stock forecasts: bullish and often wrong

Every December as the holidays approach, Wall Street gurus examine the stock market, and nearly all declare that stocks will rise in the forthcoming calendar year.

The forecasts are still coming in for 2017, but preliminary tallies suggest that — no surprise — strategists are bullish, probably mildly so. Through last year, since 2000, the consensus has always been bullish, holding that the market would rise, on average, about 9.5 percent a year, according to calculations by Bespoke Investment Group. In reality, it rose only 3.9 percent a year, on average, in that period.

So the cheery predictions have often been wrong. Does it really matter? After all, the stock market actually rises most of the time.

But here’s the rub: The stock market sometimes falls, and from time to time, it absolutely tanks. Since the start of 2000, the Standard & Poor’s 500-stock index has ended in negative territory in five calendar years (2000, 2001, 2002, 2008 and 2015) and has been virtually flat once (in 2011). But while a handful of individual forecasters have, from time to time, predicted mildly negative years for stocks, the Wall Street consensus in every single year since 2000 has predicted a rising market.

Consider the calamity of 2008. If you had money in stocks that year, you would probably remember. The S.&P. 500 fell 38.5 percent in the course of those 12 months. It would have been very useful to have received advance warning that stocks were about to plummet, but the Wall Street consensus did not ring out an alarm. On the contrary, the forecast for 2008 was unusually bullish, calling for a rise of 11.1 percent. Wall Street missed the mark by 49 percentage points that year.

How bad is the industry’s track record in making predictions? I had assumed that the annual forecasts were essentially worthless — no better than flipping a coin. But Salil Mehta, an independent statistician who has blogged about the topic, tells me I’ve been too kind. The forecasters, as a group, are much worse than that.

“It’s not easy to be as bad as they are,” he said in an interview. “They are much worse than random chance alone would predict.”

About every how many years will there be a stock market crash?

Asked on Quora.

Here's one of the answers.

the answer is that there is no set frequency in which crashes occur. It really depends on market conditions, which in turn are driven by sentiment and long-term global economics. If anything, history shows us that crashes come in streaks with long gaps in between the streaks.

Looking at the recent data there are two interesting points to note. The first is that we've had two major crashes in quick succession (2000, 2008) during a 15 year consolidation phase. The second is that market volatility has been very low since 2009 which points to us moving into a much more trending phase of the market once again. If that assessment is correct, then it could mean there won’t be another crash along for quite a while.

As an aside, it’s the availability heuristic and recency bias that leads people to think market crashes must be a regular occurrence, even though the data doesn't appear to support that premise. In fact it’s highly likely people in the 1960s thought that market crashes only happened once in a lifetime, since there hadn't been one for over 30 years.

what rising interest rates could mean

Stock market.  Stocks typically have performed well in the first year after an initial rate increase [which was last year], and the strength tends to persist in year two, albeit at a lessened pace.

Financial stocks.  A widening gap between what banks pay on deposits and charge on loans can help bank stocks.

Utilities stocks.  Utilities stocks tend to underperform, as investors shift to higher-yielding fixed income investments.

[via Schwab]

4 illusions

Here are some of the more common behaviors that can lead to irrational decisions:

Confirmation Bias
This occurs when people look for information that confirms their beliefs rather than the information that might disprove them. Before making a reasoned decision, a trader or investor should consciously look for disproving evidence.

Gambler’s Fallacy
We can wrongly project that probabilities will revert to long-term averages. Here’s an example: A coin flip has produced 5 heads in a row. We project that tails is the most likely outcome of the sixth flip. This is incorrect. The odds remain 50/50.

Availability Bias
This occurs when we give greater weight to information about a security that is more accessible or readily recalled. Traders and investors should take a step back and look at the big picture, rather than making a decision based on what’s currently happening.

Disposition Effect
We can have an emotional aversion to taking a loss in a security even when doing so might be the best decision. On the other side, we can tend to sell winners simply because they have made profits, possibly missing out on future gains.

Similar biases are prevalent among traders and investors as well. According to Dalbar Inc., a financial services market research firm, behavioral biases have led to poor portfolio decisions.

According to a Dalbar study, the average stock fund investor recorded a 4.67% return over a 20-year period (1996-2015) compared with the 8.19% increase in the S&P 500 over the same period. The difference largely comes because investors jumped in and out of the funds at the wrong time. Many panicked and sold at low prices as the market fell, and they were late to buy as the market recovered. In other cases, they attempted to time the market and missed.

“These biases are leading people to the ultimate trap in managing their portfolio – they’re buying high and selling low,” said Joe Correnti, senior vice president of brokerage product at Scottrade. “They’re moving in and out of the market, where sticking with their plan would have served them well.”

By identifying illusions, we hopefully are better able to counteract them.

Reitmeister/Zacks 2016

[12/14/16] The market continues to rotate on a daily basis with a fresh round of winners and losers. On Tuesday there was a strong bias for larger stocks. And yes, even a return to conservative dividend paying stocks that have been out of favor for quite a while.

This is a funny move on the eve of the Fed meeting announcement where they likely will raise rates for the first time in a year. That's because higher rates typically hurts dividend paying stocks the most.

However, it's not so odd when you realize that investors always look to the future. Meaning that months ago everyone knew the Fed was ready to raise rates. So that is when investors got busy selling defensive income producing stocks like REITs, MLPs, consumer staples and utilities.

