Monthly Archives: November 2011

Capital Asset Pricing Model (CAPM)

The capital asset pricing model “CAPM” is a model for pricing an individual security or a portfolio. The CAPM in it’s simplistic form takes into account expected rates of return as a function of systematic, non-diversifiable risk (its beta). The CAPM provides the foundation for the very complex Modern Portfolio Theory “MPT”.

The true test of a model lies not just in the reasonableness of it’s underlying assumptions but also in the validity and usefulness of the model’s prescription. In corporate finance applications, several potential sources of error exist in the CAPM:

 a) inadequate description of the behaviour of financial markets

b) betas are unstable through time, and

c) estimates of future risk free rates of return are often subjective

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Speculation: New world reserve currency (Part I)

This article is under speculation, because this is what it is at best, at the moment.

There is growing concern that we might be seeing a new world currency being developed at the moment. Continued euro financial crisis could inevitably put the global finance sector into a tail spin. And why would we say that?

And this is why. There are 23 countries in the European Union, and almost all of them are in a financial crisis of some sort; Greece, Italy, Spain, Finland, Ireland, Portugal are the bigger economies to bear the burden of the crisis so far. Imagine this, the 10-year treasury notes from the Government of Italy have a yield of 7.30% (as of today), and Greece with a whopping 30.71%.  Compare this to an individual in Canada, who can get loans at prime + 2% (5.5%) at the major banks without much problem. What does this mean? This means that an individual in Canada is more capable of running their own finances, and is more able to pay back the loan taken, as compared to a government that can raise taxes, and implement different policies to increase its revenues and decrease deficits. In the end, this is just absurd. As mentioned in our earlier posts (here and here), CAPM is dead, and this is the proof that no government is safe from such a systematic failure and a run on their banks.

So what is next in the play?

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All About Her: A Woman’s Beauty Is Affected By The Economy?

Suave and sophisticated men appreciate a good suit, a smart watch, a complex glass of wine, and of course, a beautiful woman.

According to some analysts in the past, there is another reason to appreciate a beautiful woman: Her beauty is a great indication of how our economy is doing.

Here is the low down:

When An American Woman Wears A Bikini

Believe it or not, there is something called the Sports Illustrated Swimsuit Issue Indicator. According to this indicator, when an American model graces the cover, the stock market is poised for a double-digit rise. The indicator suggests that when an American model graces the cover, the S&P 500 will generate a return above its historical rate. On the other hand, when a non-American cover model appears, S&P 500 shows underperformance.

Between 1978 and 2008, the average return of the S&P 500 was 10.5%. When an American model, like Brooklyn Decker, was on the cover, the S&P 500’s average annual return was 13.9%. When the cover model was non-American, like Bar Refaeli, the average return for the S&P 500 was 7.2% only.

I personally cannot help thinking that this is fiction created by American fan boys who are a little too patriotic to their women. Beauty has no borders, and neither should stock indicators.

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IMF Loan for Italy, Spurs Risk On Trade in Stocks and Commodities

The markets were hit hard last week on fears of Italy’s growing problem with the borrowing costs rising on their bonds. This lastest fear on Italy only adds to the fire of contagion and fear spread through the EU Region. Last week was the worst pre-Thanksgiving  for our Stock Markets since 1932. Last weeks deep sell offs in commodities and stocks were driven by risk off trading aversion, due to the events in Italy and Greece.

The markets have been stuck in a pattern with bad news coming out of Greece and Italy, and other EU region countries sending the markets into a risk off mode.  When the markets going into risk off mode, it leads to deep sell offs in our equity markets and commodity markets as well as hits markets around the world.  Some fears of a China Slowdown, also rocked the markets last week. Worries that China is slowing down are fueling the fire that the Global Economy is on the brink of recession and headed for trouble.

This markets can turn though on a dime if the news and events improve overnight.  It is now Sunday night, and the news out of Europe is that the IMF is preparing an emergency loan package for Italy in case things get really out of hand and they have the money they need to keep their country operating and to prevent a default on their debt.

This news is changing the market sentiment around the world, and is fueling a large surge in our equity futures. Our Equity Futures and commodities are rising on the news as traders go back on a risk on mentality with good news from this loan, and with a great sales number for our Retailers for Black Friday Sales.

