Friday, June 27, 2014

Buffett's biggest secret: cash

Warren Buffett has gone into every economic recession with an excess of cash on the balance sheet. In these recessionary periods, the average company is trying to shore up assets and deleverage. That's when Buffett swoops in and buys companies for pennies on the dollar. Plus, because Berkshire Hathaway has excess cash and no debt, he doesn't have to deleverage. He can use ongoing operating profit from his business to buy other businesses, rather than use retained cash to increase the size of his cash pile.

Financial advisers will often tell clients to dollar-cost average even through a financial panic. However, most investors won't follow that advice. Because they don't want to buy low, they consistently lose money to people like Warren Buffett, who consistently buys low and sells high.

When investors buy Berkshire Hathaway stock, they buy into a CEO who has the right temperament for managing money.

Thursday, June 26, 2014

The Loser's Game

There are two types of games: "Winner’s Games" and "Loser’s Games." Now this doesn’t mean that losers play only certain games, while winners play other games. It has nothing to do with personality characteristics. By "Loser’s Game," I don’t mean that investors are losers. It is just a way to classify games to help us understand them better.

The outcome of any competitive game depends upon the actions of both the winner and the loser of the game. This does not always imply the winner’s actions will dominate the outcome. Many games are not won, but rather, are lost. It is important to understand the distinction.

Winner’s Games are those games whose outcome is largely determined by the actions of the winner. Loser’s Games are those games whose outcome is largely determined by the actions of the loser.

Amateur tennis is a loser’s game. Non-highly-trained players do not possess the skills to deliver excellent serves and returns with consistency. An attempt to try harder to deliver superior shots, compared to the opponent, will not meet with success, but double faults and shots that go out of bounds. Trying harder to make great shots will mean that you are giving the opponent points. The player is not only competing against the other player, but also against the inherent difficulties of the game. The more competitive the amateur tries to be, the more the inherent difficulties of the game will beat him down.

The amateur who has not mastered the fundamentals of the game is far better off just trying to deliver a shot within the tennis court bounds than trying to outplay the opponent. Keep the ball in play and give the opponent the opportunity to mess up the shot. And, the harder the opponent tries, the more likely he will mess up!

If you were playing a professional tennis player, the situation would change drastically. Professional tennis is a winner’s game. Professional tennis players have mastered the fundamentals of the game. You must not only master the fundamentals of the game to win, but you must also deliver superior shots. You must outplay your opponent to win. Returning the ball within court bounds is not enough. The opponent probably won’t mess up and might well force a shot you can’t return.


Investing is a loser’s game. It is a loser’s game, not only at the amateur level, but also at the professional level. Over time, trying harder to achieve superior returns will usually lead to inferior returns. Trying to time the stock market, day trading, buying options, and most active investment advice approaches investing as though it were a winner’s game—believing you can actually conquer and beat the market.

If, for example, you had felt that the stock market was overvalued and due for a correction, and you had remained out of the stock market for the year 1995, you would have missed one of the market’s best years ever. But, maybe, you also missed the big market drop of 1987. What could you conclude from this? Probably, as with my streak of tennis losses, you would tend to remember the victories (or, near victory shots that led to losing the game!) and forget the defeats.

You reason that if only all your tennis shots or investment decisions had been as great as the best ones you remember, you would have won decisively! But, seeking that one great shot is what cost you the match.

You would tend to explain your victory as confirming proof of market timing and your skill to do it, while the defeat would be interpreted as only indicating a need to improve your methods slightly! You are interpreting investing, and more specifically, market timing, as though it were a winner’s game. It is not! It has never been shown that anyone, I repeat anyone, can master stock market timing.

Looking for stocks you feel might go up ten or twenty times from their present price in a few short years is also a form of trying to invest in the stock market as though it were a winner’s game. Or, given the late 1990’s you might be seeking growth stocks that go up 100 times or more in a few short years!

After all, you recall Dell, Cisco, Yahoo, and other companies which shot up by amazing amounts. To buy such speculative stocks implies you feel confident in finding opportunities that are grossly misevaluated by the market. Usually, you will not invest in the next Dell or Cisco, but, rather, the next He-Ro apparel company of the day. That is to say, a lousy investment. This can lead to huge losses.

