Tuesday, November 30, 2004

The Yield Curve, Part II

My last report contained the very basics of how an armchair economist can predict the future of the economy by using the yield curve. Now, we will get a little more in depth into the study of yield curves. I am doing these reports because I believe that, in a few months to a year, you will be wanting to know how to spot a recession coming up. The yield curve is one of the best tools to use for that endeavor.

The yield curve is a good predictor because it takes into consideration current monetary phenomenon along with future economic expectations. What's even better is that the long rates, which is the right part of the curve, are set on the open market (usually*). The Fed does have control over the short-term rates. Having the rates be set by a free market makes the numbers trustworthy and dependable. Most investors are not out to lose money just to fool someone else.

Current economic happenings set the short-term rates, such as the 3-month T-Bill rate. Investors' future expectations of the economy help set the long-term rates, such as the 10-year T-Bill.

Let's take a look at one study conducted in a finance and economics journal. The study is titled "The Yield Curve as a Predictor of U.S. Recessions" and is in the Current Issues in Economics and Finance Journal dated June of 1996. The study was conducted by Arturo Estrella and Frederic S. Mishkin for the New York Federal Reserve Bank.

They took the yield curve spread, which they determined to be the 10-year rate minus the 3-month rate, and gave each level a recession probability. For instance, a spread of 1.21 (Normal Yield Curve) equated out to a probability of 5% that there would be a recession four quarters ahead. A spread of -2.40 (Inverted Yield Curve) gave a 90% probability level. This was based on data from 1960-1995.

The paper provides the following example:

"Consider that in the third quarter of 1994, the spread averaged 2.74 percentage points. The corresponding predicted probability of recession in the third quarter of 1995 was on 0.2 percent, and indeed, a recession did not materialize. In contrast, the yield curve spread averaged -2.18 percentage points in the first quarter of 1981, implying a probability of recession of 86.5% four quarters later. As predicted, the first quarter of 1982 was in fact designated a recession quarter by the National Bureau of Economic Research."

Once the writers determined that the yield curve could in fact predict recessions, they compared it's effectiveness to other methods used by finance professionals. The other methods included the NYSE stock price index, the Commerce Department's index of leading economic indicators, and the Stock-Watson index.

Forecasting one quarter ahead, all of the indicators had some forecasting ability and the Stock-Watson index performed the best. Forecasting out over two or more quarters, the yield curve beat every one of the other recession predictors. The yield curve was the only indicator that could predict anything six quarters ahead, but was best when used to predict recessions four quarters ahead.

Again, the yield curve gets its power from the fact that it is a market driven system. The yield curve is the best way to see how investors with real money are treating capital currently and in the future. The yield curve has succesfully anticipated every downturn since 1959 (except the prediction in 1966 when the economy wasn't good, but wasn't in an actual recession). Yes, the yield curve did invert in 2000 predicting our last brief recession.

This was part II of the yield curve series. There will probably be at least one more. You really do need to know about the yield curve if you are a long-term investor (short-term investors/traders should know about the yield curve as well). One of the best ways to learn is through repetition. I will do my part of that equation and bring it up often. Do your part by reading and learning and you will be a better and wiser investor for it.

*I say "usually" because there are forces that can set a yield artificially; this usually does not occur. There is chatter that the Fed might set the long rate as well if they run out of weapons to use to keep the economy going. Be careful if/when it does.

Best Regards,

The Soothsayer of Omaha

Terrible Investment Strategy

Dear Reader,

Please do not fall into this trap.

It seems people are betting their entire future on the housing market. This is not smart investing like some of the individuals in the article claim (Mr. Derdzinski). Mortgaging your house for 3-times what it is worth is a dismal strategy in fact. You are relying on luck rather than astute analysis.

Doesn't this kind of remind everyone of the past equity bubble we are still working through? During the now apparent bubble, my geeky investment contacts and I would joke about the new homes being built that were being haulted because the owners were tying their loans to the inflated equity market...mainly Level 3 in Omaha. The stock price crashed and building stopped. This left many with half built million dollar homes.

So, for those of you who missed Mr. Greenspan's words in his past few speeches, here is what he said (paraphrased). He told investors that rising future rates have been telegraphed to those who care, and anyone who ignored his claim will be left with many fewer dollars.

Don't turn down free investment advice from Mr. Greenspan. Higher rates are coming. Rotate your investments to industries that grow when interest rates rise. You could even take the hassle out of that and invest in a rising rates mutual fund, as I have said before. Please don't mortgage your house to invest...pretty please.

