Quarterly Reports Systems

a timely accounting of timeless principles of personal finance

The Stock Market's gonna be great this year. Why? Because San Francisco creamed Miami in the Super Bowl. This is true! Really! Almost! Sort of! Of course not! But wait.

Double Your Money, Double Your Fun

I sit, guilt dripping down my spine, implementing my system. Free drink in hand, I am steadfastly betting on red. If I win, I double my money. If I lose, I double my bet. I am doing this, honesty compels me to admit, with one-dollar chips. (This was a long time ago.) I bet a dollar on red and if I win, I bet a dollar again. If I lose, I bet two dollars. If I lose again, four dollars. Then eight. Then 16. Any time I win, I immediately go back to betting a single dollar.

The result is that every time I win, be it on the first try or the second or the fifth, I win a dollar. (Losing one dollar, two dollars, four dollars, eight dollars and then winning $16 is a net gain of one dollar.) Not much to you, perhaps--and by now, hey, I just leave singles on the table, use 'em for scratch paper or toothpicks--but a buck's a buck (I actually smooth out their little creases and lay them tenderly in my wallet) and with this system, they just mount up hour after hour, night after night. Endless dollars.

Ever so rarely you'll get such a long string of losers--the roulette wheel will come up black so many times in a row--that (A) you don't have enough cash to keep the system going or (B) you bump up against the betting limit on the table (which is one of the reasons they have limits). But other than that, you will surely win.

So here I am, minting money, the casino oblivious to the syphon I've stuck in its fortune. Lose, win, win, win, lose, win, lose, lose, lose, win, win, lose, lose, lose, win, lose, lose, win, win--fine. My dollars mount. About 20 minutes into all this I lose once, lose twice, and again and again--this isn't supposed to happen too many more times--and again, and again; and now, facing my seventh bet in the progression, I'm up to serious money. Down $63 on the progression and facing yet a further $64 hit, I've entered the Dostoievsky stage of America's second favorite latenight pastime. ("As I was going out of the casino," The Gambler recounts, "I looked--and there in my waistcoat pocket was one surviving gulden. Ah, so I shall be able to have dinner, I thought. But when I had walked about a hundred paces I changed my mind and went back ....")

The drama is heightened by the fact that beyond this $64 I cannot go. The table limit is $500, but they don't let you bet your shoes and socks.

I take a deep breath--when you have to win, you don't--and put down 64 big ones on red. And it comes up red. I have added yet another dollar to my hoard. I decide it isn't worth it.

And, of course, the odds are against you, because, by a stroke of genius that long ago made the Roulette family one of the very wealthiest in France, there are 37 little clicky-slot things on a roulette wheel, not 36. The 37th, technically known as 0 or snake eyes or merde, is neither red nor black. It is the house edge. (In America, there are two sets of zeros and twice the edge for the house.)

Even so, you will often win with this system at roulette--but when you lose, you will lose big. It is, in fact, the oldest system in the book. And if you can do it at roulette, why not with stock options? The odds are less precise, but the idea's the same. Bet $500 on some soon-to-expire Amerada Hess options and then, if you lose it, bet $1000 the next time, $2000-- you can imagine the possibilities. For when an option does pay off, it can pay off big.

Your broker, bankruptcy lawyer and bartender will all love you, because the house take on each options bet--the commission--is around ten percent; you are almost sure to lose in the long run; and win or lose, you'll be buying a lot of drinks.

OK, so this system doesn't work. But have you ever wondered whether or not there are any that really do? Have you never had your emotions thrown into confusion by a friend's confiding, "I've got this system, see ..."?

You wish to appear worldly, so part of you is saying, "Sure, sure." But you are, in truth, yearning to be let in on the secret and, while doubting (continued on page 150)Systems(continued from page 145) that it could possibly amount to anything, hoping that it might.

Systems abound in the financial market place and range from the truly dumb (sell stocks when the average number of sun spots per month exceeds 50) to the fairly dumb (buy whatever is making new highs) to the not so dumb at all (stay out of the market in the first half of each Presidential term, when most of the tough medicine is likely to be administered; go back in for the second half). The not-so-dumb ones might better be tagged with the more dignified label "strategies." Gamblers have systems; investors have strategies. Not that it necessarily does them much good.

The beauty of systems is that they eliminate the need to think, reducing what would otherwise be an extraordinarily complex array of factors to something as simple as: If hemlines are going up (a sign of increased liberality), so will the market. Easy women, easy money--like that. It's a roundabout sort of indicator but more fun to watch than the money supply.

