Airasia Acquiring Batavia Air

Airasia is acquiring 49% of Batavia Air while the remaining 51% is acquired by its Indonesian partner. I have mentioned that it is looking at Indonesia as the base for growth and in fact this deal is even better, accelerating further the growth of Airasia as a group.

If anyone is holding any airline stocks in the region be it SIA, MAS, Cathay Pacific, Qantas etc, do change your holding as this Malaysian company is moving mountains. The larger premium airlines should be very afraid as the future of airline business is in low costs not your premium business seats!

Do not even bother about looking at the acquisition price they are paying for, as there is no point comparing someone so flexible who can bend, squat, run, hide while the other national airlines can only sit and watch. There is no competition in the future when comes to a company which can do deals with anyone overseas. Against these players, Airasia is just competing on a different rule. The deal is just an example on how fast they can get things done. National airlines would have it much more difficult.

This is the real Airasia as it no longer is a Malaysian based airline.

See announcements below.
----------------------------------------------------------------------------------------------------

AirAsia Accelerates Indonesian Expansion Plans

AirAsia and PT Fersindo Nusaperkasa acquire Batavia Air

Thursday, 26 July 2012 for immediate release

Jakarta, Indonesia: AirAsia Berhad (“AAB”) today announced that it has through its fully owned subsidiary AirAsia Investment Ltd entered into a Conditional Share Sale Agreement ("CSSA") together with its partner PT Fersindo Nusaperkasa (“Fersindo”) to acquire PT Metro Batavia (“Metro Batavia”), which operates the Indonesian airline, Batavia Air, and Aero Flyer Institute (“AFI”), an aviation training school (together “Metro Batavia Group”). The agreement was signed today between AAB, Fersindo and Metro Batavia at a signing ceremony in Jakarta.

In accordance with Indonesian civil aviation ownership regulations, AAB will hold a 49% stake in Metro Batavia Group with the 51% majority held by its Indonesian partner, Fersindo. Fersindo is also the 51% majority shareholder of PT Indonesia AirAsia (“IAA”). The total purchasing consideration for Metro Batavia Group is USD80 million (equivalent to approximately RM253 million) and will be settled in cash. The acquisition of 100% interest in Metro Batavia by AAB and Fersindo will be carried out in two stages, through acquisition of a majority 76.95% stake and subsequently followed by the remaining 23.05% held by its existing shareholders.

Correspondingly, the total purchasing consideration for 100% interest in AFI is USD1 million (approximately RM3.2 million). The acquisition is expected to complete by 2nd quarter 2013 and is subject to regulatory approvals in Indonesia.

This new acquisition will complement AirAsia’s existing Indonesian operations, IAA, which has successfully captured strong market share in Indonesia’s international airline traffic, with an extensive and well-established domestic route network throughout the Indonesian archipelago. The Batavia Air acquisition provides greater domestic connectivity and an extensive feeder network into IAA’s existing hubs in Jakarta, Bandung, Denpasar, Medan and Surabaya. Upon the successful acquisition, Batavia Air and IAA will fly more than 14 million customers serving 42 Indonesian and 12 international destinations. The addition of Batavia Air will provide AirAsia immediate access to an enlarged fleet of aircraft, experienced pilots and flight crew and increasingly competitive slots at major Indonesian airports at a time when Indonesia’s travel sector is experiencing double-digit growth on the back of rapidly growing consumer demand for air travel.

Following the acquisition the number of distribution channels in Indonesia will increase ten-fold to over 5000 authorised agents and more than 70 sales outlets. With this enlarged agency footprint AirAsia will be able to reach even more customers while complementing our internet based sales. “The Batavia Air acquisition is a fantastic opportunity for AirAsia to accelerate our growth plans in one of the most exciting aviation markets in Asia and further underlines our belief in the growth potential of Indonesia’s aviation sector,” said Tan Sri Dr Tony Fernandes, Group CEO and Director of AAB.

Founded in 2002, Batavia Air has earned its reputation as a leading domestic airline with a strong safety track record throughout its operating history. Operating a fleet of 33 aircraft, Batavia has consistently held significant domestic market share through serving 41 domestic routes and has recently expanded its route network to international destinations such as Singapore, Jeddah, Riyadh, Kuching, Dili and Guangzhou. A certified flight school, simulator training centre and aircraft maintenance facilities also support Batavia Air’s operations.

