Its looking like a bear market for stocks

   While today's action was brutal and senseless it is starting to confirm a distinct shift in the character of the market. We may be on the verge on another bear market which could be equally as vicious as the last one.  Generally speaking the best indicator of a bear market is whether the market is above or below the 200 day moving average. It is a simplistic indicator but it has been one of the more reliable indicators over the years. As you can see the market is now below the 200 day moving average and has been so for over a month. This is particularly serious and should not be ignored. The only debate right now is whether this is temporary. If you look back over the years you will often see that within bull markets, the market has brief dips below the 200 day moving average before resuming the uptrend. So the real question that we have to solve is if this dip below the 200 day is one of the those bull market dips or the beginning of a new bear market. Answering this question is never easy or a precise science but we shall try.

    One thing to remember is that there is no one indicator that will always give you the correct answer, so it is best to assemble a few key indicators and see what they are all telling you. My next indicator is the US bond market which is composed of pretty smart people who have a good history of predicting recessions and thus bear markets in stocks. There are two key things to look for in the bond market--an inverted yield curve or a distinct flatness to the yield curve. Generally these signal that the bond market is expecting slow growth in the economy and low inflation. So what is the bond market telling us now? Well we have not seen an inversion but we have seen a flatting of the yield curve in respect to the 2/10 and 10/30. Furthermore the 10 year fell below 3.00% recently which was not seen since the fall of 2008 and we know what happened back then.

   The next indicator I follow is the Yen Carry Trade (represented as AUD/JPY), which you know I think is one of the largest ponzi schemes in history. While this may be true, the carry trade is also one of the greatest sources of global liquidity as investors sell the yen short to buy more risky and high yielding assets to earn a spread. Because the spread is usually small 4-6% these enterprising investors use leverage to enhance their returns which makes their position even more dangerous to external shocks to the economy. Naturally these investors have to stay ahead of the market and are always on the lookout for potential problems that could ruin their investments. You will see that in the summer of 2007 the carry trade broke down quite violently as forced liquidations caused substantial losses in AUD/JPY. To me this is an indication that global liquidity was shrinking which could negatively impact stock prices. I use the same 200 day principal for Aud/Jpy things as with the SP 500 and things are good above and bad when things are below.

 The dollar is another indicator that is helpful. When the dollar is going down global liquidity is expanding and asset prices are usually rising. Conversely when the dollar is declining global liquidity is contracting and asset prices are falling. Currently the dollar has rallied from a low of around 74 to around 86. The dollar is also above its 200 day moving average which indicates that this is a strong trend and not some simple bounce for the buck. The move in the dollar has been mainly due to problems in Europe but the reason is immaterial in my opinion. The important thing is that the dollar is incredibly well bid and this is usually a negative for stocks.

   In conclusion, all four indicators I follow are flashing major warning signals that we are indeed entering a bear market. This does not mean that stocks are necessarily going to crash (that only occurs in October) but it does mean that stocks will most likely decline with the occasional and strong bear market rallies. But as always there are no absolutes in the market and these indicators are never 100% but it is some food for thought.

Black Swan Insights

Read more >>

Its looking like a bear market for stocks

Market Update

WOW! Today is turning into a real bloodbath thanks to that disastrous consumer confidence number and ongoing concerns in Europe. I have been pretty much stopped out of all long positions and am looking to short on any strength. The technicals of the market are awful- we have been below the 200 day for over 4 weeks. About the only positive at this point is the market holding the key 1040 level (temporarily) on the S&P 500. If we breach that the next level is 950 which is a long way down. On the bright side of things gold is holding up very well and is back to its safe have role. However I have no interest in gold stocks as they more than likely will follow the general indexes as opposed to gold (like they did in 2008).

Black Swan Insights

Disclosure: 95% cash, 2% in Stans Energy, and 3% in Africa Oil. Will likely increase short positions in Oil and base metal stocks.

Read more >>

Market Update

Tips for Investing in Junior Resource Companies

    We all know that commodities are hot and have been so for the last few years due to investors wanting protection from inflation and strong growth from emerging markets. The greatest gains have not been made in the commodities themselves but instead junior exploration stocks. These little companies are the workhorses of the mining industry. They scour the globe and try to find natural resources and often present high-risk high-reward investments to investors. These may be risky, but they offer investors the possibility of achieving 1000%+ returns which makes them irresistible to the speculatively inclined. In this article I am going to present some tips to help investors participate in this interesting sector without making some of the mistakes that doom most speculators.

1. Approx. 95% of all junior resource companies will go bankrupt and are not worthy of an investment. This is according to legendary resources investor Rick Rule of Global Resource Investments who has 40 plus years of experience.

2. The reason for the high failure rate is that the majority of these little companies have uneconomical deposits. Investors must really do their due diligence when it comes to evaluating these type stocks. All of them have fancy websites with copious amounts of PR which always presents them in a favorable light. They all claim to represent a "great opportunity" for investors. Furthermore these companies often pay research firms to publish "investment research" which gives specious projections and price targets. Don't fall for this trick.