I would urge traders to be cautious and to wait this out. One more piece of bad news out of Europe can send us right back into risk off mode and fuel another sell off.

For now it appears the market will go back and forth until there is either a huge effort that really stops the fears of the EU debt crisis such as a large Quantitative Easing program developed by the European Central Bank.

Until we get such a progam the markets will move in lockstep with what is going on out of Europe.

 

Beta Market Analyst

Win, Lose or Vanish. A Diagnosis of the Psychology of Investing Through the Art of Card Playing

Luck was a servant and not a master. Luck had to be accepted with a shrug or taken advantage of up to the hilt…Bond saw luck as a woman, to be softly wooed or brutally ravaged, never pandered to or pursued…

Casino Royale – by Ian Fleming

Although lifted from a fictional adventure of 007, created by Ian Fleming, the above quote vividly illustrates how a gentleman should tango with Lady Luck; whether you are betting on the stock market or on the green velvet card table in Monte Carlo.

Many people may believe that betting in a card game is risky and highly dependent on the mood of Lady Luck. However, a layman investor may be making the same mistakes as an oblivious gambler.

A game like Poker is in fact a perfect simulation of what goes on in the grand scheme of the investment universe. The same emotional traps set at the card table are very well the same traps that devour many investors.

Let us examine the vices of investors by using the game of Poker as a referential case study.

Vice #1 Future can be predicted

Card players like to predict what cards will turn up next based on cards already shown on the table. This is the same mistake as how investors become overly optimistic based on past information about a stock or a fund.

If a card player is trying to make a flush (five cards of the same suit) and he is holding two hearts with two others showing as community cards on the table, the card player is very tempted to think the next card turning up would be heart. However, hearts are only one of the four suits, and his odds are in reality less than 18.75%  (given one deck of cards, and no other players). Four hearts have already turned up, so in the deck of cards, only nine more hearts are present.

Similarly, emotional investors are overly optimistic about past winners and overly pessimistic about past losers. Certain investments, especially mutual funds, are advertised with high historical returns which may not have any impact on the future returns. Certain stocks also meet the criteria of investor emotional bias, e.g common stock of Ford Motor Co. was trading @ $1.43 in 2008, with a recent high of $12.51, and not much has changed in the fundamentals of the company, only the emotions are stabilized.

When investing with a portfolio, one must examine the long term. Examine the 10 year or 8 year history, and not just how the stock or fund performs in the past couple of years. For a fund, examine the fund size, fees, turnover, and manager tenure. For mutual funds, an investor must be diligent in conducting their research regarding the funds that have been closed by the company. Mutual funds with consistent losses are closed and do not show in the historical rate of return as presented in the pamphlets.

For a stock, look at the inherent value of the company, just like good old Mr. Buffett would. Do not invest in a stock just because the price has been rising. “Value Investing”, anyone?

Trying to form a pattern based on random past information is as reliable as a naïve woman trying to predict your future by reading horoscopes. If you still believe in horoscopes, then perhaps you should never be allowed to approach the card table at Monte Carlo or the stock market. Please go back to watching the “Twilight” series.

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Security Analysis: Depreciation and amortization charges from an investor’s perspective

This excerpt is taken from the book “Security Analysis” by Benjamin Graham and David Dodd. It is regarding amortization and depreciation charges and the pitfalls in these numbers:

Rule 1: The company’s depreciation charges are to be accepted in analysis whenever (both):

a) They are based on regular accounting rules applied to fair valuations of the fixed assets; and

b) The net plant account has either increased or remained stationary over a period of years

Rule 2: The company’s charges may be reduced in the analyst’s calculations if they regularly exceed the cash expenditures on the property. In such a case the average cash expenditures may be deducted from earnings as a provisional depreciation charge and the balance of depreciation included as part of the obsolescence hazard, which tends to reduce the valuation of this average cash earning power. The obsolescence allowance will be baased upon the price paid for the enterprise by the investor and not upon either the book value or the reproduction cost of the fixed assets.

Rule 3: The company’s charges must be increased in the analyst’s calculations if they are both less than the average cash expenditures on the property and less than the reserve required by ordinary accounting rules applied to the fair value of the fixed assets used in the business.

