Wednesday, January 28, 2009

Morningstar's 2008 Performance

Our performance through the midst of the historic events that shaped the past year was mixed. While our 5-star calls [marginally] outperformed the S&P 500, losses greater than 30% are still painful on an absolute basis.

What stands out in 2008 is the huge divergence between the performance of wide-moat stocks and no-moat stocks. Investors rewarded quality companies. Wide-moat stocks returned -22% in 2008 compared with -34% for narrow-moat stocks and -42% for no-moat stocks.

It's also helpful to look at the performance of our star "buckets," which are constructed similarly to our strategies shown on the previous page. For example, the 5-Star bucket can be thought of as a Buy at 5, Sell at 4, 3, 2, or 1 strategy. In 2008, stocks we rated at 5 stars significantly outperformed stocks we rated 1 star as well as the S&P 500, and the three intermediate buckets also lined up as we would hope. This holds true for our trailing five-year performance as well.

While our strategies and buckets may show outperformance, they are not what we would consider investable strategies (given the number of stocks involved). We run a number of actively managed portfolios, such as the Tortoise and Hare that appear in Morningstar StockInvestor, and the Dividend Builder and Dividend Harvest that appear in Morningstar DividendInvestor. These portfolios are real-world examples of our research in practice. In addition, our Wide Moat Focus Index $MWMFT tracks the 20 cheapest wide-moat stocks in our coverage universe. Each of these portfolios has outperformed over the past year, and they are all beating the S&P 500 over their available trailing two-, three-, four-, and five-year time periods as well.

Friday, January 23, 2009

The Trader's Finger

John Coates, a research fellow in neuroscience at Cambridge University, recruited 49 male traders from a London trading floor for his study. These were futures traders who trade at a frenetic pace -- their holding period is typically measured in minutes (and sometimes even seconds!).

Coates found that traders with a lower ratio of index-finger to ring-finger length were both successful financially and more likely to last in the business, after controlling for a number of other factors, including experience and level of risk-taking.

The explanation? In men, a longer ring finger indicates a higher exposure to masculinizing hormones in the womb. That, in turn, produces a host of characteristics that are beneficial in this type of trading: increased confidence, higher risk preference, faster reaction times, etc.

Wednesday, January 21, 2009

On the road?

"Owners of capital will stimulate working class to buy more and more of expensive goods, houses and technology, pushing them to take more and more expensive credits, until their debt becomes unbearable. The unpaid debt will lead to bankruptcy of banks, which will have to be nationalized, and State will have to take the road which will eventually lead to communism"

- Karl Marx, Das Kapital 1867

[via investwise]

[2/27 via Payam Ahdout] Actually that quote is a hoax.

Friday, January 16, 2009

2007's winners

returned an average of 242% (compared to 4% for the S&P 500). In 2008, these same ten stocks returned -61% (compared to -38% for the S&500).

Wednesday, January 14, 2009

a protracted recession?

The American Consumer has been the engine of the last expansion. We have bought houses, cars, flat screens, beach condos, etc. and financed the purchases either by extracting the equity from our increasing home prices (home equity lines) or incurring additional debt through credit cards and other forms of consumer finance. In the average American's mind, as long as the bottom line of the balance sheet continued to increase (i.e., assets greater than liabilities) then all was well. But in 2008 something happened that had not happened to these Baby Boomers before: the value of all assets (stocks, houses, rental properties, etc.) declined. As a result the debt party began to unwind as the value of the assets declined while the debt (liabilities) remained, thereby shrinking the balance sheet. Americans are feeling poorer … much poorer.

If one considers that the average 401(k) is now a 201(k) and the average house (according to Case/Shiller) declined 26% from its peak value in 2006, then it's easy to understand why the Baby Boomer is feeling gut punched. The financial shock of watching the asset side of their balance sheets crumble while the debt side remained the same or actually grew has now forced the American consumer into a dilemma: How do I retire and live the same lifestyle that my parents enjoyed? Answer: I have to save money and reduce debt.

