10 posts tagged “prices”

The reason for some institution's refusal to sell their positions that have appreciated dramatically (and that are most vulnerable to decline) can be deeper than the impression desired by publishing the positions. Management's compensation is usually a set percentage of the market value of the assets managed. If a profitable position is sold, the gain may be subject to taxation and paid out to clientele as a capital gains distribution. This effectively reduces the amount of money being managed and the associated fees.

The problems associated with selling positions that have profited most can be particularly acute in small mutual growth funds that have followed the practice of "taking losses and letting profits ride" for an extended period. The result is that their portfolio consists of only a few issues. By having locked themselves into holding a few profitable stocks, the fund's value becomes a function of the value of the rigid holdings and has nothing to do with the overall ability of management.

Keep in mind that money managers are human beings with basic needs such as food and shelter, which require employment. Also recognize that, especially in the larger institutions, clientele are not aware of the identity of the individual analyst making the investment decisions. This anonymity is often strictly enforced and a prerequisite for employment.

In this environment, the individual analyst (whether a genius or an idiot) is under pressure to conform to the crowd. To be too good or too bad relative to one's peers involves risks of criticism or resentment with the associated occupational hazards. This effect is obvious to anyone familiar with the financial media. When an analyst (usually independent) becomes popular because of accurate forecasting and then stumbles, the mistake (even though the overall return over time has been far superior) is pounced on. On the other hand, a spokesperson for a large institutional analytical service that has consistently been wrong, but that is one of the crowd, attracts media attention when making forecasts without criticism of past mistakes.

Understanding the structural aspects of institutional investing practices and employment pressures, you would logically conclude that the average institution would underperform the market, with the underperformance magnified by the fees involved. Yup.

External

Aside from the difficulties associated with internal structure and characteristics, institutions have the added problem of dealing with their clientele. Discretionary clientele who do not properly understand the stock market, although they have entrusted their investment decisions to someone else, often have a tendency to self-destruct. This is particularly evident in mutual funds, whose investors are continually adding or withdrawing (redemptions) money. People tend to add money when the market is highand the mood optimistic. Redemptions tend to dominate when the marketis low and the mood pessimistic.

The institutions are forced to invest the money—that is what they arebeing paid to do. Therefore, with more money coming in when the market is high, the institutions so affected are forced to buy at relatively high levels. Conversely, when redemptions dominate and the market is low, the institutions are forced to sell at depressed prices to fulfill the investor'sdemand for cash.

From the professional standpoint, the process is marvelous. We knowwe have buyers at high prices and sellers at low prices because of the demands of discretionary clientele creating a supply/demand imbalance. When they are doing their forced buying, it creates underlying buying demand and we can raise our prices. When they are forced to sell, we know there is "overhanging supply," and we can lower our purchase prices.

This buy-high/sell-low behavior (required to fulfill clientele's wishes) is not limited to mutual funds. It can affect any funds that can redeem or add capital according to their client's emotions: bank trust departments, pension funds, and the like. An important exception is closed-end mutual funds where the capital base is fixed and the investor must buy/sell shares in the open market rather than affecting the funds' specific holdings.

The market is a business. The purpose of the business is to acquire the monies of others through the process of buying low and selling high. Because of the anonymous nature of trading structure, it is very difficultto specifically identify the individual to whom you are selling or from whom you are buying. Consequently, physical coercion to create losingbehavior among fellow market participants cannot be applied. People do not enter the market to lose. However, they must be placed in a situation in which they will willingly part with their money. The only way to elicit losing behavior is psychological pressure. The most effective tool for applying the pressure is a change in market price. Faced with "paper" losses, those vulnerable to the emotion associated with "apparent" losses will capitulate, accepting the loss in the form of cash to relieve thepsychological strain.

The discretionary manager is subjected to the same emotional pressuresas all other market participants. It is not uncommon for discretionary managers to buckle under the pressure and sell low in direct conflict with historical or statistical precedent to alleviate pressures both self- and clientele-imposed. Conversely, when prices are too high, the emotionallure of greed can stimulate buying when prices are most vulnerable to severe decline. Those who conduct themselves professionally are acutelyaware of the psychological effects of price on institutional managers and take advantage. Such advantage is possible only by strict adherence to a methodology that prevents being lured into the irrational (emotional) behavior of the crowd. This is easily accomplished by having predetermi_ned buy/sell points dependent upon market condition, not price in itself.

The forced behavior of institutions provides one of the most important profit centers for the true professional.

When we developed our investment methods, we assumed that using P/Es based on projections rather than lagging P/Es would create a significant difference in results. Over the many years that this basic portfolio modeling has been published and applied in actual market endeavors (covering a wide range of market conditions and thousands of individual stock positions), to our surprise, that the results obtained by using earnings projections in P/E calculations has not (to date) resulted in significantly better results than using lagging P/Es. In other words, although the authors use projections in their analysis, lagging P/Es so far have provided almost identical results. Whether earnings projections or lagging P/Es are utilized, taking the calculations to two decimal points is necessary to maximize the number of buy/sell points.

Since P/E is a function of price, we must consider whether price (a much easier measurement, the week's closing price) can be substituted. The answer is yes, but there will be some (to date quite minor) loss of accuracy. For example, if a stock's earnings suddenly declined dramatically and the stock's market price also declined, the decline in market price might not be directly proportional to the decline in earnings. The price would go down, but the P/E (price now divided by lower earnings) might go up because the earnings drop was proportionately greater than the price drop. Watching for changes in price, without paying attention to earnings changes as well, will prevent your gaining a refined perspective of true supply/demand.

