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Regal Entertainment group owns the largest theatre network in USA, mainly under the Regal Cinemas and United Artists brand. I initiated this position due to the reputation of movies being a robust industry in a depression, and also because I had a price target of $15, which is a PE of 20 over its previous year’s EPS of $0.73. During the two months when I held it, the stock has underperformed the general stock market, and does not appear to be moving towards the price target. I liquidated my position for a small profit of 6% over 2 months. Perhaps the threat of Internet distribution of movies is threatening the core business of RGC, or perhaps a PE of 20 is simply too rich in this climate. I chalk this one up as a miss.

Ball Corporation is a major manufacturer of metal and plastic packaging for food manufacturers, with a minor business in aerospace and defense. Almost 80% of revenues are derived from making aluminum cans for beverages, with the remaining 20% from plastic packaging and the aerospace business. A significant amount of revenue is derived from sale of beer cans, with Ball having 30% of the US market. This is largely a mature industry, although there are small pockets of innovation and higher-than-normal profit niches, such as the introduction of vented wide-mouth cans for pouring, and cold-activated cans. Profitability is dependent on the price of aluminum and demand from major customers such as Coors and Miller.

Free cash flow in 2008 came in at around $300 million, or $3.20 per share. Analyst estimates for 2009 range from $3.70 to $4.00. Assuming an EPS of $3.50, BLL should trade at $35 at a PE of 10, $44 at a PE of 12.5, and $53 at a PE of 15. There appears to be major support at $37.50, and some resistance at $44. Given the recent improvement in economic conditions, it is likely that demand for its product will show a slight improvement. For an established company in a defensive industry, despite a moderate exposure to commodity price swings, I feel that a PE of 12.5-15 is reasonable. I have initiated a position at a price of $41.50.

To the 5 people who are still reading this blog, I apologize for not writing any posts for the past 2-3 months. I was experimenting with several new strategies incorporating a technical analysis component in my stock analysis. I felt that, as an amateur investor, I could not compete with professional stock analysts, all of whom can read the same annual reports that I can read, and have the time and resources to do back channel checks that I cannot do. My only advantage is my small size, which means I can enter and exit positions without moving the price.

Early in this experimental stage, I tried several charting techniques, but eventually found that because they were too “black magic” and did not satisfy my rational side, I did not have the confidence to take large positions with them. Eventually, I found two technical factors that were backed up by academic studies and grounded in human psychology. Firstly, the stock market overeacts to events, and corrections and pullbacks occur with a greater than normal probability. However, I found that this mean reversion effect takes place over time frames of only 1-2 days, and is really suited for automated trading rather than human trading. Secondly, runs in the stock market occur with greater length and frequency than a random walk, a phenomenon called the momentum which has been attributed to many causes, including the the herding tendency of investors and to institutional investors moving prices when they enter or exit a stock. The momentum effect is most pronounced on small cap stocks, suggesting that the role of institutional investors is dominant. I figured that if I could try and spot stocks which are starting a trend, and then use manual fundamental analysis to figure out a plausible investment thesis and thus predict where the price is headed, I could hop onto stocks just when they are making a move, and then switch to other stocks once the move is finished, maximizing my returns.

For the past 3 months, I have used a strategy where I screen stocks with the ADX technical indicator to identify stocks which are in a new uptrend or downtrend, and then manually go through them to pick out the stocks where a plausible investment thesis exists. Often, I find that due to my fundamental analysis, I am able to predict quite accurately what price level the stock is moving to (stock prices often move to round PE values). This strategy, executed in the context of a rising market, has resulted in my outperforming the stock market by a significant margin. I found that if I cut my losses within 1 month if the stock doesn’t move as I predicted and let my winners run to my anticipated targets, my profits vastly exceed my losses despite the fact that I have only a 60-70% chance of picking winners.

Because I am not a long term stock holder with this strategy, and to keep my workload reasonable, my analysis of each stock will necessarily be much shorter and shallower than my previous analyses. In the future, I will be presenting my analyses as short blurbs about specific stocks instead of the more in-depth articles that I have been writing. I also intend to devote susbtantial time to the study of human psychology and how it interacts with the stock market to present opportunities that can be taken advantage of.

