Saturday, November 29, 2014

humans finally defeat monkeys!

The New York Times on Friday ran an article on how investors sabotage their long-term goals by making decisions based on short-term results. It carried a quote by Suzanne Duncan, global head of research at State Street’s Center for Applied Research: "Morningstar gives us false comfort," she said. "There's some truth to Morningstar's ratings. But there is untruth. Dart-throwing monkeys outperform market-cap-weighted indices."

All right, that passage requires some explaining.

That final sentence certainly does. If dart-tossing monkeys can reliably beat a stock market index, then monkeys would seem to have investment skill--and surely are worth the cost of zookeepers, cages, and bananas to employ as portfolio managers. The catch is in the adjective "market-cap-weighted." As Research Affiliates' Rob Arnott (presumably the original source of the quote) has argued, if small and value stocks outperform over time, as they have done historically, then any random stock-selection system would have a higher expected return than the S&P 500. This holds true regardless of the primate.

Thus, the monkey analogy does not support Duncan's previous sentences, which concern the usefulness of fund research. Rather, it argues that equal-weighted portfolios will outperform those that are cap-weighted.

Conventionally, the mutual fund industry's performance is equal-weighted. Morningstar.com tells me today that specialty health care has the highest returns of any fund category over the past three years, at 31.02% annually. That result was calculated by averaging the totals for each specialty health-care fund over that time period, counting the whales and minnows equally.

Asset weighting, on the other hand, goes where the money is; if a single whale outweighs all the minnows, then that whale’s numbers count for more than those of all the minnows combined. Thus, asset weighting indicates how investors have fared at fund selection. If funds’ asset-weighted gains are larger than their equal-weighted gains, the big funds have beaten the small, indicating that investors have selected wisely. If the figures are similar, investors did neither worse nor better. And if the equal-weighted performance is higher, then investors were dumber than monkeys. They would have been better off growing bananas than conducting fund research.

The asset-weighted figures for the past 12 months--



The story looks pretty good for investors. However, the numbers contain a lot of noise.

Things settle considerably when looking at a full decade--



Once again, investors fare pretty well. For sure, these results should not be considered conclusive. All fund research is time-period dependent. Sample another decade and the pattern may look weaker or possibly disappear altogether. Nonetheless, at least for the past 10 years, humans have comfortably bested the monkeys.

***

To check, I looked at RSP which is the equal-weighted S&P 500.  For one year, it has returned 17.02% to the S&P 500's 16.86%.  For ten years, it returned 9.37% to 8.06%.  Monkeys win.

Friday, November 28, 2014

the current bull market

It has been five years and seven months since the S&P 500 Index hit a dreadful low of 666.79 (intra-day) in the midst of the full force of the financial crisis. This August, the index passed the 2,000 mark for the first time in history, three times above the low of the crisis, retreating slightly at the end of September. Certainly, much has changed in the U.S. economic and business environment to trigger that impressive growth (a total return of 191.53%, or 228.05% including dividends). And certainly today we live in a healthier economy with improving fundamentals, along with restored consumer and investor confidence.

Reading the news and listening to investors, it seems that to many, five years and seven months of a strong market is too much of a good thing. In recent months there’s been a lot of commentary suggesting that stocks have appreciated “too much” for too long and are now overvalued. Pundits have exclaimed that the stock market has exhausted its growth potential, and that we are at the peak of the bull market and due for a correction. Others disagree, believing that the markets still have room to appreciate, supported by a not-too-hot/not-too-cold economy, even with the much-anticipated rise in interest rates at some point in 2015.

Five years seven months and a 192% return is indeed an impressive run, but it is merely average when compared to historical bull markets. The table below lists all bull markets since 1871 and ranks them by duration. We define bull markets as those with at least a 20% increase that lasted six months or more. The return magnitude of the current bull market is slightly above average and is sixth, as measured by duration. The current bull market does not come close to two of the largest bull markets, both of which ended with speculative stock bubbles: one the dot-com bubble, and the other the Great Depression. These impressive runs also had short-term event-driven corrections. The longest bull market experienced three of them, ranging from -33% to -19%: Black Monday in 1987, the Iraq war in the early 1990's, and the collapse of LTCM in 1997.

