Posts Tagged ‘Bad Judgment’

“Street Smarts” (Saut)

Tuesday, March 6th, 2012

“Street Smarts”

by Jeffrey Saut, Chief Investment Strategist, Raymond James

March 5, 2012

Some people can have a lot of experience and still have good judgment. Others can pull a great deal of value out of much less experience. That’s why some people have street smarts and others don’t. A person with street smarts is someone able to take strong action based on good judgment drawn from hard experience. For example, a novice trader once asked an old Wall Street pro why he had such good judgment. “Well,” said the pro, “Good judgment comes from experience.” “Then where does experience come from?” asked the novice. “Experience comes from bad judgment,” was the pro’s answer. So you can say that good judgment comes from experience that comes from bad judgment!

. . . Adapted from “Confessions of a Street Smart Manager” by David Mahoney

Years ago I read a book that a Wall Street professional told me would give me good stock market judgment by benefitting from the bad experience of others who had suffered various hard hits. The name of the book was “One Way Pockets.” It was first published in 1917. The author used the non de plume “Don Guyon” because he was associated with a brokerage firm having sizable business with wealthy retail investors and he had conducted analytical studies of orders executed for those investors. The results were illuminating enough to afford corroborative evidence of general investing faults that persist to this day. The study detected “bad buying” and “bad selling,” especially among the active and speculative public. It documented that the public tends to “sell too soon,” and subsequently repurchase stocks at higher prices by buying more stocks after the stock market has turned down, and finally liquidate all positions near the bottom; a sequence true in ALL similar periods.

For instance, the book shows that when a bull market started the accounts under analysis would buy for value reasons; and buy well, albeit small. The stocks were originally bought for the long-term, rather than for trading purposes, but as prices moved higher on the first bull-leg of the rally investors were so scared by memories of the previous bear market, and so worried they would lose their profits, they sold their stocks. At this stage the accounts showed multiple completed transactions yielding small profits liberally interspersed with big losses.

In the second phase of the rally, when accounts were convinced the bull market was for real, and a higher market level was established, stocks were repurchased at higher prices than they had previously been sold. At this stage larger profits were the rule. At this point the advance had become so extensive that attempts were being made to find the “top” of the market move such that the public was executing short-sales, which almost always ended badly.

Finally, in the mature stage of the bull market, the recently active and speculative accounts would tend not to over-trade or try to pick “tops” using short-sales, but would resolve to buy and hold. So many times previously they had sold only to see their stocks dance higher, leaving them frustrated and angry. The customer who months ago had been eager to take a few points profit on 100 shares of stock would, at this stage, not take a 30-point profit on 1,000 shares of the same stock now that it had doubled in price. In fact, when the stock market finally broke down, even below where the accounts bought their original stock positions, they would actually buy more shares. They would not sell;, rather the tendency at this mature stage of the bull market and the public’s mindset was to buy the breakdowns and look for bargains in stocks.

The book’s author concluded that the public’s investing methods had undergone a pronounced, and obvious, unintentional change with the progression of the bull market from one stage to another; a psychological phenomena that causes the great majority of investors to do the exact opposite of what they should do! As stated in the book, “The collective operations of the active speculative accounts must be wrong in principal [such that] the method that would prove profitable in the long run must be reversed of that followed by the consistently unsuccessful.”

Not much has changed from 1917 and 2012, just the players, not the emotions of fear, hope, and greed; or, supply versus demand, as we potentially near the maturing stage of this current bull market. Of course stocks can still travel higher in a maturing bull market, but at this stage we should keep Don Guyon’s insight about maturing “bulls” in mind. Verily, this week celebrates the third year of the Bull Run, which began on March 9, 2009 and we were bullish. With the S&P 500 (SPX/1369.63) up more than 100% since the March 2009 “lows” it makes this one of the longest bull markets ever. As the invaluable Bespoke Investment Group writes:

“Going all the way back to 1928, the current bull market ranks as the ninth longest ever. Even more impressive is the fact that of the nine bull markets that lasted longer, none saw a gain of 100% during their first three years. Based on the history of prior bulls that have hit the three-year mark, year four has also been positive.”

