Velocity of Money - Watch out Below

The following chart is extracted from the St. Louis Federal Reserve web-site. More specifically it is the FRED database section of that web-site. Years ago (pre-internet) I had a monthly subscription to the St. Louis Federal Reserve Monthly Review - it provided an excellent update on all financial and economic indicators as well as recent economic research on monetary affairs. Nowadays, of course, the whole thing is available on the web. Very handy and I would recommend it to my readers.

The chart provides some information on M2 money supply over the past several years. In particular you might note it has been in relative decline since the mid-1990's. In fact the decline appears to be quite pronounced. If you ever have taken a basic 101 economics course you might recall the basic equation of MV=PQ where:

M = total amount money supply
V = velocity of money (or turnover)
P = price level of output
Q = total economic output

In theory if you increase the money supply you will increase econonic output and/or prices. Well, maybe. BTW, there have been historically 3 measures of money - M1, M2 and M3. Reporting on M3 was discontinued a few years ago.  I will briefly define M1 and M2 (if you don't know already). M1 is basically currency in circulation and demand deposits. M2 is M1 plus savings accounts and money-market funds.

(of course this is one theory of economic output - I believe the Keynesians have something to dispute here but that will be another post)

OK, why do I present this chart? The velocity of money measures the turnover of money in an economy. For example, you go to the your friendly neighbourhood bank and get a business loan for expanding your business. the bank approves your loan and you deposit the money in your bank. Over the next several months you expand your business by hiring people and expanding capacity. The people that you hire get salaries and they in turn deposit their money in the banking system. In this manner the money supply increases in what is commonly called the multiplier effect.

In recent years (since the 2008 crisis) there has been great debate on where the economy is going. The Federal Reserve has been "printing money" with QE programs measuring in the trillions (or is it billions?). No doubt we are going down in blaze of hyper-inflation! Well, there has been absolutely no sight of inflation yet. Long term treasury bond yields have come down over that last several years in response. I believe that given the serious decline in velocity Bernanke has been correct in implementing  a very loose monetary policy. Unless velocity turns upwards in the near future I believe we could see low interest rates for many years to come. A Japan like scenario could very well be in the cards (but not as bad).

I generally do not invest based on long term forecasts of the future because it is ultimately unknowable. However, I do like to be familiar with general trends in the economy. Once in a blue moon I will make an investment decision based on economic trends. I see low interest rates for many years to come as debt levels are worked off and behaviorial shifts take place. Low interest rates might sound great for stock market investors but hold on a second. Deflation also leads to lack of pricing power as companies cannot increase prices due to lack of demand.

I hope the above explanation provide some background for my readers.

Stop Loss Orders - I Never Use Them

To the best of my recollection I have never used stop-loss orders. Also I have no intention of using them in the future. What is a stop-loss order? A stop-loss order is an order to sell a stock at a pre-determined price sometime in the future. For example you own a stock that currently is trading at $50 per share. You bought at $30 and have made some nice profits. In order to "protect"  your profits you place a stop-loss order with your broker at say $45. If the stock declines to $45 per share your stop-loss order becomes (and this important) a market order to sell the stock. If the stock is liquid you will probably get a decent fill but you can never be sure. But In today's world of flash crashes anything could happen.

The whole thing sounds sort of logical - after all you prevent any further losses in your investment. The stock could crash 80% and you were smart enough to enter a stop-loss order. This is all great except it doesn't work. Think long and hard about what you are doing. A stop-loss order is an ARTIFICIAL CONSTRUCT in logic. If they consistently lead to superior profits everybody would be using them including Warren Buffett. You are placing an order to sell a part of a business at a pre-determined price based on what information? Is the business doing poorly? Remember that stock prices vary greatly week to week and month to month. You could be stopped out for no other reason than the general stock price level went down. Maybe some large pension fund came into the market and dumped a bunch of shares driving the stock down. Another important reason is that stop-loss orders don't work is that stock prices are not predictive. Past prices have no bearing on future prices in my opinion. Stocks are not serially correlated as the statistical people would say. It also demonstrates why technical analysts are not the richest people in the world but that will be another post.

In conclusion when a stock price declines significantly and the business fundamentals are fine you should perhaps be thinking of buying more shares.

