This will be my first “Friday Five” column on this blog. The premise is simple, I find 5 stocks with the potential for a profitable moves, write down what I think of the charts and fundamentals, and hopefully generate some discussion. To comply with all standards of financial ethics, I always disclose any positions I have. All I’m doing is using my Yahoo! Finance list to monitor the ASX and filter for some movers and shakers. I screen the stocks, I find ones that I think have potential plays on them, and leave it at that. My entry and exits are always clearly displayed. I have no qualms with auditing my results at the end of each month. I only use Yahoo! Finance and any resources I can find using basic internet search tools. Remember, this is not financial advice. This is for the purposes of learning only. Discussing ideas is a powerful way to move to an advanced level of understanding. Feel free to email or comment about any of my ideas.

1. QANTAS (QAN) - Buy

A sense of Australian pride is vested in QANTAS (QAN), one of our proudest companies. I’m going to do my patriotic part and recommend them as a buy. QAN has proved time and time again that its the strongest in its industry for cost cutting, forward thinking, and innovation. Its safety record is impeccable. It owns a virtual duolopoly over some huge cash cow routes in the Sydney -> Los Angeles, and Sydney -> Singapore. Recently, QAN purchased 133 aircraft. Oil prices are not scaring this giant into pushing for more growth, and thats shows how bullish QAN is about its prospects.. A trump card is its ownership of Jetstar. This is a stock to buy and hold for the next year. A float of Jetstar would see a huge buying spree on QAN, a great catalyst to sell into. The technicals are strong, its been in a solid bullish trend since mid 06′, and looks like it could be ready to break out. So many potential catalysts for this to happen. Go long at $5.73.

2. Singapore Telecommunications Limited (SGT.AX) - Buy

The communications industry is always very difficult to pick. Sentiment moves quickly, and so many sunk costs on new technologies make it a risk proposition. But there’s no better sector for pure growth, and I think this is a perfect time to buy into Singapore Telecommunications Limited (SGT). Owners of Optus, SGT has made some huge moves in the market since that takeover over 6 years ago. Optus never turned a profit until SGT decided to buy it from Cable & Wireless UK, then turned the company around into a profitable, forward looking dynamo. Insider trading has been very biased towards the buy side. New broadband upgrades by the new Labor government put SGT in a poll position to move forward. Technically, the company looks extremely strong. A big volume spike in buying screams institutional interest. The big boys think SGT is a good buy at $2.90. Note the support line at the $3 mark too. Excellent time to be buying. Telecommunications haven’t been getting the hype they normally get, get in now and capitalise off tomorrow’s sector! Go long at $2.95.

3. Boart Longyear Limited (BLY.AX) - Buy

If you want to see a strong chart, look no further then Boart Longyear Limited. Only listed this year, BLY has moved from strength to strength. Provider of drilling equipment, the mining business is no secret in Australia, and this stock is well positioned to take advantage of that. The last week has seen some strong volumed buying off an obvious support point. BLY is looking very oversold right now, and is due for a strong rebound. There’s no fundamental reasons why this stock shouldn’t be continuing. The nice part is, you can keep a tight stop at the $2.25 area. I’d be looking to hold this stock for 2 months, with a profit target of about $2.80. Not without its risk, but all the signs look strong. Go long at $2.38.

4. Westpac Banking Corporation (WBC.AX) -Buy

Westpac (WBC) has been getting creamed lately. It seemed to produce only sideways movement over the August financial sector decline, but I think thats because its gains have been more modest in previous years then the other big 4. I feel very good about its outlook. Looking to buy RAMS Home Loan Group (RHG), a company which has seen most of its value sliced this year, gives it a good opportunity to buy itself a broader customer base and further sell its innovative banking products. WBC hasn’t been getting the love of the other big Australian banks have been seeing this year, and for that reason I think its due for a catch up. The RHG buy out spooked investors into an early November sell off, but its starting to make its way back. I’d like to hold this one for the next 6 months and see how it plays out. If it dips below $26, I’d probably sell, the stocks getting way to weak. Come on, just look at the graph. Doesn’t this scream to you under appreciated? And once again, like almost all of my buys, insider trading has been very strong. This one is ready to shoot towards $38+. Go long at $27.60.