If you choose to substitute price change for P/E change, the accuracy differential can (in most cases) be compensated for by raising the required percentage of issues that must be down or up in price to 80 percent. There will be fewer buy/sell points derived by using price rather than P/E, but (to date) the price method would have identified all major buy/sell points. Consequently, the essential elements for an indication are:

BUY: 75 percent of the P/Es or 80 percent of the prices of the stocks monitored must be down.

SELL: 75 percent of the P/Es or 80 percent of the prices of the stocks monitored must be up.

A question is now raised: Would it not be easier just to see if the market averages had gone lower and take that (or the P/E of the Dow or some other average) as an indication? The answer is no. The averages can be misleading. They can be significantly influenced by dramatic price moves in stocks and stock groups that do not warrant consideration (that is, stocks not on the Master List) as an indicator of investment. An attempt to gauge market conditions by the average of a conglomeration of unrelated stocks brings in extrinsic factors that are unpredictable. Our stock selection is designed to make the most important extrinsic factor (earnings) predictable.

To attempt to incorporate past changes in market averages as forecasting tools for future changes can be done, but it requires extensive calculations, including degree of price change in relation to volume change for each stock involved. It results in lower levels of accuracy than achieved by our technique. In our method, the design is not only to achieve superior results; it is also designed to be as simple as possible. In our method to get a signal from our primary indicator, the degree of decline (what percentage decline in P/E or price occurred) is not a necessary measurement. For example, if 80 percent of the stocks monitored declined in price only 1/8 of a point from their previous price level, the essential criterion for a buy indication would be met. The ancillary criteria are designed to filter for the magnitude of the primary criterion.

Why (for the basic portfolio modeling techniques) do we not consider it essential to wait for some upward price movement to occur to ensure that the effect of selling pressure is gone? Conversely, why not wait for some downward price movement to occur to ensure that buying demand is gone? The reasons are twofold.

First, often when price reversals occur, they are very rapid, and a significant portion (sometimes almost all) of the anticipated price change can occur before positions can be taken.

Second, the authors are in the business of stock trading on a scale that involves many millions of dollars. We are not engaged in theoretical observations that include the naive belief that infinite amounts of stock can be bought or sold at the prices quoted. Stated flatly, for us to acquire stock in large amounts at appropriate prices, it is necessary to have adequate sellers; to sell stock in large amounts at appropriate prices, it is necessary to have adequate buyers. Real people and real money are involved. Stock purchased at acceptable prices is available only when sufficient sellers at the acceptable prices are in place; which is usually as prices are declining, not after the price decline. Selling stock at acceptable prices can be accomplished only when there are adequate willing buyers, which is usually as prices are advancing, not after the advance.

The primary criterion, be it P/E or price, will not always give a buy/sell indication. In fact, most of the time (and sometimes for very long periods) the primary criterion will not meet the parameters to form the preliminary basis for a change in basic portfolio modeling. The primary criterion (depending on which method—projected earnings, lagging P/Es, or price—is chosen) is by far the most time consuming aspect of our timing technique.

The ancillary criteria are designed to confirm or reject the primary indication. The ancillary criteria (aside from a few rare exceptions) will always be issuing a buy or sell bias. Without an indication from the primary criterion, there is no need to be concerned with the ancillary facets in basic portfolio modeling because there can be no change.

There are twelve ancillary criteria, which might at first seem too burdensome to calculate. However, most (if not all) can be determined by a casual glance at major financial publications (Barron's or The Wall Street Journal). A weekly review of the ancillary criteria can probably be attained within 10 minutes after the sources are identified.

For the ancillary criteria to confirm the primary criterion, a minimum of six ancillary criteria must be in place.

Institutional Cash Reserves

If all markets involve predator/prey relationships, to acquire the cash of others requires that the others actually have cash from which they can be parted. Because of the specific stocks we utilize, as well as the growing dominance of institutions in day-to-day trading patterns, those institutions against whom we compete are important sources of profit.

The term institutional cash reserves refers to the ratio of institutional holding of cash (or cash equivalents) to common stock. The higher the institutional cash reserves, the more money they have available for the purchase of stock. The lower the cash reserves, the lower the institution's ability to buy stock irrespective of sentiment. To emphasize the importance of this institutional cash:noncash ratio, it was all you needed to understand to avoid the crash of 1987. At the time, the institutions were so lured into the stock market and their cash reserves became so depleted, they could not support stock prices. It was an inevitable splat time because of the depletion of possible buying demand.

Institutional cash reserves are tabulated regularly by a variety of surveys that scan mutual funds and/or pensions (Lipper, Herzfeld, a wide variety of brokerage firms, and the like) and the results regularly published in major financial publications.

For our purposes, all we need to know is the change in the cash:noncash ratio relative to where it was four weeks ago (or the next nearest reporting period depending on the source utilized).

BUY: The cash amount has increased. We have isolated potential buying demand that can be lured into the market to push prices higher.

SELL: The cash amount has decreased. The institutions are depleting their buying power, making themselves increasingly weak (perhaps helpless) in providing price support and thereby allowing selling supply to more easily dominate and depress prices.

Public Cash Reserves

Because of the rapid growth of institution's dominating trading activity, it has become popular to dismiss the public as an important market factor. However, as we have discussed in detail in previous chapters, the public is a very important factor, not only because of the predictable behavioral patterns of individuals, but because of the effects these patterns have on the institutions in which the public has entrusted funds.

We monitor this group's cash status by the weekly reporting of the total assets of money market funds. Money market fund assets include monies from groups other than the public, but for our purposes the changes in money market fund assets is all that is necessary for this criterion.

The weekly money market fund asset figures are reported in all major financial publications. Our comparison period is four weeks.

