Sunday, November 25, 2012

Picking Winners and Avoiding Losers: Thanksgiving Lessons

A good analyst and a better investor learn from what they are exposed to in their life experiences. We are all interested in picking winners and particularly in avoiding losers. In the US on Thursday, we celebrated Thanksgiving. This official holiday is similar to other harvest holidays celebrated in many countries that have developed from an agrarian base. Within the US, the holiday is an occasion to watch traditional American football games, either in person, on a television or on a computer screen. Immediately after the holiday is the somewhat official beginning of Christmas and Chanukah shopping season both in stores and Online.

As family and friends gather, often there are opportunities to acknowledge what we are grateful for; forgiving those that have disappointed us, but not forgetting the lessons learned.

Weather impacts

In New Jersey and some parts of New York and other states, one of the things that we are thankful for is that we have begun recovering from the recent visit of the super storm Sandy. Some of us were just inconvenienced by the loss of power for a period of days into weeks. Others have lost their homes in part or in total to the combinations of the hurricane followed by a “nor’easter” snowstorm, and in some cases resultant fires. The physical, emotional and financial damage is starting to be more fully understood. Whatever the immediate size of the financial loss, by current estimate the money spent on rebuilding, and in many cases new construction, will be larger than the financial losses sustained. These expenditures on housing, infrastructure and shoreline development will occur over a couple of years, as much concerted planning is needed to avoid some of the ravages of future storms. My guess is that the infrastructure and the rebuilding spending will initially focus on an attempt to restore what was in the impacted area first. There is likely a second phase that may occur as people start to take a long-term view. Much of New York, Boston, Hong Kong, Singapore and elsewhere are built on reclaimed land from nearby oceans and rivers. There are people who believe that within the next 100-300 years these lands will be subject to waters rising five feet, which would flood LaGuardia Airport in Queens and Logan Airport in Boston for example. If these fears are acted upon, the indirect costs of Sandy will be huge.

The national media has heavily focused on the impact of Sandy and has largely ignored the weather event that will probably create a larger loss, the devastating drought that is affecting all or parts of 17 Midwest and Western states. The drought is expected to intensify through the winter. While the US is probably the most productive country in the world, there is some possibility that we will have food shortages and suffer some inflationary pressure, particularly intense on the less well-off. A related issue to the food shortage potential is the actual substantial curtailment of barge traffic along the Mississippi River. Due to government water conservation policy, the Missouri River, which is fed in part by dams, and in turn feeds the Mississippi, has not be receiving its full bountiful supply of water since last week. The barges with their deep bottoms that won’t be able to go downriver carry some $7 billion worth of commodities, coal and other products, much of which feeds US export markets. 

Two weekend analytical observations

As long time readers of my posts know, I usually comment upon my visits to a nearby high-end shopping mall during the Thanksgiving weekend. This time I visited the shopping center twice; once on so-called Black Friday and again on Sunday. In contrast to years ago, I was able to find parking spaces. On Sunday I parked where we normally park during the week, not a good sign for retail sales. One of the reasons that parking was relatively easy was that there were fewer cars with New York license plates. In the past, the difference between New York and New Jersey sales taxes drove New Yorkers to shop for more expensive items into New Jersey. (A new very large mall has recently opened that is much closer to New York City which could have attracted the tax conscious shopper.)  Walking in the mall was relatively easy with very few crowded locations; the Apple store being one. Judging by what people were carrying, there were more lookers than shoppers. Some high-end stores changed their merchandise mix toward lower price point merchandise, one being Tiffany. This tactic did not seem to attract many of the well-dressed shoppers that had taken great pains to look attractive. The price and tax conscious high-end shoppers were not enthused by what they were being offered. The two walking tours however, don’t tell us how much shopping is being done Online. I will watch whether the regular FedEx and UPS truck deliveries on our block are delayed from their normal delivery times and if they seem to be heavily laden. At this point, if I had to make a judgment, I'd say that this won’t be a great season for high-end retail shops.

The second observation is that there is much to learn from watching National Football League* games on Thanksgiving Day. I have long stated that my two great learning experiences were my active duty service in the US Marine Corps and my hours at various New York race tracks, trying to wager successfully and avoid too many losses. The study of past performance and other factors which I followed were called handicapping, which focused on how changing conditions would affect the results of future races. One of the techniques that I used in reviewing past performance was to look for consistent, hopefully improving, patterns. Many times these encouraging patterns were interrupted by inconsistent behavior. If there were only one or very few inconsistent results, I followed the approach of excluding the inconsistent results and believing that if the conditions were similar to the races where the results were consistent, to believe that the next race the horse was more likely than not to return to its trend of consistent results. Long before the leading Football teams acknowledged that they had hired statisticians as revealed in an article by Judy Battista in Sunday’s New York Times, I was applying this technique while enjoying watching various professional football games. On Thanksgiving Thursday, there were two games where this kind of analysis was useful. In the first game, a grudge match between the New York Jets and the New England Patriots, the final score of 49 (New England) to 19 (Jets) was misleading in terms of a comparison of the potential value of the teams in securing future victories. As is often the case, God is in the details. In the first quarter neither team scored. In the second half, the Jets scored 19 points vs. 14 for New England. However, in the second quarter through a series of interceptions and fumbles, New England scored 35 points, including three touchdowns in about one minute! From my handicapping viewpoint, what happened to the Jets is the equivalent of a jockey dropping his whip or a saddle slipping badly, which led me to exclude the second quarter as indicative of future performance. Applying this approach to selecting funds (and to some degree individual securities), I would be more interested at the right price (odds) backing the Jets than the Patriots. When I apply this to funds, I am willing to throw out the results of 2008, particularly if by early 2010 the fund had recovered from its 2008 loss. Thus one might say that I can be forgiving.

The second game put the Texans from Houston against the Detroit Lions. Detroit traditionally has a game on Thanksgiving Day, for in a much earlier time it could not get a local field to play on for a normal weekend game after the holiday; so a tradition began with the Lions playing this game on Thanksgiving. The Lions traditionally have a poor Win-Loss record. This year’s game was against the Texans who had the best record for the season in professional football of 9 wins and 1 loss. Remarkably at the end of regulation period, the two teams were tied at 31 points apiece and so they had to play in an overtime period. At our Thanksgiving dinner there were relatives from Michigan. The Lady of the House, who had suffered through many football games in Michigan, assured us who were watching the game that the Lions would find some way to lose, which they did. She was not forgetting the team’s past problems. In similar fashion, a fund or manager that consistently disappoints is not likely to rise up for a sustained period.
* I have the honor and privilege to work on the National Football League/Players Association defined contribution plans.

Applications for the care and feeding of investment managers

As we are all humans, we should learn to forgive them, as this is good for own mental health.  Even the “programmers” that control the inputs to quantitative funds are human, and therefore one should allow for some mistakes. The key is the duration and explanation for the shortfalls from our expectations. However, I firmly believe that performance results are not the key to future results but rather a starting point to raise our understanding as to the past, current and future conditions when a manager can produce consistent results for a while.    

Now it is your turn to share:
What are you thankful for?
For what are you willing to forgive investment professionals?
What should we forget?
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