Now, recall those negative nabobs that told us late last year the first half of 2012 would be really bad? W-R-O-N-G, for the SPX is off to its ninth best start of the year, while the NASDAQ (COMPQ/2976.19) is off to its best start ever! In seven out of the past ten “best starts,” the SPX was higher at year-end, which is why I keep chanting, “You can be cautious, but don’t get bearish.” Accompanying the rally has been improving economic statistics and last week was no exception. Indeed, of the 20 economic reports released last week, 15 were better than estimated. Meanwhile, earnings reports for 4Q11 have come in better than expected, causing the ratio of net earnings revisions for the S&P 1500 to improve. Then too, the employment situation reports continued to improve. Of course, such an environment has led to increased consumer confidence punctuated by the February’s Consumer Confidence report that was reported ahead of estimates at 70.8, versus 63.0, for its best reading in a year. And that optimism makes me nervous.

Nervous indeed, because the SPX has now had 42 trading sessions year-to-date without so much as a 1% Downside Day. Since 1928 the SPX has only had six other occasions where the SPX started the year with 42, or more, trading sessions without a 1% Downside Day. Worth noting, however, is that in every one of those skeins the index closed higher by year’s end. Still, in addition to the often mentioned upside non-confirmations from the D-J Transportation Average (TRAN/5160.13) and the Russell 2000 (RUT/802.42), seven of the SPX’s ten macro sectors are currently overbought but the NYSE McClellan Oscillator is now oversold, Lowry’s Short Term trading Index has fallen 12 points since peaking on January 25th (which interestingly is the day before the Buying Stampede ended), the Operating Company Only Advance/Decline Index (OCO) has nearly 1,000 fewer issues than where it was on February 1st, suggesting the rally is narrowing, the number of New Highs confirms the OCO (last April the index had similar readings right before a correction), and sticking with the April 2011 comparison shows a striking similarity to the December 2010 – February 2011 trading pattern for the SPX and we all remember how that ended (see chart on page 3). And then there’s this from my friend Jim Kennedy of Atlanta-based Divergence Analysis, whose proprietary algorithms I use on a daily basis:

“The currently developing negative divergence pattern by our Risk Indicator is a model event that historically leads to a correction phase. This correction ‘is not in play’ now, as the Risk indicator (historically) turns up again to show the final surge of the rally. Once Risk reverts down after that, the correction phase is ‘in play’. For your review a picture of the 2007 Risk negative divergence pattern and resulting correction.In 2007 this negative development led first into a smaller, trading range correction, a new higher top (with Risk diverging), and then the larger price correction of approximately 150 S&P points.This one may play out differently, but we have a nice guide to show the way.”

The call for this week: I am at the Raymond James 33rd Annual Institutional Conference this week and suggest you exercise “street smarts” in my absence. While I remain cautious (not bearish) there are still things to do. For example, I continue to like the strategy of looking at companies whose share price has collapsed for a one-off event. Recall, this was the case with Acme Packet (APKT/$30.26/Strong Buy) back in January, where in our analyst’s view the stock swoon had taken a lot of the price risk out of the equation. A similar sequence occurred last week with Vocus (VOCS/$13.52/Strong Buy), where our fundamental analyst maintains his positive view. For further information on either of these companies please see our fundamental analysts’ recent reports. I will speak with everyone next week.

Déjà vu?


Click here to enlarge

Copyright © Raymond James

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Munger’s Revenge, Concluded: The Tiger Woods Syndrome, and What Made Berkshire Hathaway as We Know It

Wednesday, August 17th, 2011

by Jeff Matthews, is the author the authoritative perspective on Berkshire Hathaway, “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”, (eBooks on Investing, 2011) Available now at Amazon.com.

Well, Tiger Woods Syndrome is breaking out all over, even in Omaha, Nebraska.

By “Tiger Woods Syndrome” we refer to what happens when the Mainstream Media has been sitting on a story it has long known of but couldn’t go with because the subject was too powerful: when the story suddenly, irrevocably blows wide open (like, oh, the guy’s wife tries to bash his head in with a golf club), well, suddenly everyone has a story to tell, and the press is happy to tell it.

And while the David Sokol Affair didn’t involve sex or golf, it did involve enough bad judgment to blow the cover off the notion that Warren Buffett’s perceived successor had everything a Berkshire shareholder could ask for, which is precisely when the knives came out here in Omaha at the Berkshire Hathaway shareholder meeting.

Friends and financial reporters who’d been told things over the years would say quietly to us, “Don’t quote me, but…” and then tell a Sokol story (more about judgment and personality than about anything you could put down as being wrong) that had either been dismissed as just sour grapes from a Sokol competitor or had been suppressed for the same reason nobody in the Mainstream Media ever bothered to investigate Tiger Woods’ extracurricular activities: the guy was too rich and too powerful.