Bull Markets Since 1871
Includes all increases in the S&P 500 Index of 20% or more

that lasted at least 6 months

Start          End          months Rank  Return Rank
13-Aug-1982    27-Mar-2000   211.4   1 1387.85%  1
July 1949      12-Dec-1961   149.4   2  419.97%  2
September 1921 September 1929 97.0   3  385.27%  3
4-Oct-1974     28-Nov-1980    73.8   4  125.63%  9
September 1896 September 1902 73.0   5  132.28%  8
10-Mar-2009    30-Sep-2014    66.7   6  191.53%  4
24-Jul-2002    9-Oct-2007     62.5   7   96.21% 11
May 1942       May 1946       49.0   8  138.52%  6
July 1877      June 1881      48.0   9  141.03%  5
27-Jun-1962    9-Feb-1966     43.5  10   79.78% 12
November 1903  September 1906 35.0  11   60.22% 15
27-May-1970    11-Jan-1973    31.5  12   73.53% 13
February 1885  May 1887       28.0  13   39.15% 18
10-Oct-1966    29-Nov-1968    25.7  14   48.05% 16
December 1907  December 1909  25.0  15   64.80% 14
April 1935     February 1937  23.0  16  115.34% 10
January 1915   November 1916  23.0  16   38.91% 19
July 1932      February 1934  20.0  18  137.32%  7
January 1918   July 1919      19.0  19   39.85% 17
May 1938       November 1938   7.0  20   32.15% 20
AVERAGE                       55.6      187.37%


[Well, being ranked 6 and 4, I'd say that's above average.  And it also appears to be above average on a percentage gain per month basis -- about 2.9% per month.]

We think the current bull market has more room to run, but we do not expect the stellar 30%+ return from 2013 to repeat this year or next. We believe that conditions are in place to sustain attractive growth rates in the companies in which we invest and attractive returns in their stock prices. In our view, current levels of widely-used valuation metrics support our thesis. Valuations are at or moderately above their 100-year average, and there are plenty of good stocks at attractive prices to be found, in our opinion.

Current valuations also imply significant forward long-term returns, particularly for growth stocks. We looked at the historical relationship between stock valuations and future returns and plotted the results in
the following charts. While this analysis is not proof of cause and effect between P/Es and future returns, it reveals a pattern that suggests such a relationship – low valuations correspond to higher five-year future returns.

The result from this analysis suggests attractive stock returns over the next five years, with growth stocks being in a stronger position. At current valuations, the analysis shows that the implied forward rate of return for growth stocks is 11.7% over the next five years, while value stocks’ implied rate is 8.5%, although there is no guarantee this will be the case.

Timing the Market Would be an Amateur’s Mistake That Can be Very Costly

Investors appear to be anxious, as demonstrated by the negative year-to-date flows out of domestic equity mutual funds and ETFs. This may prove to be an over-reaction by investors, as well as a costly mistake.

The Patriots lost 41-14 to the Chiefs in week four and had a 2-2 record. The result was a lot of noise about whether the team should bench 37-year old Tom Brady. Many were ready to have him hang up his cleats. Other factors, of course, could have been responsible for the slow start, such as the offensive line or inexperienced receivers. An experienced coach like Bill Belichick didn’t waiver in his support of his seasoned quarterback. Week five saw the Patriots face the Bengals, a team that entered the game 4-0. Brady threw for 292 yards and beat the Bengals resoundingly, 43-17. Tom Brady is not done yet – there are still more successes to be achieved in an already successful career (in week five he became the sixth quarterback to have over-50,000 career passing yards).

Over-reacting to short-term issues, trying to time the equity markets, or abandoning the equity markets entirely, should not, in our opinion, be part of an investor’s game plan. It certainly seems safer to put your money in a bank account. Consider, however, what you earn from a one-year bank CD (around 1%) and factor in the consequences of inflation (currently around 1.7%, as measured by the Consumer Price Index), and you are left with a negative return.

