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Signs of Spring

by
Paul Kluskowski

In Minnesota, there are many markers of the transition from winter to spring. The colorful clusters of ice fishing shanties that formed little villages on the frozen lakes and rivers begin to dissipate. The hard water world that provided a foundation for these transitory communities slowly gives way back to its liquid state. Open waters bring the quacking and honking of water fowl as they wing their way north again. And as the last of the snow and snow mounds disappear, we discover another marker of spring: potholes. Cursed by drivers and road crews alike, these marvels of spring are the inevitable result of the invisible but powerful forces of water repeatedly freezing and thawing. Unseen at the surface, the water finds its way into every crevice of the road's surface where it then freezes and expands. Exerting tremendous pressure on the material around it, the road eventually relents as the asphalt crumbles leaving a void in its place. Only when the freezing weather has passed can the damage be repaired so that full-speed transit can safely resume. And while the states fix the physical potholes, the Fed is busily patching the financial ones.

The Fed's financial road crew, aka the Treasury Department, has no shortage of work to be done. Many of the financial potholes are obvious: Fannie Mae, Freddie Mac, Bear Stearns, Goldman Sachs and Morgan Stanley to name a few. Others are more akin to black holes. To be sure, AIG is a financial hole that is swallowing amazing amounts of taxpayer money. At $180 billion and counting, this is a hole in the road that we will not soon forget. And then, there are all the lesser financial potholes. These are the smaller banks and credit unions that have failed under deflation's crushing pressure, leaving the FDIC to clean up. No doubt, the Fed's road crew has been busy, and likely will be for years to come.

While not a product of the Great Depression, Ben Bernanke is openly a student of it. Then, as now, debt levels reached unsustainable levels. Too, bankruptcies and bank closures exploded. In his academic research, Bernanke is often quoted that in the 1930's the federal government lacked a key weapon in the fight against deflation: a printing press. While still adhering to the gold standard, the US government was unable to stimulate the economy through monetary means. Bernanke asserted (and still does) that the government's ability to print and distribute money is the weapon of choice when faced with widespread asset deflation. And, it appears Bernanke's printing press is working overtime.

Managing the yield curve is one way the Fed manipulates the monetary supply. When the Fed sets short-term rates below long-term rates (as they are now), the yield curve is called "normal," and it is stimulative to the economy. By borrowing money at short-term rates, banks can lend at long-term rates collecting the difference. This not only fuels profits, but it provides necessary capital for the bank's balance sheets. A flat yield curve, meaning short-term rates are equal to long-term rates, has no stimulative effect. In essence, borrowing and re-lending at the same interest rate leaves no profit for the bank or economy. So, this ratio of long-term rates to short-term rates is of interest to us as investors. For our discussion, let's refer to this as the Stimulus Ratio.

Historically, our Stimulus Ratio has fluctuated in a range of 0.9 (slowing the economy) to 2.5 (very stimulative to the economy). For the better part of the 20^th Century, this range worked well for the American economy. Further, any time the Stimulus Ratio exceeded 1.15, it was fairly certain that a stock market rally could be expected. To be sure, those were the days.

Beginning in 2001, it was clear to Greenspan that the economy was beginning to struggle. The Internet bubble was deflating. The stock market was clearly tanking. A recession was well on its way. To combat these, short-term interest rates were lowered considerably. Our Stimulus Ratio exceeded the magic 1.15 during the first half of 2001. By 2003, it reached the never before seen value of 5.0! This was approximately two times the previous maximum stimulus of the preceding 50 years. Sure enough, the stock market bottomed and turned up roughly 2 years after the Stimulus Ratio exceeded the magic value. In the process, however, a housing bubble was created.

By late 2007, the unwinding of the housing bubble was well under way. Unfortunately, this one was far more pervasive than the Internet bubble. Like so much water soaked into the pavement, mortgage debt was everywhere: banks, brokerages, pension funds, endowments, municipalities. You name it. As the credit markets began to freeze from defaults and loss of trust, the resultant forces buckled and broke a great deal of financial pavement. Desperate times call for desperate measures. And these were those. Faced with a frozen credit market, Bernanke lowered rates again and again to halt deflation's progress. The rates dipped so low that our Stimulus Ratio peaked at 98 in November 2008. This represents nearly 20 times the stimulus of 2001-3 and almost 100 times the historical norm. Even today as I write this article, the value stands at 13+. Let there be no doubt, Helicopter Ben knows how to print money and shovel it into potholes.

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It has been said that the road to Hell is paved with good intentions. And most certainly the Fed's road crew means well. Our financial potholes are obvious and impeding economic traffic. At the same time, the magnitude of the stimulus is nothing less than stunning. How our economic and financial systems will respond remains to unfold. The stock market seems pleased, although volatility remains suspiciously high. While the Fed does its best to inflate, gold and other commodities could hardly be called bubble-like. It is a curious period in economic history. Never before has the world's economic engine printed so much money. And yet, never before has winter done so much damage.

