Momentum trading in 2010… and why it’s smart to buy tech companies
“The dumbest reason in the world to buy a stock is because it’s recently gone up.”
-Warren Buffett
2009 and 2010 seem to have been great years for dumb money–momentum traders and technical analysts. Thanks to the various bailouts and subsequent reflation, they’ve made a lot of money in a hurry. But the more these idiots of Wall Street talk to me about breakouts, the more misanthropic I become. So misanthropic that I don’t bother to tell them how the game will end for them. If I do care about the person, I might suggest that they’re getting lucky from a self-fulfilling prophecy that could reverse as soon as tomorrow.
A famous (or perhaps a less obscure) short seller named David Rocker wrote some great articles for Barron’s a year before the Internet Bubble imploded. http://financialservices.house.gov/media/pdf/052203dr.pdf
A lot of what Rocker said applies to the current environment. There are crowded trades in short-buster stocks such as PCLN, DECK, NFLX and BIDU to name a few. The aggregate valuation of these so-called momentum stocks is insane. Am I going to short them? Not really. I’m willing to sell naked calls against them and then buy the common stock if it runs against me and then sell more naked calls. This is clever perhaps, but it limits my upside in the event that everyone rushes from the starboard to the port suddenly (as they always do). It suits my temperament and preserves my partners’ capital.
Long/short equity funds have not been so fortunate this year. John Paulson must be down around 8% year-to-date, his former partner Paolo Pellegrini is down over 10% and Stanley Druckenmiller is down 5%. I can’t imagine why they would be underperforming other than that they were shorting some popular momentum stocks.
Momentum trading is not a major threat to the overall system at the moment. The bubble has been too concentrated in individual securities this time around such that a collapse would not be destabilizing. (And even if it were destabilizing, I’m sure the Fed would come up with some excuse for intervening.) It’s just annoying to see limited partners withdrawing from some of the smartest investors in the business. It kind of reminds me when Julian Robertson liquidated Tiger Management.
The only stocks that deserve premium valuations are tiny technology companies. Technology titans are loaded with cash, and when one of them feels the inevitable need to make an acquisition another one joins in. Look at Palm, McAfee and 3Par. The prices being paid are ludicrous. Palm was most certainly headed for bankruptcy before HP bought it out. 3Par has never earned a dime, but it’s getting acquired for about $2 billion. Apple has over $45 billion in cash by now. You would think that the institutional imperative will lead them to acquire someone soon.
Now’s the time that “value investors” will regret their aversion to tech companies. There’s a huge margin of safety. I don’t have any specific ideas, but it does look smart to sell covered calls on Yahoo!.
Finally, on an unrelated note, I am going to post a report on my short position in Prepaid Legal Services. This silly Ponzi scheme looks like it’s done for.
