What is noise?
"Noise" (physics): A usually persistent disturbance that obscures or reduces the clarity of a signal.
American Heritage Dictionary as expressed in Richard Bernstein’s "Navigate the Noise – investing in the new age of media and hype", 2001.
Games played amongst even professional investors of Old maid, Snap, and Musical Chairs can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.
John Maynard Keynes circa 1930s.
Ultimately, success in the stock-market comes down to you, for no matter how much we know, the future is difficult to predict, both in relation to time and dimension. No one cares as much about your money as you do and Ecinya encourages you to develop sources that can assist you to take advantage of many sources of information. In looking at source material be mindful of confirmations and divergences of opinion. The aim of the Ecinya pages is to help you to build a set of thought processes to assist you to successfully invest, and occasionally trade. It is considered that occasional trading can enhance performance. In defining the Ecinya approach, which is almost exclusively fundamental, our proximate matrix is 35% fundamental company, 25% the global economy, 20% the national economy, 13% technical analysis, and 7% quantitative analysis.
"About Ecinya", written 2001.
In a society confronted with social, political, religious and ethnic conflicts, whose victims are often children, the youth and women, sport and the Olympic ideal provide hope, and the sports field remains the best place for peaceful confrontation. Sport is a school of human values which we frequent when we are young and need to make further use of as a means of preventative education, in order to face the scourges which poison our society. Investing in education and youth is an investment in the future.
Juan Antonio Samaranch, at the XXVll Olympiad, Sydney 2000.
THIS WEEK’S THESIS
THE GAME OF GOLF
Once upon a time when our editor was but a young man (from age 9 to age 16) he played competitive tennis, man against man; one man or team lost, one man or team won. At the end of the season the scores were tallied, the finalists determined and the finals played, and the prize-giving night awarded the trophies to the victors of the various divisions. The game was really all about winning and losing. The best player in our team of six had his mother in attendance each Saturday and she would critique the play of her son’s partners ("noise"), but her son always played without blemish or error. On one notable occasion her son’s partner carried the day and the team of two qualified to play at Sydney’s then home of tennis, White City, in the Milo Cup. On that day she remained silent lest her congratulations of her son’s partner would reveal the shortcomings of her son on that fateful day. Such is life and such are the rigours of intense competition. At age 17, our editor found golf, and his life was changed forever.
GOLF is very different to most competitive sports. Here is a sport where the course is the master and you have only yourself to compete against in that context. Our editor plays each Saturday in the club competition with 3 mates selected from a wide circle of mates who have been members of the club together for many years. As the game is being played there is frequent exclamations of "good shot", or "bad luck". There is a consistent and certain joy in one of your playing companions playing well, particularly if it results in him winning the day’s competition, which in some cases results in having your name ‘on the board’ along with past winners of that particular trophy. This coming Saturday our editor will play with three mates and two of them will be past winners of that day’s competition, The Captain’s Trophy, an event of considerable prestige.
BUT WHAT HAS THIS TO DO WITH THE STOCK-MARKET?
Golf is a game played in isolation, the only person you have control over is yourself. Though you have 192 players in the field, the progress of only four participants is known to you, for good or ill, yourself and your three companion golfers. One of you could have the best score of the four, and a score that is considered to have likely won the day, though players are still ‘on the course’. As you enter the clubhouse for the mandatory drink and discussion, you meet other players who have completed their round and discover that someone has had a better score than the best of your foursome. Though you have not won the day, you have played well. That ‘someone’ with the better score may also not have won. We won’t know that until the day’s competition is complete. Every player has a handicap which represents an assessment of their contemporary ability. Our editor in his youth played off six, so that a round of 78 (72 plus 6) meant that he played precisely to his attributed ability. As of today his handicap is 16, so that a score of 88 reflects break-even or par for him. The idea in golf is that your good shots exceed your bad shots. In the market, the idea is that your good decisions exceed your poor decisions and that you are not blown out of the water by being over-weight a bad decision.