And, hey, David Sokol had Warren Buffett’s blessing.

But with Sokol gone, so is the glow—and a lot of shareholders would like to know exactly how close did Berkshire Hathaway come to putting Warren Buffett’s life’s work in the hands of a guy willing to pick off a few points in a stock ahead of his employer’s acquisition of that company?

Unfortunately, the real answer to that question—probably a lot closer than Warren Buffett would like to admit—was never actually addressed at the Berkshire meeting, either by Buffett or Charlie Munger.

Indeed, because of the Sokol Affair, Buffett seemed on his guard and more defensive than usual. In contrast to last year’s defense of Berkshire’s relationship with Goldman Sachs, when Buffett came out swinging, this year he was more reflective and less direct in getting to the heart of the Sokol-related questions.

He seemed still stunned at the whole turn of events.

Charlie Munger, by contrast, was sharp, hard-nosed and positively voluble throughout. Munger also got the funniest line of the day in the video within the movie that kicked things off.

(The video—the best in years—was a laugh-out-loud takeoff on the TV show “The Office,” called “Michael’s Replacement,” in which Buffett and Munger take over at Dunder Mifflin from the clueless Michael Scott and his conspiratorial number two, Dwight Schrute. When a jealous Dwight sizes up Munger, his replacement as Number Two, sneering, “You don’t look so tough,” Munger adjusts Dwight’s tie, leans in and says menacingly, “There are eighteen ways I could kill you.”)

But it was in the six-hour Q&A following the movie that Munger demonstrated what has made him so valuable to Warren Buffett and to Berkshire Hathaway all these years, participating in an unprecedented number of questions, and with more substance and fewer jokes than usual.

In fact, at one point Munger abruptly took over one of the Sokol questions from Buffett, saying sharply, “I’ll handle this,” when a shareholder suggested Lubrizol’s board of directors had violated its fiduciary duty by negotiating only with Berkshire Hathaway, and not auctioning the company.

And whereas Buffett mainly played defense, with long-winded explanations of Sokol-related issues, Munger played offense, summing up matters crisply and, as usual, with no holds barred.


Sisters Under the Skin

For example, after Buffett explains in long and meandering detail how he came to believe Lubrizol belonged in the Berkshire family, despite its tainted upbringing, Munger simply says,

“You know ISCAR and Lubrizol are to some extent sisters under the skin…very small markets…fanaticism in service. If you have any more like that, give Warren a call.”


We Own So Many Wonderful Businesses

When Buffett wrestles with an explanation for the current valuation of Berkshire’s stock ($125,000 a share at the time of the meeting) compared to one observer’s estimated intrinsic value of $185,000 (based on the faulty premise that Berkshire’s $95,000 per share worth of investments are somehow unrelated to the insurance businesses and therefore a cash-equivalent that should be added to $90,000 per share for the businesses themselves) Munger dismisses the premise that Berkshire’s share price is tied to any break-up calculation, and instead focuses the crowd on the long-term value of Berkshire:

“It’s terrible trouble you people have…we own so many wonderful businesses we hate to part with them.”


Europe Survived the Black Death…

As usual, while Buffett takes the bright side of most issues in keeping with his inherent optimism in the future, Munger offers a dour, cynical view based on his broad knowledge of history and human behavior—but usually arrives in the same spot.

Asked “How can a lousy long-term U.S. economy make you happy?” Buffett gives a long, enthusiastic, cheerleader’s answer, winding up with, “All I can tell you is…the power of capitalism is incredible.”

Munger, on the other hand, dryly notes:

“Europe survived the Black Death when a third of the people died, but we’re gonna move on.”

Still, Buffett is crisper and forceful when it comes to his comfort zone: Berkshire and its legacy. He minces no words when asked about whether, and when, Berkshire will pay a dividend.

“There will come a time, and who knows how soon because the numbers are getting big…when a dollar only buying 90c of value…but I predict the day Berkshire declares a dividend the stock will go down because that will mean it is no longer a compounding machine…”


It Had Its Head Up Its—

And Munger does hold back at least once in the six hours of Q&A, when they are asked about Berkshire’s position in Wells Fargo, one of the banking giants whose inherent profitability has been impaired by the Dodd-Frank legislation and the housing implosion. Buffett defends the investment without much input from Munger:

“US banking profitability will be considerably less than early part of this century; one reason is the leverage will be reduced… If you keep out of trouble on the asset side, it’s a good business because credit is very cheap. I like our positions there.”

