Lu, Inside the Investments of Warren Buffett

I have no idea how many books have been written about Warren Buffett, but sometimes I have the feeling that he is giving George Washington a run for his money. The latest addition to the literature is Yefei Lu’s Inside the Investments of Warren Buffett: Twenty Cases (Columbia Business School Publishing, 2016).

Lu examines 20 investments Buffett made over the course of his career that, in Lu’s opinion, “had the largest material impact on his trajectory.” He puts himself in the shoes of imaginary investment analysts “studying the businesses at the same time … Buffett did.” Why would an ordinary analyst either recommend or, as would often have been the case, argue against investing in a company to which Buffett eventually opted to commit funds?

The book is divided chronologically: five investments between 1957 and 1968 (the years of Buffett Partnership Limited ), nine investments between 1968 and 1990, and six after 1990. I found the first section the most interesting, both because it was the period I knew the least about and because it shows Buffett’s willingness to pursue a variety of analytical and risk management strategies, perhaps even some long-short pairs trades. Here I will limit myself to Buffett’s activities when he was running BPL.

The five investments Lu chooses as illustrative of Buffett’s investing during this period are Sanborn Map Company, Dempster Mill Manufacturing Company, Texas National Petroleum Company, American Express, and (of course) the ill-fated Berkshire Hathaway.

Sanborn Maps produced maps primarily for fire insurance companies. Its maps “included details of not only streets and houses of a city but also such items as diameter of water mains underlying streets, number of windows, elevator shafts, the material of construction for buildings, and production lines for industrial facilities. The commercial product sold to its customers would typically be a large volume of maps that weighed approximately fifty or so pounds….” Sanborn was a successful company, with steady revenues, until the 1950s, when a new technology, “carding,” threatened to undermine its existence. By 1958, when Buffett began investing in Sanborn, the company was struggling. Between 1950 and 1958 net income had declined approximately 10% per annum. Why, then, would Buffett have been interested in it? First, it had a securities portfolio worth more than the value of the entire company and, second, Buffett believed it could be turned around. Buffett was an activist investor in this instance. Over the course of three years he acquired a controlling interest and separated the company into two separate entities. Sanborn Maps exists to this day.

Dempster Mill, a Nebraska-based company, sold windmills and assorted agricultural equipment such as seed drills and fertilizer applicators. In the 1950s windmills were anything but a growing business. Buffett wrote that Dempster Mill’s “operations for the past decade have been characterized by static sales, low inventory turnover and virtually no profits in relation to invested capital.” But Buffett could buy the company’s stock at a significant discount (on average 63%) to book value, the bulk of its assets could be readily sold and turned into cash, and with better management it could be revitalized. Once again, Buffett played the role of activist investor, a role it turned out he didn’t enjoy and came to abandon.

The next two investments were different. Texas National Petroleum was a special situation. It had an offer to be acquired but had not yet accepted the offer. American Express, a growing business then best known for its travelers cheques, was reeling from the “salad oil swindle” and faced “unknown and potentially enormous liabilities.” Judging the ramifications of the scandal to be temporary, Buffett was willing to forgo the “cigar butt” strategy and pay a fair price for a really good business. As for Berkshire Hathaway, although it is often viewed as a mistake, “the shrinking business actually provided the capital with which Buffett would invest in many other businesses starting in 1967 with the purchase of National Indemnity.” And so, Lu concludes, “it likely did not actually lose money for Buffett in absolute terms.” And it provided Buffett with an iconic name.

Garner, Higher Probability Commodity Trading

Carley Garner, a commodity market analyst and broker at DeCarley Trading, is also a seasoned author. She previously wrote A Trader’s First Book on Commodities, Currency Trading in the Forex and Futures Markets, and Commodity Options.

Higher Probability Commodity Trading is, as the subtitle explains, a comprehensive guide to commodity market analysis, strategy development, and risk management techniques. It covers pretty much everything you need to know to start paper trading commodity futures and options. Or to decide that you’d better stick to stocks and bonds.

The first section, focused on analysis, deals with the basics, technical analysis, fundamental analysis, seasonal tendencies, sentiment, and intermarket correlations. The second section, on trading strategy development, looks at position trading, day trading, and algorithmic trading in futures, futures spread trading, options strategies, managed futures, constructing a commodity portfolio, and using futures and options as a hedge. The third section introduces the reader to e-micro and mini futures contracts and VIX futures. The final section offers some tips and tricks, explains commodity brokerages and trading fees, outlines a few risk management techniques, and describes mean reversion and delta neutral options trading. The book, in brief, is packed with information.

The novice will struggle with some of the chapters, the experienced trader can skim through others. But there’s something here for every level of trader, which is rare for a broad-based book.