The latest banking rescue has been widely panned by the punditry, with even Krugman voicing his dismay, yet was warmly received by the markets. The pundits are correct : this plan will not rescue the bad banks. Instead, the new plan will grease the flow of credit into the real economy, and lift all banks, both good and bad, along with the entire economy. In fact, I think that the new plan is a piece of genius. It finally rewards the good guys instead of the bad ones.

From the viewpoint of rescuing banks, the plan looks like a failure. It will accelerate price discovery of loans, which may cause the balance sheets of weak banks to actually deteriorate rather than improve. Banks will not tender their loans for sale if they know that the loans will fetch prices lower than their marked down value. The bad loans will stay on the books of the bad banks. What will come off the books of the banks are the good loans, those that are likely to perform well, but have been lumped together with the bad apples and now are stuck on the balance sheets of the good banks. By getting those loans off their balance sheets, the good banks will be able to do what they do well, assess credit risks and make more loans to good risks. The net effect will be an extension of credit to the economy, but in an intelligent manner, by making use of the expertise of the good bankers.

Under this plan, two groups will make out like bandits. The first group are the good banks which will be able to securitize and unload their good loans onto the markets, enabling them to make more loans. The second group are the investors in those securitized loans, who will be getting a huge government-sponsored loan on intrinsically profitable loans, leveraging their profit many times. To me, this is a refreshing change. Rather then rewarding the bad bankers who could not differentiate good credit risks from bad ones, and rewarding investors who relied on leverage to obtain eye-popping gains, the government is finally rewarding the good bankers who knew good from bad risks, and the conservative investors who did not rely on leverage and kept their powder dry.

Part of the reason why the plan has been so roundly criticized by bloggers is that the favored solution has been outright nationalization. The previous solution of extending government guarantees to loans on the books of the banks has a negative effect on the economy. It does not make the banks in question healthy enough to lend again. Instead, it is effectively a tax on the good banks to throw at the bad banks, since the bad banks are in business only because of the government guarantees. Nationalization is a possible way out of the impasse. Certainly, a nationalized bank can be made lend again, relying on the balance sheet of the government. However, this is also a tax on the good banks, because depositors and investors will prefer dealing with the government over private parties. The new Geithner plan suggests a third way out that avoids nationalization and is economically beneficial. Pump so much money into the good banks that they can now take over the bad banks. Although a bank such as Citigroup (and perhaps Bank of America) looks too large to be sold to any group, if the current plan manages to pump enough money into the good banks, there is hope that a conglomerate of the good banks can absorb a sufficient portion of Citigroup’s assets to finally solve the problem. It may seem unlikely now, but then again, mega-banks such as Wachovia, Merrill Lynch and Wachovia once looked too big to be taken over too.

The final criticism of the current Geithner plan is that it is too punitive on the taxpayer, who stand to lose too much. However, the bad loans have already been made and the losses have already been incurred. When the decision was made that bad banks cannot be allowed to collapse, it is just a matter of determining the combination of parties who should be made to shoulder the losses. Due to the magnitude of the losses, realistically speaking, the taxpayer has to shoulder the lion’s share. The only question is what mechanism to use to shift the losses onto the taxpayer. We can extend government guarantees to loans, nationalize banks, or pay private investors to absorb the losses. It seems to me that the last way is the only way which rewards the good guys, and are the least objectionable.

On 3/16 (Monday), I rebuilt a small position in GEOY at $18, in accordance with my previous estimate of GEOY’s intrinsic value at $18-$30. I sold the entire position the very next day at $19, thinking that manipulation by options traders will sink the stock price as we approached options expiration Friday. The very next day, management revealed that the delay in filing its 10k is due to immaterial accounting errors. Apparently, the market was worried that the delay was because something had gone wrong with the GeoEye-1 satellite, and relieved investors quickly pushed the stock price up to $21. I finally ate humble pie and rebuilt a position at a higher price of $20 on ops ex Friday (yesterday).

