The Speculator
A star rises from the ashes with 4 picks
He went down in flames, but this trader close to The Speculators' hearts is winning again. How? By noting when insiders stop selling and start buying.
By Victor Niederhoffer and Laurel Kenner

The story of the great hero who falls into misfortune and then rises from the ashes with renewed vigor resonates with our deepest emotions in life and markets. The fabulous solitary phoenix is a symbol of this theme. It is seen most clearly in the markets when a formerly soaring sector that crashed to earth starts rising again. We all want to be there for the moment of transformation and rebirth, and the last three months has brought shivers to all of us who can remember the great days when Cisco Systems (CSCO, news, msgs) had the greatest market value of any company in the world and people were making fortunes by investing in JDS Uniphase (JDSU, news, msgs).

Just as elating is the buzz when a once-great investment manager makes a comeback with a strikingly successful new trade. Vic’s former boss, George Soros, who made $1 billion shorting the British pound only to suffer through years of dismal performance, is back in the limelight with his new foray against the dollar. Jeff Vinik, who resigned as manager of Fidelity Investment’s flagship Magellan fund (FMAGX) in 1996 after a bad bet on bonds, started a new fund and quit a hero after four years of big gains.

Thus, when Laurel had an opportunity to interview a former star, indeed once one of the most lustrous of all hedge-fund managers, a trader who was rated No. 1 in the entire industry at his peak and then lost everything and is now coming back, she naturally seized the chance. We are delighted to report the interview to our loyal readers, particularly since this phoenix recommended four phoenixlike stocks. Needless to say, because of the sensitivity of the investment strategies of any bird of this feather, we will not reveal the name of the interviewee (until the end of the column).

An interview with 'Mr. V'
Laurel: Mr. V, what have you been up to since your meteoric rise and fall?

V: I have been climbing back up the stairs. I never have any successful trades, as you know, and the going has been rough. I had to get another job, so I got one as a columnist.

Laurel: How’s the column going?

V: Not very well. I seem to be a superfluous man. The readers want good stocks right now. You know, the ones that the sandy-haired investment managers just bought from the gurus at the white-shoe firms and wish to hype so they can unload them or market their funds. I give the readers systems, signals, statistics, strategies, stories about scams and, worst of all, supply and demand. Some of my stuff, why, I’m lucky if I can even get it listed in the index.

Laurel: But my detective work indicates that you’ve been doing some heavy buying in Apple Computer (AAPL, news, msgs), Cintas (CTAS, news, msgs), Sigma-Aldrich (SIAL, news, msgs) and Microchip Technologies (MCHP, news, msgs).

V: That’s true. But how in the world did you find out?

Laurel: Let’s just say we journalists know how to be particularly persuasive with our unidentified sources. What are the statistics that gave you the confidence to implement these trades?

V: I guess a dying man clutches at straws.

Laurel: Come now, Mr. V, I have been tracking your picks for several years now. It’s not like you to just buy a basket of stocks without some scientific study behind it.

V: Well, after I went under, I went back to my roots and re-examined a study I performed with Jim Lorie at the University of Chicago called “The Predictive and Statistical Properties of Insider Trading.” It was published in The Journal of Law and Economics. Lorie and I found what we called a macroscopic inertia in trades by insiders.

Laurel: I’m starting to recognize the old Mr. V. But keep it simple. My boss just sent me a note about interviewing you: “Re Mr. V: Keep it short and snappy. Jackie Collins, not Balzac."

V: It’s based on bits of information. When insiders have been selling in one month and do more selling the next month, that’s not very important information. It could have been predicted. But when they change from selling to buying, why, that’s new and valuable. Shows a change in regime. Those are the ones I’ve been buying.

Laurel: But of what moment is that? If insiders close out a buy within 12 months, they have to disgorge any profits back to the firm. As you’d be the first to point out, such trades would occur randomly. Can you tell us exactly. …

V: I’d like to, Laurel, but to do so would totally destroy the recurring value of the impact. Too many market-neutral funds are doing things like selling companies with large short interest and buying those with little short interest. They’re getting killed as usual this year by being behind the form.