5. Royal Resources Limited (ROY.AX) - Sell

Too much buying. We need to hedge, that’s why I like a short of this stock, Royal Resources Limited (ROY). A mining exploration company, ROY looks weak to me. No real announcements, in a saturated market of exploration companies, and the harvesters like BHP are going to take the shine away from these guys. 2 years ago, they were a great play in a booming market. Exploration companies aren’t all that hot anymore, particular when most of the Iron Ore deposits are known and ready to be mined. Why would anyone pay a premium to discover more Iron Ore? There’s plenty ready to be harvested. It is my opinion that ROY peaked way too high in May 07′, and look like 40% or more of their value could be wiped off. It’s unlikely any broker will have this stock available to go short, but its worth a try. Short at $0.405, covering if it gets $0.50, taking profits if it goes to $0.25.

Disclaimer: Educational Use Only. Never Intended as Investment Advice. I do not have an interest or stake in any of the companies on my list.

Scott Adam is the writer and illustrator of Dilbert, a very popular comic strip (as well as TV show and book series) read by millions every day. Adam’s, however, is an outspoken guy, and isn’t shy about forging a successful path beyond office satire. His new book, ‘Stick to Drawing Comics, Monkey Brain!‘ is excerpts from his blog, about life, philosophy, and even religion. His quirky one liners, like “If I’m dumb enough to buy water, I’m certainly dumb enough to pay too much for it.”, and “If you had to design a dating website that matched people on just two criteria, what would those criteria be?”, always bring a smile to my face. His blog is a daily reading of mine, his topics are always random yet strangely relevant to my own life.

Adam’s has managed to write down a 9-step, one page formula for financial success. It is his opinion that the average person tries to over complicate something which can be made extremely simple. As Paul Farrell puts it:

Thanks to Adams’ formula, the average irrational investor can ignore Wall Street: “Everything else you may want to do with your money is a bad idea compared to what’s on my one-page summary. You want an annuity? It’s worse. You want a whole life insurance policy? It’s worse. You want to invest in individual stocks? It’s worse. You want a managed mutual fund instead of an index fund? It’s worse. I could go on, but you get the point.”

Forget everything else, just re-examine these 9 steps. What are the 9 steps, I hear you ask? Easy:

1. Make a will

2 .Pay off your credit cards

3. Get term life insurance if you have a family to support

4. Fund your 401k to the maximum (Ed Note: For Australian’s, this means super contributions)

5. Fund your IRA to the maximum (Ed Note: Not relevant for Australian’s)

6. Buy a house if you want to live in a house and can afford it

7. Put six months worth of expenses in a money-market account

8. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement

9. If any of this confuses you, or you have something special going on (retirement, college planning, tax issues), hire a fee-based financial planner, not one who charges a percentage of your portfolio

Its almost simple to a fault. The reader is thinking ‘there has to be more to it then this, right?’. There really isn’t. Exploit the predictable, compounding money makers. Be consistent. Exploit government tax-breaks. Cover yourself with basic life insurance plans. Take advantage of the stability and tax breaks of owning a house. Don’t leave your assets in limbo when you die. Have a back up plan in an expenses savings account. Pay off the most expensive item first (e.g. your credit cards). In the end, this advice is the best a laymen can ever hear. Adhere to this, and financial security is yours till death, irrespective of market or personal conditions.

Once again, another market rebound, and once again, an investment bank deal and a slide in oil prices are advertised as the reasons for the rebound by the media. I personally watched the market move in real time. I can say with absolute certainty there is no correlation between oil prices sliding $3, or the citibank deal. How do I know? I witnessed each move unfold with a totally different timing characteristic. Pictured here is the Dow Jones Industrial Index, which is often the most quoted index because of its simplicity. The DJIA is the favorite of both the laymen, the media, and even institutions. The pricing is simple, as its only made up of 30 common stock, and it moves nicely between whole numbers; every 1000 points seem to be a milestone in some regard. As you can see in the follow screenshot, the DJIA started the day with a strong up move that seemed to continue till the last 2 1/2 hours of trading. Then a slide wiped away most of the days profits, only to see a late rebound in the last half an hour to bring it close to its highs. All and all, a pretty typical day. We have an uptrend, some selling pressure, then an end of day rally.