Looking forward, the company should file its 2008 10k very soon. By itself, that is a non-event, since the 2008 results are universally expected to be bad, what with the delays in the launch of GeoEye-1 last year and the accompanying loss of revenue. However, there is a chance that management will finally provide some guidance on future earnings, or perhaps even reveal additional contracts that have materialized now that GeoyEye-1 is certified and fully operational. While management had a long-standing policy of not giving guidance, there is a chance that this may change as the CEO has spent $100k of his own money on GEOY shares last December. Still, I wouldn’t bet the farm on it. Management usually has little incentive to pump up the share price unless it wants to raise cash in the equity market. Management which expects to stay on for the long-term (i.e. the kind of management you want) tend to want a low stock price so that they can issue themselves cheap options at the current low market price, and to provide a low bar for future improvements.

There is also some speculation that an acquisition of GEOY is forthcoming given its low valuation. I view that as improbable. Google, which purchases imagery from GEOY for its Google Earth product, is an unlikely acquisition partner since GEOY handles classified work for the government, and Google is likely to face an extreme amount of red tape and security checks if they were to control such a company. The other class of potential acquirers, namely the defense contractors which routinely handle classified work and already have security clearances, unfortunately have major problems of their own. The Obama presidency is likely to cut defense expenditures in order to boost domestic spending, and the share prices of said defense contractors have been dropping like a rock in recent days.

In summary, I think the GEOY is likely to trade in the range of $18-30, and a $20 entry price with a 10% downside and 50% upside presents a good risk-reward trade-off. Of course, one should always be aware of the extremely low probability of catastrophic loss of the satellite, and limit one’s investment accordingly. In the near future, I might even try selling covered calls on GEOY if the option premium is rich enough. Since I have previously advised against buying said calls, this falls squarely in the “if you can’t beat them, join them” category of behavior.

For my other posts of GEOY, please see GEOY : Liquidation and update, GEOY : Manipulation by options traders, and GEOY : Living off the government.

In recent months, I have adopted a strategy of channel trading. I pick an undervalued stock according to fundamental considerations to ensure capital preservation (strong balance sheet, valuable business franchise etc.), identify short term support and resistance levels, and then buy when the price is closer to the support level than to the resistance level. Typically, I am looking for a 3:1 gain:loss ratio based on the support/resistance levels. I sell if the price breaches either the support or resistance levels. Unlike typical technical trading, I only channel-trade the stock if it is substantially undervalued according to my estimate of its intrinsic value. I rely on the intrinsic value estimate as insurance against a permanent capital loss. Due to the increased volatility of stocks these days, I frequently find myself hitting the support/resistance levels in a matter of days, therefore this strategy is a form of short-term value investing, as advocated in the book Active Value Investing by Vitaliy Katsenelson. I have adopted this strategy because I believe that buy and hold is suitable only in a period of general economic recovery and broadly rising stock prices, and that we are perhaps 1-2 years away from such a recovery. I believe that in the meantime, the market will trend horizontally, and profits can be made in channel trading and options strategies. The channel trading strategy also protects against a general decrease in valuation multiples (my own valuation multiple has shrunk to 10 for more speculative companies, and 15 for exceptionally strong businesses). I have also abandoned my previous strategy of diversification (which did not prevent the broad-based losses from Nov 2008 through Jan 2009), and am going back to my roots of holding a concentrated portfolio, except that I now watch my positions like a hawk and am willing to liquidate at a loss if they breaks support levels. Stock research is simply too laborious for me to cover many stocks.

In the 2 months that I’ve tried this strategy, it has been modestly profitable, with gains outnumbering losses by approximately 5 to 1. And for the first time in a long while, I am finally beginning to outperform the index modestly. I have learnt several lessons.

