The Kirk Report

Focus On What Matters

Q: Like countless traders, I saw many of my positions stopped out last week, only to see them rebound to at or near where they were before the "flash crash" (e.g. AAPL). As you reflected in your recent comments, traders such as myself are still dismayed, indeed, angry that this happened. I can accept getting stopped out in any kind of market. Yet, I can't help but be angry that program trading, which accounts for about 2/3 of the volume on average, led to an environment in which a trader such as myself cannot possibly react quickly enough to adjust stops and other orders. However, the program traders, who were mainly responsible for this debacle, were able to react in a micro-second and reposition themselves. I'm generally opposed to over regulation of markets, but what happened last week is outrageous and should not be allowed to happen. I'd be interested in your thoughts and opinions.

A: We can sit here and complain until the cows come home about how unfair the markets have become or how dangerous this new environment is and what needs and should be done, but here's the question - how does that put more money into your pocket?

You and others may not like it when I ask that question (especially in a snarky tone), but for those of us who make a living (or hope to), please leave the opinion generation commentary to those who are paid to provide it. I know some of you think that's my job here, but I beg to differ.

My job is to help keep you focused and not to go off on some time-wasting rant that isn't going to help you trade or invest better. I'll still do that from time to time as I can't help myself, but I try not to as it is always a waste of time and energy. Matter of fact, if traders put in as much time and thought into their own trades this week than they have about complaining about how the markets work unfairly against them, they'd be a whole lot better off.

When my email inbox is flooded (and it has been) with questions of this nature this week, I have sufficient reason to believe that too many of you are focused on what has already happened instead of focusing on what is going to happen and more importantly how to profit from it.

Yes, the rules of the marketplaces are changing and have been for some time now in seemingly very "unfair" ways, but I for one remain confident that I can find and use new methods that will enable me to trade profitably even as market dynamics change. In some ways, these programmed trades are becoming easier and easier to spot and trade around (just my opinion) and those who are trading now are working intensely on strategies that help them do exactly that. In my opinion, that's the much better way to go and will be far more helpful than complaining about things none of us have the real opportunity to change or profit from.

Passion, Above All Else

Someone recently asked me what I specifically look for in those who apply for my mentorship program. While there are many factors, the one I'm looking for beyond everything else is a true and sustaining passion for the markets.

As difficult as it is for me to believe, people are drawn to the market for lots of reasons. For example, many hope to make a quick and easy buck. I have no problem with that, after all that's the American way. While others are simply forced in to the markets because they feel (right or wrong) they have little to no other chance of hitting their financial goals without making money in the markets. I have no problem with that either. In fact, many of my closest friends and family fit into this latter category. Which is also why I've talked about and have interviewed so many concerning passive indexed-based investing because there's simply no better option for the vast majority.

But for some, at least those who read The Kirk Report, truly desire to achieve success in the markets beyond what is financially necessary. It is why I do what I do and why it is still so enjoyable after these many years. Every day when I roll out of bed at 5AM, I'm excited about the day ahead. If that was not the case or if I would ever lose the passion I have, I sincerely hope I would find the courage to do something else. After all, our here time is short and this is something I am reminded of every May.

In my opinion, if you don't have the passion for the market and trading and investing, then you have no business being involved with them beyond what is necessary. To do exceptionally well in the markets, requires exceptional commitment. That commitment can only be reasonably sustained if you have the passion as I and others do.

I was reminded of this after watching a terrific interview of Chef Jose Andres on 60 Minutes last Sunday. The type of passion and commitment this man shows, not only for his craft, but also for helping others who are trying to get a start in his industry is something I truly admire and respect. If you missed the interview, I highly recommend it.

This is exactly the type of passion we look for when deciding who will join my mentorship group.

Doug Kass

Everyone's favorite bear, Doug Kass, has crawled out of bear den to offer up the following today:

"Arguably, the market has begun to decouple from fundamentals; instead, liquidity has overcome almost any other influence as every little setback has been countered with an avalanche of buying. It has fed upon itself, and it has contained corrections as many money managers play catch-up and chase strength. Hedge funds, in particular, are moving in; according to ISI, net exposures (at 51) are at a new post-March high.