3. Because these stocks are risky, investors need a substantial margin of safety along with a high potential reward before investing. This usually means you need to avoid companies with small deposits or are exploring in areas that are not likely yield a large find. This requires a rudimentary knowledge of geology which is usually outside most investor's ability, but it is necessary if you are to put yourself in a position to win. You only want to be investing in exploration companies that have the opportunity to discover large find (e.g 8-10 million ounces of gold, 100 million barrels of oil, etc). 

4. Diversify--no amount of knowledge will make you infallible when it comes to investing. The exploration business is tough even with the most advanced technology and capable management. In the end you never know if a company is going to find a deposit or whether it will be commercially viable. To guard against the inevitable mistakes you need to diversify your portfolio and never bet the farm on some stock with good prospects. In fact the allocation you have to junior resource stocks should be relatively small with perhaps 20% as the absolute limit. Why? Because the majority of you companies will likely go to zero after they fail to find any meaningful deposit. In this business your winning stocks will be few and far between but when you hit you will get a huge return. Also allocate no more than 1-3% in any individual stock to prevent against blow ups and somewhat help to buffer the expected volatility.

5. People--People matter when it comes to companies and this is especially true for resource stocks. Investors need to carefully evaluate a company's management to determine whether they are winners or simply losers. Consider the experience of management--what is their background (geology or finance), have they run companies before and what was the result, and finally have they every themselves made a geological find. The idea being that if you find management who has already built a company before from scratch then they have the necessary skill set to do it again.

6. Major Investors-- For me this is a big one. Its great that you think a particular company is worthwhile and a good investment but what do other more experienced investors think. Always take a look at the major owners of a prospective investment. Are there any standouts like Rick Rule, Ross Beaty, etc. Ideally you want to have strong backers because it shows that this company is for real and has a good chance (not guarantee) of success. After all, it has been vetted by very fastidious investors and passed their criteria. Checking up on a company's ownership can give you great leads and helps you avoid duds.

7. Finally do not try to trade these stocks as you would ordinary stocks. The volatility is often hard to stomach (30-50% moves for no reason) and it is very hard to get in and out at the appropriate time because these stocks are very sensitive to company announcements. Major news includes recent drill results, capital raising, purchase of prospective land, etc. Most of the time you will not know the exact time of the news release and could miss out on substantial moves (i have seen stocks double or fall 70% in one day at the open). So it is usually best to just sit tight once you have made up your mind and hold regardless of the volatility.

Good luck!

Black Swan Insights      

Read more >>

Tips for Investing in Junior Resource Companies

Market Wrap-- June 28, 2010

    Stocks remained largely unchanged as the major indices fluctuated between gains and losses. While stocks showed little directional bias, bonds remained well bid with the 10 year yield falling to 3.04% which indicates concerns about growth in the economy and deflationary fears. The 10 year is getting close to its lows back in the fall of 2008 of around 2.65% which has to provide some caution to equity bulls. Gold was the standout today falling from an intraday high of $1260 back to $1239. Some have suggested the rising dollar as the reason for gold's decline but that would go against the way gold has been trading recently (as a safe haven currency/hedge against the Euro). On the forex side of things markets remained largely neutral with the dollar increasing against most counterparts. The euro was down on market concerns regarding Spanish banks and Romanian sovereign debt problems.

We also had some economic indicators which were largely positive with personal income up 0.4% and personal spending up 0.2% indicating that consumers are still spending money and for at least now ignoring the European debt crisis.

Big economic news tomorrow with the Case-Shiller index and Consumer Confidence. Both of these should be large market movers as they provide a look at the state of housing and consumers willingness to spend money.

Black Swan Insights

Read more >>

Market Wrap-- June 28, 2010

The Keynesian disease strikes again--Krugman warns of third depression

     Keynesian aficionado Paul Krugman is out with another article today which claims we are entering a third depression because policy markers are not spending enough money to support growth. Apparently the US running 1 trillion + deficits for the foreseeable future and money printing by the Federal Reserve is not enough. You see when you have the Keynesian disease as Krugman does money printing and deficit spending are considered good and proper. Because after all, it kicks the can down the road until you end up like Greece which ran out of time (do we really want to end up like Greece?). Politicians love inflation and irresponsible spending because the majority of the population have no idea what inflation is (including the financial community) and love getting "free stuff" from the government. You can temporarily live in bizarro world where there are no consequences of your actions. Hey it worked in Greece for quite a while but when it ended it ended in the blink of an eye.

