Wednesday, March 27, 2013

Hanna, The Sharp Solution

The Sharp Solution: A Brain-Based Approach for Optimal Performance by Heidi Hanna (Wiley, 2013) is a one-stop shopping book for decreasing stress, increasing energy, and improving overall health, happiness, and performance. I’m not being sarcastic here. It is one of the better self-help books I’ve read in some time. Admittedly, I don’t read anywhere near as many self-help books as I do investing and trading books. Sometimes I think I’ve got things backwards; sometimes I’m convinced I’m wasting my time with both. That’s usually the point at which I pick up a good novel.

But enough about me. Back to Hanna’s book. The SHARP solution has five phases: balance your brain with strategic relaxation and recovery, engage your heart (create a clear vision statement that incorporates passion, purpose, and motivation), focus your mind, energize your body, and strengthen your community.

In this post I want to deal with phase three—focus your mind. First, a couple of stats. “It has been said that we only spend about 10 percent of our time in the current moment, 50 percent anticipating what’s ahead of us, and 40 percent reflecting on what’s behind us.” And “considering the fact that we have approximately 60,000 thoughts every single day, and that each thought that catches our attention requires us to spend energy, it’s no wonder that we feel as if we’re running on fumes by the end of the day.” (p. 66)

How can we better manage our mental energy? Hanna offers three suggestions. First, spend wisely. “Most people are so busy during the day they fail to even consider that they might be spending beyond their limit, which often leads to burnout and fatigue. Try to avoid spending carelessly by bringing more mindful attention to each present moment.” Second, conserve when necessary. Hanna recommends chuncking your day so that you can shift from multitasking to multi-prioritizing. And finally, invest strategically. “It is important to recognize that the same energy source fuels our brainpower and our body. This means that you will deplete the energy that’s available for your mental demands if you don’t invest in your physical energy throughout the day.” This investment involves eating high-quality food every three to four hours and “taking breaks to get short bursts of physical activity each hour. … Ideally, you should aim for about five minutes each hour to turn off your mind and engage your body for optimal brainpower.” (p. 67)

Focusing the mind also involves transforming a negative, survival-based mindset into a more positive, opportunity-based one. “Training our brain to have a positive, growth-oriented, opportunity-based mindset provides flexibility training, which compels us to be resilient in complex situations and see the positive in even the most challenging of circumstances. It also decreases our knee-jerk reactions to events in our lives that spike unhealthy cortisol levels so that we can be in our optimal energy and performance zone.” Making over one’s mindset is possible because, as William James wrote, “My experience is what I agree to attend to.” (p. 76)

Hanna continues: “[P]eople with a fixed mindset tend to be more sensitive to the negative events they experience and more aware of needs to protect themselves for long-term survival. This is similar to people suffering from chronic stress. … Take, for example, a stock market crash. The shock of what occurred may initially feel like an acute stress, but eventually, you are left in financial turmoil, which may last for a long time, keeping your system on high alert.” In this state “cortisol calls the shots in the brain. … This is one of the reasons why stress has been linked to excess fat storage: It not only stimulates a desire for comfort and distraction, but also pushes the brain into energy-storage mode.” (p. 77)

A simple (but, as the mantra goes, not easy) shift in our mindset “can change our physiological response, making us feel challenged (and releasing harmless adrenaline) rather than threatened (and releasing inflammatory cortisol). This is often based on our perception of what’s called our locus of control: that is, our belief that we can make an impact on the situation at hand, rather than feeling helpless. One particular study of 7,400 employees found that people who believed they had little control over the deadlines that other people had imposed had a 50 percent higher risk of coronary heart disease than their counterparts.” (p. 78)

In brief, you should focus on the intersection of things that matter and things you can control. A diagram from Farnam Street, a wonderful blog recommended by one my readers:

Have a happy, challenged day!

Monday, March 25, 2013

Turner & Scott, Invest to Win

Invest to Win: Earn and Keep Profits in Bull and Bear Markets with the GainsMaster Approach by Toni Turner and Gordon Scott (McGraw-Hill, 2013) is a deceptively elementary book. Although its largest audience will undoubtedly be newly self-directed investors, even the experienced investor will learn a thing or two.

