Running To Win In All Equities Markets Edjul2011

“ Running to Win in All Equities Markets

“Stock prices are like “bubbles” held aloft by operational profits, cash flow and debt service,
earnings and distributions, and every so often that are engaged (liked) or disengaged (not liked)
at the price of risk.” - Goetze 2009
“The only reason for making a forecast, is to reduce risk. But we already know that the only no
risk investing, is at the stock price, SP>SF, the price of risk.” - Goetze 2009
“Because we know where we are, we will also know when to buy, when to hold, when to take
profits, and when to sell.” - Goetze 2009
“The “gap” U=SP-SF>0 is an instance of “enduring price arbitrage” and does not depend on
the more common and uninspired micro-arbitrage profits discovered over micro-seconds by
overachieving computers.” - Goetze 2009
“I never discourage anyone from buying a lottery ticket. I don't know the future, and they might
be right. But, to win, he or she needs to buy all the tickets. And that's the price of risk (in a
lottery).” - Goetze 2009

Partitioning the DOW 2000 to 2009 – portfolio yielded compounded 29% IRR
Ladies and Gentlemen, please start your engines! That will sound in a few weeks, but it should
be today in the creation of portfolios. Doing the Dow is one thing we've talked about in some
detail in recent editions of CassandraNews. In the rather simple portfolio (there are only thirty
stocks, and seven of them are not even of investment grade, in anyone's portfolio) that we crafted
in the DOW had an IRR (Internal Rate of Return) of 29% per year through the years 2000-2009.

In that same period the DOW itself returned essentially, nothing, in fact lost 40% of the money
investors had placed there in their hope of enjoying earnings. Moreover portfolio managers
cannot tell us why, markets mumble and stumble! They condition us to buy shares, they do not
make them, mumble, caveat emptor. Not then and still not now can the economists say, either, it
seems! Classical, monetarists, medallists, Salty or Freshie, Bastian, Berkeleyian, Austrian or
Texan all with their closed macro and micro models of defined terms in separate languages,
babel, babel, bust! Munch or Lee, murmel, murmel, they lost my money in ITT?

Further, in those nine years, we made only thirteen (13) decisions to run the first and still open
portfolio of five stocks (five buys and eight sells, to take or protect profits), and fifty-six (56)
decisions to run the closed portfolio (twenty buys and thirty-six sells), all with only one rule.

The One Rule: It's in our portfolio only if the stock price, SP>SF, the price of
risk, and otherwise not.

Page 1 of 7 August 2009 & July 2011 © Copyright StockTakers Limited, All Rights Reserved. Copying Prohibited.
The author does not provide investment advice. In order to use reproduce or convey the material herein,
in any way, written agreement must be obtained from the author or its agent Architypes Inc.
StockTakers Limited is an Alberta corporation providing information on “likeables” equities.
StockTakers Limited encourages your seeking tax law advisor for capital gains tax dispositions.


The DOW (2000-2009) - And Price of Risk Gives You Odds, 2.34:0.98 To Win.

So using our analysis for risk price (SF) we created the Zero To Hero portfolio running on the
DJIA 2000 to 2009. In those nine years, we made only thirteen (13) decisions to run the first and
still open portfolio of five stocks (five buys and eight sells, to take or protect profits), and fifty-
six (56) decisions to run the closed portfolio (twenty buys and thirty-six sells), all with only one
rule.

The One Rule: It's in our portfolio only if the stock price, SP>SF, the price of
risk, and otherwise not.



The Zero To Hero Portfolio

The One Rule: It's in our portfolio if, and only if, the stock price, SP>SF, the
price of risk, and otherwise not.

The price of risk (SF) is an extension to the equity market (of cash and stocks) of the Tobin
“Separation Theorem”1 which deals with investments in cash and bonds. The price of risk is also
“the least stock price at which a company is likeable”2 and that's a theorem and the only thing
that we know – or anybody knows – about stock prices is that the “price of risk”, defined in
absentia3 in the Capital Assets Pricing Model (CAPM) of Sharpe and Markowitz, is “the least
stock price at which a company is likeable”.

Moreover, the portfolio manager always has lots of time to consider these decisions. Companies
that are in the portfolio above the price of risk, are typically in the portfolio for a long period of
time, such as six months, fifteen months, two years, or more. There's no reason that a portfolio
manager should ever be “surprised”4.

No surprise, then, that what's true in the Dow, about stock prices and the price of risk, is also true
in the NASDAQ 100. It's a theorem, after all.

The DOW (2000-2009) - And Price of Risk Gives You Odds, 2.34:0.98 To Win.
The NASDAQ 100 (2000-2009) - And Price of Risk5 Gives You Odds, 2.57:1.03 To Win.



Appendix: X-axis Scale
Since we're having so much fun, the Price Change Volatility Range [-0.5,1.0] is on the y-axis, and, I
can tell you about the x-axis. The Range [-0.5,1.0] or Range [-1.0,0.5] for each Price Risk Region,
SP>SF and SP<SF, respectively, is on the y-axis and simply represents the log-returns observed
in each quarter, in each Price Risk Region.

