Weekly Cycle: Curiosity Drives Change

It’s curiosity, not conviction, that drives change. We should be fueled, not by a desire for a quick catharsis or a life hack, but by intrigue.

From Why “Dumb” Questions Are Key to Innovation by Ozan Varol.

Stock Market Outlook 05.21.2018

Each week, I review the market using a specific set of information sources to gauge the stock market rather than relying on headlines from news sources looking to generate attention. Weekly checkups give me the opportunity to spot trends, while not overreacting on a daily basis.

Performance
stock index performance 05.21.2018
  • SPY up slightly over last week and nearly 15% in last year
  • Volatility (VIX) down over 25% in last 3 months
  • HACK up 10% over last 3 months and over 23% in the last year
Technical Indicators

Based on data and info from TradingView (Click  for 30% off a pro subscription)

Scores based on the cumulative total of positive and negative technical indicators signals over three time horizons on Trading View. Scores are weighted by multiplying total as follows: daily (x 1) weekly (x 2), and monthly (x 3). 

stock market technical indicators 05.21.2018

 

  • China Tech (CQQQ) spiked last week after returning to less bullish signals this week
  • Financials (VFH) signals are very bullish
  • SPY and VTI signals remain very positive for the third consecutive week
OldProf’s Risk Analysis

Each week OldProf takes a look at a variety of sources to gauge overall market risk on both a short and long-term basis. He tracks a handful of indexes, economic indicators from respected sources, and volatility indicators. His weekly updates include a discussion of events with potential to effect markets, as well as general insight. Highly recommended reading.

This week, OldProf short-term conditions have improved significantly

The overall picture remains positive. Economic strength is reasonable, and inflation is low.


Short-term trading conditions improved dramatically.

He mentioned an increase risk of a recession in the next 9 months, though it remains relatively low.

A notable feature of the chart is that we recently increased the nine-month recession odds to a chance of 25%. While this is significantly higher than it has been during the long stock rally, it does not yet represent a real threat. Instead of thinking of the odds as higher than before, we must keep in mind the continuing evidence that a near-term recession is unlikely. The odds are only slightly higher than the long term average.

As he’s written in the past, he reminds that many financial headline are “noise”, a subject on which Daniel Kahneman discussed in an article linked below.

The current interest rate story is mostly noise. The same sources that criticized the Fed for “punishing savers” with low rates are now worried about the gentle and gradual increase. There are so many who are selling something – and therefore on a mission!

StockTrader Recap

Mark Hanna publishes a weekly Market Recap full of charts and insight on news and market trends at StockTrader.

This week, Hanna writes that after it was a relatively quiet week with some consolidation and little change to the short and long term outlook.

This was a generally quiet week in the senior indexes, consolidating some of the prior week’s move up.

Short term: The S&P 500 remains above this trend line connecting highs of 2018.

Long term: Still very positive for the “buy and never sell” crowd.

Technical Update

Hacked (subscription-only) publishes a weekly technical update on U.S. indices with a weekly analysis of the S&P 500, NASDAQ, and DJIA, as well as a general market outlook. Other posts include trade recommendations (stocks, crypto & forex markets), worldwide-market updates, ICO analysis, and much more.

This week, Hacked’s outlook is “Bullish short-term outlook as long as U.S indices remain above their respective 8 EMAs.” They are bearish whenever S&P 500 and NASDAQ break their respective intermediate-term supports.

More info on in the weekly update.

Articles of note
Noise: How to Overcome the High, Hidden Cost of Inconsistent Decision MakingThe Projected Improvement in Life Expectancy

Daniel Kaneman is working on a new book titled Noise. He’s written on the topic previously, including an HBR article in October 2016, where he makes the case for algorithms over human decision making to overcome noise.

Algorithms are also less likely to be useful for judgments or decisions that involve multiple dimensions or depend on negotiation with another party. Even when an algorithmic solution is available in principle, organizational considerations sometimes prevent implementation. The replacement of existing employees by software is a painful process that will encounter resistance unless it frees those employees up for more-enjoyable tasks.


The most radical solution to the noise problem is to replace human judgment with formal rules—known as algorithms—that use the data about a case to produce a prediction or a decision.


It is less well known that the key advantage of algorithms is that they are noise-free: Unlike humans, a formula will always return the same output for any given input. Superior consistency allows even simple and imperfect algorithms to achieve greater accuracy than human professionals. (Of course, there are times when algorithms will be operationally or politically infeasible, as we will discuss.)

Kahneman also spoke on the subject recently with Erik Brynjolfsson, where he described the problem and solution rather succinctly.

What are the bigger risks — human or the algorithmic biases?

Daniel Kahneman: It’s pretty obvious that it would be human biases, because you can trace and analyze algorithms.

….

An algorithm could really do better than humans, because it filters out noise. If you present an algorithm the same problem twice, you’ll get the same output. That’s just not true of people.

The legal sports betting arena is about to get crowded and we’re not ready

Sports betting is coming quickly to many states, and it’s likely to be chaotic, according to Greg Bettinelli, a VC familiiar with the gambling industry.

And if you haven’t been following the case, you probably don’t realize how much is about to change. Short answer: A whole lot, very quickly. And in my opinion, straight out of the gate, it’s not going to be pretty.

Sports betting is a very low-margin business. The take rate of sports wagering is around 5 percent, while it’s closer to 20 percent in horse racing. And in unregulated markets (which will occur somewhere in U.S.), the price of the product is going to get close to zero. It’s going to be hard to make any money, and customer loyalty will be basically nonexistent without pricing power.