The GainsMaster approach has four key elements: (1) define your objectives, (2) evaluate market conditions, (3) choose your opportunities, and (4) manage your risk. Since the inputs to these elements vary from person to person and hence require a level of self-knowledge and self-assessment (“Investing strategies need to be built from the inside out”), each chapter in the book concludes with a section that addresses the emotional side of investing.

The authors cover such basics as finding a broker, fundamental analysis, technical analysis, and ETFs. But perhaps their most useful contribution is their analysis of market conditions—whether investors are seeking safety or opportunity. To ascertain whether the market is in a STOP or a GO mode, they use a combination of three indicators: the twelve-month moving average, volatility as measured by the average true range, and safety-seeking behavior (for instance, how do utility stocks perform compared to the market as a whole?).

Once an investor has evaluated market conditions, one strategy is to turn to lists of ETFs to “select opportunities and also keep an eye on the markets.” (p. 216) The most general list for a GO-sign market includes SPY, DBC, EFA, EEM, and LQD. The investor should determine which are the two strongest ETFs on this list and then drill down, looking for the four strongest ETFs on the two lists. If, for instance, commodities and emerging markets are the strongest, the investor should look for the strongest ETFs among DBC, DBA, DBB, GDX and EEM, EWZ, PIN, RSX, FXI, EWM, EPP, and ILF.

Relative strength is only one of several strategies the authors describe. They also offer two even simpler strategies, for instance, that they call “Keeping It in the Fridge” and “Making Some Dough.”

Invest to Win is a well-balanced book that seeks to improve upon buy-and-hold investing with some market timing and better stock/ETF selection. Investors could do a lot worse than to follow the advice of these two well-known financial educators.

Friday, March 22, 2013

Schoen, Your Survival Instinct Is Killing You

You might think you know where this book is going from its title—Your Survival Instinct Is Killing You: Retrain Your Brain to Conquer Fear, Make Better Decisions, and Thrive in the 21st Century (Hudson Street Press, 2013). In reality, the focus of the retraining Marc Schoen, a clinical psychologist, writes about is not so much overcoming fear as transforming the broader category of discomfort into power.

The crux of the matter, Schoen writes, is this: “Discomfort or vulnerability in our present day actually has more survival value than being comfortable once had in prehistoric times. Seeking and settling for comfort and familiarity in the present now leads to rigidity and a constriction of brain resources. Although our ancient wiring strives for familiarity and comfort because it allowed us to survive in the past, today it actually impedes our ability to function in the present world. … [B]ecoming comfortable with being uncomfortable and vulnerable really is the most important tool in the 21st century.” (pp. 209-210)

Schoen sets forth what he calls the Cozy Paradox: “despite the growing ubiquitousness of comfort in our lives, we have become increasingly oversensitive to discomfort in our lives.” (p. 19) Or, put in the form of a question, “Why is it that in the absence of serious threats—famine, war, pestilence, the proverbial saber-toothed tiger—do we wage these wars within us? Why does our internal comfort zone feel cramped when we have wonderful advancements at hand to make life easier and, in a lot of ways, better?” (p. 18)

One of the problems Schoen highlights is the growing need for constant stimulation and, concomitant with it, the rise of boredom. He gives the example of the dissonance people feel when a long period of time goes by without receiving a message of one sort or another, a dissonance that manifests itself as “boredom, anxiety, loneliness, or even depression. … It’s almost as if the increasing need to feel flooded with stimulation has gotten to the point that it’s become an addiction, which makes us feel agitated when we don’t receive it.” (p. 111)

This agitance, he maintains, needs to be curated (or, in clearer English, we need to manage our comfort zone) so as to make more room for discomfort. A few of his fifteen tips: take a technology time out, value and tolerate imperfection, stop procrastinating, and embrace uncertainty.

