Behavioral Finance

"Buy on the Rumor:" Anticipatory Affect and Investor Behavior

 

I'm citing an interesting behavioral finance article here, "Buy on the Rumor".   

The traders’ aphorism “buy on the rumor and sell on the news” (BRSN) describes a strategy for exploiting a frequently observed financial market price pattern.  This pattern (BRSN) is characterized by security prices rising prior to and falling subsequent to positively anticipated events.  Security prices are, paradoxically, often observed to decline following an event outcome that is equal-to or better-than “expectations.”  We argue that investors’ expectations of rewarding event outcomes are inflated by a neuro-affective biasing process.  A disproportionate number of positively anticipated events will yield disappointing event outcomes.

Investors often gamble both on an event outcome and on the anticipated price appreciation as a result of that positive outcome.  Anticipation of reward generates a positive affect state.  Positive affect motivates both increased risk-taking and increased purchasing behaviors.  As the anticipated potential reward approaches in time, investors’ positive affect is increasingly aroused.  Following the delivery of an expected reward, investors’ affect regresses to neutral.  This post-event net decrease in positive affect leads to more risk-averse, protective investing behaviors such as selling (consummate with the new, less positive, affect-state).

Many naïve investors are not aware that a positive event outcome does not necessarily cause security price appreciation.  Naïve investors may be surprised by their high levels of risk exposure when the euphoric affect that guided the accumulation of their high-risk positions dissipates following the event.  Their diminished euphoria motivates increased caution (risk aversion) and investment re-positioning (selling) of high-risk positions.  In this market environment, a general increase in selling causes negative price pressure.  Price decline alone augments investors’ negative affect and increases risk aversion. 


Gold Makes Yearly Highs

Throughout the year I have been writing about the merits of having gold in your portfolio here Gold. Last week gold made a new high for the year as shown below by the gold fund (GLD).  Not only has gold made a new high for this year, it has outperformed stocks by a wide margin.  Below is a year-to-date chart of the gold fund GLD.

I still do not think it is too late to be holding gold in the portfolio.  As long as central banks worldwide are on a mission to debase their currencies gold should have an allocated position in portfolios as a hedge against inflation and currency weakness.  Thank you for reading.

 

Employment Report

This morning the BLS (Bureau of Labor Statistics) reported an increase of 431,000 jobs in May.  411,000 of those jobs were temporary workers for Census 2010. Headline unemployment fell .2% to 9.7%.  So only 20k jobs were created excluding the 411k census workers who will be let go over the next two months.  This job report really challenges the notion that we are in a recovery, and now we'll have to consider the potential for a double dip recession occurring in the future. The jobs report coupled with the news out of Hungary, the Prime Minister of Hungary says Hungarian economy is in a "very grave situation and talk of a default is not an exaggeration", was enough to send the S&P 500 down -3.44% on the day. I recently wrote that I am not in any hurry to be buying stocks with the risks present.  I believe we will test the yearly lows again, and break through that level in the coming days or weeks ahead.  
Below is where I think the market is heading in the near term, the 950 level for the S&P 500 which is 10.7% lower then today's close.  At those levels stocks will present a better risk / reward opportunity to hold for an extended period of time then they are today.  Thank you for reading.

 

Tested Support Successfully

I wrote about the S&P 500 February yearly low support level of 1044.  Today we tested that level and preceded to bounce off quite hard to finish at 1074.  Click chart to view.

Testing support levels and bouncing off of them can be seen as a bullish sign and higher prices to come in the days or weeks to follow.  I expect to see a short rally (few days to weeks) then a resumption of the downtrend and the possibility of taking out the year low of 1040, so I don't feel the urgency to be buying stocks just yet.  Thank you for reading.
 

Buying the Dips

Since the March 2009 low, there have been 3 market corrections, with the current correction being -13.43%, high to low from April 26th to May 21st.  Buying the dips has been a very profitable strategy so far during these corrections as the market has made new highs later.

As long as we do not breach the 2010 low on the S&P 500 of 1044 the upward trend could still be maintained.  We are currently 3.95% higher from that yearly low.

At this time, the market pullback has created some potential opportunities in beaten down stocks.  Any buying of stocks will have to be done with risk controls in place in case the selling continues. Overall, I do feel there could be more downside for stocks in the weeks to come.  Thank you for reading.
 