“I am proud to have built Batavia Air into a leading Indonesian airline from its humble beginnings. Recent developments in the airline industry have made me recognise that Batavia Air requires greater scale in order to compete and grow further, and I am so pleased that AirAsia will now take Batavia Air to even greater heights,” said Bapak Yudiawan Tansari, Batavia Air’s founder.

“We are impressed with Batavia Air’s achievements over the past 10 years and will continue to build on Bapak Yudiawan’s legacy. We are excited with the potential synergies this acquisition will bring to AirAsia Group and see this as a natural extension of the success we have achieved with IAA . Indonesian air travelers can all look forward to even more affordable fares soon,” remarked Tan’ Sri Dr Tony Fernandes.

Read More

Do You Think Now is The Right Time to Buy Top Glove

It is no surprise that Top Glove has high ambitions as it has been proven in their past records. It is mentioned in the article by EdgeDaily that this largest glove manufacturer is planning to triple its production capacities over the next 15 years while planning to increase its global market share to 50%. Doable? A bit overoptimistic I would think but it is not an impossible task.

I have mentioned in the past that if we want to buy glove manufacturers, one may not need to look beyond Top Glove and Hartalega. My reasoning is simple. In a mature industry which has decent growth, look for company that has size, strong balance sheet, reach and ability to scale. Both Top Glove and Hartalega have that. I am not discounting other players like Supermax, Kossan, Latexx Partners etc. but chances are that the dominance would probably be by the 2 companies. Only thing is that we do not know latex gloves or nitrile gloves would be the preference. The way I look at it industry players themselves do not know as they are preparing production lines that are switchable.

Anyway, over the last 6 months, prices of latex has tapered down as it was over speculated few years ago. At one point of time the price was so high that costs of production for latex gloves was higher than nitrile gloves, an unprecedented event. We will not know the future of these raw material however, but I believe these players would be more ready in future in the event any of the raw material shot up in price again.

With the recent price of raw latex reducing to below RM7 per kg, I am just wondering whether it is time to buy Top Glove again. Prices of these raw material however should not be a consideration for any long term investors. The main concern is the strategy.

Over time, it may not be the prices of latex or petroleum that is to cause concerns to these players but what I am more concern of is whether there can be a glut in terms of supplies as well as the increasing labor costs. Hence, these players will have to convert their plant to embrace automation much more than before as Malaysia and Thailand are introducing minimum wages almost at the same time.

On the concern for glut in supplies of rubber gloves, I am just worried as every time I read about the industry news, these players are preparing themselves for massive expansion. Can the demand be taking so much?

Read More

Optimize Your Trading for Better Profitability

What do you have on tap for this weekend?  Gonna hit the bars with some friends? Hang out at the beach?  Perhaps you and your significant other are going to go to Home Depot and maybe Bed, Bath, and Beyond as well (if you have the time).

Let me be so bold as to suggest that you set aside a few hours this weekend for a project that will improve your trading….and your profitability.

This project can be as complex and in-depth as you want, but it need not be.  As long as you have a basic understanding of a spreadsheet program like Excel, just follow the outline below and you will be fine.

The first step is to download your trade history from your broker into a spreadsheet.  How far back you want to go is up to you, but obviously the more data you are willing to look at the better your results will be.

The goal here is to match up your opening and closing transactions to determine profitability. The best way to do this if you are a day trader is to sort the spreadsheet by “date and time” and if you are a swing or position trader by “symbol.”

Once trades are matched you might find it helpful to categorize them as “winning,” “losing,” and “break even” trades. The “break even” category should also include trades which were small wins or losses.  Once you match them up I suggest you color code the categories, with green, yellow, and red being the most obvious choices.

Now you want to go through each category and do some analysis by looking at the following;

Asset Class – Are there certain asset classes that you do better with than others?  That you do worse with?  A trader friend of mine who used to trade numerous asset classes went through this process and found out that he did worse overall trading equities than trading forex.  He dropped stocks and began focusing exclusively on forex to the benefit of his account’s P&L.