Schoen offers a range of suggestions for transforming discomfort into power, from breathing exercises to drawing on empathy and love. Personally I was more attracted to the idea of the importance of challenge/resilience. A study that followed 450 Illinois Bell Telephone managers going through the trauma of industry deregulation (from six years before the breakup of the telephone company to six years after) found that “two-thirds of the group fell apart, as they suffered from heart attacks, depression, anxiety, alcoholism, and divorce. The other third not only survived but actually thrived. … [T]he successful study subjects shared three qualities now known in the field as the three Cs of hardiness: a commitment to what they were doing, an enthusiasm for challenge, and a sense of control over their lives. … [T]hese were people who struggled to have influence, rather than being passive, and kept learning from their experiences, whether positive or negative.” (pp. 166-67)

Your Survival Instinct Is Killing You is neither tightly written nor cogently argued. Schoen’s meandering style gave rise to a certain “agitance” in this reviewer. But I think his central message may be important; it’s certainly worth pondering.

Wednesday, March 20, 2013

Burton and Shah, Behavioral Finance

Behavioral Finance: Understanding the Social, Cognitive, and Economic Debates by Edwin T. Burton and Sunit N. Shah (Wiley, 2013) pits the efficient market hypothesis against behavioral finance in an effort to unearth the essence of financial markets. Their analysis is detailed, their conclusions modest. Both authors teach economics at the University of Virginia and, like most economists, are prone to “on the one hand on the other hand on the third hand” reasoning. But even if they don’t arrive at a grand synthesis, their study is well worth a read.

The book is divided into five parts: introduction to behavioral finance, noise traders, anomalies (such as prospect theory and perception biases), serial correlation (including short term momentum and calendar effects), and other topics. In this post I’m going to concentrate on noise traders since I haven’t dealt with the theme before on this blog—at least not as an intellectual concept.

A noise trader, as defined by Fischer Black in 1985, is someone who trades not on information but on noise and who, he adds, will lose money most of the time. Lest you jump to the conclusion that noise traders are simply short-term, possibly high-frequency, traders, the authors explain that “a noise trader could be as harmless as a year-end tax seller, paying no attention to values at the moment of sale. It could be a grandmother buying a present of stock for a grandchild, where the main interest in the stock is that the company produces something appealing to children, regardless of the inherent investment merits of the company itself.” (p. 38)

In 1990 the Shleifer model of noise trading rewrote Black’s definition to make noise trader activity systematic and to assign profitability to noise traders “for a significant period of time.” The Shleifer model (and in many of its assumptions it is admittedly a rather simplistic model) dispels the notion that similar assets will necessarily always be priced similarly in the marketplace. Overly optimistic or overly pessimistic forecasts by noise traders will presumably shift the locus of risk. “The risk being taken by the noise traders is not, as Shleifer is careful to note, based on any fundamental risk related to the risky asset, of which there is none. The risk being borne arises solely from the existence and activities of the noise traders.” (p. 50) Essentially, Shleifer models the Keynsian notion that “markets can remain irrational a lot longer than you and I can remain solvent.”

Trading based on technical analysis (noise with a capital “N”) has always been a thorn in the side of the efficient market hypothesis. “But regardless of the calumny heaped upon technical analysis by adherents of the EMH, it is an undeniable fact that technical trading underlies a very large amount of actual trading in modern financial markets.” Trend trading, a subset of technical trading, “if widespread, can create and sustain a pricing bubble” (p. 67) which is both irrational and inefficient and which, if Minsky is correct, is also inevitable in financial markets. Regulators may try to make markets less noisy and more rational—and thereby smooth out market returns, but ultimately they will never succeed. If, to mangle Shakespeare, in the final analysis “the risk is not in the fundamentals but in ourselves,” markets can never be truly efficient.

The authors do not reach this one-sided conclusion (which I personally believe to be true). They suggest that we use whichever theory “best serves the immediate purpose. If the goal is to understand why people sell winners, not losers, then behavioral finance seems best positioned to provide an answer. However, if one wishes to know why a stock with higher earnings growth commands a higher price/earnings multiple, the EMH seems to provide the best framework for producing an answer.” (p. 230)

Monday, March 18, 2013

Rogers, Street Smarts

If you’re not familiar with Jim Rogers’ Hot Commodities, Adventure Capitalist, or Investment Biker, or if you’re simply a fan of this maverick commodities investor, Street Smarts: Adventures on the Road and in the Markets (Crown Business, 2013) is a fast, if sometimes snarky read. It’s a combination autobiography/critical commentary.