Yet, months later, speaking to investors in Los Angeles, Munger will say that what he admired about Wells Fargo is its management didn’t hesitate to admit “it had its head up its ass” when it came to mortgage lending.

But Munger bit his tongue here in Omaha.


Not a Terribly Rational Thing

Still, when he does speak here, it is just as straightforward as that observation in defense of Wells Fargo management.

When asked about gold as an investment, for example, Buffett launches into almost a professorial discussion of investing. “There are three categories of investment,” Buffett begins, describing currency, which depends on the behavior of monetary authorities to maintain its value; gold and other commodities that “don’t produce anything and you hope somebody will pay you more for later one,” and then assets “that make things, like a business, a farm”—which is the category Buffett and Munger have generally stuck to, with a few bets on currencies and commodities along the way.

Munger simply says:

“Buying something that only goes up if the world goes to hell is not a terribly rational thing.”


This Attitude of Trust

When Buffett is prodded by a shareholder about Berkshire’s lack of formal compliance procedures “like most firms,” he gets defensive, first saying “I don’t think most companies have them” (which is absolutely not true when it comes to financial giants like Berkshire), then dismisses the idea altogether:

“But we could have all the records in the world…they could be trading in their cousin’s name.”
 Munger, on the other hand, defends Berkshire’s culture entirely:

“If you look at the greatest institutions in the world, they trust their people…it’s so liberating…I think your best compliance cultures are the ones that have this attitude of trust.”

Glitches

That “attitude of trust” may be Munger’s Achilles heel when it comes to BYD, the Chinese car company of which Munger was a shareholder and fan for their efforts in battery technology well before Berkshire invested in the company.

BYD’s initials stand for “Build Your Dreams,” but the company has been accused of copying other carmaker’s designs in diplomatic cables uncovered by WikiLeaks, one of which read: “BYD seeks to ‘Build Your Dreams’—based on Someone Else’s Designs.”

Asked by a shareholder about the company, whose earnings and share price have been under pressure, Buffett demurs, saying, “Charlie’s the BYD expert.”

Munger begins his answer with the worst line of defense, BYD’s stock price, and then dismisses any issues with bland assurances as uncharacteristic as they are unenlightening:

“Of course the price is still way higher than the price BRK paid… Any company that tries to move as fast…is going to have its glitches…I’m quite encouraged…”

“Glitches” is the same term Munger employed to describe the Sokol stock trading affair in the immediate aftermath of that black eye, and it may be as understated an adjective when applied to BYD as it was to Sokol’s $10 million investment in Lubrizol in the weeks preceding Berkshire’s bid for the company.

BYD thus far has failed to produce anything like its past promises, as contained in this 2009 Reuters article:

BYD says that its new E6 electric car due out before the end of the year will do 250 miles (400km) on a single charge.

This is a very big number. The Tesla electric sports car does almost as much, but has little room for anything else in the car but the battery.

The E6 is roomy with space for five passengers and a good-sized boot. The battery tucks under the back seat.

—Roger Harrabin, Reuters

The E6 was not out “before the end of the year” 2009, nor was it out before the end of the year 2010. And when the Wall Street Journal inquired about the delay late last year, BYD gave the paper a howler of an excuse:

Stella Li, BYD’s senior vice president and head of its U.S. operations, said the holdup was caused by BYD’s efforts to make the car roomier, especially its rear-seat area that was cramped thanks to a beefy battery pack that needs to be stored under the seat.

Ms. Li told the Journal the E6 would be ready for sale in 2012. (We here at NotMakingThisUp would call that bluff.)


A Star Rises in the East

But, BYD aside, Munger has few blind spots, and enough blunt assessments about the ways of the world to keep Berkshire shareholders happy…

On why Berkshire does not trade commodities like oil:

“Oil trading worked best of all for the people who bribed Nigeria.”

On what caused the financial collapse:

“My answer is that past panics and depressions tended to involve great waves of speculation…. I think you can confidently expect a new mess before your career is over… Part of this mess is due to our academic institutions… Finance really attracts people who should be in snake charming.”