Individual investors usually have not mastered business evaluation and fundamental analysis sufficiently to actively select the very best aggressively-chosen stocks from among the larger market. But don't feel bad. The professionals who are paid millions of dollars haven't done much better.

Understanding that investing is a loser’s game at heart should keep you from trying to force too many shots. Rather than looking for one big winner, aim for consistency in your results. The bulk of an intelligent investor’s portfolio should be invested in high-quality, larger companies purchased at reasonable prices. Such a portfolio will likely beat, not only a market timer’s portfolio, but also a speculative portfolio of "carefully" selected, aggressive stocks on a risk-adjusted basis.

[This seemed familiar.  Looking in my copy of The Investor's Anthology, this article looks like a rip-off (or adaptation) of The Loser's Game by Charles Ellis.  Ellis also apparently wrote a book around the article called Winning the Loser's Game, now in it's sixth edition.]

add to stocks in retirement?

Benz: You have done some research. You co-authored a paper with professor Wade Pfau where you looked at what equity allocations should look like in retirement. And your research came up with a somewhat counterintuitive finding, where you actually suggested that equities should trend up as someone goes further in retirement. Let's talk about your general findings and why you think that this is maybe something that retirees should look at?

Kitces: Certainly the reactions to some of the research that we've done have been interesting at the suggestion that maybe equities should actually glide upward and you would get a little bit more aggressive through retirement.

We see a natural retiree bias toward that anyways. We don't really want to own any more equities than we have to. [They can be] a little volatile and a little scary. And we've had this kind of rule of thumb for a very long time of "Own your age in bonds, or 100 minus your age in stocks," all of which gets you to the same point. As you're getting older your equity exposure declines and that was a way to own fewer equities through retirement.

The problem is that particular approach where you decrease them over time, psychologically I think there is some comfort to it. Unfortunately from the research, it just doesn't work very well. [Financial expert] Bill Bengen did some work on this back in the late 1990s after he had done his initial safe withdrawal-rate research and found that decreasing equity exposure through your retirement hurts; you got lower income and withdrawal rates. Not a huge difference if you only did a little bit of trimming, but you got lower outcomes.
David Blanchett, Morningstar's head of retirement research, did a wonderful study on this six or seven years ago where he tested something like 43 different versions of decreasing equities--so you decrease by little a year or a lot every year, or a little bit and then more, or more and then a little bit--all the different ways that we could glide that equity exposure down. And basically what he found was just sticking with the same balanced portfolio and rebalancing to it worked better than all of these decreasing-equity-exposure approaches.

What Wade and I did was really just kind of take it one step further and ask, "If starting [with higher equity allocations] and coming down doesn't work very well and starting [at one level of allocation] and sticking [with that same level of allocation over time] goes better, what would happen if we started lower and glide it back up to where we were going to be in the first place?" So we'll own less in equities early on and will maybe end out with a portfolio that we would have held throughout anyways. So, if I were going to be 60%-40% in retirement, we're never going to go higher than 60%, but rather than being 60% equities every year, what if we went down to 30% in equities and then started gliding back up toward that original 60% target. And what we found was it actually works.

One of the key things to note about that coming right out of the gate, though, is equities would be gliding upward through retirement, starting from a much more conservative point. While a lot of the discussions around this have been framed as "How aggressive is it to be adding equities for people through retirement?"--what we were actually finding is that this is a strategy to give you lower equities in retirement, lower average equity exposure overall, just doing it in a manner that works a little bit better.

how rich people think

According to Steve Siebold, what separates the rich from the rest of us isn't so much what they do.

It's how they think.

Siebold spent nearly three decades interviewing millionaires around the world, and boiled his findings down in "How Rich People Think," a book he describes as "so brutally honest it will shock some and inspire others." 

In it, he touches on everything from beliefs about the root of all evil to faith in what drives the financial markets and what parents should teach their children to set them up for financial success.

[for example]

Rich people believe in acquiring specific knowledge

... while average people think the road to riches is paved with formal education.

