History may not repeat…..but it sure RHYMES

Few old headlines that are very similar to recent headlines:
It’s a funny old World:
1989-1991: Housing and savings and loan crisis: Fed eases aggressively as economy enters deep recession
1992-1994: Existing financial architecture in Europe (ERM) blows apart
1995-1998: European convergence trade in both FX and Bond spreads keeps European currencies relatively stable vis a vis the USD with a good rally in 1998.By 1996 BUBA has lowered the discount rate to 2.5% while US rates remain well below the pre-crisis highs of 9.75% in 1989.
The carry trade and capital flow into emerging markets (Asia in particular) is center stage
March 1997: In a seemingly “innocuous” move the Fed “tinkers” by raising rates 25 basis points.
April 1997:Japan raises its consumption tax as USDJPY has rallied from a post Kobe Earthquake low of 79.7 to 127.50 . USDJPY collapse to 111 by June
June 1997-Jan 1998: Severe reaction in Asian currencies as “hot money flees”
August-October 1998 : Russia defaults, Long term capital folds and the Fed eases aggressively as the Equity market drops 22% (S&P)
History may not repeat…..but it sure RHYMES
Source: CitiFX


Let Fear Be Your Friend in the Market

Our friends at Forbes published this article in Dec 2013 and it serves as a good example of how Fear is typically misunderstood on Wall Street. Instead of buying into downtrends (thesis of this article) we prefer to buy into uptrends on periods of temporary weakness. Or short strength in bear markets.

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Forbes: Let Fear Be Your Friend in the Market
Let us share an investing secret we live by, at your absolute pinnacle of fear, do the exact opposite of what you want to do.
We believe from a trading perspective that your return on an investment shall be in direct proportion as to how much you fear it.
The very best advice we can give any investor comes down to measuring one’s fear in entering any investment.  Fear is your friend, if you can learn to use it to your advantage.
Capitulation Can be Your Friend
Quarter end, in combination with year-end, often provide spectacular investment opportunities as capitulation mounts near peak levels and portfolio managers are forced to re-balance positions.
Risk managers and investment committees review portfolios and ask themselves, what do we want to own at year end?  Or more importantly, what do we want our investors to know we own when they look at our portfolio and year-end account statements?
Believe it or not, the end of 2013 is much like recent years as fear is mounting in some unpopular sectors.  Gold miners GDX are off more than 53%, rare earth metals are 30% below January levels, and coal names have been bludgeoned off 20%.  Even the once loved home builders are off 6% from their May highs with the S&P 500 up 7% even from the same point.
S&P 500 in 2013
Airlines +96%
Travel & Leisure +77%
Elect Equip +76%
Biotech +67%
Gold Miners -52%
Rare Earth Metals -30%
Coal -20%
REITs -4%
Yet those who bought fear at the end of 2012 were handsomely rewarded.  From mid-August 2012 to the end of December, shares of Best Buy were off some 43%, while First Solar FSLR shares were torched, off 33% from their March 2012 highs heading into year end.  The most pain was felt in Hewlett Packard HPQ, which collapsed over 60% from February 16th to December 26th2012, off 30% in the 4th quarter alone.   These 3 stocks were up on average 90% in the first half of 2013.  We say “buy fear.”
What about 2011?  The ugliest sector, no one wanted to own in the 4th quarter of 2011 was the financials.  The space was off nearly 25% in 2011, 17% in the 2nd half of the year.   Bank of America alone was off 32% from Sept 1st through year end.   Over the next 12 months, investors fell back in love with the financials, up 27% on the year, BAC surged 100%.
Tax Man Cometh
Many high income taxpayers now face tax rates in excess of 50%.  High net worth investors are staring down the barrel of a combination of federal tax increases for 2013: a top marginal rate of 39.6%, up from 35%; a 20% tax on long-term capital gains and dividends, up from 15%; and a new 3.8% on investment income.
After recent tax law changes, qualified dividends and long term capital gains can be taxed as high as 25% if you include limits on deductions and the new surtax.  In 2013, there are more reasons than ever to rebalance your portfolio at year end, take losses where they are, and get in the best position possible for this higher tax climate.  This is causing a fear induced rush to the exits in some sectors as investors sell their losers to offset gains in their winners.
So How do you spot a Turn Around?
We look for clues that indicate the part of a company’s capital structure is the cheapest.
At year end, a solid equity buy signal is when we see a company’s bonds outperforming.  Credit tends to lead equities.  In many cases 40% to 60% of a company’s capital structure lies in its bonds or debt, so why would you just focus on the stock price?  You’re only seeing half the playing field!
Credit Leads Equities
In many of the gold miners such as Newmont NEM, coal names such as Peabody Energy BTU and the home builder Hovnanian HOV; the credit is substantially outperforming the underlying equity.  Simply put, the company’s bonds are doing much better than the stocks.  This is a positive buy signal for the equity.
Every year in December we have a model that searches for these dislocations in value. We look at the 5 year credit default swaps of companies and compare their performance relative to the company’s stock price.  In many cases, exceptional investment opportunities arise when we spot the cheapest part of the company to own.
For example, Peabody’s 5 year credit default swaps CDS are 140bps tighter since their worst levels this summer but the stock price is 15% lower.  Translation; investors love the credit but hate the equity.  Someone is very wrong; it’s likely the equity is mispriced.
(Credit Default Swaps: CDS is a form of insurance against default of a company, the lower the bps spread the stronger the credit profile.)
A look at Hovnanian HOV equity and its 5 year credit default swaps CDS is even more telling.  This was a standout in our model.  Since the first week of September the CDS has moved from 630 bps to 468 bps, a substantial credit improvement.  But since mid-September HOV equity is off some 10.5%.  The company’s credit profile is improving while the equity is moving lower.  Sounds like tax loss selling divergence to me.   Why is this important?  The company has an enterprise value of $2.18 billion, $682 million equity market capitalization and $1.5 billion of debt.  If most Hovnanian’s value is in the bonds, again why just watch the stock?
Where’s the Value?
As the stock market has marched higher, the dividend yield on the S&P 500 is down to 1.85%, while coal stocks as represented by the KOL ETF now yield 2.12%, gold miners through the GDX ETF 2.25%.  With the Federal Reserve promising investors a 0.25% Fed Funds rate (low interest rates) well out to 2016, we must appreciate an income advantage where it’s found.   Dividends don’t provide a floor on stocks but in a low interest rate world they do provide relief as investors are searching high and low for yield.  Likewise, with the PE on the equity market nearing 17, the gold and coal names look cheap at 10 and 12 respectively.
With the S&P 500 up 28% this year vs. the Gold Miners GDX, off 55%, and Coal KOL names off 20%, one has to ask how long can the spectacular spread of outperformance continue.
With Uncle Sam in mind, one has to ask, after January 1st who will be left to sell the Gold and Coal stocks?  In the first quarter of 2014, we expect these underperformers to play some serious catch up.  With the average gold miner off some 65% from their 2011 highs, a lot of bad news is priced in at today’s levels.  Today’s losers will become tomorrow’s winners once again.

