Trader’s Narrative

Here’s an up and coming sentiment tool that I discovered recently. It is released weekly by the National Association of Active Investment Managers (NAAIM), a non-profit association of registered investment advisors formed in 1989. Since the (200 or so) member advisors provide active money management services to their clients, as opposed to buy and hold, they position their portfolios according to their opinions of the market’s future. In reality every portfolio is actively managed because there is no way to be passive.

In any case, each week on Wednesday, the advisors communicate their equity exposure by choosing one of the following answers:

• 200% — Leveraged Short
• 100% — Fully Short
• 0% — 100% Cash or Hedged to Market Neutral
• 100% — Fully Invested
• 200% — Leveraged Long

Their answers are then averaged to produce the NAAIM Trend Survey of Manager Sentiment:

Although we only have two and a half years of sentiment data and a relatively small sample size, this sentiment indicator shows promise. To start its extremes correspond to tops and bottoms in the S&P 500. For example, when active managers reduced their exposure to “neutral” in late August 2007 and July 2008, we saw the S&P 500 find its feet again.

But the latest active managers sentiment is somewhat troubling because even as the market weakness has continued for several months, they have positioned their portfolios more and more aggressively long. Once again we are seeing that we do not have a “wash-out” or complete capitulation. On the contrary, everyone it seems is even more hopeful… as the market falls even lower!

Although the NAAIM data is weekly, it comes out with a delay. The latest result is for January 14th 2009. I’ll update the chart when the new data is released or when it tells us some other interesting things about the market.

If you want to get more information or download the raw data to play around with it, you can do so at the NAAIM website.

While the active vs. indexing argument rages on in the investing world, it is a moot point. Everything is actively managed. The only difference is that some funds are more actively managed than others. (Sorry Bogle.)

Every single index out there was created by someone or by some committee and it is regularly updated and managed to keep pace with the changes in the real world.

That goes for the Standard & Poor’s 500 Index, the behemoth out there that has more money following it than any other index out there. The composition of the list of 500 stocks is presided over by the S&P Index Committee, a group of employees of McGraw-Hill Companies.

They follow a few guidelines:

• U.S. Company
• Market Capitalization: min. $4 billion
• Public Float at least 50%
• Adequate Liquidity and Reasonable Price.
• Sector Representation
• Company Type: operating, not CEF, REIT or BDC

But, in the end, these are just guidelines and the committee has full discretion to include any company and to exclude another, even if it technically meets all the criteria.

Every once in a while the committee faces a rare situation where a large portion of the S&P 500 Index does not meet one or more requirement they have outlined. Usually the simply ignore it and hope that it just goes away on its own.

In October 1987 there were 35 S&P 500 Index stocks that traded for less than $10 a share. In the aftermath of the September 11th terrorist attack, 59 S&P 500 Index companies traded for less than $10 a share. Right now we are going through a similar situation.

Currently there are about 101 S&P 500 Index stocks trading at sub $10 a share. Unbelievably, one S&P 500 component, E*Trade (ETFC), closed below $1 a share. And there are 36 stocks trading below $5 a share. These are levels at which stocks are called “penny stocks”. You can find a table of the constituents, ordered by share price here:
Continue reading ‘S&P 500 Index: Now More Poor, Less Standard’

The following is from San Francisco magazine (online). I’ve included it here because, for some odd reason, the original site shows it as a 404 error now. This is much too good to let disappear into the ether, so bookmark this, delicious it or just print it off and read it.

Just remember to not get drunk on the indexing Kool-Aid. All methods of investing are active, even indexes like the Dow Jones. Passivity does not exist. All indexes have their components picked by someone and regularly rebalanced and modified by someone (or some committee).