BUY: The amount (gross, no ratio needed) has increased. This isolates potential buyers (buying demand) and the associated potential for higher stock prices.

SELL: The amount has decreased. The amount of potential buying demand is lessening, and selling supply can more easily become dominant to depress stock prices.

The two previous factors were designed to isolate specific participants and their ability to effectuate future behavior because of their cash/noncash position. The amount of money in the overall economy is also important and is influenced by the actions of the Federal Reserve.

The figures relating to available money supply are provided weekly by the Federal Reserve and reported by all major financial publications. The money supply calculations include various categories (M-1, M-2, and M-3 being the most popular in gross form). Because of the various components of the money supply categories and changes in the economy, there is an ongoing debate within the financial community as to which measurement (with a myriad of adjustments) is the most accurate. For the purposes of our basic market timing, time and brain cells need not be wasted in agonizing as to which "M" (money supply measure) is chosen. One need only be concerned with sticking with the M originally chosen. We use M-1, which is basically the amount of cash in circulation.

As a criterion in our basic timing method, we compare the gross (not ratio) amount of M-1 to its level four weeks before.

BUY: The amount is increasing. More money is coming into the system, a portion of which can be lured into the stock market in the form of buying demand. In addition, the increased amount of available money helps the overall economy to expand.

SELL: The amount is decreasing. The withdrawal of money from the overall economy creates cash needs, on which investors draw against their stock holdings (because of the liquidity) before selling most other assets. This selling supply can function to depress prices. And the lessened money supply is often a good indication of a coming constriction in the broadly based economy.

Gold Price

The stock market, as with any other market, is constantly in competition with other investments. Gold, because of its history and physical nature relative to paper money, is a good indicator of relative popularity. Real estate, collectibles, and other "hard" commodities could probably be substituted for our gold criterion; but we have selected gold for its liquidity (with the metal being actively traded in markets throughout the world).

Again using a four-week comparison, we simply look at the net change in price for our indication. We use spot prices, but futures can be substituted as long as the same contract month is being compared.

BUY: Gold is up in price. This can be a good indication that stocks have become unpopular and undervalued. When the gold price declines and the metal disappoints investors, their buying demand can more easily shift to the stock market.

SELL: Gold is down in price. This can indicate stocks have become overvalued and can precede a reversal in investor sentiment, creating increased selling supply in the stock market.

Bonds

There is an inverse relationship between bond prices and interest rates. Higher bond prices mean lower interest rates, and lower bond prices equal higher interest rates.

There is also generally a very strong, direct correlation between stock and bond prices. Higher bond prices are usually accompanied by higher stock prices, lower bond prices by lower stock prices. The bond/stock price relationship is logical. Higher interest rates (lower bond prices) increase corporate costs borrowing and as such function to reduce earnings. Higher interest rates, because of the increased cost of capital, tend to slow the overall economy which can adversely affect corporate sales and consequently have a negative effect on corporate profitability. Within market structure, higher rates increase the cost of margin buying, which reduces buying demand.

Periods during which stock and bond prices diverge usually involve high levels of investor emotionalism. If sentiment is extremely pessimistic, high-quality bonds become viewed as safe havens and buying demand increases, adding price support for bonds while stocks falter. Conversely, during periods of extreme euphoria, bonds can become viewed as providing returns too low relative to stocks, creating selling supply in the bond market; this lowers bond prices while stock prices are advancing.

Our concern with the bond market in our timing model is the most common, direct price relationship. Using a four-week comparison period, our indication for this criterion is the next change in bond price down or up—we are not concerned with the magnitude of the differential. We use long-term U.S. Treasury bonds.

BUY: Bond prices are down. Interest rates have moved higher, probably depressing stock prices and making a price reversal more likely.

SELL: Bond prices are up. Interest rates have moved lower, possibly having an unsustainable elevating effect on stock prices and increasing the chance for a reversal.

Our previous criteria were designed to get a general idea as to our opponent's ability to participate in the market (cash or the lack of it), as well as some insight into the effect of alternative investment types.

We will now turn our attention to what is actually happening within the stock market. The two most important variables are price and volume. If volume is increasing as prices are advancing, it is indicative of an expanding number of buyers coming into the market. This can also indicate that the buyers are depleting their power and will eventually no longer be able to maintain price support. Conversely, if volume is expanding as stock prices are declining, it indicates that those selling out will eventually lose their force (depleting selling supply), which can allow prices to reverse.

In calculating this criterion, we want to know if the cumulative volum_e over the last 20 trading days is greater or less than the cumulative trading volume of the preceding 20 trading days. This is accomplished by adding up the total volume on the New York Stock Exchange over the last 20 trading days and comparing the total with the volume the preceding 20 days. Forty days of data are needed. Calculating this criterion takes only a couple of minutes: adding the newest day and deleting the latest in an ongoing total. For most indications all you need to do is look at a chart of recent volume (available in most major financial publications) by which significant changes in volume can be quickly and easily identified.

For this criterion to be given any consideration, volume must have increased. The amount of the increase is of no concern. If the volume has decreased, this criterion is not considered to have given any indication.

For the price component of this criterion, the net change (plus or minus) of a popular average will suffice. The amount of the change is of no concern, just the direction. Using a four-week comparison period, we use the New York Stock Exchange Index because of the large number of issues forming the measurement. The Standard & Poors 500, Dow Jones Industrials, or other popular averages could be substituted.

BUY: Volume is increasing as prices have declined—an indication that selling supply is being depleted.

SELL. Volume is increasing as prices are advancing—an indication that buying demand is being depleted.

NO INDICATION: Volume has decreased.