Following what everyone else does in the equity markets will often result in selling after the market has gone down or buying after the market has gone up. Instead, it forces investors to participate in the downside and keeps them from participating on the upside, which is not a particularly successful strategy.

Linda S. Martinson
Chairman, President and COO
October 20, 2014

pari-mutual betting

I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They’re sending money out net after the full handle – a lot of it to Las Vegas, by the way – to people who are actually winning slightly, net, after paying the full handle. They’re that shrewd about something with as much unpredictability as horse racing.

"And the one thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.

"It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it – who look and sift the world for a mispriced be – that they can occasionally find one.

"And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

"That is a very simple concept. And to me it’s obviously right – based on experience not only from the pari-mutuel system, but everywhere else.

"And yet, in investment management, practically nobody operates that way..."

From "A lesson on elementary, wordly windsdom as it relates to investment management & Business" by Charles Munger , USC Business School , 1994.

Tuesday, November 25, 2014

stocks to hold for the next 10 years

Finding the best stocks to buy for the next 10 years probably isn’t on most folks’ radar these days. After all, the market is making new all-time highs seemingly every other day and is poised to deliver more-than-solid returns in 2014.

However, long-term investors know that the key to successful investing is to ignore day-to-day and year-to-year market moves and focus on longer periods when hunting down the best stocks to buy.

After all, stocks get bounced around by all sorts of issues outside a company’s control, from geopolitical crises to recession overseas. What really separates good investments from the bad and the ugly is how a stock performs over a decade or more. A well-managed company in the right industry will prove itself over time. Just ask Warren Buffett, whose preferred holding period is “forever.”

As we head into the end of 2014, it’s a perfect time to look at the best stocks to buy for the long haul. These are names that will benefit from powerful secular trends, as well as their own strengths within their respective industries. Hey, buy-and-hold can indeed work if you’re patient. Look at a long-term chart of the stock market and you’ll see that despite some painful crashes, the line always moves up as it moves to the right.

If you can remain patient for a decade or more, look to this list of the 10 best stocks to buy for the next 10 years (and beyond):

[I agree with the premise, but I don't necessarily agree with the stocks.  It is interesting to note that the author owns none of the stocks he mentioned.]

shades of 1928?

The uptrend out of the October 15 low just can’t be stopped. On Monday, amid light volumes ahead of the Thanksgiving holiday, the S&P 500 notched another record high by climbing 0.3% to close above its five-day moving average for the 27th consecutive session.

That’s the longest such winning streak since March 1928, which marked the start of the great 1929 stock market rally that, when it crashed back to earth, was the genesis of the Great Depression.

Sunday, November 23, 2014

Living Legends 2

Today, we’re going to take a quick look at four legendary investors nearing the end of storied careers.  I don’t expect any of these gentlemen to retire, per se.  In fact, I would expect all to die in the saddle with their boots on, God willing.  But when these investing legends do eventually leave for that great boardroom in the sky, they will be missed by generations of investors that learned the trade from watching them operate.

Any list of living legends has to start with Warren Buffett.  I hope the Oracle of Omaha lives forever, if for no other reason than I appreciate his wit.  When asked what his plans were after becoming the world’s wealthiest man, his deadpan reply was “to become the oldest.”

Buffett admitted to CNBC’s Becky Quick that buying Berkshire Hathaway was the worst trade of his career, yet he’s managed to do quite well, all things considered.   Buffett has compounded Berkshire Hathaway’s book value at an astonishing 17.9% annualized return over the past 30 years, beating the S&P 500 by 6.8% per year.  Again, that’s over a period of 30 years.

Next on the list is Marty Whitman, founder of Third Avenue Management and lead portfolio manager of the Third Avenue Value Fund (TAVFX) for most of its history.  Like Buffett, Whitman is a noted value investor, though he tends to focus more on “deep value” special situations.   And like Buffett, Whitman has been around for a while; he’s worked in the investment management business for more than 50 years.

Whitman retired from full-time management of the Third Avenue Value Fund in 2012, though he remains active in his company and as opinionated as ever. His letters to investors are as entertaining as they are insightful; if you are a student of finance, I recommend you spend a few days browsing them (see letter archive).