Best Regards,

The Soothsayer of Omaha

Monday, November 29, 2004

The Yield Curve, Part I

I’m sure most of you have heard the term “yield curve” before but never really understood its meaning or what it can show you. I am going to try to explain exactly what the yield curve is, what it does, and how you can use it for long-term investing. You will want to remember this article in a few months…trust me.

You can find the yield curve every day here at Yahoo Finance.

Basically, the yield curve is a line graph that plots the different yields for bonds of differing maturities. The shorter the maturity, the lower the yield…usually. The longer you hold a bond, the riskier it is since you don’t know what is coming around the corner. Investors will want a higher yield (rate) to compensate for that risk. So, the “normal” shape of the yield curve is upward sloping. There are some instances where the yield curve can slope downward or invert, but those times are relatively few and far between.

Investors want to pay attention to the yield curve because it has historically been a good leading indicator of what is to come in economic activity. A steep upward sloping curve usually precedes an economic upturn. A flat yield curve frequently signals an economic slowdown. An inverted curve can mean a recession is just around the bend.

How does the yield curve tell us all of that with just a line? Well, that line represents a few things. The yield curve’s shape is based on two major factors: investors’ expectations for future interest rates and “risk premiums” that investors require to hold long-term bonds.

Using the above paragraph as a guide we can now interpret what the different shapes of the yield curve mean. An upward sloping yield curve (good economic activity ahead) says that interest rates will begin to rise quite a bit in the future. Investors will therefore demand more yield (interest) the longer they hold the bond due to the increased risk of higher inflation and interest rates.

Click to Enlarge Posted by Hello

The flat yield curve (economic slowdown) usually occurs during the transition from one of the sloping curves to the other, i.e. upward sloping to downward sloping and vice versa. The flat yield curve usually shows up when the Fed is raising interest rates to constrain a rapidly expanding economy. So, short-term yields rise to reflect the new rate hike. Long-term rates fall as investors are now expecting inflation to come down since the Fed is putting on the economic breaks.

Click to Enlarge Posted by Hello

The downward sloping, or inverted, yield curve (recession) is the worst curve a bullish investor wants to see. An inverted yield curve usually is telling you that a recession is not too far away. This curve suggests the exact opposite as the rising yield curve. When you see a downward sloping yield curve, investors expect interest rates to decline in the future. Declining interest rates usually occur in conjunction with a slowing economy and lower inflation. Historically, the yield curve has become inverted 12 to 18 months before a recession.

Click to Enlarge Posted by Hello

My next yield curve article will contain some actual academic studies for us to look through so you know that I am not just filling my web space with hot air.

Best Regards,

The Soothsayer of Omaha

Sunday, November 28, 2004

SecurityTraders.com Investment Roundtable

The SecurityTraders.com Investment Roundtable for the week is up and running. This week we dissected Disney (NYSE: DIS). Come check out what some of the best financial writers on the web had to say about DIS here.

Best Regards,

The Soothsayer of Omaha

Congratulations to the Trader Wizard

Congratulations is in order to one of our fellow financial writers. Bill Cara (Trader Wizard) had a very good write up about his website in Barrons this week. Everyone who reads his musings daily knows that he deserves this. He is one of the good guys in the investment world.

Congratulations Bill!

If you don't already know, you can read Bill's words here every single day.

Here is what Barrons had to say:

"Smart Blogging

This week's featured blog is a bit different from those we've covered to date. Rather than an investment trying out pundit wings, William J. Cara, proprietor of Trader Wizard (www.traderwizard.com), is a seasoned investment professional who is using his years of experience to provide an insightful, news - and analysis - heavy blog. This daily chronicle is one element of a larger investment research Website.

Cara has over 30 years of experience in the Canadian securities and financial services industry. He makes buy and sell recommendations on securities and drops in charts and provides links to other data and research that help him come to his decisions. Cara also contributes intelligent commentary on issues, such as interest rates, the dollar and oil, and provides an assessment of the market's current technical position. A discussion on gold included several links to information about the new gold exchange-trade fund. We're surprised he is giving this insight away."

Best Regards,

The Soothsayer of Omaha

Wednesday, November 24, 2004

StockCharts.com Feature

I just found a useful feature over at StockCharts.com that I would like to share with my readers.

