Browsing articles in "Risks"

Will Bulls Reign In 2015?

Feb 19, 2015   //   by Profitly   //   Market, Profitly, Risks  //  Comments Off on Will Bulls Reign In 2015?

People will often ask our gurus what their general outlook for the market is the following year and 2015 is no different. What we want everyone to know is that for us, it doesn’t matter if the market goes up or down. We train our students to know how to trade in any market. There will always be weeks where there are more plays then others, but the general direction of the market does not have a large impact on their ability to make money. They know how to short stocks and buy stocks by just learning technical patterns and the impact of various news stories.

If you are still curious how the market s going to do in the following year though, here is a post form Business Insider that will give you some insight. Please do keep in mind that making these types of predictions is like rolling a dice. New events can quickly pop up throughout the year and turn these estimates on their heads.

Finally, A Top Wall Street Strategist Goes Contrarian And Predicts US Stocks Will Fall In 2015

Until now, we couldn’t find a single major Wall Street strategist that was predicting US stocks would fall in 2015, and neither could Barron’s:

barrons-729x1024

The lowest level on Barron’s list was 2100 by Jonathan Glionna of Barclays. Keep in mind that the S&P 500 closed on December 31, 2014, at 2,058.90, so these are all higher than that level.

Of the strategists followed by Business Insider, 2100 was also the lowest, with the most bearish coming from Goldman Sachs, Credit Suisse, and Barclays.

But Societe Generale has come out with a contrarian view: US stocks are going to slide in 2015.

“Since 1875, we have never seen the S&P rise for seven calendar years in a row, so an eighth year would seem highly unlikely,” Societe Generale’s Roland Kaloyan said in a Dec. 17 note to clients. “We assume that the S&P 500 will finish the year slightly down as the strengthening of the US dollar and the new tightening cycle offset the strong US GDP growth already priced-in at the start of the year.”

@finansakrobat tweeted this map summarizing the firms outlook for global stocks in 2015.

The red map of the US with “S&P 500: -1%” really sticks out.

cd-17

Via Societe Generale

 

However, Kaloyan is feeling positive about other countries in Asia and Europe.

The firm is expecting stocks soaring in Hong Kong, Japan, Taiwan, and several European countries including Spain.

The Great Search For Yield

Jun 1, 2014   //   by Profitly   //   Market, Profitly, Risks  //  Comments Off on The Great Search For Yield

There has been a great search for yield following the financial crisis. Investors were scared to get back into the stock market but were also hesitant to earn a very low yield on their safer investments such as bonds due to the low interest rates by the Fed.

In 2013, Stocks jumped on the first day of trading in January and didn’t go negative for the ENTIRE YEAR. They went up a historic 30% (still less than I or the other Profitly gurus earn) and finished the year at a new record high.

What drove this? It was mainly investors rebalancing their outrageously lopsided portfolios after five years of the fear I addressed earlier. Flows into equity funds went positive in 2013 while money only trickled into bond funds.

2014 has shown a pause in this movement, however. Bond inflows are ahead of equity inflows year-to-date (reverse of last year). This means that the longer-term move into bonds and out of stocks, is still enormous even though stocks gained ground last year. There has been $1.2 trillion into fixed income funds since 2006 versus a negative $800 billion pulled from stock funds.

However, fund flow data since the beginning of 2013 shows that investors have been rotating from bonds into equities. Equities have had $298 billion in inflows since January 2013, while fixed income has had only $75 billion. But bond flows have picked up this year with inflows of $71 billion vs. $46 billion for equities.

The first chart below is the cumulative flows – stock funds versus bond flows – going back to 2006. You can see a drastic preference for “safety” that is so large, even last year’s enthusiasm barely dents it:

Screen-Shot-2014-05-25-at-7.47.20-AM

The second chart shows close-up on this year’s interruption of the Rotation:

Screen-Shot-2014-05-25-at-7.47.39-AM

Images and argument via The Reformed Broker.

So, to better understand this movement, let’s define what a bond is. Investopedia has a fantastic definition and example:

“A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities.

Bonds are commonly referred to as fixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents.

The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply ‘Treasuries.’

Two features of a bond – credit quality and duration – are the principal determinants of a bond’s interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipals are typically in the three to 10-year range.”