Instruments –  Here you are looking at the instruments within asset classes you trade to see what patterns emerge.  Are you a consistent loser with ETF’s?  How about leveraged ETF’s?  Do you do better with small caps or large caps.  Do your option profits come from in the money or out of the money options?  What forex pairs do you shine at trading?

Sectors –  Maybe you will find that you do better trading consumer goods stocks than pharma stocks.  You might be the axe in the NASDAQ E-mini (tech) and the donkey when trading oil futures (energy).  If you are crushing it in the $AUD make sure you know you are trading a proxy for commodities.

Time of Day –  Most historical trade data will not only have the date but the actually time that you entered the trade listed.  See if there is a pattern that you can identify.  Often the opening and closing hours are the good for trading, while the middle of the day is not.  Are your losing trades clustered around less than optimal times of day?

Length of Trade –  This is a critical area because even with a swing or position trade that you break even on, you still have to factor in how long your funds are tied up in those trades with no return.  Many traders don’t consider themselves day traders, but will find that in the few day trades they do take, they have a better win ratio than their longer term trades.

Price –  Where is the sweet spot here?  Are you coining money it the $20-$60 range of stocks?  Are you weak in the under $10 stocks but a monster in the $AAPL and $GOOG’s of the market?

Liquidity –  You won’t get this data from your history download but it’s easy to pull up the average volume numbers on the stocks in each trade category to determine if there is a pattern related to less or more liquid issues.  You can take this one step further if you like and browse the intraday charts of these stocks in more depth.  Many stocks that have what is normally considered “decent” volume can still move in a choppy fashion with wide spreads on an intraday basis, and a 5-min charts will show you that.

These are just some suggested filters and you can use whichever ones you think are most relevant.

In the end what you are trying to accomplish is to throw out any preconceived notions you might have about your trading and let the facts speak for themselves.  If you are open to what they are saying you can then start to eliminate factors related to your losing trades and emphasize the factors associated with your winning trades.

We all know that our weekend time is very valuable and it may seem a little bit tedious at first when starting this project.  But once you get into the process I think you will quickly see the value of it, and besides, nobody says you can’t still drink while you do it.

Why not subscribe to bclund.com for free  Via E-mail or Via RSS and follow me on StockTwits and Twitter?

What bclund is, is the intersection of markets, trading, and life (with some punk rock, pop culture, and off-beat humor mixed in).  Check out “The Best Of bclund” to get started.

Read More

Timely Research Piece On Plantations

HDBS Research:



Sector valuation is overpessimistic. 
Even with lower crude oil prices and the EU debt crisis, we believe plantation stock prices have been unjustifiably sold off despite precarious vegetable oil supply outlook. By end Sep12F quarter, the combined ending stock of palm, soybean and rapeseed oils (as a share of consumption) would have been at its lowest since Sep05. There is no remedy for lack of supply. 


Looming end to soybean export boom.  
We recently examined soybean export data issued by Oil World and found that global inventories are fast depleting, due to South American crop failure earlier this year. Any US crop setback in Sep-Nov12 – if El Nino developed – would exacerbate this situation; as South American stocks would already have been depleted by then. Aug12 global stock levels are now forecast to be the lowest since Aug05. Subsequent stock levels are due to decline further – even after US output reaches the market – as Chinese imports are expected to jump 11% y-oy. We believe the market is ignoring this.  


Priced below market. 
Despite expectations of a further tightening in soybean supply, current palm olein (cooking oil) price discount to soybean oil is the widest since Oct11. Most planters PE now trade at -1SD and are pricing-in long term CPO price at 7-20% below current depressed levels. We think this is unsustainable; as CPO prices may not fall to such level on global vegetable oil supply constraints. In China, brisk soybean imports have so far defied poor crush margins. The coming supply crunch could spell even poorer margins, unless both soybean oil and soybean meal prices rise further. 


Don’t miss the boat.  
Planters with significant volume growth such as Sampoerna A., First R., TSH and Bumitama stand to benefit the most from both pricing and volume 
recoveries. Recall that poorer-than-expected 1Q12 FFB harvests, higher fertilizer costs – hence earnings – triggered the earlier sell-off. We also like Sime and Genting P. on sound balance sheets, decent growths.

