Kevin Phillips has been warning of the dangers of the “financialization” of our economy, ineffectual politics, and overreliance on foreign debt and oil for years. In Bad Money, the reader is finally offered a glimpse of the consequences of “American Capitalism.” As a former historian and former Republican strategist, Kevin Phillips provides a unique perspective on the economic and political motivations of many of America’s foreign and domestic policies over the last century and demonstrates for the reader how it has shaped the society we live in today. From the beginnings of “financial mercantilism” and “dollar diplomacy” to our recent binge on debt and dangerous dependence on foreign oil, Phillips draws parallels between our “period of American triumphalism” and the rise of the British and Dutch empires which preceded ours. The observations are not inspiring. In Phillips’ eyes, wayward politics guided by a lack of foresight particularly with respect to energy policy and a reliance on excessive debt coupled with our societal deification of finance have left our nation vulnerable and on the precipice of fading relevance as the world’s economy matures around us and realigns away from us.

From the above description, it’d be easy to writeoff Bad Money as just another “sky is falling”, “doom and gloom” conspiracy theory. But, Kevin Phillips does not at all present his thesis in such a manner at all. Instead, he lays out easily verifiable facts and observations and goes to great lengths not to pontificate on could-have-beens or what-ifs. In fact, while ample guidance is given to the reader of the conclusions that are to be drawn, it is the reader which ultimately is given the choice of deciding. Is America already a superpower in decline? Or, can we right the wrongs of the past and forge ahead as a relevant and admired world power?  What cannot be argued, is that mistakes have been made not just in the last 8 years, but over the course of the last century as our nation’s rise to wealth and comfort has lulled us into state of satisfied hubris.

This book is a must read for anyone who wonders about all the media hoopla over OPEC nations discontinuing the denomination of oil in dollars or is confused about attention being paid to US Treasury issue bid-to-cover ratios. Bad Money provides a terrific primer of some of the most important political and economic issues facing our nation today. As respnosible citizens, we should all be getting better informed on these topics and asking ourselves just how we can make a difference.

Political and social implications aside, this book also provides a great macroeconomic primer for investors. The topics of international trade, currency exchange, and peak oil are discussed in depth throughout the book and will ultimately shape much of the long term discussion in world markets over the next several decades. As an investor, improving clarity as it relates to these topics will go a long way to enlighten your investment decisions as you look for alternative asset classes and international diversification for your portfolio.

For more reviews of investing and finance books check out The Curious Investor’s Book Reviews Directory.

Winning with the Dow’s Losers

Beating the Dow

For those that don’t know, the strategy is basically a simple contrarian strategy that limits the stock picking universe to the Dow Jones Industrial Average (DJIA). The idea being that the Dow Jones will do the heavy “due diligence” for you since you can be generally sure that a company included in the DJIA is one of America’s largest and most steadfast corporations. As such, people who ascribe to a dogs of the Dow philosophy believe that you can outperfor the Dow simply by buying some set of the worst performing Dow components. O’Higgins advocated choosing the ten Dow stocks with the highest dividend yield and rebalancing yearly. 

Charles Carlson takes this O’Higgins’ theory one step further in Winning with the Dow’s Losers and believes that you can beat the Dow on capital appreciation alone simply by looking for stocks with the largest percentage drop in share value or trading furtherst below their 200-day moving average which he defines using close ratio (share price to 200-day MA). The majority of his book involves the presentation of back testing data going back to the 1930s including analysis of companies which have been added and subtracted from the Dow Jones. To follow up on his assertions, Carlson has even set up a website – DowUnderdogs.com – where he provides yearly analysis of Dow losers and tracks their performance. 

In the end, it’s hard to say that this strategy is fool proof. In fact, if you look at the performance of the strategy over the last year, you’ll find that nearly all configurations of the Dow Underdogs strategy vastly underperformed the Dow. Furthermore, Carlson’s book itself presents that the 10-stock strategy barely outperforms the Dow over the last 70+ years with outperformance just north of 100bps better than the Dow itself. And, would anyone really be bold enough to commit the majority of their capital to a strategy that relies on just 3 or 5 Dow components? These strategies seemingly offer better performance but significantly more volatility over the same period. 

Overall, Winning with the Dow’s Losers is a well written book that presents a pretty effective case for a so-called “lazy strategy” that has the potential to outperform over a long period of time. I think it’s real value is getting the reader to think more about the value of “contrarian” investing and realizing that today’s losers will not necessarily be down and out forever. The key, though, is not to confuse this strategy for a true value strategy. In the end, Carlson relies more on technical concepts like mean reversion and relative performance to prove that his strategy can beat the Dow. Furthermore, the strategy, as any “lazy strategy,” suffers from the fact that it prescribes a yearly rebalancing when market cycles are not bound to any predetermined time frame. One of the reasons why the strategy so bady underperformed last year is exactly this. Two of the Dow’s biggest losers in 2007, GM and Citi, were at the center of the downturn that has only accelerated in 2008. Will these two stocks someday rise from “worst to first,” possibly. But, from 2007 to 2008, they went from worst to worst-est. Speaking of which, it would be interesting to see how this strategy performs on a dollar cost averaged basis. 