Bonds aren’t the first thing that people tend to think of when they talk about investing. Most people think about stocks, which is what I and the other gurus trade. Perhaps older individuals think more about bonds, since they are viewed as safer and financial advisors often tell people to weight their portfolio more towards bonds as they get older and approach retirement.

But the general public thinks of stocks and the potential for a big return. Stocks are more exciting, so who can blame them! Bonds are also pushed to the side during a bull market (hence the data regarding the great rotation in the beginning of this post). There is also the fact that bonds have some weird jargon that goes with them.

But all it takes is a bear market to make investors run for bonds and the “safe investment.”

So here is just a basic lesson in bonds. First, know that a bond is simply a type of loan taken out by companies. Say you take out a bond in GM. This means that you are lending GM money. In exchange, you will get a “coupon” or interest payment on that bond. These payments come in set intervals. But wait, you can give GM money when you buy their stock, right? The difference is that when you buy GM’s stock, you are buying a portion of equity while when you buy GM bonds, you are buying a portion of debt.

There are a few terms of bonds that you need to familiarize yourself with, as not all bonds are created equal. First is the maturity. This is the date when the principal on the bond will be paid to investors and the company’s bond obligation will end. For example, you can buy a GM bond that matures in 2015, and then in 2015, you get the principal investment back and GM no longer owes you those coupon payments.

The second is Secured vs. Unsecured. Bonds that are unsecured are called debentures; their interest payments and return of principal are guaranteed only by the credit of the issuing company. If the company fails, you may get little of your investment back. A secured bond is one in which specific assets are pledged to bondholders if the company cannot repay the obligation.

A third term is coupon. We addressed this briefly earlier, but it’s the amount of interest paid to bondholders, (normally annually or semiannually).

Fourth is the tax status of the bond. Most corporate bonds are taxable, but some government and especially municipal bonds are exempt from taxes, which essentially increases your return.  But these bonds also typically have lower interest than equivalent taxable bonds, evening it out a bit.

It is also important to point out that bonds are not risk free. There is a credit/default risk, prepayment risk, and interest rate risk. the default risk is that interest and your principal payment will not be made. The prepayment risk is that the given bond issue will be paid off earlier than expected. Why is this bad? Well, the company only has an incentive to repay the obligation early when interest rates have declined substantially…meaning that instead of continuing to hold a high interest investment, investors are left to reinvest funds in a lower interest rate environment. This leads us to interest rate risk. This is the risk that interest rates will change meaningfully from what you expected when you made the investment. If they significantly decline, the you face the possibility of prepayment. If interest rates increase, you will be stuck with an instrument yielding below what you could be making in a similar bond that was just issued later at a higher rate. The longer the maturity on the bond, the greater the risk.

One thing that often confuses people and business students learn in finance 101 is that yield moves inversely to price. Yield is the figure that shows the return you get on a bond. The simplest version of yield is calculated using the following formula: yield = the coupon amount/price. When you buy a bond at par, yield is equal to the interest rate. When the price changes, so does the yield.

Investopedia gives a great example of this.

“If you buy a bond with a 10% coupon at its $1,000 par value, the yield is 10% ($100/$1,000). Pretty simple stuff. But if the price goes down to $800, then the yield goes up to 12.5%. This happens because you are getting the same guaranteed $100 on an asset that is worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield shrinks to 8.33% ($100/$1,200).”

Sounds simple and you are probably wondering why people get confused, right? Well, this is more complicated in everyday life. When bond investors refer to yield, they are usually referring to yield to maturity (YTM). This is a more advanced yield calculation that shows the total return you will receive if you hold the bond to maturity. It equals all the interest payments you will receive (and assumes that you will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if you purchased at a discount) or loss (if you purchased at a premium).

I’m not going to dive deep into how to calculate YTM, just know that it’s the more accurate way for  you to compare bonds with different maturities and coupons.

In conclusion, think of it this way: the relationship of yield to price can be summarized as when price goes up, yield goes down and vice versa. How can high yields and high prices both be good when they can’t happen at the same time? The answer depends on your point of view. If you are a bond buyer, you want high yields. A buyer wants to pay $800 for the $1,000 bond, which gives the bond a high yield of 12.5%. On the other hand, if you already own a bond, you’ve locked in your interest rate, so you hope the price of the bond goes up and then you can cash out in the future.

