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HardnoseDotCom (60.50)

August 2009

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Goodbye US Dollar, Hello Chinese Yuan

August 29, 2009 – Comments (3)

China could be trying to replace the US dollar with the Chinese yuan as the world's reserve currency. The dollar is especially vulnerable now because of the enormous and growing national debt. We had a relatively higher national debt after World War II, but the current situation is very different. Previously, the debt was held by patient Americans. Now, the debt is held by nervous foreign central banks.  [more]

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Defensive Stocks versus Counter-Cyclical Stocks

August 17, 2009 – Comments (2) | RELATED TICKERS: CTSH , DISCA , MVL.DL

Many investors believe that the US will stay mired in recession because the stimulus plan is not working. If you believe this (I do not), avoid the temptation to switch into the stocks of defensive companies.

A defensive company is one that cannot suffer a large drop in sales because its products are vital or addictive. Food, beverage, and tobacco companies are examples.

But people can lower the cost of food by switching to unbranded items and buying in bulk. Furthermore, reduced income might just be the final straw that makes people follow through on their long-standing pledges to reduce or eliminate their intake of coffee, soft drinks, alcohol, and tobacco. Therefore, defensive companies tend to fall in bear markets, although not as much as the general market.

I recommend that you avoid defensive companies if you are bearish, and consider counter-cyclical companies instead. When the economy is growing, the emphasis in business is on expanding capacity to meet demand, and the desire of consumers is to spend freely for goods and services they can now afford. But when the economy is shrinking, businesses and consumers primarily want to cut costs. A counter-cyclical company offers cost savings to businesses and consumers, so it can grow even in a declining economy.

Business costs can be cut through information technology and information services. Companies involved in these activities are Cognizant Technology (CTSH) and Health Grades (HGRD).

Consumer costs can be cut by switching to home entertainment via targeted television, and switching to local entertainment via theater movies. Companies involved in these activities are Discovery Communications (DISCA) and Marvel Entertainment (MVL).  [more]

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Accounting For Short Sales

August 14, 2009 – Comments (0)

If you have both long and short positions, your broker will maintain two separate accounts.  The long positions will be in a margin account, and the short sales will be in a short account. Your broker will mark your short postions to the market, which will affect both your short account and your margin account.  [more]

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Hedge Candidates

August 13, 2009 – Comments (0)

When bearish, it is prudent to hedge all long stock positions. Hedging can be accomplished by shorting a related stock, a commodity or industrial exchange-traded fund (ETF), or a geographical ETF.   [more]

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The Volatility Index

August 13, 2009 – Comments (1)

This chart shows the Chicago Board of Options Exchange Volatility Index (VIX) versus the S&P 500 index (SP). The chart has been filtered to remove most of the noise.

VIX2  [more]

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Averaging Down Versus Momentum Investing

August 13, 2009 – Comments (1)

Most highly successful investors average down -- they interpret a drop in price as an invitation to buy. If the stock keeps on dropping, they buy more. The more the stock drops, the lower is the average cost. Warren Buffett and Jim Cramer invest in this way.

Averaging down is not to be confused with income averaging. Income averaging, also called dollar-cost averaging, means investing equal amounts on a periodic basis. Averaging down is a method of acquiring a position in a single stock. Income averaging is a method of acquiring a portfolio of stocks.

Averaging down is suitable only for investors who are outstanding fundamental analysts. They are sure that the stocks they buy are undervalued. If the price drops, a stock becomes even more undervalued, hence a better buy.

Other investors buy a stock only if it has developed an uptrend. These people are called momentum investors. Momentum investors are less skilled or less interested in fundamental analysis. They need confirmation before they invest. An uptrend provides such confirmation by indicating that the stock is becoming more highly regarded. Of course, the uptrend could quickly be reversed, but it is more likely that the uptrend will continue because stocks move in exaggerated trends.

It is unlikely that you are an outstanding fundamental analyst. I certainly am not, so I buy into uptrends.  [more]

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Tops and bottoms

August 13, 2009 – Comments (0)


When asked what he thinks the market will do, Warren Buffett replies "I haven't the slightest idea," and he continues to look for wonderful companies at reasonable prices. Jim Cramer (see his book Real Money), on the other hand, thinks it is not only possible to predict tops and bottoms in the market, but in individual stocks as well.

Cramer calls himself a bottom fisher. You should not fish for a stock bottom unless you have absolute confidence that the company is sound and the selloff is irrational. Cramer gained confidence by talking privately with company officials. This method was never available to you and me, and is now illegal for everyone.

Cramer also fishes for market bottoms. This is a very dangerous game. What appears to be a market bottom might prove illusory as anxiety turns into fear, fear turns into panic, and panic turns into despair. During the Great Depression, the common belief was that America would never recover.

Therefore, do not bottom fish. Also, do not bother trying to find market tops because they provide inadequate timing information. Market bottoms are sharp because many stocks bottom out simultaneously, but market tops are rounded because stocks top out at different times.
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Beware of Stock Market Commentators

August 13, 2009 – Comments (0) | RELATED TICKERS: AAPL , NOK , BB

Listen to stock market commentators with caution. You can learn from them, but even the most popular and highly respected stock market commentators frequently give bad advice. Here are some of the most common ways they mislead:

1.  They make short term forecasts. Nobody knows what the market will do in the immediate future. Nobody knows what a stock will do in the immediate future. But investors wants to know, so talk show hosts pump guests for answers. No matter how authoritative the source, ignore the answer.

