Go Long Volatility

I continually search for asset classes or specific investments that are depressed in price, unpopular, or undervalued based on asset values or cash generation.

After major global stock indexes returned more than 16% (including dividends) and almost 4% more so far in January, there are few depressed assets or instruments.  Earlier this week I identified gold and gold stocks as providing such an opportunity.  

Now I think volatility is another opportunity.  There is a high level of complacency, if not outright ebullience, among investors now.  This is reflected in the extraordinarily low level of the VIX index of volatility on options linked to the S & P 500 stock index.  

High levels of the VIX Index are historically reliable indicators to buy stocks, since the expectation of high volatility in stock prices reflects anxiety (and is a contrarian indicator to buy).  The evidence supports buying stocks when the VIX Index is above 30.

Low levels of the VIX, on the other hand, do not have the same empirical support as a market timing tool (in this case as a sell signal).  Yet, the current level of 13.5 on the VIX is exceptionally low and, I think, worth "buying."  There are several exchange traded funds that are linked to the VIX Index (such as VIXY).  These instruments are not appropriate to buy and hold, as they tend to erode over time when held indefinitely.  But at current prices, I think they are a worthy speculation and a way to hedge core stock holdings against a broader market decline.

Steve Lehman

LehmanInvest.blogspot.com/

S & P 500:  1470

VIX:  13.5

Buy Gold and Gold Stocks

Ethical issues about gold mining aside, from a purely investment perspective gold and gold stocks look like a good buy at current levels.

The 12-year bull market in gold might have ended more than a year ago, when its price reached $1,925 an ounce.  Its current price of $1,650 is 15% below the peak, yet gold still rose in price last year (though by only 7%).  But from a tactical standpoint, both the gold price--and gold stocks--now offer the potential for a rebound.

After a year in which major stock indexes around the world returned about 15%, it is difficult to find asset classes that are depressed enough to offer an attractive return given the risks.  I think gold-and especially gold stocks--now offer this.

I do not, however, consider this a "buy and hold" situation.  The long-term bull market in gold may indeed be over.  But I think there will still be a solid move higher from here.

The prices of the metal and the stocks have fallen sharply, and are now technically "oversold" (and likely to rebound).  And key investor sentiment measures indicate levels of pessimism that historically have been followed by large percentage gains in the stock prices.  The Hulbert Gold Sentiment index, for example, is now at a level which over the past fifteen years, has been associated with annualized gains on the XAU gold stock index of 60%.

Remember, the best time to buy something is usually when few others are clamoring to do so.

Steve Lehman
LehmanInvest.blogspot.com/

Gold:  $1,650

Uptrend, Downtrend, or What?

The idea that studying graphs of past price movements of a stock or commodity (known as "charting" or "technical analysis") can reveal its future price movements is appealing, since we can't reliably predict the future course of events. 

While there have been prominent "chartists" or "market technicians" on Wall Street who  have had successful careers, I'm skeptical of the value of technical analysis.  

We all have biases as investors.  I favor assets that are unpopular and depressed in price, rather than widely popular assets that are already sharply higher in price (regardless of whether fundamental prospects are favorable).  When selecting stocks, I favor valuation, financial strength, management quality, and contrarian market psychology, rather than business fundamentals or upcoming profit reports.

I do look at some technical indicators while favoring stocks or assets that are depressed or "oversold" (abruptly lower) in price.  However, I have a bias against pure charting, where the name of the company or the commodity is irrelevant to the decision whether to own, not own, or short the asset in question.  

My impression over nearly three decades of following markets is that for every example where charting would seem to work in predicting the future price direction, there is another that would not have worked.  

A case in point is the use of uptrends, downtrends, and "breakouts."  It typically takes so long for an uptrend or downtrend clearly to have reversed direction that by the time it is decisively reversed, the percentage move in the opposite direction is substantial--and often unreliable.  That means giving up a significant portion of profits when an uptrend has been reversed by a sharply falling price, or missing a significant gain when a downtrend has been reversed by a sharply rising price.

I noticed in this week's Barron's that as of last Friday, all three Dow Jones indexes--Industrial, Transportation, and Utility--had decisively "broken down," or fallen below the rising line that connects the daily closing prices of each index.  Given that supposedly clear signal, one should sell--or even sell short--each index.  

But in the first two trading days this week, all three indexes reversed the supposed new downtrend by rising sharply (the Dow Jones Industrials rose 4%).  Which is it?  Buy or sell?  The Dow Jones Industrials declined nearly 4% before clearly breaking down and giving a "sell" signal.  Now it has rebounded 4%--and given a new "buy" signal?