    Krugman tries to play the beneficent economist who is worried about the workers of America and demands that money printing accelerate to help the people. No matter that inflation has destroyed the middles class as wages adjusted for inflation remain stagnant for 40 years. The Krugman (Keynesian) solution of course was to get the desperate population addicted to debt (mortgage debt, credit cards, HELOC) which temporarily helped families maintain their lifestyle without more income. But then of course we have the housing bubble created by the Federal Reserve (following Keynesian principles) which put the final nail in the coffin of the US middle class. Today you now have debt slaves who owe $500,000 to the bank when their home is only worth $300,000. Don't worry though, Krugman and his Keynesian lunatics have a solution for this: inflation. If they can debase the purchasing power of the dollar enough, it will wipe out the majority of debt in the economy and magically allow consumers to releverage again with another fantastic credit bubble. It's going to be one hell of a ride.

Black Swan Insights

Read more >>

The Keynesian disease strikes again--Krugman warns of third depression

My favorite momentum stock right now

Heartware International (HTWR)

Company Description

HeartWare International, Inc. (HeartWare) is a medical device company developing a family of implantable Left Ventricular Assist Devices ("LVADs") for the treatment of advanced heart failure. The Company is listed on both the Nasdaq Stock Market and the Australian Securities Exchange (ASX).

Chart

Comment

You can see why this is my favorite momentum stock. Whether rain or shine (or market crash) this stock keeps going up. I also like it because it is relatively unknown to Wall Street analysts and major institutions. The only question is when to get out before the inevitable crash all stocks face. For me I will probably get out if the stock breaks below 70 or before earnings. As you may know I never trade stocks before earnings after my many bad experiences.  

My basic trading style is pretty simple. I pick 10 stocks making 52 week highs and buy them and then pick 10 stocks making 52 week lows and short them (boring strategy but it has worked for me). I generally don't mess with large cap because you can get larger percentage moves with small to mid cap companies. My investment style as compared to my trading style is completely based on fundamentals and research. I often require a substantial potential reward versus risk before I buy stock for investment purposes  

Disclosure: I own shares in HTWR with a cost basis of around 60 and will most likely sell on any weakness.

Read more >>

My favorite momentum stock right now

Emergent Group in Good Health

About Emergent Group

Emergent Group provides mobile medical laser and surgical equipment in 16 states on a per-procedure basis to hospitals, outpatient surgery centers and physicians' offices. Surgical equipment is provided to customers along with technical support personnel to ensure that such equipment is operating correctly. Through its wholly owned subsidiary PRI Medical, the company currently offers its services in five states in the western United States and 11 states along the eastern seaboard.

Company Website: http://www.emergentgroupinc.com/

Stock Symbol: LZR

Market Cap: $48 million

Investment Thesis

Emergent seems to be in the right place at the right time. The market for mobile laser/surgical equipment is expected to grow at low double digit rates for the next few years thanks to favorable demographics (older populations require more health care services) and hospitals looking for cost effective medical solutions. Emergent rents its laser and surgical equipment on a per use basis to hospitals and physician offices. This service is in great demand because hospitals are starting to see that they can save money by simply renting Emergent's equipment instead of purchasing the often expensive laser and surgical equipment. Also Emergent provides the necessary technical support which is another added benefit to hospitals who may not have staff experienced using this kind of equipment. Furthermore this business model allows hospitals and physicians to give their customers access to the latest technology.

The company operates in only 16 states so the potential for growth is there along with possible international opportunities later on. Another source of future growth is through expanding their product offerings. Right now the company mainly rents surgical and laser equipment used for BPH, urinary incontinence, pelvic organ prolapse, menorrhagia, cryosurgery for treatment of prostate cancer, TMR heart surgery, and lithotripsy. The company also offers lasers used in popular cosmetic procedures.

One of Emergent's greats appeals is that it operates in an almost recession proof industry which holds up well during periods of economic weakness. While the economy has been horrendous over the last 3 years, Emergent has grown revenues and cash flow every year which is quite a testament to the strength of the business model. However the CEO did warn investors that while there is always risk of people delaying certain procedures they cannot do so indefinitely.   

Another thing I like about the company is that the stock is trading at fair price. Based on 2009 earnings of .49 cents the company only trades at 14 times earnings which is attractive considering it is a growing company with strong fundamentals. Best of all the company pays a large dividend which equates to a 5.8% yield. While some might see the large dividend as evidence that the company has few growth prospects, I disagree. This simply reflects the advantages of the company's business model which requires little capital expenditures to grow. It also reflects management's treatment of shareholders (they prefer giving the money back to the company's owners instead of wasting it).

As with all investments there are risks that must be considered as well. The primary risk is that larger and more diversified companies get involved in this industry because of its attractive fundamentals and compete on price. This could easily squeeze margins and force smaller names like Emergent out of business. So far this has not occurred but it is always a serious risk.