Volatility

The faster prices are going down, the faster sellers are getting out, and the higher the probability that the excess selling supply will soon diminish and allow buying demand (higher prices) to dominate. The faster prices are going up, the faster buyers are using up their money supply, and the higher the probability that selling supply can soon dominate to push prices lower.

In the past, we have incorporated beta measurements as one of our volatility criterion, but these calculations were time-consuming and difficult for many investors. We are now substituting a very simple measure of volatility rather than the more time-consuming beta comparisons. The simplified method can be applied without any loss of accuracy.

Remember that, by confining specific investment interest to the stocks that qualify for our Master List, we are effectively participating in a market within a market. When purchasing stocks, we would prefer to invest in those that will outperform the market. When selling, we want to get out when the chances are that our stocks will go down at a faster pace than the overall market. Consequently, it is to our benefit to have some idea as to how the stocks we follow are doing relative to the broadly based market. If our stocks are relatively depressed, to us they represent better values. If our stocks are relatively overvalued, they would appear more vulnerable to decline.

To determine the relative over- or underpricing, we compare the percentage price change of the stocks we monitor to the percentage price change of the NYSE Composite Average. Any other broadly based market "average" could be substituted for the NYSE Composite.

Using a four-week comparison, the percentage of advance/decline of the popular average selected is calculated and compared with the average percentage advance/decline of the stocks we follow. Whether this ancillary criteria develops a buy or sell indication depends on what direction the popular average being followed has taken.

If the NYSE Composite has declined.

BUY: If the stocks we follow have declined more than the Composite average.

NO INDICATION: If our stocks advanced or declined less than the Composite.

If the NYSE Composite has advanced.

SELL: If the stocks we follow have advanced more than the Composite average.

NO INDICATION: If our stocks declined or advanced less than the Composite.

It is always helpful to know the mindset of the competition: the crazierthey become, the easier the task of separating them from their money.

In the old days, the best measurements of the speculative public sector's behavior were odd lot ratios and cumbersome calculations associated with price/volume shifts in low-priced stocks. Thanks to the advent and popularity of listed option markets, we can now use put:call ratios as an easily observed substitute, taking only the time to flip to the proper page of Barron's to get an insight into this sector's current behavior. The purchase of call options is an indication that the buyer anticipates higher prices. Conversely, the purchase of put options indicates that the buyer forecasts lower prices.

Because of a lack of knowledge, the reluctance to sell short, or whatever, the volume of call buying generally exceeds the volume of put buying. Therefore, the two opposing elements cannot be considered equal in their volume: Calls are more popular. Consequently, it is the change in the ratio of put:call volume that is important to us as a measure of nonprofessional sentiment. Whether you use the volume of listed options associated with specific stocks, or those associated with market indices, or a combination, you should get the same results as long as the measurement is consistent. We use the total volume associated with individual common stocks plus the listed options on market indices (averages).

A somewhat more refined analysis involves the changes in option premiums, that is, the amount that the option's market price is above its intrinsic value.

Whether volume, premium or a combination is used is of little concern because the results are almost invariably parallel.

In determining this ancillary criterion we use a very simple comparison of the current ratio (and/or premium) with that of four weeks ago.

BUY: Put volume (and/or premium) has increased disproportionately to calls. This can be indicative of excessive pessimism, reducing overhead supply and allowing prices to advance more easily.

SELL^. Call volume (and/or premium) has increased disproportionatel_yto puts. This can indicate excessive optimism, making the market more vulnerable to decline.

Advisory Sentiment

We consider put:call relationships as measures of the sentiment of the public speculative sector. To gain a measure of the feelings within the analytical community and the effect on the institutional sector, a variety of services survey analysts and report their findings. These services vary in their clarity, most dividing analytical sentiment into three categories: bulls, bears, and neutral (or "correctionist").

Many an analyst's outlook is ambiguous: "If the market fails to advance or decline, it will stay even, and so on, and so on . . ." This is of no use in practicality, but it does help in job retention because the analyst cannot be wrong.) Most surveys also incorporate a great deal of subjectivity in their results. In addition, the surveys can be biased by a lack of adequate sample size, an overweighting (lack of randomness) of investment techniques utilized by the analysts selected for the survey, and a lack of method for compensating for changes in the analyst's forecasts between surveys.

Despite these shortcomings, the surveys (especially during extreme conditions) can be useful. If overly optimistic they have likely followed their emotions and have bought, possibly exhausting their buying demand and allowing prices to descend more easily. Conversely, when pessimism prevails, the analysts have likely sold, thereby reducing overhead supply which can allow prices to more easily advance.

The selection of the survey to be utilized is not important because, when dealing with adequate sample size, their results are generally parallel. Several are followed by Barron's weekly, you need to do to see the survey's results is flip to the appropriate page. The survey selected should be consistent, that is, use the same survey for each weekly comparison.

As previously mentioned, these surveys divided the analyst's sentiment between the percentage of bulls, bears, and "other." We only look at thepercentage of bulls, comparing the current reading to that of four weeks ago.

BUY: The percentage of bulls has decreased. This can be an indication of pessimism and a reduction in overhead supply, making an advancemore likely.

SELL: The percentage of bulls has increased. This can indicate that increasing optimism is depleting buying power and making the market more vulnerable to decline.

By its very nature, the business of reporting is to describe events after they have occurred. This is fine. However, when applied to financial markets, descriptions do very little to enhance profitability which requires being properly positioned before the price change occurs. As a business, reporting depends on sales, which are made to customers attracted to the product being sold. That attraction is a direct function of sensationalism: the more sensational the news event, the greater the attraction. When it comes to the stock market, the most sensational event is dramatic price change after the fact that the price change occurred.