Interest in commodity trading is about as cyclical as commodities themselves. Traders jump on the band wagon when they think a commodity is hot. But few prepare themselves properly. Trading is trading, they think. Trading CL is like trading AAPL. Trading GC options is like trading SPY options. No, no, a thousand times no. Anyone who contemplates putting money to work in the commodity markets has to understand that he is operating in an entirely different world. Otherwise, he can expect to have his head handed to him.

Garner does an excellent job of explaining what it takes to succeed in commodity trading. The reader will, of course, have to map his own course. Not everyone, for instance, is comfortable selling unhedged options. But from the many ideas Garner offers, the reader should find something worth pursuing further.

Polk, For the Love of Money

If you are eagerly expecting to read yet another Wall Street tell-all book, you’ll be sorely disappointed in Sam Polk’s For the Love of Money (Scribner, 2016). It is the memoir of a self-sabotaging young man who has a destructive relationship with his father. At the age of eight he is thrilled to get a dog and ends up killing the poor thing by leaving him in the family’s stiflingly hot car. He fights with bullies. By the time he is in college, at Columbia, he is drinking too much, doing too many drugs, and (early on) suffering from bulimia. He gets suspended for a semester for breaking into his drug dealer classmate’s dorm room. Women come and go, as do jobs, usually dramatically. We’re almost halfway into the book and Wall Street is nowhere.

Visiting the family of one of his girlfriends, our anti-hero is impressed with her father’s power job and money and is inspired to start building toward a life like his. He applies for summer internships in the trading department of every investment bank, but with a sub-3.0 GPA and a resume “littered with half-truths and obfuscations” he is an unlikely candidate. Nonetheless, in 2002 (and page 101 of 232), he gets an internship at CSFB. He breaks up with his girlfriend, stops drinking and taking drugs, and doesn’t get offered a permanent job. Finally, he is accepted into the Bank of America analyst class of 2003, finds a father figure at the bank, transitions to the trading floor, and eventually moves from Charlotte to New York.

A tiny section of the book is devoted to the tensions of bond trading (the rocky Verizon bond issuance is particularly interesting), but Polk doesn’t linger over anything that gets in the way of recounting his own personal transition from fear and rage to charity and “redemption.” When he leaves Bank of America, voluntarily, after a devastating trade (he “had overlooked an important variable when [he’d] constructed [his] portfolio—the difference between how bonds and derivatives perform in a funding crisis”) to accept a million dollar job at Pateras Capital, it is the beginning of the end of Polk’s trading career. He loses faith in the system even as it is an argument over his bonus that eventually leads him to walk out the door.

He waxes populist. “Our obsessive accumulation of money had led to the widest inequality in centuries. Our hoarding had left millions of people unemployed, starving, and marginalized. Prison populations were swelling; families were starving. Our greed was the source of that poverty. We were the source of that marginalization.”

“It’s not where you are but who you are” may never have made it to a poster. But it may be a way to sum up my attitude to this book. Polk had a knack for making the worst of the many opportunities he was offered, and the financial world shouldn’t be unfairly vilified because it couldn’t solve his personal problems. It’s got enough problems of its own.

Ponsi, Technical Analysis and Chart Interpretations

Books on technical analysis, with few notable exceptions, have pretty much become commoditized. Ed Ponsi’s Technical Analysis and Chart Interpretations: A Comprehensive Guide to Understanding Established Trading Tactics for Ultimate Profit (Wiley, 2016) is unfortunately not one of those notable exceptions. It is a clearly written, well balanced introduction that checks all the right boxes, but it breaks no new ground.

Ponsi’s expertise is the forex market. He is the author of Forex Patterns and Probabilities (2007) and The Ed Ponsi Forex Playbook (2010).

In this book, however, he focuses on equities. In a little over 350 pages he deals with such topics as support and resistance, trends and trend lines, volume, gaps, price patterns, candlestick patterns, Fibonacci techniques, technical indicators, point and figure charting, cycles, and sentiment indicators. He illustrates these topics with ample black-and-white charts.

Someone new to technical analysis would, I believe, find Ponsi’s work to be a useful textbook. For those who already incorporate technical analysis into their trading and/or have read two or three decent books in the field, it is not a must-have addition to the library.

Bulkowski, Chart Patterns: After the Buy

Thomas Bulkowski has been researching chart patterns for years. His Encyclopedia of Chart Patterns was first published in 2000 and became an instant classic. Since then he has written several more books on trading and chart patterns, including Trading Classic Chart Patterns, Getting Started in Chart Patterns, Encyclopedia of Candlestick Charts, Visual Guide to Chart Patterns, and a three-volume series on the evolution of a trader.