Laurel: Those terrible switches again, right?

V: Yes. The academics and those who follow them are always a few generations behind the coming results sequences.

Laurel: Would it be possible to give me a basic description without compromising your proprietary stuff?

V: OK. The sample was based on a complete enumeration of all non-options-related insider trades for the current set of Nasdaq 100 ($IQX) companies over the last two years. I looked at what happens when you buy companies after an officer buys shares after at least one insider sale, and sell companies after an officer sells after at least one insider purchase. The results show that buys selected by this system performed some 7 percentage points better than the Nasdaq Composite Index ($COMPX) during the same period.

Laurel: And what about the uncertainty?

V: It seems to be about a 1-in-100 shot by chance alone. Good enough for me to trade, anyways.

Laurel: What’s the average holding period for these stocks?

V: About three months.

Laurel: So if the Nasdaq goes up 10% in a three-month period, these are likely to go up by 17% during the same period. How do you protect against the Nasdaq going down 20% and your stocks going down 13%?

V: Well, against these trades I’d be shorting an equal dollar amount of the Nasdaq index, like the Nasdaq-100 Trust (QQQ) on the Amex. The QQQs are very actively traded -- 80 million shares a day there on a $30 base. I personally am short Nasdaq 100 futures, which trades some 500,000 contracts a day on the IMM (International Monetary Market), each contract having a value of some $30,000.

Laurel: Mr. V, Apple’s fundamentals are lousy -- a P/E ratio of 120 and a PEG of 11. Value Line says Apple has little investment appeal because the company spends a lot on R&D and retail stores. You couldn’t be advising our readers to buy a stock like that. You’re generally known as a businessman.

V: Yes.

(Laurel waits for Mr. V to continue. He doesn’t. She raises her eyebrows. He raises his eyebrows.)

Laurel: Our readers are always interested when a former star bites the dust and then tries to recover. Sort of reminds us all of the rhythms of the sun and life. What did you do to get yourself out of the doldrums after your fund went under?

V: Well, with six college tuitions to pay, I didn’t have the luxury of wallowing in misery too long. I circled thFinal note
Laurel has obtained a workout of Mr. V’s insider system; readers will find it on The Speculators' Web site. We gain sustenance from readers’ compliments and critiques, and answer all of them. So e-mail us. To reward our loyal readers, we’re having a Spec Party at 1 p.m. Sunday, June 29, at the Central Park Conservatory Garden, 105th Street and Fifth Avenue, and will hold a drawing for an official Old Speculators Association gold-headed walking stick, the kind used by Wall Street veterans for hobbling down to the ‘change to buy in times of panic. To enter the drawing, e-mail us with your name.

Disclosure: As of Tuesday morning, Victor Niederhoffer (“Mr. V”) and Laurel Kenner owned shares in Apple, Cintas, MicrochipTtechnologies and Sigma-Aldrich. They were short the Nasdaq-100 Trust, or QQQ, and Nasdaq 100 futures. e wagons. Stayed out of emerging markets. Did research to improve my game. Out of that research came these buys.

Laurel: What else are you up to, Mr. V? Is the book doing well?

V: No, it came out in February just before the war when no one was interested in the market. We were highly bullish, and we likened the people spreading the bearish meme to the Body Snatchers.

Laurel: What are Body Snatchers?

V: Jack Finney wrote a science fiction story in the 1950s about aliens who snatch the bodies and personalities of humans. The victims look and sound like their former selves, but the spark has gone out. They have no ambitions, no hopes, no romance. The Snatchers always tell you at the bottom of a market to get out of stocks and put your savings into cash. We took the other side, and explained why stocks are still the best bet. We’ve had some attention in the U.K., but U.S. journalists like to write about how capitalism stinks, and we haven’t had any good reviews here at home.

Laurel: But there has been a gigantic rally in the stock market since the book came out.

Vic: Laurel, thank you for noticing.

Laurel: We’re out of time. Thank you, Mr. V.

V: Thank you, Laurel.