Has Apple Reached a Bottom?

Of course I do not ultimately know the real truth here. As mentioned in an earlier post I feel that margins will be OK and the stock is a buy in the low 400's. Many pundit's have argued that that the stock is making a transition between growth and value. Maybe so. Since the earnings release a few days the price action has been quite good. Here is the most recent chart (updated May 16) of Apple:

Quick Note on Placing Orders

I feel obligated to provide a quick note on placing orders for thinly traded stocks such as I have provided on this blog. Speaking for myself I usually use limit type orders for the more thinly traded stocks - usually they are small cap. It takes a bit longer to get your fills but it is worth it. Occasionally I violate this "rule' when I am placing a small order - say less than 1000 shares. With the large cap American stocks (such as Apple) they are so liquid that I find placing a market order is usually quite acceptable.

Charts for ARE, STN and TIH - Courtesy of StockCharts.com

For those folks that are chart lovers here are the charts for the stocks I cover:

Updated May 16 2013

Aecon:

Stantec:

Toromont:

Toromont Industries - Symbol TIH on the Toronto Stock Exchange

Yesterday I bought a few shares of a company called Toromont Industries. The symbol is TIH. The company is based just outside of Toronto (in Concord). They are the primary Caterpillar dealership in Eastern Canada and also have design/build Cimco refrigeration systems. The sales are approximately $1.7 billion with over 3000 employees. They have been in business for several decades. A regular dividend of $0.48 is provided giving a yield of 2.1%.  They have a long history of increasing their dividend every year. The stock trades with a low volatility (0.78 - Google Finance).

I have been following this company since the early 2000's. They have an excellent operating record providing historically an ROE in the high teens. Yesterday they reported quarterly results. EPS was a very slightly disappointing (0.23 vs 0.25 expected). Sales were up 11%  year over year. Margins were down slightly. Due to the EPS coming in slightly worse than expected the stock is down a bit.

Finally, this company is somewhat cyclical but defensive as well due to the low volatility.

Comment on Apple and New Buy - Toromont Industries

As you probably know the Apple results are out. Basically they met expectations with perhaps the exception of guidance. I do not possses any special insight into Apple. I just think it is decent buy in the low 400's. If you want some guidance on Apple valuation I would refer to Damodaran Musings on Markets - the post on January 27, 2013. http://aswathdamodaran.blogspot.ca/search?updated-max=2013-02-13T06:49:00-08:00&max-results=7

Anyways, today I bought a few shares of a company called Toromont Industries. More on Toromont tomorrow.

Stock Review - Stantec - Symbol STN on the TSX and NYSE

Stantec is a relatively small engineering company based in Alberta, Canada. They conduct work primarily in North America. The market capitalization is currently around $2 billion CDN. This is relatively small compared to the giants SNC, Fluor and Jacobs Engineering (and others). They have grown significantly over the past 15 years due to aquisitions of smaller type firms and also some organic growth.

I have been following this stock since about 2003 and buying/selling the shares. Originally I had bought the shares around 2004 and sold them in 2007 for a nice profit. I just did a quick check on the stock performance since 2000 on Google Finance and I get almost a 1500% return over that period (2000 to present). This vastly outperforms the TSX over the same period. The reason is simple - consistent earnings growth, strong margins, decent competetive position and capable management.

In my opinion this is a well managed company that at the right price could be an excellent investment over the long term. The stock currently trades around $44 CDN on the TSX. I do not currently own STN having sold out in the high 30's. I am currently worried about valuation here. The stock has advanced signficantly over the last 12 months or so. I have a feeling that some money has come over from SNC Lavalin (ie. disappointed shareholders). In other words, with all the headline controversy at SNC some investment money will flow into Stantec. In my opinion at $44 and a trailing P/E of about 17 the stock is currently overvalued (slightly). I would like to see a pull-back into the mid 30's if possible. Let's wait and see. STN does provide a small dividend. The dividend yield is 1.5%.

On a cautionary note this stock is cyclical and therefore paying attention to business cycle indicators might be helpful.

Stock Review - AECON - Symbol ARE on TSX

Aecon Group Inc. is a Canadian based construction and engineering company. The company has been in business for several decades in one form or another. The stock symbol is ARE and it trades on the Toronto Stock Exchange. The company is small cap by most standards - the market capitalization is approximately $650 million. The company operates mostly in Canada but does have some international exposure. It also operates in both the public and private sector.

