Analyst recommendations: well, that was helpful.

President Truman asked for one-handed economists to avoid hearing “on the one hand…but on the other”. Winston Churchill complained that any meeting with 2 economists provided 2 competing views – unless one of them was John Maynard Keynes in which case you got 3.

And so it is with equity analysts who try at one and the same time to recommend but point out the probable pitfalls of their advice. Consider this graph from a Morgan Stanley research report:

It so happens it is a great piece of research. But one must wonder about the worth of the blue triangle which says a buyer might make 61%. But on the other hand he might lose 75%. And there, in between, is the ‘Lord Keynes’ view that a gain of 10% is most likely.

This is why hedging is attractive: the finest brains of analysts and economists cannot – and as a rule do not – forecast. They assess current conditions.

Portfolios: navigating safe passage

Is directional risk real?

In the 2017 edition of the Credit Suisse Global Investment Returns Yearbook, published this month, is this terrific illustration of the power and danger of equity investment:

US equity investors have enjoyed 6.4% average returns over the period 1900 to 2016. That has come with a fairly hefty standard deviation of 20%. But compared to other global markets that’s not bad.

On the other hand, the US standard deviation includes a worst year return of -38.4%. But, again, not bad compared to, say, Germany or Japan right after the Second World War.

However, when the years 1929 and 1930 are included the US decline was 80% in real terms, peak to trough. For the UK the worst such range was 1973-1974 when markets fell 71%. More recently, 2008 has been the worst year on record for almost half the markets listed.

Bottom line – it’s not easy to forecast when they will happen but catastrophic declines will punctuate our equity existence. So hedge.

Subscriber research: Issue 18 released

Our latest research was released today at 10h30 GMT! It covers the following:

• A featured pair from the steel and construction sectors
• Signal price slippage – your experience
• Performance update
• Research review: commodities & cointegration
• Status of research pairs

What does a ‘featured pair’ look like? An example excerpt from issue #9 (note, not today’s release) is below:

The full version digs into both halves of the pair, provides a fundamental accounting profile and the backtest out of the ArbMaker cointegration software tool-set. If a signal is subsequently generated for this pair an alert is sent via email and mobile phone alert with complete entry details.

Trials available here.

Long / short: blending stat and fundamentals

Research review: Percent accruals (2010)

A subscriber to our premium research newsletter and owner of our software commented that he was surprised by the depth of fundamental analysis we applied to our selections.

This is particularly the case where the anticipated trade horizon demands it. That is, it is frequently a good idea to identify the stronger half of your pair and trade with it rather than against it – especially for longer trade durations. Over time pricing is more likely to reflect fundamentals than not.

This approach is in keeping with the notion of “filters” we have written about several times in our research to clients: the stat tells one story; technical indicators another; sentiment yet another; and the accounting one more (and so on). The sweet-spot where these filters overlap represents a validation of one’s primary methodology.

To underline this point have a read of this older but still valid paper that is accounting-focussed. The core, entirely reasonable notion is that cash trumps accruals – and the large data set presented demonstrates the payoff. The authors are positing that a single indicator allows traders to select both a long and a short and expect a significant reward (in the aggregate) over the following accounting exercise.

These types of indicators are useful secondary triggers that help validate a trade’s thesis. But limitations remain and it would be a misguided trader who sought to apply it (i) in isolation; and (ii) for very short-term trades.

*This is an abridged version of an excerpt from our research service. Try it free.

All time highs!

This week US stock markets hit records. Will the run continue?

Long/short approaches should not care either way – it is generally directional investors and traders who rejoice (and hope). In an ideal world one would have exposure to both strategies. But there are always important provisos to consider for long only strategies.

There is sometimes comfort taken from “momentum” arguments when buying high. Others view purchases made at all-time highs under the assumption that, over the “long term”, the passage of time will forgive paying too much today.

Maybe so, but there is no guarantee of that. A long term investment is sometimes only a euphemism for a short term investment gone bad. Worse, events may subsequently prove the purchase did not fully appreciate the context in which it was made.

We point you to an article here showing how such an attitude unravelled for one set of professional private equity investors caught in a “we must not miss out on this” mindset. It’s about a 10 minute read.

Any investment can tank. Often that may be due to factors beyond one’s control. But succumbing to the temptation of a roaring market without taking everything – most of all price – into account is avoidable!

Better still, hedge.

S&P 500 Q4 earnings season report

Some interesting and informative data for long/short traders from a 13 February “Earnings Season Update” report compiled by BoA Merrill Lynch.

With 85% of companies reported:

• 61% have beaten on EPS
• 48% have beaten on sales
• 36% have done both

Those EPS beats are better than post-2000 average of 53% but the sales results are worse than their historical 56% level.

Perhaps most interesting were these 2 graphs:

Health Care and Tech have had most positive surprises with the opposite being the case for Staples, Telecom and Utilities.

Something to bear in mind when considering sentiment.

We do Twitter (so long as it lasts)

Well those were rough results for TWTR!

None the less, we like it very much as a news source and general sounding-off platform. If you care to follow us just go here or click the graphic below.

Trump wall now an IKEA pairs trade

Satire site The Postillon has provide the world with one half of a neat pairs trade in this article.

Assuming IKEA win the Mexico Wall contract – and the pricing is undeniably attractive – the natural coupled position is provided by another IKEA product: the flat pack refugee shelter featured in the non-satire Guardian.

The main issue is getting the exposure to unquoted Ikea.

In the absence of that get non-satirical research on hedged trade ideas right here.

Trading a new Dodd-Frank Act

“The key elements of the Dodd-Frank Act in the cross hairs of President Trump (and his intentions towards these) are:

• The stress tests: relax them
• The Volker Rule: redefine (at least) the rule and permit banks to make speculative investments with deposit insured funds
• The Fiduciary Rule: enters into force this April and would stop the sale of high fee & commission products in the name of greater choice
  

Clearly, if you are in the banking and investment business such changes would mean more profit. At what cost is another matter.”

That excerpt comes from tomorrow’s edition of our research newsletter along with a specific trade idea close to execution. A trial accessing the research can be obtained here.

A broader concern in the discussion of Dodd-Frank is would such changes be, on balance, a good turn of policy? It is easy to see how they might not.

• For example, relaxing the stress tests is a step towards greater bank sector consolidation and thus increased too-big-to-fail risk. By what process might this occur? Well, should the threshold defining “systematically important financial institutions” (SIFIs) be raised it will promote M&A activity that creates larger entities that flirt with, but do not meet, SIFI status. Such new entities raise consolidation risk incrementally.

• Reinterpreting or abolishing the Volker Rule risks going all the way back to the mixing of commercial and investment bank activities that the Glass-Seagall Act abolished after the Great Depression. Glass-Seagall was specifically intended to create a firewall between customer deposits and bank speculation with those funds. Its systematic erosion in the name of “competitiveness” was a material factor in the 2007 to 2009 crisis.

• It is difficult to accept as serious an argument that suggests an incentivised salesmen sets out the case between a high commission product and a lower commission product evenhandedly. The contrary assumption has been seen before, very recently, in the subprime mortgage market. The Fiduciary Rule is due to take effect this April. A still birth would be a cause for concern.

There are usually ways existing regulatory legislation can be finessed for the greater good. With these three elements doing so requires great care.