Now that those groups have been pounded so heavily some money is starting to rotate back. Yet, I bet that is a short lived phenomenon. 2017 will be growth oriented...and smaller cap oriented. Make sure you stay overweight those groups. And underweight conservative, dividend paying stocks.

[10/12/16] The "test" = the 100 day moving average.

Indeed stocks failed that test with the first close under this important support level since the Brexit vote in late June. As you will remember, stocks quickly rebounded followed by a breakout to all-time highs.

This time we have a four pronged attack on stock prices. First, rates continue to be on the rise as economic data has improved and the Fed players are talking tough again. Second, the increased certainty of a Clinton victory hurt healthcare stocks because the industry has been a target of her scorn. Third, oil gave back some of the recent gains. Fourth, Alcoa got earning season started on the wrong foot. Their shares fell -11.4% on the day hurting many other related companies.

What should investors do now?

I saw Tuesday's drop as another reason to buy the dip. My Reitmeister Trading Alert portfolio is now up to 86% long from 62% just a week back. Heck, I'll even tell you the stock I chose. Goodyear Tire (GT) which is a Zacks #1 Rank with VGM Score of A in the #1 Ranked Industry...that is a lot of proven advantages in its favor.

[9/13/16]  VectorVest Views Essay: by Dr. Bart DiLiddo 9/2/16

MS. YELLEN IS NOT RAISING RATES IN SEPTEMBER

Once upon a time the only spokesperson for the Federal Reserve System was the Chairperson. Responding to a call for more transparency, former Chairman, Dr. Ben Bernanke, allowed the Fed's communication policy to change. Now-a-days, Fed Governors and Presidents of Federal Reserve Banks can say whatever they want regarding matters related to the Fed. Unfortunately, the opinions expressed by these officials have caused more confusion than clarity on what the Fed is likely to do. See my essays of May 20, 2016 and June 17, 2016.

In an August 28th editorial, entitled "The Federal Reserve's Politicians," The Wall Street Journal (WSJ) said, "The Fed's decision making is so ad hoc and arbitrary now that no one has any idea of what the Fed will do in December - including Ms. Yellen."

As I see it, even the WSJ editors are confused. Ms. Yellen knows exactly what she's going to do. She's stirring the pot for a potential interest rate hike in December and will not raise interest rates in September. Ms. Yellen remembers what happened after she raised rates last December. In case you forgot, the dollar got stronger and stock markets plummeted.

Even under the best of circumstances, she wouldn't risk upsetting financial markets around the world prior to the November's Presidential election. Ms. Yellen Is Not Raising Rates In September.

[8/10/16] After hitting a three year low back in April the NFIB Small Business Optimism Index has risen for 4 straight months. This is important because small businesses continue to be the main drivers of growth in the US economy...especially employment growth. So the better they feel about the future...the better we investors should feel about the economy and stock market.

Indeed the stock market did rise Tuesday after this news, but not by much. It was yet another sleepy summer session marked by low volume and low volatility. The key is that the market refuses to fall. So it is fairly safe to assume we will have a rendezvous with 2200 in the near future.

Again, it is the aftermath of that event that is subject of debate. Fly higher or consolidate or tumble from profit taking???

I will put it this way...2200 will likely not be the high this year. So perhaps what happens immediately after 2200 is a moot point. As such, I am the most aggressively long the stock market I have been since January of this year.
[7/25/16]  The breakout above 2135 is now two weeks old and we just keep on trucking to new high after new high. At this stage one does have to contemplate where a top may form to take profits.

2200 has a certain appeal as a near term spot of resistance. However, my sense is that it will not be the high for the year as that is a fairly small 3% breakout above the previous highs.

For a FOMO rally to really work its magic, it needs to keep pressing higher thus forcing most every bear to start buying stocks. Thus, up closer to 2300 is a much more likely peak for 2016.

What will be the all time high before the next bear?

Too early to contemplate that as this low yield, no recession environment could keep the bull chugging along for a lot longer. So let's tackle that further down the road.

For now ...keep riding the bull!  
[6/18/16] The following phrase has lost investors more money than just about any in history:

This time is different

That is because history typically does have a way of repeating itself. Thus, to predict that things will be different this time around is often a fool's errand leading to hefty losses.

Unfortunately every now and then that saying is actually very true, making it all the more difficult knowing whether to heed history or ignore it. That is the crossroads we stand at right now where one path leads to a continuation of the 7 year bull market. The other points to the beginning of a new bear market.

The purpose of this article is to share with you some important facts that may indeed point to why this time may be different. And thus why this bull market stays aloft against all the historical odds. Then I will share the details that will eventually pave the way for the next bear and how to invest during these trying times.

Just the Facts Ma'am

No doubt you have read many articles this past year pointing out all the ways in which the current economic and stock market picture looks quite like the beginning of past bear markets. I have put forward many such comparisons. However, I have to admit that none of those past periods had bond rates this low. In fact, in the past 140 years the 10 year Treasury rate has never been this low for an extended period of time.

Low rates punish those who wish to hold cash. This forces many to take on more investment risk to gain a decent rate of return. The stock market being one of the main beneficiaries.

Long story short, this time may be different allowing stocks to reach higher valuations since they are more attractive than putting money to work in bonds or cash. This relationship will hold up as long as rates stay low and there is no fear of a looming recession. Once either of those concepts comes into question, then stocks will begin to fall in a meaningful way.