Read More

Crude Awakening

(WSJ) HOUSTON—America will halve its reliance on Middle East oil by the end of this decade and could end it completely by 2035 due to declining demand and the rapid growth of new petroleum sources in the Western Hemisphere, energy analysts now anticipate.

The shift, a result of technological advances that are unlocking new sources of oil in shale-rock formations, oil sands and deep beneath the ocean floor, carries profound consequences for the U.S. economy and energy security. A good portion of this surprising bounty comes from the widespread use of hydraulic fracturing, or fracking, a technique perfected during the last decade in U.S. fields previously deemed not worth tampering with.

By 2020, nearly half of the crude oil America consumes will be produced at home, while 82% will come from this side of the Atlantic, according to the U.S. Energy Information Administration. By 2035, oil shipments from the Middle East to North America "could almost be nonexistent," the Organization of Petroleum Exporting Countries recently predicted, partly because more efficient car engines and a growing supply of renewable fuel will help curb demand.

The change achieves a long-sought goal of U.S. policy-making: to draw more oil from nearby, stable sources and less from a volatile region half a world away. "Whereas at one point there were real and serious concerns about the ability to maintain sustainable access of supplies to the United States if there were disruptions in the Middle East, that has changed," Carlos Pascual, the top energy official at the State Department, said in an interview.

U.S. officials stress that the Middle East will remain important to American foreign policy partly because of the region's continuing influence on global oil prices. "We need to continue to pay attention to how global markets function, because we have a fundamental interest that those markets are stable," Mr. Pascual said.

That means the U.S. military will keep guarding the region's oil shipping lanes, as it has done for decades. "Nobody else can protect it and if it were no longer available, U.S. oil prices would go up," said Michael O'Hanlon, a national security expert with the Brookings Institution, who says the U.S. spends $50 billion a year protecting oil shipments. But China, a growing consumer of Middle Eastern crude, is seeking a larger presence in the region, with its navy joining antipiracy efforts near Somalia.

Still, growing domestic energy production could allow the U.S. to lessen its focus on the unpredictable region over time. Dependence on Middle East oil has shaped American foreign, national-security and defense policies for most of the last half century. It helped drive the U.S. into active participation in the search for Arab-Israeli peace; drove Washington into close alignments with the monarchies of the Persian Gulf states; compelled it to side with Iraq during its war with Iran; prompted it to then turn against Iraq after its invasion of Kuwait, bringing about the first Persian Gulf war; and prompted Washington to then build up and sustain its military presence in the region.

Whatever the success such strategies had in ensuring American influence in the region, all also came at a price. Involvement in the Arab-Israeli peace process brought the U.S. the enmity of many of the region's most radical forces upset at the failure to create a Palestinian state. The decision to build up an American military presence in the region was used as a rationale for anti-American agitation and attacks by al Qaeda and other extremist forces.

The shift away from Middle Eastern oil means closer ties with Canada, which is emerging as the top U.S. energy ally, but also with Latin neighbors that are strong trading partners. A dollar spent buying oil from these countries is more likely to end up back in the U.S. than a dollar spent buying Iraqi or Saudi crude. Economies buoyed by petrodollars also lessen the appeal of northward migration for Latin America's poor, says Jeremy Martin, director of the energy program at the Institute of the Americas in La Jolla, Calif.

The American energy revolution also is making a splash across the Atlantic. Countries in Eastern Europe, long dependent on Russia for their energy, are seeking to tap their own shale resources with the help of U.S. companies. Even Russia, which needs new sources of oil to maintain its status as an energy superpower, is getting into fracking with the biggest U.S. oil company, Exxon Mobil Corp. This month Exxon and Russia's state-controlled OAO Rosneft broadened an existing alliance to include the joint development of tight oil reserves in western Siberia.

The prospect that new sources of supply in the Americas could lead to years of flat or even falling oil prices is a source of great concern in the Kremlin. Surging oil revenues over his 12 years in power have helped President Vladimir Putin pay for an eightfold increase in government spending, going to everything from pension and wage hikes to costly projects like the Sochi Olympics to a major military buildup. Now, his government is scrambling to find ways to tighten its belt as oil prices—and thus tax revenues—slide. Finding a new driver for Russia's economy is "a colossal challenge," said economy minister Andrei Belousov.