"Many world-class performers have little formal education, and have amassed their wealth through the acquisition and subsequent sale of specific knowledge," Siebold writes.

"Meanwhile, the masses are convinced that master's degrees and doctorates are the way to wealth, mostly because they are trapped in the linear line of thought that holds them back from higher levels of consciousness ... The wealthy aren't interested in the means, only the end."


Rich people believe you have to be something to get rich

... while average people believe you have to DO something to get rich. 

"That's why people like Donald Trump go from millionaire to $9 billion in debt and come back richer than ever," Siebold writes. 

"While the masses are fixated on the doing and the immediate results of their actions, the great ones are learning and growing from every experience, whether it's a success or a failure, knowing their true reward is becoming a human success machine that eventually produces outstanding results."


Rich people would rather be educated than entertained

... while average people would rather be entertained than educated. 

While the rich don't put much stock in furthering wealth through formal education, they appreciate the power of learning long after college is over, Siebold explains.

"Walk into a wealthy person's home and one of the first things you'll see is an extensive library of books they've used to educate themselves on how to become more successful," he writes. "The middle class reads novels, tabloids, and entertainment magazines."

[and more]

Tuesday, June 24, 2014

the most important metric

What is the most important metric tied to stock performance?

The complexity of the investment field makes it difficult to ever determine a “right” answer to this question. Benjamin Graham’s exploration in ‘The Intelligent Investor’ was the first work to provide convincing answers. But the 80 years following the book’s release have seen thousands of ever more complex theories and models all trying to answer this same inherent question. From the Nifty Fifty to the Dogs of the Dow to The Little Book That Beats the Market, it seems like everyone has offered a simple solution that
temporarily outperforms.

Wall Street has of course taken it several steps further with stock-correlation algorithms, momentum trading systems, and multi-variable back testing. But their long history of excessive fees and embarassing underperformance leaves little envy for their methods – at least in the minds of sophisticated investors. As value investors, we are wise enough to know that additional complication does not result in superior results.

But given the amount of data and calculation we are now able to perform, it makes sense to re-visit this age old question and finally produce a definitive result.

Two works of research will be referenced in this article. The first is by in-house GuruFocus analyst Vera Yuan. Her article, ‘Earnings, Free Cash Flow, Book Value? Which Parameters Are Stock Prices Most Correlated To?’, examined the stock price correlation to eight fundamental metrics across a full business cycle.

The picture here couldn’t be much clearer. When it comes to banking, investment and other financial stocks, book value is king. Book and tangible book were the consistent winners here across all four market periods.

Non-financial stocks produced similar results, albeit less overwhelmingly than the previous group.

However, one research study is not a sufficient basis from which to base our entire investment philosophy.

The second test for the validity of book value superiority was constructed by Tobias Carlisle of Greenbackd. He back tested this topic using 87 years of equity data in ‘Investing Using Price-to-Book Value Ratio or Book Equity-to-Market Equity Multiple (Backtests 1926 to 2013)’.

Carlisle’s research examined book value to stock price correlations back to 1926. Using a 3,715 stock sample with complete financial data, stocks were grouped into a value decile representing the 459 lowest price-to-book multiples and a glamour decile containing the 404 highest multiples. Unsurprisingly, the value group outperformed the higher multiple glamour group for the period.

***

Looking at my copy of What Works on Wall Street, "Over the long term, the market rewards low price-to-book ratios and punishes high ones.  Yet the data show why investors are willing to overlook high price-to-book ratios -- for 20 years, large stocks with high price-to-book ratios did better than the Large Stocks universe.  A high price-to-book ratio is one of the hallmarks of a growth stock, so high price-to-book ratios alone shouldn't keep you from buying a stock.  But the long-term results should caution you against the highest price-to-book ratio stocks.