Even technicals have taken a backseat to liquidity. For example (as my favorite technician reminded me), the recent two-week rally has been accompanied by a low put/call ratio (0.52). The last time the equity-only put/call was this low (summer 2002), a six-week correction ensued." - Doug Kass

Is it just me or does it seem like the bears only come out only on down days for the market to offer up their opinions?

Times Are Good

Needless to say, times are good for those with cash in their pockets. Case in point, my wife and I purchased two new cars over the past few weeks - a Buick Enclave & Chevy Mailibu - at a substantial "fire sale" prices. In fact, the deals we received were so significant that I actually felt bad for the dealership. In complete contrast with other car buying experiences, the people we purchased the vehicles from went over and beyond what we've ever seen to make sure we were more than satisfied (i.e. free oil changes, weekly car washes, extended warrantees, free accessories, etc.).

The clear upside from all of the economic upheaval that we've seen is that businesses are again appreciative to have us as customers and those with cash have the opportunity to get some great deals. While no one wants to spend money right now in such uncertain times, if you've been putting off some of these big ticket purchases for awhile, you may want to go shopping. I think you'll be pleasantly surprised by what you find.

The Rubber Band Effect

Although I don't normally turn on CNBC during the trading day, I made the mistake of doing so this morning. Frankly, I couldn't believe what I was hearing since so many people were making the call that we're near or at the bottom. Until today, I've pretty much isolated myself away from the media (which is what you have to do in highly emotionally driven markets) but I have to tell you that the hair on my neck raised when I heard those predictions.

Moreover, I spent some time this morning scanning some of the more popular financial websites and I'm seeing more of that same across the board. In fact, you even have "sell everything" Jim Cramer out this morning advising that "you must hold your nose and buy." As one who is looking to put cash to work amid the crash, I have to say that this wasn't exactly what I wanted to see on TV.

As difficult as it is to admit, at this point and time, we've seen absolutely no reason from the market itself to suggest that we're near or at a bottom. Every day this week we've come in with countless indicators suggesting that at least a bounce is imminent and everything that all of us have learned for many years clearly suggests so, but it simply hasn't materialized. Failure to rally here is important to both acknowledge and understand.

I've talked about this analogy before and I think it is more than appropriate to do so again. The market frequently operates like a rubber band. It gets too stretched (oversold or overbought) and we see a snap back. The more extreme the rubber band is stretched, the more extreme the subsequent bounce and sell off. We've seen this countless times over the years and have benefited tremendously from that as a result. In fact, I'd say that 90% of the money I've earned from the market in my career has been from positioning ahead of and playing these moves for all their worth.

The problem that we're dealing with now we've seen absolutely no significant snap back which now opens the door to the question that no one (even I) wants to face. Which is, to put it bluntly, has the rubber band (i.e. the market) finally been broken? And, if so, what does that mean for the future of the market and the economy?

To make the assumption that the market cannot break ever is making a giant leap of faith which is ok to do so long as you recognize the fact that you're making that leap all the same. In addition, to make the assumption that it will be a quick recovery to fix the rubber band (i.e. the market) is a tremendously tall assumption given what we're seeing right now. While I don't think that every company in America is going out of business and/or that we're at the first stage of the next Great Depression, the market itself hasn't told us anything different. At least not yet and, until that changes, we must at least recognize it.

Obviously, I don't have the answers, but I think I can at least identify the questions we should be asking ourselves during these darkest of days. Without the market proving that it can rally (even if only for just a day), how can we even start to say that a bottom is at hand unless we're simply making a leap of faith, based on experience, but not grounded by any evidence whatsoever?

Mood Of The Moment

This pretty much sums up the mood of the moment:

Bailouts Are Band-Aids

Though it is difficult to recognize, an economic crisis is a really good thing. It cleans up the system, destroys the excess, and it brings valuations low so that the risk/reward of being an investor is most advantageous. Like always, financial crisis creates opportunity.

Yet, it seems, this lesson is lost among all who continue to work against the natural evolution of the market and free market economy. Right now, the government is pulling every string possible in an attempt to save the country from financial ruin. We've watched our leaders go from telling us that there is no problem to worry about to now taking billions of dollars out of our pockets (and those of future generations) to help the rich and powerful who've made poor choices over the past few years. I say enough is enough. The rich and powerful want us to pay for their problems and they threaten our financial futures if we don't follow along. This is ransom, pure and simple, and we should not tolerate it any longer.