I have noticed similar results when studying moving averages, either 50-day, 100-day, or 200-day moving averages of the price of an asset.  Sometimes when the price rises above--or falls below--the chosen moving average, it signals a trend reversal.  But often it is just price fluctuations that do not indicate a trend reversal.  The result is buying and selling and buying and selling, often buying somewhat high and selling somewhat lower, followed by buying back in at a higher price and selling at a lower price.  It seem to me that the result often is to "buy high and sell lower," rather than what we're supposed to do:  "buy low, sell high(er)."

It may be unfair to assert that charting often causes investors whiplash, as they reverse positions abruptly following broken uptrends or downtrends.  It does seem that when an asset builds a "base" by fluctuating at a depressed level for some time but not falling further, it produces significant gains once it "breaks out" by rising sharply.  And I realize that dedicated "chartists" would tell me that there is much more to technical analysis than I've presented.  Nevertheless, I continue to view technical analysis with skepticism and as only a small input to my investment decisions.

Steve Lehman
LehmanInvest.blogspot.com/

Sell Into This Rally

The sharp gains in stock prices on Monday and so far today will lift the spirits of investors.  After months of tedium following the deadlocked fiscal negotiations in Washington, it was encouraging that the two parties were able to reach an agreement (despite having to pass it on a holiday).

Yet, I wouldn't get carried away.  I think this might be a case of the adage, "Buy on the Rumor, Sell on the News."  Last year was a solid year for investors, with mid teens returns from many stocks.  Any further rebound early this year would seem to offer a prudent opportunity for profit taking and to rebuild cash reserves for better entry points later.  

After all, one of the most important lessons in investing is, "Starting Price Matters."  And for a growing number of stocks today, the starting price facing investors is not low enough to provide a sufficient margin for error, or "margin of safety."

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500:  1449  

Happy New Year!

Though I am no longer managing a mutual fund portfolio, I continue to enjoy opining about investing through writing this blog.  I hope readers find it useful in making investment decisions, whether as professional investors or as amateur investors trying to grow--and protect--one's own portfolio.

This was a year when putting a portfolio in a stocks and bonds using index funds would have produced an excellent risk-adjusted return.  I expect that next year will not be so straightforward and that such an approach will yield much more modest returns.

Bonds have continued to produce amazing returns (except for U.S. Treasuries, finally).  High-yield bonds (actually more like equities than fixed income) and other corporate bonds have been excellent investments in recent years.  The need for investment income has pushed yields to such low levels that further declines in interest rates (which produce capital appreciation in bond portfolios) seem unlikely.

Despite the likelihood of a modest increase in tax rates on corporate dividends, there still are a number of high-quality stocks that have dividend yields that are higher than those on U.S. Government bonds (and shorter-term corporate bonds).  I still think the attractive starting dividend yields and likely dividend increases are attractive for investors who need some income from their investments.

After sharp gains in stock markets over the past six months--and even sharper gains over the past four years--I advocate holding some cash on hand for selloffs (and potential buying opportunities) that may arise.

Best wishes for a healthy, happy, and prosperous New Year!

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500:  1405

Stocks: Too High to Buy, Too Low to Sell

There often are times when the odds do not favor widespread buying or selling in the stock market.  That happens when indicators of valuation, price trends, and sentiment are mixed.  Stocks are not extraordinarily cheap or expensive.  Price trends are not notably depressed (and likely to recover) or sharply higher (and likely to decline).  Investor sentiment is neither gloomy (a good time to buy) nor ebullient (a good time to sell).

At such times, one needs to focus on individual stocks that are reasonably priced or on themes relating to a particular market sector or societal trend.  I think today is such a time.

I still find a small number of stocks that are attractively valued (VOD, AGXXF, AAPL, MOFG, KSS, FDP).  In general though, after the sharp rebound since June of this year and the doubling of major stock indexes over the past four years, I urge caution when considering making large new stock purchases.  This is despite a likely rebound in stock prices if elected officials in Washington make meaningful progress on spending and taxes.

Steve Lehman
LehmanInvest.blogspot.com/

S & P 500:  1402

Depressed Assets After a Strong Year

In a year with significant gains in most U.S. stock prices as well as in other asset classes like corporate bonds and emerging market bonds, where can a contrarian look for depressed assets?  Gold and gold equities would be a place to start.

Though I wonder whether gold's 12-year bull market has ended, from a trading standpoint I think it is worth considering gold and gold equities.  The gold price is approaching oversold levels with fairly wide pessimism among market participants.  Gold equities are even more depressed, with several leading gold equities selling at 52-week lows, at a time when most major stock indexes and leading companies are selling near 52-week highs.

I have serious concerns over the social and environmental costs of gold mining.  Those who do not have those concerns might consider a trade in the SPDR gold exchange traded fund (GLD) or a stock like IAMGOLD (ticker:  IAG).  IAG has fallen 32% in the last three months, and it has net cash on the balance sheet and is trading for close to tangible book value per share.

Steve Lehman
LehmanInvest.blogspot.com/

GLD:  159
IAG:  11.17