The consequence to the economy is, in my opinion, going to be a protracted, painful recession. Why? Because this recession is driven by asset devaluation, and that is different than a cyclical downturn. There is a need for institutions and households alike to reduce debt and restore equity to the balance sheet. For the consumer/individual this will only happen with an increase in his/her saving rate to reduce debt and fund future retirement. For example, if the average consumer goes from a 1.7% savings rate to a 5% savings rate, then that equates to $400 billion a year in either debt reduction or retirement funding. From the contra angle, that means there will be $400 billion less of American consumption. I label this the "Paradox of Thrift," in that we can't restore our balance sheets without additional savings, and our stock markets cannot recover without consumer spending and corporate profitability.

-- by Cliff Draughn

Sunday, January 11, 2009

As the calendar turns

A rare event occurred as the calendar turned from 2008 to 2009: A single trading day when at least 75% of New York Stock Exchange (NYSE) stocks rise is uncommon (there have been only 65 such occurrences in the last 10 years), yet this happened on three consecutive trading days from December 30 through January 2 (79%, 83% and 82% of stocks, respectively).

According to Bespoke Investment Group (B.I.G.), the market has performed a feat like that only twice before—both times in 1938. In each case, the Dow Jones Industrial Average was positive during the following day, week and month.

Last year was the single worst for the S&P 500 since the Great Depression—1931 to be exact. Nothing escaped the carnage, with global equity, credit and commodity markets imploding, and only U.S. Treasuries saving the day.


I asked a number of my Wall Street friends the following question during the holiday break: There were 253 trading days in 2008. How many days was the market (S&P 500) up versus down? With no exception, the answers were heavily skewed to down days making up the majority. Nope. Remarkably, the market rose on 126 days, and the market fell on 126 days (with one flat day).

So then what drove the overall massive market decline? The skewing of the down days. The average up day increased 1.6%, but the average down day decreased 1.9%. In addition, there were 42 days (nearly 17%) when the market rose or fell by more than 3%: 19 days that were up and 23 days that were down.

Clearly, volatility was off the charts, particularly following the Lehman Brothers bankruptcy in September, with 18 single-day moves of at least 5%. There had only been 17 such moves in the prior 53 years! In October, stocks enjoyed two of the six biggest one-day percentage gains in history—but gave back all of the gains, and then some. Four of the 20 biggest daily percentage declines in history occurred during the last four months of 2008.


Reviewing the 10 worst calendar year total returns for the S&P 500, take comfort in knowing that the average subsequent five-year annualized total return was 10.8%, with all five-year periods in positive territory—even those that began with 1931's 43% drop and 1974's 27% fall.


NDR did an interesting study of "waterfall" declines, similar to what we experienced last fall. In waterfall declines, the Dow loses more than 20% in a short period, and near the end, the 10-day average of NYSE total volume rises to two times its average seen just a few months earlier. In the majority of cases, the end of the waterfall decline wasn't the end of the bear market.

However, in the composite average, the lows were tested but not broken, followed by a basing phase of up to three months before a breakout to a new bull market.

Three post-waterfall phases were designated, and it appears to us that we're currently in the second phase—bear-market bottom to recession end.


Given current cash hoarding, there's now $8.85 trillion held in cash, bank deposits and money market funds. That's equal to 74% of the market value of all U.S. companies—the highest ratio since 1990, according to Fed data compiled by Leuthold Group and Bloomberg. According to SentimenTrader.com, assets in money market funds alone are now enough to buy 42% of the entire S&P 500 index.

The latest asset allocation survey from the American Association of Individual Investors showed another push into safe investments. Individual investor allocations to the stock market dipped to 42%, the lowest since 1991. And these folks' investments in cash instruments moved up to 42%—the highest in the history of the data (November 1987).

Never before have these investors allocated as much or more to cash as they have to stocks. The only other times when the two allocations came close were in January 1991 (42% to stocks, 38% to cash) and October 2002 (43% to stocks, 39% to cash). Both turned out to be good times to be taking a long-term contrary stance against these investors.