Citibank and Crude Oil Futures, however, were not having typical days. News of Citibanks new refinancing deal broke mid day, as the market was slowing. In fact, once the market stabilised at 13000 at 4:45am AEST (i.e. midday in the US), we see some sharp dropping. It appears the market couldn’t care less whether Citibank just received an injection of capital. The reason is obvious; everyone knew this deal was going to happen, so it was never really modeled in as a factor. Then when the deal finally broke, other strategies were already in play. It made the Citibank news release irrelovent to the market participants, which is very normal. A single stock located large sector releases information that everyone either expected or already knew about, how the hell is this supposed to greatly affect the index pricing. The Citibank CEO would love the flattery that his new deal created a market move in the indexes. The truth is, even he’d admit it’s not really the reason.

That leaves us with oil. Oil gapped lower; in other words, it opened at a price much lower than the previous day close. And that was it. It stayed very close to that opening price. Oil didn’t move at all. That was until the final 2 hours of trading. Oil started dropping again as traders started hitting their stops, or selling out to wait for a better moment. But this action had no relevance to the index. The charts moved with absolutely no correlation.

Investors in other areas, eye balling the oil commodity chart, looking for some sort of sign, would be disappointed. Sure the markets rallied strongly from the open, but then again, if this oil move was such a big sign, we should have seen more. You’ll notice the drop after the first hour, right where my crossbar is located. Thats a lot of indecision, considering oil showed its hand from the very first minute of the market open.

Truth is, traders were making sure participants have finished most of their selling before accumulating some inventory. As long as the market could stay afloat from the first hour onwards without too big a move, traders were happy to stock up on long positions. After all, you don’t want to be humiliated putting in an open order, only to see a big downwards movement against you. Why not wait and see what plays out? Late in the day, some sellers returned as the prices moved higher, but its the same theme, 12850 was seen by the market as a great opportunity to buy into a few positions. Even individual stock buys and sells was very up and down. Traders saw a bargain, and snapped on it, and neither oil prices nor Citibank news swayed the decision to execute.

The same old story re-hashed itself. The media has to print something. Bargain hunters are boring, unless they’re buying an all-time low. It doesn’t make sense to a laymen why institutions would be looking for long positions. But it’s all context. But its all relative to the timeframe and goals of the institution. It doesn’t make for sexy journalism, but this true understanding gives me a fatter bank balance.

Hype surrounding the Kindle, Amazon’s new portable e-book reader, has been fairly subdued in Australia, especially when compared to the latest iPod or iPhone. No conspiracy however, its release is just bad timing. With all that election coverage, mainstream press space is scarce, and an oddity story about a product us Australian’s can’t buy yet are not high on the media’s agenda. This hasn’t stopped me from getting very excited about this product, and for the future of e-books. The concept is sexy; a portable reader that can download books, newspapers, and blogs from anywhere with mobile phone signal reception, but is also light enough to be easily transported on one’s person. Click on the image to the right for a demonstration.

The question is, will this product be a winner? So far, so good. It’s already sold out, even at the expensive asking price of $450US (or $436 Canadian, ha ha). Supply was low for testing purposes, so we can’t look too far into these preliminary sales figures. Nevertheless, the product would be very attractive to a large consumer base. Many people enjoy taking a book with them during their train ride to work, or even when going out for coffee. A device that stores up to 200 books that weighs about half as much as a large one will surely be a hit. And as the iPod has proven, people don’t mind paying large premiums for convenience. Hopefully this product gets released in Australia (for a substantially reduced price, I might add), there’s nothing worse than waiting for a shipment of fresh books, with origins of Amazon’s gigantic warehouse to arrive on our shores. Paying the shipping fee isn’t all that flash either, I might add.

