The Kirk Report - One Pro's View Of The Stock Market

Q&A with Laszlo Birinyi

I am very pleased to present this month's very special Q&A with Laszlo Birinyi.

As you will soon discover, Laszlo provides us with perspective that comes with experience. Over the past year, I've become much more familiar with his firm's research as a subscriber to their newsletter. If you've ever wondered what information the big boys and girls on Wall Street have at their disposal and how they interpret those results, Laszlo's website is a great read.

Many of you should already be familiar with TickerSense, one of my favorite blogs that is managed by two of Birinyi's research staff - Justin Walters and Paul Hickey. I frequently link to their website because they provide some of the most timely and thought-provoking research around. In addition, my personal communication between both Justin and Paul have been incredibly helpful and cordial (these guys are winners). Unlike many in this business, my impression is that Laszlo and his firm are keenly focused on helping investors make smarter, more informed decisions. There is no greater objective in my view.

I recently asked Laszlo to answer some questions I have about his views and strategies and I think you'll find them as informative as I have. While we don't share all the same opinions (he is far more bullish than I am right now), I'm always looking at the other side of any view I have about the market. I also think his approach using money flow analysis is sound. I incorporate it a great deal within my own analysis and I think it is a valuable tool for both investors and traders. Enjoy the Q&A!

Kirk: For readers who don't know you, can you provide some general background about who you are and how you got started in this business?

Birinyi: I graduated from UNC with an undistinguished degree in history but took some computer courses. I was working as a programmer for a Wall Street firm and realized that as a type A personality, trading was my true calling. I joined Salomon Brothers in 1976, where I was initially in charge of designing research products and gathering intelligence that would be tangibly helpful to our traders. One of the first products I created detailed the accumulation and distribution of block trades, and that eventually led to what is now our money flow product. In 1989 I left Salomon Brothers to start Birinyi Associates, and Michael Bloomberg, who once ran my department at Salomon, was one of my first clients (we developed some equity functions for Bloomberg LP).

Kirk: How is your research, analysis and approach different than the typical Wall Street firm?

Birinyi: Most approaches to the market are what I term “the housewife's dinner process”: she decides what she wants to serve and then goes shopping. But the great chefs go to the market first, and based on what is available, fresh, etc, they plan their menu. As one once said, cooking is three quarters shopping. Like the French chef, I let the market dictate what I should do.

Kirk: I think I first became aware of you when I watched a televised interview of you on Wall Street Week with Louis Rukeyser. I remember that interview well because you focused on the importance of money flow (otherwise known as ticker tape analysis) which was coincidentally something I was researching quite a bit at the time. In short, can you provide a brief, but relatively detailed explanation of the "ticker tape analysis" you find so valuable?

Birinyi: Instead of relying on fundamental ratios to assess value, "ticker tape" or money flow analysis looks to what the market itself is signaling about a stock, sector or market. Money flow is equivalent to the net buying or selling interest in a stock, sector or market. This is the volume of the trade multiplied by the price of the transaction. A buy-led transaction (up-tick) is treated as positive money flow, while a sell-led transaction (down-tick) is treated as negative money flow so that a cumulative picture of money flows can be built up. The longer the time period associated with any trend of buying or selling identified by the cumulative money flows, the more statistically accurate it is. For investing purposes, I look for those divergences between money flows and stock price. If a stock price is falling or trading sideways but there is underlying accumulation in the stock (positive money flow), the market is telling me something that has yet to be factored into the price.

An easy but somewhat crude comparison can be drawn from sporting events. Let's say the Dodgers have 30 hits over two games but have only scored 6 runs and have lost twice, whereas the Cubs have scored 9 runs over those two games on only 15 hits. You might surmise that the Dodgers have the better offense but haven't managed to quite capitalize on it yet, and you place your bet on them next time. Another analogy would be looking at shots on goals to measure the strength of a soccer team rather than just looking at goals scored.

Kirk: Can you provide a specific example of how you successfully used money flow analysis in your own approach?

Birinyi: One of the most recent examples is General Motors (GM). Late last year and early this year, most people thought GM would end up as the year’s largest bankruptcy, but the money flows showed the stock under heavy accumulation. Now the stock is turning out to be one of the year's biggest winners. The money flows didn't tell us why people were buying the stock, they just told us that people were buying it.

