Valuation Investing

This year has been the year of broken records for the S&P 500, and the string of wins continued last week. The S&P 500 finished October with a positive total return, which means it has gained ground in all ten months of the year for the first time in the 90 years of S&P data. October also marks the twelfth consecutive positive month for the index, which equals a record set only twice before, in 1935 and 1949.

With a long list of historic records being smashed, there is no shortage of “gurus,” bloggers, and media types calling for anything from a pullback to an outright crash in U.S. equities. The primary rationale attached to these claims is “over-valuation.” This type of thinking is a great reminder of why it’s critical to always remain data-dependent in financial markets.

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The Boy Who Cried Wolf

Twenty-six hundred years before Cher, Bono, or Madonna, Aesop was the “one name” big shot. This guy accomplished a lot in his thirty-six years on this Earth; his fables are still a rite of passage for many children.

None capture the modern environment of financial media better than “The Boy Who Cried Wolf.”

Financial media, from mainstream news sources to blogs and newsletters, are full of people always calling for a financial market crash. These folks wear tinfoil hats and secretly wish the Illuminati would make a comeback. We refer to them around the office collectively as Dr. Doom.

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Fortune Teller

For the life of me I can’t understand Wall Street’s obsession with forecasts. These guys will forecast anything, like prop bets for the Super Bowl. It’s out of control! Regular readers know how I feel about forecasts, but for the uninitiated, Wall Street forecasts are the equivalent of fortune telling: a lot of pomp and circumstance but absolutely zero real value.

Wall Street has two particular favorite fortune telling games. The first happens each January, when strategists love forecasting where the S&P 500 is going to finish the year. In the second game, analysts forecast which companies will be winners and which will be dogs in the coming year.

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Fifty Shades of Gray

Get your mind out of the gutter; this isn’t that kind of commentary. Today we are going to discuss operating in the gray area that exists in financial markets.

It’s interesting to watch my teenage daughter navigate life with a very black and white view of the world. Things for her are either right or wrong, up or down. She doesn’t yet appreciate that it’s the nuances of life that make it simultaneously worth living and challenging to navigate.

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The Art of Knowing

A man known simply as Rumi said some of the most profound things I’ve ever read. No, I’m not talking about Beyoncé’s baby: Rumi was a 13th century poet, and he managed more memorable one-liners than a Vince Vaughn flick. One of my favorite Rumi quotes is “The art of knowing is knowing what to ignore.” Rumi would have made one hell of a global macro maven because that 800-year-old quote succinctly sums up the key to successful investing.

One objective of this weekly commentary is to shift your focus away from the plethora of distractions the markets and media send your way and towards the most critical developments.

With that in mind, let’s take a quick tour of Washington, D.C., a road trip to Cleveland and then discuss what markets are signaling as we begin the final three-month push of 2017.

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Doing Too Much

Multi-tasking has become a way of life for many people these days. I’ll admit that there are times when multi-tasking can boost productivity but, as usual, people have taken this concept way too far.

On my short commute to work the other day, I saw someone putting on makeup while driving. I’m not talking about a quick swipe of lipstick at a traffic light. It was the kind of makeup regimen Cher goes through before concerts, only this lady was doing it at 45 miles per hour.

I also saw a guy eating breakfast, and it wasn’t a breakfast burrito in one hand and the steering wheel in the other. This guy was eating a continental breakfast complete with freshly squeezed orange juice that he was juicing himself while driving through a school zone.

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Wax On, Wax Off

When anyone refers to the daily price action in financial markets as “risk on,” it makes me lose my freaking mind! It’s like being forced to watch the NBA Finals games from the ‘80s when the Lakers lost to the Celtics, while simultaneously listening to the Beaches soundtrack on repeat. It drives me crazy! That’s because there is no such thing as financial market risk being “on” and “off.” This isn’t the Karate Kid, you aren’t Ralph Macchio, and I’m sure as heck not Mr. Miyagi. There is no risk on, risk off, Daniel-son.

Risk is always on, my friends. The problem is that most investors have no idea what the word “risk” really means. I’m going to do my best to awaken the risk manager that lies dormant inside you. But be forewarned: once awakened, you won’t like what you see in financial markets at the moment.

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The Benjamins

There are tens of thousands of financial instruments investors can trade to gain access to hundreds of markets across all four major asset classes: stocks, bonds, currencies and commodities. Of the plethora of instruments and markets to be traded, there is one that causes more ripples across the globe than all the others, the US Dollar.

Despite being pronounced dead on many occasions in the past and despite the cryptocurrency fanatic’s best efforts to convince you otherwise, it’s still all about the benjamins. The dollar remains King and is currently at a critical inflection point, which will have widespread market ramifications.

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If You Focus on Average, You Get Average

No, this week’s commentary isn’t going to be a Tony Robbins-esque speech about not settling for mediocrity. Rather, with so many new readers, it’s a good opportunity to discuss why I believe in focusing on slopes rather than averages. Most investors, media gurus and other market participants are consumed by averages.

The simple fact is that if you focus on average, you get average.

A true edge and subsequent ability to outperform other investors over long periods comes from focusing on the “slopes,” which is how fundamental and quantitative data changes as we move through time.

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Divergence Creates Opportunity

The best trading opportunities come when investors’ perception of an event, or market, diverges from the most probable outcome of that event or the most probable direction of that market.

The most attractive opportunities present themselves when there is a shift in the Fundamental Gravity of a market from one bias, bullish or bearish, to the opposite but investors are slow to react. These divergences get me salivating like Pavlov’s dogs. Right now, there is a divergence occurring in the Eurozone that is being ignored and providing a compelling short opportunity. The origin of this divergence is Germany.

