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12/27/2002 |
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The Speculator
The safest bets are against the crowd in
2003
It’s
time to reverse course. What worked best in 2002 will work worst in
2003 -- and vice versa.
By Victor
Niederhoffer and Laurel Kenner
Perhaps it is possible for you to let me know in
what manner I could obtain from the Prince Regent at least the
cost of copying the Battle Symphony on Wellington’s Victory,
dedicated to him. He did not even do me the honor of a reply as to
whether I was permitted to dedicate this work to the Prince Regent
in publishing it. What a fate for an author!!!
-- Ludwig
van Beethoven, letter to Johann Peter Salomon, June 1,
1815
Year-end is always an ideal time to contemplate
the law of ever-changing cycles. As investors, we tend to have blind
spots about the past and future. We assume that recent events are
likely to be repeated, that current trends are likely to continue
and that future events will occur within the same framework as past
events. We never tire of reminding ourselves of Robert Bacon’s
timeless advice for racetrack bettors:
The beginner plunges ahead on a favorite that
loses, then bets lightly on a fair-priced horse that wins. He
keeps switching amounts and positions, so that he never has a
worthwhile bet on a winner at a worthwhile price. He is always one
race behind the form of a horse and several races behind the
rhythm of the results sequences. Bacon was a
racetrack tout writing for lowlifes with a stake of $40 who could
afford to lose $1 a bet. But even the cultural giant Ludwig van
Beethoven wasn’t immune to ever-changing cycles. In fact, the lowest
point of his career offers a lesson in avoiding psychological
investing pitfalls.
In December 1813, Beethoven became a
superstar with “Wellington’s Victory,” an orchestral overture
celebrating a big British defeat of Napoleon. Patriotic feeling ran
high, and the piece was performed repeatedly at packed benefit
concerts for wounded soldiers. Vienna’s most famous soloists played
in the orchestra. The public could not get enough Beethoven. His
Seventh Symphony met an ecstatic reception. Even the opera
“Fidelio,” which had bombed seven years earlier, was revised and
revived to great acclaim. At the Congress of Vienna festivities,
crowned heads paid court to him.
A year later, patriotic
fervor had waned. A performance of “Wellington’s Victory” in
December 1814 found the hall half full. The public’s fancy turned to
the comic operas of Rossini and music set to magical literary
themes. Beethoven’s patrons died or lost their fortunes. Now
completely deaf, he gave up playing the piano in public. In 1816-17,
he composed nothing of substance. He fought for the custody of his
nephew, openly railed against the aristocratic establishment and was
increasingly perceived as being insane.
In short, the same
thing that happens to systems that work and gurus who are right
happened to Beethoven. Yet the composer went on to create a
completely new style in his last decade, composing masterpieces such
as the Ninth Symphony, the late string quartets, the late piano
sonatas and the Diabelli variations. Investors may wish to keep the
tale of Beethoven in mind as they plan their investment strategies
for 2003.
Reversing
course
A very good rule to follow for a new year is that
whatever worked the best in the last year will work the worst in the
new year, and whatever worked the worst will work the best. A
variant of this rule is to take whatever the most-recommended trade
of the big houses is and do the opposite.
Last year, the
trade that was guaranteed to succeed by a wide margin was to buy the
dollar-yen -- i.e., to bet against the dollar. The yen’s strength
peaked at 140 to the dollar and now stands at 120. The loss on
margin is staggering. And that’s a typical result for such year-end
recommendations.
In 2002, the S&P 500 Index ($INX)
went down more than 20% and 10-year notes rose 15%. We’ll go out on
a limb and play it for the reverse. We’ll buy stocks as of year-end,
and we’ll sell bonds. (In fact, we bought stocks heavily on Dec. 19
at the close.)
(We note in passing that an oil trading seat
on the NYMEX Division of the New York Mercantile Exchange sold for a
record $1.3 million on Dec. 19, and that the price of crude oil is
up 54% this year.)
New York’s tallest
In January and February, we offered a series of studies
that quantified the effects of corporate hubris on stock
performance. In our Feb.
27 column, we found that companies or countries that build the
tallest skyscrapers were prone to crash. Imagine our horror, then,
on hearing that the leading entrant in the design competition for
the former World Trade Center site would be the tallest skyscraper
in the world. The design by British architect Norman Foster, who
built Europe’s tallest building, the Commerzbank headquarters in
Frankfurt, is of two 1,764-foot towers. (Just look at Europe -- and
the horrible financial and stock results of Commerzbank this
year.)
When Congress recently voted to guarantee terrorism
insurance -- making the United States safe for more skyscrapers --
we wrote to William Mitchell, MIT’s Dean of Architecture, the genius
we interviewed for our February column. It was Mitchell’s writings
that first alerted us to the hubristic aspects of skyscrapers, but
his reply shows that he isn’t about to be trapped in the last cycle:
There is, of course, a long tradition of insuring
buildings against fire, earthquake, flood, storms, and other such
disasters. Over the long run, insurers have exerted considerable,
and often effective, pressure for safer siting and construction of
buildings in relation to these dangers. I would expect the same of
terrorism insurance, so in that sense, it's a good
thing.