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About the Author: Paul Kluskowski is an independent investment manager currently living in Minnesota. He is a long-time student of the stock market and Van Tharp. Paul was the founding president of Van's Local Chapter in Washington, DC and has participated in the Super Trader program. He can be reached at pjk@trfinancial.net.

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More Top Notch Internet Resources Part VI
Stock Screening - Google Finance Falters

by
D.R. Barton, Jr.

Last week we ended by talking about Google Finance's use of Web 2.0 tools to make an addictive little screener.  And it is truly fun to play with.  But alas, when the playing is done and it's time to get down to some real work, Google Finance's stock screener really has little to offer. 

First the good stuff about the Google screener.  Compared to almost every other screener, it's easy to find.  A little thing, I know, but it's frustrating trying to go through the multiple layers of web pages to get to some of the better no-cost screeners.  At the top of the Google Finance homepage, right next to the ubiquitous Google search box, is a single hyperlink, the stock screener (in typical Google minimalist style).

Once you get to the screener you'll find four default screening criteria with boxes for minimum and maximum values.  The truly unique part is the slider that's between the min/max boxes.  Between the min and max sliders is a little histogram that represents how many stocks are at each increment of the slider.  Cool.  For most criteria, this looks like a normal distribution, with some skew to one side or the other.  What makes this really fun is that if you move one of the min or max sliders to reduce the universe of stocks, you get instantaneous feedback on how many stocks satisfy the scan, plus a sortable list of stocks that meet all of the criteria.  And when I say instantaneous, I mean less than a second.

As Google has set this up, it's a very visual process, but I'll try to describe one example for you.  With all of the criteria set as wide as possible, Google shows 2,950 stocks. Move the 'dividend yield' minimum value slider to the right from 0% to 5% and the universe is reduced to 512 instantly sortable stocks.  You can do this with 61 different criteria that Google provides, if you so choose.

But the good news pretty much ends there.  The minus side of the ledger is unfortunately well populated for the Google Finance screener.  And there are some deal killers.

First and foremost, there's no way to export the results of your scans to a spreadsheet or trading platform watch list.  And if you devise a scan that you really like or need and want to run it later, there's no way to save a set of screening criteria.  In addition, the universe of screening criteria is fairly limited.

Here's the bottom line.  If you're just wondering how many stocks have a Market Cap over $1 billion and a dividend yield between 2% and 6%, and you want a lightening quick answer, Google can get you there with a sortable list.  But you won't be able to save or export the scan, making the utility of this Google app marginal at best.

In the end, the Google Finance stock screener is a bit like a Slinky.  It's fun to play with and can occupy you for minutes on end, but when all is said and done, you can't turn your time and effort spent into anything really useful.

Next week, we'll start to look at some screeners that scan for technical criteria.  So please send any suggestions/thoughts/reviews of your own to drbarton "at" iitm.com.  Until then...

Great Trading,

D. R.

About D.R. Barton, Jr.:  A passion for the systematic approach to the markets and lifelong love of teaching and learning have propelled D.R. Barton, Jr. to the top of the investment and trading arena.  He is a regularly featured guest on both Report on Business TV, and WTOP News Radio in Washington, D.C., and has been a guest on Bloomberg Radio. His articles have appeared on SmartMoney.com and Financial Advisor magazine. You may contact D.R. at  "drbarton" at "iitm.com".  

Percentage Volatility Explained

Question:  I have just finished reading TYWTFF and found it to be an excellent resource. There is however confusion in the position-sizing department. I understand the Percent Risk Model very well. However, Percentage Volatility needs more elaboration. Can you please provide an example where a tight stop would be useful with this model? What kinds of stops can be used?  I've read a few of the forums post on it and I got the idea that volatility model uses volatility stops ONLY.  Thanks. Z.M.

Answer: You are making some assumptions and then trying to fit the models to this assumption rather than using logic.

Let's say you have a $50 stock and a $100,000 portfolio, risking 1%. Thus,your risk per position is $1000.

However, let's assume that you are a day trader and your stop is 10 cents.

If you divide your risk per share into your $1000, then you can purchase 10,000 shares which, at $50 per share amounts to $500,000 worth of stock.

Based upon the position sizing model you could do it (with 1% risk) even though you'd be breaking all the margin requirements.

If the daily volatility is $3, even without a volatility stop, you could position size based upon volatility. If you want to only allocate 1% of your equity, then you would divided $1000 by $3 and get 333 shares. You could thus purchase 333 shares of the $50 stock or $16,650 worth. Thus, is a little more realistic than half a million worth, but you would still have your $10 cent stop. --Van

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