Tag Archives: sentiment

The Signal and The Noise (Part 2)

How can we tell what’s really happening?

Great Circus Parade, Milwaukee, WI. Photo: Royal Broil. Source: Wikipedia

When the newsreels stop rolling and the microphones go away, we’re sometimes left with the impression that a circus parade just rolled by. Did anything actually change, or did we just see a cavalcade of horses, camels, and clowns roll down Main Street? We’ve heard about news stories with an underlying agenda too many times.

When we read any important news item, something that always changes is our perception of the news. Our perceptions meld together into expectations, and those expectations get built into stock and bond prices. It doesn’t happen perfectly and it doesn’t happen all at once, but market prices then reflect the general news stream.

That’s why everyone was so downcast last winter. Several Fed Governors gave speeches where they said that the Fed planned to raise rates four times in 2016. That got investors scared: was the Fed “behind the curve”? By contrast, the sky-high sentiment we’ve seen lately among the software giants mirrors the expectation people have today that software will eat the world.

Market trends then tend to get overdone. Feelings investors have reinforce and feed on themselves. Black days or sunny skies look like they will stretch on forever. But they never do. We look back at those times and ask ourselves, “What were we thinking?”

It’s a fair question. Because when everyone thinks alike, everyone is likely to be wrong.

Douglas R. Tengdin, CFA

Investing in Quality

Investing in Quality

What makes the market shine?

Photo: Ivan Melanchthon Serrano. Source: Morguefile

Over time, companies earn profits. Good companies earn consistent, growing profits in both good times and bad. The profits don’t necessarily grow every year—after all, if you sell oil and the price of oil falls 80%, your margin has to fall. But a managers can still earn a profit, because they haven’t bet the ranch on a the future price of a volatile commodity.

Investors pay for the rights to the profits. When investors are in a good mood, they pay a lot for these rights. When they’re in a bad mood, they don’t pay so much. That’s the “Mr. Market” that people talk about: a moody fellow who is either manic or depressive. That’s really all there is to the stock market: profits and emotions.

It’s better to buy from Mr. Market when he’s in a funk, and sell when he’s elated, but don’t get too hung up on that. If we own good quality companies, or a broad range of companies, over a long period, profits go up a by lot. Investor sentiment, though, tends to cycle back and forth. In 1985 Proctor & Gamble—the maker of Crest toothpaste–earned $700 million. Last year, they earned $11 billion—growth of over 9% per year. During that period, the stock price went up 10% per year—pretty close. Compound interest means the stock’s now worth 17 times what it was 30 years ago.

P&G’s stock price. Source: Bloomberg

What makes for a quality firm? Different investors have different views, but my opinion is that it’s strong, predictable cash generation that increases over time from a moderate investment base. In accounting terms: a consistently high return on capital, high cashflow relative to earnings, and steady sales growth. A well-diversified portfolio should have companies that get their revenue from different sectors, industries, and countries. This reduces the risk of having to take a permanent loss.

That’s really all there is to stocks: investor sentiment, company profits, diversification, and the magic of compound interest. As writer Richard Brautigan says, the simple things in life go on, while we become more difficult.

Douglas R. Tengdin, CFA

Chief Investment Officer

Not So Sweet

What’s happening to Candy Crush?

Photo: EJ Augsburg Source: Pixabay

King Digital, the maker of Candy Crush and other addictive mobile games, is being acquired for $18 per share in cash by Activision Blizzard, a mainly PC-based game maker, perhaps best known for Call of Duty and its multi-player online game, World of Warcraft. That’s a 20% premium from where King opened yesterday. Investors should be happy. After all, back in September the stock was a lot lower.

King’s mobile games were on the freemium model, where the game is free but virtual goodies cost real money. The game was addictive, and their initial public offering last year was widely anticipated. The stock listed for $22.50 / share. But it has struggled since then, never seeming to re-capture the original excitement. Now, Activision’s proposed take-out price is a 20% loss.

Source: Financial Visualization

Candy Crush—the marquis title—has remained a steady financial performer, consistently one of the top-grossing games in Apple’s app store. But King’s other games haven’t proven as popular—not even Candy Crush Soda, a related title released last year. It’s not easy to adapt to changing consumer tastes and moods. Rovio, the maker of Angry Birds, has yet to come up with a follow-on version as popular as the original.

The deal illustrates some of the dangers of a hot IPO. Everyone’s looking for the next Google—a phenomenal upstart that can take the world by storm. But running a public company is different than running a private one: different reporting, different rules, different pressures. The original business model may need an overhaul—and the current managers may not be able to execute a new strategy.

By buying King, Activision adds a successful mobile franchise its own stable of products. It’s just too bad King’s IPO investors ended with such a sour return.

Douglas R. Tengdin, CFA

Chief Investment Officer

Fear, Greed, and Complacency

Are we near a market top?

With the Dow nearing 17,000 and measures of volume and volatility fairly low, many folks are saying that the end of the five-year bull run is near. It’s true that valuations are stretched. The US stock market has nearly tripled since 2009. It’s also true that sentiment indicators show that market bears are harder to find than beach bums in a tuxedo store. But discerning the top of a bull market isn’t like looking at the top of a mountain. You can’t just set your altimeter and declare, “We’re here.”

Markets aren’t objective, physical things. They’re the agglomeration of millions of buy, sell, and hold decisions on contingent claims on future cash flows. Sentiment and fundamentals matter, but so do economic growth, inflation, trade, politics, and myriad other factors. The world of human interactions is extremely complex. It’s hard to understand what’s already happened, much less what is going to happen next week, next month, or next year.

Like most market participants, we have a forecast of what we expect from the economy and market from year to year. But our investment process doesn’t depend on correctly calling the market’s turns. It’s driven by finding value and structuring portfolios so they have the right combination of return, risk, and other issues for each investor.

Bull markets mature on optimism and die on euphoria. Investors seem pretty optimistic right now. But euphoric? That’s impossible to tell.

Douglas R. Tengdin, CFA

Chief Investment Officer

Shoe-shines and Wunderkinds

Have we reached the silly season?

The news is filled with movie starlets discovering the stock market and 16 year-old actresses day-trading from their iPhones. Are these signs of a bubble?

An old market saying goes, “When even shoeshine boys are giving stock tips, it’s time to sell.” The market is a discounting mechanism that incorporates not only the latest news, but our sentiments about the news. So big, emotional events like Pearl Harbor, 9/11, Neil Armstrong’s walk on the moon, or the Lehman Bankruptcy tend to magnify what we’re already feeling.

But market buzz can permeate the culture, and encourage otherwise sensible people to buy and sell on a whim. Until Friday the market had risen for 11 straight days, something that hadn’t happened since 1996. And market volatility has fallen to the lowest level in six years. Complacency and momentum are a powerful cocktail.

I have nothing against bubbles. They can be profitable if you have the good sense to leave the party before authorities show up. But what the wise do at the beginning, fools do in the end. When the music stops, be sure there’s a chair nearby.

Douglas R. Tengdin, CFA

Chief Investment Officer