1. There is no shortcut for fundamental research. One of my first speculative plays was Citigroup; I was unable to estimate an intrinsic value, yet decided to hold a small position. C promptly gapped through my protective stop. Thus, stops may fail, and there is really no substitute for gaining in-depth knowledge about your stocks.
2. Be equally willing to take gains and losses. Initially, I was risk averse and was quick to sell when stocks breached my support levels, but slow to take gains when they rose above resistance levels. Eventually, I found that I was taking losses repeatedly yet taking very few gains. I promptly readjusted my strategy, and everything has been okay since.
3. Monitor your strategy constantly. The greatest advantage of short-term trading over long-term buy-and-hold is that feedback is continuous. Therefore, you quickly gain an instinctive feel for what works and what does not. I also feel strongly that a trading strategy should be supported by an overall thesis (macroeconomic or otherwise). For example, I engage in channel trading because I do not think stocks are likely to make large moves upwards or downwards due to the uncertain economic climate. Once economic recovery begins in earnest, I expect the channel-trading strategy to begin to underperform a buy-and-hold strategy, and will adjust my strategy accordingly.
4. Adjust support and resistance levels proactively. The advantage of a channel-trading strategy is that one can adjust the support and resistance levels constantly, even proactively to anticipate as yet unestablished levels. I realized this when I discovered that several of my best stock ideas (GEOY, MOS, AMTD) were making higher lows and higher highs over a few months, and when I stuck to the previously established lows and highs, I was consistently missing much of the move. I decided to estimate and anticipate the constant rise in both support and resistance levels, and have done better since. Interestingly, I found that as long as the volatility is large enough, channel trading outperforms buy-and-hold after trading expenses even if the underlying stock is on a long-term uptrend. Of course, I will immediately cease to channel-trade a stock if it is approaching my estimate of its intrinsic value.

In summary, it has been educational, and its good to be making money again after the devastation that was 2008.

I have recently liquidated my entire position in GEOY for a 15% gain, shortly after the completion of the NGA certification process. While the certification provides $150 million in annual revenue to GEOY, ensuring that it will be able to cover expenses and removing the risk of bankruptcy, the risk of satellite failure as well as the uncertainty of its profit level still remain. This is mainly because management has refused to provide the numbers associated with its commercial contracts (including its Telespazio, Google and CRISP contracts). On paper, GEOY has a high debt load and extremely lumpy earnings, which tends to discourage institutional ownership of the stock. If management does not provide earnings guidance, then several quarters would have to pass for the market to get a feel for the profitability of the company. This is compounded by the fact that the capital expenditures associated with building GeoEye-2 is still unknown. In the absence of guidance, I can only make a guess about the future profitability of the company. I estimate that the NGA contract will cover operating expenses and interest payments, leaving the revenue from GEOY’s commercial contracts as pure profit. In 2007, GEOY derived $65 million from foreign governments and $15 million from commercial companies. While the successful launch of GeoEye-1 suggests that additional revenue will materialize, I am also worried that both foreign governments and commercial companies will cut back on expenses in the midst of this recession. For the sake of argument, lets say that revenue from non-US government sources rises modestly to $100 million. Applying a discounted cash flow analysis with a discount rate of 10% over GeoEye-1’s useful life of 7-10 years suggests that a PE of 6-10 is appropriate. At $100 million gross profit and $65 million net income after taxes, GEOY would have a fully diluted EPS of around $3, suggesting a fair share price of $18-30. Of course, the preceding analysis is merely a stab in the dark; I simply do not know the future earnings of the company.

In addition, there are short-term issues that may prevent the stock price from rising. GEOY will soon announce its earnings for 2008, which is guaranteed to be bad, since 2008 was a year plagued with problems regarding the launch of GeoEye-1. There is also the matter of the 3.25 million warrants (GEOYW)outstanding on GEOY stock with a $10 strike price which expires in March 2010. Hedging of the warrants account for the majority of GEOY’s current short position, and the low strike price ensures that moderate dilution of existing shareholders will occur in 2010. Covering of the short position is unnecessary since the warrant holders are perfectly hedged, and can exercise their warrants to deliver shares if necessary. Management may be giving a conference call in mid March, during which they may or may not give further guidance on the value of GEOY’s commercial contracts. If the conference call is not forthcoming, or if guidance is not provided, I expect GEOY will sink back below $18, at which point I may rebuild my position. The chance that the stock price will sink is also increased as options expiration date approaches, due to manipulation of the stock price by option traders. Of course, I could be wrong, and management could give a spectacularly good guidance as soon as next week, causing the stock to skyrocket. However, I generally tend to shy away from gambling-type situations and prefer to purchase deeply undervalued stocks, of which there has been no shortage of recently.