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When You Fear Making the “Wrong” Decision

Most people make fear -based decisions on Wall Street. Invariably, instead of avoiding losses, they attract them (b/c they are making emotional, not rational decisions). This is an interesting story but there are many parallels to trading. Replace Korea with your next buy/sell decision.

“Fear is a natural reaction to moving closer to the truth.” ~Pema Chodron

For the past three weeks, I’ve been trying to decide whether or not to move to Korea for a year. Some days, I’ve completely made up my mind to take the trip. I get excited about teaching myself Korean and spend hours and hours online learning about the culture.
Other days, I’m an emotional wreck, terrified that I’m making the wrong decision.
What if I get homesick? What if I’m supposed to be doing something else? What if I don’t like kimchi? What if? What if? What if?
And then there are those days where my mind resists all attempts to make any kind of decision at all. I’m immobilized, unable to push through the debilitating fear.
Being the self-reflective (over-analyzer) type that I am, I decided to dig deep within myself to find the root of this pesky little emotion that has been sabotaging my efforts to move forward (or in any direction, for that matter).

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I realized that the issue isn’t about being afraid to go to Korea. The real issue is that I have an overall fear of making the “wrong” decisions in my life.
Interestingly enough, I also realized that this brand of fear directly coincides with my decision to live a more purposeful and spiritually centered life.
(Record stops.)
Huh? I embarked upon this journey hoping to find inner peace, bliss, rainbows, and unicorns and I actually seem to be experiencing more negative emotions than before. Seems counter-intuitive right?
Not exactly.
What I’ve been interpreting as an increase in negative emotions can more accurately be described as a greater sensitivity to myself. I’m “hearing” the messages my mind, body, and spirit are trying to tell me because I’ve made a conscious decision to listen.
Listening closely to my fears about Korea made me aware of some pretty negative beliefs I held about myself and doubts I had in my abilities. The fear I was avoiding actually turned out to be the one thing that made my decision clear and gave me the courage I needed to prepare myself to go to Korea.
For those of you who may be struggling with your own fears, I’d like to share some lessons I’ve learned along the way:

Make peace with your emotions.

