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Investment Strategy

The purpose of this site is to provide insights into the factors that affect the stock market and consequently, ideas on market direction.  We also provide ideas on positions in individual stocks--positions that will take advantage of our beliefs and ideas.

Following are three distinct factors which we believe have a profound impact on the stock market.

Sentiment

In the short-term, one of the most significant factors that drive the stock market is sentiment. The spectacular bear market rallies during the last three years have been great examples of what could happen when sentiment turns around. Whether one is trying to time a top, a bottom, or a breakout in the stock market or individual stocks, sentiment is a prime indicator. To track sentiment, we look at various indicators such as the price action and volume (by far, the most important), put/call ratios, short interest, the Investors Intelligence readings, what the mainstream media is saying, and so forth. Another indicator that we consistently track is the VIX and the VXN. While these would not tell us exactly when a top or a bottom is reached, we do get a good idea of how close we are. At the very least, we will know when a call or a put option is relatively expensive or not.

Dow Jones Industrials from June 1929 to May 1933

Dow Jones Industrials vs. VIX from January 2001 to June 2003

Liquidity

Another very important factor that affect the stock market is liquidity.  This is represented in the money supply data (measured by MZM, M1, M2, M3, etc.), the Fed Funds rate, the daily repos, mutual funds cash, and so forth.  While this is a huge driving force (representing the amount of money which could potentially go into the market) it is only so in the intermediate to long-term.  This "idle money" will just remain idle if investors do not choose to invest.

Liquidity, however, does tell us what the potential of the market is.  For example, if MZM has been flat for a whole month and mutual fund cash is sitting at 4%, then we are virtually sure the market does not have much further upside room to go.  On the other hand, if MZM has been increasing at a over 10% annualized rate and shows no signs of abating, then a continuation of an uptrend (if we are indeed in one) can be reasonably assumed. 

Valuation

We believe, in the long-run, valuation is the most important factor in investing.  Figures such as Warren Buffet and John Templeton have been very successful in basing their investment decisions on valuation alone.  During the bubble, investors and Wall Street alike lost their perspectives on valuation-believing that stocks are a bargain at any price.  Ultimately, however, people realized that you do not pay $100 million for a hot dog stand.  Not even a hot dog stand in a good location.  Not even one which is opening another one and plans to open a dozen more in the next few months!  You also do not value a website (which should go unnamed) that base 90% of their revenues in online advertising at twice the value of General Motors.  $1 trillion market capitalization for Cisco, etc.  Need we say more?

The long-run, however, could be very long.  Until stocks are of good value (which we will determine based on P/E, P/D, etc., and relative potential with other investments such as bonds, real estate, or even precious metals) we do not recommend a buy-and-hold philosophy.  For now, we will concentrate on investment sentiment and liquidity.

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