The Goldilocks Scenario

If you boil it down investors are still bullish because of the current Goldilocks Scenario. That is where economic activity is slow enough to keep the Fed from raising rates...but not so weak as to worry folks about a looming recession.

The merit of why this is attractive is not readily apparent. So let me spell it out for you.

The simplest way to explain it is to say that bonds are the #1 competitor to stocks for investment dollars. The lower the bond rates, the more attractive stocks become.

Why is that?

This is where the Earnings Yield (EY) comes in (S&P 500 annual EPS divided by S&P 500 price...aka the inverse of PE). The best way to appreciate the validity of the earnings yield is to imagine you buy up every share of S&P 500 stocks and take them private. If that were the case you would no longer care so much about the daily fluctuation of stock prices. Instead you would be concerned about your rate of return, which is the amount of profits the companies pay out relative to the cost of your investment in the companies.

We all appreciate that owning any individual company is risky. But owning the bulk of Corporate America is not that much more risky than investment in the US government via treasuries. Thus, the risk premium for owning the S&P 500 should not be that much greater than the 10 year Treasury.

As it turns out the average spread between the 10 year and the S&P 500 earnings yield going back to 1970 is only 0.06%...basically nothing. (This comes from data I pulled from http://www.multpl.com/s-p-500-earnings-yield, which is using a more conservative calculation of earnings than most other sources...but the basic truth remains that the lower bonds rates are, the better it is for stock prices).

According to Multipl.com right now the Earnings Yield is 4.2% while we see that the 10 year stands at 1.5%. The extra return that comes from stocks relative to bonds is why stocks stay aloft at this time. And this relationship is the reason why virtually all other comparisons of this investment landscape to prior periods may be irrelevant.

(Read that last paragraph again...and then one more time so it sticks. Then continue).

Over the last 140 years, the 10 Year Treasury has never been this low. Repeat...it has NEVER been this low. And certainly not this low for such an extended period of time. Thus, all the normal ways we compare this time period with the past to judge if the environment is bullish or bearish may be irrelevant because none of those past periods had rates this low, which tips the scales towards stock ownership.

When Does the Next Bear Market Start?

If all of this is true, then it says the bull market stays in place until bond rates come higher or earnings go significantly lower, thus wrecking the Earnings Yield math advantage over the 10 year yield. That is why slow growth is not an issue because it still keeps earnings high enough to produce better earnings yield than Treasury yield. And that is why every time the Fed seems on hold with moving rates higher is celebrated with a stock rally.

[6/1/16] Tuesday was an interesting session for stocks. On the surface it seems that stocks retreated since the Dow was down -0.5% and the S&P 500 could not stay above 2100 at the close.

However, there truly is more than meets the eye in the Tuesday results when you see that the Nasdaq rallied +0.3% and the small caps in the Russell enjoyed a solid +0.4% session.

Reity, why do you point this out?

Most investment commentators will focus on how the S&P 500 did not breakout above 2100 Tuesday. Yet it is hard to say it was a negative session because the more aggressive/growthy/risky sectors of the market were in the plus column. That "Risk On" mentality is a sign of greater optimism and I sense a leading indicator of more gains ahead.

So yes dear friend, your recently bearish commentator admits that the bulls may be in charge a while longer. Perhaps just to challenge the old highs at 2135 or perhaps pressing to new highs. That is because the #1 ingredient the stock market has going for it right now is pessimism. Yes, pessimism. And according to AAII, pessimism is at a eleven year high.

Remember that the market loves to climb the wall of worry and pessimism is the high octane fuel for that journey. That is because as bears become buyers, that extra demand propels stocks higher. A break above 2100 will certainly add to the upside momentum and I am prepared to ride it for a while all the while looking for signs of the next bear.

Perhaps that is just around the corner. Or perhaps the Muddle Through Economy coupled with ultra low rates creates a unique formula for a historically long bull market that defies most every expectation. I would call that debate a coin toss decision. For now, best to go with the momentum. And a break above 2100 will mean momentum is decidedly to the upside.

[OK, that edges me more in sell mode.  But not screaming sell yet.]

[5/23/16] Saturday May 21, 2016 is the one year anniversary of the last time the S&P 500 made a new high. Whereas most anniversaries are a cause for celebration ...this time is not so pleasant.

Why is that?

Because over the past fifty years there have only been eleven occasions the stock market has gone this long without making a new high. Unfortunately eight of those eleven turned out to be the start of a new bear market (73% of the time).

Yes, that is a small sample and not proof of what is happening now. And as shared in my recent commentary, I truly believe stocks are at a crossroads. Are they ready to break above 2100 and keep running higher or has this rally run out of steam and investors are ready to retest levels below 2000 once again???

Typically I let fundamentals be my guide in predicting that outcome. However, I don't think fundamentals have been part of the investment equation for about three months. Rather, the technicians are in charge. Thus, I will wait for that breakout above 2100 or below 2000 to ride that wave of momentum.

[5/19/16] Even a recent bear like me has to admit that things are not as gloomy anymore. That is not to say we are fully out of the woods, but it does give a nod to the improved economic picture that may keep the next bear market at bay a while longer.

