Trim Tabs Liquidity Theory

I want to make a correction to my final post last night regarding the $12 billion cash Petrohawk deal that is expected to close this week. I wrote that according to Trim Tabs 1/2 of a cash deals value acts as an inflow into the market upon closing. I was mistaken in that according to Trim Tabs 1/3 of a deals value acts as an inflow upon closing. 2/3 of the value is recognized at announcement of the deal as arbs take the shares from fundamental investors and fundamental investors reinvest that cash . I would note that we had the $12 billion cash Motorola deal announced this week as well. Combining the Motorola and Petrohawk deal, they acted as a $12 billion cash inflow.

In the nineties Trim Tabs had the novel idea of tracking what corporations were doing as a way of predicting market direction. They looked at corporate buying which included cash takeovers, share repurchases and insider buying. They compared this to corporate selling which included IPOs, secondaries and insider selling. They came up with a formula that figured out on net if corporations were buyers or sellers. They ignored the public and thought of their behavior as erratic and unpredictable.

This formula worked fabulously for over a decade as it absolutely trounced the market. However, it missed the top in 2007 and then missed the bottom in 2009 and they stayed short for a long way off the bottom. Trim Tabs than veered from their formula and started blaming the Fed for manipulating the market. I believe they should have simply added a factor to their model to account for the public. At the 2009 lows the public was underinvested and short and therefore had a lot of buying power. The opposite was true at the 2007 top.

I have used their formula as a factor in my trading and it has helped a lot. My best trade of this year was to be long biotech during the closing of the Genzyme deal as the sector absolutely exploded higher. I believe that closings of deals might have larger effects than they used to when the formula was originally conceived. The reason being that so much more money is indexed these days and the indexes don't reinvest the money until closing.


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