9/14/11…MPT, EMH and other forms of sin!

Bloomberg Top Stories:


*European Stocks, U.S. Index Futures Rise on China Bets; Treasuries Retreat

*Wholesale Prices in U.S. Are Little Changed as Energy, Vehicle Costs Drop

*ECB Will Lend Dollars to Two Euro-Region Banks as Market funding Tightens

*Deposit Flight From European Banks Means Collateral Risk Piling Up at ECB

*Credit Agricole’s Debt Ratings Cut by Moody’s Along With Societe Generale

*Only Half of U.S. Corporate Cash Stays in Home Country – tax evasion?

*Bernanke Hampered as Divisions at Fed Bring Incremental Action on Economy

*Swiss 1970s Inflation Specteer Seen in Central Banks’s Unlimited Franc Sale

*Obama Approval Plummets to New Low Among Americans Skeptical of Jobs Plan


Volume declined slightly to 4.2B shares from 4.46B shares for NYSE stocks while trades executed on the Big Board declined to 1.07B shares from 1.09B, barely average. Advance/Declines were positive but net change remains negative: +3.2:1 vs -1.1:1 vs -3.5:1 vs +9:1 vs -2.6:1 vs -5.6:1 on NYSE and +3.1:1 vs +1.2:1 vs -3.1:1 vs +5.5:1 vs -2:1 vs -4.6:1 on Nasdaq. Breadth was also positive: +3.1x vs +1.3x vs -5.7x vs +18x vs -3.8x vs -19x -7x on NYSE and +6x vs +3.2x vs -1.8x vs +26x vs -1.9x vs -14x vs -4.7x on Nasdaq. New 52 week highs were steady at 29 while new lows, slid from 552 to 126 – still highly negative and raises questions on the rally! The VIX rose declined but remains elevated and closed at 36.91 -1.68. 48 was the selloff high, not seen since 5/21/10: 48.20!


Look at the last seven sessions…all are net negative: Dow +0.4% vs +0.6% vs -1.0% vs +2.5% vs –0.9% vs -2.2% vs -1.0%; Transports +3.4%!?! vs -0.2% vs -1.3% vs +3.4% vs -0.9% vs -3.4% vs -1.4%; S&P 500 +0.9% vs +0.7% vs -1.1% vs +2.9% vs -0.7% vs -2.5% vs -1.2%; Nasdaq Composite +1.5% vs +1.1% vs -0.8% vs +3.0% vs -0.3% vs -2.6% vs -1.3%; 100 +1.3% vs +1.3% vs -0.4% vs +2.6% vs flat vs -2.3% vs -1.0%; Russell 2000 +1.8% vs +0.9% vs -2.1% vs +4.2% vs -0.4% vs -3.4% vs -2.5%.


Global stocks are rallying but pale in comparison to Monday’s and Tuesday’s losses: FTSE +1.5% vs flat vs -0.4% vs -0.6% vs +2.1% vs -3.6% vs -1.5%; CAC 40 +2% vs +0.5% vs -1.1% vs -0.3% vs +2.9% vs -4.7% vs -2.3%; DAX +1.1% vs +1% vs -0.5% vs -1.1% vs +3.8% vs -5.3% vs -2.4% vs -1.6%; Nikkei -1.1% vs +1% vs closed vs -0.6% vs +0.3% vs +2.0% vs -1.9% vs -1.2%; Hang Seng -3.5% vs closed 2 days vs  -3.5% vs closed vs -0.2% vs -0.7% vs +1.7% vs -3.0% vs -1.8%; Korean KOSPI -3.5% vs closed vs -1.8% vs +0.3% vs +3.8% vs -4.4% vs -0.7%; Indian Sensex +1.5% vs -0.2% vs -1.7% vs +0.9% vs +1.2% vs -0.6% vs +0.9%, only net gainer. U.S. futures weak and slipping: DOW -100; SPX -11.70; NDQ -16.75. If you are trying to trade this you are a true believer and a fool! U.S. stocks are opening slightly up except Transports whose rally yesterday is inexplicable. As for bonds, stocks are up so bonds are a tad weaker: 10 yr 1.99%; 30 yr 3.34%.


Gold is weaker following its usual pattern: after hitting a record high of $1923.50 on Tuesday it plunged below $1900 and has oscillated around $1900. Overnight it is $1827.8 -$2.30. Crude is now $89.62 -.59, with major resistance at $90!


…that would be Modern Portfolio Theory, aka the Efficient Markets Hypothis, etc. How many of you remember when Fidelity legend Peter Lynch who was fond of saying over any twenty year period you would not have lost money in the stock market. What? You don’t have 20 years and are already down for more than a decade? Worse, that was the S&P 500 which eliminates the losers and replaces with up and comers periodically. Whatever happened to buy and hold?


MPT suggests, by eliminating all those niggling exogenous variables that markets are efficient. It assumes that all information is known (did you know that the financial stations transmit breaking stories in code for computers…do you really think you can beat that?), and therefore pricing is correct. Ask anyone around in 1987 or during the dotcom bubble or 2008 if they agree.


Furthermore, the rampant use of derivatives has reduced investing from a zero sum game, more or less, to one that can be heavily skewed. Flash trading through ETN’s has made a mockery of the traditional exchanges. Did you see Eastman Kodak on Monday? Surged 12% in two minutes on 2 million shares…it was a $3 stock but is now back to $2.82! Is that an efficient market? Oh, and there was no news. That is just an extreme example of a market that is not trading on fundamentals but the whims (sic) of computers.


So why the column on this today? Because, since the 1970’s, finance majors have been immersed in MPT and the Chartered Financial Analyst Program (CFA) has churned out tens of thousands of disciples since then. You have to drink the Kool-Aid if you want to become one. Just like anything though, once everyone starts believing in something and acting accordingly it no longer works, and that folks spells opportunity. We saw it with the demise of ‘buy and hold’ and at enormous cost to true believers.


Name a great stock? Apple! Yes, incredible innovation, marketing, and supply management. But one problem: they are too big and not wanting to go the way of the others who failed they know that it is not possible to continue growing at their long term growth rate of 21%! It is mathematically impossible, especially with the U.S. and global economies weak. So what are they going to do? Most likely return capital to shareholders. They have cash flow of +12%and ar sitting on more that $25 billion in cash and marketable securities which is a huge drain on return on equity…that is one-third of their total assets! Pullease! They have never paid a dividend and the last stock split was in 2005. Now consider all the companies that are hoarding cash and earning zip on their investment (Bank of New York Mellon is now charging them for the privilege of having an account!), and whose growth rate is not so stellar. Consider GE at 13.5%, a one year return of -1.36% and nearly 60% of their assets in cash and marketable securities…and of course they pay NO taxes!


Back to MPT, the Beta, or how the stock should perform relative to the market – in up or down moves – is 1.2x for GE and just 1.1x for AAPL. Which would you rather own? TB likes GE…not the common but the preferred which trades around it’s $25 par and can be called on 30 days notice which reduces volatility. Question: Why haven’t they called that 6.1% preferred??? Is that good management?

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Back from Rotary so this is a little late…ciao, friends!




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