It all boils down to sentiment. Or more specifically, how the stock market often drives sentiment and risk aversion which reverberates into consumer and business economic activity. Indeed the stock market is the leading indicator for the economy which has been proven time and again.

Truly we are at a crossroads for the stock market and the economy. The next breakout move will likely dictate what happens with sentiment and future economic data and therefore the long term trajectory of stocks. Let me be more specific.

If stocks breakout above recent resistance at 2100 it means that concern about the bear have greatly abated. This will continue to heal economic sentiment, which leads to better economic readings, which gives more fuel for even higher stock prices.

However, if stocks break below support at 2000, it will quickly reignite the fears found in the two recent corrections from August/September 2015 and January/February 2016. This would be a damaging blow to economic sentiment with deteriorating fundamentals to follow which will only serve as greater catalysts to the downside. And here I don't mean a retest of the recent low at 1810. I mean a full on bear market sending stocks down a minimum of 20% from recent levels...likely more like 30-40% retreat when all is said and done.

Yes, it is confusing...which outcome will it be? Bull or bear?

Instead of sharing with you just one possibility, I want to share with you two separate views of the market. Each detailed in the following special reports now available to Zacks Ultimate trial customers.

[so that's helpful, now he's saying the market could go up or down..]

[4/9/16]  Reity remains bearish...

On February 8, 2016 I officially made my bear market prediction. That sure looked brilliant for the next few days as stocks tumbled to new lows. Since then I have looked quite foolish as the stock market bounced higher.

The question that needs to be answered is...Am I wrong or am I early?

This led me towards an extensive research project to analyze what previous bull market tops and bear market beginnings looked like. That culminated in a 33 slide video presentation shared with Reitmeister Trading Alert customers on Wednesday 4/6/16.

When you boil that presentation down, the 9 slides shared below truly tell the tale of why a bear market is still on the way. The bulk of them show the S&P 500 price chart from the last five bear markets in order to compare it to the current situation...which looks far too similar.

Please give it your full and fair consideration because if I am right, then stocks will likely drop 30-50% from current levels.

When you review the charts below keep the above concepts in mind. Such as, how many times does the market have false rallies that don't take out the old high? And how long does it meander around before finally succumbing to the downward pressure of the new bear market? Those common traits from the last 5 bear markets are telling signs of what is now taking place.

And now our current market situation. Last high made nearly a year ago. Drops to lower lows followed by bounces to lower highs. Not to mention a current Q1 GDP estimate of only +0.4% and earnings growth going negative.




This ninth and final slide above sums it up. This is currently the 3rd longest bull market of the last 25. Thus, long in the tooth. Plus it is showing the same topping formations discovered in the charts of the last 5 bear markets. Plus economic data is lower than when we last made new highs with near recession level GDP estimates for Q1-2016. And earnings growth has gone negative. All wrapped in a stock market that is above historical valuation norms giving little reason to rise more.

Listen folks. I am not a permabear by any stretch. I rode this bull firmly for several years enjoying ample profits along the way.

However, just like night follows day...so too does a bear follow a bull. It is natural and it is time.

[4/1/16] Kevin Cook here for Reity, paying close attention to this morning's ISM survey...

Being overly cautious-to-bearish in Q1 was not a good strategy. I know because it's a trap I fell into. And now we watch several sectors eclipsing their Q4 highs, with Industrials, Materials, and Energy the standouts as the US dollar weakens further.

Here are the four main drivers of the current exuberance for US equities...

1) Earnings Recession Discounted: Investors seem to believe they have seen the worst at -10% growth for Q1 and that things will only get better from here.

2) Yellen's Fed As Dovish As Ever: The US dollar trended lower throughout Q1 on ideas that the Fed couldn't possibly hike at the March meeting. Since then, the "dot plot" and Yellen make the market believe the doves will only allow one hike this year.

3) Manufacturing Bouncing Back: Regional surveys from Richmond, Philly, Dallas, and Chicago all point to the national ISM number this morning getting back above 50.

4) Fund Managers Can't Miss Rallies: Besides the fact that they "have to buy" stocks with the money they are given, there are still few alternatives to US equity markets.

Now that they are done dressing the windows of their portfolios for Q1, I still believe S&P 1950 comes before new highs in Q2. But the first three drivers remain formidable.

Bottom line: No matter how overbought and overvalued the market is right now, these macro forces could combine to make April another green month for US indexes.

[Reity remains a bear though]

[3/22/16] Reity is back:

The October 2015 rally lasted 35 days and rose 13% in that stretch. The February/March 2016 rally is so far a near perfect replica also gaining just over 13% in 36 days.

My guess is that the comparisons between these two rallies will continue a while longer. That being the end of the big upwards moves for the market. Instead stocks will likely meander around in a trading range for a while.

The trading range scenario after that October rally lasted for nearly two months before the next devastating drop to new lows. I suspect here too it could be 1-2 months going sideways before we head lower. And the reason to head lower is that virtually every vital fundamental metric is currently worse now than in October.

[3/21/16] This is Tracey Ryniec filling in for Steve.

The bulls are getting bolder, as they finished last week on a high note, pushing stocks up into the finish. Investors even abandoned utility stocks, previously 2016's darlings, into the close.

If that's not a bullish indicator, I don't know what is.

It's been awhile since we saw the bulls remain in charge into the close on a Friday. This has been a sustained 5 week rally off the February lows. The bulls haven't even paused. The last time a rally was this powerful after stocks had gone into the abyss was in April and May of 2009.