Bailouts are band-aids. While they reduce the pain, they don't cure the disease. We need to get back to a country that generates wealth because it is the smartest and most creative and that its businesses are the most productive, profitable, and competitive. Not a country that continues to lie to itself and creates one bubble after another in a desperate attempt to continue a standard of living that simply is no longer deserved. As Americans, we value money above all else, but we've lost a true understanding of how to create it. Instead, we try to look for short cuts that wreak utter havoc. And, even amid our darkest days, we continue to try to do the same instead of facing facts, owning up to our mistakes, and punishing those who deserve to be punished so we can move on.

In sum, let Rome burn. What will result is a much better America and a stronger financial system. But, if we continue to let our government transfer wealth in the same manner we've seen all year, the road ahead will be much tougher than anyone currently wants to think about. It will only delay the inevitable and the quicker we face and own up to our mistakes, the better off we will be. It is time for the system to punish the stupid. Let's make sure they do so we can move on, get on the right track, and prosper once again.

The Only Rule

Although it may not seem like it, this too shall pass. Eventually.

Until then, stay frosty and refuse to let small losses grow into larger ones. That's the only rule you need in this market and it will save you a fortune.

The Little Book That Makes You Rich

In spite of a horrendous title for any serious investment book, I enjoyed reading "The Little Book That Makes You Rich" by Louis Navellier. I have a bias against anything that claims to "makes you rich" so, if you're like me, don't hold the title against this little gem.

Although many of the concepts Navellier covers is already well-known by more savvy and experienced growth investors (and especially those who use stock screening in their strategy), this small book is worthwhile and has offered up some ideas and an online tool I think you may want to become more familiar with.

Navellier starts out his book out by outlining what makes for a great stock. In his view "the plain fact is at the end of the day what makes for a great growth stock one that can grow to 20 times your original investment is the fundamentals of the company." (page 2) The problem is, as Navellier talks about (and which I completely agree) is that fundamental variables have a short life span before they stop working and the edge is gone. For example, there will be periods of time the market "favors stocks with earnings momentum while there will be other periods that cash flow will reign supreme." (page 3) I've seen the same thing in the screens I monitor and this is a very important point to consider.

When people ask me what my favorite fundamental criteria is that I use in my favorite stock screens or why I utilize so many stock screens instead of just one, I realize they've yet to understand something very important - the market is always evolving and, like all of us, the market's preferences to what it rewards the most also do change over time. For example, you may hate eating sushi as a child, but later grow to love it when you get older and your tastes mature. The market is the same way. The challenge all of us have is to develop a strategy that takes that into consideration and to fit our strategy to the market's preferences. That's why any strategy or system that is built on the principle that "Do A, B, or C and you'll get rich" is ultimately doomed for failure. Nothing is that easy even though all of us wish differently.

In the bulk of the book, Navellier then goes on to make the case (and a compelling one at that) for 8 "tried and true" key fundamental factors to incorporate when screening your stocks. They are:

1. Positive earnings revisions

2. Positive earnings surprises

3. Increasing sales growth

4. Expanding operating margins

5. Strong cash flow

6. Earnings growth

7. Positive earnings momentum

8. High return on equity

If you don't know what these are or how important they are in the screens you use, then I think you'll find this book to be very worthwhile. I especially liked his perspective on why earnings estimates are typically a lot lower now (i.e. why most companies are beating their estimates) and why analyst revisions are so important to watch for. For example, Navellier talks about how herd mentality forces analysts to follow each other and stay too conservative because their most important goal is to avoid getting fired for being wrong by being too optimistic about a specific stock. (Surprise - their top priority is not to make you money!) In his view, analysts can miss as long as others miss along with them and they are too conservative because analysts don't get fired for being too conservative anymore. Therefore, when you do see analysts raising their estimates, it is a clear indicator that good things are happening in that stock.