2.  They focus too much on earnings and too little on revenues. They are impressed by an earnings increase even if there was a drop in revenues. A company can pump up current earnings by cutting product development, image advertising, and customer support, but there will be unpleasant consequences in the next few years.

3.  They imply that there is a strong short-term connection between the economy and the market. While it is true that the market and economy move together over the years, they go their separate ways in shorter time spans.

4.  The market precedes the economy. In fact, the S&P 500 is one of the so-called "leading indicators," so making a market forecast based on economic analysis is especially foolish. Nevertheless, pundits frequently start by talking about the economy and end by predicting whether the current market trend will continue or be reversed. 

5.  Most short-term market moves are the result of many overlapping fundamental, technical, and psychological forces. Nevertheless, pundits try to relate every market move, even intra-day, to a news item. News cannot cause a move unless it is unexpected and unambiguous. However, most news is predictable, and even when unexpected is subject to interpretation which can make it seem either favorable or unfavorable.

6.  They seem to think that the world economy is dominated by the US, whereas the US economy is only about one-fourth of the world economy. For example, pundits might lead you to believe that Apple (AAPL) and Research in Motion (RIMM) are beating Nokia (NOK) in smart phone competition, when actually Nokia is the leader in global market share.

7.  They think a rip-roaring stock market is a sign of a healthy economy, but it is actually a sign of an insufficiently regulated economy. Good regulation prevents asset bubbles, and results in a restrained stock market. China punctured its stock market and housing bubbles by choking off credit, and is now growing strongly while the US and Europe, which ignored their bubbles, are slowly climbing out of a deep recession.  [more]

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P/E, PEG, and Beyond

August 12, 2009 – Comments (1)

Investors want to be able to determine if the stock market, as measured by a market index, is fairly priced. Investors also want to know if an individual stock is fairly priced.  [more]

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Trend Persistence in Stock Prices

August 12, 2009 – Comments (0)

To determine trend behavior in stocks, I analyzed historical daily closing price data from finance.yahoo.com for three stocks and three market indices covering the period 1985 January 11 to 2004 November 3. A random walk has an average trend length of twice the minimum trend size -- any trend length beyond this indicatates non-random behavior.  [more]

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Day of the Week Timing

August 12, 2009 – Comments (4)

I have done a little research on the Value Line Geometric Composite Average from 1985 January 13 to 2005 October 28:  [more]

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Day of the Month Timing

August 11, 2009 – Comments (4)

I have done a little research on the Value Line Geometric Composite Average, which represents individuals better than the major indices do, to see if some days of the month are better than others for buying or for selling. Two time periods were used to check for consistency. The second column is for the period 1/11/85-12/31/99. The third column is for the period 1/1/00-6/29/2006:  [more]

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My Current Picks

August 10, 2009 – Comments (3) | RELATED TICKERS: CHL , PBR , PWRD.DL

I use the current picks as a watch list of stocks for possible purchase. The selection process was:  [more]

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Rebalancing Your Portfolio

August 05, 2009 – Comments (8)

     It is sometimes a good idea to rebalance your portfolio if one or more long positions have risen sharply. A good rule of thumb is that you should sell half of any holding that is more than twice the current tranche size. If the position is hedged with a short sale, you should also cover half of the hedge unless this would result in your portfolio being net long. I failed to rebalance before the bear market than started in 2008, and was badly burned because my portfolio had become overweighted in oil and mining stocks.
     Understand that you are rebalancing, not taking profits. Many people wrongly believe that things tend to even up because of "the law of averages." They are not referring to the Chebyschev inequality, they are referring to a vague feeling that is probably genetically coded. These people believe that a rally must be corrected, which explains why traders tend to take profits.
     Many investors want a high percentage of winning trades, which is another reason that traders tend to take profits. They say "You can't go broke taking a profit." The Motley Fool recognizes this, and their ranking system includes winning percentage. But even though winning percentage is important in sports, in investing you should aim to maximize portfolio gains.
     Jim Cramer recommends taking some off the table when you have a profit because you are then "playing with the house's money" and "hogs get slaughtered." But it is your money, not anyone else's, and it is likely that a good use of the money is to keep it where it is. People who let their profits run can reap hoggish profits, as Peter Lynch and Warren Buffett have shown.
     Karen Finerman has a different reason for taking profits. She says that a gain in a stock increases its risk potential and decreases its reward potential. She does not seem to know that stocks move in exaggerated trends. Instead, like many analysts, she calculates downside and upside targets. However, long-term investors who sell losers to establish tax losses have minimal downside potential, while the upside potential is unlimited. 
     I have to disagree with Cramer and Finerman, who are both smarter, more successful, and more experienced than I am. The only reason to reduce your position in a stock that has risen sharply, unless you are anticipating a bear market, is to rebalance your portfolio into a more diversified position.  [more]