Kirk: What are the key weaknesses of money flow analysis? In particularly, how does the analysis tend to go wrong and/or provide you with false-tells?

Birinyi: Like any approach, money flows are not infallible. In our experience we have found that the reliability of money flows can be off when a company is involved in a large corporate action such as a merger, or when the company is in financial duress. In the case of mergers and acquisitions, the actions of arbitragers tend to skew the results, while in the case of a company being in financial strain, you tend to have situations between the company's stock and its bonds, where investors will buy the stock as a hedge against a short position in the company's bonds.

Kirk: How do you suggest the individual trader/investor incorporate money flow analysis into their strategy?

Birinyi: We have always advised investors to use money flow analysis as a complement to their own processes. Just as no one should go blindly buying a list of a brokerage company's buy list, we wouldn't advise investors to go out and buy all the stocks that we have rated a buy based on money flows. Ideally, we look for situations where money flows and another approach are giving similar signals, whether it be timing, valuation, or fundamentals. Furthermore, not every stock fits every investor’s risk profile.

Kirk: What sectors have the best money flow scores on your screens right now?

Birinyi: Currently, telecom, energy, and utilities are scoring the strongest, while health care, consumer staples and tech are the weakest. The money flows in energy have been strong on their entire run-up and continue to show strength. Tech stocks have had negative money flows for months now, and health care and staples have seen some outflows as their prices have increased, indicating some negative divergence.

Kirk: According to your research, healthcare stocks have outperformed when the FOMC stops raising interest rates but your money flows indicate a negative divergence. In this case, which one would you give higher value to - money flows or historical trends? Obviously, both in agreement would be nice, but if you had to rank them which one is more instructive?

Birinyi: I follow the money first and if the historical tendencies confirm the positive/negative money flows, an investment decision can be made. Health care stocks were positive going into the most recent Fed meeting, but maybe the negative money flows are anticipating a different future outcome.

Kirk: In looking over your watch lists, can you provide charts of 10 stocks that have the best money flow characteristics?

Birinyi: The top ten are:

Kirk: Which three stocks are your bottom line most favorite opportunities for the rest of 2006 when you look at all of the factors including money flow?

Birinyi: I continue to be a great fan of Google (GOOG), and I also like New Century Financial (NEW), a housing stock that pays a 17% dividend. Investors are shunning the sector, but any company that keeps raising its dividend knows something. China and India will keep the demand for US Steel (X) strong as well.

Kirk: Within the entire global landscape, which sectors and markets offer the most value?

Birinyi: Utilities, for the average investor, are intriguing. Not just electrics but also water. That is not to say they are the best, cheapest, or likely to be the best performers, but on a valuation basis they are attractive.

Kirk: Can you name a few sectors you are currently avoiding like the plague and tell us why?

Birinyi: From our research on how sectors perform following the end of a rate hike cycle, technology, consumer discretionary and industrials have historically underperformed the markets. The money flows on each of these groups rank in the bottom half of the major sectors so we are staying away from them. Granted, some individual stocks look positive within these sectors, but as a whole, there are opportunities elsewhere.

Kirk: In your firm's newsletter, it was pointed out that securities which have performed the best recently either pay high relative dividends and/or they are defensive in nature. Do you expect this to continue?

Birinyi: In the defensive sectors, the money flows in consumer staples and health care stocks have not been following the prices upward, as we have recently seen some distribution in these names. Within utilities and high dividend paying financials however, flows still remain positive.

Kirk: For the last six years, value stocks have outperformed growth stocks. Will this continue? If so, can you share some ideas that you think will benefit from this trend?

Birinyi: Value stocks certainly have been a great place to be invested over the last several years, but like anything else, there is always a reversion to the mean. I remember very clearly, back in 1998-2000, value investors were about as popular as Congress. While it’s hard to say when the shift will take place, the fact that value stocks are currently as a group more expensive than growth stocks tells me that the shift probably isn't too far off. Tech, which is everyone's least favorite sector now, could benefit from this trend as the launch of MSFT's new operating system (if it ever occurs) will spur a new binge of buying in that sector.

Kirk: In your view, what makes for an attractive investment opportunity?

