“Things are Always Different. The Art is Figuring Out Which Differences Matter.” Laszlo Birinyi

One of the interesting things about the investing world is how people are willing to try different methods of investment analysis in order to generate market beating returns. With the modern age development of astronomical computing power, the ability to analyze huge volumes of data is at everyone’s fingertips.

One strategy which has gained popularity is called factor investing. Factor investing is an investment approach that involves targeting quantifiable firm characteristics or “factors” that can explain differences in stock returns. Usually, it is used in algorithms where weights are assigned to different aspects to come up with a mathematical equation. Data is then plugged into the equation to rank investment possibilities based on those criteria. If you consider over 80% of all trading data in the market comes from algorithmic trading (as of last year), clearly large pools of capital are using these strategies. I find it interesting, but I believe the strategy is flawed in the majority of cases. Why?

Factor Investing?

First, the factors are a byproduct of what the decision makers find to be most important in evaluating businesses. If the factors are weighted in a manner which does not weight each criteria accurately, the whole algorithm becomes, shall we say, questionable. Second, in many cases, these algorithms don’t pay enough attention to underlying changes in specific firms operations. The changes can cause dramatic differences in results. The results show up in time, and that affects the stock price.

You can pick all kinds of examples which might illustrate this- say Apple introducing the watch, Airpods, subscriptions and payments, Disney’s huge success with Disney Plus, Google’s acquisition of YouTube (maybe Fit-bit will be similar), and there are hundreds or thousands more. Third, factors might not weight or discern a change in management, be it a CEO or a new hire in an important position like CFO or director of operations. Essentially, factor investing doesn’t get into the nitty-gritty of analyzing what can move the needle on a business. With so much volume in equity markets traded this way, it allows for um, well, let’s call it, mis pricing.

Market Events

In the market last week, there was plenty to pay attention to. The world wide increase of the coronavirus continued to dismay investors and cause concern. Oil stocks remain in the doghouse over the idea the global slowing will cause less demand. In addition, more scrutiny by those preaching ESG (environment, social, and governance) puts anything related to fossil fuels in the do not touch or sell pile. There were a couple of big deals in the financial sector. Morgan Stanley bought eTrade for a cool $13 billion as a competitive response to Schwab buying TDAmeritrade. Next, Franklin Resources paid $4.5 billion for Legg Mason, Bill Miller’s old firm (Miller beat the S&P 500 for 15 years in a row).

On the earnings front, Wal Mart missed and Apple warned about China because of you know what. Transunion beat and Bluebird Bio also whiffed, while Blue Apron continues to struggle. Copart, long an excellent company and performer, keeps racking up the numbers. Zillow also excelled as their home buying initiative is starting to gain some traction.

On the macro front, the Purchasing Manager’s Index for Manufacturing came in a little light, which is understandable given the Coronavirus craziness. Berkshire Hathaway released the 2019 annual letter this morning, and the emphasis was on retained earnings. Simply put, these are the dollars a business earns from operations that get put back into the business (as opposed to buybacks or dividends). If you are interested in a preview of what might take place in the United States, here is a nice article on the challenges in Argentina and the Vaca Muerta (large shale complex) after a political change.

Democratic debate

Speaking of politics, the Democrats held an interesting tussle here in Las Vegas last Wednesday. While having a little entertainment value, the viewing audience did not get much substance as far as issues, especially on the economic front. The moderators play to the Democratic base and ignore major problems across the United States and globe. Fiscal or monetary policy was hardly mentioned, nothing on foreign policy, middle east tensions, Brexit, over ten trillion dollars of negative yielding fixed income bonds, entitlement spending versus the military, and on and on. Whiff. Crickets.

For me, the most interesting moment was when Mr. Bloomberg, he of the disgusting, grotesque wealth (Bernie’s attack line) asked the other participants if any of them had ever started or run a business. You can guess what the answer was. Bloomberg, who was savaged by Senator Warren about his non-disclosure agreements with female employees, looked like a deer in the headlights during most of the night. He will get another shot at it on Tuesday, and you have to think there will be some improvement. Meanwhile, the Nevada Caucus is today and it looks like Bernie will become the clear frontrunner with moderates undecided about which horse to back. Many think it will ultimately get decided by a contested convention, but right now the ‘Socialist-Democrat (communist) appears to have a line to the nomination.