I am a long-term investor. Therefore, my first stop is always Bigcharts.com. I look at their charts with "all data" selected. They show you the whole picture, from when the stock first started trading (not always with the companies that have been around forever, but most of the picture).

Then, if I like a stock from a long-term perspective, I will go to stockcharts.com to get a better idea of the short-term possibilities. I feel they just have better short-term charts and they are easier to use.

The above is not really the topic of this post though. I just wanted to let you know how I look at charts of stocks. Now, I will get on with the real topic of this post.

Being a long-term investor, you have to look for stocks to come down in price to where you think they are good buys. Buy low...sell high...you know the saying. Knowing when the markets are at a bottom would be really helpful in this regard. Well, stockcharts.com makes it easier for us do-it-yourselfers.

They chart for you several indicators of interest:
  • Bullish Percentage Indexes
  • Sector Bullish Percentage Indexes
  • Count of stocks above a certain moving average
  • Market Breadth Indicators
  • Volatility Indicators

You can find all of them at the symbol catalog at stockcharts here. Type in a "$" in the search and 21 pages of helpful symbols pops up.

The Bullish Percentage Indexes indicate the percentage of stocks in a given set of stocks (exchange or index) that have buy signals on their point and figure charts.

<>The idea is that when too many stocks have buy signals, most of those traders who would want to buy would have bought already. This would lead to a lack of new buyers to push the prices up further. It is a contrarian indicator. The opposite is also true, but it has been found that these are more useful for picking bottoms. Here is the Bullish Percent Index for the S&P 500 in a weekly veiw. The S&P 500 Spyder is right under it for comparison.

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

You can see that a reading of around 30 or under is a good indication of a bottom forming in the S&P Spider. Play around with it to see what you can come up with.

The sector bullish percentage indexes are the same just with different sectors instead of larger indexes.

The "stocks above a certain moving average" indicators is pretty self explanatory. Stockcharts.com gives you the number of stocks above a certain moving average. They have the 200-day, 150-day, and 50-day.

Here I will show you on the Nasdaq what the 200-day indicator chart looks like in the weekly view.

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

Play around with this one too to see what you can come up with. Make sure you let me know in the comments section. On all of these you can add different moving averages and use that as times to purchase as well. For instance, buying QQQs when the stocks above their 200-day moving averages crosses above it's 10-day moving average...or whichever.

Market Breadth Indicators use the advancing and declining stocks to try to find out where the market is going to go. There is a chart for new highs, new lows, new high-low ratio, record high percent index, and NYSE volume advancing-volume declining.

Here is are some charts for you to play around with:

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

Click to Enlarge Posted by Hello

Make sure if you play around with these indicators to let me know what you come up with in the comments section. I hope these indicators help in your learning.

Best Regards,

The Soothsayer of Omaha

Monday, November 22, 2004

Is Value Safe?

I don't believe this is the best time to begin trading. It is probably going to be one of the best times to learn to trade/invest, but it won't always be pretty.

You don't become a good trader from your gains, you become a good trader/investor from your losses. I knew many people who thought they were great traders during the end of the 90's. You can guess how that ended up.

The traders that didn't quit are better for it. They learned a valuable lesson. You are not as smart as you think you are. You need a strategy and not just CNBC. You need to be consistent. You can't just invest in a company because you heard its name from one of your friend's brother's cousins who knows this guy.

I say the above because I believe the stock market is in trouble. I would say that around March of '05, the markets are going lower...give or take a month. March 2005 is when, I figure, the higher interest rates will be hitting the bottom line of companies and that's when the negative earnings surprises will begin.

How do you pick stocks when in the back of your mind the market is going lower?

It's not easy; especially from such a small subset of stocks to choose from such as the Benjamin Graham Value candidates I'm looking at. Most of these stocks have been appreciating pretty well the past few months to a year. I should have become the SOO a little sooner. I'd be famous by now.

So, I need to choose stocks that will be able to weather the next investment storm. Stocks that have appreciated 50% or so are not going to be the concrete walls I'm looking for to protect me from the storm. I need something stronger than concrete...maybe a titanium type stock. When I find it, I will let my readers know.

Let's take a look at how value stocks have fared during some past downturns.

Most people believe that value stocks are less risky. Value stocks will go down less then the market during times of distress. That is not always the case. Naifu Cheng and Feng Zhang conducted a study called "Risk and Return of Value Stocks", which was published in The Journal of Business in October 1998.