Birinyi: The stocks where we have had the greatest success are those where the buying anticipates price. Like a good poker player, great investors don't need all the facts (or all the cards) before they buy. In 1995, as one great example, financials were being accumulated long before rates peaked and we made 50% in our GTE position that year. On a broader level, in December 1990 and July 2002, we saw a pronounced pickup in our money flow indicators, causing us to turn bullish at times when that position was very unpopular. Generally speaking, the most attractive opportunities for us are ones that at the time seem the most unattractive in the public eye.

Kirk: More market watchers are starting to see a recession either late this year or in 2007. Is a true recession around the corner?

Birinyi: Warren Buffett once commented on "the Noah Rule": Predicting rain doesn't count; building arks does. We constantly analyze the likely implications of several different scenarios, and prepare ourselves accordingly. Right now, we don't see a recession as imminent, but if events unfold to change our outlook, we are well prepared to shift our strategy and focus on the sectors that tend to work best under that scenario.

Kirk: In your firm's last newsletter the following statement was made: "Despite the academic mantra of diversification, markets today are more correlated than ever." Can you explain that statement?

Birinyi: Can you tell me one investment in the last three years that isn't up in price (besides DELL stock)? Nowadays, when the markets rally, everything goes up in price, and when they fall everything goes down. I think part of the reason for this stems from the fact that the cost of moving money from region to region or asset to asset is so cheap that inefficiencies are quickly exploited and taken advantage of.

Kirk: Your firm has remained bullish this year and from what I've seen that view is based on bearish sentiment surveys, strong earnings performance, and that positive flow of corporate earnings should continue. Does that fairly represent your view?

Birinyi: The current bull market is the only one in which p/e ratios have actually compressed. Even as oil prices have skyrocketed, companies have shown resiliency and have been able to continue growing earnings at a steady pace. In addition to strong earnings growth, companies have been consistently beating analyst forecasts, and raising their own guidance. Sentiment measures remain negative because of external factors like rate hikes, inflation, oil prices, and the Middle East crisis, but earnings remain strong. This along with positive money flows on the market as a whole makes us remain bullish.

Kirk: My big picture view is that we're set for a multi-year sideways trading range. In your opinion, why am I wrong?

Birinyi: To begin, that is probably the prevailing, conventional view, which I always view as suspect. Furthermore we still remain in a bull market and they tend to go out with one last hurrah.

Kirk: I'm always looking for reasons that prove me wrong in my opinions and analysis about the market. Can you share some things you and your firm are looking at now that would cause you to change your bullish stance?

Birinyi: Sentiment is the great critical element that most investors ignore. 1990 comes to mind. In the midst of that year, at one point I was the only Wall Street Week elf who was bullish. At the end of 1993, everyone was recommending emerging markets and issuing country funds, which I suggested shorting. If the mood becomes bullish and overly so, be careful.

Kirk: You are on record for saying that we need a significant upside catalyst for the market's performance to significantly improve. In your view, what are some potential upside catalysts ahead of us in the coming months that will be supportative of a strong rally?

Birinyi: No idea. One of my objections to many analysts is that they try to predict events. My view is to understand the environment and if there are dry papers and greasy rags, a fire will develop, but I can't tell you where the match will come from.

Kirk: According to research you provided in a recent newsletter, the five months that follow the last interest rate increase the market has averaged a -4.7% decline. Do you think history will repeat again this time?

Birinyi: The most dangerous words in this business are "It's different this time." Wall Street thrives on cliches and adages of which this is the most pervasive, but in reality, it is always different. Given that, we often look for parallels to the past in order to get some guide as to what the market might do under a given set of circumstances. Historically the market has traded lower once the Fed finishes raising rates, which does make us more cautious. At the same time however, there are plenty of positives out there (earnings, valuation, etc.) which make us want to still be invested in the market.

Kirk: What do you make of the inverted yield curve?

Birinyi: When the yield curve first inverted late last year, we weren't terribly concerned. The reason was that everyone else was. We tend to worry when no one else is worried, and get excited when everyone else is worried. When the market becomes so fixated on an issue and its potential positive or negative implications, things seldom shake out as expected. Late last year, everyone was occupied with the inversion of the yield curve and the recession it was likely to cause, which means that they were positioned for that occurring -- the result was a strong Q1 rally. Now however, we once again have an inverted yield curve, but this time no one seems to care. With no one paying attention this time, the likelihood for a surprise becomes that much greater.