I have been following the company closely for about 6 years. In 2008 I got lucky when I bought the company at a low of about $6.50 and the stock doubled over the next 6 months as the federal government implemented a substantial infrastructure program.  On the negative side this company does tend to be deep cyclical - when economic activity goes down hill this stock can get hit hard.

On April 23rd the Stock closed at $12.26 CDN. The book value is slightly over $10 according to my calculations. More importantly over the last year they have significantly increased the dividend and in the latest quarter they reported an earnings surprise at $0.72 per share. This significantly beat the street at $0.56 per share. If the current economy holds up and the oil sands work also holds up they could earn $1.40 this year. Over the past couple of years they have increased the operating margins - this is a key goal according to John Beck the President.

I am currently long this stock buying in at an average price of about $10.40. On a cautionary note I am keeping an eye on economic data as well as oil sands developments.

Excellent Post on Gold Valuation by Damodaran

I follow a lot of blogs. One of the best blogs out there is by Aswath Damodaran. It is called Musings on Markets.

Here is an excellent post on the valuation of gold:
http://aswathdamodaran.blogspot.ca/

Markets are Forward Looking

Markets are forward looking. This should be intuitively obvious. The reason that I bring this up is that I keep getting emails from Seeking Alpha telling me that Apple is grossly undervalued. Usually they quote the P/E ratio or some other valuation metric. What they are missing is that markets are usually forward looking. In my opinion the market is saying that profitability is going down. This, of course, could be right or worng. Time will tell.

Despite the fact that profits will likely go down I still think the stock represents decent value here. A great deal of bad news is worked into the stock and a positive surprise this week will move the stock higher.

Wells Fargo Economic News and Market Commentary

If you follow this kind of stuff the service provided by Wells Fargo (https://www.wellsfargoadvisors.com/market-economy/economic-market-reports.htm
is outstanding in my opinion. More importantly it is free to subscribe. Give it a try.

Investment Newsletters and Martin Zweig

First of all please read this piece on gold by David Kotok:
http://www.cumber.com/commentary_archive.aspx
When David writes (or speaks) I listen.

I recently read that legendary investor Martin Zweig had died. The event was broadcast on cable news CNBC and he received many accolades. Many years ago (early 1990's) I subscribed to Mr. Zweig's investment newsletter. At that time, according to Mark Hulbert, the Zweig Forecast had an excellent track record in picking stocks. Zweig used quanitative methods which attracted me since I also had a background in mathematics.

Unfortunately this and other newsletters have a serious intrinsic flaw. Mr. Zweig had a hotline which recommended individual stocks and general strategy. Unfortunately when you received a stock recommendation you could not buy that stock (when the market opened) at the recommended purchase price. The reason is simple. Immediately following the newsletter advice the market would move since people would place market-based orders (instead of limit orders). The bottom line is that you would never get the stock at the recommended price point. The same happens on the sell side. This is commonly called "market impact". In the mean time the newsletter records a purchase at the recommended price. The subscribers are left out to fend for themselves. What happens when the investment returns are compiled for the newsletter they are based on the recommended prices. Clearly there is a "disconnect" between what happens in reality and what happens on paper. This is the reason that I no longer subscribe to any newsletters. I do (and will in the future) subscribe to stock compilation advisory services. These would be like VALUELINE, STANDARD AND POORS, ZACKS, etc. These subscription services differ in the sense that they compile large amount of financial data for many (read 1000's) of companies.

The bottom line is to be very cautious of investment newsletters.

A World without Macroeconomists - My Reply

Recently I came across a blog post by Noapinion. Here it is:
http://noahpinionblog.blogspot.ca/2013/04/a-world-without-macroeconomists.html

First of all I would like to say that the Noapinion blog is generally very good. I have it on my blog list and I would recommend following it if you have a chance.

The blog post makes the claim that macroeconomists are required since the alternative would essentially gives decision making to "dangerous people".  Who exactly these people are remains unclear. I presume he means policy makers without any economic training.

