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The Final Clarke and Dawe


Downer EDI

Here is a chart of Downer EDI (Dow)


If you bounced into this on the breakout from congestion well done, you got a nice trade and then it all went pear shaped. DOW have apparently launched a bid for Spotless which I mentioned last week. This bid entails a capital raising whereby for every 5 existing DOW shares you own you get another 2 at $5.95. This brings the true adjusted price to $7.01. Now as sometimes happens things dont always go as planned. The market is a giant voting machine and in this instance it has decided that the takeover of Spotless has knobs on it but that is not the point. The point is that I have heard that people who have been recommend DOW have been moaning and whinging that it has gone down.

Well, here is a news flash for all of you who take a trip to Brown Gouge to get your pants cleaned every time things dont go perfectly…..SUCK IT UP.  The market is not perfect, it is an odd, organic, sometimes self correcting, maddeningly chaotic system that in no way has to conform to your belief structure. This sort of event will happen at least once in your trading career and if you cannot handle that without blaming everyone else in sight then this business is not for you. So step aside and leave it to the grown ups.

Financial Disclosure

The disclosure statement below is currently doing the rounds and it is apparently from a long defunct fund called the IPS Millennium Fund. Apparently it is being lauded as being an honest example of what a disclosure statement should be instead of the usual corporate speak that these things are comprised of.  However, the tone of the language indicates to me that the fund was always going to go broke simply because of the cavalier attitude of the funds owners with other peoples money. The statement seems to indicate no understanding whatsoever of trading and risk management. Granted corporate speak is a pain in the arse and once you are subject to any sort of regulatory regime it becomes part of the territory. However, it is not an excuse to be a dickhead with other peoples money and the way you do one thing is the way you do everything. If you are a dickhead in the way you frame your understanding of risk then you are going to be a dickhead when it comes to managing that risk.

First of all, stock prices are volatile. Well, duh. If you buy shares in a stock mutual fund, any stock mutual fund, your investment value will change every day. In a recession it will go down, day after day, week after week, month after month, until you are ready to tear your hair out, unless you’ve already gone bald from worry. It will insist on this even if Ghandi, Jefferson, John Lennon, Jesus and the Apostles, Einstein, Merlin and Golda Maier all manage the thing. Stock markets show remarkably little respect for people or their reputations. Furthermore, if the fund has really been successful, you might be buying someone else’s whopping gains when you invest, on which you may have to pay taxes for returns you didn’t earn. Just try and find somewhere you don’t, though. Dismal.

While the long-term bias in stock prices is upward, stocks enter a bear market with amazing regularity, about every 3 – 4 years. It goes with the territory. Expect it. Live with it. If you can’t do that, go bury your money in a jar or put it in the bank and don’t bother us about why your investment goes south sometimes or why water runs downhill. It’s physics, man.

Aside from the mandatory boilerplate terrorizing above, there are risks that are specific to the IPS Millennium Fund you should understand better. Since most people don’t read the Prospectus (this isn’t aimed at you, of course, just all those other investors), we thought we’d try a more innovative way to scare you.

We buy scary stuff. You know, Internet stocks, small companies. These things go up and down like Pogo Sticks on steroids. We aren’t a sector tech fund, we are a growth & income fund, but right now the Internet is where we think most of the value is. While we try to moderate the consequent volatility by buying electric utility companies, Real Estate Investment Trusts, banks and other widows-and-orphans stuff with big dividend yields, it doesn’t always work. Even if we buy a lot of them. Sometimes we get killed anyway when Internet and other tech stocks take a particularly big hit. The “we” is actually a euphimism for you, got it?

We also get killed if interest rates go up, because that affects high dividend companies badly. Since rising interest rates affect everything badly, we could get killed even worse if the Fed raises rates, or the economy in general experiences higher interest rates beyond the control of those in control, or gets out of control. Whatever.

Many of the companies we buy are growing really fast. Like, 50% – 100% per year sales growth. Many of them also don’t make any money, although they may be relatively large companies. That means they have silly valuations by traditional valuation techniques. We don’t know what that means any more than you do, because we have never seen anything like the Internet before. So we might overpay for these companies, thinking we are really smart and can get away with it because they are growing so fast. It doesn’t take a whole lot for these companies to drop 50% or more, because nobody else knows what they are worth either. Received Wisdom can turn on a dime in this business, and when that happens prices fall off a cliff.

Even if we were really smart and stole these companies, if their prices run way up we are still as vulnerable as if we were really dumb and paid that high a price for them to start with. If we sell them, you will get pretty irritated with us come tax time, so we try not to do any more of that than we have to. The pole of that strategy, though, is that if we are really successful, you will have a lot of downside risk in a recession or a bear market. Bummer.

Finally, if you haven’t already grabbed the phone and started yelling at your broker to sell our fund as fast as possible, you should understand the shifting sands of technology. It doesn’t take billions of dollars to start a high tech company, like it did U.S. Steel or Ford Motor. Anybody can do it, and everybody does. Many of our companies are small, even though they dominate their market niche. It’s much easier for a new technology to blow one of our companies out of the water than it was in the old days of canal, mining, railroad and steel companies.

Just so you know. Don’t come crying to us if we lose all your money, and you wind up a Dumpster Dude or a Basket Lady rooting for aluminum cans in your old age.


The Misguided Beliefs of Financial Advisors

Below is the abstract from this paper – The Misguided Beliefs of Financial Advisors

A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest their personal portfolios just like they advise their clients. They trade frequently, prefer expensive, actively managed funds, chase returns, and under-diversify. Differences in advisors’ beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same—their own performance would actually improve if they held exact copies of their clients’ portfolios, and they trade similarly even after they leave the industry. These results suggest that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones. Policies aimed at resolving conflicts of interest between advisors and clients do not address this problem.