Presidential Cycles

Market Logic in Fort Lauderdale reports that holding a representative basket of New York Stock Exchange stocks in the second half of each Presidential term from January 1, 1960, through the end of 1980, and cash in the other years, would have netted you (before tax) better than 11 times your money. Compare this with holding stocks in the first two years and cash in the latter years. That back-assed strategy, says Market Logic, would have lost almost half your funds.

Longtime market observer Yale Hirsch, publisher of the annual Stock Trader's Almanac, has tracked this phenomenon back to 1832 and reports a net market gain of 515 percent for owning stocks in the latter two years of each Administration versus a piddling eight percent for the first two years. (His figures ignore dividends and compounding.)

But will the pattern hold? It only sort of did for Reagan's first term (1982 and 1983 were the good years, not 1983 and 1984); but does that mean you should sit out 1985 and 1986, awaiting 1987 and 1988? Or that Reagan is the exception to the rule? Who knows?

Thank God It's Friday

If you could keep your commissions low enough, you'd certainly want to buy stocks or options two or three days before Thanksgiving, because on 31 of the past 32 Fridays after Thanksgiving, the market has risen. Last year the Dow jumped 18.78. In fact, Fridays generally tend to be a lot better than Mondays, and Market Logic reports that the last trading day of each month and the first four of the following month form a highly favorable five-day span. Not to mention the two days preceding market holidays.

If this sounds like hocus-pocus--the reasons for it are subtle, at best--consider this: Ignoring commissions and taxes, had you bought the Standard & Poor's 500 Index at the beginning of each favorable five- and two-day period, and sold at the end, between December 30, 1927, and December 30, 1975, Market Logic calculates that $10,000 would have grown to $1,440,716 (not counting dividends). Remaining fully invested throughout those years instead of jumping in and out, the $10,000 would have grown to a mere $51,441. And jumping in and out backward--buying when you should sell and selling when you should buy--would have shrunk your $10,000 to $357. In other tests after 1975 and involving real money, the phenomenon has been confirmed.

Unfortunately, if your broker charges you two percent every time you buy or sell a stock, the only millions generated by following such a system will be his. Still, if you're thinking of selling a stock, you might wait until the fourth or fifth trading day of the next month in the hope of an extra few dollars on the trade. And if you play the index options game--where you can, indeed, bet on the S&P 500, the S&P 100 or several other baskets of stocks, with relatively low commissions--these timing hints should obviously be considered.

You might even add two more Market Logic twists:

1. If the five- and two-day periods mentioned above begin on Mondays, advance your purchases one trading day to include the previous Friday (buy at the opening). If they end on a Thursday, stretch them out a day to sell at the close on Friday.

2. Adjust your options trading for the knowledge that "if the market is up today [particularly if it closes strong in the final few minutes], the odds are it will also be up tomorrow; and if the market is down today, the chances are better than even it will be down tomorrow."

This is one of the few true systems that might conceivably pay off, in the sense that you might theoretically type up a page of rules for your broker to follow, work out an extra-low commission rate in recognition of all the trading you'll be doing, throw a few thousand dollars into the till and leave for a 20-year trip to Alpha Centauri.

(For more information--little of it cheap, none guaranteed to work--write to Market Logic, 3471 North Federal Highway, Fort Lauderdale, Florida 33306.)

A Simple System for options

A genius I'll call Biff (obviously not his name; in all of recorded time, there has never been, nor ever shall there be, a genius named Biff) developed a simple system for beating the options game. It had nothing to do with doubling his bet after every loss. Quite the contrary, it had to do with winning most of the bets. "It's easy," he told me, as he ran an initial $400 stake up to $18,000 in a matter of months. He tried to describe it to me, but it never fully penetrated my veil of skepticism, which is why--forgive me--I can't pass it on to you. What I do know is that with the same system in the months that followed, he proceeded to lose the full $18,000, and then some.

The worst thing that can befall anyone in a game of chance--particularly one like the options game that purports to involve an element of skill--is early success. It may actually lead him to believe he's found a way to make money.

It is for this reason that the slot machines at the Las Vegas airport are geared to pay out 140 cents on the dollar. It is a savvy investment on the part of the casino owners. They let you win a few bucks while you're waiting for your Vuittons, which gets you primed to do some real gambling when you get to the hotel. And when you straggle back out to the airport a couple of thousand dollars later, tossing your last few into the slots in disgust while you wait for United to call your flight, they let you win cab fare home. That reawakens the spark for your next trip. (None of this is true--as far as I know. It sure sounds plausible, though, doesn't it?)