CAPE Ratio Pointing to a Downturn?

May 2, 2014   //   by Profitly   //   Market, Profitly, Risks  //  Comments Off on CAPE Ratio Pointing to a Downturn?

With the Dow and the S&P near record highs and people talking about a bubble in the tech and biotech sectors, a lot of people are studying up on different valuations so they can catch the next big trade and trade the best stocks, whether long or short. The Dow’s recent record closing high of 16580 on Tuesday and intraday record of 16631 on April 4 along with the S&P 500’s record closing high of 1890 on April 2 and intraday record high of 1897.28 on April 4 have everyone buzzing about stocks trying to find the best stocks out there.

One of the valuations metrics that people have been looking at lately is something called the “CAPE ratio,” also known as the “P/E 10 Ratio” or “Shiller PE ratio.”

So what exactly is it and how can it help you learn how to trade the best stocks and find the best stocks to invest in? Let’s start with this a great definition by Investopedia:

“It’s a valuation measure, generally applied to broad equity indices, that uses real per-share earnings over a 10-year period. The P/E 10 ratio uses smoothed real earnings to eliminate the fluctuations in net income caused by variations in profit margins over a typical business cycle. The ratio was popularized by Yale University professor Robert Shiller, who won the Nobel Prize in Economic Sciences in 2013. It attracted a great deal of attention after Shiller warned that the frenetic U.S. stock market rally of the late-1990s would turn out to be a bubble. The P/E 10 ratio is also known as the “cyclically adjusted PE (CAPE) ratio” or “Shiller PE ratio.”

The P/E 10 ratio is calculated as follows – take the annual EPS of an equity index such as the S&P 500 for the past 10 years. Adjust these earnings for inflation using the CPI. Take the average of these real EPS figures over the 10-year period. Divide the current level of the S&P 500 by the 10-year average EPS number to get the P/E 10 ratio or CAPE ratio.

A criticism of the P/E 10 ratio is that it is not always accurate in signaling market tops or bottoms. For example, an article in the September 2011 issue of the “American Association of Individual Investors’ Journal” noted that the CAPE ratio for the S&P 500 was 23.35 in July 2011. Comparing this ratio to the long-term CAPE average of 16.41 would suggest that the index was more than 40% overvalued at that point. The article suggested that the CAPE ratio provided an overly bearish view of the market, since conventional valuation measures like the P/E showed the S&P 500 trading at a multiple of 16.17 (based on reported earnings) or 14.84 (based on operating earnings). Although the S&P 500 did plunge 16% during a one-month span from mid-July to mid-August 2011, the index subsequently rose more than 35% from July 2011 to new highs by November 2013.”

One prominent individual that has been taking a close look at valuation measures, including the CAPE ratio, is Henry Blodget, editor-in-chief of Business Insider. In a recent post, he said “Every valid valuation measure I look at suggests that stocks are at least 40 percent overvalued,” adding that he wouldn’t be surprised if we saw a crash soon. He thinks that just investing in stocks is likely to deliver crummy returns for the next seven years (or so). Not only does that mean that give you more reason to learn from people like the gurus on Profitly that trade rather than invest, it means that the average person in the stock market isn’t going to do very well for the next several years. His points and reasons for coming to this conclusion? He lays out the bullish and bearish cases:

  • Every valid valuation measure I look at suggests that stocks are at least 40% overvalued.
  • Corporate profit margins are at record levels and look like they might finally be rolling over.
  • Lots of sentiment indicators are flashing warning signs (folks are just way too bullish).

And what are the arguments that these concerns are silly and that stocks will keep rising?

  • One of the big bullish arguments seems to be that “there’s no catalyst” for a crash or bear market.
  • Another bullish argument is that the economy’s getting better.
  • Lastly, there’s a general sense that the financial crisis is finally over and that everything finally feels fine.

So which valuation measures suggest the stock market is very overvalued?

  • Cyclically adjusted price-earnings ratio (current P/E is 25X vs. 15X average — higher than any time in the past century with the exception of 1999-2000 and, very briefly, in 1929).
  • Market cap to revenue (current ratio of 1.6 vs. 1.0 average).
  • Market cap to GDP (double the pre-1990s norm).

