Profitable Readings

In the midst of trying to understand the direction of the market going forward I tried to make sure I was up to date with all the relevant news. There were too many contradictions. Some managers say buy. Buy now. Others say it will only get worse. Who is right? I may have found my answers in the words of Carl Von Clausewitz’s classic “On War”. Here are words from the Chapter on Perseverance:

["The reader expects to hear of angles and lines, and finds, instead of these citizens of the scientific world, only people out of common life, such as he meets with every day in the street. And yet the author cannot make up his mind to become a hair's breadth more mathematical than the subject seems to him to require, and he is not alarmed at the surprise which the reader may show.

In war more than anywhere else in the world things happen differently to what we had expected, and look differently when near, to what they did at a distance. With what serenity the architect can watch his work gradually rising and growing into his plan. The doctor, although much more at the mercy of mysterious agencies and chances than the architect, still knows enough of the forms and effects of his means. In war, on the other hand, the commander of an immense whole finds himself in a constant whirlpool of false and true information, of mistakes committed through fear, through negligence, through precipitation, of contraventions of his authority, either from mistaken or correct motives, from ill will, true or false sense of duty, indolence or exhaustion, of accidents which no mortal could have forseen. In short, he is the victim of a hundred thousand impressions, of which the most have an intimidating, the fewest an encouraging tendency. By long experience in war, the tact is acquired of readily appreciating the value of these incidents; high courage and stability of character stand proof against them, as the rock resists the beating of the waves. He who would yield to these impressions would never carry out an undertaking, and on that account perseverance in the proposed object, as long as there is no decided reason against it, is a most necessary counterpoise. Further, there is hardly any celebrated enterprise in war which was not achieved by endless exertion, pains, and privations; and as here the weakness of the physical and moral man is ever disposed to yield, therefore only an immense force of will which manifests itself in perseverance, admired by present and future generations, can conduct us to the aim."]

In other words until you realize the contradictions in any situation can you then AND ONLY THEN make sense of what it is actually happening. Many people would rather believe what they want to believe or believe only what they know without considering what they don’t know or at least accounting for the downside.

Intelligence:CNNMoney carries today its interview with the only fund manager to beat the S&P in 2008. The Forester Value Fund earned .4% last year in contrast to the 38.5% decline of the S&P. Fund Manager Tom Forester likes Valero Energy, Newmont Mining, and Symantec among others. As with all mutual funds past performance is not necessarily a guarantee of future results, yet his mention of Symantec is interesting.

Analysis: The rise of cyber security is one of the fastest growing segments of the IT industry. The rise of mobile devices and the volume of electronic transactions has forced many companies to upgrade their security networks. Symantec got me thinking about Websense. As chess master Bruce Pandolfini says if you find a good move look for a better one. This from their 3Q earnings “”We posted another solid quarter in Q3 as we continue to exceed our original expectations for earnings and cash flow accretion due to the SurfControl acquisition. We have yet to see a significant negative impact on our business from the recent economic turbulence.”

Takeway: Websense (WBSN) trades at 16.26. I think it will reach 22 in six months. (7/6/2009)

Follow The Money

Intelligence: Today’s Wall Street Journal has a very interesting take on energy investor George Keiser. Keiser, the article claims, is considered one of the world’s smartest energy investors. Recently he purchased 5% of energy producer SandRidge at $5.62 a share. It is important to note that he can sell back the shares in February for the same price. The stock currently trades at $8.44 probably due to this articles’ mention, rising oil prices, and an overall belief that Sound Ridge is a solid company.

Analysis: One of ideas that struck me while reading this article is how often are actions in life are based on what the “experts” tell us. They carry more influence and persuasion that we think. Eugene Garfield is credited with coming up with a concept called Citation Analysis. He theorized that the more one is mentioned in the press or in journals than the more important and thus more of an expert they must be. The smart money should not be the end of one’s investment research, but it makes for a good beginning.This article illustrates there are experts in almost every field and discipline. It is just a matter of locating them. The experts are not always right, yet good experts are always right the majority of the time and that is what is most important.

Takeaway: I am going with Keiser. SandRidge should reach $12 in six months. (7/6/2009)

I am working on new concepts and ideas and format for this site. In the meantime I am going to stand by the title here. It will be the year of mergers.

Trade The Time

In the investment community words like “greed” and “risk” are generously and freely tossed around when speaking of the enormous boom and bust of both the Dot-Com Era and the Current Crisis of ‘2008. Yet, what is also important to remember is that there is a third element involved which is “time horizon.”

In the late 1990’s the best performing stocks such as eBay and Amazon were built on an almost impossible scale of potential growth. They  make predictions that suggest they can see years into the future. In retrospect, one of the winnigest strategies would have been to have bought and sold stocks whose yearly projections for the future were the greatest. In good times trade the future.

