For Every Solution there is another Problem

For Every Solution there is another Problem

It is inherent in the nature of the markets that every solution to the problem creates a new problem.

Albert Peter Pacelli

The Stock market is a social, multi-faceted and self-correcting phenomenon. If we as individuals create our own reality, then the stock market is the product of millions and millions of thought forms all flowing together forming a river of energy that could go anywhere. It is folly to try to predict the direction it might take but that doesn’t stop people from trying. Investors, traders, momentum players, quants, academics, hedge funds, you name it, have all tried their hand at developing strategies to take money out of the market. And for awhile some do it but then they give it back. As soon as someone solves the problem of the market; the market adjusts and changes, creating new problems.This is the discounting nature of the marketplace in action. To discount is to take into account in advance and so lessen any effect thereof.

The markets continually change so that no formulated solution can beat them. Instead it makes more sense to ignore the market and focus on investing in individual companies that are investing in themselves. Its more boring than trying to predict the direction of the market but in the long run it is far more profitable. People forget that the original intention of the stock market was to allow people to invest in companies providing their management teams with seed money to develop and grow their businesses.

But human nature, being what it is, people will continue in their attempts to forecast what can't be forecast, but that is how the market teaches you, if you are willing to listen. If you aren't interested in learning these lessons, you will be continue to lose your money in the market which is unfortunate because the object of the game is to stay in the game. If you manage to stay in the game, making money will generally look after itself.

The Nature of Market Tops

The Nature of Market Tops

The markets have been going up for a long time and everybody has forgotten about the Lucky Idiot’s gun with its ten thousand chambers. You remember; that’s the gun that had ten of those chambers filled with bullets. But everything has been so good for so long everybody has forgotten about that. The indexes have been constantly pushing higher. The media is leading the parade cheering each new high in the indexes with firecrackers bursting and banners flying. Investors are out in the streets doing cartwheels or at least it just feels that way. But underneath the indexes, the market, the real market is giving way. The adv/dec line of the NYSE is slowly deteriorating. Its 39 day moving average is flattening out and turning down to the extent that the adv/dec line is now spending more of its time below that moving average. It might be mid June, 2015. After awhile the 39 day ma will move below the 144 day ma which in turn is slowly rolling over and headed down. The underlying market is unmistakably getting weaker, much weaker. It’s now early August, 2015. You know how this story ends.

The lords of the playing field (informed money) have been slowly distributing (selling) their shares out to the great unwashed (everybody else). Everybody who can buy has already bought and there is no way to go but eventually down. When the music stops the chairs will be full with no place to sit.

It’s been my experience to ignore the market indexes. Everybody follows them. There is no Wager Value in looking at them. Instead keep a close eye on the adv/dec line of the NYSE (based on common stocks only). You can get this information summarized neatly for you in the weekend edition of Barron’s. The adv/dec line along with its assorted moving averages and momentum indicators has Wager Value in that few people pay attention to it.

Pockets of Market Inefficiency

Pockets of Market Inefficiency

I’ve talked about the wager value of the small and mid cap sectors of the stock market but these market inefficiencies are more structural and part of the investing landscape. There also exist pockets of inefficiencies that are more transient and temporary in nature.

When stocks are plunging and market conditions appear obviously bleak and fear holds sway over all of the market participants it can be a good time to go shopping for value. Chances are what you buy will continue to go down but rest assured you will get a good fill and you will see that price again back on the way up. Just try to pay less for a stock than what you feel it is worth. They will be out there. During a market plunge there will often be levered investors facing margin calls who will be forced to sell out their holdings. This will have nothing to do with what their investments are worth. The stocks they sell are basically on sale for anyone who has the capital and confidence to take advantage of the situation. Quite frequently after the plunge has run its course the markets will be sold out (everyone who could sell has already sold). So all the money that was in the market is now on the sidelines. If the market fails to go down anymore while the news remains bad chances are the worst is over. At this time the tiniest bit of buying will lift the markets up. When the markets recover as they always do, there will be a great influx of money back into the mutual funds who in turn will be forced to put it to use (back in the market). Prices often surge upwards because of this. Not a very efficient market is it?

When the time horizon of your anticipated change in value extends out beyond a year or so, you can copper the short term tendencies of the other market participants. In other words while they are focusing on the next quarter, you can be investing in companies that are growing their businesses for the long term (high ROE and ROIC).

Finally when the markets fall into the trap of unanimous opinion, its time to fade the market and do the opposite (like George Castanza in my favorite Seinfeld episode). This situation often describes market tops that are slowly distributing their shares out to the unwitting public. See my posts on the Current Market Environment and the Hidden message in the Stock Market.

One more thing to bear in mind. Justin Mamis wrote about this years ago. In a bear market or a bad correction, the future market leaders will often bottom first. Now I'm not sure this is true or not as I've never conducted any research into this idea but its something to bear in mind. And if you see any stocks that are going sideways while everything else is going down well that's a message in itself. relative strength works. In the long term I think the markets get it right but in the short term pockets of inefficiency exist for the astute investor to take advantage of.