Buffett's Alpha (again)

In their paper Buffett’s Alpha, Andrea Frazzini, David Kabiller, and Lasse Heje Pedersen analyzed Buffett’s returns from 1976–2011 and decomposed them to identify the primary factors driving Buffett’s significant alpha. For regular followers of Buffett, the results should come as no surprise, but let’s dig in and discuss the three primary sources of Buffett’s alpha …

In summary, the authors regressed Buffett’s returns against factor exposures commonly known to influence returns. The three factors that showed as significant are forehead-slappingly obvious.
  • Value: Buffett has a tendency to favor low price-to-book value stocks.
  • Safe: He bets against beta in that he favors low beta stocks.
  • Quality: Finally, he favors quality companies (profitable, growing) over junky companies.
Which brings me to my take-home point: Investing is simple, but it is never easy. Warren Buffett (Trades, Portfolio) identified early on in his career the value investing tenets that would guide his investing career. He then had the audacity to apply those concepts year in and year out regardless of what was happening in the world around him.

Buffett’s worst years were at the height of the TMT bubble when the market saw his way of investing as out of date and not fit for this “new era” of investing. (Side note: Whenever something is said to be in a “new era” or of a “new paradigm,” do yourself a favor and short the ever-loving shit out of those securities—it’ll be like winning a rigged lottery because all those words really mean is “BUBBLE!” and bubbles always burst).

Despite this external pressure, Buffett stuck to his process and made an absolute killing in the tech wreck years that followed. Being a value investor often means you are taking a contrarian view by definition, which can be hard for humans. We are hardwired to take our social cues from the herd, so maintaining an opposite view requires determination and guts.

Do your homework better than the other person, stick to your process, and you too can tilt the odds in your favor.

[see also Buffett's Alpha]

Monday, June 23, 2014

Millionaire Mistakes

In a recent survey, high net-worth clients (those with more than $1 million in assets) were asked about their top five investing mistakes. Not surprisingly, some of these are ones that everyone faces, regardless of net worth. Some of these mistakes can be very costly, making the difference between financial dependence and financial independence.

Here are the top mistakes and what you can do about them.

1) Failing To Diversify. Almost a quarter of millionaires said their top investing mistake was not diversifying enough. No matter how much you make, diversifying is crucial to investment success. Karl Eller was a founding investor in the Phoenix Suns, built a successful advertising business and was head of Columbia Pictures. He invested almost his entire net worth on purchasing the convenience store chain Circle K. Under his leadership, it grew considerably, but he failed to diversify. When Circle K declared bankruptcy in 1990, he lost close to $1 billion and left with almost nothing. In an interview with Tony Robbins, he mentioned that lack of diversifying was the biggest mistake he made. Spreading your investments around is one of the best ways to manage and lower risk. It has to be done correctly. Diversifying only is helpful if each different investment has a different risk profile. Spreading your money around different tech stocks is not the same as spreading it around different industries. If the tech industry takes a hit, the other industries may bolster your investment portfolio.

2) Investing Without A Plan. If you fail to plan, you will plan to fail! Investing without a plan is gambling — 22 percent of millionaires regret not creating an investment plan. A good plan will help you set goals, choose the right type of investments and stay disciplined. Studies show that people with an investment plan will outperform those who do not. Visit artofthinkingsmart.com for sample plans.

3) Making Emotional Decisions. About 20 percent stated that emotional investing decisions have been their biggest mistake in the past. Emotional investors buy when things are going well and sell when things are going bad. This is the opposite of what they should be doing. Sticking to your plan and working with a financial adviser will help prevent emotional decisions.

4) Failing To Review A Portfolio. Sixteen percent said they failed to regularly review their financial plans and portfolios. As the market changes, investors should review and rebalance on a regular basis. As your goals, time horizon and risk changes, you will need to adjust your investments to be in line with your updated investment profile.

5) Fixating On Previous Returns. Fourteen percent said they relied too much on historical returns and not enough on future expectations. Just like an athlete who may have had a good season in the past, it doesn’t necessarily mean he or she will do well this season. It can be one criteria, but it should not be the basis of your investment decision. Studies have shown that many mutual funds that were in the top percentage of their category were in the lower performance categories later on.


david@artofthinkingsmart.com

Investment Wisdom

Unfortunately, over the period of 1994 to 2013, the average investor earned only 5 percent while the average stock fund returned 8 percent annually. Why? And how can we get our money to work better for us?

These next two weeks I will cover the essential wisdom of the greatest investors and how you can use them for your benefit.

* “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” -Benjamin Graham, father of value investing and mentor to Warren Buffett.

