Gone Fishing

In 1951, Louis Armstrong joined Bing Crosby on television’s popular “The Chesterfield Show” to sing a duet. Of all the chart topping songs each singer made, the song they chose to sing was a tune called “Gone Fishing”. We thought about that song fifty five years later as we perused volumes of new market data and graphs and realized Louis and Bing were singing about an investment strategy custom made for the summer. We began to shop for ‘fishing pole’ stocks – stocks whose trajectory resembled the silhouette of a fishing pole with its line immersed in water.

An investment shift to the “fishing pole” sector?

Sensing opportunity after the market pullback of May 2006, we began tenaciously reviewing pricing patterns and recent financial reports for clues of the “next best thing.” We expected a “next best thing” candidate to emerge from our work as in the past – for example “Japanese stocks”, “oil stocks”, “consumer cyclicals.” Instead what we found (with the lyrical assistance of Mssrs. Armstrong and Crosby) was “fishing pole stocks.” Stocks of all sectors and sizes were being subject to what we will term the “fishing pole” effect. That is to say, the severe drop in the growth of the economy in the second quarter had resulted in a growing number of stocks falling rapidly in one day so that the appearance of the stock’s price chart loosely resembles the silhouette of a fishing pole with its line immersed in water. (Find attached a number of examples below for your visual inspection. A picture IS worth a thousand words in understanding this phenomenon).

CHARTS

Stock prices whose trajectory somewhat resemble the silhouette of a fishing pole with its line immersed in water…

Our point? Some stocks that have already fallen in such a “fishing pole” manner have shown notable relative resilience to a new downturn when one is presented. If this stable behavior continues, we would consider looking into new positions from stocks that showed ‘fishing pole’ behavior.

We made two observations [observations not research findings] on the “fishing pole” effect:

a. The severe one day drop of the stock prices of so many well-known, profitable companies’ stock prices may represent speculators or hedge funds getting flushed out of a position in those stocks. Consider, is UPS really worth $10 billion less in market capitalization on Tuesday simply because its earnings fell on the lower half of its previously stated earnings guidance on Monday? Speculators may be folding as we write.

b. Admit it or not, if an increasing number of stocks are subject to a 10, 15 or 20% one-day price drop, would THAT not be considered “the crash”? That is, if, say, each of the 30 stocks in the Dow Jones Industrial Index fall 15 or 20% in one-day BUT those falls are scattered over 30 to 60 days, the index should be “down 15 to 20%” in total. We are not suggesting that the Dow will fall by such a magnitude necessarily.

What we are suggesting is a 20% crash could occur on one fateful day and garner the moniker of “Black Tuesday” or the fall could occur more slowly over a longer period of time. We submit we may be witnessing the latter. Either way a stronger case for a firmer market bottom can be made once double digit drops are in place.

As we proceed through 2006, we look with great interest on the possibility of catching a ride on the bottom of the line descending from the fishing pole on many a stock.

Let the Data Do the Talking

Are Hedge Funds Making the Healthcare Investment Sector Unstable?

Proposition #1: The first-world’s population is aging and requires incremental increases in healthcare spending to address ailments which afflict the aging.

Proposition #2: The first-world enjoys unprecedented prosperity, wealth and standard of living.

…Proposition #3: If a population is wealthy, they will spend their wealth on something. If that population is elderly, they may be obliged to spend their wealth on products and services to improve their health and extend their lives.

The propositional logic contained above is compelling and arguably has become conventional wisdom among investors. Yet the healthcare investment sector has displayed similar volatility as other investment sectors (see third quarter 2005 and second quarter 2006). Why? If one searches for clues as to why this volatility appears in a sector believed to be demographic dependant and not financially dependent, the counter intuitive aspect of this phenomenon emerges. That is to say, the unexpected volatility of the sector might have less to do with the demographics or the financial viability of companies selling in the healthcare sector as it has to do with who is invested in the sector: hedge funds. Topol and Blumenthal considered hedge funds and their influence on healthcare investments:

“There are more than 7000 hedge funds operating in the United States, with assets approximating $1 trillion.   More than 425 hedge funds were started in 2004. The numbers are imprecise because these funds are not currently required to register with the Securities and
Exchange Commission, but this will change in 2006 [still uncertain at press time].

Since 1990, the assets in worldwide hedge funds have increased 100-fold, from less than $10 billion in 1990 to nearly $1 trillion in 2004.   Hedge funds have a long history beginning in 1949 and typically use higher-risk strategies for investing, such as betting on a stock to fall or borrowing capital to make investments. Nonetheless, pension funds invest as much as 20% of their assets in these funds, and universities and charitable foundations, more than 10% of their endowments. For example, Harvard University invested $500 million, or 2.5% of its $22 billion endowment, in a single hedge fund. In 2004, individuals invested more in hedge funds than all institutional investors combined.

A typical hedge fund charges a 2% fee plus 20% of any gains, which is a considerably higher investment fee than that charged by most alternative investment vehicles.

Approximately one third of hedge fund investments relate to life sciences, particularly publicly traded stocks and derivatives of pharmaceutical, medical device, medical diagnostic, and biotechnology companies”.

Conclusion: We will watch attentively if hedge fund exposure to the healthcare investment sector (~ 33% exposure to healthcare) begins to regress to a percentage found in a broader market index. For example, healthcare companies compile only ~12% of the S&P 500 Index.

Source: JAMA “Physicians and the Investment Industry,” Eric J. Topol, MD and David Blumenthal MD MPP,
JAMA. 2005;293:2654-2657.
Source: moneycentral.msn.com

The Jeweler’s Eye

Whatever one’s political persuasion it would be difficult to dispute the observation that after living through the 1990s with an administration that could not stop daily adjustments of its core policies to suit the latest polls; since 2000, the American voter has lived with an administration that seemingly does not acknowledge the latest polls.

Our political sources estimate the popularity poll ratings of the sitting president to rival those of Richard Nixon during the Watergate hearings. But the problems do not stop in the Oval Office.

– Over 22% of U.S. respondents to the latest ACNielsen Online Consumer Confidence Study said they are short on cash after they cover their basic living expenses, per marketwatch.

– Outflows of cash from [U.S.] stock funds in July and inflow into foreign funds are big and the Commitment of Traders (CoT) report shows small speculators have given up on US stock ownership, per Salamone September 1, 2006

If the President is under pressure, the US consumer shows signs of being strapped for cash, investors are selling US stocks to buy foreign stocks and the small speculator is betting against US stocks, what’s an investor to do?

May we suggest one consider U.S. stocks?

The decision to ‘go American’ is a vexing one. To begin with, the domestic economy is either in a recession or one shade this side of a recession – we will find out in next month’s data release. Additionally, the US Consumer represents approximately 70% percent of GDP and does not show signs of strengthening (per Nielsen above). Thus we break our present mindset into two parts: (a) the other side of the economy and (b) happy days will come again.

‘The other side of the economy’ has to do with the 30% of the GDP not represented by the US consumer – e.g. industry, infrastructure, et al. Some companies which are in decent financial shape may gather steam whilst the consumer struggles to boost spending.

‘Happy days will come again’ deals directly with how fast the Federal Reserve will come to the rescue of the Indebted US Consumer in the way of reduced interest rates. The housing woes facing the over-leveraged are well covered in the press and do not require re-hashing here. However, the Fed can boost rates to save the dollar or cut them to save the consumer. You can make your bet on which one will play out. But before you do, recall mid-term elections are just around the corner; something that might sway our guess.