Management

Since 2003 the company has been run Bruce Haber who has 27 years of experience in the health care industry and running businesses. The management structure is a bit peculiar. Officially Bruce Haber is President of BJH Management, LLC, a management firm specializing in turnaround consulting and private equity investments. Emergent entered into an agreement with BJH Management to contract the services of Mr. Haber to serve as the company's Chief Executive Officer. I really can't find any problem with the company's current management and they seem more interested in value creation as opposed to looting the company (always a positive). Management and the board together own approx 48% which certainly align their interests with shareholders. More importantly the company pays a strong dividend which is extremely rare for a small cap company which is growing at double digit rates. Bottom line: since present management took over the stock has gone from .40 cents to $6.95 in 7 years. You can't argue with results.

Financial Position

Emergent is in a very strong financial position with $5.3 million in cash and little debt. More importantly the company generates substantial cash flow which easily covers the large dividend. One favorable aspect of the company's business model is that a lot of their revenue is recurring with minimal capital expenditures which gives the company financial flexibility.  

Major Investors

The company for the most part is unknown on Wall Street and as such enjoys little institutional interest. The company's shares are mainly owned by management and the board of directors with the CEO owing 24% of the company. Only 8% of shares are held by institutions with the rest owned by retail investors.

Summary

Emergent is a small cap company which offers the unique advantage of providing investors with growth and a large dividend. The company's business is somewhat protected from economic fluctuations which gives investors more stability than other cyclical companies. The only problem I see with the company is a lack of catalysts to significantly move the stock. While this may not be a drawback to some I usually like to know that my investment will not be simply left up to the direction of the general stock market. However, if you are looking for a company with good growth prospects and in a stable industry Emergent may be for you.
Black Swan Insights

Disclosure: Nothing yet but strongly considering buying the stock.

Legal Disclaimer: I am not an investment advisor and nothing on this site should be interpreted as investment advice. Please consult with your own financial advisor before investing in the stock market or any financial asset. (I know this is a stupid statement but for legal purposes I have to say it. Thanks)

Read more >>

Emergent Group in Good Health

Weekend Reading and Audio

Here are a few interesting reads and audio.

1. Nations Must Resist Protectionism, G-8 Leaders Say

2. Gulf oil spill: Could 'toxic storm' make beach towns uninhabitable?

3.King World News Interviews--Technical Analyst Robin Griffiths and James Turk

4. Top Small Cap Stocks of the Week

5. Gold Seek Radio--Peter Schiff & Keith Schaefer

6. China’s Export Economy Begins Turning Inward

7. Trader's Narrative Weekly Sentiment Update

Have a great weekend!!


Black Swan Insights

Read more >>

Weekend Reading and Audio

Why do Stocks crash in October?

It is a funny fact of history that stocks seem to crash (20% drop in a few days) in October as opposed to any other month. The only theory which seems to explain this with any real validity involves agricultural cycles and liquidity problems for New York banks. After the Civil War, a federal law was passed that required country and agricultural banks to keep 25% of their deposits with certified national banks which were mainly based in New York. Because the New York banks had to pay interest on these deposits which could be recalled at any time, they lent this money to the Wall Street brokerage houses which in turn lent it to speculators for margin loans. In theory. this made sense to the national banks because call rates were high, and if any of their deposits were recalled, they could quickly get their money back on a daily basis as long as liquidity was good.

So to a certain extent, stock market liquidity was dependent on how much agricultural banks had on deposit with the major New York banks. This, of course, was dependent on the agricultural cycle and particularly the wheat harvest. When the harvest was complete and ready to be shipped East, the agricultural and country banks would recall their deposits with the New York banks which would recall their margin loans. As a result, money became very tight on Wall Street, and margin rates soared (reaching at times 1% per day).The worst of the liquidity crunch was in, which would be the reason that speculators on margin were forced to sell their shares to meet margin calls. This would create a cascade effect if there was a enough leverage in the system.

While this theory explains market crashes in the late 19th and perhaps early 20th centuries, it still does not explain why we still have crashes in October like 1987 and 2008. The only idea I have is that by now every market participant and investor has developed a deep psychological fear of October (because of previous crashes), which leads to a self-fulfilling prophesy. Finally, I will leave you with a quote from Mark Twain who wrote, "October.this is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February."

Black Swan Insights

Read more >>

Why do Stocks crash in October?

No Surprise from the Federal Reserve--the lunatics are still running the asylum

The Federal Reserve run by our favorite bedlamite Ben Bernanke announced that they intend to kept rates at 0% for a long time. It is pretty simple for the Fed decision makers--follow the Taylor rule which says that rates should remain at 0% through at least 2012 thanks to excess slack in the economy and high unemployment. Who cares if savers get robbed and all of the profits flow to our virtuous banksters, after all its good for the economy.

This zero interest rate policy shows you how weak and vulnerable the Fed believes the economy really is (officially of course it is recovering). I also doubt the Fed will every sell there portfolio (bought with printed money) and is more likely to expand the program to prevent housing from double dipping.

But for now the markets like it.