Ben is saying that we need to avoid destructive investor behavior. Emotions can be our greatest enemy when it comes to investing and wreak havoc on our ability to build long-term wealth. I mentioned that the average investor sacrificed close to half of their potential return.

This gap is called the “investor behavior penalty.” This is because they engaged in negative behaviors like chasing the hot fund manager, stock or asset class, avoided areas of the market that were out of favor, attempted to time the market, or just abandoned their investment plan.

The greatest investors know that building long-term wealth requires the ability to control one’s emotions and avoid self-destructive behavior.

* “History provides a crucial insight regarding market crises: They are inevitable, painful, and ultimately surmountable.” -Shelby M.C. Davis, legendary investor.

History has shown that the stock market will always encounter crises and uncertainty, but the market has continued to go up over the long-term. The greatest investors understand that short-term underperformance and volatility are unavoidable.

Ninety-five percent of the top fund managers from 2004 to 2013 fell into the bottom half of their peer groups, with 73 percent falling into the bottom quarter of their peer groups for at least one three-year period. Even though these professional managers delivered great long-term returns for a decade, almost all of them experienced some difficult short-term stretches.

Investors who understand and recognize this are less likely to engage in the “investor behavior penalty” and make unnecessary and often bad decisions with their investments.

The greatest investors understand that we shouldn’t overreact to short-term fluctuations of the market.

By being disciplined, sticking to your personal investment plan, and avoiding destructive behavior, you are better positioned to benefit from the long-term growth potential of the stock market.

***

* “Though frustrating, stretches of disappointing results for the market are not unprecedented. History shows, however, that these difficult stretches have been followed by periods of recovery. Why? Because lower prices increase future returns.” -Christopher C. Davis, portfolio manager, Davis Advisors. History shows that after disappointing 10-year periods for the stock market, the average return for the next 10-year period is 13 percent per year! Nobody knows what the next 10 years will bring, but investors with long-term goals should look into maintaining or even adding to their stock allocation after a prolonged stretch of poor returns. It may be tempting to sell or abandon stocks, but this would be selling at the wrong time. Investors should be confident that stocks in the long term will go up after a prolonged period of bad returns. Why? Because low prices help increase future returns and opportunity.

* “Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves.” -Peter Lynch, legendary investor and author. When the market goes down, many investors move out of stocks with the intention of coming back in when they think it will go up. Unfortunately, this has led to disastrous results. If patient investors remained in the stock market the past 20 years, they would have received 9.2 percent per year. If these same investors, however, missed the best 30 days during this 20-year period, their investment would have remained flat! If they missed the best 60 days, they would have lost a significant amount in the market. Nobody knows when these best 30 or 60 days will be, so attempting to time the market will hurt you more than just staying in and riding out the market corrections.

* “Be fearful when others are greedy. Be greedy when others are fearful.” -Warren Buffett, legendary investor and chairman of Berkshire Hathaway. Building long-term financial wealth involves counter-emotional investment decisions. Investors want to buy when there is maximum pessimism with the market, and sell (or resist buying) when there is maximum euphoria and excitement with the market. The stock market was booming from 1997 to 1999, with record amounts of money flowing in 2000. Unfortunately, they just got in to experience terrible years of returns from 2000 to 2002. Many of the same investors sold during this downturn, only to see the market go up more than 30 percent in 2003! This happened again in 2008, when many pulled out of the stock market at the bottom, missing the subsequent double-digit returns a few years later.

The greatest investors understand that an unemotional, rational and disciplined investment approach is crucial to building long-term financial wealth.

-- by David Chang, MidWeek

Tuesday, June 17, 2014

sell, sell, sell

Don't look now, but the Dow Jones Industrial Average ($INDU +0.16%) is suffering a technical breakdown.

On Tuesday, the index crashed unceremoniously through its 50-day moving average -- a level that has held it up for two months after not one, not two, not three but four separate tests.

The bulls have their buy orders locked in at this level. Can the bears overrun them?

Yes, the Dow is rebounding some Wednesday. But given all the other evidence, including technical (weak volume and breadth), sentiment (options prices on the "fear gauge" is at the lowest level in at least eight years), and fundamentals (economic data has been weak both here at home and overseas), I think they will.