On the political environment in Washington:

“I remember an era when we had a bipartisan foreign policy, the Marshall plan. Now it seems we have two parties competing to be more stupid.”

On CEO compensation:

“I think somebody has to be an exemplar for not grabbing all you can…”

On which asset class he would add to his ‘circle of competence’ if he were going to live another 50 years:

“It would either be tech or energy.”

But the best line of the day—one not picked up on by everyone in the arena, so fast and subtle it was—came towards the end, on a question asked by a very sincere investor.

“If you were to have a baby in the next 5 years,” the shareholder begins, drawing titters from the crowd, “how would you incentivize them to compete against hungrier kids from other parts of the world…”

Munger, whose age (six years older than Buffett and now approaching 90) has always been the subject of jokes between the two men, sits up in his chair and a huge smile crosses his face at the idea of becoming a father as an octogenarian: “A star rises in the east,” he says in an awe-struck voice, drawing broad laughter as Buffett begins his answer.

A Fortune Fairly Won and Wisely Used

Still, it is not wisecracking that makes Charlie Munger so important to Berkshire Hathaway. It is the genius of his recognition—forged as an attorney working with struggling companies in Los Angeles before hooking up with his fellow Omaha native in the 1960s—that buying good businesses at reasonable prices was better in the long run than buying bad businesses however cheap they appeared to be, which was how Warren Buffett came to take control of Berkshire Hathaway before Munger came along.

It was Munger’s crucial notion about the long-term value of good businesses versus bad business (“Bad businesses throw tough decision after tough decision at you; good businesses throw cash,” was how he once put it) that led the two men to make their first acquisition together in 1972—See’s Candies, for $25 million.

And See’s was a very good business. For one thing, it almost immediately began generating excess cash (well over a billion dollars so far) for Buffett to reinvest elsewhere. For another, it created the template by which Berkshire would amass a collection of good companies, bought at reasonable prices, that today employee over a quarter-million people and churn out a billion dollars a month in cash.

Asked about their legacies at the Berkshire meeting, Buffett initially wisecracks that he would like it to be “Old age,” then says he’d like to be known as a teacher.

Munger, who has always seemed more well-rounded, if less wealthy, than his partner, sums up his answer as succinctly, and appropriately, as you’d expect:

“I have an uncle with a saying: ‘A fortune fairly won and wisely used.’”

Indeed.

The End.

Jeff Matthews

Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”

(eBooks on Investing, 2011) Available now at Amazon.com

© 2011 NotMakingThisUp, LLC

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Did Goldman Hijack the Oil Market?

Sunday, April 5th, 2009

A new article from the current issue of Forbes Magazine discusses allegations that Goldman Sachs and J. Aron and Co. may have had something to do with the spike in oil prices that brought oil to $147 per barrel. The controversy surrounds the very large short position, held by Semgroup, a then $14-billion per year (in sales) company, that was the equivalent of 20% of US oil reserves, and the [alleged] price manipulation that led to an incredible short squeeze. Nonetheless, this is a very interesting and insightful article.

Did Goldman Goose Oil?
Christopher Helman and Liz Moyer, 04.13.09, 12:00 AM ET

How Goldman Sachs was at the center of the oil trading fiasco that bankrupted pipeline giant Semgroup.

When oil prices spiked last summer to $147 a barrel, the biggest corporate casualty was oil pipeline giant Semgroup Holdings, a $14 billion (sales) private firm in Tulsa, Okla. It had racked up $2.4 billion in trading losses betting that oil prices would go down, including $290 million in accounts personally managed by then chief executive Thomas Kivisto. Its short positions amounted to the equivalent of 20% of the nation’s crude oil inventories. With the credit crunch eliminating any hope of meeting a $500 million margin call, Semgroup filed for bankruptcy on July 22.

But now some of the people involved in cleaning up the financial mess are suggesting that Semgroup’s collapse was more than just bad judgment and worse timing. There is evidence of a malevolent hand at work: oil price manipulation by traders orchestrating a short squeeze to push up the price of West Texas Intermediate crude to the point that it would generate fatal losses in Semgroup’s accounts.

“What transpired at Semgroup was no less than a $500 billion fraud on the people of the world,” says John Catsimatidis, the billionaire grocer turned oil refiner who is attempting to reorganize Semgroup in bankruptcy court. The $500 billion is how much the world would have overpaid for crude had a successful scam pushed up oil prices by $50 a barrel for 100 days….

Read the whole article here.

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