horizon and goals, but also your risk tolerance. As Zero Hedge aptly says, "In the long run we're all dead." So for some doing nothing works, others prefer a cocktail on the beach, and a few investors will try to profit from chaos. Socrates put it best: "Know thyself."

Monday, June 6, 2022

Absolute Alpha

Absolute Alpha


What better day to launch a new investment strategy than D-Day? 78 years ago today, America launched the largest offensive the world has ever seen to help defeat Nazi Germany and the Axis powers. Men dropped from the sky, motored on boats, and stormed the beachheads of Normandy. By sunset, blood-red tides lapped the sands...but we were victorious.

D-Day marked the beginning of the end of World War II. Nearly every freedom we enjoy today was defended and secured that day through enormous sacrifice. Much of this "paid-up capital" came at the cost of lives unlived. Thousands that day, and millions of progeny this day are not with us because of past battles. And almost every meaningful battle in history had at its core the fight for truth: What is right? What is wrong? What is the truth?

What better way to pay this sacrifice forward than a search for the truth? One of the greatest challenges investors face is trust. Indeed, a hallmark of our era is the collapse in public trust in both government and various "experts" of all types. Who do you believe? What are their qualifications? What is their track record? These questions beget another: Why should we care?

Traditionally, stock return estimates are predicated upon using macroeconomic variables, financial ratios, and to a large extent, data provided by corporations themselves. The summation of these forces has formed the bedrock of the financial industry throughout the world. CNBC, Bloomberg, Wall Street Journal, etc., etc. 

The list of established mediums of "trust" is long. Absolute Alpha strives to relieve investors of dependence on traditional stock market "trust" such as financial commentary, corporate messaging, or even Government reassurances. These data may or may not be accurate. Absolute Alpha is interested in sustained market movements, regardless of direction. Commentary, forecasting, and assurances be damned, Absolute Alpha seeks the truth!

The Absolute Alpha trading goal is simple: Seek a positive yearly return (absolute alpha), regardless of market conditions. Consider the chart below showing the performance of the S&P 500 from Jan '22 until May '22:


From a pure date-to-date perspective the S&P 500 was down 13.85%. Yet look closer and you will see something else entirely. Buried in this chart is an abundance of "truth." Rather than struggling with emotional turmoil experienced on a regular basis worried about whether XYZ will beat earnings, or how many units were sold, or if FDA approval was granted, investors can potentially benefit from a broad market approach focused solely on momentum vectors.

As previously discussed, Absolute Alpha's goal is to consistently produce alpha, regardless of market conditions. But how? By being on the right side of longer-term momentum vectors. In the chart above there are MULTIPLE (most likely infinite) vectors during this 5-month snapshot. The trick is capturing as many sustained momentum vectors as possible, while limiting downside losses by being late to a trade.

If we were to "cut" this chart into various date ranges there would be both negative and positive momentum vectors whose cumulative absolute total would far exceed the negative 13.85% value if timed correctly. Why not capture alpha on BOTH the upside and downside? Simply put, when the wind changes, a sailboat tacks. Investors need to do the same. Therein lies the truth.