Rogers, an unabashed fan of China, lives in Singapore with his wife and two young daughters, both of whom speak Mandarin. He believes the sun is rising in the East and, doting 70-year-old father that he is, wants his daughters to be on the winning side of the globe. The economic and innovative glory of the United States is to his mind best described in the past tense. He spends several chapters lambasting everything from the outsized national debt to academic tenure.

The highlight of Rogers’ career, at least in popular investing history, was the decade he spent at the Quantum Fund, which he co-founded with George Soros. He had initially intended to retire at the age of thirty-five, but he outlived his goals. At the age of thirty-seven, he was “psychologically prepared for retirement, and would not have stayed on that much longer, but,” he writes, “my decision to go was still not final until, suddenly, everything stopped being fun.” The SEC accused Soros of stock manipulation and offered him the opportunity sign a consent decree, “in which he and the firm admitted no wrongdoing but promised not to do it again.” Why, Rogers asked, sign it, why “let it be construed that we were manipulating the stock? I was taken aback by his answer—‘Because that is what I was doing,’ he said. ‘George,’ I remember telling him, ‘my reputation is worth more to me than a million dollars.’ And I remember just as clearly his answer. ‘Not to me it’s not,’ he said. He said it jokingly, but he meant it.” (p. 55)

If Soros is accused of malfeasance, Jim O’Neill, the former Goldman Sachs economist who coined the term BRIC, is derided for ignorance. O’Neill, in a 2001 paper, predicted a shift in global power from the G7 countries to Brazil, Russia, India, and China. Rogers writes: “Of course, he had no idea what he was talking about, and as I have pointed out to him since, speaking to him face-to-face as recently as the year of this writing, clinging to the thesis shows an ignorance of the world that is disconcerting, at best.” Only China is a clear winner, and that was obvious to Rogers as early as 1988. “But backing off the proposition is more than he can do. It is the hobbyhorse that has carried him to the celebrity he enjoys, and he shows no signs of dismounting before riding it into the ground.” (p. 78)

And then there is Alan Greenspan, described as “a mediocre Wall Street economist who was perpetually seeking government employment” and who “had been flitting in and out of Washington for maybe fifteen years when President Reagan in 1987 finally rewarded him for his inadequacy.” (p. 94) Bernanke is dubbed “Greenspan the Younger.” (p. 96) “He knows little about economics or finance, he has no idea how markets work, and the only thing he truly understands about currency is how to print it.” (p. 100)

In between taking whacks at people, educational institutions, and governments and waxing lyrical about his family Rogers imparts the occasional nugget of wisdom. I consider Street Smarts worth reading even though it won’t have a permanent place in my library.

Friday, March 15, 2013

Dyer, Steel’s: A Forgotten Stock Market Scandal from the 1920s

I don’t normally include subtitles in my post titles, but in this case I’ve made an exception. Not only did I know nothing of the stock market scandal; I had never even heard of Steel’s. So I figured the reader might also need a little help. This new Syracuse University Press book by Dave Dyer, an independent investor, recounts the story of a man, Leonard Rambler Steel, who did “almost everything right. Almost.”

Steel was a visionary. He founded his company in the fall of 1919 in Buffalo, at that time a boom town and the eleventh largest city in America. By June 1922, “he had 225 business locations, including sales offices, five-and-dime stores, candy shops, and cafeterias. He had more than forty-five hundred employees and forty thousand investors.” He sold stock in the company directly to the public on an installment plan. His idea was not only to raise capital but to create loyalty: “if the customers actually owned the stores, why would they ever shop anywhere else?” (p. 9)

Steel envisaged a vast chain of large discount stores in small towns—forty years before Sam Walton opened his first Wal-Mart store. “A single large store in a small town that supplied almost everything people might want would be the principal, and probably only, retail outlet in the community. It would drive out existing competitors and discourage others just because of its size and range of merchandise. In addition, a chain of 1,600 of them would have enormous buying power, resulting in prices so low that no competitor could possibly compete.” (p. 78)