Anyways, on with the show. Margin of Safety by Seth Klarman is one of those mythical investing books that investing enthusiasts from retail to professional wish to get their hands on. Seth Klarman wrote the book in the mid-1990s and inexplicably (or rather shrewdly) decided to stop printing it. These days used copies sell for $600 and new copies can run as much as $2000. Rich hedge fund managers go as far as to steal copies fom public libraries. But, if you’re lucky, you’ll manage to find a copy with some creative internet searching – either through legal, semi-legal, or outright illegal means. 

Who is Seth Klarman? Seth Klarman runs the Baupost Group and has returned nearly 20% a year since 1982. Klarman is a true value investor who is as disciplined as any out there and has been known to hold upwards of 50% of his portfolio in cash and shun any sort of leverage. He’s a master of distressed buying and, like Warren Buffett, is willing to purchase securities throughout the capital structure – not just stocks. 

Klarman’s book, Margin of Safety, is one of the most well-written and interesting investment books I’ve ever read. The book’s subtitle is “Risk-Averse Value Investing Strategies for the Thoughtful Investor” and it delivers in every facet. Klarman discusses the principles and philosophy of value investing while sprinkling in anecdotes and analysis of various market events in the 1980s and 1990s ranging from the savings and loans crisis to his own personal investments in spin-offs, mergers, and distressed debt. 

The book is highly informative for beginning investor and professional investor alike as Klarman, more than anyone else that purports to be a “value investor” these days, truly understands the essence of value investing and provides a truly articulate and well-thought out exposition on its merits and how anyone can become a disciple of value investing.

For all that the book does offer in breadth and insight, it is lacking somewhat in actual tutorials. For a new investor, Klarman’s cursory discussion on how to value securities and where to hunt for bargains is not likely to be enough to get one started in implementing a value investing strategy. In fact, I found myself looking to other resources after reading this book to get a clearer view of certain topics. 

I definitely do recommend Margin of Safety if you can get you hands on it. It’s a great read and definitely somethng fun to mention to your other investing buddies. But, do you need to shell out $600+ for this book to be a good investor? Probably not. In fact, after reading this book, I almost immediately felt that you could very closely approximate the book’s contents with two other books I’ve reviewed on this site – Bruce Greenwald’s Value Investing and Joel Greenblatt’s You Can Be A Stock Market Genius. These two books cover, in even more detail than Klarman’s book alone, value investing philosophy and technique as well as searching for stock picks through special situations investing.

So, what is contrarian ripple trading? Is it a day trading strategy? Is it a volatility trading strategy? In fact, it is none of these things. Despite its edgy and mysterious name, it is actually a sort of hybrid trading/investing strategy designed for the at-home investor by a couple with no real financial background. Martha Brozyna is a medieval history Ph.D. who trades at home for herself and other family members. Aidan McNamara is a graduate in political science who has worked in international banking, but has spent the last 11 years working in financial publishing. They claim that this background makes them uniquely qualified to teach the at-home investor who is likely just looking to earn some extra money and doesn’t want to be overly involved with their stock portfolios.

The strategy they present (which they seem to have gone to great lengths to hide on their website so I won’t go into too much detail) is, in fact, magnificently simple. It’s contrarian in that it expects the follower to purchase only down trodden stocks. And, “rides the ripples” by purchasing and selling only while the stock stays at depressed levels. They sell only when they lock in a nominal profit net of commissions. Hence, why they only claim never having lost money on a roundtrip trade. In addition to these basic principles, the authors purchase only stocks of large cap companies or companies that they themselves feel a unique understanding of.

Unfortunately, the authors’ inexperience and lack of understanding of the fundamental and technical underpinnings of their strategy is readily apparent throughout the book and to some degree detracts from the impact of their very successful strategy. Ultimately, I find that the book is probably not suited for the novice investors that it targets as the authors, probably unintentionally, are somewhat misleading and oversimplify their strategy. Let me explain why.

First and foremost, the buy strategy presented lacks depth and boils down to buy big companies which are trading at 52-week lows when the market is down. I take this to mean when it is in a trading range near its lows for the year and not in the middle of a slide to new lows, but the average reader may not know this. Furthermore, while I appreciate the attempt to be contrarian even to the point of a purchase by telling the reader to buy on a day both the target stock and the market (DJIA) falls, it isn’t necessary for their strategy and is likely dangerous. Basically, they tell the reader to catch a falling knife especially if the reader has misinterpreted and doesn’t wait for their target stock to reach a trading range/base.