The x-axis is scaled as -½ logab = -½ log(b)/log(a), where “b” is the logarithm of the product of
all the positive returns (SP/SP1, SP>SP1) in any quarter (and the product is therefore greater
than one), and “a” is the logarithm of the product of all the negative returns (SP/SP1, SP<SP1) in
the same quarter (and the product is therefore less than one). The “scale factor” (f=1/2, in this
example), can be used to compress or expand the scale on the x-axis to provide a “spectral
analysis” of the results, locating the “centre of mass” of the price changes, in terms of risk and
uncertainty.

Each company is coloured by a different “thread” that joins through (using a cubic spline) all the
log-returns that we obtain for that company in each Price Risk Region and the x-axis scale tends



to allocate “gainers” to the right, and “losers” to the left, using the distribution that is developed
in the region, by the data.
We notice that there tend to be more gainers in the “high-priced” low risk tolerance region, the
stock price, SP>SF, the price of risk, and that “gainers” and “losers” are more or less equally
distributed in the “low-priced” high risk tolerance region, SP<SF. There also tends to be more
and better investment opportunities in the “high-priced” low risk tolerance region, whereas the
high risk tolerance region appears to be a “trader's delight”, and rife with sure profits only in
micro-arbitrage, agency, and transaction costs.
The NASDAQ 100 (2000-2009) The Spectrum of Risk and Uncertainty

The S&P 500 (2000-2009) And Price of Risk Gives You Odds, 2.06:1.10 To Win

The S&P - TSX (2000-2009) And Price of Risk Gives You Odds, 2..04:1.01 To Win



These results – and the margin of risk is never less than 2:1 in any of the major North American
markets that we have studied – have profound implications for mutual fund and pension fund
managers.

Implications for Mutual Fund and Pension Fund Managers.

1. An investor, who knows the price of risk, can do it himself or herself, and understand his
or her portfolio, and also yours.
2. A portfolio manager, who doesn't know the price of risk, doesn't know anything about the
stock price. “Good intentions”, “market savvy”, and forty years of doing the same thing,
count for nothing in these markets. One needs to know where we are.



3. A “Growth Fund” buys and sells stocks that don't pay dividends. That's all that one can
say if one doesn't know the price of risk. One can't even call it an “investment” and
especially not, an “investment that favours capital growth by capital gains” if one does
not know the price of risk.
4. A mutual or pension fund that has stocks in both the low risk tolerance region, and the
high risk tolerance region, doesn't know what it's doing if it doesn't know the price of
risk. Ask your broker, what's the price of risk? And how is it dealt with?
5. A fund cannot be said to “protect” or “preserve” capital, or to be “conservative”, if it does
not know the price of risk, and cannot calculate the downside exposure i.e. the “gap”
U=SP-SF>0.
6. An “Income Fund” buys and sells cash, bonds, and dividend paying stocks. It cannot be
said to protect or preserve capital unless the manager can state the downside risk of the
capital exposure, and has made a provision to protect it.

Our reasons for having any equity in our portfolios are clear, concise and reliable. The equities
we hold are “likeables” tending to gain 67% of the time. We respond to stock price movements,
by our knowing the price of risk, and buying and holding accordingly. That is our theory works
in obtaining 29% IRR. Of course we require a fee for doing that. Mail us for our help.

Ernst and Hans Goetze,
Architypes Inc and StockTakers Limited
Head Office
76 Midridge Close SE 7 Balsam Avenue 351 Chemin Boulanger
Calgary, AB Toronto, ON Sutton, PQ
T2X 1G1 M4E 3B3 J0E 2K0
450 538-1270

1
James Tobin, Liquidity Preference as Behavior Towards Risk, Review of Economic Studies, 1958, and William F. Sharpe,
Capital Asset Prices with and without negative holdings, The Nobel Foundation, 1990, and Harry M. Markowitz, Portfolio
Selection, Journal of Finance, 1952. This work is further informed by Verne H. Atrill, How All Economies Work, Principles and
Applications of Objective Economics, 1979, and Ronald H. Coase, The Firm, the Market and the Law, U of Chicago Press, 1990,
and James Tobin, Money and Finance in the Macro-Economic Process, The Nobel Foundation, 1981. This work is otherwise an
original and unpublished work of the author.
2
E. Goetze, The Price of Risk and Enduring Price Arbitrage in the Capital Markets, 2009. Available from the author.
3
It's well-known that the “market price of risk” cannot be calculated within the equity markets only.
4
Bloomberg – August 6, 2009 - “I’m surprised they’d do it this early,” Brian McGill, senior analyst at Janney Montgomery Scott
LLC in Philadelphia, said of Hyatt’s timing. “While hotel stocks have performed well these last two or three weeks, investors
will be sceptical of the industry’s fundamentals.”, or “It makes me angry, but it also throws up a lot of question marks,” said Ian
Nakamoto, director of research at MacDougall MacDougall & MacTier Inc., which manages about $3 billion, including Manulife
and Sun Life. “This is definitely out of left field.” (regarding Manulife which cut its dividend by 50% even after promising that it
wouldn't have to).
5
The Range[-0.5,1.0] is on the y-axis. The x-axis is scaled as -½ logab = -½ log(b)/log(a) where b is the logarithm of the product
of all the positive returns (SP/SP1, SP>SP1) in any quarter (and is therefore greater than one), and a is the logarithm of the
product of all the negative returns (SP/SP1, SP<SP1) in the same quarter (and is therefore less than one). The same scale
calculation is used in the Dow charts (with respect to those data).


Running To Win In All Equities Markets Edjul2011

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