Gold Showing Strength

Gold is also a good store of value during financial turmoil and has shown a non-correlation to the S&P 500 over the last three years.  As shown by the chart below, gold has appreciated by 75% while the US stock market measured by the S&P 500 has lost -15% during the same time period.  Thank you for reading.

 

SMTS 1st Q Results

We wrote about Somanetics (SMTS) on Feb. 28th here The Long Case for Somanetics, and felt that a good buying opportunity existed in the mid teens.   On Wednesday March 17th, the company announced first quarter results.  The results beat the analyst estimates handily and the company guided sales higher for the year.  The stock reacted by appreciating 19%.

 

We'll continue to monitor SMTS throughout the year and give important updates as they occur.  As for now, things look bullish for this small cap medical technology company.  Thank you for reading. 

 

The Hidden Cost of Mutual Funds

The Wall Street Journal had a great article detailing how expensive it truly is to own a mutual fund. The average investor knows that when investing in a mutual fund, they will need to pay an expense ratio to compensate the portfolio manager and cover operating expenses. Currently, the average annual expense ratio of a U.S. stock fund is 1.31%.
However, that's not the true bottom line. There are front-load costs not reflected in the annual expense ratio and those expenses can make a fund two or three times as costly as advertised. Unfortunately, the average investor has no idea what these additional costs amount to due to a lack of information. Some of these costs are hard to find, being buried in a thick prospectus. I did my own study of two popular mutual fund companies and ran charts to see how they correlate to the overall market, the S&P 500.  In other words, what makes these funds so special that they need to charge up to 6.48% and 6.80% respectively during the first year of ownership. The popular American Funds - Growth Fund of America sports a 5.75% front load fee on top of other miscellaneous expenses bringing the first year expense to 6.48%.  Below, let's see how the performance stacks up against the S&P 500 low cost index fund (SPY) which costs just .15% to own.

As expected this fund shows a high correlation and just tracks the low cost S&P 500 (SPY) fund that charges just $150.00 on every $100,000 invested, as opposed to an approximate $5,230 first year cost for the American Fund (AGTHX), which includes volume breakpoints.  Where's the value.

 

At Shaw Investments, we do not use high cost mutual funds that give kick backs from the mutual fund company to the advisor selling the fund.  We have a fiduciary duty first and foremost to our clients, and receive no commissions, kickbacks or referral fees and will always consider the costs associated.  Thank you for reading.

 

 

February Employment Report

Last month I wrote about the January employment report here January Employment Report.  That report had some positives as the trend for improved employment was heading in the right direction, to the plus side. Today the Bureau of Labor Statistics (BLS) released the February employment report. 
Nonfarm payroll employment was little changed (-36,000) in February, and the unemployment rate held at 9.7 percent, the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and information, while temporary help services added jobs.  February lost -36K jobs compared to January's loss of -56K, so a slight improvement.  Within the report was this. Professional services contributed 51,00 jobs to the plus side, but 50,000 of them were part-time jobs! The quality of employment is not what it used to be, as many employers are only offering part time positions. The official unemployment rate is 9.7%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is.  That rate is 16.8%, which is how unemployment feels to the average Joe on the street.  Thank you for reading.
 