Black Swan Insights

Read more >>

No Surprise from the Federal Reserve--the lunatics are still running the asylum

My investment in Stans Energy

UPDATE: Position Sold 2/5/2011

Click Link for Update On Stans Energy Oct. 25, 2010

About Stans Energy

Stans Energy Corp is a Toronto based company focused on developing properties containing Rare Earth Elements (REEs), Uranium, and Associated Metals. Stans owns five mineral properties in Kyrgyzstan, of which Kutessay II is most advanced.

Company Website: StansEnergy.com

Symbol: RUU.V on the Toronto Exchange and STZYF.PK on the american pinksheets.

Investment Thesis

Before I go into the investment reasons for Stans I think I should first discuss the rare earths industry in general. Overall the rare earths industry is in somewhat of a mania thanks to James Dines (major investment newsletter) who pumped the stocks in May 2009. This had the effect of propelling many of these nothing companies 8-10 fold in under 9 months , leaving many of them egregiously overvalued. However, Stans Energy has escaped this mania because the company only acquired their rare earth property in Dec 2009 which benefits investors looking for exposure to rare earths.

With that said lets get to why Stans Energy makes a compelling investment. Instead of going out and exploring for rare earths Stans simply bought an existing mine in Kyrgyzstan called Kutessay II for $855,000 (pretty good deal). This previously producing mine was operated by the Soviet Union between 1960-1991 and made up 80% of total rare earth output. After the fall of the Soviet Union the mine was placed on care and maintenance. It is estimated that the mine was only 1/3rd mined and has potential for expansion through further drilling. The mine produced all 15 rare earth elements (at 65% recovery rate-good for rare earths) and included a good mix of 50% Heavy rare earths (HREE) which are the most economically profitable. Because this was a previously producing mine, there is excellent infrastructure which minimizes the cost to Stans Energy. All necessary roads are there along with a power source and a railway. More importantly Stans has purchased an option to buy the processing mill which was previously used for Kutessay II. This is a major plus for Stans because processing mills are extremely expensive to build from scratch. Stans management has indicated that 3 of the 4 required processing plants are there and in adequate condition. Obviously they will have to spend money to upgrade and enhance some of the facilities but this gives Stans a real advantage over its rare earth competitors.

One major concern regarding Stans Energy is the political turmoil and violence in Kyrgyzstan which does not seem to be going away any time soon. However I do not think this is a major problem for Stans considering the current government is supportive of opening the mine and has not shown any interest in expropriating privately owned assets. Also the violence you hear about on TV is not located anywhere near the mine so the reduces the chances of the mine or processing facility being vandalized. Finally, many members of Stans board and management have important political ties and contacts in Kyrgyzstan which should help them get this mine back into production.

Timeline

For a company which only acquired their property 6 months ago I must say management has been very quick to get the ball moving. The company recently outlined the plan for the next few months which includes completing a JORC resource estimate, underground drift resampling, complete a comprehensive study to discern what it will take to get the mill processing plant up and running, and identify future drilling sites to potentially expand the official resource estimate. Once this is completed the company will go ahead with a feasibility study. Stans goal is to become the first rare earths producer outside of China and because they are only redeveloping an existing mine I think they have a good chance of accomplishing this. As to when the mine will be back into production I do not for sure as the company has not disclosed this fact. However, I would estimate that we could see this mine back into production by the end of 2012.

Management

From what I have observed so far the management team under CEO Robert Mackay is pretty business savvy. After all they were able to get a proven rare earth mine for $855,000.  No doubt the boards extensive Kyrgyzstan political contacts helped the process but it was a great move for shareholders. Furthermore, the company has done an excellent job of recruiting knowledgeable experts in the rare earths sector which should help provide the technical know-how to get this mine back into production. My only complaint is the high share count which is always a problem for junior resource companies (currently 141 million).

Financial Position

There is no question that Stans will need to raise more money which of course means future dilution to shareholders. However this is what happens with junior resource companies and is necessary in order to get the mine into production. The company should not have a problem raising the money the only question is on what terms. The company has approx. 23 million warrants outstanding which should also be a potential source of funding assuming there in the money. My hope when it comes to future capital raising is that the company waits until they complete the JORC estimate in October 2010, which should provide a nice bounce for the stock.

Because of the strategic nature of the deposit I believe the company will be able to arrange an off-take/financing agreement with a user of rare earths. This will dramatically reduce dilution to shareholders and raise the company's profile within the investment community.

Major Investors

For some reason I have not been able to find an ownership list for Stans Energy. However, management has a strong interest in the stock and owns 23% fully diluted. Also, Pinetree Capital owns aprox. 9% of the company.


Summary

Overall Stans Energy represents an attractive investment for investors interested in the rare earths sector but do not want to buy into the high flying stocks. Stans is in my opinion a much lower risk than the other companies because they are not blindly exploring for rare earths but already have a proven mine which requires much less capital to put into production than building a mine from scratch. There is also an upcoming catalyst (approx Sept 2010) when the company will announce their JORC estimate which should confirm historical estimates. While Stans has a lot in its favor there are always potential risks and in small junior resource companies there are in more risks to evaluate. Most people will point to the political problems in Kyrgyzstan but my greatest are of concern is with future dilution and how the company is going to raise all of the money necessary to get the mine into production. However I believe in this case the potential reward greatly out ways the risks and provides investors with an excellent opportunity.