Disclosure : I do not have a position in GEOY

Related posts

GEOY : Living off the government

GEOY : Manipulation by options traders

Ark Restaurants (ARKR) runs 20 restaurants and bars, and 30 other food operations, including fast food restaurants, food courts, and wholesale and retail bakeries. The company owns operating leases at some of the most prominent and well-trafficked locations in the US, including Bryant Park Grill and Café and The Grill Room (next to the World Financial Center, formerly the World Trade Center) in New York, Center Café and Thunder Grill at the Union Station in Washington DC, and multiple restaurants in famous casinos at Las Vegas and Atlantic City. In total, the company has 7 restaurants in New York, 4 in Washington DC, 5 in Las Vegas, 2 in Atlantic City, and one each in Connecticut and Boston.

The business model of Ark Restaurants is a rather interesting one, being a blend between the traditional individual restaurateur business and the restaurant chain (such as Applebees and TGI Fridays). Compared to an individual restaurant, the chain restaurant has a cost advantage, being able to centralize backroom operations and exploit economies of scale. A meal at the individual restaurant therefore costs more, but offers the prospect of an artisan meal amid a better atmosphere. Ark Restaurants tries to marry the best of both business models. By setting up multiple restaurants at prime locations in a single city with a healthy tourism industry, yet allowing each restaurant to retain its own chef and unique identity, the company is able to centralize backroom human resource and purchasing operations and still charge the higher fares typical of full-service restaurants. Multiple restaurants in a single city gives the company local market power, as well as allows some degree of vertical integration. For example, Ark Restaurants typically sets up wholesale bakeries in the cities where its restaurants are located. In addition to providing its own restaurants with baked goods, these wholesale bakeries also provide goods to the local restaurant industry. Ark Restaurants also owns catering businesses in these cities, which provide food from its restaurants for special occasions at other locations. Furthermore, landlords are more willing to charge a lower rent to Ark Restaurant because its healthy balance sheet and demonstrated expertise in running restaurants. This lower rent reflects the fact that Ark Restaurant is a better credit risk and is less likely to default on its lease and leave the landlord with an empty location. Lastly, this business model is capital intensive. Mature well-run restaurants are filled to capacity and typically do not show year-over-year growth in sales, so opening new restaurants is required to achieve growth. Opening new restaurants is capital intensive, as pre-operating losses in the first year is routine due to costs incurred for training personnel, excess kitchen costs, and publicity, as each new restaurant must build its own reputation anew. Restaurant chains typically operate with the franchise model, where individual managers pay part of the startup costs, and benefit from immediate brand recognition and a shorter break-even period. Compared to the restaurant chain, Ark’s business model does not bring costs down as much, and growth requires more capital. However, Ark is primarily competing in the space of individual restaurants, which provides a unique dining experience that chains cannot provide, where this particular business model gives it substantial advantage over the individual restaurateur.

Many new restaurateurs focus on the dining experience and ignore the two critical factors required for a restaurant’s success, location and rent. Therefore, the failure rate of independent restaurants is extremely high, with many failing within the first year of opening up shop. At Ark Restaurants, CEO Michael Weinstein has been managing restaurants since 1983, and has a reputation for good negotiation skills, being able to secure operating leases of prominent locations at reasonable rents. Furthermore, Weinstein was an investment banker before he caught the restaurateur bug, and unlike the typical restaurateur, concepts such as shareholder value and return on investment are not foreign to him. Being the largest shareholder (Weinstein owns 1 million of the 3.5 million shares outstanding), his interest is aligned with that of minority shareholders. Weinstein is quick to shut down unprofitable businesses, and has previously shut down several restaurants and a wholesale bakery in New York after they failed to be profitable. In 2006, Weinstein was offered $14 million for his lease at the Venetian Resort Hotel Casino in Las Vegas by other prospective tenants. Recognizing that this is a good deal, Weinstein took it and distributed the proceeds as a one-time $3 special dividend to shareholders. In short, management is competent and shareholder-friendly.