The Long Case for Somanetics

Somanetics (Nasdaq SMTS) Troy Michigan, is the pioneer and leader of cerebral and somatic (of the body) oximetry, providing U.S. clinicians with the first adult cerebral oximeter, the first pediatric cerebral oximeter and the first simultaneous brain and body oximeter.  Known as the INVOS Cerebral/Somatic Oximeter, this noninvasive patient monitor continuously measures changes in blood oxygen levels in the brain and in the body of patients who are at risk for restricted blood flow so clinicians can detect and correct a variety of threatening complications. Today, the INVOS System is in use at 700+ U.S. hospitals, including 80% of centers performing pediatric cardiac surgery.  They have placed a total of 2,927 monitors worldwide.
I have been following SMTS for 10 years. Today, I feel more confident in purchasing shares then anytime in the past. The INVOS System is being accepted by the medical community as a necessity at a faster clip than at any previous time.
The financial crisis has caused the cost of capital to increase to the point that all businesses including hospitals are hoarding cash. New technology has a harder time getting a piece of the limited capital spending budgets and that has and will continue to effect sales of the INVOS System. However, there is a growing level of pent up demand, which should result in a catch up quarter down the road.
Vital Sync System:
The Vital Sync System aquisition makes Somanetics a two-product company answering one of the risks (one product company) sighted by analysts over the years. Several companies market bedside devices that display data from monitoring devices. All of the products on the market today only collect information from their own products. Somanetics’ Vital Sync System is patented and it integrates data from a broad array of hospital bedside devices, such as physiological monitors and ventilators, into a single bedside display for comparison, data management and storage. It has the latest touch screen technology and is extremely user friendly. The system takes the entire patient data collection and management process paperless (something President Obama is pushing very hard for the entire Health Care system). The Vital Sync System is priced at $25,000, which is an acceptable price point for hospitals. The parts are “off the shelf” and the technology is software driven which translates into high margins. Somanetics has placed 8 devices with key customers for feedback.
The potential market for the Vital Sync System relates to the number of hospital beds in this country, not the number of hospital beds designated for adult cardiac surgery. The INVOS monitors are sold or placed initially with a stream of recurring revenue from the sale of the deposable somasensors. The Vital Sync System is sold initially with only a small maintenance contract to provide the latest software enhancements.
The Vital Sync System provides Somanetics a second access point to obtain funds from hospitals. The bedside displays are recognized as a cost saving device and is on every “wish list” for capital. The INVOS System and the Vital Sync System will be marketed separately initially, but clearly combining the two together provides a compelling value proposition for the hospitals. The company does not view CAS Medical (CASM) as a serious threat to their business. The company announced they were suing CAS Medical for patent infringement and false and damaging claims. The purpose of the lawsuit seems tactical in several ways. CAS Medical has been claiming that their FORE-SIGHT Absolute Cerebral Oximeter showed measurements to be three times more accurate than those of the INVOS System. The company believes these claims are false and misleading and are based on an unscientific study that will never be published. The numbers that we hear on the quarterly conference calls refer to monitors that have been placed or sold to hospital accounts under contract. There are numerous monitors installed in many other hospitals that have not been included in the “installed base” because the training period has not been concluded and there has been no sale or somasensor contract signed.
Technical Analysis:
The chart of SMTS looks ok with an upward trendline from the March lows and resistance at around 18.50.  Buying in the mid teens make sense on a risk / reward basis with limited downside due to over $6.00 per share of cash.

 

Investment Strengths:

Somanetics has experienced double-digit sales growth for the last 12 years, including record revenue in 2009 of $50 million.

• Gross profit margins exceeding 85%.
• Over $6.00 in cash per share.
• Extremely high barriers to entry.
• Established and longstanding management team.
• Takeover target as a potential catalyst.

To Summarize:
We remain confident in the future of Somanetics Corporation. They are making a lot more headway than the quarterly numbers suggest. The financial crisis has slowed their growth rate in a year that should have shown acceleration. They are doing all of the right things to be successful.
They have or are:

• Adding new valuable products to their line.
• Constantly upgrading their technology and applications for its use.
• Investing at the right time to be prepared for accelerating demand.
• Gaining clinical support and evidence critical to the adoption of their technology by the medical community (FDA 510k).
• Defending their technology and intellectual property.
• Negotiated a three-year extension to their exclusive distribution deal with Covidien for Europe, the Middle East and Africa.
• Have set aside 13.5M for potential share buyback. 

January Employment Report

We wrote about the December Employment Report here.  There was not much to like in that report.On Friday the Bureau of Labor Statistics released the January 2010 employment report. The unemployment rate fell from 10.0 to 9.7 percent in January, and nonfarm payroll employment was essentially unchanged (-20,000), the U.S. Bureau of Labor Statistics reported today. Employment fell in construction and in transportation and warehousing, while temporary help services and retail trade added jobs. A total of 60,000 goods producing jobs were lost (higher paying jobs). Professional services contributed 44,000 jobs to the plus side, but 42,000 of them were part-time jobs!

The official unemployment rate is 9.7%. However, if you start counting all the people that want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is listed in the above chart under the U-6 column, which is 16.5%.

The trend is heading in the right direction, but jobs are still being lost, although at a much slower rate and close to break even.  We need to create 200k jobs monthly just to have a sustainable recovery.  The unemployment rate went down from 10.0% to 9.7%, but that percentage can be misleading due to the fact that discouraged people have left the pool of the unemployed while jobs are still being lost. Thank you for reading.