And if so, these three dogs of the Dow are headed for trouble.

-- By Anthony Mirhaydari

The article was written on May 21, 2014.  The three dogs named were INTC (at 25.99), WMT (at 75.72), IBM (at 186.44).

Their current prices a month later (6/17/14) are 29.95, 74.99, and 182.26.  Hey, two out of three ain't bad, especially since the market is up since then.  (Actually pretty good.)

What does this mean to me?  Buy WMT and IBM.

Monday, June 16, 2014

a perfect portfolio?

Like most people who write about finance, I have a problem.

My job makes it effectively impossible for me to manage my own investment portfolio. When I first became a full-time investment writer back in 2007, I had to sell all my stock . . . in Diageo (DEO), Amazon (AMZN) and Berkshire Hathaway (BRK.A). (I don’t even want to think about how much that cost me.)

So where does this leave me?

Oddly enough, it leaves me in a very good place . . . for a financial writer. Because it means that by accident I have landed in the same spot as a great many readers: It leaves me looking for a new way.

I want a simple investment portfolio that I don't have to fool around with, and which I know maximizes my chances of earning a good long-term return, and minimizes my chance of ending up in the poor house.

I want an investment portfolio that is exposed to all likely environments, and committed to none. One which is based on intelligence and reasonable suppositions about the future, and not merely data mining from the past.

Have I found it? I think I may have.

To reach this solution, I've spent more than six months plucking at the sleeve of every wise investment expert I know. I've tapped the opinions of the bullish and the bearish, the optimistic and the fearful. I looked up the investment strategy of a tycoon in medieval Germany.

Here are the principles I've relied upon:

The portfolio, in the words of Albert Einstein, should be as simple as possible, but no simpler.

It is based on humility. I don't know what's going to happen next, nor does anyone else. It is prepared for all potential economic environments, but committed to none.

The portfolio is weighted toward equities, because even most bears concede that those have produced the highest long-term returns.

The portfolio is exposed to natural-resource stocks and to real estate, as distinct asset classes which have often done very well during periods of inflation, when other assets have done badly. It prefers natural-resource stocks to pure commodities, despite their equity risk, because they generate income and because "commodity funds" are often hosed by fees and trading costs.

The portfolio owns long-dated "zero coupon" Treasury bonds as insurance. They are the one thing that has gone up in a crash, such as in 1929, 1987 and 2008.

The portfolio owns long-dated Treasury Inflation Protected Securities, which offer some hedge against inflation and deflation.

The portfolio is truly global in its exposure to stocks, bonds, natural resources and real estate, because the U.S. is just a small, and shrinking, percentage of the world economy.

The portfolio uses periodic rebalancing to take advantage of "reversion to the mean." Rebalancing allows you to benefit from volatility and contrarianism without actually having to sweat.

The portfolio includes cash, or a near-equivalent, because as the financial consultant Andrew Smithers, the GMO strategist James Montier and the late investment legend Sir John Templeton have all argued, cash is a distinct asset class, and it is correlated with nothing else.

The portfolio takes advantage of research showing that "riskier" stocks have tended to produce worse returns over time than higher quality or less volatile stocks, and for sound reasons.

The portfolio also keeps its costs as low as possible, because fees are a straight loss.

nd so, what is in this all-weather portfolio?

It's 10 percent each in the following 10 asset classes:

    U.S. "minimum volatility" stocks

    International developed "minimum volatility" stocks

    Emerging markets "minimum volatility" stocks

    Global natural-resource stocks

    U.S. real estate investment trusts

    International real estate investment trusts

    30-year zero-coupon Treasury bonds

    30-year TIPS

    Global bonds

    Two-year Treasury bonds (cash equivalent)

For simplicity's sake, the portfolio I've modeled is rebalanced once a year, on Dec. 30.

I suspect performance in the last 15 years has been flattered unduly by the boom in emerging markets, which were in crisis in the late 1990s. I would be staggered if this portfolio produced a similar performance over the next 15 years to what it has produced over the last 15. However, what are the alternatives? It entails much broader diversification, and lower risk, than the three alternatives I've included (the "balanced" portfolio in the chart, by the way, is 60 percent MSCI All-World Stock and 40 percent U.S. Intermediate Bond Index).

