Unintended Consequences

According to sociologist Robert K. Merton, unintended consequences can be roughly grouped into three types: 

1. A positive, unexpected benefit (usually referred to as luck, serendipity or a windfall).
2. A negative, unexpected detriment occurring in addition to the desired effect of the policy 
3. A perverse effect contrary to what was originally intended (when an intended solution makes a problem worse)

When we talk about the government, which one fits like a glove?  Actually, #2 and #3 fit.  Think about the war on drugs. Restricting access does indeed reduce some consumption but it also creates a black market. It also got young experimenting idiots to smoke sevia.

But since I am a financial guy, let's talk about #3 - the irony of making it worse. You know, the road to hell is paved with good intentions.  Think about low interest rates so people can buy houses. Not only did it create a bubble but it left many of those new house owners in bankrupt and worse off than they were before.

In the stock market, everyone knows (eyeroll) that the small investor was out of it since the last financial blow up. The Fed gooses the market (not the economy) with free money and suddenly everyone is interested in buying Facebook. After all, the fist quarter was one of the best on record.

Those of us in snarky-ville say that the little guy is about to get hosed on Facebook and by extension everything else. Just when you thought it was maybe, kind of safe toe play in the stock market the Fed takes away the punchbowl, analysts prognosticate that Facebook could double before earnings matter and although the stock closed with a teeny tiny gain anyone believing it after the open got snookered.

I have seen this before. IPOs go to the moon and just when my company went public and I was actually allowed to buy into it the end was near. I saw that stock trade at the IPO price as underwriters feverishly supported it. Guess what happened after they stopped?  Kablooey!

You can stop reading here. I am afraid I am about to wax a little political. 

So, thank you Fed for "saving" the economy by allowing banks to base their whole business on arbitrage instead of lending. Thanks for artificially inflating the stock market so it has a long way to fall to get back to true equilibrium. And thanks for keeping saving rates so low so that savers got screwed.

Noble intentions. Unintended consequences.

Smoke 'em

Here is an excerpt from Thursday morning's Quick Takes Pro:

Here we are several days after JP Morgan's big loss. The math says that the loss was a small percentage of their overall business but the stock is still easing lower. If this was such an "absorbable" loss then why is this happening? Analysts fell over themselves to say how this is now one cheap stock but the market seems to be saying something different.

Where there is smoke, there is fire.

How many times has this axiom proved prophetic over the years, especially in bad markets? 

Smoked banks. Downgraded banks. And the BKX has fallen off a cliff.

Asset Allocators

You've heard this before: If you ASSUME, you make an A$$ out of U and Me.

How about if you ASSET ALLOCATE, you do something similar to you and your clients.

What? Sacrilege! Asset allocation is tried and true.

Whoa, cupcake, I have a twist for you. I am not against asset allocation. After all, if you moved into bonds and out of stocks in 2008 you did pretty dang well.

But think about what this can do in a steep move - up or down. Let's use the easier to understand - the bear market.

Let's say you reallocate your funds quarterly. Seems reasonable. You want to keep a balance of 60% stocks, 30% bonds and 10% cash. Again, reasonable although not my cup of tea.

Using round numbers, let's say your stocks drop 10% in value. At reallocation time you buy more stocks and trim some of your bonds and cash to get back to that 60-40-10 allocation.  So far, so good, right?

Now let's say stocks drop another 10% and you repeat this process of getting back to 60-40-10.

And then it happens again. This is a bear market. Stocks are going to get cut by 40% in a year - big but not outrageous.

Do you see what has been happening? You've been adding to losing positions and trimming winning positions. Did they teach you that in CFA school?   If the bear lasts long enough, you may have allocated your capital away.

I propose you apply a little technical analysis to the allocation process. Do not reallocate unless the relative values of stocks relative to bonds and cash turns the corner. In other words, when stocks stop falling. Then, by all means, allocate your assume off.

Good news for chartists

In Friday's Quick Takes Pro report, I wrote this seemingly benign phrase. 

"However, it does show that the charts are really starting to telegraph big moves again."

Looking at it again this morning as I was preparing today's missive, it hit me that this was a bit more profound than I thought. QE is seemingly out of the way - at least until the Fed is compelling to "do something," misguided as it is.  With QE gone the market is healing itself. Unfortunately, healing brings pain first.

Think of it like exercise. You know your first weekend out leaves you sore and limping Monday morning. But after a few weeks, you bounce back stronger than you were before. 

So, fellow technical analysts, the world may be safe to ply our trade again.   The word "may" is key.

Why do we pay them?

Today, an analyst from a big firm (a really big firm) downgraded shares of Fossil (FOSL) to neutral from overweight. That's fine...except that yesterday the stock collapsed 27%. One more time, why do these analysts get paid so much money?

But there is good news. Today a different analyst at a different firm upgraded it to from hold to buy.  Doesn't that make a whole lot more sense then closing the barn door after the cow left?

And just to be fair to an industry - some people actually protect their clients. This same analyst cut the stock from a buy to hold in February after a big pop higher.

Kudos to the Benchmark Company.

A lump of coal to JP Morgan.  Oops, I said it.

Yeah, it was Greece :-p

Man, what a day! No, not that the market fell down this morning but that everyone blamed Greece. As Mad Magazine once parodied, "all the news that fits, we print."

Also, as someone who is faced with daily journalistic deadlines, as well as a publish or perish demand (no column, no paycheck) I know that you cannot blame the media. It's like blaming the banks for charging fees. That's what they are supposed to do.

Sometimes, the news does trump the charts and the market does move when something big happens. Scandal? Enron shares collapse. Fed prints more money? Up we go.

But how many times have you seen something like this?
Monday - Stocks fell as oil prices rose, stoking inflation fears.
Tuesday - Stocks fell as oil prices fell, signaling a slowdown in the economy.

Hmmmm.

Sometimes stocks go up or down because the collective pressure of buyers and sellers happened to tip one way or the other. Sometimes they move when a technical level is breached changing the market's mood and the herd instinct kicks in.

So, yes, it was Greece today. Or was it France? How about Ireland tanking 3% in two trading days? You did not read about that one, did you?

Maybe the market got toppy because President Obama is ahead in the polls. Or maybe because Mitt Romney is ahead in the polls.

Follow your charts. The market knows better than people do.