What Do You Catch When You Chase Your Tail?

Good Evening: U.S. stocks went virtually nowhere today, allowing both the bears and the bulls to claim victory. Those predicting an imminent decline in U.S. share prices took note that a slight majority of stocks went down on a day when the economic data came in stronger than expected. For their part, those forecasting a continuation of the rally since March can rightly say that the major averages have held in well and refuse to sell off in spite of a laundry list of worries. Perhaps we are all straining our eyes too much in looking for directional clues. To me it seems as if everyone wants to chase what’s “working now” in favor of what is well priced to work in the future.

Stock index futures weren’t doing much prior to this morning’s data releases, and market participants were nonplussed by both a rise in mortgage applications and a surge in durable goods orders (see below). This usually volatile statistic jumped 4.9% in July, thanks mostly to orders in the transportation sector (think: cash for clunkers). The 0.8% rise in the ex-transportation component actually just fell shy of consensus estimates of 0.9%, so there wasn’t much news in this release.

Equities opened 0.5% this morning before swinging higher by the same amount after new home sales figures were announced. Market participants double-checked their screens when they saw sales rise almost 10%. Double digit sales gains and housing have not shared the same sentence for many moons, but percentages can play tricks on the mind when the base is low enough. Plus, new home sales are but 15% of total sales (existing home sales account for the other 85%). It was thus easy to understand why the averages rolled over and went back below unchanged in the wake of this report.

The trading was then very dull for the rest of the day. The averages bobbed over and under the unchanged mark all the way into the bell. By day’s end, only the Dow Transports (-1.3%) were more than a fraction away from Tuesday’s closing levels. Treasurys, too, saw a pretty slow session. A 5 year note auction was fairly well received, and it helped support bond prices after an early decline. Yields finished 1 to 3 bps lower. The U.S. dollar index (+0.4%) caught a minor bid, while commodities went the other way by a similar amount. A 1% retreat in crude oil and other energy products paced the CRB index to a loss of 0.5%.

It’s been 3 years since traders, salespeople, and investors have been able to take a vacation in August without too much angst about the next twitch in stock prices. I guess we’re all a bit out of practice when it comes to relaxing during the two weeks preceding Labor Day, and it shows. You can’t open up a newspaper, go to a financial website, or turn on Bubblevision (a term for CNBC that Bill Fleckenstein coined more than a decade ago) without being assaulted by the latest speculative opinion about which direction the stock market is headed during the next 5 minutes — give or take a commercial break.

The bull/bear debate I described in the opening paragraph is symptomatic of our instant gratification, gotta-know-now society. Like waiting for the latest polls during election season, equity investors have fallen prey to waiting for the latest bit of information to seize upon before deciding what to do next. And earnings season has almost become a joke, since the only thing that seems to matter is whether or not a company “beat the Street” last quarter. Investors only want to see a win, and they don’t seem to care what has actually been “won” or how victory has been achieved.

Take Williams-Sonoma — please! Down on this struggling, mid to high-end retailer going into today’s earnings report, analysts were expecting the company to lose 9 cents a share (see below). When the company revealed that it actually MADE 5 cents, the buy orders flew in well ahead of the serious questions about how WSM did it (the stock rose 11.25% to finish the day at $15.47 — I have never owned or shorted a single share). The company turned punk revenues into a profit by closing stores, slashing their advertising budget, and delaying planned capital expenditures — hardly the strategy one hopes to see in a growth stock. But is WSM a value stock at these levels? Let’s say the company’s thriftiness persists and it continues to earn a nickel every quarter. Let’s also be generous and say the company triples this amount during the quarter encompassing the holiday season. After a year, WSM would post a profit of .30 versus a stock price north of $15 per share. Paying 50 times earnings for a company that is trying to shrink its way to prosperity is hardly the stuff that would make Ben Graham or Warren Buffett reach for a buy ticket. True, “normalized” earnings might well be more than $1.00 per share, but this is the “new normal” for consumers, not the old normal.

I hope more people get to experience the strange feeling I had today when I tried to establish a small long position in a tiny company that I think has a strong balance sheet and a bright future. The Charles Schwab order system wouldn’t allow me to place the order, however, offering me a phone number to call instead. When I actually reached a live person, I soon discovered the problem. I couldn’t buy the name because Schwab doesn’t log a stock into its database until someone wants to buy (or sell) it. That’s right; I’m the first investor in Schwab history to try to buy shares in this thinly traded name. “Wow”, said the order taker on the other end of the line, “I’ve never seen this happen before. And you know what? There’s no listing of any analyst coverage, either!” I may or may not make a dime owning this company, but it sure felt nice to be far away from the pulsating throng that felt the need to compete over shares of Williams-Sonoma today

What’s been lost in the modern approach to investing is a true sense of value. It’s been replaced by a deification of momentum. Thus conditioned, the investor class is starting to become a herd of momentum seekers, chasing the latest information or movements in price. Judging from the email traffic I’ve received from readers, even smart people are trying to game what the less cranially endowed crowd is doing so they can try to profit from zigging after the next zag. No matter where the market goes in the next month or two, let us hope all the short term focus, this zany worshipping of momentum, starts to fade in favor of a return to the basic principles of value. If chasing momentum was such a fruitful endeavor, then why do we laugh at dogs that chase their tails?

— Jack McHugh

Most U.S. Stocks Drop After Report on Orders for Durable Goods
U.S. Economy: July Home Sales and Goods Orders Jump
Williams-Sonoma Rises After Profit Beats Estimates

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