If you want some more information on the company you can check out a presentation by the CEO at an investment conference by clicking here.

Black Swan Insights

Disclosure: 2% of my portfolio is invested in Stans Energy. My basis in the stock is .30 cents.

Legal Disclaimer: I am not an investment advisor and nothing on this site should be interpreted as investment advice. Please consult with your own financial advisor before investing in the stock market or any financial asset. (I know this is a stupid statement but for legal purposes I have to say it. Thanks)

Read more >>

My investment in Stans Energy

How Much Do You Really Pay in Taxes?

I always get a kick out of pundits who claim that we are lucky to live in the US because we have lower taxes than the rest of the world. Yes, its true that compared to Europe we have slightly lower taxes but that certainly does not mean we have low taxes. In fact I have compiled the total amount of taxes that I have to pay for the "privilege" of living in the US and California. As it turns out I pay more than medieval serfs did to their feudal lords (lucky me!). No wonder people are leaving the US to escape this form of slavery.

33% goes to the Federal Government (for foreign wars which enrich defense contractors)

9.5% goes to the California state government--most of it goes to corrupt politicians and welfare for illegals.

7.5% to Social Security and Medicare (talk about a ponzi scheme), which I cannot opt out of. If I do not pay this unconstitutional tax I will go to jail.

8.25% for California Sales Tax---Ah its great to live in California(LOL)

1.25% property tax. (you see it is by default the government's land, even though I pay for the mortgage.)

3-5% is stolen through inflation by the Federal Reserve (kudos the Ben Bernanke and his banksters) and remember this tax compounds every year, becoming more and more oppressive.

As you can see almost everything I earn goes to taxes. I even left out other taxes like gasoline tax (35 cents a gallon), car registration tax ($500 for the privilege of a car), etc. But at least corporations like Goldman Sachs and Intel don't have to pay taxes (at most 1% in income taxes according to their 10-Q's).

Black Swan Insights

Read more >>

How Much Do You Really Pay in Taxes?

Evaluating Risk versus Reward in Stock Analysis

One of the biggest mistakes people make when investing in a stock is failing to consider the stock's potential risk versus reward. Oh sure they fantasize about the upside while dismissing any thought of a serious decline in the stock. Other more prudent investors think they are being sagacious by purchasing "safe" blue chip stocks like Bank of America, Procter & Gamble which will protect them from a declining market. what these investors forget. Unfortunately these investors have seen there supposedly safe stocks fall by large amounts   In this article I will postulate that purchasing safe stocks with limited upside is the most dangerous kind of investment and that it would be safer for investors to set aside 20-30% of their portfolio in a basket of 20-30 high-risk high-reward small cap stocks.

The line of reasoning behind risk/reward analysis is that a stock's potential reward (appreciation) should greatly out way its risk (substantial decline) by a large margin. Why? Because when you invest in a stock (or even index fund) you are assuming a major risk that you could permanently lose your investment capital. I know that this is somewhat of a controversial statement to some investment advisers who believe that stocks always do well over the long term and that you should assume 10% stock appreciation. However as most investors have learned the hard way over the last decade it is not your divine right to 10%+ returns in the stock market. Many investors thought buying big blue chip stocks like Citigroup, AIG, or Enron would be a conservative way of protecting their capital and providing a decent and reliable return. I would argue that contrary to their intentions these investors were actually recklessly gambling because they forgot to consider the risk/reward that these stocks presented. When you purchase large (above 50 billion market cap) stocks like I previously mentioned you know that you will never achieve large returns (3-10X) and at the very most will likely receive 7-15% per year. Even these returns are only achievable if the general stock market itself rises. So you can see that the upside to these stocks is severely limited and this assumes favorable market conditions.

Now lets consider the downside (risk) of these type stocks. You will have noticed that over the last 10 years there have been two occasions where the market itself has fallen by approx 50% which took down all stocks with it. We have also witnessed formerly reliable companies like Citigroup and AIG fall 90%+ in less than a 1 year.  If you look at a chart of almost any stock over the last 10 years you will see that it has had at least 1 period where it fell at least 50%. I realize that there always the exception but my point is that stocks often have the ability to fall significantly for no other reason than the general market did. So when considering the downside risk of a stock I like to assume that any stock has the potential to fall between 50-70% and the worst case 100%. I realize that some may argue that this is a purely arbitrary assumption that cannot be relied upon but I would counter that investors should always assume the worst so that can prepare for it and not be shocked and panicked when it does occurs. After all no professional analyst thought it was possible for Citigroup, Bank of America, etc to fall as much as they did. i remember an analyst who thought Citi was a buy in 2007 at 55 and had a price target of 65 based on "strong fundamentals." So lets consider the risk/reward in this case: the upside is 10 dollars or 20% and the downside is assuming 50% is 27.5 points. Would you invest with these kind of odds? I certainly would not because it does not present a favorable risk/reward.