Price change occurs because of demand/supply imbalances created by the conscious buy/sell decisions made by market participants, the majority of whom have a long, well documented record of the being wrong during pricing extremes. They are engaged in either panic selling or emotionally induced euphoric buying. In reporting the sensational pricing extremes, most reporters find themselves forced to justify the pricing: high prices "justified" by some positive event, and low prices "justified" by some negative event. To do otherwise entails the risk of looking stupid. After all, if you saw a reporter who said prices have risen dramatically because of bad news (or conversely prices have fallen because of good news), your natural reaction might be to categorize the reporter as a fool. Even if the reporter knows that pricing extremes are at nutland levels and very likely to soon reverse, job preservation can take precedent over reason.

Now, let's combine the media's after the fact reporting of price sensationalism with the sales aspect of the securities industry and its effect on a typical misguided investor, Mrs. Shnook. She is greedy, and she and her hubby have some bucks. Mrs. Shnook sees, reads, or hears about sensational price gains in the stock market and seemingly logical reasons given to justify the gains. When hubby comes home, she shows him the news and their greedy brains consummate as one. The phone rings; it's JoeBroker, letting them know about the news. They already know why it is all wonderful, having seen it themselves through the media. Joe has little problem selling a customer who is already preconditioned to buy. In go Mrs. Shnook and hubby's money, and they are happy to be there. Watching their stock purchases go up on paper, they have no intention to sell as the ride looks as though it can never end, and they can count up how much their worth has appreciated. Glee.

But, then, as with every period of excessive overpricing in the market's history, a decline eventually ensues. When the downmove occurs, the glee associated with counting paper profits turns into discomfort as the paper profits change to paper loss. As the decline becomes sensational, the Shnooks turn to the news, which reports negative rationalizations after the fact of price change. Their greed turns to fear and they call Joe to whine. Joe replies, "Well, you saw the bad news. Gosh, what a surprise!" With little coaxing, they sell at a loss, happy to relieve themselves of the pressure of watching their presumed wealth fade. Joe gets another commission.

As with every overly discounted condition throughout the history of the market, prices eventually advance. The Shnooks, of course, don't like the market after taking a loss. However, chances are that they will be back the next time sensationally high prices occur, fully believing the news rationalizations. They will think the market is "different," get their greed juices flowing, and plunk down their bucks again. Heh. Heh.

Mr. and Mrs. Shnook went for an emotional ride along the road to loss (buying high and selling low)—and chances are that they will do it again! In this simplified example, it is helpful to reinforce three points.

1. The buy/sell decision process was the result of a chain reaction: media sensationalism after the fact of price change, with accompanying "justifications" for the change, followed by emotional preconditioning, followed by the sales pitch of the securities industry.
2. The victims liked it. They didn't like the end result of loss, but they enjoyed feeling the greed when they bought and relieving tensions associated with fear when they sold. After all, as adults they made the conscious buy/sell decisions.
3. They will likely do it again because the next wave of sensationalism stimulating their greed will be accompanied by different reasons for price "justification." The market will appear to have changed, creating the same lure and providing the same end result. History clearly attests that every time the stock market has become exceptionally over- or underpriced, with the associated sensationalism, the pricing reversed direction—often quickly and dramatically.

So the media are among our closest allies in eliciting irrational behavior among our opponents. The criteria are simple.

BUY: A leading nonfinancial newspaper (or network evening news program) finds the stock market so sensationally bad that it makes the front page of the paper (or the lead story on TV).

SELL The same publications (or program) find the market so sensationally wonderful that it makes the front page (or the lead TV story).

Although we find the basic Time Overlay method satisfactory in achieving our objectives of profit consistency and return, several factors can significantly increase return in actual market endeavors.

1. Rotation.

The published models are very strict. They will only change positions during outright buy/sell points that can only occur on the Report's publication date. The models completely disregard price movements between the predetermined, published mechanical buy/sell periods. Almost invariably, better prices are available at times other than the instant of a published buy/sell indication.

We know, by the results derived over the many years of the modeling's publication, what the average percentage return per position is by strictly adhering to the published buy/sell points. We also know that each stock selected has an equal chance of concluding profitably irrespective of price fluctuations between the predetermined buy/sell points. If we can get equal or better prices than those of the published models between buy/sell points, there is no reason not to capture gains before an outright sell signal.

Knowing that prices fluctuate, we can attempt to take advantage of the intervening price movements by rotating our positions. For example, let's say there is a buy indication and two stocks (A and B) appear equally suitable for purchase, and both are selling at 20. We purchase stock A. Rather than wait for a sell signal, we decide that we will take our profit if we realize a 10-percent gain. The 10-percent profit would capture a return greater than that averaged by the published models for individual positions. (Any parameter can be used, it is a matter of personal preference). Now, let's say that our stock (A) advances to 22, meeting our 10-percent objective, and that stock B has stayed at 20. We do not want to reduce our investment level because there has not been a sell indication. We sell stock A, taking the profit and move to stock B. Then, let's say stock B goes to 22 providing us our 10-percent profit, and stock A has fallen back to 20. We sell stock B and rotate back to stock A, and so on, until there is an indication to sell out entirely and/or reduce the investment level.

In actual managed accounts, the rotational process is utilized and, to date, without exception accounts incorporating rotation have outperformed the published Time Overlay models. During exceptionally volatile periods, the incorporation of rotation can create very active trading. However, during such periods and/or during extended market cycles, the use of rotation can dramatically improve results.

2. Optimizing Rotational Selections.

In the previous rotation example, the rotational selections were made from stocks selected at the time of buy indications without consideration of the other issues on the Master List.