Here is a recent chart of the CAPE ratio from Bill Hester of the Hussman Funds.

shiller-cape-1

The blue line shows the prediction for 10-year returns. The red line shows the actual returns. If you have heard people say, “CAPE doesn’t work anymore,” you might want to read Bill Hester’s analysis. He looks at all the arguments why CAPE doesn’t work and concludes that it does. (We’ll know for sure in 10 years.)

Second, in case you have been convinced that the “CAPE” ratio no longer works, here’s a look at price-to-revenue.

screen shot 2013-12-24 at 8.58.26 am

This measure is calling for a slightly better long-term return for the S&P 500 — just under 5% — but still a far cry from the long-term average. And far less than the guru’s and their students make in a year. Can you see why looking at charts like this will help you better understand technical patterns and other charts that the gurus look at? You have to know about stuff like this if you want to be a successful trader. Profitly gives you the tools and resources to learn from the best.

The Scary Chart Being Shown Around the Internet

Feb 20, 2014   //   by Profitly   //   News, Profitly, Risks  //  Comments Off on The Scary Chart Being Shown Around the Internet

The pesky chart that is blowing up the internet…

Sell all of your stocks….now! We’re about to see a crash! That’s what many people are thinking when they first take a look at the chart below, but investment advisors are begging you to do your research before you act irrationally.

Chart 1929

There is much, much more to the story that what the uneducated person would think. This chart is a superimposition of the recent market performance and the crash of 1929. Mark Hulbert of MarketWatch defends the chart, saying that the market will face “a particularly rough period later this month and in early March.” One of the main objections to this chart is that there are different scales on the left and the right axes. “The scale on the right, corresponding to the Dow’s DJIA +0.79%   movement in 1928 and 1929, extends from below 200 to more than 400—an increase of more than 100%. The left axis, in contrast, represents a percentage increase of less than 50%,” Hulbert says. But he goes on to say that this doesn’t discredit the chart. “You can still have a high correlation coefficient between two data series even when their gyrations are of different magnitudes.”

Hulbert wasn’t the only one defending the chart. Hedge-fund manager Doug Kass wrote about the parallels with 1928-29, saying, “While investment history doesn’t necessarily repeat itself, it does rhyme.” Kass believes that “the correction might have just started.”

Josh Brown of The Reformed Broker was far more skeptical in his post titled “The Chart That Wouldn’t Die.” (Link)

He goes straight into it saying that the chart has been debunked numerous times yet keeps showing up at any hint of correlation.  Just like on TV, people like drama and emotion, and this chart enforces both of those.

“The studies all confirm that the human animal is, at the end of the day, more risk averse than it is ambitious. This is why content that frightens us can continue to get the traction it does, time after time,” Brown says.

Brown actually seems relatively pissed off at some points. “This frightens investors into making poor decisions – big decisions that will have a major impact on their mental health and financial condition well into the future,” he says. He also points out that the more charts like this are spread around and people fall for them, the more potential they have of becoming a “self-fulfilling prophecy.”

Now the Wall Street Journal has even stepped in (link). Steven Russolillo writes that we should all put an end to this drama. He interviewed several investment professionals and here are some of their responses:

“I have been in this business for over 43 years, yet I do not ever recall getting as slammed with the same email as many times as I have about the attendant 1929 comparison chart,” says Jeffrey Saut, chief investment strategist at Raymond James. “You can ‘scale’ any chart to do just about anything you want it to imply! In this case, the scale makes the comparison to 1929 with the present stock market chart pattern appear eerie. However, if you index that same chart so that you are comparing apples to apples, the correlation to 1929 disappears. Moreover, I have been around long enough to have seen this “act” before. The time period was the 1980s – 1990s when ‘they’ were trying to scale Japan’s Nikkei Index to that of the Dow Jones Industrial Average. All these kinds of chart shenanigans prove is that, ‘Where you stand is a function of where you sit, or that you can make numbers do anything!’”

Daniel Wiener, chief executive at Adviser Investments in Newton, Mass. told his clients in a note that he blamed the Internet for the ruckus this chart has caused. “Before the Internet these charts would never have seen the light of day, or if so they’d have been seen, and dismissed quickly,” Mr. Wiener said. “Not so today’s ‘eyeball seeking’ web sites that work hard to capture your attention whether they are selling snake oil or…snake oil.”

