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Adventure Investing in the Stock Market

August 23, 2012

Despite the recent outpouring of professional manager and investor angst (please see these Letters, The Wrong Tools Eventually Strip All Nuts, August 2012), the US and other reasonably well regulated stock markets are the only markets (in our view) in which we can practice a systematic policy of investment risk aversion rather than one of risk-taking or “gambling”.

The criteria of risk aversion are that the portfolio should demonstrate the properties of “100% Capital Safety”, “100% Liquidity” and, we have reason to add, “Alpha-smart”.

The Perpetual Bond™
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
Guaranteed

If one is satisfied with less than that, then, by all means engage “The Risk/Reward Equation”

The Risk/Reward Equation

Notwithstanding our good luck or happenstance,
– if we accept the “risk/reward equation” – no risk, no reward – we will lose our money;
– if “caveat emptor” is good enough for us, we will lose our money;
– if “past performance is no guarantee of future performance” is good enough for us, we will lose our money;
– if we like Jeremy Siegel’s book, “Stocks For The Long Run”, McGraw-Hill, NY, 1994, now in its fourth edition, we will lose our money;
– if we give it to our clients, we will lose their money.

Or, we could buy high grade corporate and sovereign debt on the oft chance that inflation will remain low and we’ll also get our money back, or TIPS or RRBs which at least assure capital safety and a return at the rate of inflation in a reliable currency. However, for a possible downside to that strategy, please see our recent Letter, Numbers 20:12, August 2012.

Or, we could set up a data centre and do micro-arbitrage which should work. However,  please see, for example, Forbes, August 6, 2012, “Knight Capital: The Ideal Way To Screw Up On Wall Street” by using, apparently, an errant logarithm which, alas, doesn’t seem to have much to do with the real economy of the production and sale of goods and services.

Oh well, despite the passion and any number of apparently reasonable and exciting ways for adventure investing, of which we’ve only touched on a few, all of the major markets are significantly up but not many of the major portfolios are, apparently. The Dow Jones Industrial Companies are up +9%, the S&P TSX Composite Index is up +1% (and our portfolio in these companies is up +7% plus dividends), the S&P 500 Companies are up +13%, and the NASDAQ 100 Companies are up a spectacular +22%, so far this year.

And one is minded of Mr. Obama’s recent observation that “the US economy is doing just fine”. Thank you very much.

The Table below (Exhibit 1) summarizes our current benchmark portfolio (which is a Perpetual Bond) in the NASDAQ 100 for the year-to-date. The actual data can be had from us for free by simply sending us an email request at RiskWerk@gmail.com and consists of the three data files NASDAQ 100 (B)(N), NASDAQ 100 (B)(N) Risk Price, and NASDAQ 100 (B)(N) Stock Price in a convenient machine readable format.

At the end of December 2011, this portfolio was worth $6,759,000 (please see our Letter, NASDAQ 100 – (B)(N) There And Done That, June 26, 2012) and held an equal number of shares in fifty-one companies of the NASDAQ 100 companies . The equity portfolio was worth $3,699,000 and we also had $3,061,000 in cash which needed to be deployed by buying more of what we had and by  “selling” companies that had made a (B)- to (N)-transition in December and early January, and/or by buying the common stock of companies that had, similarly, demonstrated an (N)- to (B)-transition as new balance sheet data became generally available.

Exhibit 1: The Perpetual Bond (B) in the NASDAQ 100 Companies in 2012

(Please click on the Table to make it larger.)

“Buying” and “selling” stocks is not as easy as it sounds and the “market” provides a number of ways to do it sensibly, especially for portfolios that are much larger than this one. Please see our Letter, The Wall Street Put, August 2012, for a more detailed discussion of how we do it.

By the end of December 2011 and in early January 2012, we had increased the equity portfolio to fifty-three companies worth $5,959,000 (the Portfolio line in the Table) and retained a cash account of $800,000 (Cash) for future transactions. “Cash In” is the result of selling and “Cash Out” is the result of buying and the actual number of Transactions is noted at the bottom of the Table.

This portfolio is now worth $7,469,000 for a gain of +11% exclusive of earned dividends that will add another 2%-3% to its value when they are paid and we are holding approximately sixteen hundred shares in each of fifty-seven companies. The equity portfolio is now worth $5,533,000 and the cash account is worth $1,936,000 which, again, we have new opportunities to invest.

The Cash infusion to $2,909,000 in July over $605,000 in June was primarily generated by “selling” our interest (at profit on capital gains) in just three relatively high priced stocks (CMG Chipotle Mexican Grill at $377, ISRG Intuitive Surgical Inc at $536, and PCLN Priceline.com Inc at $643) which were indicated as having made a (B)- to (N)-transition. That’s the rule but we can also “sell” at the current price, or any time before,  by buying a “protective put” and partially offsetting the cost of that by selling an opportunistic call option on our long position with a much higher strike price and expiry date at or before the put expires. Please see our Letter, The Wall Street Put, August 2012, for more on this and the unique ability that knowing the Risk Price and (B) versus (N) affords us in the well regulated markets.

We also note that the NASDAQ 100 Index returned +22% during that time but that buying all the NASDAQ 100 companies on an equal number of shares returned only +3% (please see the Companies line in the Table). The reason is that the index is not uniform but is magically calculated by the market capitalization of each of the companies in it. And one might have to deal with a -7% decline in just one month, such as occurred in May, and many investors “deal” with that by taking the loss as hope turns to despair. Or the margin account comes-a-calling.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”.

Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability.

We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now.

The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”,  ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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