The Steel store in Denver was “the final embodiment of his retail theory. He built a store large enough to dominate a market with low prices and surrounded it with satellite stores that were fed from the same warehouse. The product selection was so wide that there would be little need to shop elsewhere. Low prices and high turnover would keep competitors out, keep customers loyal, and keep investors happy. More stores would mean more opportunities for his employees to grow with the company. It was all going to work, and L.R. was a hero to all.” (p. 81)

He asked his well-paid employees to help fund the construction of the Denver store. The four-story building with 53,000 square feet of space, including a cafeteria with seating for 500, opened on December 9, 1922, just in time for the Christmas shopping season. On the first floor was a candy store as well as women’s lingerie and hats. The balcony overlooking the first floor housed a beauty shop. On the second floor was a “totally furnished six-room bungalow that helped shoppers visualize their purchases in a homelike setting.” The third floor was a food market.

On the same day that the Denver store opened to great fanfare and overwhelming crowds, Steel’s opened two other department stores—one in Hamilton, Ontario, and the other in Buffalo.

Unfortunately, Steel’s, it turned out a month later, was out of money. The stores had never been profitable; sales volume could not compensate for the combination of high overhead and very low prices. Steel was forced to resign and a new management team took over. But they had no magic pill. They defaulted on a large loan and other creditors sued over unpaid bills.

The sale of stock in the various companies had been very profitable, “but it was stopped cold on February 20, 1923, when the Maryland attorney general issued an order restraining the sale of stock. … Although his order was effective only in Maryland, publicity from it made sales in other states difficult. The New York attorney general stopped all stock sales on March 1, 1923. … The New York State investigation showed that Steel’s was getting ready to sell $30 million in stock. They had already sold $26 million to about sixty thousand people, so they planned to pay the bills by more of the same. It might have worked, at least for a while, but they were not allowed to do it.” (pp. 106-07)

About three weeks later Steel died—broke. He had all his savings in the stock his now bankrupt company had sold. “There was not even enough money to pay his funeral expenses.” (p. 116) Investors in Steel’s were never compensated.

Steel was ahead of his time in many ways. He promoted women through the ranks, bought coal land to provide a consistent supply of energy for the company, and produced and showed three-hour infomercials to rapt local theater viewers (who were later visited by the company’s stock sales force). Dyer suggests that “if the stock-selling enterprise had not been so easy, so lucrative, and so tempting, he actually might have been more successful. With his energy and creative talent focused only on the business, and without an addictive stream of easy money, he might have been more like Wal-Mart and less like Enron.” (p. 133)

Wednesday, March 13, 2013

Moss, Salt Sugar Fat

A side trip (and zero calorie treat) today. Salt Sugar Fat: How the Food Giants Hooked Us by Michael Moss (Random House, 2013) has received a lot of well-deserved praise. Even though I myself contribute almost nothing to the bottom line of the food giants (peanut butter is, I think, the only processed food I eat—admittedly, regularly and with relish—and, oh yes, some ice cream come summer) and even though I am no zealot when it comes to healthful eating, I found Moss’s book fascinating.

Let’s start with a provocative question that Moss didn’t raise: Should the likes of Kraft, NestlĂ©, or Pepsi be excluded from socially responsible investing portfolios? If gambling, tobacco, and alcohol are deemed in some way “sinful” (presumably because of their potentially addictive qualities and sometimes damaging consequences), why not processed food?

