At the onset of SLO2 I put one third of my portfolio into airlines. The airlines have done very poorly in the last few months. My thesis for airlines had three components and all three are still in play. I expect these components to come to fruition in two to three years, but the contest has a limited time horizon and I have no expectation any of them will recover by the end of this contest. I have sold all airlines from my SLO2 portfolio.

The first component was the likelihood of a consolidation. This notion is still in play and recently the expected merger of Delta and Northwest was finally announced. Such news heightens one's expectation for an eventual three-airline industry. But it was met with a yawn by the market and it fails to bring more money into either airline. There is further expectation that a European airline will buy one quarter of the combined airline. This is unlikely to happen before the end of SLO2. When this does happen, if this is a genuine cash deal then we will see a bump upward. However, if the investment is in more airline stock or if there is a deal that creates a separate class of stock diluting the value of common stock, we may not enjoy such a bump.

The second component is airline pricing power. The airlines seem to impose additional fees to their customers with impunity. The demand for air travel remains high and there are limited seats on many routes. Further, airline executives speak frequently of reducing capacity. Unfortunately this pricing power is not keeping up with rising jet fuel prices. Even the consistently profitable Continental (CAL) cannot show a profit. The next round of earnings announcements will be after the end of SLO2.

The third component was an expectation of declining fuels prices. It seemed to me oil prices were in the right-hand shoulder of a head and shoulders pattern. I was in good company (e.g. T. Boone Pickens) anticipating lower oil prices. Alas, quite the opposite happened and the rise in oil does not appear to be abating. While the run-up is likely unsustainable, I do not anticipate oil dropping significantly before the end of SLO2.

My recent chess-themed post discussed where I've invested the proceeds. http://www.investorplaceblogs.com/users/jmcdowell/2008/04/how_investing_imitates_chess_8.php

Comments: View Comments |  Thursday April 24, 2008

Every chess move involves a balanced decision regarding material, time, and quality. In chapter seven of How Life Imitates Chess Garry Kasparov states making correct evaluations and corrections requires understanding the trade-offs of these core elements.

Material describes our tangible assets. Chess players start with the same 16 pieces; All SLO contestants started with $1M. NAVs below ten (10.0) indicate the market has captured some of our material. NAVs above ten indicate the contestant has captured material from the market. In contrast, in real life we are all investing with different amounts of seed money.

Time is how long it takes to achieve a specific objective. Regarding time, chess has tempo with alternating moves between players. In SLO all contestants are ticking through the same five months of contest duration. In contrast, in real life we all have different time horizons.

Quality is value. In chess a measure of value is the power wielded by a piece due to its permitted movements and its position on the board. A knight in the center of the board exerts itself onto 8 squares. On the side of the board it only exerts itself onto four squares; in the corner only two squares. Hence the chess adage "a knight on the rim is dim" (sometimes said as "is grim").

This chapter touches on another popular chess adage which is to find an improved location for your worse-placed piece. So let's examine each of my holdings in terms of the worse-placed piece. Or simpler yet, look at my three strategic areas and determine the worse of the three. Unfortunately, the evaluation is not difficult: my worse-placed piece is my position in the airlines. Over the last few days I've put this adage into motion by selling all my airline positions. This was simple but not easy. It meant giving up on the hope airlines will recover in the remainder of the contest period. It also meant admitting error. But so it is. I will say more in a separate post about the airlines. But where is the better place on the stock market chess board? In real life I see opportunity in financials, retail, and in some closed-in debt funds, but the time horizon for these investments' to pay-off is three to five years. For SLO2 purposes, I'll keep to my three stated themes. The other two are consumer and internet industries groups. My better contest stocks are in the internet space. I placed the airline proceeds into both internet infrastructure and internet content. I bought Google (GOOG), Yahoo (YHOO), Overstock.com (OSTK), EMC Corp (EMC), and JDS Uniphase (JDSU). By the way, I've taken profits in BIDU.

Comments: View Comments |  Tuesday April 22, 2008

In chapter six of How Life Imitates Chess Garry Kasparov explores Preparation as an ingredient of success. Many fine anecdotes are provided ranging from sports to inventors spotlighting Michael Jordan, Thomas Edison, Thomas Jefferson and of course chess players such as Alexander Alekhine, Bobby Fischer, and Mikhail Botvinik. A common theme in these stories is that of disciplined hard work. The author advocates one seek out their own level of efficiency in terms of a ratio of work to results through practice and observation. The keys to great preparation are self-awareness and consistency. He points out a near mystical correlation between preparation and good results even when in retrospect the two cannot be directly tied.

Self awareness in investing is noted by Jack Schwager in Stock Market Wizards. After presenting interviews with fifteen stellar traders he summarizes a number of Wizard Lessons of which one is The Need for Self-Awareness: "Each trader must be aware of personal weaknesses that may impede trading success and make appropriate adjustments." Weaknesses cited include listening to other people's opinion, gambling urges, bargain hunting to the point of missing good trades, and the excitement from trading on options-expiration days. Schwager emphasizes that making proper adjustments is the necessary consequence of self awareness.

Regarding preparation, I recall an early seventies news clip which featured Fischer carrying two black notebooks with him everywhere he went. One titled "Spassky - White" and the other titled "Spassky - Black." Studious baseball pitcher Greg Maddux reportedly carries two black notebooks containing scouting observations from the league's opposing players' every at-bat. If I were to carry two notebooks pertaining to investing, what would they contain? The answer might reveal a valuable nugget of self awareness that needs to be addressed. My reflex is to carry charts. Perhaps one titled "Stock Charts - trending market" and the other "Stock Charts - sideways market"; or a pair of books labeled "Charts exhibiting channels" and "Charts exhibiting reversals." Whatever my final selection may be, I did not immediately think of fundamental themed notebooks. Say "Value Stocks" and "Growth Stocks;" or "Cash Flow Generators" and "Strategic Capacity Builders". I did not immediately think of story themed notebooks either. Say "Rule Breakers" or "Talented Management" or "Demographically Positioned." One can easily continue the possibilities, but the indication is clear: an oversized reliance on charts and technical analysis. A habit breaking approach might be to avoid charts for several months until a pattern of investing decisions on fundamentals or story emerges. The longer term correction might be to incorporate fundamentals into the technical analysis or prescreen stock ideas prior to examining charts. The interesting thing is that I am cognizant of the need to balance these three approaches but I am absent any habitual discipline integrating the three. I've been on autopilot with a single approach for too long.

Kasparov points out that targeting an area of life for efficiency need not mean becoming a fanatic. Fifteen minutes a day looking at chess openings would make you a better player. An hour a day learning Mandarin can change your career. Speaking of black notebooks, on my shelf are two Value Line binders. The contents are dated 1996. Wow. These books contain solid data on 1700 companies. So if I had read only one a day, I could have read the material twice between now and then. Granted the opinions become dated (though an active subscription provides weekly updates rotating the entire content every quarter) and the business landscape changes. But slow absorption of this single resource could enrich reception of all investing sound bytes for the remainder of one's investing lifetime. Not advocating Value Line per se here, but advocating consistency.

The preceding chapters have pertained to ingredients of success. The following chapters will pertain to evaluation and analysis. With each chapter I'll strive to discuss each with respect to specific SLO portfolio decisions.

Comments: View Comments |  Thursday April 3, 2008