Many of you remember that time. The world was still in the midst of the Great Recession. Things were grim. Millions were out of work. But stocks defied sentiment and moved higher and never looked back.

This week is a shortened trading week as the exchanges will be closed on Good Friday. Will traders finally be cashing in some of their recent profits?

Friday's trading action seems to indicate the answer will be "no" but all eyes will be on crude and the other commodities, which are still driving the rally.

The story of 2016 is changing. It started on a dark note but you know what they say, it's always darkest before the dawn. Stocks are forward looking. After the last 5 weeks, they seem to be indicating that bright times are ahead.

[at last report, Steve is still predicting a bear market]

[3/19/16 Kevin Cook] I am reevaluating my thesis since October that the current earnings recession makes the market more over-valued with each passing week and thus destined to make new correction lows to the S&P 1700-50 area for a more complete valuation re-set.

If large investors can envision the worst already and see light at the end of the tunnel, then you don't want to stand on the tracks of that bull train. Instead, you want to tactically play the new trading range up to the June Fed meeting between S&P 1900 and 2100.

"Don't fight the Fed" was never more true. The Fed is your ally, if not your friend, in the current macro storms. This week they proved they are still fully committed to supporting the US economy, despite global tremors, and especially during a volatile election year.

You now have the answers to the only two questions that matter currently. And I will continue watching the earnings estimate data closely to see if we could be building a significant bottom in the outlook. 

I believe that's what is getting priced-in and driving stocks higher. And that could mean new highs for the S&P this year, possibly by Q3. 

But in the short-term, I am seeing a cycle top in stocks that should unfold when the last short-covering and late-bull chasing is over. The result could carry the market up to S&P 2080 and back down to 1920 in a matter of weeks.

[2/12/16] The Battle of 1812

Oh, did you think I meant the Battle of 1812 between the US and Great Britain? Sorry, I am referring to the stock market low of 1812 made back in mid-January. We retested that support level today and it stood firm.

Helping the cause was some rumor that OPEC may cut production to bring relief to oil prices. However in the final hour most people realized that was bogus and got right back in a selling mood.

While stock investors sell everything in sight, bond investors are downright giddy with buying. This Risk Off trade has pushed the 10 year Treasury rate all the way down to 1.57%. That is the lowest rate since the summer of 2012.

One could say that is bullish for stocks given the more attractive earnings yield. Or they could look at the low rates as a measure of fear which predicts more pain ahead for stocks...I am in the latter camp.

There may be a little more bounce up from this test of 1812 before testing it again. Sooner or later I expect that support will crumble with a much more important test around 1708 (which marks the official bear market territory of -20% for the S&P 500).

Even if this proves to be nothing more than a nasty correction, I would still be shocked if we didn't test 1708. So do keep that in mind even if you are currently bullish.

[Personally, I would be surprised if it gets that low.  It hasn't been that low since 2013.  Well, we shall see.]

[2/10/16] Bear Market Roll Call

Here is the roll call of world markets already in bear territory:

-21.0% England

-23.2% Japan

-24.3% France

-28.3% Germany

-32.5% Hong Kong

-46.7% China

I know what you are saying. The US is healthier than these other guys. So let me show you what US stock indices are already in bear market mode.

-24.1% Dow Jones Transportation

-25.6% Russell 2000

-26.1% KBW Nasdaq Bank Index

So yes, the S&P 500 is only down -13.2% from the peak. However, the bearish waves from abroad keep hitting our shores and some indices are already drowning. I suspect the S&P 500 is not that far behind. Time to grab a life preserver.

[If he's right, I'll be having more opportunities to nibble.  The problem is how much to nibble.  You don't want to run out of money long before the bottom.]

[2/9/16] Reity's Bear Market Manifesto

There are permabulls who never see the next bear market coming given their unwarranted eternal optimism.

Then there are permabears who are proudly pessimistic even in the midst of a 200% bull rally. The joke is that these types have called 19 of the last 3 bear markets correctly ;-)

Investors should stay as objective as possible to profitably align their portfolios with the prevailing trend. This approach will rarely lead to calling a perfect top or bottom...but you won't be left that far behind as conditions change.

My investment track record shows the ability to go both long and short the market depending on the evidence in hand. And over this past weekend I put the pieces of the puzzle together to realize we are indeed rolling towards the next recession and bear market.

This prompted me to write a 14 page commentary providing the evidence to support my new bear market view and, more importantly, the specific picks to profit in this environment. This was shared early Monday morning with Reitmeister Trading Alert and Zacks Ultimate customers.

Obviously a 14 page commentary is too long to cut and paste below. And it's a bit too valuable to share with free customers as it really is reserved for our paying subscribers. However, I think it's really important that you read this document at this crucial time. So here is the best compromise.

Just start a $1 trial to Zacks Ultimate now which gives you access to the Reitmeister Trading Alert and this vital commentary from Monday morning. Plus it gives you access all our other private portfolios, commentaries and recommendations.

If you cancel within 30 days there will be no further cost to you. Even better, if you truly don't think my bear market commentary was worthwhile, then we will even refund the $1 you paid for the trial.

