Market Forecast - 01/22/2016 - David Settle

Good perspective on current market volatility.  30 minute listen

David uses a proprietary tool called Market Forecast that is available on TD Ameritrade charts as a lower study.  After listening to a few of his daily market forecasts you can pick up on how to use the tool as a leading indicator.

Learn Fundamental Analysis

Business Finance Online - This site is an interesting learning site in understanding how to evaluate the financial condition of a company and spotting value.  A lot of the things on this site can be obtained at online quote sites but this helps break down how they are calculated plus have some info that cannot be obtained unless you calculate yourself.  Information and calculator pages are simply good and the site is free, no advertising and no registration required. 

Market Correction or Start of Bear?

3 Month performance of all ETF's July, Aug, Sept 2015

Market has been overall bad past 3 months.  The question is are we just correcting or starting a downtrending bear market?  The optimist in me says we are at the bottom of a correction.

 

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My Take On The Market

I have not posted anything for about a month now due to summertime activities and necessary work/research on my portfolio.  Also, my education takes up a lot of time as I continue to learn as much as I can about stock investing trading systems like Growth, Value and Income methods along with how and what to watch with the economy as a whole to “indicate” future direction.

Lately I have been seeing things online from the “Experts” and a few are saying we are headed for a major crash of 50% or more.  I hate these bear type doomsayers because they like to act like they have all the “data” behind their opinion and know what they are saying.  Some even point to their past accurate predictions of past stock crashes.  The real facts and data just get in the way for these guys.  I could easily tell you today that the market is going to crash by 50% in the next 6 months.  Then, 2 years later the data might support and hint to this and actually happen and I’ll say.  Oh, yeah, I predicted this I saw it coming.

Just as bad on the bull side are the experts that tell you to use their investing methods to double and triple your portfolio even in down markets.  They will sell you a system that any normal person is unlikely to have the stomach to follow and when everything goes south on you the expert will say that you didn’t follow the plan exactly as they sold it to you.

One major thing I’ve concluded with what my current training has convinced me of is that both camps are HOGWASH.  Anyone that thinks they can predict where the market is heading by interpreting one or two “signals” or bases things on “The last time I saw this combination of events…”  is full of bear or bull crap.

So here’s a few basic concepts I have adopted from my training with Investools not because they told me to but because what they are teaching is reasonable and verifiable through past performance and use of play money in a paper money platform to monitor current trades and try methods without any risk. 

First and foremost is that it is not a question of if the market will go down, it’s only a question of WHEN will it go down.  The reverse holds true for upward movement.  This is a fact since it moves one way or the other every trading day.

Second, prices on stocks are based on one seller saying I want “$X” for my share of company YZ, or one buyer saying I will pay “$X” for your share of company YZ.  It’s no more complicated than that.  The complication comes into play in what motivates the buyer or seller to bid on what they are willing to pay for or accept for their shares.

What makes a seller say, I’ve had enough with this company and want out versus a buyer who thinks the seller is wrong? 

What a company earns (profits) and more importantly what the company is expected to earn up to 5 or 10 years down the road is what drives the price of the stock, not past data and not current earnings.  When a buyer comes in it is on the expectation that the company will do better in the future..  This concept is very important and somewhat difficult to wrap your head around.  This is where past data is considered because it is what drove the engine to it’s current location.  Motion tends to continue in the direction it is moving unless acted upon by another force (basic physics) 

This is where current data driving the overall engine of the market comes into play because they contain forces that can change the direction of the engine on companies thus impacting future profits and drive the price up or down. 

But, just as important is the companies future guidance they provide when reporting current quarterly profits.  Companies provide their plans for the future and analysts consider the companies ability to deliver what they are projecting.  That is the information that if positive and analysts agree is possible will drive a stocks price up and conversely down if either the companies guidance or a failure to convince the analysts.

Investment Risks–Let me count the ways

When I first started investing I was well aware that there were risks involved but I had the most basic idea that risk was simply the threat of stock going lower then what you paid for it thus creating a loss.  I had no real idea of how varied risks were and how to manage it.  Because of that lack of knowledge, my first year had mixed results and thankfully were not totally devastating but did keep my overall returns flat because I did not know how to manage the stocks that were falling.  When I delved into the subject of investment risks I learned just how many types of risks were present. 