My enduring memory of the 78-year-old Carl Icahn will always be his manhandling of fellow activist investor Bill Ackman live on CNBC over Ackman’s Herbalife (HLF) short.  At one point, Icahn called Ackman a schoolyard crybaby.

Icahn isn’t the warm, grandfatherly type like Warren Buffett.  He’s kind of a mean old man, to be honest.  But he’s a hard-nosed, no-nonsense investor with a reputation for fixing broken companies. He’s also a natural contrarian. In his own words, “The consensus thinking is generally wrong. If you go with a trend, the momentum always falls apart on you. So I buy companies that are not glamorous and usually out of favor. It is even better if the whole industry is out of favor.”

Irving Kahn has seen it all.  At 108 years old, his career predates the Great Depression.  In fact, he made his first trade—a short sale of a copper mining company—in the summer of 1929, was just months before the Great Crash.  Like Warren Buffett, Kahn studied under Benjamin Graham, the father of value investing as a discipline.  He was also one of the first professionals to earn the CFA designation.

If I am lucky enough to still be alive at 108, I probably won’t still be running money.  Frankly, it’s a stressful job.  The fact that Kahn is still actively managing portfolios is testament both to incredible genes and to the emotional detachment he brings to his value investing methodology.

Per the Kahn Bother’s website,

Kahn Brothers thinks of a portfolio as an orchard of fruit trees. One cannot expect fruit every year from each species of tree. Investments can and often do have varied and unpredictable timetables to maturity. We believe a suitable time horizon for investment fruit to ripen for harvest can be three to five years or longer. Indeed, a key factor in realizing outstanding performance is having the discipline and patience to maintain time-tested principles and not abandon the orchard before the fruit has ripened.

At 108 years old, Kahn has no doubt learned a thing or two about patience.

And finally, we come to the granddaddy of macro hedge fund traders, George Soros.

Soros’ investment returns were the stuff of legend.  In its heyday between 1969 and 2000, Soros’ Quantum Fund generated annual returns in excess of 20% per year.

Soros will be forever remembered as the man who broke the Bank of England—and as the man who pocketed nearly $2 billion in a single day shorting the pound.

[so I count five, not four.  I guess that's what the headline of the article counted too.]

Saturday, November 22, 2014

Ken Cramer

Jim Cramer's father passes away at 92

Cramer talks about his father on Mad Money and on The Street

Friday, November 21, 2014

Robert Reich's presidential candidate

I asked Reich what kind of presidential candidate he was looking for in 2016.

“In general terms we need candidates who clearly and truthfully assess what has happened to the middle class and the poor,” he said. “Unless more of the gains are shared, the economy will not work. It will become so top-heavy that it can’t sustain itself because there will not be enough purchasing power in the middle class and among the poor. We need candidates to be bold and specific as to what needs to be done.”

He is not overly optimistic this will happen, however. Both Democrats and Republicans, he says, go “hat in hand” to wealthy corporations and individuals to raise money either to launch attack ads or defend themselves against attack ads.

And, as the old adage goes, he who pays the piper calls the tune. It is hard to attack a system that favors the super-rich if the super-rich are funding your campaign.

-- Roger Simon, Politico

Monday, November 17, 2014

Bernanke on inflation

He also fought back against those who have railed at the supposed-inflation implications of a now-$4.5 trillion Fed balance sheet courtesy of three rounds of QE. He recalled thinking, “we were never concerned about [inflation]; that was just bad economics; inflation was never a risk and is not a risk now…inflation is non-existent and we’re adding 200,000 jobs a month to the economy.  Four years later there’s not a sign of inflation. The dollar is strengthening. They’re saying, ‘Wait another five years, it’s going to happen.’ It’s not going to happen.“

-- Liz Ann Sonders, Schwab Investing Insights

Tuesday, November 11, 2014

Anton Ivanov

Anton Ivanov isn’t your average millionaire.