[1/24/16 Mitch Zacks] Corrections (drops in the 10% - 20% range) are normal, natural occurrences within bull market cycles. Plain and simple. In fact, since 1980 the market has suffered an average intra-year decline of -14.2%. Think about that… -14.2%! Nobody wants to experience that type of decline, but it’s almost always been a part of the investment experience. It comes with the territory. For patient investors, though, positive rewards also come with the territory – in 27 of the 36 years, since 1980, the market finished positive.

To be sure, the knowledge that pullbacks are frequent and normal does not make enduring them any easier. Investors dislike losses more than twice as much as they enjoy gains, so to see a drop in the value of a nest egg is gut-wrenching. I understand that completely. To make matters worse, corrections are almost always sharp, scary declines accompanied by what seems like catastrophic news. In this case, the potentially huge fallout from a slowing China and falling oil prices.

But, both of those are old stories - re-runs from fears we saw emerge throughout the last year. Neither of them should have the power to outright reverse the economic and earnings growth we expect this year. In fact, lower oil prices should ultimately help more sectors than it hurts – it just takes some time for the benefits to flow through.

The Single Most Important Feature of a Market Correction 

Everything I’ve written above you’ve read before in some form. I’ve consistently made my views clear that I think we are still within a bull market cycle and that I see any pullbacks as temporary disruptions. But, in the context of the current downside volatility, I want you to think about it from another angle: if you were to come to me and ask, “Mitch, when would you say is the very best time to invest in equities? My answer would be that, in my experience, the best time to buy stocks is when economic fundamentals are strong and earnings are growing, but no one notices because fear dominates the headlines. Sound familiar? 

If I see red all over the screen, notice an uptick in client calls and find that CNBC is non-stop calling for doomsday – yet nothing has changed with the fundamental outlook for the U.S. or global economy (which we still expect to see grow in 2016) – it makes me even more bullish. The ‘wall of worry’ grows when market activity and investor sentiment divorce themselves from the fundamentals, and that’s precisely what we are seeing now. 

So, with that all being said, what is the single most important feature of market corrections? It’s that, by definition, corrections are short, sharp declines in the market that tend to emerge from redundant fears not associated with earnings and economic fundamentals. Call me crazy, but that is exactly what I see right now. 

Bottom Line for Investors 

Looking back on my personal history as an asset manager, I cannot show you a single time when market volatility didn’t cause clients to worry and want to change their asset allocations. In 1998 the market fell 19% mid-year because of the Long Term Capital Management implosion, yet the market finished up 27%. In 2010 and 2011 the market dropped sharply (-16% and -19%, respectively) on account of fears over the European sovereign debt crisis, yet the bull market pressed-on. History gives us dozens and dozens of similar examples, and in every single one there are investors who give-in to the fear-inducing headlines and abandon their long-term approach. We think a similar action in this environment would be the wrong course of action. 

Of course, I can’t say with certainty that the bull market will work its way through this downside volatility. No one can ever forecast the direction of the market with certainty. But I also cannot imagine anyone convincing me to be bearish in the midst of a sudden and sharp decline when fears are dominating headlines and yet the fundamental outlook for growth, earnings, inflation, and interest rates remain favorable. That, to me, is about as far from bearish as it gets.

[1/21/16] The Reitmeister Nausea Index

The time was 12:53pm ET on Wednesday. The S&P was down a whopping -3.5% causing me to send out the following message to members of the Reitmeister Trading Alert . I thought it was worth sharing with the rest of you as well:

"Long time RTA members may remember my infamous Reitmeister Nausea Index . It truly is a "gut feeling" I get from extreme market sell offs. And when it triggers, we are usually very close to a capitulation point.

Another way to look at it is to say that this sizeable drop is making me sick because it is beyond my rational understanding of what should happen. Historically this gut reaction has been triggered within 1-2 sessions from when a meaningful bounce occurs. Hopefully history repeats itself now.

Unfortunately, what happens after a potential bounce is a bit more of a mystery. Is risk aversion already so high that it will tilt the US into recession with a bear market as the natural outcome? Or do we shake this off and continue to bounce higher given that the solid state of current economic fundamentals?

[1/17/16 Mitch Zacks] China’s wild volatility is back. Investors were greeted in the New Year with a replay of last summer’s Chinese markets drama and big single day downswings in the first week of trading.

It would be unfair to dismiss the effect of China’s volatility on global and U.S. stocks. The impact is real, and the volatility is contagious. But, last summer the market shook it off quickly and I think we’ll see a replay this time around again. It is easy for investors to get swept up in the emotionality of media coverage and the ‘red on the screen,’ but don’t let that drive your investment strategy. Ask yourself: has China’s episode somehow changed the outlook for U.S./global growth, inflation, corporate earnings, or interest rates? Not for us it hasn’t. The impact of this kind of rapid fire volatility is almost always short-term, and the downside ends just as quickly as it begins. Stay steady.

China does not currently correlate very closely with the world. China has experienced three bear markets since 2009 (the world has experienced zero) and its economy has continued to grow throughout. Bear markets with no recessions?! Welcome to China! A big part of the issue is government intervention, but there’s also the fact that China’s main stock market is essentially closed-off from foreign participation. It’s almost entirely traded by Chinese nationals who buy and sell on margin and were influenced into the market through propaganda. In that sense, the Chinese stock market isn’t a great barometer for the Chinese economy, and it’s a worse indicator for the direction of global stocks and the global economy. We think the global economy will do just fine this year and we see this China hysteria as a replay of last year. If anything, it adds a few more bricks to the wall of worry – a good thing.