In my opinion I feel that he misses an obvious point and this applies to all economists to some degree. Economists engage in the study of human affairs. Most ( almost all) academic economists have absolutely no experience in the real working world. In other words they possess no direct experience in human affairs. They are going about advising policy makers on economic matters without ever really worked in either business, labour or government. Well Ok, maybe they have some experience in governement. It is like virgins giving advise on sex. It is a dangerous situation to say the least. The solution is of course to bring mandatory work periods with state licensing requirements. Similiar to medicine where direct work experience is a mandatory requirement before a doctor can practice.

Of course there are problems with macroeconomists but I will leave that for another post.

Markets Finally Appear to be Correcting

After a substantial runup since the intermediate bottom back in November 2012 the equity markets appear to be finally correcting. The commodity markets have been hit hard. Oil and gold are down sharply today. Many of the stocks I follow (see TEX, MTW and other industrials) in the US have been up more than 25% in the past 5 months. A correction is long overdue. According to Jeff Saut of Raymond James in his Monday commentary this buying stampede is 70 sessions long and apparently he not seen anything like it in 50 years. I see only a modest correction and not a full blown bear market ( at least in the US). The Canadian markets are much more difficult to assess. Commodity prices are globally driven and they appear to heading down. The TMX has not gone anywhere in 1 1/2 years since peaking at over 14,000 back in Q2 2011. I see no change in this trend.

I did not sell anything today. A few days I bought AAPL at about $436 average price. I think that at low $400 the stock is a buy. The world is not coming to an end for AAPL. Yes, the margins are declining and there is demand weakness. However, with over $130B in cash the stock seems to offer good value.

P.S. I invested in Apple which seems to violate my "do not invest in high tech" principle. Guilty as charged. I do not really consider Apple a "high-tech" company. To my thinking it is more of a gadget company (ie.consumer product discretionary) which uses higher technology.

I Am Not a Gold Bug

First of all a confession. I generaly hold conservative points of view when it comes to politics. I would like to see smaller government and lower taxes. One view that American conservatives seem to adhere to is Sound Money and the Anchoring to Gold. I part ways with this belief.

I can not understand investing in a yellowish hunk of metal that has little functional value. Gold, in my opinion, is entirely a speculative commodity. If you buy gold directly or on the futures market you are basically hoping to sell your holding in gold at a higher price. Gold does not generate income and therefore is not a productive asset. This is essentially the position of an investor named Warren Buffett.

I bring up this issue since gold got crunched today and it looks like 1980 to 83 all over again.

How I Screen for Stocks

As mentioned under the Investment Philosphy post I tend to look for companies where I understand their products or services. This has generally led to the industrial sector where I can use my business and engineering background to assess the investment. I do not really have a specific methodolgy but I do use most of the major financial services (web-sites) available.

There are many financial informational services available (some free and some are subscription based) where stock screening can be done. In fact if you have an account at a major financial institute there is good chance that the firm provides (free of charge) some stock evaluation service. Some of the services (web-sites) that I use are Bloomberg, Valueline, Standard and Poors, Globe Investor Gold (real time quotes), Morningstar, Google Finance, Marketwatch, Wall Street Journal, Barrons, Investors Business Daily, Federal Reserve (economic research), Wells Fargo, Seeking Alpha and many other names.

I have on-line subscriptions to many of the above web-sites (services).  Others are provided mainly free of charge.

Using the above services I am constantly on the lookout for an investment opportunity. Generally speaking if I am able to find 1 or 2 companies per year I would consider that a good result.

For those folks that like a summation:

1) Look for companies that offer a product or service that I understand.
2) The company should offer decent return on equity (capital).
3) The company should have a strong a sustainable competitive position.
4) Capable management.

My Investment Philosphy

When I first started to invest  I made all the usual investment mistakes. I bought on margin and traded options. Needless to say I lost money but it did make me a bit wiser. In the late 80's I managed to complete the securities exam, as well as the futures and options courses from the Canadian Securities Institute. I also read just about every investment book that I could get a hold of including those from the CFA. Unfortunately I did  not complete the CFA due to the difficulty of combining my engineering work load and the studies. I also worked as a stockbroker for about 18 months in the early 90's when I was temporarily out of work as an engineer.