The best investment advice you’ll never get
For 35 years, Bay Area finance revolutionaries have been pushing a personal investing strategy that brokers despise and hope you ignore. The story of a rebellion that’s slowly but surely putting money into the pockets of millions of Americans, winning powerful converts, and making money managers from California Street to Wall Street squirm.
By Mark Dowie

As Google’s historic August 2004 IPO approached, the company’s senior vice president, Jonathan Rosenberg, realized he was about to spawn hundreds of impetuous young multimillionaires. They would, he feared, become the prey of Wall Street brokers, financial advisers, and wealth managers, all offering their own get-even-richer investment schemes. Scores of them from firms like J.P. Morgan Chase, UBS, Morgan Stanley, and Presidio Financial Partners were already circling company headquarters in Mountain View with hopes of presenting their wares to some soon-to-be-very-wealthy new clients.

Rosenberg didn’t turn the suitors away; he simply placed them in a holding pattern. Then, to protect Google’s staff, he proposed a series of in-house investment teach-ins, to be held before the investment counselors were given a green light to land. Company founders Sergey Brin and Larry Page and CEO Eric Schmidt were excited by the idea and gave it the go-ahead.

Continue reading ‘The Best Investment Advice You’ll Never Get’

Today the venerable Dow Jones Industrial index is undergoing changes to its component stocks: Altria Group, formerly Philip Morris (MO) and Honeywell (HON) are being replaced with Chevron (CVX) and Bank of America (BAC).

Actively Passive
Which explains why I always chuckle when people get into debates about “passive” (aka index) funds vs. “active” funds. As today’s change should evidence, all funds, including indexes are active.

Somebody has to decide: a] what to put into an index b] rebalance it using some formula and c] make changes to the components, from time to time.

In an active fund, those calls are made by the manager who charges a hefty fee and in the case of an index fund like the Dow Jones the decision is made by the editors of The Wall Street Journal. Same difference.

The only real distinction is the portfolio turnover and the MER. While changes to the Dow happen every few years, an actively managed portfolio can have positions traded into and out up to several times a day.

Better Out Than In
Another interesting twist to this debate is that historically, stocks deleted from the Dow Jones end up outperforming the ones that replace them. That goes for not just the Dow but all major indices.

For example, Chevron was in the Dow before until it was deleted on November 1st, 1999 in a swap that involved 3 other boring stocks getting dumped for sexier stocks: Home Depot (HD), Intel (INTC), Microsoft (MSFT) and SBC Communications - now AT&T (T). The editors of the WSJ weren’t immune to the lure of the internet bubble.

The four new stocks went on to produce an average loss of 40% while the deleted and unloved stodgy ones produced an average gain of 27%. So the Dow would have been much better off had there been no changes at all!

The most (in)famous change to the Dow is the elimination of IBM from the index in 1939. While it was eventually added again, according to Norman Fosback, the Dow would now be twice what it is today had there been no change.

Still like indexing? still think it is passive?

Technical Analysis
Rather than a typical technical analysis of the Dow using its own chart, I thought I’d share something a bit more advanced and perhaps more insightful.

The chart below is a ratio of two breadth indicators: the percentage of Dow components above their 50 day moving average, divided by the percentage of Dow components above their 200 day moving average. If it sounds familiar, you’ve probably read this: “Timing the Market with % Above MA Ratios”

Whenever the ratio spikes, the Dow is extremely oversold. The current ratio has spiked because the denominator is 13.33% - the lowest it has been in five years.

Anything in the 2.0+ range is beyond extreme. We’ve only exceeded this level in recent times when the market was making the 2002-2003 bear market bottom.

Fundamental Analysis
According to Morningstar’s fundamental analysis, the Dow is undervalued by 17%. They arrived at this valuation by doing an analysis of each component. They also expect the index to rise 50% in the next 3 years.

According to Jeffrey Ptak, “The Dow hasn’t looked this cheap to us since September 2002 when the index stood at 7,592″. Sound familiar?

The research note was released before today’s changes to the Dow but Morningstar added a note saying that Chevron and Bank of America will actually make the Dow even more undervalued, reducing both trailing and projected price earnings ratio and increasing the dividend yield.

I’m not big on fundamental analysis but when it dovetails so neatly with technical analysis, I can’t help but take notice. Oh and for another take on the general market fundamentals, take a look at the IBES model.

Remember to add your own thinking and due diligence.