2009 Predictions

An article published on Bloomberg.com contains a table summarizing the predictions of Wall Street strategists for the performance of the S&P 500 in 2009. They’re a pretty optimistic bunch, predicting an average increase of 17% this year (with a range between negative 3.2% and positive 44%!).

Even if they’re right, the S&P 500 would end 2009 at 1,056, 28 percent below where the benchmark index for American equities started in 2008 and 35 percent lower than where the analysts said it would be now, based on the consensus of 11 strategists surveyed by Bloomberg News. Some of the biggest investors are growing more optimistic as the S&P 500 advanced 24 percent since reaching an 11-year low on Nov. 20.

* * *

Mauldin chimes in:

Ten out of ten analysts in the recent Barron's forecast saw stock prices rising 10-20% this year. For reasons I outlined last week, I think we could see a tradable rally in the next few months, but at the very least test the lows this summer, if not set new lows. Earnings are going to be far worse than any analyst's projections I have seen. And earnings drive stock prices.

Further, this recession is going to be the longest in anyone's memory. It is going to seem like it is never going to end (it will, I promise), and more and more investors are just going to give up on stocks. The buy and hold for the long run mantra is wearing thin. In inflation-adjusted terms, the stock market is about where it was in 1973! If you reinvested dividends, that gets you to 1991 (again, inflation-adjusted). It takes a lot of buying to make a bull market. It only takes an absence of buying to make a bear market.

Could we get a rally after the summer or fall lows? Sure. And it could be a good one. A lot depends on how fast the stimulus kicks in and whether it really has an effect.

* * *

Liz Ann Sonders says the conditions are right for a rebound, though it may (or may not) be too early.

Wednesday, January 07, 2009

you just missed the bull market

While no one is calling it that, we are technically in a new cyclical bull market and have been since December 8th. Since the 11/20 lows, the S&P 500 is up 24%, which meets the standard bull market definition of a 20% rally that was preceded by at least a 20% decline. But the unwillingness for the majority to call it a bull market is what bulls should be thankful for, since the market typically climbs a wall of worry where investors are full of doubt throughout the rally.

Regardless of what you call it, some of the performance numbers since the 11/20 lows are downright crazy. Even though the S&P 500 is up 24% since 11/20, the average stock in the index is up 41.25%. This means the smaller cap names in the index are up much more than their larger cap brethren. And the stocks that were down the most during the 10/9/07-11/20/08 bear are up much more than the ones that were down the least. As shown below, the average performance since 11/20 of the 50 stocks that were down the most during the bear market is 112%!

[via paraguay2es]

Tuesday, January 06, 2009

German billionaire commits suicide

German billionaire Adolf Merckle has committed suicide, in despair over the huge losses suffered by his business empire during the financial crisis, his family said on Tuesday.

The media-shy billionaire, whose family controls some of Germany's best-known companies, was hit by a train on Monday evening, local officials said.

"The desperate situation of his companies caused by the financial crisis, the uncertainties of the last few weeks and his powerlessness to act, have broken the passionate family entrepreneur and he took his own life," a family statement said.

State prosecutors from the southern city of Ulm said Merckle, 74, left work on Monday and died after being hit by a train near the town of Blaubeuren. He left behind a suicide note to his family, they added.

Merckle, a father of four, inherited the basis of his fortune from his Bohemian grandfather, but went on to build up the chemical wholesale company into Germany's largest drugs wholesaler.

The passionate skiier and mountain climber assembled a business conglomerate with about 100,000 employees and 30 billion euros ($40.45 billion) in annual sales.

His family controls a number of German companies including cement maker HeidelbergCement and generic drug company Ratiopharm.

But the empire was rocked last year by wrong-way bets made on shares in Volkswagen after a surprise stakeholding announcement from Porsche sent the VW share price rocketing as short sellers scrambled to cover their positions.

Banking sources had told Reuters the family lost hundreds of millions of euros on investments, with about 400 million euros lost on Volkswagen shares alone.

Since then the family has been in talks for weeks with banks to renegotiate loans. Banking sources said on Tuesday his death was not expected to affect loan agreements with the family.