For starters, he’s barely 27 years old, he doesn’t work in Silicon Valley and he isn’t heir to a family fortune. He doesn’t live in a tiny house or get his food from a compost garden in his backyard, either.

Ivanov, who shares wealth-building tips on his blog, Financessful.com, made his million the old-fashioned way: He read books. He saved early and often. And he started planning his rise to millionaire status before most kids his age had their driver’s license.

“I’m a testament that if you want something bad enough and you keep working towards it ... you will get to where you want to go,” he says. "It was my habits and my principles that made me rich."

“In high school, there was pretty much no financial education and my parents wouldn’t talk to me about money,” he says. “Everything I learned about money I had to learn myself.”

He devoured books on wealth building. An early favorite was “Think and Grow Rich,” the 1937 classic by Napoleon Hill, which details strategies that can be used to overcome psychological barriers to wealth.

“That book was extremely influential,” Ivanov says. “It wasn’t a ‘how to get rich’ book but it gave me a vision and a mental system that I could use to achieve pretty much anything I wanted.”

At age 16, he had one goal in mind: become a millionaire.

College or career? 

While his friends signed up for college classes, Ivanov celebrated his 18th birthday by opening his first Roth IRA. After spending some time working (mostly administrative jobs near home), he decided to enlist in the U.S. Navy at age 20. He earned about $55,000 a year as an electronics technician and took distance learning classes to earn a Bachelor’s degree in information technology and programming. Uncle Sam picked up the tab for his tuition and fees.

“When I compared [going to college] to joining the military, the latter seemed like a smarter idea because I would be earning income right away instead of waiting until I graduated,” he says. “And I could receive an education pretty much completely free, which I did.”

The ‘lazy’ investor

After Ivanov maxed out his Roth IRA (the annual contribution limit is $5,500), he opened up a small brokerage account with TradeKing. Years of careful research convinced him stock-picking wasn’t for him. His investing strategy was simple: focus on low-cost stock mutual funds that covered a variety of major asset classes and let the market do its job.

“It’s what I would call a lazy portfolio,” he says. After doing research, Ivanov decided to invest in seven asset classes: domestic, large-, mid-, and small-cap funds, emerging market funds, commodity funds, with a small chunk in bonds. Then he let it ride. He rebalances his portfolio once a year, if at all.

A couple of years into his stint with the Navy, Ivanov faced his first true test as an amateur investor. By saving 60% of his Navy income and taking on freelance jobs on the side, he had been investing somewhere between $40,000 to $45,000 per year when the financial crisis hit in 2008.

He says he lost “a good amount,” but when the market sank he didn’t sell like many other investors did. “I powered through and when the market hit bottom, that’s when I tried to save and invest even more. To me, it was a no brainer,” he says.

Getting into the real estate game

Heavily influenced by books like “The Millionaire Real Estate Investor” and “The Millionaire Next Door,” Ivanov knew he wanted to start investing in real estate. His timing couldn’t have been better. The bust had essentially turned the housing market into the world’s biggest bargain bin.

In 2009, Ivanov put down $80,000 on a $400,000 condominium in San Diego, which he rents out for a $36,000 a year (he nets about $12,000 a year after making his mortgage payments). Today he estimates the property’s value is well over $600,000. 

Since then, Ivanov has added another property to his nascent housing empire. He purchased a $430,000 duplex earlier this year. He collects $21,000 a year in rent ($12,000 net after his mortgage is covered) renting out one of the apartments, while he and his fiancee live in the other.

“I believe in taking smart risks,” he says. “If you see an opportunity and you think it’s a good opportunity, you should take it and understand that you may be wrong and understand what the repercussions may be.”

He hopes to own at least 10 properties by the time he hits his 40s, but he’s in no rush. Once his housing expenses are taken care of, he puts all of his income — from his rental properties, his job and his freelance work — first into his retirement account, emergency savings account, and then into his taxable brokerage account. Once those goals are met, he contributes to a separate high-yield savings account, which he sets aside for future real estate purchases. You can see a full breakdown of Invanov's assets here, or check out the graphic below.

Ivanov crossed the $1 million net worth mark just two months shy of his 27th birthday in June this year. He was thrilled to finally reach this milestone — but not surprised.  