While I don't want to give too much of the book away, if you're looking to understand what is currently working in modern stock screening now, Navellier does a great overview by explaining why each of these eight fundamental factors are important for stock selection. My only qualm is that I would have also like to read about how these factors have changed in his career and more importantly, what caused them to change. In addition, he provides little insight to how he modifies his screening system to provide greater weight toward certain fundamentals rather than others and how he adjusts them over time. I suspect this is a relatively large part of his proprietary strategy, but he provided little insight along these lines. While we both agree that things do change and you have to modify your criteria to suit the market, it would have been nice for him to offer a more complete review of how and why they have changed and how to recognize when and how to make routine adjustments based on market conditions. Doing so would have made his book more useful for experienced investors who utilize stock screens. But, I suppose I'm asking for too much from a book that is only 185 pages long and can be read in a couple of hours.

After covering the different fundamental factors, Navellier then goes into strategy of evaluating risk versus reward - in other words how to formulate portfolios that do well utilizing screens that lead toward selecting certain stocks. It is in this section that I personally found the most interesting. This is also a topic that I don't cover as much as I should something I would like to focus more attention on. The reason is simple - I provide a lot of very good stock screens that will serve members well, but if you don't know how to build a portfolio out of stocks those screens highlight, then chances are fairly good you're not using the screens the way you should and your results won't achieve the level you desire.

Navellier's approach is fairly simple. In essence, he calls it his Zig Zag approach. To do well in the market, Navellier recommends to create a portfolio that is 1) diversified across different industries & sectors, and 2) with individual stocks that have very different levels of risk. While most of us understand the importance of the first, it is the second point that I found the most interesting.

According to Navellier's research, a good starting portfolio will be comprised of a 60/30/10 mix. (page 106) In other words, 60% of your stocks should be rated "conservative," 30% of your stocks will be rated "moderately aggressive," and 10% will be rated "aggressive." In his research, this mix provided for "smoother, steadier returns." In essence, Navellier doesn't believe in using market-timing, but creating a portfolio that will do well no matter what happens in the market. In addition, the mix provides for a group of stocks that "tend to zig and zag against each other, thus helping to achieve higher and smoother returns." The bottom line is that by both diversifying your positions across a number of industries AND by varying your risk levels your portfolio is built do well without any market-timing. That kind of system should appeal to many of you who don't like timing the market or simply suck at it (in fact, most do including me at times).

So, how do you find out the level of risk of a particular stock or how a stock stands up to the 8 key fundamental factors that Navellier favors? Well, here's the nice part. As a free compliment to the book, Navellier's has created a website Get Rich With Growth which allows you to filter your favorite stocks so you can see how they rank both in terms of the 8 fundamental factors, but also in terms of risk, and also what he calls his "Quant Grade."

Although Navellier doesn't reveal how he creates his quant grade, he says on page 97 that high quant scores are typically indicative of "institutional buying pressure." This sounds like a fancy way of saying "money flow" or "accumulation" in an aloof way, but clearly he does utilize that in his strategies as I do as well and which I've also previously discussed in prior posts. For example, the MoneyStream filter I've shared I suspect is another way of doing this same thing although I'm sure Navellier's approach has been modified/perfected to suit his own strategies. Without more extensive evaluation and cross comparison of his quant scores with my own strategies, it is difficult for me to know exactly how he does it, but I intend to try to figure it out.

Near the end of the book, Navellier then talks about how to utilize his PortfolioGrader tool. For example, on page 123 he makes the claim that stocks that scored a fundamental A and that have A or B scores in all fundamental categories were true superstars even though "A" grade stocks remain A's for an average of four to five months. That list, he says, returned more than 50% per year from 1998 to 2003 and his website offers the following compelling graphic:

As you know, in the past I've found it fun and interesting to filter my screens' results against other systems. (See this previous post). So while we are at it, I thought it would be useful to go ahead and filter my stock screen machine stocks through Navellier's filtering system.