One of their main conclusions is that the risks inherent in value stocks are going to most likely show up at the worst possible times. From 1929 to 1932, the S&P 500 fell 22.7%. Large-Cap value stocks fell 31.8% and small-cap value stocks fell 36.5%. Value stocks fell more than the market.

Another study, "The Value Premium," by Lu Zhang comes to a similar conclusion. He claims, " They (Value Stocks) are more risky than growth stocks in bad times and less risky in good times, but to a much lesser extent." Zhang claims this to be true because value stocks are typically companies with unproductive capital.

Unproductive capital suffers greater negative volatility in earnings because the burden of nonproductive capacity increases and they find it more difficult to adjust capacity than do growth companies.

That is what occured in the period from 1929 to 1932. The risk of value stocks does not show up in all recessions. 1973-74 was a period when value stocks were not as risky as the market. The S&P 500 fell 20.8% during that time period where large-cap value stocks fell 12.3% and small-cap value stocks fell 22.2%. Most believe that this was due to the fact of the high inflation during these times. Since most value companies are highly leveraged, inflation reduces the real cost of the debt.

The point is that during a recession, most stocks depreciate in value. Even value stocks will fall in a recession. Value stocks sometimes even fall more than the market. I am planning on there being a recession soon. I am not hoping there is one, but it seems rather likely.

This is not a good time to be investing, but it will be a great time to be learning. Maybe just watch me lose all of my capital. If you don't have much of a net worth, learn by watching.

I'll promise to find some of those titanium like stocks if you promise to learn something along the way.

Mr. Buffett must think I am all talk by now. He is the advocate for only wanting individuals to have 20 investments per life-time, though. I'll be coming Mr. Buffett, you just wait and see.

Best Regards,

The Soothsayer of Omaha

Thursday, November 18, 2004

Do Something Already...

What am I doing? I thought this was a web site about investing. How are you, the reader, going to learn anything if there is not any investing going on? Well, here is a good lesson for you: Don’t trade/invest just to trade/invest. For long-term oriented traders and investors you have to let the market, stocks, bonds, currencies, wheat, gold, etc. come to you.

I have a goal for this web site of teaching individuals who are from the ages of around 20-30 how to invest so that they can retire wealthy and not have to worry about their future. I also make it fun to watch by challenging a known deity in the investment world. I need to achieve gains of above 25% per year to accomplish my goal. Am I going to accomplish this goal by buying GOOG at $200? No. I will accomplish this goal by waiting for, let’s say, GM to come down to its long-term uptrend (by long-term uptrend, I am referring to a 25+ year uptrend line).

I have my watch list with the stocks that meet the “value” criteria I have set forth for this investment site. That takes care of the fundamentals I am looking for with regards to these investments. Now, the technical analysis side involves sitting and waiting patiently for a good set up. The better set up you get, the better risk/reward ratio you get, the better your odds of making money, the better your profits will be, the sooner you will retire.

I am not investing just to invest.

Best Regards,

The Soothsayer of Omaha

Tuesday, November 16, 2004

Hoping to Retire Soon?

This post is for my Grandma and to whoever else is hoping that the stock market is going to go back to the good 'ol days of the 90's. This hope is well grounded...you want to retire at some point in your life. The only problem is that no matter how much hope you have, it is not going to be enough to push the markets higher. You could have 10 lbs of hope or 1,000,000 lbs of hope (is hope measureable???), the only way you could influence the markets through your feelings is if you had $100,000,000,000,000 to back them up and even then it would be difficult in the long-run.

The markets go up and yes, the markets go down. I'm not saying that all stocks go down at the same time. There will be some stocks that increase while the market, in general, falls. But, the markets can fall just as easily as they can rise. So, why do we have to believe that the market must go up? Well, emotion gets in the way. The hardest thing for an investor to do is to get rid of that emotional impulse. There are countless books written on this subject alone. There is an entire psychological profession dedicated to only investors and traders. So, I will not get into it here with the little space I have. The information is available, you just have to look.

The markets are not going to rise substantially any time soon...sorry Grandma. This does not mean you can't make money. You have to take what the market gives you and react. Investing is not any different then any other action reaction that occurs in the world. A car is speeding at you at 100mph, what do you do? You get the heck out of the way. The NASDAQ goes up 20 years in a row and climbs from 250 in 1984 to over 5000 in 2000 (largest gain in the history of the markets), what do you do? You get the heck out of the way.