Secondly, they present their trading record without any information on total invested capital or the percentage return. This leads to a rather fuzzy picture of just how succesful they were. In fact, some losing positions are held for over 2 years and a back of the envelope analysis of the positions held at the end of their trading record leads one to believe that the strategy requires in excess of $250,000 to be invested at any given time as a result of having to hold some losing positions for long periods of time but still having to make new investments to continue generating nominal returns. Keeping in mind that the authors chose the very bullish years between 2005 and 2007 to report their earnings, the $30-40,000 in realized profit made each year (~15%) is a lot less compelling and even more so when one weighs the risk of keeping $5000 to $10,000 in unrealized losses in their portfolio. In fact, with their rather laissez faire attitude towards holding losers and a suspect buy strategy, I’m surprised the portfolio didn’t include much larger unrealized loses.

The authors would probably counter my above complaint by saying that their strategy is designed to help you make regular nominal profits through stock trading and is not for those looking to invest their money for capital preservation or dividend income. I still believe that the merits of any strategy cannot be properly measured with nominal returns especially without any disclosure of how much money is actually invested at any one time. Let me give an example. I have a strategy which will yield $50,000 every year! This is more than people in the US make per year. They should all quit their jobs and use my strategy. It’s simple. Just take $1,000,000 and invest it in a CD for 5% annual interest.

Third, I have some issues with the authors’ attempts to connect themselves to established traders and investors or established investment theories despite the fact that their strategy does not conform to them. Most glaringly, they spent a lengthy chapter describing Dow theory and using the analogy of the markets moving in ripples, waves, and tides. Unfortunately, Dow Theorists believe that ripples were random ought to be ignored. They mention this, but provide no explanation as to why they feel it is okay that they’ve devised their strategy in direct opposition to the Dow Theory they are trying to connect themselves to. Furthermore, they provide no further technical reasoning for why their strategy should work despite the fact that this trading strategy seems dependent on the very technical phenomena of “ripples” in a stock chart.

Finally, the authors devote much of their book to breaking down some of their best trades and it is here where the book completely loses focus. The authors provide their logic and reasoning for each of their trading positions yet it is obvious that their investment ideas are based on long-term, macro ideas behind a company and its business. There’s nothing wrong with this, but their reasoning is not necessarily a sound way to establish a trading position in a particular stock. Good companies alone do not a good stock make. For example, I could identify Boeing’s stock as being a good buy because it has fallen to 52-week lows but in the long-run I know that Boeing has a brand clout in an industry with relatively high barriers to entry (not everyone has the capital or expertise to make planes) so I decide to buy. This is not the same as identifying that these 52-week lows are as far as the stock will fall or that the stock will rebound anytime in the near future and this is what is necessary when attempting to make a trading decision to make short term profits.

Ultimately, I believe the authors of this book might actually have served themselves better simply being contrarian investors. I give them much credit for having well-formed investment theses behind their stock picks and their insights into the companies that they invested in probably could have made them much more money if they had held their positions longer rather than sell them whenever a minimal nominal gain was reached. I suspect that their trading strategy (particularly the way they have employed it) would not have worked quite so well in the bear market environment we have faced at the end of 2007 and beginning of 2008 where falling markets do not quickly bottom and rebound, but instead seem to just keep making lower lows. Without an unlimited bankroll, the consistent generation of realized profits that this strategy boasts does not likely hold up.

So, is Contrarian Ripple Trading without merit? I don’t believe so, but it could have been better written. The way the authors present their strategy and trading habits minimizes their strategy into basically a Dow Underdogs strategy coupled to a hyper-conservative sell strategy. The implications of their strategy, however, are a lot more interesting and could have been presented as such. On a strictly technical basis, they seem to have found a method of trading which allows them to capitalize on the volatility exhibited by a stock during a basing period. Their success in over 1000 round trip trades (even during a bull cycle) deserves to be commended and, with a little further analysis and research, they could have a real winning trading strategy on their hands. In fact, in the coming days, I will publish my own post proposing my take on “contrarian ripple trading” which might work well as an addendum to their book especially for more seasoned market technicians.

Contrarian Ripple Trading

And, since this book looks to be a pretty quick read, I’m also writing to let my readers know that I’ll be taking a quick break from reading Margin of Safety to read this book. I’m sure Seth Klarman just spat out whatever he was drinking, but I’ve only got about three months left of being able to actively trade (I will be starting a full time job soon), so it would seem prudent to spend some time researching trading strategies now as opposed to later. Feel free to sound off if you’ve read this book yourself or know anything about this “Contrarian Ripple Trading” strategy.

Also, for people new to the blog (much to my delight I’ve had an influx of hits lately), let me recap my policy on sponsored reviews. While I will accept requests for sponsored reviews, I don’t promise positive reviews in exchange. I do, however, try my best to see things from all sides and generally will try to highlight both the good and bad of a book or product as I believe there are few things that are completely without merit. If you’d like to see how your tastes match up with mine, check out my past book reviews.