The US has reached extreme consumer pessimism. That’s the reading given by the latest consumer sentiment numbers, which show a sharp fall in the spending outlook for many US households. Extreme pessimism has traditionally been lagging indicator; in other words, once it reaches a low, it usually signals the worst is over. The theory is, the consumers are the last to know of how bad an economy is, so by the time they do know, the cycle has already passed. According to a research study by Meir Statman:

Low consumer confidence is followed by high stock returns more often than it is followed by low stock returns.

Before you all go out and go long on everything to do with stripes and stars, it is just one indicator, and there’s a myriad of reasons why this time might be different. That doesn’t phase me though; exceptions to the rule are much more fun to study!

SMH reports that Steve Keen, author of ‘Debt Watch’, has called for Reverse Mortgages to be banned. Money quote:

“I want them abolished. [They represent] a systemic danger to the banking system. [With reverse mortgages] the banks are building in an expectation of continued asset price inflation for the next 25 years,” Keen says.

Hyperbole aside, Reverse Mortgages present a much different challenge to financial institution, renowned for penny pinching and walking over their own mothers for profit (in this case, it’s grandmothers, of course). Mortgages are simple. You find people who have a high percentage chance of repaying the loan, you give them money, and you let them speculate. If the property dives in value, its not really the banks problem, the speculation was performed by the borrower, thus the risk lies with him. Trying to standardise speculation is fraught with danger, as the US has found out with the sub-prime debacle. The problem is, mortgages rely on minimising red tape, keeping transaction costs low. Reverse mortgages will not have this luxury. Banks will now have to survey home prices, future interest rates, and their own balance sheet to determine whether a reverse mortgages is a profitable move. The best people to do this get paid in excess of $200,000 a year, and work with much more prestigious titles than ‘Mortgage Broker’. Traditional mortgages don’t need much thought from the people giving the all clear from the loans. Reverse mortgages do.

Does this mean they should be banned? No, properly diversified banks can easily afford the risk. Is this a boon for banks? We have a saying in finance; ‘Beware the high risk, low yield proposal’. Banks could make money off this, just like I could easily make money trying to hit and run a casino using the martingale system. It doesn’t mean it’s a good practice.

What’s hundreds of billions between friends? The answer: not much when there’s more to come!

And of course, this is all Russia’s fault!

But don’t worry, invest in gold and we’ll all be rich!

I love it when my links speak for themselves.

Also, my favourite search of the week: ‘nostradamus predictions about economy’ . Most of my searches are about Pineapple’s, and the supply/demand of. I’m still scratching my head to think of whenever I used the word ‘nostradamaus’, but hey, who am I to argue with the all omnipotent Google!

While the nation ponders the eternal decision; stick with the old, or go buy something new, Pineapple Watch has decided to hold a quick sneak attack by updating our layout into something a little more presentable. I’d like to thank my designer from Counter Entropy for taking the time to take my ideas and work them into something physical. If you need a blog update, go see him, he does great work for a low price.

Next week some major changes are coming in the works. The blogs premise will still be the same, but you’ll notice a flash of what is to come in the navigation bar to the north. I’ll be adding an alternating stock report and essay each week on Friday. If you haven’t bookmarked the site or added RSS updates, now is the time to do it. Feel free to leave any suggestions or feedback.

The Wall Street credit crisis. Its now infamous for anyone with any ear for market updates and news. The media can use it to explain anything, a minor slide on the ASX, or even predict the RBA’s next move. In short, investment banks have had to write off a lot of money in order to keep the books balanced. This causes panic in the market place, and stifles capital injection into markets. The cost of debt not only rises, but there’s also a reduction in leverage; i.e, the amount that a business can borrow per dollar of asset. People start fearing a recession. Fund managers trim their portfolios. But the overall economic outlook is good; emerging markets are strong, just about every other business is thriving. People are optimistic, in general. Its not time to start panic selling yet, not for everyone, anyway.