Stocks now considered good buys are those that will produce consistent returns. They offer finite growth. Examples would be utility stocks and consumer good companies.Yet, another way to invest is to trade what is happening now. One recent example appears to be regional banks. Goldman Sachs recently received a bank charter and Citigroup is said to be still considering an acquistion in the light of Wells Fargo acquiring Wachovia. It is very possible within the next six months there will be several bank mergers in the Northeast as it holds the greatest concentration of the U.S. population as this article illustrates.

The Sun Will Come Out

One of the most common mistakes human beings make is assuming that what happens today will happen tomorrow. When we do this we see life as linear. This is not always a bad thing because in many situations it is an effective tool for planning. In fact this is a frequently used technique in the forecasting business which is commonly referred to as extrapolation. We take a small picture of what is going around us at the current time and we project it onto the future through our own individual imagination. Yet, the danger in an exercise like this is fails to ignore possible situations and events that may arise. For example in the current crisis of ‘08 many people assume that the situation will continue to get worse. Why? Because that is the trend for one. It is important at this stage to really try to separate one’s own individual emotions be they positive and negative and arrive at a more balanced viewpoint and understanding of the events going on.

How do we do this? Richard Heuer, a 20+ year veteran of the CIA, provides clues. Heuer wrote what is considered the gold standard in intelligence literature called the the Psychology of Intelligence Analysis. The book lays out the pitfalls the mind can enter into and makes recommendations on how to avoid them. Specifically, he notes we often come up with a story in our own mind of why things are happening now or what will happen in the future. After we arrive at this point we go out and seek information that will back this up. Consciously and subconsciously we ignore all information that does not fix this model. This is also commonly referred to as confirmation bias.

What Heuer argues instead is that we do the exact opposite. When we come up with an initial idea or story we should then try to find information that will disprove this theory. He took this approach one step further when he devised the analytic method known as the Analysis of Competing Hypothesis or ACH. This method allows one to weigh various pro vs. con arguments together to come up with a probable outcome. ACH software allows anyone to follow this process.

So let us look at the current Wall Street Crisis. There are many reasons to look at the facts and assume the crisis has the potential to cascade. Many peope have voiced their opinion that it might to take the country years to recover. For this argument you can cite the a 6.7 unemployment rate or Google cutting back its employee benefits. In fact it is hard to do a quick scan of any of the leading financial websites and not come away with a pessimistic impression. Yet, there are several positive signs out there if we take Heuer’s advice and look for evidence to refute our original perception.

• Business Schools-Traditionally, when the economy falters business school applications tend to rise. This current crisis is no exception. In fact the recent BusinessWeek article entitled “MBA Programs Eye Expansion” noted that testing firm ” Kaplan surveyed 245 B-school admissions officers in August and found that more than half were considering increasing program size, some by up to 25%.” The choice to invest in graduate education is akin to purchasing a big ticket item such as a car or real estate. One does not undertake it without feeling somewhat confident that he or she will reap a significant return on their investment somewhere down the road.
• Video Games- The video game industry primarily catered to the young. Yet, video games are gaining a new popularity with older adults as seen with the popularity of the Wii. According to the AP the November sales for video games, software, and consoles in the U.S. totaled. approximately $3 billion, almost 10 percent higher than last year. The results were reported by NPD Group, who anticipate total video game sales for the year to reach approximately $22 billion in the U.S. Video games are an activity that is pursued in discretionary time.ie after work. It is hard to believe you will be throwing down $40-$50 a game if you think your greatest concern will be keeping or finding a new job.
• Smartphones- Market research and consultancy firm IDC projects that smartphones( BlackBerry, IPhones, Palm, etc.) shipments worldwide shipments will grow from 164.7 million units this year to 363.2 million units in 2012. The number of applications available on these phones continues to grow at an enormous rate. Smartphones have become the new handheld computer. Again, if things are going to be that bad in the coming years why do people think they be so busy that they will have to go out an purchase one.

Time Tells The Story

The latest issue of Fortune Magazine contains an interesting interview with discount broker king Charles Schwab. Schwab strikes an optimistic note to the current crisis stating that in 1979 BusinessWeek ran a cover story titled the “The Death of Equities.” Sure, one could argue not much has changed in light of the current circumstances. Yet, that would negate the explosive growth of the stock market. Consider for instance that the Dow Jones Average was just over 780 points in August of 1982. People ,it appears, have short memories and lose context.