This is an unnecessary constraint. It is possible that, at the time a purchase is warranted because of a rotational sale, there might be a stock on the Master List that is a better bargain than any of those selected at the time of a buy indication. In actual rotational trading, we move to whatever stock appears most undervalued from all those on the Master List, irrespective of whether they are being held as open positions in the published modeling. This wider selection generally expands return.

3. Delaying Buying.

The published modeling is designed to be early. That is, lower prices are available after buy indications and higher prices are available after sell indications. As discussed, this is necessary to assure that compensation has been made for transaction costs and to provide sufficient price latitude so that the method can be duplicated in actual trading.

At the time of a buy indication, each specific stock selected has an equal chance of concluding profitably. Price fluctuations between the predetermined buy/sell points are of no concern to the strict models because nothing is going to happen between the buy/sell points.

Price fluctuations (both up and down) between the predetermined buy/sell points can be significant and, since each position has an equal chance of concluding profitably, there can often be some advantage in waiting until after a buy signal and then selecting issues that are demonstrating relative discounting. For example, let's say that there is a buy signal and two stocks (A and B) are selected, each at a price of $20. Instead of buying one immediately, we wait and see that stock A is remaining at $20 and stock B has declined to $18. We then buy B because it is relatively discounted, having an equal chance of being above its initial published purchase price as does stock A when specified to be sold.

In our real time application of the Time Overlay portfolio modeling, we do not wait until after a buy indication to begin expanding the investment level. Although better prices become available after the buy indication, we usually get them anyway because of the rotational aspects. In fact, because of the rotational advantages, we are often a bit more aggressive in our investment level than the Report. However, for those wishing to avoid the sometimes rapid trading associated with rotation and/or the added analytical time, delaying buying and emphasizing the most discounted issues can often significantly increase return.

The stability factor can be clearly demonstrated in open-end mutual funds where the investors can add money (that is, buy mutual fund shares) or withdraw money (through mutual fund redemptions) at any time. Mutual fund sales are highest during periods of euphoria when the public's greed has been stimulated after seeing stock prices advance significantly. The fund manager is forced to invest the monies coming in because that is what those investing expect. In effect, the manager is being forced by the institution's structure to buy at high prices. When prices falter and the investors become fearful and/or disgusted, they want to redeem. To meet the investor's demand for cash, the institutional manager is forced to liquidate stock positions at low prices. In effect, through no fault of personal investment ability, the manager so placed is forced to buy high and sell low—the precise formula for disappointment. Even without net redemptions, this basic problem is further compounded by the fact that there is more money to be invested when stocks are overpriced than when stocks are underpriced.

The Sheep Syndrome

Irrespective of the stability aspect, almost all institutional managers are under pressure to achieve acceptable relative performance. That is, the manager does not want to look bad when compared to other managers. This results in what we term the "sheep syndrome," which is the predictable herdlike behavior of the majority of managers who make identical judgments as to their movement into, out of, and within the market. As with their animal counterparts, those who stray or straggle behind are easy targets for the crafty predator. And the herd itself, relatively defenseless because of predictability, has no great strength in numbers when attacked.

To understand this phenomenon, try to empathize with the institutional manager. He or she has certain goals and needs, among which survival through job preservation is of prime consideration. Most portfolio managers, although tending to exhibit little individuality, believe themselves to be in a very competitive environment and are keenly aware if they are over- or underperforming their peers. As long as everyone is doing about the same thing, the status quo is maintained and all proceeds relatively smoothly. The manager who does not stay with the crowd is easily singled out and comes under the scrutiny of others. The manager who demonstrates exceptionally profitable performance has effectively shown up the others and, as a result, may be resented rather than applauded. A manager who underperforms only draws attention as being inferior to the crowd.

In the market, it is mathematically impossible to be correct all the time. Therefore, when a maverick manager (even though consistently doing better than others over time) does make a mistake, it attracts inordinate attention. The result can be analogous to a baboon like cuffing when one of the adolescents gets out of line. In a more civil context, it is peer pressure. This pressure can intimidate a manager into thinking that the investing public is focusing attention on the error and into magnifying the imagined detrimental effects to his or her image.

This real and/or supposed pressure can make even the most original manager fall into line with the others. In other words, the manager may be forced into what may be considered a herd of other managers. But n_ot all managers choose the herd because of peer pressure. It is also _a convenient place to disguise incompetence or lethargy. Just do what the others do and you will never be singled out as less capable. This also reduces the possibility of being disliked, which enhances the chances of obtaining alternate employment if it should become desired or necessary.

Our observation of the effects of peer pressure among institutional managers is far from theoretical. It is not unusual to see institutional managers have their personal funds managed under strategies far different from those employed by the institution itself.

What really roils me is that so many Americans have their necks overexposed to the risks of common stocks to start with. By that I do not mean that stocks are generically too risky, although I do recommend staving out of the overpriced U.S. stock market and dollar-denominated stocks. Stocks that are selected conservatively and pay high cash dividends are, in fact, my favorite investment alternative, especially where there is the prospect of currency profits, as I'm going to discuss later in detail.

But Wall Street has led the American public to think stocks have the safety of bonds. There's a huge difference, of course. Stocks carry all the risks inherent in business ownership Bonds are contractual loan obligations that must be paid before owners get anything. Because stockholders have all that risk, they should naturally expect a higher rate of return than bondholders. But Wall Street has fostered a myth that because shareholders enjoy unlimited upside (capital gain) potential, they Should settle for a dividend return that, if it exists at all, is often far lower than the interest rate on comparable bonds.

I also feel Wall Street puts an unhealthy value on potential Capital gains. Just look at the widely used formula for setting up an individual's investment program. You take 100 and subtract the investor's age. That determines the basic asset allocation. If the customer is 20 years old, you recommend 80 percent stocks and 20 percent bonds, and then adjust the proportions as the investor gets older on the reasoning that youth justifies risk and advancing age requires safety and income.

