Listen to the Interview[/caption]
It’s hard to find proven investors. Wall Street pros often take offense when I tell them they must prove themselves first before I’ll let them manage money for our clients. That’s why it was a real pleasure to meet Wayne Himelsein during the vetting process to become a Marketocracy Master.
Wayne started his Marketocracy model portfolio at the end of September, 2000. Over the past (almost) 12 years, while the S&P 500 returned 1.29% a year, Wayne averaged 11.05%. Outperforming the market by close to 10% a year for over a decade is enough proof of investment skill in my book to qualify for an interview.
Wayne was my guest at the Investment Masters Roundtable on Saturday. Click here to hear the interview.
During the interview I learned that Wayne started his Marketocracy portfolio at about the same time he started his own hedge fund to manage money for high net worth investors and institutions around the globe, including heavy hitters like Millenium Partners and Hyundai Securities.
Wayne is one of the best practitioners of a “technical” approach to investing that I have ever met. He is the newest Marketocracy Master to be made available to clients in our separately managed account program. At a time when many investors are getting whipsawed between hope and fear, an unemotional approach to investing, like Wayne’s, has a decided advantage.
Ken: I have to admit that I have been skeptical that anyone can make good investments decisions without knowing anything about the companies other than their stock prices over time. How is that possible?
Wayne: When auto enthusiasts compare two race cars and one of them consistently wins in time trials, they can ask why it did and inquire as to all the details of the engineering; perhaps it was the tires, or the cylinders, or the aerodynamics, or maybe it was the weight that gave it those crucial 3 seconds. But whether or not they can find the specific superiority, they will more likely put their money on the proven winner for the next big race.
Yes, it may make us feel better to “know more” about the relationship between going faster around corners and wider tires, or perhaps it excites us to be able to talk more specifically to our friends about its technical qualities, but these variables do not improve our already established certainty of which car is more likely to win the next race.
In reality, the intricacies of the engine and tire and horsepower combinations are only important to the designers and engineers when trying to build a top performing car, or in terms of stocks, the managers trying to build a top performing company. As for the rest of us, we tend to be results oriented; if the engineers have done a good job, we'll see the numbers play out on the track!
Similarly, when studying stock prices in order to best assess the most probable future outcome, we care less about the loads of information behind the decision-making, and more about carefully observing the history of the results of those decisions. When we observe a car win a race, we may have noticed its “edge” around tight corners (regardless of what engineering feats led to this edge), which helps us place our next bet with greater certainty, especially if the next race is on a hairpin-turn filled track.
Ken: How can any model that looks only at historical stock trading activity plausibly outperform other investment styles that utilize much broader sources of information?
Wayne: The current stock price is a single number that reflects the most recent collective judgment and aggregate decision making of all market participants based upon their interpretations of all known information and their anticipation of a broad range of expected paths of future events.
In other words, the information being assessed is both what is already known, such as the balance sheet or proven success of the current product line, and what is anticipated, such as the success of a brand new product or results of an ongoing legal battle.
As a result of this duality of interpretation, prices incorporate both a rational and an irrational component; the interpretation of past information usually being more rational, while the interpretation of future potential (and the emotions surrounding those expectations) usually being more irrational.
In this way, we are able to collapse all of the reasons behind the decisions into a singular linear view; whether rational or irrational, quantitative or qualitative, emotional or logical, smart or ignorant, reactionary or preemptive, the result is always a singular quantitative metric -- the current price.
Ken: OK, so the current price is the result of a lot individual decisions based on a lot of data and a lot of emotions. What does the current price tell you about what the future price might be?
Wayne: It is not the price itself that we analyze, it is how the price changes over time that matters most, and which helps us estimate what the future price may be.
Every trade requires two opposing opinions on the stock’s future performance at the very same moment. Since buyers and sellers must be equal in size for a trade to occur, there is always a meeting of the minds at the point of transaction. The stocks’ price movement, or the range of meeting-of-the-mind moments over time, is therefore evidence of a battle between buyers and sellers as they struggled to reach each equilibrium.
If I have decided to buy a stock and you have decided to sell a stock, but we are a dollar apart, there is no trade. A trade can only be reached if I move up or you move down; one of us has to want the outcome more intensely else the meeting of the minds will not be reached.
What is interesting about this battle is that it is not the buy or sell decisions themselves that makes stocks move up and down, it is the energy, or pressure, behind each decision. When the price moves up, we can infer that there was more pressure from the buy side, whereas when the price moves down there was more pressure from the sell side.