What is also missing is experience. Many current investors due to their age did not have a stake in the market of the 1970’s. Similarly, when one talks about the 1930’s as they do now one has to be especially careful as well. Unless, you have lived through the time period you have to discount for a lack of first person perspective. Structured Analogies , which is a analytical method for highlighting similar situations can be very usefull, yet should complement any first person narrative when possible. In a recent podcast from the Long Now Foundation , scenario planner Peter Schwartz noted that as people live longer they are able to impart a greater insight into current events. They have experienced more events are perhaps able to draw greater inferences from them. For example Irving Kahn, who is 102, worked on the floor of the stock exchange in the Crash of 1929 here gives his take on the current crisis.

Many people too often are tempted as they were in the early 2000’s to declare that “This time is different.” It is the refrain offered today declaring the greatest crisis since the 1930’s. Perhaps. We are not there yet however. Keep in mind the Great Depression was highlighted by 25% unemployment and did not go below the 10% level until 1941. Some project we will be lucky to miss 10% unemployment next year. Even still these numbers don’t match.

The best exhaustive research used to create predictive intelligence will be that which incorporates both secondary sources and interviews with first person individuals.

See how many analogies you can draw from this NYTimes Article “Dark Days of Wall Street.”

Strength in Numbers

The expression “boots on the ground” is a military phrase suggesting a force already engaged in combat. Often times you will here the expression to mean the need for more resources ie “The situation can improve if we have more boots on the ground” to stabilize the area.

In law enforcement “boots on the ground” has a similar connotation. It means the use of police officers to survey, assess, and key an eye on troubled areas and criminal suspects. In a recent interview with Portfolio magazine, NYPD Commissioner Ray Kelly stated that an effective boots on the ground strategy was the key to rooting out crime and maintaining order over the use of sophisticated crime tracking software. Similarly, LAPD Commissioner William Bratton in “Top Cop In Los Angeles Says Cutting Crime Pays” ” argues that the drop in violence in Los Angeles can be attributed to consistently increasing the number of police officers in the city and thus increasing the boots on the ground.

In the intelligence community “boots on the ground” is commonly referred to as “human intelligence”. Many would conclude this too mean information obtained through sources or through government field agents. However, any information derived from individuals containing some value can be considered intelligence. One of the most effective producers of this type of intelligence is the State Department’s INR or Bureau of Research. It is able to leverage all intelligence coming out of the U.S. Embassies worldwide giving in a up close worldwide understanding of events. In this case “boots on the ground” are really “eyes on the ground.” SEE: “Analyze This” to learn more about the INR.

In the investment community there is no such expression as “boots on the ground.” In its place you have what is considered your network of knowledge. To this end you want to be as much informed as possible through as many sources as possible without too much duplication. For example, you want to know as much as what was just on CNBC as what the latest social networking site is coming out of Silicon Valley. You want to develop your own internal network of sources in the industry to develop a “pulse” of what’s going on. Get to know the personalities behind your favorite columnists or experts you rely on. Know their bias or know that what they believe might affect there opinions. You want to be familiar with the geography of these places as well. It is not enough to refer to “Wall Street” untils it becomes a cliche. It would help to go there or even Silicon Valley.

The concept of “boots on the ground” and “network of knowledge” is a very effective strategy for obtaining some of the most accurate intelligence. The chief reason is this. Information is harder to be lost in the translation when it can be obtained in first or by second person. Secondly, this process speeds up the transfer of information. When there is a lag time in processing intelligence there is always a good chance the story has changed. Decisions run the risk of reflecting old intelligence and not current intelligence.

Attached you will find an original case study Profitable Readings has taken up to understand the Wall Street Crisis of 2008. There are many facets and angles to focus on surrounding the event. The intent was to focus on those situations most relevant and emblematic of a pattern. It is this pattern that might play out in future financial crisis’. The details, players, and situations will be different, yet the pattern may take hold the same way.

profitable-readings-case-study1

Below are the final series of excerpts you might find informative from the “Global Trends 2025″ Report.

“The future development of novel drilling techniques may create new opportunities to find and exploit previously unexplored ultra-deep oil fields. Such fields, however, may be located in areas of contested ownership, such as Asia or the Arctic, creating the potential for conflict.” page 63

“As big emerging markets in Asia and elsewhere grow, globalization will less often be equated with Americanization. As traditional ways of life are upset around the globe, unwanted foreign ideas and customs will appear more the product of modernity than of American sprawl. …………Potentially unfavorable would be perceived slowness in tackling pressing transnational problems such as global climate change, food security, and energy security. A currently indeterminate factor will be the effect of increasingly pervasive mobile telephony, Internet connectivity, and direct satellite media on how individuals around the world receive their images of the United States. On balance, however, major trends suggest that anti-Americanism is declining. page 96