What I found was no surprise - the vast majority of stocks found within my stock screen machine rank very high in Navellier's system. For example, only 7 stocks out of 170 were tagged with low ratings while the rest scored at the top end of his ratings system. In fact, 15 stocks received Navellier's highest marks - with a score of A in total, quant, and fundamental grades. To view the excel file scores, take a look at this excel file I created (please also note my notes near the bottom of the excel file as I separate the top 15 stocks by risk):

As the excel file shows, within the top 15 highest rated stocks, the risk levels are close to Navellier's target allocations with 50% of them being conservative, 40% moderately aggressive, and 10% aggressive. (These are not precise percentages - I have to make some generalizations since I'm only dealing with 15 stocks in this small sample). The problem is that as you can see, the most of the top stocks represent only two sectors: information technology and industrials (according to Navellier's very own sector designations). And, there presents the challenge. Most of these ratings systems will target really good stocks in well-performing sectors, but diversification throughout sectors becomes the key challenge. Ideally, you would then want to fill in the gaps by looking for stocks in other sectors that are also highly ranked.

In addition, I'd also like to make the point that Navellier avoids (since he's advocating a stock-only focused strategy) is that you can also utilize ETFs to provide for some of this risk and sector distributions. For example, take my 80% passive/20% active lazy portfolio strategy I've recommended. In the 80% lazy portfolio section, if you do a good job of both separating your risk and sector allocations, you can afford then to add stocks to the portfolio that are more sector-concentrated and which present greater levels of risk. This is part of the nice thing about combining ETF and stock strategies now is that portfolio allocation becomes a whole lot easier to manage. For example, a portfolio that is structured so that 80% will match the performance of the overall market with 20% in well-selected individual stocks even with high levels or risk and sector concentration will serve you well.

For tracking purposes, I will create a model portfolio out of the highest ranked 15 stocks in the stock screen machine (again see excel file) and report back after some time has passed. Like with other systems I've profiled, I also like to evaluate how a system performs by what it doesn't rate well. Since the vast majority of stocks in my screen machine don't fit that category, I will use Navellier's built-in filter of the top 20 stocks to sell which he also makes available at his website. I know many of you are looking for short-sell screens, so I'm interested as well to see how this filter of the worst of the worst fares, especially in comparison to my own screen of junk stocks. If you intend to track these as well (and I suggest you do) in all fairness to Navellier's system, I will utilize Monday's closing prices for tracking purposes since these grades are based on Monday's update (he updates his ranking system every weekend). The top 20 stocks to sell have also been added to the excel file above in case you don't want to visit his website right now.

Bottom line - you'll want to check out his tool when you have time, if not add it to your toolbox. The fact that my stock screen machine stocks rank so highly in his system is a good sign of its utility. For now it is free, but keep in mind that after you provide an email address in registration, Navellier will begin to send you emails to inspire you to sign up for his expensive newsletters ($999 per year). A truly excellent marketing approach, if you ask me. By opening his system this way, he's making a bet that people would rather have him do the screening and provide his favorite picks instead of people doing the work on their own. From what I know of the investment public, that's a very low risk/high reward bet to make.

Notwithstanding this issue along with lots of boastful commentary about how smart he has been (a common element among newsletter gurus), Navellier did a good job with the book and offers a nice introduction to screening and the fundamental elements that are working in today's market. He also offers some perspectives in terms of risk management that make sense for most investors and so I do recommend it. In addition, he should be given full credit for freely opening up his system to everyone, especially for those of us looking to tweak, upgrade, and compare and contrast their own investment strategies to his approach. Without a doubt, I know I'll enjoy playing with his PortfolioGrader!

My Inflation Watch

In preparing my third quarter estimated taxes over the weekend, I made the mistake of looking over our spending patterns and household budget. As many of you could probably confirm with your budgets, we seem to be paying quite a bit more this year for two main things: travel & food. Quite a lot more.

In fact, what was our usual $100 per week in grocery bills is now averaging around $140 (a +40% year-over-year increase). I guess I shouldn't be surprised with the Fed more than willing to print money to throw at the economy. I suspect that in a couple of years these prices will seem really cheap in comparison to the amount we'll have to spend for the same items.

Clearly those who think inflation is dead must not be spending money the way we do. For now, I'll lump this behavior in the same category with those who previously thought that "you can't lose money in the housing market" and "all tech stocks will grow over 100% per year forever."

Yes, Bernanke is flooding the market with liquidity, but there is no free lunch. Enjoy it while it lasts.