Sunday, March 15, 2009

Bungee Jumping Aegon and ING Preferred Stocks/ BlackJack and Stock Investing: Lessons Learned & Applied

Added 3/8/2010: A detailed discussion of the Aegon hybrids is contained in a subsequent post from December 2009: Aegon Hybrids: Gateway Post (and in posts linked therein). The link to the Gateway post on the ING hybrids is ING Hybrids: Links in one Post

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I saw in the print edition of Barron's (at p. M15 ) that several of the ING and Aegon preferred issues were up 80 to around 90% last week. AEV gain 87% moving from$3.51 to $6.45. I was impressed. As I said, if those securities could take drugs, their erratic and bizarre behavior would be consistent only with a constant ingestion of a heavy cocktail of some of the stronger, illegal drugs. Buy 50 AINV at $2.35 in IRA/Revisions to top Twelve Causes of the Not So Great Depression

How many people make a concerted effort to act only after acquiring accurate and reliable information? I am not just talking about investors, but any individual making a decision in business or just in the simple act of casting a vote. There was a story in the Tennessean today about a woman who is going to send Obama a bunch of tea bags in protest of the recent stimulus bill. She has decided to become involved and has become informed about the issues by spending some time recently listening to Rush Limbaugh on the radio. This is just bizarre to me, but there are millions who form opinions and take actions based on little or no accurate information. Now, I am not going to say that Rush rarely, if ever, dispenses accurate, unbiased information. I would simply say that there are millions who view him as the only reliable source of information in the U.S., and they have a right to vote. So if anyone wants to know how the U.S. ends up invading a country that has not attacked us based on false information that millions do not even accept as false even after being proved false, then that tidbit may assist you in understanding how it happens.

It takes a lot of effort to sort through the vast array of data and information. The first thing that I do is separate fact from opinion. I could really care less about the person's opinion of what the facts mean. That is my job as a citizen and an investor. Then, I have to decide whether or not the source of the information is an ideologue who is likely to distort facts to fit their ideology. Those people have to be identified and largely ignored as unreliable sources of accurate information. A number of different sources have to be checked for confirmation rather than just looking for sources likely to confirm a pre-existing opinion. This is what many are doing when they listen to a Rush Limbaugh, Sean Hannity or Ann Coulter, that is, seeking confirmations for beliefs already held with whatever "facts" fits their ideology and are dispensed by these talk show personalities. Each source has to be assessed on a reliability scale based on my knowledge, intelligence and experience. Some data may be from a reliable source, but its very nature suggests at best accuracy only in a range. An example would be government data on inflation, unemployment, and GDP. The sheer amount of data necessary to compile such numbers requires some skepticism on accuracy as well as a recognition that it is at best an approximation. Most importantly, the search for accurate and reliable information can not be governed by any pre-existing opinion and ideology, and information inconsistent with a a belief or opinion can not be discarded as unreliable just because it is inconsistent with an opinion.

But, even after every effort is made to acquire all material information that is publicly available, there still exists factors that are unknown and unknowable. Some of the unknowables deal with the future, including matters specific to the company or the larger macro economic conditions that impact the business. When will the current downturn end would be such an unknown? I can just make a good guess, that is all. Other unknowns involve matters relating to the existing business. How much is really known about a bank's balance sheet, or the viability of their loans for example? What does even the head of GE Capital know about every risk on its balance sheet? So, how does one cope with the unknown after doing research, learning whatever you can, and applying your intellect and experience to make the best judgment on how to proceed, eliminating emotion and ego from the equation.
In blackjack, as played in a casino with real money, you can have all the information that could possibly be gathered about what to do, make the correct decision based on what you know, and still lose. Or, you could do the most stupid thing conceivable and win. Over the course of many hands, the player making correct decisions based on available data will win more games than the one making wrong decisions. Investing process with a story illustrationNow, if the good player had one more piece of information, the dealer's hole card, then there would be no contest but that piece of information will be the one unknown that will never be knowable. But even though each hand has to be played with incomplete information, the good player still has one other factor within his control-RISK. The good player can decide how much money to put on each hand, whether to double down and split a pair which will double the potential reward or loss, and when to walk away, either with winnings or the maximum amount of loss that you are willing to suffer. Investment advisors may not want to counsel clients in risk control by using blackjack as an example, but the same fundamental risk control principles are at work. I told Tyler that playing blackjack for real at a casino can be an excellent way to learn risk management and making decisions based on the maximum amount of accurate information.