I need to backtrack here even to make sense of this question. Through a combination of science and marketing, the processed food industry has been a powerful force in shaping America’s (and increasingly the world’s) eating habits. The average American now consumes 22 teaspoons of sugar a day and as much as 33 pounds of cheese a year, triple the amount of cheese and pseudo-cheese products he consumed in the early 1970s. Those 33 pounds deliver “as many as 60,000 calories, which is enough energy, on its own, to sustain an adult for a month” and “have as many as 3,100 grams of saturated fat, or more than half a year’s recommended maximum intake.” (p. 170) As for salt, if you gobble down a frozen roast turkey dinner from Hungry Man, you’ll take in 5,400 milligrams of salt, “which is more salt than people should eat over the course of two days. Unless, that is, the people are baby boomers or older, black, or suffering from sodium-sensitive disease. In this case, the Hungry Man dinner would deliver enough salt to meet their quota for half a week.” (p. 267)

Moss takes the reader into food labs where scientists have worked on such projects as determining the bliss points for sugar and fat. By the way, there is a bliss point for sugar above which the taste buds cringe, but “the bliss point for fat, if there is one, is much higher, probably up in the stratosphere of the heaviest cream.” Fat is also energy dense, with twice the calories of sugar. (p. 260)

The numbers Moss provides are shocking and go a very long way toward explaining the obesity epidemic in this country.

Salt Sugar Fat is not just a book of numbers, of course. It is an engrossing tale of how companies have tried to provide consumers with what they like best at a competitive price and how they themselves have often created consumer demand. Take cold raw pizza, for instance. It might have seemed an unlikely candidate to become a runaway success, but kids loved this version of Lunchables. It didn’t hurt that the ad campaign offered a message of independence and empowerment: “All day, you gotta do what they say. But lunchtime is all yours.” (p. 208)

Moss, a Pulitzer Prize winning investigative reporter for The New York Times, did extensive research for this book and obviously tried to be fair to the industry even as he criticized it. Salt Sugar Fat is the kind of book that should advance a responsible national dialogue on healthful eating.

In the meantime, I’m starting to plan my vegetable garden for this year even though it is still heavily blanketed with snow. No St. Patrick’s Day pea planting here!

Monday, March 11, 2013

Nichols, Taking Charge with Value Investing

Investing primers are a dime a dozen, so what makes Brian Nichols’ Taking Charge with Value Investing: How to Choose the Best Investments According to Price, Performance, and Valuation to Build a Winning Portfolio (McGraw-Hill, 2013) worth a look?

To start with, it’s an easy read, where stories break up what—almost by definition—is the tedium of measuring value. Second, it goes beyond the metrics of stock selection and deals at some length with the psychology of investing. Nichols also offers an unconventional model of diversification.

“Most of the time,” Nichols writes, “an investor’s fundamental knowledge is sufficient to return gains, but it’s her emotions that get the best of her.” He recounts his own early failings. “You may not realize it, but the more engaged you are with your investments, the more likely you are to return a loss. When I first began investing, I was the worst in the world; I watched every fluctuation of a stock throughout every day. I could barely focus at work because I was so worried about logging onto my online brokerage account to see how much I had either lost or gained. If it was a day when the market fell by 150 points and I lost $300, I was selling my stocks with no questions asked, regardless of the loss. … I would become even more frustrated as the stock would rise the following day or week because I could see the gains that I had missed. Seeing the potential gains led to desperation on my part, so I would buy as the market was trading higher and repeat the process all over again when the market turned for a day’s loss.” (pp. 137-38)

Nichols now uses limit orders both to buy and to sell. He keeps these limit orders in place for one year or until the stock hits his target entry and exit (as a rule of thumb, a 20% gain) levels. “This strategy eliminates the need for both buying and selling a stock, so all you have to do is find a stock that is fundamentally growing, has strong metrics, and is priced for value.” (p. 144) He sometimes has multiple limit orders on a single stock and sells a fraction of his position at each level.

Nichols introduces the reader to his ten-ten-to-ten system, which offers a rough heuristic for finding companies that are presenting value. Its baseline is a value of ten for each of three measured metrics: growth, valuation, and performance. “In theory, a company with 10 percent growth, a P/E ratio of 10, and a one-year return of 10 percent would be fairly valued.” (p. 186) Stocks can be measured against this baseline to get an idea of whether they are under- or over-valued. It’s just a starting point, Nichols admits, but a useful one nonetheless.

As should be evident from these excerpts, Nichols’ book is not merely an introduction to value investing for the novice. It offers tips that more seasoned investors might explore profitably.