One important thing to remember regarding risk/reward analysis is that it is entirely subjective. You ask 10 different people to analyze the risk/reward of a company like Apple and you will probably get 10 different responses. However there are few principles which can help determine a company's true risk/reward. The larger the company (by market cap) the slower the growth rate and as such the lower the capital appreciation potential of the stock. This obviously favors small cap companies because it is much easier for a 50 million market cap company to double than a 100 billion company. Another principle is to be conservative with future estimates and not over exaggerate a company's prospects.

I know at this point you thinking I must be crazy for saying that it is safer to put 20-30% of your portfolio into a basket of  high-risk high-reward micro cap stocks compared to safe blue chips companies. It's an understandable first impression but give me a change to explain the logic. First, I would say that it is important to adequately diversify your micro cap stocks picking say 25-30 companies (from different sectors and industries) so they would only represent around 1-1.5% percent of a portfolio. This will help mitigate the effects of a company blow-up due to unfortunate events, fraud, and mismanagement. Second, this strategy puts the odds of finding a few success in your favor. All you need is 2-3 big winners to offset any losers and then some. To someone like myself this really appeals to me because I do not have to be right very much in order to make a nice return on capital.

So you have heard the advantages of this strategy but it is now important to understand the risks as well. This strategy only works in a rising market--if the market crashes 50% like in 2008 all stocks will drop and micro caps because they are smaller and less liquid will likely fall much more than the market. For example in 2008 junior resources companies fell on average 80-99% regardless of fundamentals. Now some foolish experts (Greenspan, Bernanke, etc) will postulate that 2008 was a 1 in 100 year event that should never be expected to occur again (LOL). Personally I am not satisfied with this conclusion and believe that the stock market could easily fall 50% again in the next few years. So the question is how to know when it is safe to buy these micro/small cap stocks? Generally speaking when the S&P 500 is above its 200 day moving average the market is in a bull market and below it is in a bear market. So as long as the market sustains the bull market (above 200 day) it would be all right to maintain this strategy.

One other consideration with regards to this strategy is obviously stock selection. Theoretically an inexperienced (or simply unlucky) individual could pick 25-30 losers and sustain a large loss for his overall portfolio. This is why the only person who could attempt this strategy would be someone who has the time and inclination to do the research on individual companies. Believe me is is quite tedious finding information regarding these companies because there are no analyst reports or anything. You have to do your own primary research surveying the general industry including competition, regulatory problems, and other variables.

In conclusion I am not telling anyone to do implement strategy but hope to help investors by showing them how to apply risk/reward analysis to stock investments. As we have seen bigger and safer stocks recommended by investment advisers are not as risk free as they would like you to believe. Even indexes like SPY can and do fall 50% and rarely offer an attractive risk versus reward to most investors. The only talk of potential risk/reward that I have ever read relates to active traders and not investors. I think it is a valuable tool in evaluating stocks rather than the usual technical and fundamental analysis.

Black Swan Insights

Read more >>

Evaluating Risk versus Reward in Stock Analysis

Using Sentiment Indicators for Market Timing

While many market participants are constantly looking at charts trying to decipher what the zigs and zags mean, they are forgetting about a powerful indicator called investor sentiment. Quite simply, a sentiment indicator measures what market participants are thinking and feeling. The line of reason behind this method is that the herd is usually bearish at the bottom and bullish at the top and make for a great contrarian indicator. I have noticed that over the last 1-2 years sentiment indicators have been more accurate when it comes to market timing than normal technical indicators. Remember March of 2009 when everyone was bearish and retail investors were busy pulling tens of billions out of the market? That of course was the exact opposite of what they should have been doing as the market bottomed and surged 80% in 14 months. In the stock market emotions (fear and greed) are not your friend. You have to have the understand that it is most profitable to buy fear and sell greed in the market and sentiment indicators are the only way to achieve this.

There are many sentiment indicators out there and none of them are 100% accurate. I have found that it is best to follow 5-10 indicators and only make a trade when the majority of them are at a buy/sell level. Here are a few that I follow:

1.  NASDAQ Daily Sentiment Index---

A proprietary indicator developed by Market Harmonics to measure bullish and bearish sentiment trends and potential reversals in the NASDAQ and tech-related
 
2. Put/Call Ratio---
Daily Put/Call ratio data based on total CBOE options volume.
 
3. Volatility Index (VIX)---
Vix is generally considered the fear gauge in the market and always spikes higher when the markets are declining and people are panicking. Short term bottoms are usually close when the vix gets between 30-40.
 
4. Investors Intelligence Survey---
Charts created from weekly data courtesy of Investors Intelligence. The data is used to determine the ratio of bulls to bears to signal potential sentiment extremes that lead to market reversals. Not as reliable as the other indicators but is useful when the indicator is at an extreme.  
 