“If you have a really strong desire in your head, you can power through any obstacle you may face,” he says. “I truly believed that when I was 16 and I believe it now.

Monday, November 03, 2014

How to pick SMART Stocks

A well-balanced stock portfolio should consist of, at a minimum, 15-20 stocks in seven or more different industries so you are diversified. You want to use both technical and fundamental analysis to find financially strong companies with above-average growth.

Interestingly, out of the 8,800 stocks in the U.S., there are only about 250 stocks that fit this description. Since you want to hold stocks for the long term, it is important to choose the right ones. Steve Connell, former partner with The Capital Group and now CEO of Interlaced Advisors, states, “Being successful in the stock market … requires patience while riding the right horse. The stock market by nature undervalues opportunities that last more than a few years.”

Here are some more tips:

* Choose Companies You Understand. Warren Buffett is arguably the world’s greatest investor. One of his top rules is to only invest in what you understand. You want to pretend as though you are personally buying the company and have to run it. If you understand the business, you have a better chance of seeing opportunities and problems before they come up. This will help give you a leg up when investing. If you don’t understand the business, how it makes money, or it’s one that is too complex, then it becomes difficult to predict future cash flow, performance and growth of the company. To quote Buffett, “I try to buy stock in businesses that are so wonderful that an idiot can run them because, sooner or later, one will.”

* Look For Diversified And Recurring Revenue. Some companies go through periods of high sales growth followed by periods of no growth. You want to find a stock where there is diversified and repeatable sources of revenue. This way their income is more predictable with additional ways to make money. Also check to see how many clients or customers a company has. If a company is solely reliant on very few clients, it will hurt revenue if one of them leaves.

* Be Disciplined And Patient! Fidelity Investments analyzed the performance of their accounts and found that the clients who performed the best were the ones who either died or forgot they had an account! This is because emotions can be our greatest enemy, and we tend to make trades at the wrong time. Connell looks for companies that “improve the human lot more than any others for the indefinite future, they know how to capture the value they create, and the stock prices do not yet reflect the long and fruitful future that lies ahead of them. There are very few other investment opportunities like this in the stock market.”

-- David Chang, Thinking Smart, Midweek, October 15, 2014

Sunday, November 02, 2014

QE ends ... and QE begins

In response to the growing concern about European weakness, the European Central Bank took action earlier in the month by buying bonds which essentially implemented quantitative easing. This will cause European interest rates to fall, and that in turn puts downward pressure on the Euro relative to other currencies including the Japanese Yen.

Now, if you are Japan and looking to export some Hondas, the last thing you need to happen is for the Euro to depreciate relative to the Yen. In order to prevent this, the Japanese Central Bank put on their Godzilla costume for Halloween and joined the fray with an unanticipated round of bond buying.

Effectively, the Central Bank of Japan is going to buy on the open market more than double the amount of new bonds issued by the Japanese Government. This level of stimulus makes the Federal Reserve's latest round of quantitative easing which ended this month look timid by comparison.

So effectively, the weakness in Europe caused the European Central Bank to push interest rates down. Japan, not wanting their currency to appreciate, responded by pushing their interest rates even lower.

Excellent news for stocks.

I don't know if this is going to help sell more Mercedes or Hondas, but I do know that the net result of the race to depreciate currency is to pull global interest rates much lower for much longer than investors are anticipating. This is a positive development for stocks and most other financial assets over the next few quarters.

-- Mitch Zacks, ZIM Weekly Update

Saturday, November 01, 2014

Oxfam America on inequality

Extreme inequality and poverty
Hardworking people can't get ahead when the rules are set against them.

What's wrong
The rigged rules of our economic and political system hold our economy back and make it tough for hardworking people to get ahead. Extreme inequality destabilizes global economies and pushes more and more people into poverty.

Making it right
Practical, smart reforms can level the playing field: Closing tax loopholes; increasing the federal minimum wage; using oil, gas, and mineral revenues responsibly; and ensuring the voices of hardworking people are not drowned out by special interests will all help reduce inequality.