[1/12/16] What if This is Not Bottom?

After support was broken at 1950, the next important level was 1900 according to most technicians. That level was tested twice on Monday from which shares did bounce higher into a slightly positive finish at 1923.

If 1900 is not bottom, then the next logical support level is 1870, which marked the lows found in late August and once again in late September. That second test proved to be strong support followed by a 13% rally all the way up to 2116.

If stocks cut through 1870 like butter, then it will likely pay for everyone to get more defensive. That is because panic could truly start to set in, which can bring about a whole host of negative consequences on the fundamental side of the ledger.

I am referring to how business executives are part of the investor class. If their fears from stock market losses leaks over into more risk averse business decisions, then what was nothing more than a technical stock problem could become a fundamental one. Meaning that what I describe above is often the chain reaction that can lead to a recession and bear market.

I know that sounds ominous. But remember how many nasty corrections we have endured during this 7 year bull market that did NOT create the negative domino effect noted above. So do not assume that will happen now. I am simply opening your mind to the possibility of why it could be prudent to get more defensive under 1870. Hopefully we find a lasting bounce before we get there.

[1/7/16] In less than a week investors have taken on 3 fresh fears that have caused the market to head lower:

•  More soft economic data from China
•  Increased tensions between Saudi Arabia and Iran
•  North Korea bomb testing.

Really there is nothing new about any of these stories. Investors have been worried about China's economy for three years and yet they continue to grow and the world spins on. And truly, when has there not be tensions in the Middle East? And when has North Korea not done some ludicrous sabre rattling?

Above is my rational response to explain away these issues. However, fear is wholly irrational in nature and thus hard to judge how long, or how deep, its affects. Meaning things could get uglier before better.

In time my rational view should become the norm allowing stocks to rise back up given that GDP continues to expand and bond rates are low, which keeps the long term bull market alive.
Best,

[1/5/16] First Day Farce

We are told that Chinese manufacturing data ruined the first trading day of the New Year. That is patently false. Their numbers were in the same ballpark that they have been for several months.

So what caused their 7% stock decline?

As it turns out, this is just chickens coming home to roost on another gross manipulation of markets by the Chinese government. I am referring to the policies they put in place six months ago during the previous market collapse. One such ruling stopped large shareholders (5% ownership or more) from selling their positions in listed companies. That party ends this Friday and thus some Chinese investors are trying to get out ahead of the potential stampede.

History shows us that the Chinese stock market is pretty disconnected from the actual economy. So this is another "Boy Who Cried Wolf" event like we've had many times over the last several years. Meaning it is a temporary dip caused by unnecessary fear that is followed by a bounce in the market. That is likely why traders rushed in at the end of the US session to bid up stocks 1% into the close.

[1/3/16 Mitch Zacks]  2015 was a fairly disappointing year for most investors with flattish returns and a sizable summer correction that jarred sentiment. To be sure, we weren’t expecting much to begin with for stocks on the year – modest single digit returns that would, perhaps, move in-line with aggregate earnings growth. Therein lied the problem – the year didn’t produce aggregate earnings growth!

The issue, of course, was the Energy sector. We expected weakening earnings with falling crude prices. But, the extent of the damage in the sector was more than substantial given that crude oil prices fell much faster and farther than anyone could have anticipated. The end result is that the Energy sector tugged the aggregate S&P 500 earnings numbers into negative territory, which looks bad on paper but also masks strengths in other areas of the economy.

When 2015 is all said and done, we expect earnings to have fallen 0.3% on the year, and the market’s performance simply to reflect that.

Are There Reasons to be Hopeful Going Forward?

There are plenty. Perhaps the biggest one is that, if you strip away the Energy sector from aggregate S&P 500 earnings, you’ll find that earnings growth was nicely positive on the year for just about every other sector. Additionally, we think the lion’s share of the big losses in Energy are already on the books. Now, it’s a matter of the strong surviving and earnings in the sector leveling-off as crude oil prices do the same.

For the broader S&P 500, consensus has earnings growth for 2016 at +7.8%, which I’d even say is a little too optimistic. I’m looking for earnings more in the 4%-5% range, and I think stock prices could mimic that number just like they did in 2015.

Another big part of looking ahead to 2016 is recognizing the forces that held stocks back in ’15. Earnings growth (ex-Energy) was healthy, so we think it’s safe to assume that there’s a ‘lane’ open for stocks to rise through. Aside from Energy, we think some of the other forces restricting stocks in 2015 should fade in the coming year.

Europe has started to turn the corner into a growth cycle, and the efforts by the European Central Banks to stimulate the broad economy using quantitative easing have largely been effective. But, there were pesky issues holding Europe back from a comfortable growth pattern – there were issues with Russia and the Ukraine, a humanitarian crisis with Syrian refugees seeking asylum, more Greek bailouts and an awful terrorist attack. The good news is that all of those headwinds we see as temporary and surmountable and, beneath the surface, Europe is gaining real strength. It will start to show once those issues fade and could be a boon to global stocks.

Another factor was China’s slowing growth and fears that it is slowing too fast. We see these fears as overblown. China is intentionally making moves to restructure its economy, and a marked slowdown in manufacturing and state investment is the expected collateral damage. It’s weighing on growth, but the media’s fixation on the 7% number seems silly. China’s contribution to global GDP is still enormous if growth falls to 6.5% or even 6%, which seems unlikely.