The domestic oil picture has become part of the presidential campaign this year. President Barack Obama likes to point out that output has surged during his first term. "We've added enough new oil and gas pipeline to encircle the Earth and then some," he said in a speech earlier this year. Mitt Romney, the presumed GOP candidate, says the U.S. must do more to promote domestic exploration and says Mr. Obama is holding back the industry. Mr. Romney's campaign ads say that on "Day 1" he will give approval for the Keystone XL pipeline, a project to bring oil from Canada that Mr. Obama's administration has rejected for now.

The renaissance of the U.S. oil patch is pushing down oil prices, giving a boost to the economy at a time when a global slowdown threatens to crimp demand. Research firm Raymond James lowered its 2013 forecast for U.S. crude prices this month to $65 per barrel from $83, partly because production in the U.S. has risen much more quickly than previously expected.

Just the same, obstacles to developing the Western Hemisphere's oil riches remain.

Argentina recently nationalized the assets of Spanish energy giant Repsol SA, arguing that the company wasn't investing enough to develop the country's full oil potential. The action makes investors leery of risking capital there to tap shale-rock formations that could rival booming U.S. oil fields.

In Brazil, where most of the newfound oil lies under thick salt domes far beneath the seabed, a small spill in a Chevron Corp. offshore field led to criminal charges, which Chevron contests. Also, state giant Petroleo Brasileiro SA cut its world-wide 2020 production forecast by 11% earlier this month while estimating that extracting its oil would be more costly than anticipated.

In the U.S., offshore drilling in the Gulf of Mexico is recovering slowly from the impact of the 2010 Deepwater Horizon oil spill.

Still, U.S. government forecasters expect that U.S. petroleum purchases from the Middle East, Africa, and Europe will drop to about 2.5 million barrels a day by 2020, from more than four million barrels today. Oil imports from the Persian Gulf's OPEC members—a group that includes Saudi Arabia, Iraq and Kuwait—will drop to 860,000 barrels a day that year from 1.6 million barrels currently.

Global oil and gas investments tripled between 2003 and 2011, according to IHS Cambridge Energy Research Associates. In the Western Hemisphere, where the U.S. and Canada provided more political stability for investors, they nearly quadrupled. In 2011, 48% of global oil investment, or $320 billion, ended up in the Americas, up from 39% in 2003.

A lot of that money went into the revival of the U.S. oil patch, where energy companies learned to profitably produce oil from tight oil formations by injecting them with high-pressure jets of water mixed with chemicals and sand. The technique has raised concerns with environmentalists who claim it uses too much water and can contaminate water supplies.

First developed in natural-gas fields, fracking yielded an unexpected oil boom that has redrawn America's energy geography. Abundant crude, combined with a huge refining base and waning demand at home turned the U.S. into a net exporter of refined products last year; the EIA expects that situation to continue beyond 2020.

North Dakota went from being a minor producer to surpassing Alaska in March in petroleum output thanks to the Bakken Shale, which is being developed through fracking. Now it is only second to Texas in oil production.

The Bakken, as well as Texas' booming Eagle Ford Shale and the deep-water U.S. Gulf of Mexico, helped average daily U.S. oil production rise 6% between October 2011 and March 2012, topping six million barrels a day for the first time since 1998, the EIA said this month.

"U.S. oil production was for nearly 40 years in total decline, and that decline was never supposed to end," says Jim Burkhard, an analyst with IHS CERA. "This is a major pivot point."

Canada's oil sands—where the earth is drenched in thick, tar-like oil—contain some of the largest quantities of oil in the world but for years they were too expensive to tap. Companies had to mine tons of oil-drenched sand for each barrel of oil, or inject steam deep beneath the earth to make the oil liquid enough for extraction.

As oil prices began to rise, starting in 1999, oil-sands reserves became more profitable, and early investments from Canadian producers like Suncor Energy Inc. and Encana Corp., along with international producers like Royal Dutch Shell PLC turned Canada into the largest oil exporter to the U.S. Later in the decade, international investment poured into Alberta's boreal forest from U.S.-based companies like ConocoPhillips and Exxon Mobil, and Chinese oil companies like Sinopec, PetroChina Co. and CNOOC Ltd.