I have discussed at great deal numerous risk reductions techniques that I employ regularly. Some are specific to individual securities and others are relevant to stocks as an asset class. The VIX asset allocation model is one risk reduction model that I use now among many others. Basically, it says reduce exposure to stocks when investors become more fearful and less sanguine about stocks coming out of a long period when the VIX meanders under a reading of 20. Some have told me that my discussion on this topic is hard to follow. I would pull up an interactive chart of the VIX in a separate window and trace the movement while reading the passages in the posts. ^VIX: Summary for CBOE VOLATILITY INDEX - Yahoo! Finance
It would be difficult to build a sustainable bull market move at elevated levels of volatility, which is where we have been for over a year now. People have to have stability, feel safe and secure, and comfortable about the future, as a predicate to sustain a bull market over the long term. The kind of volatility that we have been seeing particularly since Lehman's failure is the enemy of a bull market's formation.
The VIX index is for the volatility of the S & P 500 index. In some of the above linked posts, I discuss volatility indexes for the DJIA, Russell 2000 and Nasdaq. They all fit the same basic pattern, where elevated volatility is a signal to lighten stock exposure and stable readings at low levels would indicate a greater risk assumption provided the pattern was stable for at least three months for the VIX (though, history may not repeat itself).

One hard and fast risk reduction rule would be to sell stocks when there is a move in the S & P 500 index to elevated P/E ratios. The chart of ten year moving averages for the S & P 500 P/E shows two clear cases when to leave the party. NYTimes.comWhenever it spikes I will sell and I will not listen to pundits trying to justify a market P/E of 44.2. If I am alive to see it happen again as it did in the late 1990s and the late 1920s (just look at the chart), I will not hesitate to sell, and would not even pay attention to the arguments about how it is different this time. Parabolic moves in any asset class have to be sold in my opinion. The only question is how to structure the selling. My approach has been to start selling when the parabolic nature of the move becomes evident to me, space out the transactions until I believe that it would be foolish to try and hold on for more and then sell whatever is left in the particular asset class undergoing the parabolic move. I would never expect to sell at the absolute highest level and view even having such an objective to be a foolish. Then, once the decision is made to entirely eliminate the asset undergoing the parabolic move, I have to stay out until it crashes, bottoms, and everyone just throws in the towel on it. Energy was one such asset class that I eliminated during the rise to $140 a barrel oil. Treasuries are such a class now in my opinion. Technology stocks had their day in the late 1990s and real estate between 2002 to 2006.

A lot of my risk decisions involve just how much to commit to a position and how to manage it. For some bonds, I have used volatility to trade the position and to lower my cost, thereby increasing my current yield on them (e.g. the Aon TCs). Sometimes risk is managed in turbulent and uncertain times by slicing a dicing a normal order into several parts, using the volatility to manage the position by selling higher cost shares on a spike and then buying them back on a meltdown below the lowest cost purchase. For example, I made a recent purchase of Coca Cola at 41 and then in the 38 and change level. If KO spiked to 45 say, I could sell the shares bought at 41 and keep the lower cost shares. If KO then fell to 35 say, then I could buy back the shares sold at 45. This process uses volatility to make a profit, collect the dividends, and hopefully end up with shares at a very satisfactory price to me for a long term hold when the troubles end. Another way is simply to wait and buy a very high grade security on a meltdown like my buy of the TC JZE last quarter. But, in the final analysis, the most secure investment in this market is cash, and I am still sitting on about a 30% allocation even though part of me got a little feisty recently.

Mike, my much older older brother, talks about the incessant chatter that goes on in our brains and how to calm that unproductive activity. Part of that chatter may involve criticisms of other people or how we would want them to change to suit us more. I told him many years ago that my mind was free of that kind of unproductive brain chatter, and he doesn't believe me. Instead, I am engaged in a constant debate, not with another person, but with myself. Sometimes I characterize it as a right and left brain decision making process but that is inadequate. Even the intuitive and creative part is based on information accessed, evaluated and catalogued by the extremely rational side. It has a foundation, just not as cautious and deliberate . The debate can become fierce at times but that is just about the sum total of my brain chatter. There was a good debate starting on 3/6.

AIG is starting to detail how much of the taxpayer's funds went to other financial institutions.NYTimes.comYahoo! Finance

I hope that the Treasury secretary has a lot more details about the bad bank/toxic asset plan that may be revealed next week. If he has a plan that the market thinks will work, that could set off a rally.


  1. You keep making amazing posts, I enjoy reading them, full of insights!


  2. Thanks for the comment. I noticed that one of the blogs that you were following was in a foreign language that at first glance appeared to be French but it must be another language. Are you from the U.S.?