5. ISEE Sentiment Indicator-
Is an indicator that uses the number of calls and puts purchased by customers on the International Stock Exchange and does not include market makers. Generally a number above 225 means the market is bullish and is likely near a top. Conversely a number near 100 means the market is negative and the market is near a short term bottom. I only use the 10 day moving average.
 

Lets take a look at one of my favorite indicators (NASDAQ Sentiment Indicator) and see if it was helpful to investors.

If you look carefully you will notice that towards the end of April the index hit an extreme high indicating a high degree of investor sentiment. This turned out to be a good warning to contrarians to be selling long positions and initiating short positions. You will also see that the index fell quite sharply during May's steep decline in stocks and fell to a low that had not been seen since Oct/Nov 2008(market crash). Despite the doom and gloom in the press and blogosphere this was the time to be buying and since then the market has rallied nicely.   

So far I have discussed the benefits of these indicators but I also need to note the disadvantages. Based on my personal experience these indicators are correct within about 3-10 trading days. While this may sound pretty good it is very hard to be buying stocks when the markets are in free fall. You feel like you are walking into a buzz saw so you have to be willing to hold your position knowing that you will never perfectly time the market. To do this I suggest buying in increments and only averaging up for long positions and averaging down for short positions. 

In conclusion sentiment indicators should be an integral part of an investors tool kit to help them make investing decisions. It allows you to take control of market fluctuations rather than being a victim who sells in panic at market bottoms and buys at market tops. I can say from personal experience that following sentiment has helped me stay on the right side of the market. My own sentiment regarding market fluctuations has changed dramatically in the sense that I am only bullish when there is extreme market bearishness and visa versa.  

Black Swan Insights 

Read more >>

Using Sentiment Indicators for Market Timing

Update on Africa Oil Investment

Since my last post on Africa Oil the stock has done pretty well (up approx 45%). The main reason for this was Casey's Research(very respected) recommending the stock as their top pick for 2010. This was enough to move the stock from 88-90 cents to 1.35 in only two days. Even though this benefits my position I don't like this kind of action. What you have is a bunch of hot money speculators moving into the stock hoping for a quick profit. This will undoubtedly lead to more volatility (both to the upside and downside). This is unfortunately part of investing in small cap resource companies.

Regarding Africa Oil's fundamentals little has changed since the last post. The company finished drilling their exploratory well in Kenya and failed to find any oil. However they did find 4 natural gas pay zones which is positive. In the next month the company should announce whether the find is commercially viable. I am not terribly optimistic-- Kenya has a long history of finding natural gas which was not economically viable but Africa Oil has a better chance because they found gas in 4 zones. If the find is economically viable it should be positive for the stock. Outside of this there is not much to move the stock until they spudd the Somalia well in the 4 quarter of 2010.

The only other piece of news regarding Africa Oil is their farm-out agreement with Red Emperor Resources. In exchange for paying a large amount of drilling expenses, Africa Oil will give Red Emperor a working interest in the Somalia blocks. I do not like this transaction because I would have thought Africa Oil could find a larger and more respected company to partner with. Look up Red Emperor Resources and you will see that it is a small cap nothing shell company listed in Australia. Also the company had to pay a finder's fee to commence the transaction (CDN $250,000). Could the company not find a larger company for the farm-out transaction? Overall this is a small issue but is peculiar considering the excellent prospects of the Somalia blocks. In the future I would hope the company could partner with an oil major which would increase the legitimacy of the company's prospects.

Original Article on Africa Oil

Black Swan Insights

FD: 3% of my portfolio is in Africa Oil. This is not a recommendation to buy or sell this stock. I am not an investment advisor.

Read more >>

Update on Africa Oil Investment

Still long stocks and buying more

So far the market is rebounding as the European crisis temporarily (keyword) abates. I am still long stocks and have added a few more including HTWR, NPK, MCF, UPI, IDX, and RUU.V (stans energy Canadian company). I believe that this move in the markets will take us back to 1220 (or a little higher) by late July/early August. Then things will get nasty with an expected drop of 20% in the fall. However you have to make sure that you own the right stocks as not everything will rally. I do not think commodities as a asset class will do very well. If you look at the charts all major commodity stocks failed to make new highs in April (FCX, POT,etc) which shows that they have moved from leaders to laggards. So investors have to be very careful which stocks they choose this time around. Look for stocks with good technicals and strong upward momentum like HTWR, UPI, LOGM, VASC, and OPEN. You will notice that all of these stocks are hitting new 52 week highs despite the market correction of May. They must be doing something right!

Stay safe in this volatile market!

Black Swan Insights

FD: Currently long Africa Oil, RUU.V, MCF, HTWR, MO, LOGM, NPK, SPY, IDX, and short SPY puts (terribly dangerous but for some reason I did it anyway).

Read more >>

Still long stocks and buying more