To this day I still read widely on investment, general finance and economics. I have probably over 500 books in my library which I have digested over the last 25 years. I have also read many research reports, annual reports and the like. Needless to say I am a close follower of the investment world. I am writing this blog mainly for fun and it is my hobby. feel free to follow it as you like. Please do not consider anything written on this blog as investment advice. Refer to my disclaimer.

Since I started my own self directed retirement account many years ago I have acheived about 21% compounded investing in primarily common stocks trading on Canadian and American exchanges. I only had 1 negative year in 2010 when I was down 2%.

In point form here are my main investment rules:

• Invest in businesses that you understand well. For example I usually invest in engineering, construction or industrial companies. Stay away from investments that are complex or hard to understand. If you deviate from this rule do so with a relatively small amount of money.

• Do not diversify too much. I avoid Mutual Funds and ETF's. The fees charged (MER) by Mutual Funds are around 1-2%. Add in market making costs and other soft costs you could be starting off down 2% or more if you are into mutual funds. I have never been a big fan of diversification. Warren Buffett is on the record as to investing in "about" 5 to 6 companies that you know well. See his speech to the University of Miami which is on the web. I tend to agree with this approach. It makes sense to me but clearly it is not for everybody. It depends on your risk tolerance.

• Have a view for reasonable valuation. This is a tricky subject since it can be  difficult to determine exact value. Read Benjamin Graham and Awath Damodaran to get more guidance on this subject. Mr. Damodaran is a Professor at the Stern School of Business at New York University and has written widely on finance issues and business valuation. See this site: http://pages.stern.nyu.edu/~adamodar/

• Avoid trading on margin (borrowing money) and also avoid derivatives (options and futures) trading. Brokerage houses make a fortune in these areas. Avoid short selling since you have to post collateral. Generally speaking avoid stocks that trade less than $5 - there may be exceptions in Canada due to all the junior issues out there. Be careful though.

• Avoid excessive trading based on economic information. There might be some exceptions within business cycles and potential crises. Economic data comes out every day and if you try to "trade" the information you will simply make your broker rich.

• Invest in companies with strong business fundamentals. Stay away from a business that has storm clouds around it. Stay away from bankruptcies, turn-around situations and other exotic situations. Keep it simple. Research the stocks that you want to invest in. Read the annual reports, security filings and any other information you can get a hold of. 

• Try to avoid commodity based businesses, complicated high technology and businesses that are hard to understand. They are just too tough to value. Stay with a business that has a durable competitive advantage and consistent margins. Commodity based businesses have little pricing power and are vulnerable to wild swings in the underlying commodity (see oil in 2008 and early 2009). If you deviate from this rule do so with a relatively small amount of money.

• Avoid excessive trading. Market makers love it when you trade often. Unfortunately, there is no clear definition of what is "excessive" means. For myself I might make 5 investment decisions a year. I usually follow a small group of stocks that I have known for many years.

• When it comes to technical analysis or charting I am generally a skeptic. The methods used by the technicians does not seem very rational or scientific to me. Having said that I do look at the charts for many of my investments - I don't really have much choice - stock charts are located on almost every web-site or publication. However, I would honestly say it does not form the basis of my investment.

• I generally do not invest in Canadian (or US) bonds or notes. This includes government and corporates. I am not really sure why I am so averse to buying bonds - it is probably due to the low yields in recent years that has kept me away. This may change in the future as I slowly get more risk averse.  I also have never invested in REIT's. I am not against REIT's so this might also change in the future. There seems to be general sentiment that the secular movement in lower interest rates might be over and interest rates are headed higher. This might make REIT's and long term bonds a poor performer in the coming years. We shall see. 

 

 

 

Welcome to Marty Invest.

Welcome to Marty Invest. This is Marty providing some insight into the world of finance and econonics from the viewpoint of an Engineer. My background is in mechanical engineering over the past 30 years. I am now semi-retired living outside of Toronto, Ontario, Canada. As a hobby I have decided to start a blog based on my experiences in the stock market and finance. I have been investing for over 25 years in the Canadian and U.S markets and I have also completed (through the Canadian Securities Institute) the Stock Brokerage course as well as the Futures and Options trading courses. I do not manage anybody's money except my own.

Please note that investing in securities involves risk of loss of principal. Please refer to my disclaimer.