I still think those of you who manage a portfolio of individual securities can earn the best returns, so long as you approach the task with great wisdom. But for the rest of us, this all-weather portfolio may be a good alternative.

By Brett Arends, MarketWatch

Sunday, June 15, 2014

Summers says..

None other than Larry Summers, the former Secretary of the Treasury, advanced the Bull Case for the stock market to defy those calling for a correction. He predicts it will continue to head substantially higher. Summers' bull-market case is fascinating.

His thesis is that the economy has structurally changed. This change is basically that capital and labor are no longer complementary.

In the past, to produce goods you needed people, and people needed machines to produce goods. If you were running an automobile factory in the 1950's, you needed assembly line workers plus the machines or capital that were used by the people.

What Larry Summers is proposing is that, starting in the late 90's, capital began to be not a complement but a substitute for labor. Essentially, the automobile factory no longer needs the same ratio of people to machines. Effectively, the people making the cars can be replaced with technology.

This is causing the aggregate share of labor income to decline and the share of capital to rise. From a common sense perspective, if capital is a substitute for labor the economic pie is going to go more and more to those that own the capital and less to those that own the labor. This is the explanation for the growing amount of income inequality in the world. People are being replaced by technology and the capitalists are taking greater and greater gains from economic growth.

This disruption is extremely positive for publicly traded corporations. We would expect to see higher profit margins in aggregate as a result of low wage growth and this is exactly what we are witnessing.

If this shift from capital being a complement to labor to becoming a replacement for labor is truly here, the effect will be twofold:
  1. First and foremost, interest rates will remain much lower for a longer time than anyone is currently anticipating. With capital replacing labor, wages remain under pressure. As I have said many times, there has never been a period of price inflation that has not been accompanied by a period of wage inflation.

  2. Second, and most important to investors, the stock market should go much higher than what people, including me are anticipating. If technological advances are causing capital to get a greater percentage of the economic pie than it used to, the best course of action is to own the capital. In other words, invest in the stock market.
What Do I Think of This?

Well, an old saw of wisdom is that when people start saying that "This time it is different," they are usually mistaken. The theory that capital and technology are becoming substitutes for labor is a well thought out, if not brilliant argument. It explains why interest rates are globally low, profit margins are high, wages are stagnant, inflation is benign, inequality is rising, and yet the market keeps heading higher and the P/E multiple keeps expanding. The theory explains the data, but brilliant theories usually do.

However, I tend to feel that the more things change the more they stay the same especially with regard to the equity market. This time around nothing is different.

Wages will eventually go up, inflation will return, interest rates will rise and the market will appreciate not at an accelerated rate but at its historical rate of 6% above the risk-free interest rates.

Summers' argument is very powerful, but it is simply a brilliant way of saying "This time things are different."

-- Mitch Zacks, ZIM Weekly Update

Saturday, June 14, 2014

p/e 84?

Now the RUT rally has exceeded even my expectations for how quickly it could get back to 1180. I'm sure there is a fair amount of "bear hunting" going on, but some of my favorite small caps are acting great for good reasons and I want to buy more. In fact, I did buy one today.

But, here's the number that still bothers the bears the most about the RUT: 84.

That's the 12-month trailing P/E for the index.  [wsj has it at 83.  they have the Nasdaq at 22, the S&P 500 at 19, the Dow at 16.  I thought the average was more like 16?  Well let's look at the VFINX.  Morningstar has it at 16.67.]

That is worrisome. But here's another number the bears should focus on: 19.

That's the 12-month forward P/E.

Now, of course, I'm not saying that I believe the RUT will fulfill those wonderful forward estimates. But that's not the point.

The point is that many large investors are piling fresh cash into many small companies that they believe will move from a triple-digit P/E to a double-digit one, or that they believe will be doubling or tripling their sales in the next year.

-- Kevin Cook

[not that p/e 19 is all that low -- and the market is apparently a bit more expensive than I thought]

Friday, June 06, 2014

buy high?