[via paraguay2es @ chucks_angels]

Monday, January 05, 2009

how cheap are stocks?

Unless you are in your late 80s and were an adult as World War II ended, stocks are cheaper, adjusted for tax rates and interest rates, than they've been at any time in your adult life. That's a simply stunning statement looking forward. You're walking forward. Stop myopically looking at your feet and focus on the horizon. Just buy great franchises at cheap prices now and be patient.

Friday, January 02, 2009

yes, we are in a recession

[12/1/08]

The National Bureau of Economic Research said Monday that the U.S. has been in a recession since December 2007, making official what most Americans have already believed about the state of the economy.

The NBER is a private group of leading economists charged with dating the start and end of economic downturns. It typically takes a long time after the start of a recession to declare its start because of the need to look at final readings of various economic measures.

Many people erroneously believe that a recession is defined by two consecutive quarters of economic activity declining. That has yet to take place during this recession.

The current recession is one of the longest downturns since the Great Depression of the 1930's.

The last two recessions (1990-1991 and 2001) lasted eight months each, and only two of the 10 previous post-Depression downturns lasted as long as a full year, according to the NBER.

several economists said the real concern is that there is no end in sight for the downturn.

Some suggested that the best case scenario for the economy is that it would reach bottom in the second quarter of 2009. And even if that happens, that would still make this recession the longest since the Great Depression.

Thursday, January 01, 2009

Recessions and stock market performance

[1/1/09] To better understand how recessions typically work, note these four important trends:

1. On average, the S&P 500 has started to lose ground approximately seven months before recessions began.
2. Recessions have lasted an average of 10 months.
3. On average, the stock market has started to recover six months into the recession or four months before it ended.
4. It took approximately 13 months for the stock market to traverse from its peak to its trough.

These averages might not apply to the current recession, but we believe there's a strong chance that some trends could repeat. For example, the stock market could anticipate the beginning and end of the recession before the economic data reflects it.

[6/3/08] Ned Davis Research (NDR), an investment research firm, recently analyzed market performance before, during, and after the 10 recessions since 1945. These have had a median duration of about 10 months. The stock market has generally been a good indicator of these economic slumps.

In past recessions, the broad market began declining several months beforehand, as investors anticipated weaker corporate profits, and continued to drop over the five to six months after the start of the recession, the NDR study shows. From pre-recession bull market peak to recession low, the S&P 500 Index of large-cap stocks fell an average of 23.6%, NDR calculates.

But just as the stock market has anticipated economic downturns, it also has looked ahead to the economic recovery and an earnings rebound. The market historically began rising about midway through these past recessions. On average, the S&P 500 gained 24% six months after reaching a recession low and skyrocketed an average of 32% a year after the recession low.

However, it has taken an average of 20 months for the index to recover to its pre-recession peak after hitting its recession low. (It took the index more than five years, though, to recover from the severe 1973–74 and 2000–2002 bear markets, both of which were accompanied by recessions.)

NDR observes that each of the 10 postwar recessions was accompanied by a bear market, as defined by the firm. In each of these cases, the stock market’s low during the recession was also the bottom of the bear market. (Unlike recessions, there is no official definition of a bear market. The firm notes that 10 of the past 18 bear markets were accompanied by a recession.)

Small-cap stocks tend to underperform those of larger companies leading into and during the early stage of a recession. However, NDR says, just as the S&P 500 Index starts its recovery about six months into a recession on average, small-cap stocks tend to significantly begin outperforming large-cap stocks at about the same time and typically continue leading for at least a year after the recession has ended. For the 12-month period following the end of the last nine recessions, small-cap stocks on average provided a 24% gain compared with 17.6% for the S&P 500.

In terms of market sectors during recessions, NDR found that health care and consumer staples (such as food, household products, and beverage firms) were the bestperforming sectors on average six and 12 months after the start of the last five recessions, dating back to 1973. In fact, health care led in each of these five recessions.

-- T. Rowe Price Report, Spring 2008