Kirk: In your opinion, how has the market changed over the length of your professional career? They say nothing is new on Wall Street. Would you agree with that statement?

Birinyi: One of the greatest thinkers of the 20th century, Marshall McLuhan argued that innovations and structural changes bring about all sorts of changes in the process. We have gone from long term, fiduciary investing, to performance investing, and now trading. Huge dislocations have resulted which I don't think many people understand.

Kirk: I'm always on the hunt for the next big thing. Do you see any big things on the horizon that investors would be smart to pay attention to now?

Birinyi: Be very concerned about system failure. There have been an increasing number of computer and communications breakdowns that have cost us dearly. While these events have generally been more nuisance than anything, what happens when one of these ‘glitches’ occurs at the wrong time i.e. a time of national or market crisis. As a side point, when Google reported its latest earnings, we were bidding $360 for stock. A large block traded at $38!!! And then the stock went under $360 but our order was in the $38 block, which was obviously wrong, and before things were set straight, the stock was around $370, and we lost an opportunity to make a lot of money. In 1994 I recommended puts on the Hong Kong market and while the market went down 30% our puts also went down 30% because of illiquidity. Now investors can buy ETFs that correspond to twice the inverse of the daily move in an index. Investors should be wary of these products, as many financial innovations do not benefit investors.

Kirk: Is there any way an individual investor/trader can hedge against widespread "system failure?" Are you saying that has the potential to ignite a major market crash at some point down the road?

Birinyi: I am concerned because there are more breakdowns and failures than people realize. Earlier this year there were a number of days in Tokyo where the market structure failed. I am not of the view that it be the cause but will exacerbate a difficult situation.

Kirk: Is it true that you keep articles and news clippings from any pertinent market news story going all the way back to 1962 so you can always see what everyone was thinking at the time? What have you learned from doing this?

Birinyi: Yes, and it's a collection we spend a lot of time maintaining here. It is extraordinary how little we know about the market’s history. One sterling example was the view in 2003 that we would not have a bottom until there was capitulation. While that was an articulate idea, in fact it seldom happens. In August 1982, a week after the market bottom, the NY Times wrote an in-depth story arguing that we need to see a sell-off, a capitulation, and so forth before we could go forward. But we had bottomed 5 days prior. If we can identify aspects of a current situation that mimics something that happened in years past, then we can look back and see what was being said at that time, and also see how things actually played out in the market. It's interesting to see how often people analyze a situation exactly the same way they did when it occurred last, say twenty years ago … which was the same way they interpreted it forty years ago. And often both times their predictions proved inaccurate.

Kirk: In this week's televised interview on Bloomberg TV, you made a couple of statements I thought was interesting given your research-based approach. You said that "sometimes you have to forget about the fundamentals" and "go with your experience and gut feel." How do you determine when it is the right time to listen to your instincts rather than the cold hard facts you have right in front of you?

Birinyi: Hopefully after all these years in the business, experience does count. Furthermore sometimes those cold hard facts are dubious. When I see someone talk about the 13.5 week moving average, I get my guard up because the norm is probably 20 weeks. It suggests to me that the 20 week result doesn't fit his scenario so he finds one that does.

Kirk: Can you provide any tips to investors and traders who are just starting out?

Birinyi: Read, study, and learn. It is amazing how little people understand about the market, even professionals. One example: my idea of money flows holds that if a stock trades on an uptick, that it was bought. Many managers have argued that if there was one buyer and one seller, how can we conclude that it was bought? But ask yourself, housing prices rose sharply over the last several years but in every case was there not just one buyer and just one seller? How can we then classify it as a boom?

Kirk: Is there a specific lesson and/or trading rule that you think everyone should know?

Birinyi: There are no experts. Most commentators are just that. Like movie critics or restaurant reviewers, they know how it should be done but they are not doing it. Trust your own judgment, develop your own processes and remember that it is an on-going, never finished process.

Kirk: Thank you again for participating in this month's Q&A.

I hope you enjoyed this month's Q&A. As always, let me know what you think!

For those who would like to contact Laszlo Birinyi or subscribe to his newsletter, the information can be found below:

Laszlo Birinyi
Birinyi Associates, Inc.
Newsletter Subscription: $225/year
Mini-Institutional Subscription (All research): $750/6 months
www.Birinyi.com