THE STOCK-MARKET is a game of relativities; your handicap is your experience, your ability, and the time you care to devote to investing, and occasionally, trading; the other players are numerous and what they are thinking is largely unknown to you, though some clues are contained in the market aggregates; every day in the market is a brand new day; the unexpected can happen, the bad bounce, the fortunate bounce. The stock-market requires effort, discipline and patience, so does golf. Your performance is a matter of record. When you act upon a decision the outcome will not be revealed for some time, the stock may go up or down. If it goes down you may re-visit your assumptions and buy some more. Past success does not guarantee future success. Your reading of the market may be awry, the timing may be out of kilter. ECINYA has always suggested that in a bull-market focus on price and momentum; in a bear-market focus on value. Sometimes it is difficult to tell whether, or not, you are in a bull or bear-market, or participating in a rally or retracement in either context. Today, much of our thoughts revolve around that complex question; Has the recession ended? What will shape the recovery? Are the banks fully provisioned? Is there more bad news to come?
THE NOISE
Now that we have compulsory superannuation in Australia the stock-market has become a feature of our daily lives. We are all aware of The Dow, moves in global stock-markets, we know the name of The Reserve Bank Governor, the Treasury Secretary; their speeches are played on our TV sets. Interest rates, a dominant economic variable, are discussed ad-nauseum. Housing prices feature prominently. If you have Foxtel you have a wide range of business programmes of which Sky Business, CNBC, and Bloomberg are the most notable. CNBC is largely ‘infotainment’ and the commentators are made up of good-looking females, earnest young men, and a few old sages to give a balance. In fact "balance" and "perspective" are alleged features of the broadcasting commentary. But there are also a few ‘ratbags’ who rant and rave over the day’s affairs. When a villian is caught his crime, his motives and his detainment are reported with zeal and regulatory agency failures recognised. Examples of this are the recent episode with Mr Madoff, the sub-prime calamity, Storm Financial. People on the infotainment channels who called the market make guest appearances to forecast the future and dwell on the past whether, or not, they anticipated the likely course of events. There is a lot of noise everywhere.
NAVIGATING THE NOISE
An old adage in newspaper publishing is "90% of the message is in the head-note." But generally the day’s head-notes tend to follow, rather than lead the market; if the market is up the stories are generally bullish, if the market is down the stories are generally bearish, if the market is steady, the one lead head-note is generally bullish, the other generally bearish or neutral. Recent examples on the same day from The Australian Financial Review Market Wrap lead-page:
- 18/8/09: Harsh reality sinks shares/ Sustained recovery hinges on consumers.
- 12/8/09: Experts sceptical over earnings/ $A soars to 13 year peak against pound.
- 10/8/09: Pundits factor in early increases/ RBA holds longer-term view of China.
- 27/7/09 : Word of recovery is spreading/ Strong $A dulls shine of overseas orders.
- 24/7/09: Don’t miss boat analysts warn/ Alarm bells ring over commercial property.
- 23/7/09: Shares rise seven days in a row/ Price of stimulus may be a slow recovery.
- 22/7/09: Gains prompt soaring hopes/ As crisis eases, the next move will be up.
- 20/7/09: Hopes high for reporting season/ Busy week to test new found optimism.
- 15/7/2009: Rosy data sparks dash higher/ Boom on way for corporate funding.
- 14/7/09: banks and resources wipe gains/ Earnings recovery down the line.
From 13 July until 14 August in All Ordinaries terms the market rose 17.8% and our global proxy, the S&P 500 rose 14.2%. These numbers were clearly unsustainable and last night the S&P fell 2.5%. A retracement is almost certainly underway and this, in our view, will last 5 to 40 days with a most likely time-frame of circa 20 days. The recession is not over; the world has not returned to sustainable growth. Keynes would say that the ‘game of musical chairs is being played with zest and vigour and some will find themselves unseated’. Volatility is high. Though the reporting season is meeting our modelled expectations, those expectations are low to lowish, and the euphemism for the days ahead from most of the managing directors is "challenging."