What are quant funds? Instead of taking the pain and effort of writing my own second rate summary, I’ll just steal it from InvestorsInsight:

Like stock fund managers, there are various breeds of hedge fund managers. Among equities, fund investments may be concentrated in companies or indexes of a particular growth stage, industry, or geographic area, such as Growth vs. Value, Tech vs. Consumer stocks, International vs. Domestic, etc. Many hedge funds also specialize in a particular field and are typically categorized as Global/Macro, Long/Short, Distressed, Quantitative, Market Neutral, etc.

Licensed for use from the New Yorker Magazine.

In the hedge fund world, the label “quant fund” has a distinct meaning, quite different than your plain vanilla long/short fund. But unless you knew better than most, differences may have been hard to distinguish until this fateful August.

The funds that got the most press were market neutral quant funds characterized by the “statistical arbitrage” or “algorithmic trading” models they used. These models allow a computer to scour historical price data for relative value inefficiencies between stocks, futures, currencies, or fixed income securities.

To better explain what happened to quant funds, I will tell a fictional story that is roughly based on the facts as we understand them at Altegris. I will change the names to protect the innocent (and avoid any litigation!).

Let’s create a hypothetical quant fund called the PhD Fund. The fund is owned by a big name Wall Street firm and is marketed on the street to wealthy individuals and institutions under the banner of a “market neutral” fund. This means that the net exposure for the fund is zero, or, in other words, the dollar amount of long positions in the portfolio is offset by the dollar amount of short positions.

The PhD Fund employs dozens of “propeller heads” (a hedge fund moniker for our mathematically inclined friends in quant shops). They build computer-based models that try to find and trade overvalued and undervalued stocks. Some of these models are longer term but some are short term, and so in order to trade in and out of these markets, these funds need to trade large, liquid positions.

The PhD Fund chooses to play in the US stock market because of this market’s breadth and depth of securities. Let’s assume that PhD Fund has dozens of measures for stocks in certain sectors and their models are constantly being built and augmented. They have income models that look at EBITDA, quarterly earnings, growth and more. They have balance sheet models that look at debt to equity ratios and book value, among other figures. They have technical models that look at short term momentum, daily volume, open interest and daily tic-by-tic trade data. You get the picture. These funds employ highly paid Gepettos, pulling the strings on computer models and trying to create money out of historical data.

So, how did it go wrong, exactly? I read a fantastic article today at InvestorsInsight that explained much more eloquently the details than I ever could. To paraphrase, the Quant funds started becoming over crowded. Many traded with the same strategies as each other. In other words, they were all piling on certain positions, causing a disruption in the supply/demand, thus eroding their profit margins from each individual trade. Its not unlike any other market; as soon as something becomes sought after, its harder and harder to make a profit as more people enter and disrupt the pricing. To compensate for this, Quant funds over leveraged themselves (e.g, borrowed too much money) to keep profits high. Still, on these eggheads whiteboards and super computers, this increase in risk was fine. Historically, there would have been no problem, they said. Nothing but the perfect storm could bust them. And they were right.

Enter a perfect storm. The credit crisis. The financial markets are unique, because they touch everyone. Absolute every business needs financing. You can’t run anything beyond a mom and pop set up without access to debt and capital investment.  When the financial sector in the US had a virus that had already spread and lay dormant through the rest of the world, everyone was affected. Suddenly, a key characteristic of the algorithm used by these Quant funds to price the assets they buy or sell has been tainted. Uncertainty reins. This causes fund managers and debt holders make some bizarre moves, causing a huge amount of volatility (think August, which I was unfortunately on holiday for. I would have loved to have watched it in real time). Quant funds, highly leveraged, are now facing a melt down. They can’t make money anymore. And the only thing worse then losing your ability to earn, is losing your ability to pay back those who you have promised to earn for. Funds were now posting huge intra-month losses left, right, and center. Major stakeholders, like the investment banks, even forced some of them to fully liquidate and recover what they could. The risk was just too great.