Despite this chart and a few bad days in 2014, the major indices aren’t doing so bad. They were nearing and sometimes entering pullback territory at points, but now they are close to turning positive for the year. It’s interesting to look at all perspectives, but make sure you are educated enough to separate the more accurate from the “far fetched ideas.”

Commodities Risks

Dec 14, 2013   //   by Profitly   //   Market, Risks  //  Comments Off on Commodities Risks

A lot of people like to diversify their investments by finding alternative ways of trading. The large world of commodities is one way to do that. Particularly after the 2008 financial crisis, people wanted to put their hard earned cash to work in places other than equities. Corn, coffee, gold, orange juice, oil, and even cattle are different types of commodities that are traded on exchanges. This is a stark change from when commodities used to only be used for hedging, where for example farmers could ensure a certain price for their crops.

Some of these have turned out to be great investments since 2008; gold is up from $850 in January 2008 to about $1200 now. But actively trading commodities is an extremely tricky business and a lot of people don’t really understand what they are getting into.

In case you weren’t aware, most people who trade commodities lose money. A majority of the estimates are in the range of 80 to 95 percent who have lost or who are losing trading commodities. Pretty bleak statistics if you ask me. Yet, people continue to trade commodities every day and more and more people give it a try as well. Fortunately, there are several commonalities in terms of the mistakes that people make while trading commodities, meaning that if you read this and learn from it, you have far better odds of making money.

According to about.com, here are some of the most common trading mistakes:

First is lack of education. Just like I said above, a lot of people don’t know what they are getting into when they start trading commodities. This is just like people that try to trade penny stocks without learning from Tim or the other gurus. Sure, even without education you will get lucky and have a good trade or two, but the odds are not in your favor. Far too many new traders neglect to educate themselves on how to trade commodities before diving in head first. Commodities is a zero sum game, meaning for every person that makes $100, another person lost $100.

Second we have the leverage problem. This is probably the number one issue when it comes to trading commodities. There is huge leverage when trading commodity futures, so a couple bad trades can wipeout the over leveraged trader. Do not trade a contract that is too large for your account size. For instance, do not trade three futures contracts that average a $2,000 move a day when you have a $10,000 account.

Third we have money management. This is another biggie and relates to the tip we previously discussed regarding leverage. You should not risk more than a small percentage on any given trade. There are statistics showing that most professional money managers risk less than 2 percent on any one trade. This becomes more difficult when trading commodities and other futures contracts.

Finally, remember to have a plan. How many times have Tim and I written about having a PLAN before making a trade?! Traders get so lazy and impatient when it comes to this. You have to have a plan.

So now that you have that advice, let move in to the elevated risks of trading commodities. You can’t help but think about risk when you think about trading commodities.

The key reason why commodities are considered risky is that commodities are traded in futures contracts and they are highly leveraged (addressed in the four tips above). A commodities trader normally only has to put up 5 to 20 percent of the contract in futures margin value to control the commodity investment. When you buy one contract of crude oil, you aren’t just buying one barrel, unlike when you buy a stock, you can buy one stock. You are actually buying 1,000 barrels of crude oil when you purchase one contract. That means in crude oil is trading at $90 a barrel, you are buying $90,000 worth of oil, not $90. However, a trader doesn’t need to put up the full $90,000. They would be required to put up a much smaller percentage, around $6,000 in this case. This also means that if oil moves from $90 a barrel to $89, the value of your position would change by $1,000. That’s leverage since you don’t have to put up the full amount. How do you feel about entering a commodity trade with $5,100 in margin and realize that position can move for or against you by about 40 percent every day?

The fact that uneducated traders do this without even realizing what they are getting themselves into is very, very scary. This kind of leverage in the hands of an undisciplined trader is the reason so many new commodity traders lose money. It is commonly discussed in the futures industry that anywhere from 80 to 95 percent of traders lose money in commodities, slightly more than the average number of people that lose money trading stocks. Those educated in trading commodities, such as commodity trading advisors (CTA’s) have a much better track record with managed futures. The popular Barclay CTA Index has CTA’s making an average compound annual return of 11.56% from 1980 to 2009. There were only 3 losing years and the worst was -1.19%.