This paper is interesting because it posits a parallel explanation as to why the advice that individuals receive from financial planners is so poor. Traditionally it is thought that poor advice stems simply from a conflict of interest. Planners put their own financial interests ahead of the clients and recommend high fee rubbish. As the paper mentions measures are now being put in place in various domains to prevent this from happening – a move the financial planning industry has resisted with profound vigour. My reading of the paper is a somewhat cynical interpretation of this sentence from the abstract –

These results suggest that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones (See Dunning -Kruger, authors addition)

My interpretation of this is that financial planners as a population are simply stupid and unaware of the intricacies of either providing accurate, timely and relevant advice to clients and therefore they provide themselves with the same stupid advice. It is probably somewhat unreasonable to expect someone who gives themselves rubbish advice to demonstrate a schism between what they tell a client and what they tell themselves. The way you do one thing is the way you do everything.

The Uncomfortable Effort of Thinking


Mining Industry

I have been thinking about this table I put up the other day. It merely confirms my view that the mining industry is an historical economic distortion that is vastly overrated in its importance. Employing less that 2% of the Australian workforce (see below) and only contributing about 6% of GDP yet receiving about $10B in subsidies annually, it is perennial parasite that governments continually suck up to in order to curry favour with a handful of very wealthy people. And actual mining companies are an idiot tax on investors.


Why Not To Listen To The Media And Brokers

A comment appeared in relating to this piece I wrote the other day and it deserves a fuller explanation. I will state at the outside that it is my contention that if you listen to the financial media and the sell side of the finance industry you will never get anywhere. And as a first step I recommend that everyone read Where Are The Customers Yachts by Fred Schwed. Now approaching its sixth decade it is still profoundly relevant.  In terms of broker advice as a source of recommendations upon which to build your wealth I thought I would look at an extreme example – Enron the US energy trading company that was in essence one giant scam. The trajectory of Enron’s share price can be seen in the chart below.

Enron chart

As befitting a company of Enron’s size it was covered by numerous brokers and you can see in the chart above I have highlighted the decline in Enron’s share price – this decline coincides as you would expect with it becoming known that Enron was a scam of massive proportion. The table below looks at the recommendations offered by brokers at this time. This table has a few components, on the left are the names of the brokers offering the recommendations, in the centre are the recommendations themselves. These are colour coded as to the type of recommendation and along the bottom is the price at which these recommendations were made. When viewing this table keep in mind the chart above.Enron

As you can see for the majority of the decline Enron was either a strong buy or a buy for the majority of brokers. Even after it became common knowledge that Enron was a fraud and was under investigation by the SEC brokers still continued to recommend it. In fact as it disappeared it was still considered to be a hold. So let me state that again – even after it was known that Enron was a giant con job and was headed down the toilet brokers still continued to recommend it. The most perceptive observation on this situation was actually offered by the humourist Dave Barry –

Wall Street relies on “stock analysts.” These are people who do research on companies and then, no matter what they find, even if the company has burned to the ground, enthusiastically recommend that investors buy the stock.

Dave Barry
February 3, 2002

This quite naturally raises the question as to why this sort of thing occurs and the answer can be found in the structure of the finance industry. In very broad terms  what people generally refer to as stockbroking has traditionally been split into two very broad camps – corporate advice and retail advice. Corporate advice covers high end activities such as capital raising, mergers, and company listings. Retail advice covers telling people who used to ring in to buy BHP because its a good company. Each of these arms generates a very different revenue stream for the firm, corporate advice generates fees in the millions whereas retail advice might involve an order that generates $6 in brokerage. You can see where the massive imbalance in revenue comes from and therefore you can see which side of the firm is more important. Consider a simple example, I head off to my local merchant bank/broker and I want to list my company to liberate some of the value in it and this listing will generate for the firm $5 million in fees. Naturally, if I want to list my company I need shareholders so it is the job of the retail arm to go a get them for me via selling the prospectus to them and after that via selling it to new punters via the secondary market. In terms of importance I am immensely important and my needs come first because I have given the firm $5 million, a retail investor doesn’t even give them enough for a slab of beer.

Underlying all of this is the simple need of stockbrokers to eat – stockbroking at its heart is a sales profession. If I dont sell you a second hand good in the form of a share then I dont eat. Even better if I can get you to sell one stock you own for another because then I get two lots of commission. You might think that with the advent of online trading that this situation might have evolved and changed because technology has removed the need to actually talk to someone. In some ways it has but it has also shown a new flaw in the advice model and that is in the recommendations that are generated by broking firms. If we think logically about markets then you would assume that markets are comprised of a mass of differing stocks, some doing well and going up, some doing poorly and going down and others doing nothing in particular. This is not how the industry sees markets – to them every single stock is a buy. Consider the table below which I generated a few years ago.


This chart looks at the ratio of buy to sell recommendations being offered by brokers. The lowest the ratio got was in 1983 when the industry were net sellers – this coincided with the beginning of the 1980’s bull market. Since then the industry has always been net buyers and the latest figures I could find indicate that the buy to sell ratio sits at around 100 to 1.  It doesn’t seem logical that for every stock that is a buy there could only be one that is a sell. The industry is overwhelmingly biased towards the buy side.

In looking into the industry over the years the best explanation for the behaviour of its members can be found in the following quote –

“An investor might expect advice that is free of both psychological bias and self interest. Instead they discover belatedly that the advice is a mixture of wishful thinking and self- serving hype.”

Brian Bruce Journal of Psychology and Financial Markets (2002 Vol 3, No4, 198-201)

As the question as to how to navigate all of this the answer is really quite simple – do your own thinking. If you want to be subject to the whims of others then that is fine but just remember this is an industry that had to be dragged kicking and screaming into acting in the best interests of their clients.




General Advice Warning

The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.