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The Most Valuable Commodity

Gordon Gekko may have been from the Bernie Madoff school of investing, but his quote from the 1985 film Wall Street holds up: “The most valuable commodity I know of is information.”

Fast forward thirty years, and the explosion in the amount of readily available information hasn’t necessarily reduced its value, but it’s made it critical to have a reliable and time-tested approach for processing it.

Make no mistake: as an investor, you are nothing more than a processor of information. The better and more efficiently you process information, the better your risk-adjusted returns and the more consistently you can earn them. Being a great processor of information comes down to being a combination of Jack Daniel and Eckhart Tolle.

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Shorts are Not Just for Summer

There are very few areas of life where the ability to “go both ways” isn’t a marked advantage. In basketball, the player who can dribble only with his dominant hand is a far weaker player, and much easier to defend, than the one who can dribble well with both hands. The baseball player who can switch hit is much harder for a pitcher to game plan against and is more valuable to his team because of his flexibility. Even Zoolander’s career didn’t break out to new heights until he figured out how to go right as well as left.

In financial markets, everyone can “go left” and invest on the long side. But far fewer investors are able to make the leap to being a capable and competent short seller. Being able to “go right” gives you a marked advantage over most market participants, who can only go left.

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Our Main Business

I’ll be the first to admit that talking about current economic conditions isn’t as entertaining as watching a guy push sound effect buttons while rattling off a bunch of stock tickers until he has you investing in every company in the Wilshire 5000. But if you can understand the impact that growth and inflation have on asset prices, then you can gain insights into risks and opportunities that other investors miss.

Since last week, it appears as though the world has started to drink my Kool Aid because all anyone can talk about is U.S. inflation. The problem is that they believe inflation is the key to forecasting the Fed’s next move.

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All We Need Is Just a Little Patience

Yes, I just started this week’s commentary with lyrics from Guns N’ Roses. Don’t count out a future Vague Destination entitled “Welcome to the Jungle.” Both titles are very appropriate springboards for a conversation about financial markets.

One of the overarching themes of my investment philosophy is patience. In the investing game, patience means acting only when opportunities present themselves, and not one moment earlier. Practicing patience, all by itself, can give you a huge edge over other investors because the hardest thing for most people to do is nothing. It’s incredibly difficult for investors to grasp the idea that making a decision to do nothing is just as proactive as making a decision to change something. But as you’ll see, doing nothing must become a regular part of your process if you want to be a successful investor.

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Somewhere Between Love and Hate

Author Shannon Alder wrote, “Somewhere between love and hate lies confusion, misunderstanding and desperate hope.” Last week, Mario Draghi spoke at the ECB forum in Sintra, Portugal, and the investor reaction to his comments made it clear that euro bulls are caught somewhere between love and hate.

These poor souls immediately piled into the long side of the trade at the fastest pace in five years, bidding the euro to a one-year high in the process. The bulls are desperately hopeful and confused, and have completely misunderstood Draghi and his intentions for ECB policy.

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The Cryptocurrency Rant

Most ranters want to blow off steam, but some people want to help others make wiser choices in the future — which brings me to my own rant.

I’ve seen enough cryptocurrency stories over the last few weeks to last me a lifetime, especially about Bitcoin. Bitcoin is not a store of value, and it’s not a reasonable investment candidate. You’ve been warned!

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You've Got One Job

Last week, I was behind a lady who approached a four-way stop sign as she was applying her morning makeup. Her car crept into the intersection until she actually stopped right in the middle of it. She had been completely oblivious while she put on her face. That is, until I gave her a polite “you’ve got one job to do, and that’s to drive” honk.

This incident reminded me of what happens when investors ignore the data and instead pay more attention to media narrative, friends at cocktail parties and nut jobs on TV with more sound effects than financial market acumen. This commentary, my friends, is your “you’ve got one job to do” honk.

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One More Night

I have a confession to make: I love reality TV, and the trashier the better. After a long day traversing the globe generating alpha, there’s nothing quite like kicking up your feet with a glass of Kentucky water and watching women fight over whose Birkin bag cost more. I was indulging in my guilty pleasure recently when I saw a commercial for an upcoming show called A Night with My Ex.

Seriously, can you think of anything worse than spending a night with your ex while the cameras roll and hundreds of thousands of viewers witness the whole thing? Those people are going to discover that it always turns out like the Maroon 5 song One More Night. They’ll wake up hating themselves.

I’m definitely recording that show, but luckily I don’t have to wait until July to get my fix. That’s because right now investors are making a Night with My Ex-type mistake in U.S. equities, and I’m bearing witness.

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The Key to Good Performance

Focus and concentration are the keys to accomplishing anything of significance and experiencing success in any area of life. Yet when it comes to investing, concentration seems to be a four-letter word.

Instead, diversification gets all the glory as the way to invest, and as the primary tool for sound risk management.

Like a game of telephone that started in the '70s, the definition of “diversification” has been somewhat butchered. “Diversification” has come to mean that the more investments you have in your portfolio, the better.

But is that really diversification?

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Three Pitchers of Beer and a Black Light

I turned on the TV the other night and was shocked to see college bowling being broadcast. When did colleges start forming bowling teams?! More shocking was when one of the commentators referred to the participants as "athletes."

My athletic career ended in high school, but I’m quite confident that nothing athletic occurs under black lights after three pitchers of beer. Well, at least not anything that can be shown on network television.

Saying people who bowl are athletes is like saying people who play paint ball are Navy Seals.

Just as that announcer got carried away, so too have investors who are piling into the long side of the euro because they believe the European Central Bank is ready to taper and begin shifting towards a more hawkish policy.

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