Chart Patterns: After the Buy (Wiley, 2016) is, I believe, his best book yet. He looks at 20 popular chart patterns and analyzes, using 43,229 case studies, how they tend to play out. One qualifier: he studies the behavior of these patterns only during bull markets. That is, he is excluding the periods from March 24, 2000 to October 10, 2002 and from October 12, 2007 to March 6, 2009.

Most chapters follow the same (dare I say?) pattern: behavior at a glance, identification guidelines, buy and sell setups, best stop locations, configuration trading (that is, how the setup is likely to behave), the measure rule (for setting targets, and how likely they are to be reached), trading examples, and setup synopsis charts.

Bulkowski covers the most familiar chart patterns, such as double tops and bottoms, flags and pennants, head-and-shoulders tops and bottoms, measured moves, rectangles, and triangles. But he also looks at patterns that are less obviously visual, such as the behavior of stock prices after an earnings miss.

Bulkowski’s statistics can be sobering, though again we have to remember that he is dealing only with bull markets. Topping reversal patterns that might have some efficacy in bear markets will be more prone to fail when markets are moving to the upside. For instance, unconfirmed double bottoms fail 44% of the time whereas unconfirmed double tops fail 53% of the time. Admittedly, neither statistic is heartwarming, but a bull market regime obviously favors double bottoms.

The author offers specific recommendations on how to trade each pattern to improve the odds of a successful outcome. In the process, he gives what amounts to a mini-course in trading in general.

Although statistics (and good computer programming) is at the core of Bulkowski’s research, he writes remarkably clear, sometimes even breezy prose. And he includes lots of illustrative charts.

Chart Patterns: After the Buy is a reference book that belongs on the shelf of every trader who thinks he can see something in the squiggles of price movement. And, in one way or another, don’t we all?

Orrell & Chlupatý, The Evolution of Money

We’ve been on this journey before, but writers keep returning to the fascinating story of money. In The Evolution of Money (Columbia University Press, 2016) David Orrell and Roman Chlupatý offer a new take, one that is more conceptual than historical, one whose final chapter is titled “Utopia.”

First, on a purely historical note, they set the record straight about the origin of money. It is not the case, as is commonly accepted, that money arose out of a barter economy. “Coin money did not supersede barter; rather it was predated by state-backed systems of credit. And rather than emerging naturally, with government and its legal system only stepping in at the last moment to claim credit by putting its stamp on everything, the use of coin money was imposed by government in the first place. It was forced on the population….” (pp. 28-29)

Money, they argue, is inherently dualistic and reflects the unstable relationship between number and value. Moreover, the history of money oscillates between periods of virtual and physical money. “During a virtual phase, money is seen primarily as mathematical debt—a score in a ledger—while in a physical phase, money is seen primarily as material wealth. However, the two sides cannot be separated, so money always retains the essential characteristics of each.” (p. 54)

The authors use this dualistic framework to trace attitudes toward money over time. For the most part they reorganize the familiar in a new way. But, in describing the cycles of virtual and physical money, they sometimes wander off in strange directions.

Here’s one instance. They claim that “the psychology of money … has much to do with our attitude toward femininity. For example, it is often said that market behavior is driven by the twin emotions of greed and fear. These responses both shape and are programmed by our scarcity-based monetary system. But while they have been treated as normal by economists … psychologists might argue that there is something else going on. In his book The Mystery of Money, Bernard Lietaer points out that this fear, which affects so much of our economic life, is related to our repression of the life-giving abundance of the feminine principle.” (pp. 115-16)

And a few paragraphs earlier: “Today, currencies such as the dollar and pound, with their Federal Reserve and Old Lady of Threadneedle Street, are in a state of transition. They retain many of the trappings and pretensions of their old scarcity-based, gold standard versions, but in fact are completely virtual. They are male-principle virtual currencies dressed up as female-principle physical currencies—money in drag.” (p. 114)

At its best, the authors believe, “money is virtual and can exist in a variety of forms.” (p. 195) Once we accept this view of money, they argue, our attitude to it changes. For instance, ”the strongest impediment to basic income is psychological—it seems unfair to give scarce funds away for nothing. But if basic income were delivered using a complementary currency, similar to Alberta’s old Prosperity Certificates, it would be more clear that the funds represent a kind of birthright.” (p. 195)

I appreciate the authors’ agenda, and I have no doubt that we will see a range of currencies, mostly digital, in the future as well as an increase in non-monetary transactions (such as gifting and, sometimes, sharing). I also think they are correct in predicting that “some of the most interesting [social, intellectual, and economic] developments will take place in the areas that are least well-served by our conventional money system, where the gap between number and value is the greatest.” (p. 236) But since money can never shed what the authors see as its inherently dualistic nature, even they concede that “money will continue to be a source of human drama and tension, no matter what form it takes.” (p. 237)