Deep-water technology enabled Brazil, which for years depended on oil imports, to become a net exporter in 2009. By 2020, Brazil's production is expected to rival Canada's, rising 57% to 4.7 million barrels a day, thanks to some of the largest offshore oil field finds in 30 years.

The drop in American energy imports comes at a time when hundreds of millions in the developing world are beginning to consume more energy as they rise from poverty. "We're very fortunate that this is happening," said Marvin Odum, the president of Shell's U.S. unit, who also heads its exploration and production activities in the Western Hemisphere. "It enables resources to flow to emerging economies."

Read More

Broken Record Repeats Itself

Traditional music records have been replaced with CDs (compact discs) and digital downloads. Although the problem of a broken record repeating itself is no longer an issue, our financial markets have not conquered the problem of repetition. More specifically, the timing of the -6.3% stock market decline during May (as measured by the S&P 500 index), coincides with the same broken sell-offs we have temporarily experienced over the last two summers. First, we had the “Flash Crash” in the summer of 2010, and then the debt ceiling debate and credit downgrade of 2011.

So far, the “Sell in May and go away” mantra has followed the textbook lessons over the last few years, but as you can see from the chart below, the short-lived seasonal sell-offs have been followed by significant advances (up +33% from 2010 lows and up +29% from the 2011 lows). Given the global challenges, a two-steps forward, one-step back pattern in equity markets should not be seen as overly surprising by investors.

Although the late-spring and summer doldrums have not been a joy-ride in recent years, these overly simplistic seasonal trading rules of thumb have not been exceedingly reliable either. For example, even though the months of May in 2010-2012 produced negative returns, the previous 25 Mays going back to 1985 produced positive returns more than 2/3 of the time. Rather than fiddle with these unreliable, unscientific trading rules, individuals would be better served by listening to famous Jedi Master Yoda from Star Wars, who so astutely noted, “Uncertain, the future is.”

Voting Machines and Scales

Given the spread of globalization and technology, the speed of news dissemination has never been faster. With the 2008-2009 financial crisis still burned into investors’ minds, the default response to any scary news item is to shoot first and ask questions later. Renowned long-term investing legend Ben Graham famously highlighted, “In the short run the market is a voting machine. In the long run it’s a weighing machine.”

As it relates to short-run current events, here are some of the items that investors were voting on (no pun intended) this month:

Europe, Europe, Europe: This problem has been with us for some time now, and there are no signs it will disappear anytime soon. In a game of chicken between the EU (European Union) and Greek legislators, fresh elections are taking place on June 17th, which will ultimately determine if Greece will exit the Euro monetary union or stick to the bitter medicine of austerity prescribed by the key European decision-makers in Germany. As Greece attempts to clean up its own mess, European politicians and G-20 leaders around the globe are scrambling to create plans that ring-fence countries like Spain and Italy from succumbing to a Greek-born contagion.

Presidential Politics: If you haven’t been living in a cave for the last six months, you probably know that 2012 is a presidential election year. Regardless of your politics, there are big questions surrounding the economy, jobs, deficits, debt, taxes, entitlements, defense, gay marriage, and other important issues. Answers to many of these questions will remain unclear until we get closer to the elections. The financial markets do not like uncertainty, so probabilities would indicate volatility will remain par for the course for the foreseeable future.

Facebook Folly: Despite my warnings, Facebook’s initial public offering (IPO) failed to live up to the social media giant’s hype – the share price has fallen -22% since the shares originally priced. Great companies do not always make great stocks, especially when a relatively new kid on the block has his company’s stock initially valued at a hefty price-tag of more than a $100 billion. Finger pointing is being spread liberally on the botched Facebook deal (e.g., Morgan Stanley, NASDAQ, Facebook), but no need to shed a tear for 28-year-old founder Mark Zuckerberg since his ownership stake in the company is still valued at around $15 billion – enough to cover a European trip to McDonald’s with his newlywed wife.

Dimon in a Rough Spot: Jamie Dimon, the poster child of the banking industry (and CEO of JP Morgan Chase – JPM), dropped a bomb on the investment community earlier in the month by explaining how a rogue “whale” trader racked up $2 billion in initial losses (and growing) by taking excessive risk and throwing controls into the wind.