Bettinelli also names a handful of businesses that may look to capitalize on the new opportunities.

In addition to all the sports leagues like MLB, MLS, NCAA, NFL, NHL and the PGA, keep an eye on media companies like AT&T (DirecTV), CBS, Comcast (Golf Channel), Disney (ESPN), Fox, Time Warner (Turner), Verizon (Oath) and Action Network/Barstool Sports (with the backing of the Chernin, Kerns and Jacobs dream team). Don’t be shocked if StubHub and even Ticketmaster figure out a way to get in the game, as they know the customers with high propensity to bet on sports

The Finance To Value Framework

Venture capitalist Fred Wilson wrote on the subject of how much startups should raise. In the post, he lays out his philosophies of valuing businesses that are yet to turn profitable.

The first thing you need to know is how your business will be valued by a buyer or the public markets when it is a scaled business. I like to use EBITDA and Revenue multiples for this work. And the best place to get them is from bankers who work in your sector and/or investors who are active in your sector. The key point is these multiples are what you are going to be valued at upon exit or IPO, not currently.

Revenue multiples work better for this than EBITDA because very few companies have positive EBITDA during their growth phases.

I’ve always been impressed with his commitment to investing for the long-term and how he manages to look at startups with a framework more similar to value investing than most startup investing.

“Do People Really Downsize?”

Bill McBride pulled some quotes from a post by economist Josh Lehner, at the Oregon Office of Economic Analysis on the topic.

In fact it is less common today than in decades past. However, among those that do move in their 60s and 70s, they downsize. Given the large Baby Boomer generation continues to age into their retirement years, the absolute number of such moves is expected to rise, even if it remains a relatively small share of the housing market overall.

The original study did not include state by state data. My guess is there are very few intrastate moves in California, due to tax laws that tie tax values to the purchase price, thus adding a cost even when downsizing to those that purchased homes at prices far below today’s values.

Do Long-Term Investors Need Bonds?

Ben Carlson answers a reader’s question on bonds, saying they have underperformed stocks in all but three eras. He believes they are important for investors looking for more stability:

Investing 100% of your retirement assets in stocks may seem like the right thing to do on paper but very few investors have the intestinal fortitude to pull it off in the real world. Investing all of your money in stocks sounds great until you actually have to live with seeing bone-crushing losses and volatility in your life savings.

I tend to believe bonds are not worthwhile for a relatively active investor given the small upside.

Sheep Logic – Epsilon Theory

A long, winding post on the behavior of sheeps, and what we can learn about humans, herds and investing.

Here’s the thing I’ve learned about sheep over the years. They are never out of sight of each other, and their decision making is entirely driven by what they see happening to others, not to themselves. They are extremely intelligent in this other-regarding way.

It’s not what the crowd believes. It’s what the crowd believes that the crowd believes. The power of a crowd seeing a crowd is one of the most awesome forces in human society. It topples governments. It launches Crusades. It builds cathedrals. And it darn sure moves markets.

This type of observational decision making seen from herds leads to common knowledge.

Common knowledge is information, public or private, that everyone believes is shared by everyone else.

The power source of the Common Knowledge Game is the crowd seeing the crowd, and the dynamic structure of the Common Knowledge Game is the dynamic structure of the flock.

Final Thoughts

Nothing much has changed in the short-term and we are remaining fully-invested, letting curiosity lead to new opportunities.

 

Elimination mortgage interest deduction increases homeownership

This seem paradoxical on the surface, but makes sense in this light:

Eliminating the mortgage interest deduction causes house prices to decline, increases homeownership, decreases mortgage debt, and improves welfare. Our findings challenge the widely held view that repealing the preferential tax treatment of mortgages would depress homeownership.

via Eliminating the mortgage tax deduction could boost homeownership at Marginal REVOLUTION

Not near a real estate peak

However – even though investment in single family structures has increased from the bottom – single family investment is still very low, and still below the bottom for previous recessions as a percent of GDP. I expect further increases over the next few years.

via Q4 2017 GDP Details on Residential and Commercial Real Estate at Calculated Risk

Alternative Investment Options

Alternative investing, meant to include anything not traded on the traditional finance exchanges, are enticing to small investors because of the potential for more control and greater upside. This typically comes in exchange for more volatility and/or less liquidity. Essentially, there’s a cost for investing in public markets due to the ease of access and liquidity and alternative investments should seek the investments that may be a little harder to reach and get greater returns.

With that in mind, here’s a few ideas on alternative investment options:

  • Real estate. The biggest alternative investment market. Many different ways to invest from very hands, fix and flip, to passive investments in real estate projects. Lots of potential to use leverage. Many online tools have become available to help investors find projects. Returns often not as good as what can be found by networking for deals.
  • Crypto. New market that went from ~$15 billion to $500 billion in 2017. Lots of potential to invest still. Bitcoin and ethereum have potential. More exciting is new technology will result in some big winners. Finding the best tokens is very difficult. Very risky overall.
  • Forex. Never interested me much as it seems there is always somewhat limited upside. Seems not meant for passive investing but active trading.
  • Peer-to-peer lending. Appears quite risky but have not looked into it much.
  • Angel investing. Many online tools for investing in new businesses. Very limited liquidity. Potential for big gains. Very volatile.
  • Buying businesses. Not necessarily passive, amount can be determined by owner. With right criteria, risks can be mitigated. Some potential for leveraging money. Can result in cashflow or flip for a big payoff.

We’ve already invested in some of these and we’ll look at some of these options in more detail with new posts over the coming weeks and months.