As I've said before, you can still make money in a generally falling market. There are obvious trends being established right now. You know that interest rates are going to rise in the future. What should you do? Purchasing a Rising Rates Fund doesn't seem all that unwise.

I am trying to warn the "hopers" right now that the markets are not going to rise, in fact I believe they are going to fall. So, be prepared for it. Even if you don't believe me, you should be prepared for the chance.

The key here is education. Do you think that retirement is important? If your answer is "yes", then you better start learning now. I got lucky and for some reason this "stock market stuff" excites me so I am learning about it every day and have been every day since I was 16. There are plenty of resources available to you...keep checking my sidebar for links to educational sites to peruse through.

A good start would be to continue to read this blog and the other blogs I have on my sidebar...especially, SecurityTraders.com. Another good read that I look forward to every week is the free newsletter of John Mauldin. You can get the most current newsletter here along with the older ones.

I am done with the lecure now...sorry.

Best Regards,

The Soothsayer of Omaha

Monday, November 15, 2004

Not a Joke

Do you think I am joking when I say that Wall Street and their friends are not the average investors' friend? I am truly not a "nut" and just posting random backlashes against them for some secret reason.

Here, Marginal Revolution writer Alex Tabarrak fills us in on a tiny little secret that my readers would probably like to know.

"Senatorial Privilege"


Makes you think doesn't it?

Best Regards,

The Soothsayer of Omaha

Saturday, November 13, 2004


Our first report is up at SecurityTraders.com. Come check it out! We are seriously taking on Wall Street. I've said before that Wall Street's business model is old and outdated. I'll get into that more some other time.

The individuals involved in the Financial Writers Guild have nothing to sell. All we want is to help individuals increase their wealth and realise that Wall Street is not their friend. The ST Roundtable is just the beginning. Soon we will have many helpful areas that everyone can benefit from. So, check out SecurityTraders.com frequently. You will not be disapointed.

As I promised I will soon have an investment report up on this web page. So, check this site often as well.

I will be investing real money in the picks I present as the Soothsayer of Omaha. This is not a joke. I have presented my actual Ameritrade statement below. I am here to help individuals who are my age (or around my age) invest wisely and hopefully retire early. I also have the goal of becoming the best investor to come out of Omaha, NE. This will not be an easy task, but it is possible. I have been studying the markets since I was 16 and it is time to put my skills to the test for all to see.

Come along on this journey and let's retire early together.

My first investment pick is coming soon...come back to see what it is!

Best Regards,

The Soothsayer of Omaha

Real Money

Just so you can see that I do have actual money on the line with my picks, I have posted this account statement. I have obviously taken off my name, address, and account number.

Click to Enlarge Posted by Hello

You have the money Soothsayer...let's make a pick.

Soon I promise!

Best Regards,

The Soothsayer of Omaha

My First Pick

I have not yet made an investment pick. I was waiting for the emotions to cool down from the election. Well, cool down they did not, they took off. The market indices have shot up after the election without me on board. It does not matter much. The stocks I have been looking to invest in have not participated in this last run up.

So, my first pick will be coming shortly...be patient. If you are looking for investments right now and can't wait, check out securitytraders.com.

Best Regards,

The Soothsayer of Omaha


I am a part of a project that will revolutionize investment research for the individual investor. It is called securitytraders.com and Wall Street should be scared. It is basically an open source community of like minded independent investment writers. These writers are sick of the hype and sales pitches that Wall Street tries to pass off as valid research. It is not a level playing field out there in the investments world and we are going to try and change that.

At first, we will be doing a weekly ST roundtable where we will discuss one stock. That is also where I will post my one pick each month. I will also be positing it here, but also over at ST. We have big plans though!

We are going to get a database of “picks” by these so-called experts. These talking heads of Wall Street always trot onto CNBC and try to sell to the public what their institutions want. They don’t think that the viewers have the attention span of a few days and will forget the pick so it doesn’t matter if it goes up or down. Well, now it will or they will lose credibility fast amongst us who are watching.

That is not the only plan, there are others, but this is going to be a lengthy process if we have to do it all ourselves. We are looking for readers interested in helping in any capacity possible. We have many groups drawn up and need some more members. So, if you are interested and want to help in this project, E-mail me at Levi@securitytraders.com.

I hope I hear from you soon and we’ll take Wall Street and Mr. Buffett on all at the same time. I think we’ll be fine.

Best Regards,

The Soothsayer of Omaha