Chinese Dragon Losing Steam: The #2 global economy has been losing some steam as witnessed by slowing industrial production and GDP growth (Gross Domestic Product). In turn, the self correcting economic forces of supply and demand have provided relief to consumers and corporations in the form of lower fuel, energy, and commodity prices. Chinese leaders are not sitting still – there are plans of accelerating infrastructure spending and assisting banks in the form of capital injections and lower reserve requirements.

As I discussed in a previous Investing Caffeine article (see The European Dog Ate My Homework), although the current headlines remain gloomy, that will always be the case. Just a few years ago, Bear Stearns, Lehman Brothers, AIG, CDS (credit default swaps), and subprime mortgages were the boogeymen. In the 1980s, we had the Savings & Loan financial crisis and the infamous 1987 Crash. During the 1970s, the Vietnam War, Nixon’s impeachment proceedings, and rising inflation were the dominating issues. Since then, the equity markets are up over 20x-fold – time will always reward those patient long-term investors. Despite all the doom and gloom, stock markets have roughly doubled over the last three years and all the major indexes remain solidly in the black for the year. Choppy waters are likely to remain as we approach this year’s elections, but for those who understand broken records often repeat themselves, there’s a good chance the music will eventually sound much better.

Read More

The Pleasure/Pain Principle

The financial crisis of 2008-2009 was painful, not to mention the Flash Crash of 2010; the Debt Ceiling / Credit Downgrade of 2011; and the never-ending European saga. Needless to say, these and other events have caused pain akin to burning one’s hand on the stove. This unpleasant effect has rubbed off on investors.

Admitting one has a problem is half the battle of conquering a challenge.  A key challenge for many investors is understanding the crippling effects fear can have on personal investment decisions. While there are certainly investors who constantly see financial markets through rose-colored glasses (my glasses I argue are only slightly tinted), Nobel Prize winner Daniel Kahneman and his partner Amos Tversky understand the pain of losses can be twice as painful as the pleasure experienced through gains (see diagram below).

Said a little differently, faced with sure gain, most investors are risk-averse, but faced with sure loss, investors prefer risk-taking. Don’t believe me? Well, let’s take a look at some of Kahneman and Tversky’s behavioral finance work on what they called “Prospect Theory” (1979) – the analysis of decisions made under various risk scenarios.

In one specific experiment, Kahneman and Tversky presented groups of subjects with a number of problems. One group of subjects was presented with this problem:

Problem #1: In addition to whatever you own, you have been given $1,000. You are now asked to choose between:

A. A sure gain of $500

B. A 50% change to gain $1,000 and a 50% chance to gain nothing.

Another group of subjects was presented with this problem:

Problem #2:  In addition to whatever you own, you have been given $2,000. You are now asked to choose between:

A. A sure loss of $500

B. A 50% chance to lose $1,000 and a 50% chance to lose nothing.

In the first group, 84% of the respondents chose A and in the second group, 69% of the respondents chose B. Both problems are identical in terms of the net cash outcomes ($1,500 for Answer A, and 50% chance of $1,000 or $2,000 for Answer B). Nonetheless, due the different “loss phrasing” in each question, Answer A sounds more appealing in Question #1, and Answer B sounds more appealing in Question #2. The results are irrational, but investors have been known to be illogical too.

In practical trading terms, the application of “Prospect Theory” often manifests itself via the pain principle. Due to loss aversion, investors tend to cash in gains too early and fail to allow their winning stocks to run higher for a long enough period.

The framing of the Kahneman and Tversky’s questions is no different than the framing of political and economic issues by the various media outlets (seePessimism Porn). Fear can generate advertising revenue and fear can also push investors into paralysis (see the equity fund flow data in Fund Flows Paradox).

Greed can sell in the financial markets too. The main sources of financial market greed have been primarily limited to bonds, cash, and gold. If you caught those trends early enough, you are happy as a clam, but like most things in life, nothing lasts forever. The same principle applies to financial markets, and over time, capital in today’s winners will slowly transition into today’s losers (i.e., tomorrow’s winners).

A healthy amount of fear is healthy, but correctly understanding the dynamics of the “Pleasure/Pain Principle” can turn those fearful tears into profitable pleasure.

Read More