Exposed to the unfashionable tourism and restaurant industries, Ark is now being heavily sold off by its institutional holders, Loeb Partners and Pride Equity Partners. The suspension of Ark’s dividend also contributed to its decline, although Weinstein felt that conserving capital to launch new restaurants in this environment is a better use of cash. However, Joel Greenblatt, who runs Gotham Asset Management, has recently become a new holder of this stock.

My investment thesis for Ark is this : Ark Restaurants will be able to survive the downturn due to its healthy balance sheet and low costs, and many independent restaurants will go out of business before it does. Furthermore, it possesses leases of outstanding value at multiple prominent locations, which can be probably be sub-leased for cash if necessary. Unless the restaurant and tourism industries in the US is permanently wiped out, ARKR is likely to emerge from this recession with better market power and profitability. This investment thesis is similar to Pabrai’s thesis for Frontline, an oil shipper hurt by a downturn in shipping rates in the 2001-2002 recession. While shipping rates were running below the level required for profitability, Pabrai saw that small Greek shippers with single hull tankers were being hurt more than Frontline, and were rushing to scrap their ships before other shippers flood the market with scrap. He reasoned that Frontline could stay afloat simply by scrapping one or two ships if the need arose, and when oil demand next surged, Frontline would be in a position to capitalize on it, which was indeed what happened.

I estimate that Ark has annual fixed costs of $9 million for SG&A, and $15 million for other fixed expenses. Variable costs include food and beverage costs (25% of revenue) and payroll (33% of revenue). Rent is partially fixed, with some restaurants being charged a portion of sales, while others have fixed non-cancellable rents. Management reports that minimum non-cancellable lease payments total $7M annually, with typical rents being 14% of revenue. In fiscal 2008, ARKR had revenues of $125 million, and net income of around $7 million. In the first quarter of fiscal 2009 (last 3 months of 2008), management reports that revenue is down 15% from year ago, mainly due to a 23% drop in revenue from its New York City restaurants, and smaller declines in revenue from other restaurants. Assuming that revenue in 2009 takes a 20% hit to $100 million, then with fixed costs of $24 million and variable costs of $72 million, operating profit will drop to $4 million, and net income to $2.6 million (assuming a 35% tax rate), or $0.74 EPS. In addition, Ark has surplus working capital of $8 million, or $2.28 per share. Therefore, at the current stock price of $10, the market is valuing ARKR at slightly above 10 times earnings. In the worst case scenario, the company may run at a loss. In that case, Ark may have to either draw down on its substantial cash holdings, or more likely, negotiate lease reductions to regain profitability, or alternatively sub-lease its locations to other companies who can profitably run other businesses from those locations. Given that Ark holds leases in many prominent and well-trafficked locations, even if the restaurant business prove to be no longer viable at those locations, it is likely that other businesses will achieve profitability in those locations. I estimate that ARKR is minimally worth $10, and probably much once the recession passes.

I’ve been following GEOY for quite a few months now, and every month on or near options expiration, the stock takes a beating and closes near an option strike price. Numerous academic studies have shown that on options expiration Friday, stock prices tend to close around option strike prices. This does not happen with stocks without options, only with optionable stocks. What is happening is that options traders systematically look for stocks which command a high option premium yet has a low trading volume. The traders proceed to sell a large number of options and collect the option premium (in GEOY’s case, I’m referring to call options), and then starting about a week before options expiration, they slowly short the stock downwards to close at or near the strike price. The call options expire worthless, and the traders then cover their shorts while driving up the share price tantalizingly close to the next option strike price, thus luring the next batch of option buyers in for the kill.

If you look at the short interest of GEOY, you’ll see that shares short declined dramatically after the successful launch GeoEye-1 last year, with short covering probably responsible for GEOY’s spike above $25. Since then, trading volume in GEOY has declined significantly, yet at the same time, there has been considerable bullish attention on the stock among retail investors, and many of these retail investors apparently has opted to buy call options rather than the shares, resulting in a very rich options premium. In the midst of this positive attention, shares short has actually been rising modestly but steadily, probably because the option traders have been unable to completely cover and sterilize their short shares.