My problem with that kind of thinking is that it assumes stocks rise in value as a function of time, that they are always a good buy regardless of valuation, and that there's always going to be a pool of people that you can sell out to so you can buy bonds and retire on the interest. As we'll see, though, the market has a well-earned reputation for perversity and there have been long periods when prices remained flat or declined.

Call me old-school, but I've seen enough of self-serving corporate management to make me want cash on the barrelhead. I want stocks that pay cash dividends and provide a higher yield than bonds do.

Wall Street has also muddled the distinction between investing and speculating. The argument that growth stocks of companies that plow all their net earnings back into the bussness reward shareholders with future capital gains assumes that the objectives of corporate managers and shareholders are the same that the two interests are in alignment, to use more elegant language. Now I'll grant that there have been many companies over the years where this has been true, and where investors profited handsomely from capital gains that, until recently, were taxed at a more favorable rate than dividends.

But to overpay for stocks that don't produce income and derive their attractiveness from the promise of future capital gains that may or may not materialize to my mind smacks more of speculation than investment Some stocks will gain, of course, but only at the expense of other companies, whose earnings shrink. If the market is trading at a given multiple, there have to be stocks whose earnings go up and stocks whose earnings go down. They can't all be winners.

Conflicts of interest are rampant on Wall Street and in corporate America, and the victim is the little guy. I started out as a broker with one of the big investment banks, and know from firsthand experience how Wall Street's symbiotic relationship with corporate America has operated to the disadvantage of retail investors. Year in and year out, the risks of common stocks are played down by firms that make their real money from advisory or underwriting services performed for client corporations.

Brokers are paid extra commissions to push certain stocks as favors to corporate clients or to move positions held by their firms acting as dealers. "Suitability rules" designed to protect investors from undue risk are treated perfunctorily as brokers pass spoon-fed recommendations off to trusting customers who think they're getting thoughtful advice.

On the research side, although stricter regulation has resulted from recent scandals, analysts are under pressure to favor existing , or potential corporate clients by assigning higher ratings than their shares warrant or failing to assign negative ratings to inferior stocks that retail investors might otherwise avoid.

Lately, the interests of corporate executives and shareholders have diverged to a point bordering on or actually constituting scandal. The most infamous example, of course, was Enron, where shareholders walked away with nothing after criminal _activities by top executives that were so complex and extensive they are being analyzed to this day. Here’s the point, though, and it’s a big one: if Enron had been forced to pay cash dividends, it could never have pulled that paper off!

There were so many other examples of corporate skullduggery at the expense of shareholders-WorldCom, Global Crossing, Adelphia, et al.-in the early 2000s that it really serves no purpose to go into them.

More significant than the laundry list of major scandals are practices we read about every day. Executive stock options that are timed and structured in ways that give managers incentives to make corporate planning decisions designed to maximize their personal profits at the expense of shareholder values are now commonplace. Just the salaries of top corporate executives have become so outsized as to penalize shareholder returns. Stock repurchase plans are often timed to create capital gains to benefit managers.

As this is written, a scandal seems to be breaking that involved the back-dating of executive stock options to capitalize on favorable stock price movements.

Wall Street has conditioned the public to think about stocks simply in terms of their prices. According to Wall Street, prices can only go up if one simply holds them for the long term. Most investors regard low-priced stocks as being cheap and high-priced ones as being expensive. The real fundamental value of the business those shares represent seldom comes up. This general misconception concerning stocks is evident even among my own clients. Whenever I call one to recommend a stock, the first question that I am usually asked is "What's its price?" My typical response is "What difference does price make?"

By itself, the share price confers no real information about the underlying value of the stock. Price is meaningful only when related to other factors, such as earnings, sales, book value, and shares outstanding. When such factors are considered, a stock selling for $5 per share can be expensive while another selling for $100 per share can be cheap.

That's why the public is so confused about stock splits, where a stock's perceived value is enhanced simply by reducing its price, with investors ignoring the increased number of shares outstanding. Stock splits originated because under the old system of trading and commissions odd lots (increments under 100 shares) were expensive to trade, so splits made it easier for small investors to trade in round lots.

For similar and equally foolish reasons, investors believe that it is easier for a stock selling at a low share price to double than for one selling at a high price. However, price is meaningless, as a company's earnings would have to double for the real value of its shares to double, which of course has nothing to do with price. If it were really easier for low-priced shares to rise, perpetual stock splits would rule the day.

The only reason low-priced stocks tend to move faster is that most are less liquid and often manipulated. If it were true that low prices meant faster appreciation, all high-priced shares would split, not at $50 or $100, but at $10, $5, or even a dollar. In most Asian markets, share prices below $1 are the norm, even for billion-dollar companies. However, their prices appreciate no faster as a result of prices being lower.

Wall Street's failure of responsibility is glaring even where clear conflict of interest isn't the issue. I strongly believe Wall Street deserves much more opprobrium than it got for its failure to discourage in a proactive way the naive investor behwior that drove the dot-com bubble. Sure, brokers were only giving customers what they wanted, but I strongly feel they had an implicit fiduciary responsibility to make investors aware of the insanity they knew they were witnessing.

At the risk of sounding unctuous, I don't mind saying that I personally sleep at night with a clear conscience. When other brokers were riding the tech-stock wave, 1 spent many hours persuading my clients to avoid the foolish risk of buying stocks without earnings. "But it's a long-term investment," I'd hear. "Sure, in a company that will not even be around in the long term," 1'd tell them, and more often than not I was right. At Euro Pacific Capital, I do no investment banking. I don't make markets or act as a dealer. I am purely a retail broker specializing in stocks that pay cash dividends, and I plan to keep it that way.