A more Complicated one

I related the prior story, sans the Las Vegas fantasy, to the Investment Club at Harvard Business School. Afterward, a student topped it. It seems he had run $5000 into $150,000--we are beginning to talk some serious money here--in five days, using a system that linked Dow Theory (which tells you where the market's headed by comparing the Dow Jones industrial, transportation and utility averages with their past highs) to the important observation that Teledyne stock, then in he 90s, was breaking through its 200-day moving average. Thus inspired, he bought $5000 worth of far-out-of-the-money Teledyne November calls, which is a fancy way of saying he bet $5000 that the stock would soar. Mirabile dictu, it did.

I began to take notes--forget playboy, these were notes for me--when he smiled and acknowledged that using the same analytical tools over the subsequent year and a half he, too, had managed to give back all his winnings. (continued on page 202)Systems(continued from page 150)

Hold that Hemline!

Since the first Super Bowl in 1967, the Standard & Poor's industrial average has gone up without fail in years when a premerger N.F.L. team has won and has gone down without fail in years when an A.F.L. team has won.

Knowing this, the market shuddered and dived the day after the Los Angeles Raiders, a premerger A.F.L. team, won in January 1984. That was the first year broad attention had really been focused on the indicator, which had by then racked up a perfect 17-year record; and, as often happens with these things, that was the year it began to falter. The market should have gone down in 1984, because the Raiders won, and, in truth, for a lot of investors it did. The Dow Jones industrial average was down. But the Standard & Poor's industrial average was up a hair, from 186.24 to 186.36.

Does this invalidate an otherwise solid principle of finance? Certainly, 1985 got off to a hell of a start, just as it should have, after San Francisco (a premerger N.F.L. team) whomped Miami.

Maybe the guys who rig professional football are the same guys who rig the market! Maybe the Trilateral Commission has something to do with it. (You notice how quite Jimmy Carter's been lately?) Have you noticed how truly powerful men cannot communicate an economic thought without using a football analogy? There's definitely something going on here.

Professor Steven Goldberg of the City University of New York, an ex-Marine and something of a Renaissance man (recent articles include "Is Astrology Science?," "Does Capital Punishment Deter?" and "Bob Dylan and the Poetry of Salvation"), has written what may be the definitive dissertation on the Super Bowl system--and it has nothing to do with Jimmy Carter (though I'm still suspicious).

"Whenever you are surprised," writes Professor Goldberg, "it is because you are comparing the thing that surprises you to some background expectation in your mind. You would be surprised to hear that it snowed 300 times in Hawaii last year because your understanding and expectation are that it hardly ever snows in Hawaii. You would, of course, be justified in your surprise. Surprise, however, is not always justified."

We think the Super Bowl's ability to call the market 17 times in a row (through 1983) is like flipping heads 17 times in a row. The odds against this are 130,000 to one. But coin tosses, unlike Super Bowls, are 50-50, random affairs.

From 1967 through 1983, Goldberg argues, because of the bias caused by inflation and the fact that five of the games were between two premerger N.F.L. teams, the odds come down to 36,000 to one.

Oh, hey! So no big deal.

Goldberg can get the odds down even lower, to 13,000 to one, if you'll buy his notion that, just as the market was more likely to rise than to fall in any given year, a premerger N.F.L. team was more likely to win than to lose. That would have been because the N.F.L. teams were better than the A.F.L. teams, but I don't want to start any fights over anything as idiotic as football (I mean it! You guys are nuts!), so let's let that lie.

"I can tell," Goldberg writes, "you're still not impressed. After all, 13,000 to one doesn't happen every day, does it?" To which he answers, "Yes. And this is infinitely the most important point. Surprise is justified only if an unexpected event takes place. This would be the case if someone had, in 1966, predicted a correlation between future Super Bowl results and the S&P." But no one did. It was only looking back that the coincidence was noted.

"On the other hand," Goldberg explains, "had someone predicted, in 1966, that some variable, he did not know which, would offer a sequence perfectly matched" to the annual direction of the S&P, "we should not be in the slightest surprised in 1983 to find that he turned out to be correct."

If it hadn't been the Super Bowl, it would have been temperature readings in Grosse Pointe or any of 13,000 other variables you could look at. Except that the Super Bowl chance correlation was noticed because so many guys who follow football follow the market. Other chance correlations, he says, are out there--you're just not likely to notice them.