The game of retail investors versus institutional traders is a particularly lopsided one. Not only do retail investors have less capital then traders at investment banks, even when they refuse to sell their shares at unreasonable prices, traders can always borrow the shares from the retail investors’ very brokers to short. In fact, with ineffectual SEC surveillance, I wouldn’t be surprised if there is some naked short selling going on. In other words, the traders can conjure up and infinite supply of phantom shares and the share price will be exactly where they want it, regardless of the opinions of the retail investors.

What can the retail investor do about it? The one thing you can do is to stop buying call options! Buy the shares instead. If you really want the leverage, consider using margin. As I am typing this, the Mar $20 call options is selling for about $1, representing a 5% return in a single month. The margin interest you incur in a single month will be dramatically less than this.

Will we always be at the mercy of the traders? There are several ways that this will end. Firstly, management does hold an appreciable amount of stock, and better communication on their part about the company’s earning prospects may attract another institutional buyer with enough firepower to face down the manipulators. Secondly, there are signs that the traders are gradually accumulating a net short position, because they are unable to cover their shorts at cheap prices. At some point, the risk department in their bank will sit up and take notice, or more likely, some other opportunistic trader will notice and proceed to set up a short squeeze.

Division of labor has played an large role in the economic achievements of mankind. The ability to specialize and accumulate knowledge in a narrow domain has allowed incredible efficiency gains that have lifted living standards for all of us. When I want to get a pair of shoes or a new shirt, I do not try and cobble my own shoes or sew my own shirts; I go to a retailer. I trust that competition and free markets will keep prices reasonable, and I will not be charged exorbitant prices due to my ignorance in the arts of shoe- and shirt-making. The modern economy has allowed us to ignore many important skills and routinely rely on others to provide goods and services which we cannot do without. Usually, it is a smart thing to rely on others who are more specialized than us. But is this true for all goods and services?

The experiences of many retail investors during the recent financial crisis suggest that the answer is “no”. It has been revealed that investment advisors (IAs) sold retail investors securities that were inappropriate for their risk profiles. For example, retirees were sold Lehman bonds and auction rate securities. The IAs and finance professionals involved were either incompetent, and did not understand the risks involved, or criminal, and did not care about the risks involved. In addition, retail investors lusted after higher yields and deliberately bypassed the more conservative and intelligent IAs, and other less competent but more morally flexible IAs stepped in to satisfy their needs. I remember an analagous situation which happened to a neighbour. She was given a diagnosis of breast cancer from her family doctor, but in a state of shock, she requested a second opinion from another doctor. The second doctor told her that it was a benign cyst, and she was relieved and put off further treatment and investigation. A year later, the cancer had metastasized, and she had to undergo aggressive chemotherapy. In both medicine and finance, human psychology coupled with bad incentives lead to unfortunate results. IAs and doctors are both paid on a commission basis; their income is entirely dependent on the number of trades/procedures their clients undertake. Ironically, if they provided advice that actually improved their clients’ physical and financial health, their income will go down. Furthermore, doing the appropriate things to improve one’s physical and financial health is often psychologically distasteful (think exercise and saving), and the market is always ready to provide painless free-lunch type solutions from less scrupulous practioners. Human psychology and market forces virtually dictate that IAs and doctors will give bad advice.

This is why I strongly advocate self-sufficiency in the areas of personal physical and financial health. You should know whether you are in reasonably good physical shape for your age group. You should understand the main causes of death for your age group (for middle-aged men, the top 3 causes are heart disease, cancers, and stroke), and how to minimize your risks. You should know the amount you require for a reasonable living standard after retirement and to fund your children’s education, as well as how likely you are to get to that amount given current income and expenditure growth rates. These are all important but scary questions, and it is likely that no doctor or IA will take the initiative to broach them with you, because they know that scared clients tend to leave. And that is why you should take matters into your own hands.