There is two categories of risk, unsystematic and systematic.  Unsystematic risks can be lessened through diversification of the portfolio as opposed to systematic risks that do not respond to diversification.

Examples of unsystematic risks are:

Business/Financial Risk:  This risk is specific to a company or industry.  Company profits can change based on management decisions or industry trends.  Financial risk comes into play when companies take on to much debt and management perceptions of the company’s ability to repay is misjudged. 

Event Risk.  This risk is caused by an unforeseen event that impacts the company’s finances like tax law changes or regulation changes.  Also lower then expected quarterly earnings and revenue surprises are event risks.

Political Risk.  This risk primarily applies to forgein stocks where changes in political and economic climates are not stable

Liquidity Risk. This is the risk of not being able to sell an asset quickly near or at the market price.  U.S. stocks are considered the most liquid but even in the U.S. volume levels must be considered for quick exits.

Examples of systematic risks are

Inflation Risk.  This risk applies primarily to bond, CD’s and other fixed income type investments.  Erodes your buying power if inflation exceeds returns set on the fixed income instruments.

Reinvestment Risk.  This is the opposite of the inflation risk.  If interest rates are falling when fixed income assets and are to be re-invested, the rate of return will be less then desirable.

Exchange Rate Risk.  This risk applies mostly to forgein stocks.  Currency exchange rates are constantly changing so you could be buying on a strong dollar and selling on a weak dollar which impacts how much you get in U.S. dollars.

Market Risk.  This risk affects all types of securities and most often is driven by changes in the economy.

Understanding these risks are important considerations as one evaluates where to allocate what percentage of what assets in the overall portfolio.  How much in stocks?  How much in bonds/fixed assets?  In the stock portion, how much in income versus how much in growth stocks?  In the bod portion, how much in long term versus short term?  Then, in stock selection, how much do I risk in each stock?  How do I manage that risk?

When I said above that my idea of risk was the risk of the price of my stock going down, while accurate, certainly fell way short of the actual risks.  As I learned about these risks over the next 3 years of my vast experience, I have made several adjustments to my investment methods to mitigate the risks so I am not as exposed as I was.  But, let there be no mistake, as much as you learn about risk you cannot eliminate it if you seek to be successful in your investments. 

Value Investing Stock selection criterion

Here are a few value type criteria to screen for potential value stocks.  Use results for a watch list for further analysis before investing in any of the results.

Market cap

Market capitalization less than $5 billion - Lynch generally avoids large, well-known companies in favor of small-cap stocks that still contain significant upside potential. Most fund managers define small-caps as companies with market capitalizations under $1 billion. Institutional investors often use market one investment criterion, requiring, for example, that a company have a market capitalization of $100 million or more to qualify as an investment. Analysts look at market capitalization in relation to book value for an indication of how investors value a company’s future prospects.

PEG ratio < 1.2

PEG ratio below 1.2 – The PEG ratio is a valuation metric that compares a company’s price-earnings ratio with its projected growth rate. Small, high-growth stocks generally trade at higher PEGs compared to the big-caps. If the PEG ratio is around 1, the company is considered fairly valued. A PEG ratio that is much higher than 1 indicates an overvalued company, and a PEG below 1 indicates an undervalued company. While the PEG ratio can effectively provide insight in certain evaluations, it is limited by its overriding focus on earnings growth. Revenue growth, cash flow, dividends, debt, and numerous other factors are also critical in determining value. Additionally, while PEG is useful for smaller companies it may be misleading for big-caps, since sustained growth is less important to their total returns. PEG is most useful when supplementing a thorough discounted cash flow analysis or relative valuation.

Earnings growth 15–30%

Five-year earnings growth between 15% and 30% per year - In investments, earnings growth refers to the annual rate of growth of earnings, or the amount of profit a company produces during a specific period, usually defined as a quarter (three calendar months) or year. Earnings typically refer to after-tax net income.. When the dividend payout ratio is same, the dividend growth rate is equal to the earnings growth rate. Earnings growth rate is a key value that is needed when the DCF model, or the Gordon's model as used for stock valuation. Companies that exceed a 30 percent earnings growth rate are confronted with two fundamental problems: (1) sustaining a high growth-rate over the long term is extremely difficult; and (2) stocks growing that rapidly are usually already being actively covered by Wall Street analysts, and Lynch prefers less well-known names and avoiding competition.