Case closed. Except, boy, it's still a heck of a coincidence to be just a coincidence.... Do you think Howard Cosell could be involved in this thing someplace?

Charts

Most investment systems are technical in nature. I don't mean technical in the sense of complicated, though many are that, too; I mean technical as distinguished from fundamental. A fundamentalist looks at a stock in terms of the underlying assets it represents. What are they worth? A technician looks at patterns of price movements and at charts, at rules such as "A market that goes up the first week in January is likely to be up for the entire year."

For a good dose of this, you might try to scare up a copy of How the Average Investor Can Use Technical Analysis for Stock Profits, by James Dines (Dines Chart Corporation, 1972). Dines, long associated with an enthusiasm for gold, was described in "Adam Smith's" The Money Game as being "so pessimistic he must make up adverbs--'unmeechingly'--to describe his pessimism."

But Dines--whose pessimism has waned a bit--is also one of the smartest technicians around. His book is 599 pages long, but that shouldn't stop the Average Investor. In it, he will learn of pennant bottoms, megaphone bottoms, wedge bottoms, false breakouts, head-and-shoulders formations (for those embarrassing white flecks on your charts), saucer tops, tombstone tops, Prussian-helmet tops, the Seasonal Rule for Years Ending in Eight (not once in this century has the Dow finished lower than it started in a year ending in eight), the Dines Buoyancy Index, the Dines 30 Tick Rule, the Dines 90-109 Rule and more.

Here's the way I read charts: If a stock is real low, I take it as a good sign. If it's real high, I steer clear.

I am vaguely aware of some of the more sophisticated charting techniques and of the relationship, held by chartists to be crucial, between price movements and trading volume. There are even logical underpinnings for some of this. But to put more than a little weight on a stock's chart in deciding whether or not to buy it is ... well, listen to a writer named Thomas Gibson, as quoted in The Money Game:

"There is an incredibly large number of traders who pin their faith to the so-called 'chart system' of speculation which recommends the study of past movements and prices, and bases operations thereon. So popular is this plan that concerns which make a business of preparing and issuing such charts do a thriving business."

This quote, Adam Smith tells us, comes from The Pitfalls of Speculation, published by Moody's in 1906. It continues:

"There are various offshoots and modifications of the system, but the basic plan is founded wholly on repetition, regardless of actual conditions. [Meaning that past patterns will repeat themselves, regardless of the fact that out in the real world a leak may have occurred in a fertilizer plant owned by the company whose stock chart you are analyzing, killing and injuring 200,000 people.] The idea is untrustworthy, absolutely fatuous and highly dangerous."

This, Adam Smith notes, was published some years before Moody's went into the chart business.

Now I know what we were looking for when we sent those guys to the moon

An otherwise respectable Harvard Business School graduate several years into a successful career on Wall Street came to me once with a book relating cycles in human emotions to phases of the moon. Those cycles, he argued--the market being driven as much by emotion as by anything--could be used to predict movements in the stock market. The book, by Dr. Arnold Lieber, was called The Lunar Effect: Biological Tides and Human Emotions. Everybody knows the moon's effect on water--high tide, low tide--and everybody knows human beings are 80 percent water, so there you are! There were certain days every few months, my friend said, when the lunar phase virtually guaranteed a major stock-market move.

In a burst of uncharacteristic charity, I decided not to tell anyone of his theories or reveal his name (Mason Speed Sexton, Harvard M.B.A., 1972).

For this column, though, I figured I would track him down and, promising anonymity, find out just how badly his astrological fling had gone and what he was up to now.

Well!

Far from giving it up, he and partner Michael S. Jenkins, a seasoned mutual-fund manager, now sit at the offices of Rooney, Pace Inc. in New York, managing money and publishing a biweekly newsletter called "Harmonic Research." The moon thing is part of it (well, people do become more aggressive during periods of full moon, if only because they have more light to fight by; weather and agriculture are affected by lunar forces). But "Harmonic Research" attempts to encompass all kinds of cycles, not just lunar ones, ranging from the long waves, such as the 50-year Kondratieff Wave, to the rather more complicated Elliot Wave, to waves that have no names but that scream off the charts if you just know how to look.