What they are discussing over here deals with the idea that most property plant and equipment do not just wear and tear (per the amortization charge per year on the income statement) and it is hardly ever the case that companies will have sufficient cash and resources to construct a new plant after the useful life is over. In most instances factories do not actually wear out; they become obsolete.  And that is a business hazard which is not captured by the income statement.

Alpha

On Greece

Let’s talk Greece.

But first, let’s talk about how I came about writing about Greece. You see, I’ve been sitting at my desk for hours, flipping through news articles, trying to decipher economists’ words, and my mind drew a blank, which stayed blank for days. How do I write this, so that the average population, without sophisticated business degrees, can understand this? That is, until I changed my location, and spent the night with my best friend, watching a chick flick. And then, it was when I realized, Greece and its debt is like watching the plot of a typical chick flick. Girl meets boy, they fall in love, they go through many trials and tribulations, but at the end of the 2 hours, they are together and all is well.  In this case, Greece meets Euro, Greece likes Euro, gives chase and finally adopts it as its own, but things don’t go as planned and we are in the middle of the movie where Greece and the Euro are having many trials and tribulations.

Don’t get me wrong; like any blossoming relationship, it is very good in the beginning, especially for Greece. Things were looking in the up and up. The Euro was shared amongst the Eurozone countries; thus, it doesn’t appreciate or depreciate based on Greece’s actions and events that affect the country. Now, because Greece adopted the Euro, they get many benefits that they otherwise wouldn’t receive if they had used their own currency, the drachma. When the Euro didn’t depreciate, foreign goods will be cheap, hence Greece consumes more, but at the same time, they produce less. The other benefit that Greece received from adopting the Euro was that countries have confidence in the Euro; hence they kept lending money to Greece without second thought. The point in the movie we are at now, is when the girl is asking her boyfriend to buy her more luxury goods, while she herself has quit her job, and stopped taking care of herself.

So now, we come to the part where the boyfriend is growing tired of the girlfriend. The European Union is having doubts about the relationship with Greece. What will come of it?

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Power Play: Is Research in Motion doomed?

It may seem that the entire world is up in arms with Research in Motion (RIM.TO) and its executives.

What should RIM do in the upcoming months.. any thoughts?

At the moment RIM.TO is trading below the bookvalue. The last retained earnings of $9,917 (in millions) over 520.60 million shares, give the book value of the shares at $19.0459.  However, it is not always necessary that the past earnings will reflect in future earnings as well.

Just today (November 14th), RIM got the backing of hedge-fund manager Leon Cooperman, who believes that the company will comeback from faltering share price and loss in customers. However on the other side of the spectrum, Highfields Capital sold 1.44 million shares of RIM on November 14th.

The company has sufficient cashflows to meet any obligations, it has no debt, $1 billion in cash and it invested almost $2 billion on capital expenditures (purchase of investments, other companies etc) for the 6 months ended August 2011. The market has been punishing the company due to customer loss, but to my understanding, Research in Motion’s BlackBerry devices are immensly popular in non-North American markets, and that is where the company is going to see majority of its revenues for the next little while.

The company has been focusing away from the short-term into the long-term horizon, which is great for the long-term shareholders. If the price drops any further, I would be increasing my steak in the company.

More analysis to follow.

Alpha

Power Play: Occupy Toronto, supersized with Anonymous

Hacker group Anonymous threaten to remove The City of Toronto website from the internet if the city moves forward with eviction of the “Occupationists”.

Per Vancouver Sun (link), the group had previously refused to take part in any activity north of the border, however, given that one of the longest occupation movements in Canada is under attack, the group has changed their course. “

The brave citizens of Toronto are peaceful and well mannered occupiers, and we  will not let the city . . . get involved.

I believe that the protest should be allowed to continue as they are not disturbing anyone. It is a right of the citizens to come together in a peaceful protest, which is what they have been doing. It is essential that their voice is heard by the legislature to amend the rules governing banking and the financial sector. Canada has been lucky to have strict banking regulations, compared to their North American counterpart, U.S.A. Here is one more example where increased regulation has saved the industry.

You can read an earlier post re: what the Occupationists need to do next here.

I am with the Occupationists. Good luck!

Alpha