In discussion of this issue it's worth keeping in
mind that explosive attack is probably not, in fact, the biggest
threat at this point. If a smart terrorist wanted to cause
widespread disruption and panic, the most effective strategy would
be to attack the electrical supply, telecommunications, air
supply, and water supply networks on which the habitability and
safety of all modern buildings depend. Being optimists,
we empathize greatly with the excitement over the proposal to
rebuild at Ground Zero. But we are not wholly convinced of the
project’s merit, particularly since it is not being handled by the
private sector.
Cash money: Time to
flip the mattress?
In 2002, the public’s taste turned
from expansive visions of an Internet future to cash -- in money
market accounts, in companies’ financial statements. Even the Spec
Duo wrote about dividends and indicators based on cash flow, taking
a momentary break from their usual pursuit of looking for profitable
anomalies in pricing patterns. We thus provoked the disbelief of one
reader who wrote: “The Speculator writing about dividend payouts?
Now I know I’m not in Kansas any more.”
Yet there are
problems with a single-minded focus on cash. One came to our
attention last week during an exchange with Jake Thomas, the Ernst
& Young professor of accounting at New York’s Columbia
University. We wrote about Dr. Thomas’s discovery with a former
student, Huai Zhang, that changes in inventory levels are the best
fundamental indicator of a company’s market performance. Thomas is
unquestionably one of the giants in the field, and it’s worth
considering what he had to say about cash flow statements:
Combing through the statements of cash flows and
footnotes is painful but rewarding. There is no substitute for
doing it the old-fashioned way. Unfortunately, the disclosures are
often so cryptic and there’s so much intentional distortion that
most of us remain confused even after reading the damn thing over
and over. The art of confounding the public with
complicated accounting practices has evolved to the point that the
best, most sophisticated minds in the business admit to having a bit
of difficulty in making out a cash flow statement. We are as awed as
we are when contemplating the mystery of the origins of the
peacock’s tail or the human eye. But still the question remained:
What is an ordinary investor to do? For starters, we’d counsel
against relying completely on “tried and true” fundamental
indicators.
Goodbye,
2002!
We asked our friend Dick Sears, inventor of the
Gilder Technology Index and chairman of the Old Speculators Club for
closing thoughts on 2002. His primary thought: Good riddance. He
added:
“These have been three incredibly bad years,
especially for high tech stocks, my area of involvement. If you
exclude the beginning of 2000, when the bull was still around
(i.e., through March 6), and the end of 2002, when we have been
(or at least seem to have been -- time will tell) recovering
(i.e., from Oct. 10 on), here are the lowlights of the last three
years for my Gilder Technology Index:
| Gilder Technology Index, recent
lowlights |
| Time period |
Change in value |
| March 6, 2000 to Dec. 31, 2000: |
-64.0% |
| Jan. 1, 2001 to Dec. 31, 2001: |
-43.4% |
| Jan. 1, 2002 to Oct. 9, 2002: |
-70.9% | |
The
combined return for the 31-month period is -94.1%. Can you believe
it? And these weren't fly-by-night dot-coms. They were the blue
chips of the Internet backbone, companies like
Qualcomm (QCOM,
news,
msgs),
JDS Uniphase (JDSU,
news,
msgs),
Corning (GLW,
news,
msgs),
Nortel (NT,
news,
msgs)
and Global Crossing (GBLXQ,
news,
msgs),
companies with real assets.
So, what else can I say but
good riddance? Surely 2003 will be a good year, maybe even a
gangbusters year, but I thought 2002 would be also, so what do I
know?
If nothing else, it's been a wonderfully humbling --
even bracing, like a cold shower --
experience.
Winning advice
on losing
It wasn’t just tech stocks that were down in
2002. The entire U.S. market has now had a third down year, only the
second time this century that such a thing has happened. Under the
circumstances, it is well to consider some advice on losing that we
received this week from a man who wins a lot -- British chess
grandmaster Nigel Davies.
One important character trait that I've noticed
amongst strong players is that they take responsibility for their
defeats. If they lose it isn't the fault of the opening, the
arbiter, or the guy rattling his change when you had to make a
critical decision. It's because the opponent played better than
you on that particular day.
So I try to be as gracious in
defeat as I possibly can, even if it means biting my lip at the
time and forcing myself to congratulate my opponent. Then I think
about what I can improve. More difficult to deal with are the
feelings of wild triumphalism that I get after winning, though I
have been told that this is more endearing than the winners who
try to be sympathetic towards their beaten opponents. We
wish all our readers many moments of wild triumphalism in the New
Year. A bit of text that Beethoven set to music in the dark year of
1815 bears keeping in mind: “Brief is all pain, endless is
rejoicing.”
Final note
If
there’s one rule that provides the rudder for all spec activities,
trades and writings, it’s that everything must be tested. Along
these lines, we have tested our assertion that it's good to go
opposite for one year what worked the previous year. These results,
along with a year-end commentary by the President of the Old
Speculator’s Society, are available on dailyspeculations.com, our
Web site, where we also update the VIC index daily. (For more on the
VIC index, see “A buy signal
that's as easy as 2 + 2.”) As we were going to press, we
received a sapient -- and relevant -- note from the trader and
writer David Bacille: "According to ICI, bond funds have taken in
$133 billion this year . . . while equity funds have seen the first
outflow (nearly $20 billion) since 1988 (Dow rose 25% in 1989)." We
encourage all readers to write to us there so that we can learn
together during the next year.
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