Emotions, even ones we assign negative value to, (like fear) provide us with valuable information and serve very specific functions. If you can get over the hostile relationship with emotions, they can be highly useful.
Emotions can:

  • let you know what’s important to you
  • prompt you to take some action
  • guide you toward an aspect of yourself that needs to be exposed and healed
  • let you know when you’re our of balance so that you can bring it back to center

Understand that there are no “wrong” decisions.

It really takes the pressure off if you understand that every experience you have, whether you characterize it as “good” or “bad,” is exactly the experience you need to have at that moment. Some choices may lead to more painful lessons than others, but living life in fear of living life is no way to live. For the most part, the same is true in the market, don’t make buy or sell decisions based on the outcome, focus on developing a good process and then the outcome should take care of itself.  Life involves risk. If you have sound rules and they say buy, then buy, define your risk, and see where it leads you.

Intuition can use fear to help you grow.

Fear is often described as a psychological response to a perceived threat (losing money in Wall Street parlance). Most scientists agree that when it comes to survival, fear has served an evolutionary purpose. It only makes sense to avoid things that can potentially harm you.
However, many of us have developed fear from negative experiences in our past. We have built a protective fence around our emotional scars, and learned to ward off anybody or anything that triggers an unconscious fear.
Sometimes our intuition guides us toward those things we fear the most so that we can push past them and become stronger as a result. The next time you feel fear, embrace it, examine it, and if guided to do so, move boldly toward it.


Source: http://tinybuddha.com/blog/when-you-fear-making-the-wrong-decision/

Fear Conditioning & Psychological Damage


This article touches on two important areas market participants face when trading/investing: Fear Conditioning & Psychological Damage. The good news is that you can change your conditioning and overcome your psychological market related damage. It requires a lot of knowledge, time, patience, hard work, and practice. While you read this article- think about how you are conditioned and what psychological market related damage you suffer from (most common are: how things went wrong for you in the market or your past losing experiences). Once identified, more importantly, do you want to change/overcome them?

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Fear Conditioning

The circuitry of the fear response may have been honed by evolution, but there is also another side to fear: conditioning. Conditioning is why some people fear dogs as if they were fire-breathing monsters, while others consider them part of the family.
In the 1920s, in what is probably not one of psychology’s finest moments, American psychologist John Watson taught an infant to fear white rats. “Little Albert” had no fear of the laboratory’s test animals. He showed joy at the sight of the white rats especially and always reached out for them. Watson and his assistant taught Albert to be terrified of white rats. They used Pavlovian (classical) conditioning, pairing a neutral stimulus (the rat) with a negative effect. Whenever Albert reached for one of the rats, they created a terrifyingly loud noise right behind the 11-month-old child. Not only did Albert very quickly learn to fear the white rats, crying and moving away whenever he saw one, but he also started to cry in the presence of other furry animals and a Santa Claus mask with a white beard.
Like Little Albert’s fear of white rats, a person’s fear of dogs is most likely a conditioned response. Perhaps he was bitten by a dog when he was three years old. Twenty years later, the person’s brain (the amygdala in particular) still associates the sight of a dog with the pain of a bite. We’ll take a closer look at some common fears in the next section.
Source: http://science.howstuffworks.com/life/fear.htm/printable

Psychological Damage

Successful traders/investors have learned how to over come their psychological market-related damage. Remember we all started somewhere and during our journey we have all paid our market “tuition” in some way shape or form. As a result, we have accumulated a certain amount of psychological damage along the way. How do you handle losses? Do you take them personally? Do you get upset or angry when you lose money? The list goes on and on but there are two key questions to ask yourself: 1. Are you aware of your psychological damage? and 2. Do you want to repair the damage? The first secret is to define your Psychological Damage and then work on repairing it. This is best done by separating your emotions/ego from your results and do not let trading define you. It doesn’t.

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Fear & Greed Intro & 8 Practical Tips To Deal With Fear

FEARFear & Greed play a huge role in trading/investing.  Every serious trader/investor should be very aware of their psyche. Here is an intro to fear and a few steps on how to deal with it. 

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How To Deal With Fear? Identify & Quantify It
I have found that the best way to deal with fear (especially in the market) is to identify your fear (what do you fear most) and quantify your downside (how much you are comfortable losing, if wrong). Then exit if your pre-determined stop loss is triggered. This is much easier than it sounds. But through practice it is very possible. 
-Adam Sarhan
PS: Here are 8 ways to deal with fear:
The Prevention magazine article “What are you afraid of?: 8 secrets that make fear disappear” offers these tips for dealing with everyday fears:

  1. It doesn’t matter why you’re scared. Knowing why you’ve developed a particular fear doesn’t do much to help you overcome it, and it delays your progress in areas that will actually help you become less afraid. Stop trying to figure it out. Just accept it, release it, and look for a solution.
  2. Learn about the thing you fear. Uncertainty is a huge component of fear: Developing an understanding of what you’re afraid of goes a long way toward erasing that fear.
  3. Train. If there’s something you’re afraid to try because it seems scary or difficult, start small and work in steps. Slowly building familiarity with a scary subject makes it more manageable.
  4. Find someone who is not afraid. If there’s something you’re afraid of, find someone who is not afraid of that thing and spend time with that person. Take her along when you try to conquer your fear — it’ll be much easier.
  5. Talk about it. Sharing your fear out loud can make it seem much less daunting.
  6. Play mind games with yourself. If you’re afraid of speaking in front of groups, it’s probably because you think the audience is going to judge you. Try imagining the audience members naked — being the only clothed person in the room puts you in the position of judgment.
  7. Stop looking at the grand scheme. Think only about each successive step. If you’re afraid of heights, don’t think about being on the fortieth floor of a building. Just think about getting your foot in the lobby. Then slowly go from there.
  8. Seek help. Fear is not a simple emotion. If you’re having trouble overcoming your fear on your own, find a professional to help you. There are lots of treatments for fear out there, and no good reason not to try them under the guidance of someone with training and experience.Source: http://science.howstuffworks.com/life/fear.htm/printable

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Intro To Greed

Emotions are a very powerful force that nearly every trader/investor learns to deal with as they grow. This is a general overview to Greed. The other powerful emotion is Fear which will be covered under other articles in the Psychological Analysis section of this site.

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GREED is one of 7 basic character flaws or “dark” personality traits. We all have the potential for greedy tendencies, but in people with a strong fear of lack or deprivation, Greed can become a dominant pattern.

What is greed?

Greed is the tendency to selfish craving, grasping and hoarding. It is defined as:

A selfish or excessive desire for more than is needed or deserved, especially of money, wealth, food, or other possessions [1]

Other names for greed include avaricecovetousness and cupidity.
Greed is generally considered a vice, and is one of the seven deadly sins in Catholicism and is (considered a sin of some sort in every major religion)—a greedy person is one who values material acquisitions and possessions more than God.
Less judgementally, but in the same ballpark, Buddhists regard craving as a hindrance to enlightenment. Craving is a delusional state of seeking happiness through acquiring material things.
As with the opposite chief feature of self-destruction, greed is a faulty approach to life. The person with greed is driven by a fundamental sense of deprivation, of something lacking within, and becomes fixated on seeking comfort by getting the one thing that will eliminate that feeling.
That one thing could be money, power, sex, food, attention, knowledge … just about anything. But it will be the one thing on which their entire greed complex is fixated. The greedy person’s basic strategy is to dedicate himself or herself to acquiring as much as possible of that thing.

Components of greed

Like all chief features, greed involves the following components:

  1. Early negative experiences
  2. Misconceptions about the nature of self, life or others
  3. A constant fear and sense of insecurity
  4. A maladaptive strategy to protect the self
  5. A persona to hide all of the above in adulthood

Early Negative Experiences

In the case of greed, the early negative experiences typically consist of insufficient or inadequate nurturing in early childhood.
The situations causing such experiences could be natural and unavoidable, such as the death of a parent or living in a time of famine. Alternatively, the situation could be deliberately imposed on the child, such as willful neglect. Another example would be a mother who is too off her head on drugs to look after her child.
Whatever the circumstances, the effect on the child is a sense of deprivation, of never having enough.
All infants are born with a natural desire for love, nurture, care, attention and interaction. In some cases, however, the source of such things—notably the caregiver—may be absent or unavailable. Perhaps not all of the time, but enough for the infant to experience the lack. Enough for the child to become terrified of never getting enough of what he or she needs.
Another factor in the origin of greed is the availability of substitutes. Perhaps the parent, out of guilt, perhaps, repeatedly provides gifts in the form of money, toys, chocolate, TV. In effect, the parent says “You cannot have me but you can have this instead.” Ultimately, the substitute is always inadequate. No amount of TV can make up for lack of human contact. No amount of chocolate can make up for lack of genuine love. But the child learns to make do with whatever is available.


From such experiences of deprivation and lack, the child comes to perceive life as being unreliable and limited, but containing the missing ingredient for happiness:

My well-being depends on me getting all that I desire.
I cannot truly be myself, a whole person, until I get what has always been missing.
Life is limited. There isn’t enough for everyone. I miss out because other people are taking my share, getting what is rightfully mine.
Once I have it all, I will never lack anything ever again.

Over time, the growing child might also become cynical about what life has to offer:

All I ever get are unsatisfactory substitutes.
I cannot trust anyone to give me what I need.
If I am given a gift, there must be something wrong with it.
Everything falls short of my requirements.
Source: http://personalityspirituality.net/articles/the-michael-teachings/chief-features/greed/

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