Analyzing price movements can tell us a lot about the human behavior during these battles. For example, the more afraid I am, the faster I want to execute my sell order, and therefore, the less patient I am to wait for a good price. “Get me out,” I scream, “at any price -- just sell the damn thing”.
At the extremes, this hope and fear leads to panic or euphoria, which translates into prices far below or far above the “correct” value of the stock. Quantitatively speaking, excess uncertainty exaggerates the deviation of prices from their “correct” value, creating greater volatility. Volatility, then, is evidence of exaggerated supply or demand generated by greater disagreement or greater uncertainty between market participants. So where there is more volatility, there is more uncertainty and/or disagreement, and therefore less of a chance of knowing what may come next. Likewise, when there is very little volatility, there is a high level of agreement between buyers and sellers and therefore a greater certainty around future expectations.
Using this type of logic, a critical study of the behavioral characteristics of buyers versus those of sellers offers the deepest insight into the moment to moment results of all known information and emotional inputs, and thereby generates the greatest predictive value.
To be clear, I am not claiming that we can know a future price of a stock is going to be at $107, only that through a rigorous analysis of the results of human decision making preceding a current price, we can better determine whether the future price is more or less likely to be up or down.
By seeking to understand the behaviors of investors (i.e. their commitment, intentions, legitimacy, consistency, eagerness, excitement, certainty, etc...), we reveal such aspects as the excess flow of capital into certain stocks and the confidence behind that flow, which in turn, provides us with an early look into the heavy accumulation of that stock and therefore a greater likelihood of follow through or of a significant break out.
Through 45 years of rigorous empirical research we have developed indicators that reveal the internal behavior of stocks, telling us whether a stock does better “handling turns” or “accelerating through straightaways”, and as such, helps us pinpoint its more likely future price movement.
Ken: What are your indicators telling you about the market now?
Wayne: Funnily enough, my inability to answer that question is one of my favorite aspects of our approach. Given the gargantuan amount of variables and potential events that could sway the broader market up or down, I don't believe that its necessarily worth trying to predict the broader markets. To me, macro economic factors and influences are infinite and therefore uncountable.
What I can say, however, is that in any market environment, there are always stocks that behave better than their peers. For example, during times of economic turmoil you might see a weakening of high end retailers like Tiffanys or Nordstrom, but at the same time, you would see a strengthening of discount retailers like Family Dollar Stores or TJ Maxx or Ross. The point being that even in the worst of times, certain companies perform well. As everybody needs clothes, the only question becomes where they get them from! To give a more extreme example, during a nuclear fallout, I would bet on heavy accumulation and other strong trading behavior in drug companies that produce radioactivity blockers!
Similarly, because we scan and rank all 500 stocks in the S&P 500, we observe very meaningful relative behaviors and can purchase those stocks that demonstrate the “strongest” behavior. Essentially, the activity that our models identify tells us where the crowd is moving (i.e. out of Nordstrom and into Ross) both in the real world and consequently, in the stock market.
Ken: That's very interesting. Because you are always judging one against another, and because money is always moving SOMEWHERE, your indicators are able to find the next good potential. Well then this begs the question, what stocks are your indicators shouting out right now?
Wayne: For starters, what I described above as an example with retailers has actually been happening for quite some time. We've liked Dollar Tree (DLTR) and Ross Stores (ROST) and continue to. Is this because the post credit crisis environment has created an explosion of bargain shoppers? Perhaps. But again, regardless of the “tires” or the “cylinders” that went into the performance, we like how these stocks have been behaving during this market, and we like the powerful supply/demand characteristics. Likewise, we see great trading behavior in Expedia (EXPE), Whole Foods (WFM), and in Biogen (BIIB). Might you suggest that Expedia makes a lot of sense because people these days are generally booking flights online and that the old travel agency model is going extinct? Sure, this might be the factor that produced the signals, but our indicators just don't care. They see buyers scooping up Expedia on heavy volume and they like it!
Its nice to hear people's differing explanations of price behavior, and in fact its almost funny to watch analysts debate over how this or that issue will affect a stock. But to me, its all just chatter. I encourage folks to stop worrying about all the opinions surrounding what effect this or that may have on stock prices and which analysts know more or less than the other, and to just look at the buy/sell results of all that chatter. If the stock is up on high volume when the market is down, then everybody is buying and the remaining sellers are likely stepping away.
Ken: Thank you Wayne.
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Disclosure: I am the portfolio manager for mutual and hedge funds advised by Marketocracy Capital Management, an SEC registered investment advisor. Before relying on the opinions expressed in this article, you should assume that Marketocracy, its affiliates, clients, and I have material financial interests in these stocks and may hold or trade them contrary to these opinions when, in our view, market conditions change.