But Wall Street, I'll say again, is rigged against the little guy and I see no signs of that changing, either.

Mutual funds are an overrated investment heavily promoted by Wall Street. During the latter 1990s, as I was still cold-calling prospective clients, a typical question I would ask those who professed to be invested in mutual funds was "What is the yield you are earning?" Of course it was a loaded question, as dividend yields at that time were next to nothing, if not zero itself. Even if the stocks that the funds owned paid some minimal dividend, they were not high enough to offset the fees charged by the funds. However, the typical answer to my question was "My funds are yielding about 20 percent per year." What my prospects were doing, of course, was confusing yield with past performance. How much a fund's share price had risen over the years has nothing to do with its dividend yield.

However, shareholders typically confused illusory price appreciation with actual dividend yield.

Another major problem with mutual funds, and one rarely understood or seldom discussed, is the concept of relative versus absolute performance. Investors of course should be concerned with the latter; however, managers are far more concerned about the former. That often overlooked conflict of interest is vitally important and is the principal reason that most mutual funds will underperform the market in the long run.

This conflict arises from the way fund managers are paid and the way funds themselves are marketed. It's all about short-term quarterly performance, relative to either a benchmark or competitive funds with similar objectives. Therefore, no manager wants to underperform and no fund wants its recent performance to compare unfavorably to the performances of its competitors. This reinforces speculative behavior and causes fund managers to chase performance by buying overvalued stocks, the prices of which keep rising as more funds buy.

Then those funds buying such overpriced shares post impressive relative performance numbers, which results in increased inflows from performance-chasing investors. Those funds need to be invested in those same overvalued shares that goosed the performance in the first place, and it is a self-reinforcing cycle. When it ends, of course, the share prices collapse, and long-term investors lose big. However, the managers already earned their bonuses, and since all the funds collapse together, no one cares as no one's relative performance suffers.

Assume a diligent fund manager, with the good sense not to buy the overvalued shares, who instead invests in undervalued companies. The prices of such shares could languish for years before finally rising to reflect the true value of the companies they represent. While such a strategy is fine for investors, it Could be disastrous for fund managers, who would likely lose their jobs long before such investments paid off.

In the final analysis it does mutual fund investors no good to pay managers big-time fees for impressive short-term perfor malice when by the time investors need their money it's all gone. What is important to investors is absolute, long-term performance, which is the furthest thing from the minds of most fund managers.

If you think mutual funds aren't a flagrant enough example of conflict of interest, try hedge funds. Once relatively obscure bastions for the superrich, hedge funds, which are largely unregulated and exempt from disclosure requirements, have become the current rage, now numbering around 9,000 and holding over $1 trillion in assets. Their managers, the latest crop of gazillionaires, conventionally charge a 1 to 2 percent annual management fee plus 20 percent or more of the quarterly profits. You heard right: 20 percent or more of quarterly profits.

Since "hedge" means to protect against risk, it's ironic that the conflict of interest in hedge funds exists because of heightened risk taking, the very thing hedging was supposed to minimize.

Although, to be sure, the hedge fund universe has its share of exceptional managers, too many of the impressive returns boasted by the industry are produced not by outperforming investments, but by investments with ordinary returns that excessive leverage has turned into huge dollar windfalls on which managers base their 20 percent performance fees.

There's actually very little hedging being done. Most hedge funds would be more accurately termed "risk funds" or "ultra leveraged funds." For example, a yield of 8 percent might be achieved by buying junk bonds. But leverage it up 10 times by borrowing

money at 4 percent, and you magnify the return over fivefold.

In other words, simply by assuming additional risk, an 8 percent return is transformed into a 40-plus percent return through the magic of leverage. If a$1_ billion hedge fund specializing in junk bonds merely leverages up 10 times, an 8 percent return becomes a windfall of more than $400 million, That gives the manager a payday of $80 million.

Hedge fund investors, trusting the expertise of hedge fund managers, are accepting risks they would never assume on their own and giving away 20 percent into the bargain. The hedge fund managers are taking a ton of risk, but with other people's money, not their own. When the risks pay off, the manager gets 20 percent. If the risk goes bad, the manager doesn't lose anything; he just doesn't gain anything. The investors take the hit. Heads, the manager wins. Tails, the investor loses.

Sure, when losses occur the fund managers have to get back to the last high-water mark before they can start collecting performance fees again. But the effect of this is a moral hazard even greater than existed before the loss: Now they have an even stronger incentive to push the risk envelope.

So that 20 percent performance fee creates a powerful incentive to use leverage and, since hedge funds tend to pursue similar strategies, they create short-term market momentum in the direction money is flowing. This tends to increase the paper gains for funds already positioned in those strategies, creating a lot of performance fees in the process.

The problems will arise when everyone tries to get out. The big paper profits will quickly evaporate when the momentum reverses, but that's the investor's problem. While the managers were raking in their 20 percent of profits each quarter on the way up, it's not as though they'll have anything to lose on the way down. They will gain as long as there's a profit. Managers can press a trend until it ends. There's no need to get out early, because there's no way they can lose. They can have their cake and eat yours, too.

Take the recent example of Amaranth, the $10 billion hedge fund that blew up in September of 2006. It lost better than 60 percent of its capital in a few short weeks as some highly leveraged natural gas bets went south. As those bets were paying off the managers made millions, but when they finally blew up, it ",as their investors who got creamed.

Did the Amaranth managers really earn their fat incentive fees for strategies that ultimately caused their investors to lose lots of money? Do you think they're going to reach into their personal pockets to help cushion the blow for their shell shocked investors? Don't hold your breath.