So how to read the newspapers: Firstly, we recommend The Australian and The Financial Review, with an occasional glance at Ross Gittins in The Sydney Morning Herald. Go through the head-notes to get a sense of ‘bullish’ or ‘bearish’, mark the articles that you wish to return to, and then read them in full. Sometimes the head-note can be misleading. If a stock attracts you, go to a chart and look at the trend. Then visit the company’s web-site to get a feel for what the company does. If you can access research reports then do so. We recommend Aegis Equities Research and Huntleys/ Morningstar. Focus on sales and earnings growth.
THE IMPORTANCE OF HAVING INVESTMENT AND TRADING RULES
Rules provide a framework around which you can make investment and trading decisions. The Ecinya Investment rules are contained under our tab-heading ‘Market Wisdom’ though we do suggest that you devlop your own rules and benchmarks. Over the course of the next few months we will add the rules from a number of other published sources. There are many ways to think about investment, just as there are many ways to swing a golf club to good effect. BUT there are certain fundamentals that have been proven to work on a sustainable basis over the years. In golf you must be balanced, accelerate but don’t rush, avoid bouts of despair and euphoria; when in trouble take your punishment, get back to a position where you can play an aggressive shot towards the target; play one shot at a time etc. Success in the stock-market is similar – ‘let your profits run, cut your losses’; if it’s too good to be true it generally is; stay alert to what is going on around you. An elevated noise level is a sign of a potential turning point – up or down.
TACTICS
We do not like the expression ‘long term’ and our models take an 18 month view on a rolling full year basis. This means that after we have factored in the actual results for the year ended 30 June 2009, we will have a full year view for the year ended 31 December 2009, the year ended 30 June 2010, and the year ended 31 December 2010. These rolling full year views obviously morph into a longer-term view. But within that context we have a tactical trading perspective to assist with timing and asset allocation between equities and cash. These tactical positions are described as (1) Going with the flow, with conviction. (2) Going with the flow, without conviction. (3) Going against the flow, with conviction. (4) Going against the flow, without conviction. (5) Ambivalent, uncertain, relatively clueless
MACRO ECONOMICS
Briefly, we cover the macro in a simplistic acronym – ‘ICE’: Interest rates, Confidence, and Earnings. Of these, Earnings is generally the most important. The ECINYA Market Barometer demonstrates where we are in the market cycle and to, a lesser extent, the economic cycle.
We access The Economist and ANZ Economics, particularly their Quarterly Outlook document and The Wall Street economics panel. We view all economic forecasts with a degree of scepticism and are more interested in trend or mood changes than the actual numbers themsleves. We also talk to a lot of small businesses to gauge how sales and sales trends are. When visiting super-markets and other retail shops, gauging the difficulty of getting a car space, talking to cab drivers, our spouse etc. There is a lot of observable information about. We know what our friends are doing. We talk to our travel agent on a regular basis, even though we are infrequent overseas travellers. We talk to people who have just returned from overseas. John Mauldin is an American financial adviser who writes regularly on the blogosphere and Paul Kasriel is an American economist who writes clearly with precision. When we see views expressed by them we print them out and highlight and underline their conclusions. And there is always Google.
CONFIDANTS
Over the years, associations are formed with people who are investing in the market. We talk to these people on a regular basis. We call these people our ‘confidants’ and occasionally refer to their thoughts and actions in the ECINYA pages, either to agree or disagree. You should do the same. We try to avoid falling in love with our various theses and if market action is proving us wrong we re-visit our assumptions.
BOOKS
IF we had just two books to recommend on the stock-market they would be Victor Sperandeo’s "Trader Vic – methods of a Wall Steet master" and Richard Bernstein’s "Navigate the noise – investing in the new age of media and hype". Both of these books belie their titles and offer significant insights beyond that suggested by their titles.
THE OVERALL MESSAGE is that you have to develop your own sources of insightful information, balanced against what you see and read around you. Write down why you are investing in any particular stock in a note-book and then re-visit your notes when something goes terribly right or terribly wrong. Naturally we are hoping that ECINYA becomes one of your trusted sources. Our aim is that the ECINYA pages, over time, assist to remove a lot of the ‘noise’ from your investment deliberations.