Today's stock market exhibits plenty of worrisome signs. Stocks of small companies have been sinking, which is often a bad sign for the broader market. Economic growth remains sluggish years after the worst recession since the Great Depression. Vladimir Putin's mischief ultimately threatens the crucial flow of natural gas from Russia to Western Europe.

Why buy now, when the leading market indexes are at record highs?

Because a review of recent history shows that the date you pick to invest doesn't matter that much, even if you invest at the market's highest level of the year.

Sound crazy? Dan Wiener, editor of "The Independent Adviser for Vanguard Investors," compared the records of two hypothetical investors over the past 30 years. Each started by investing $1,000 in the Standard & Poor's 500 index ($INX +0.46%) at the end of 1983. (Of course, you can't buy an index, but you can invest in a low-cost index fund.)

Over the subsequent 30 years, each investor put $1,000 annually into the S&P 500. But investor No. 1 bought on the last trading day of the year, while investor No. 2 bought at the S&P's highest point each year. In other words, investor No. 2 bought on the worst possible day each year.

Here's the surprise: At the end of 30 years, investor No. 1 had achieved an annualized return of 9.9 percent, while investor No. 2 earned an annualized return of 9.5 percent. The difference in returns was just 0.4 percentage point per year, on average.

***

Of course, if you could accurately time the stock market, you could enrich yourself enormously. Over the past five years through April 30, the S&P 500 returned a sizzling 19.1 percent annualized. But from December 31, 1999, through April 30, the index returned only 3.7 percent annualized. So clever market timing would have done far better than buying and holding through this period, which included two vicious bear markets.

Monday, June 02, 2014

which index fund?

Buffett is directing that 90% of the cash he's leaving to his wife should be put in an S&P 500 index fund.

Buffett suggests Vanguard's, but there are other index funds.

Here's what I wrote last year, when contemplating switching out of my holdings of FDGFX.

Morningstar rates it two stars.  They had 537 stock holdings with turnover of 63%.  That's more holdings than the S&P 500.  You might as well just hold an index fund, like the Spartan 500 Index Fund (FUSEX).

FDGFX's top holdings are AAPL, WFC, GOOG, C, PG, JNJ, PM, BRK.B.  Which sounds fine to me.

FUSEX holds, naturally enough, 500 stock holdings with turnover of 4%.  The top holdings are AAPL, XOM, MSFT, JNJ, CVX, GE, GOOG, IBM, PG, PFE, T, BRK.B, JPM, WFC, KO.  Didn't realize that BRK.B is up there in the index.

Looking at the ten year returns of the Fidelity U.S. stock funds, FDGFX returned 6.66%, FDSSX 7.46%, FUSEX 7.81%, FCNTX 10.58%, FLPSX 12.31%.  So I'd say it's the odd fund out.

Looking at the current ten-year returns, FUSEX actually outperformed VFINX over 10 years: 7.50% to 7.46%.

Schwab has an index fund too, SWPPX with a minimum investment of only $100.  It returned 7.52% for ten years.  This is the benchmark I should be using for comparing funds.

[6/5/13] Or how about an equal weight ETF like the Rydex S&P 500 Equal Weight ETF (RSP) which is commission free at Schwab.  It has returned 9.50% for ten years compared to 7.33% for the S&P 500.  SWPPX has returned 7.28%.

This would be good to switch to, when you think the largest cap stocks (currently AAPL and XOM are the largest) have run up too high.  RSP rebalances quarterly.  Which means they'll sell the largest weighted stocks at the end of the quarter.  And buy the smallest.  Their highest holding is currently First Solar FSLR, which has gone from about 27 to over 50 since the end of March.

[12/2/15] looking at equal weight since Roberts at chucks_angels has been writing about it] Then again, if you look back to 1990...

[12/2/15] Another alternative to cap-weighted index funds is the WisdomTree funds.

build wealth over time

successfully building wealth over time need not be an all-consuming, overwhelming task. In fact, it does not require much more than simply following a set of basic guidelines

1.  pay yourself first
2.  invest your savings smartly
3.  build a portfolio you can stick to

and 7 more.