Institutional ownership 5–65%

Institutional ownership ranging between 5% and 65% - Institutional investors are organizations that trade large volumes of securities. Percentage institutional ownership is the fraction of shares outstanding owned by mutual funds, pension plans and other institutional investors. Most well-known stocks have at least 40% institutional ownership. Usually more than 70% of daily trading on the New York Stock Exchange is from institutional investors. Peter Lynch, among many other investors, uses institutional ownership to gauge market interest. He believes stocks with low institutional ownership have the best return potential. When mainstream Wall Street analysts identify a stock, price growth can be dramatic with the support of institutional money. Lower levels can be associated with greater price volatility.

Return on Equity > 15%
Indicates high profitability and potentially a competitive advantage

Debt-to-Equity ratio < 0.5
Implies that the company does not heavily depend on outside capital to finance its growth

Current ratio > 2
Makes sure that the company is able to pay its short term obligations

Differing Outlooks on the Market

Below are excerpts from an article on Seeking Alpha from a poster known as “Chowder”.  It matches a lot of what I use to try and keep my investment choices in perspective since my personal allocation is based on differing time frames.  The dividend portion of my portfolio is 10 plus years and I have taken into consideration his comments below about which ones to invest in. 

Excerpts from:  http://seekingalpha.com/article/3244406-differing-outlooks-on-the-market

Many individuals, when faced with a simplistic analysis of the markets, tend to lean towards the belief that everyone in that market is thinking and acting as one, with common beliefs in terms of future price movement. Needless to say, things are not as simple as they appear.

The market is a battlefield where very different groups of individuals and institutions collide. Each one of these actors will bring with themselves very diverse outlooks on the market, trading or investing it within different time frames, often with very different goals and objectives, and thus, with oftentimes opposing views. Day traders, swing traders, core traders, hedge funds, mutual funds, ETFs, short-traders, individual investors, banks, insurance companies and others won't necessarily share the same investing ideas in terms of the amount of time they plan to hold their positions, or even the direction the market is bound to take.

This doesn't mean that the different groups can't profit from the market at the same time, it's that the different time frames and various goals and objectives will inspire them to manage their portfolio's differently.

Stick to trading or investing in the timeframe your plan calls for, sticking with the relative points of your business plan. If the plan calls for buying high quality companies at a 10% discount to fair value, and the opportunity presents itself, don't let market conditions or others talk you out of it. You've planned your work, now work your plan, always keeping your time frame in consideration. Different time frames require different tactics. Know yours!

Don't allow others to distract you, or tell you your goals are meaningless, or try to place obstacles in your way.

Obstacles are those frightful things you see when you take your eyes off your goal. --Henry Ford

Over the years, I have found that the best approach to investing in companies is to be sure you have the full faith and confidence that the investment will rise. If you do not, then during the tough times you may force yourself to sell. Any investment that offers a threat to long-term confidence, that may be appealing to sell at the bottom, rather than appealing to buy at the bottom, is not the right long-term investment. The right long-term investment will be, ironically enough, one that becomes more attractive to you as it declines. The opportunity to add more to your investment becomes as attractive as the actual gains you are seeking. From a psychological standpoint this will always be the best investment or investment strategy, because a strong holder and one who can buy declines will always stand a better chance of success than one whose investment life is governed by the fear of loss.

Put another way, a good investment is one in which paper losses are tolerable.

According to Lowell Miller, the author of The Single Best Investment , the best long-term investment is one that is easy to hold, and easy to buy in moments of decline. The best long-term investment has something about it which builds confidence in the long-term future - even though the current moment may include aspects that have frightened other investors.

We don't need to get more than we need in an investment! We don't need to strive for maximum return or shoot for the biggest number. The best long-term investment is one in which we can achieve reasonable long-term goals. Reasonable goals are attainable. Fantasies are not.