A truly disruptive event generates surprisingly large moves – sectors, stocks, and sometimes the overall market. Methods that work well in normal times may break down under this stress. Traders and investors must ask:
- Is my system still working?
- Should I adjust?
- Should I suspend operations for a time?
When trading based upon scientifically developed models, these questions are somewhat easier to answer. We have solid expectations for behavior and performance, because of extensive testing on a generous helping of out-of-sample data. Most importantly, the human managers know and understand the model inputs.
We have great respect for our group of models, but we retain human control. This week, for example, Oscar liked our solar sector. We knew something that Oscar didn’t – the likely effect of Trump policy on solar stocks. What appeared to be a buying opportunity, might be an illusion. The trade might still work, but there are other, safer choices that are nearly as good.
Technical analysts can always be tempted by confirmation bias and their knowledge of events. When using models, you very sparingly use exceptions. If you view every trade as a suggestion, you wind up doing your own trading, with your model advice used only for (biased) confirmation.
The Stock Exchange provides an expert-level debate on technical and fundamental analysis. I have placed more background at the end of the article. Comments, dissent, and specific stock questions are welcome!
[drizzle]This Week—Athena Loves Amgen
This week’s featured expert is Athena. Vince (our modeling guru) designed Athena to be very aggressive in finding new positions, but swift to exit those that were not working. These are not “stops” as we normally think of them. Exits are not based upon specific downside limits. Instead, there is an increased risk warning (IRW) that signals a change of behavior in how the stock is trading. The result is exceptionally good risk control both for individual positions and the overall portfolio. While we have not told the other models, Athena is Vince’s favorite.
Here are the ideas for this week, beginning with Athena, our featured expert.
Athena
I love to make a quick buck finding trends. An insider secret: There’s nothing trendier than the baseless speculation following a big election. My pick this week is AMGN, one of many biotech stocks rocketing skyward since this week’s big news. It’s still attractive at this price, but I’ll dump it in a heartbeat, maybe by Inauguration Day.
[J] You actually know about the election?
[A] Yes, but don’t tell the other models. They already resent my wisdom. I do not use fundamental information, but I am aware of it.
[J] This choice does seem logical on an earnings basis, as you can see from this chart. The stock trades at a discount and has a nice 2.7% dividend yield as well.
[A] It is nice to see that you finally agree with me on a choice. My other picks have also done well.
Felix
I look for long-term themes. Oil and gas stocks have been a very long-term holding. We are picking up and I still am adding to the sector. I am going to pick ECR as the example this week. This is a fairly small company with modest revenue but the chart reflects that of the big boys. That is a good sign and something that I like immensely.
[J] You have been early (a euphemism for “wrong” on energy and mining).
[F] I sold some miners, as I will do when necessary. The energy investments will prove out in the long run.
[J] I have suggested a ceiling on energy prices in the low 50’s, mostly due to more supply returning.
[F] That is a short-sighted, I mean short-term viewpoint. You will see.
Questions for Felix
From Seeking Alpha
Tiki Bar Capital comments:
Great call on healthcare, Jeff! And BMRN in particular.
The biotech sector is close to retesting its lows. Biotech and pharma in general seem like the sectors that will see the biggest rallies once the smoke clears after the election.
1234gel joins in:
Ditto the BMRN call…
[F] Those were not comments for me—or for you. BMRN was an Oscar pick.
From A Dash
Phil
Comments on my two favorites- AAPL & BRK/B?
[F] AAPL is a weak buy and BRK/A as about neutral.
[J] I like AAPL a lot.
[F] This is my question section. I need more of them since I am saving up for Spring Break.
[J] It is only November…
[F] With what you are paying me for each answer, that is how long it will take for a nice trip.
Oscar
Basketball season is back in full swing, which means I’m looking for a rebound. My favorite sector this week is Diversified REITs, demonstrated here by CMO. This area was already looking up at the beginning of October, and now we’re seeing gains as a part of the broad based post-election rally. Grab the rebound, make an easy layup, and move on to the next play.
[J] I thought that Holmes was our rebound specialist.
[O] Sometimes the dog and I agree.
[J] This one has fundamental appeal as well. The dividend of 9.5% is great. The PE is 12.3, above the average level of the last nine years, 7.9. What will happen as interest rates rise? Chuck Carnevale’s excellent tools help us out on that question. This chart shows the P/E versus interest rates over the last nine years.
