By Charles Biderman
I have been playing the financial markets for over 40 years. Successful investors all share a common trait: They each have found an edge that enables them to outperform. Historically, before the internet, there were mainly two “edges” available to investors. The first is to know more about a company, industry or product than what the market knows. The second is to be the first to get the news, also known as trading on insider information.
But with the internet providing universal real-time data albeit it some of it for a fee, a third edge is now possible. Starting in 1994, I have worked on and developed a supply and demand model that has become much more robust as real-time aggregate market and ticker level data is becoming available. The result, I have outperformed more often than not. One proof: Goldman Sachs, the most successful Wall Street firm ever and my biggest client at the time, bought a minority interest in TrimTabs in 2007 before the Volker rule ended that game. A second proof: Check out the historic performance of my float shrink ETF compared with the overall stock market including all other actively managed ETFs.
Going back to the first edge, knowing more about a company, industry or breakthrough product, is a proven method of developing an edge. Warren Buffet is the obvious example of that. I know of many other successful stock pickers who have made a great living because of their in-depth understanding of companies and business.
The second type of edge, using insider information not known by the market was legal in most markets up until the 1930’s. Before the SEC was legislated into existence, insiders and their buddies could legally buy or sell ahead of the public. The Rothschild family made a fortune buying British bonds for pennies on the pound when their carrier pigeons brought them the first news of Napoleon’s defeat at Waterloo.
Insider activity, despite the recent criminal and civil prosecutions, has been and is ongoing. But it is also illegal. That is why I recommend not using it and ignore for my methodology. Looking for other legal ways of being first, billions have been spent over the past twenty years to develop ever faster high frequency trading systems. But now, with so many high frequency traders competing against each other, my guess is that more are doing less well then before.
The bottom line: availability of financial data and high speed execution has eliminated being first as an edge. Therefore my business model is: Develop an edge by making the best use of the availabile real-time data.
What I have done is create a supply and demand model tracking net share issuance and cash available. To understand my universe you need to know the theories behind it.
The first is that the house has an edge in all financial markets. Each market is started by a house. If the house loses its edge, that market will cease to exist. That is true for the stock market, bond market, your corner market, casinos whatever.
The house in the stock market is the public companies. In the stock market, the players give the house money and get back shares. Then the companies say try and outsmart us. What I have discovered is that when companies in aggregate reduce the number of shares outstanding, the market has gone up and when the number of shares grow the market usually has gone done. Except of course when new supply of money overwhelms corporate selling.
A second ground rule: In every market all there is the assets being traded — stocks, bonds, currencies, physical commodities. That is why TrimTabs keeps tracks of data in real time, by ticker, changes in outstanding shares, free cash flow and debt to equity ratios.
A third ground rule: In each market money moves in and out of the checking accounts of the players. In the stock market, 80% of all shares are held by institutions. As a result we track flows in and out of all type of funds.
I remember painfully when the US Federal Reserve changed the game in 2009 by being a brand new source of cash with which to buy stocks. I had been up 30% for the year at the March 2009 low and I ended up being down 30% for that year by the time I figured out that the Fed was the phantom provider of cash that had zoomed the stock market higher.
A fourth ground rule: Logic says that new money with which to buy stocks should grow quicker the faster wages and salaries grow. I believe that over time when the rate of wage and salary growth accelerates, companies reduce the number of shares outstanding. On the other side, in my experience companies sell more shares than they buy when wage and salary growth slumps. That is why I track daily withheld income and employment taxes rather than relying on survey oriented US government GDP, income and jobs data.
A final ground rule: The most dangerous information is what I do not know that I need to know. Markets always change. That means that any supply and demand model has to be vigilant as to changes in the supply demand equation, or else.
Tags: Biderman Bonds Investing Stock Market Stocks TrimTabs Wall Street