Sexton and Jenkins see the markets as psychological lakes. Into those lakes from time to time have been dumped all manner of pebbles, boulders, rocks and sand, each rippling out endlessly, forever and ever. (They could explain this better than I can, but they're tied up on the phone.) Often, the lake is a jumble of these waves, with, say, a couple of sizable up cycles more or less canceling out a bunch of down cycles. But from time to time there's more of a confluence--all the important waves are running in harmony, all headed up or down in their cycle--and then, oh, boy, big stuff. (You will recall the Not the New York Times parody that had the Queensboro Bridge collapsing from the harmonic vibrations of 10,000 New York City marathoners all jogging in cadence.)

The essence of the newsletter each issue is a calendar for the ten trading days ahead, telling what the market will do on each of those days. For the day I was in Sexton and Jenkins' office, they had predicted a trend change between noon and one, with the Dow Jones industrial average showing a loss for the day. I arrived at one, their prediction, published a week earlier, firmly under my arm, and found them in a state of some excitement. "It's turning! It's turning!" they were saying, as the Dow, which had been up as much as eight points that day, began to fall. "This could turn out to be one of our most courageous calls," Speed was saying to Mike, between efforts to explain how their system worked. By 1:13 the Dow was up only five.

By 1:20 it was up only three, and Mike began placing shorts, betting that the market would go lower.

Speed was telling me about "killer waves." Mike was telling me about "master reverse mirror-image symmetry." If you look at a chart of the stock market, or of a single stock, you'll see it--the left side of the mountain looking like the reverse of the right side, the whole thing looking like jagged edges cut out of a folded piece of paper that's then unfolded. You think all this happens by chance? By 1:40 the Dow had bounced a hair, but by 2:07 it was up only 2.80 on the day.

Mike points to the market's first hitting 1000 in 1966, takes a tape he's marked off and stretches it out 1000 days. It falls on another market top. You think that's coincidence? We try it at a market low, 570 on the Dow in 1974, and stretch the tape ahead 570 days to the next major high. You think that's coincidence? There is a definite relationship between price and time in these cycles. Amplitudes and periodicity. You and I don't understand it, but then you and I haven't spent years working with the charts and the computers and a sixth sense that tells us how to use these things. The Dow, at 2:13, is up less than a point. It could go negative.

Say I, "Gee. Once you program in all the cycles, you could print out the ups and downs of the market for the next 20 years! Does this mean you could actually write all your newsletters at the beginning of the year and then go on vacation?"

I am being a wise-ass, but Speed says, "Yeah. Probably." (The Dow, at 2:28, is now down three.) Only, as Mike points out, wave lengths are not always constant and vary with the height of the Dow (or whatever else you're scoping out). What's more, while the interacting cycles are awfully good at calling turning points in the market, sometimes, maddeningly, the turning point turns out to be the opposite of what's predicted. Instead of zooming up on the appointed day, it may zoom down. (Of course, even the knowledge that the market will zoom on a particular day can be played to great advantage by buying options straddles--your broker will be thrilled to explain what these are--or, at least, by limiting your losses with "stop-loss" orders, in case the call happens to be dead backward.) The Dow, at 2:42, is now down less than a point--but "Harmonic Research" has called for a strong close this day, so I shouldn't be too surprised, Speed says, now that it has, indeed, dropped about eight points since one o'clock, to see it close up for the day.

Mike shows me more of the cycles on the charts, more of the symmetry, more of the 30-degree, 45-degree, 60-degree and 90-degree angles that have special meanings, and the half, third and quarter cycle points. There's a natural rhythm to it, he says (and this is a man whose mutual fund, when he managed one, was up 45 percent in 1979), a cadence, a harmony. Mike has been working on translating the chart into--yes--a symphony. It's not done yet, but one day you could sit back and listen to The Dow Jones Industrial Symphony--the 1982nd or the 1983rd or the 1984th--with the oboe, tuba and flute, perhaps, representing the separate movements of Merck, G.M. and Sears.

The Dow closes the day down 4.30.

I had promised Speed before I arrived that I'd keep an open mind, and, while it was naturally impossible for me to keep it open very far, I must tell you I was more impressed than I had expected to be. Not by that day's call, which by itself meant nothing, but by the over-all effort. There are lots of "cycle jockeys," Speed and Mike admit, but few, if any, who've developed the art as far as they have.

This isn't to say the Dow will necessarily peak at 3600 in November 1988, as they predict; or that they'll be able to compound their money, or yours, at ten percent a month, as they hope (move over, J. P. Morgan); or even that they won't ultimately wind up losing a bundle. But their predictions should be fun to track. Next quarter, I'll report to you on how they've done and will add billions to your millions with the revelation of several more market-beating systems.

"If hemlines are going up ... so will the market. Easy women, easy money--like that."