Holmes
This week I’m picking TSCO, Tractor Supply a specialty consumer cyclical stock. After a sharp decline in September, this stock has proceeded to consolidate and backfill making a low of 61.62 on October 28th. This is a logical place for a stop. I bought this stock a few days ago at 65.91 so it is slightly higher now. I am looking for a nice rebound to low 80s. If we start to rally, I’ll be moving up my stop aggressively. Risking $4.30 to make $15.00 is the sort of Risk/Reward scenario I like. If I’m right just half the time, I can still be a big winner.
[J] There are plenty of these stores around here. It is not just tractors. Think clothing, footwear, hunting supplies, garden, parts, and more. If they do not have it, you probably do not need it. The costal elites do not understand this.
[H] As I told you last week, you only need to track the information from technical data.
[J] You were right about BMRN.
[H] As I told you last week, and I quote “The stock prices tell you everything you need to know about upcoming events, including this election. If a Clinton victory is expected and is negative for health care, that is already reflected in the stock price. My trade works if this sentiment is overdone, and it works big if Mr. Trump wins.”
[J] You were right.
[H] My YTD results are also great.
[J] It is unseemly to boast. See how you can do in the poker game!
Background on the Stock Exchange
Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am the only human present, and the only one using any fundamental analysis.
The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities. Each week features a different expert.
What is this about? Since launching this series I have had good questions on three general themes. Here are the questions and some brief answers.
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The model characters are fun, but please tell me more about what they do.
I include the general personality of the model at the end of each article. I will begin featuring one approach each week with more detail, and soon provide a reference page for readers.
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Why don’t you show a track record on performance?
I understand that those trying to sell a newsletter or chat room often provide some sort of time-stamped real-time record. You will find that most of these people are not subject to compliance rules. The “track records” tell you nothing, since they do not have enough trades to get into the “long run.” Confidence in a model comes from knowing how it is developed and tested. I would rather ask a few questions to a developer than see a few months of real-time picks. It is easy to spot the amateurs.
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Why should I care about these model picks?
You probably read many articles with stock ideas. Some are a single idea based upon technical analysis from a source you do not know about. At the Stock Exchange, you get four different recommendations from technical “experts” as well as some fundamental commentary as a rebuttal. I am not trying to sell anything. We are developing an institutional product. The results are good enough that I am willing to share and discuss with readers. Some of my clients are invested in these models, so I am not going to provide every trade in real time. It is supposed to be interesting and fun! Look at the ideas and do your own research.
Questions
If you want an opinion about a specific stock or sector, even those we did not mention, just ask! Put questions in the comments. Address them to a specific expert if you wish. Each has a specialty. Who is your favorite? (You can choose me, although my feelings will not be hurt very much if you prefer one of the models).
Cast of Characters
Felix is fussy, precise, and very cautious. He looks for what is working, but it also must have upside potential. He is an investor who thinks long term. Felix will not usually announce new picks, but he will answer questions, saying what he thinks about specific stocks. He will also comment on favorite themes and sectors.
Oscar is naturally optimistic and a bit excitable. He likes to go with winners, and focuses on a one-month time frame. He trades either sector ETFs, or a basket of stocks (equally weighted) that reflect a sector. Oscar will mention a favorite sector each week, and will also answer questions about sectors.
Holmes is a trader, but a cautious one. Holmes emphasizes asset protection through profit taking, stops, and trailing stops. He is careful in selecting new positions, and generally looks at an intermediate time frame. While he does not know the definition of “mean reversion” he loves rebounds! There is no set holding period, but two or three months is not unusual. Holmes will tell us one stock recommended that week. For those who sign up for his email list (no charge, privacy respected, holmes at newarc dot com) he will report exits with a one-day delay.
Athena trades more frequently than the others, but still limits risk. Her inspiration helps to find good ideas. Her excellent quant skills find attractive risk/reward opportunities. Her wisdom leads her to exit trades that are not working. Athena will provide a new idea each week.
Jeff usually has some comments about stock or market fundamentals. Unlike the other witty participants, he sounds like an old prof.
The conversation is light-hearted, but the stock analysis is serious. We own positions in each of the stocks mentioned.
And finally, you can learn about the eternal debate between technical analysts and those using fundamentals.
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