But as InvestorsInsight explains, not all funds were hit hard. The more vanilla funds, e.g. the funds who didn’t over leverage and properly assessed risk, managed to come out relatively unscathed. They posted a different story on the balance sheet:

Meanwhile, across town, a competing quant fund called the Braniac Fund feared the market would worsen and hit the reset button, liquidated all positions and went to cash. They lost faith in their models and believed they could easily lose more money. In an effort to get some breathing room and reassess, they overrode their model: human intervention. The Braniac Fund posted a -30% loss for August and were lambasted by their peers for lack of faith in the computers.

And the Vanilla Fund…well, they lost -8% intra-month. After their risk management kicked in, they posted a -6% month for August. No red lights, no panic, no excess leverage, just prudent risk management. They are now easing back into stocks, and welcoming the volatility.

You, as an investor, are mercifully unaware of any of this. You had no idea that mid-August the PhD Fund was down 30% and the propeller heads were levitating and on the verge of implosion. All you know is at month end the PhD Fund posted a -1% loss and you find out the Vanilla Fund posted a -6 % month. You mumble on the way to your foursome that you are glad you didn’t invest in Vanilla, and you are reassured when you receive a letter from the PhD Fund that, although they fired their CFO, they hired four new propeller heads.

As you can see, thanks to some tricky accounting, some ‘book cooking’, and asset movements,  the PhD fund can boast a return thats untrue. But the scars still remain, and the lesson, still needs to be sunk in. HedgeFund Blog says it best:

For those funds of hedge funds and pension funds intent on redeeming from good quant hedge funds it is worth recalling that after the October 1987 crash statistical arbitrage produced excellent returns in the following months. Statistical arbitrage has been around over 20 years and has had several difficult periods along the way as with EVERY investment style. However this overdue shake out will ultimately be a positive for good systematic hedge funds. No matter what happens I’d rather bet on alpha than beta. Before people get too hysterical about hedge funds they should remember the much larger amounts at risk in unhedged long only.

The truly strong funds use this as an opportunity to re-evaluate theories, and take advantage of a less crowded playing field. Like I always say, in a years time, we’ll know. Remember, any questions, feel free to leave a comment and I’ll explain everything in the plainest bad english I can!

One of the hottest topics of discussion in mainstream investing, and probably the least talked about subject behind the rotating doors of the investment banks, is whether its possible to earn above average returns using your own stock picks, rather then a diversified index fund. Extending on that question, would it possible to do so without having to face an increasing risk curve? In other words, can we use our own skill to make more money by applying different theories about stock price movements? The answer is, of course, yes, yes we can. A more in depth answer is, 99% of people can’t. Ideas are too complex, the human mind is to prone to focusing on results, and statistical deviation is to great (i.e, even a winning stock pick system can undergo long losing streaks). Many people have lost a fortune trying to conquer the market. Some have made a fortune. There’s no doubt winning systems are published on the internet. TraderX is one of these traders whom posts his trades for the day, and gives his thoughts on each. Scrolling through his archives, his system is available for all to see, but of course, only available to use by those who truly understand it.

The latest Market Wizard using promotion to gain stature in the investing community is Timothy Sykes, a 26 year old trader. Sykes recently released a book, ‘An American Hedge Fund‘, detailing how he turned his bahmitzvah gift of around $12,000 into $1.65 million. An impressive feat. His systems were simple, and utilised market conditions that existed during the dot com boom, and the subsequent bear market years. After opening a hedge fund and closing it this year, Sykes has decided to go back to his roots, attempting to turn that same $12,000 into 1.65 million, again, proving it was not a fluke. Each one his daily trades are updated on his blog, and verified by Covestor.

Is this guy for real, or is he a pretender? Looking at his strategy, he seems to use baseline breaks with momentum piling as his bread and butter. This is a strong pattern to trade, but also one of the most difficult. Whipsaws (false signals that a breakout in price is going to occur) are rampant in this strategy. But its also a strategy which allows large leverage, and most of his trades can be closed intraday, protecting himself from market disturbances. He seems like he knows what he’s doing, but its too early to tell. Rest assured, you can read about all his moves in real time. Who knows, may be in 20 years time this kid will be known as a ‘Warren Buffet’ style legend, and you’ll be able the equivalent of: “I watched Warren Buffet in real time!”.