The recent upwelling of attention on the high yield market also has some worried, with spreads rising and some defaults occurring at the margin. But, again, we have Energy in large part to blame. Junk only comprises about 25% of the total corporate bond market anyhow, and it’s not like the entire junk bond market is doomed. When you look at the aggregate credit picture, the troubled area is just a piece of a piece of the debt market. And that piece is really small.

Bottom Line for Investors

If you take these three headwinds together, what you actually create is that lovely “wall of worry” that stocks yearn to climb. And, that adds to our bullishness. Investors are actively looking for things to fear, and I think this will persist throughout 2016. If it does, and an earnings recovery takes hold in earnest, we expect stocks to do just fine.

Trump wins, now what?

After a historic, hard-fought campaign, businessman and real estate investor Donald Trump is set to become the 45th president of the United States. Given pre-election expectations, a Trump victory may not have been fully reflected in market prices, which could lead to a degree of near-term volatility as investors digest the news. In the end, however, what matters most to investors are key economic drivers like growth, interest rates, investor sentiment, and productivity gains. These drivers often move to their own rhythms, independent of whichever officials or parties happen to be in power. That said, there may be several notable ways the Trump presidency could impact the economy and markets.

Taxes—During the campaign, Trump offered a number of proposals related to tax policy. These included moving from seven to three tax brackets, streamlining deductions, repealing the estate tax, and cutting the corporate tax from 35% to 15%. He also proposed a one-time repatriation tax of 10% on corporate profits held overseas—a move that could enable corporations to use those funds for capital expenditures, dividends, or share repurchases. It’s worth noting, however, that some of these reforms may have a hard time winning approval by Congress. Many believe the likeliest to pass may be some form of tax repatriation and a watered-down tax cut on individuals and corporations.

Health care—One of Trump’s central campaign promises has been the full repeal of the Affordable Care Act (ACA). He also proposed the sale of health insurance across state lines and more favorable tax treatment on premiums. Whether Trump will be successful with ACA repeal will depend on the makeup and disposition of Congress, though it’s likely he’ll at least be able to roll back key parts of the law via presidential powers and the budgetary process. This could potentially boost several sectors of the health care industry, including pharmaceuticals. On the other hand, hospitals and Medicaid providers could suffer, as if they’ll no longer stand to benefit from the higher reimbursements provided by expanded coverage.

Regulatory environment—Based on Trump’s campaign proposals, he’s likely to seek to relax or overturn an array of government regulations. These include Dodd-Frank, the sweeping reform of Wall Street that passed in the wake of the 2008 financial crisis, and the Clean Power Plan, an initiative of the Environmental Protection Agency. In terms of energy policy, Trump has mentioned loosening restrictions on fracking and offshore drilling. Taken together, these actions could serve to benefit companies in a range of sectors—from financials to traditional energy companies, especially those focused on domestic oil exploration and production.

U.S. dollar and foreign affairs—Since Trump does not have traditional experience in foreign policy, this remains an area of some uncertainty. However, he’s consistently spoken out against free trade, and has had particularly contentious words for both Mexico and China. It’s possible that this may have just been campaign rhetoric. If not, and if Trump pursues policies in keeping with what he’s said during the campaign, trade tensions could escalate, and demand for U.S. dollars could wane. Investors may find both issues concerning, especially since strong demand for U.S. dollars has helped minimize inflation and keep yields on U.S. Treasuries at historically low levels.

Ultimately, only time will tell what the market impact of the Trump presidency will be. As with any presidential transition, especially from one party to the other, there may be some bumps in the days and weeks to come. With history as our guide, it’s likely, however, that these will subside as markets adjust.

The Little Book That Beats The Market (Greenblatt's Magic Formula)

[5/3/17] The new Magic Formula?

[10/14/16] Quotes on finding a magic formula

[5/28/13] Does the Magic Formula really work?

[3/12/10] The Magic Formula has trounced every mutual fund from 1998 to 2009.

[8/12/07]“Keep the big picture in mind.” Joel Greenblatt

Thortnon O’glove wrote a terrific book, Quality of Earnings. The book helps the reader understand the nuances of financial statements. The theme is to spot blow ups and fraud by companies before an investor is affected by it. In an interview Thortnon O’glove stated, “I looked at the footnotes but they are not the big picture. Don’t lose the perspective of the big picture. Listen, I lost the big picture.” When an author and analyst is as adept as Thortnon O’glove is, at spotting these errors in the forest of information on companies, states that he lost sight of the big picture, we should all heed notice. Greenblatt has taken Mr. O’glove’s advice and has written the book The Magic Formula. In it Greenblatt focuses solely on enterprise value to earnings before interest and taxes and return on invested capital. These two numbers and the future of these two numbers are what Greenblatt wants to figure out before he invests.

[4/2/07] How to outperform the Magic Formula (part 1)

[2/4/07] John Reese on the Magic Formula

[1/25/07] The Magic Flawmula?

[11/26/06] Robert Haugen indicates that other metrics can be used effectively instead of ROC and earnings yield. [via geraldgianoli@MFI, 11/20/06]

[11/20/06] Joel Greenblatt's course descripton [via falcon880@MFI, 11/13/06]

[11/9/06 from BL@MFI] Victor Niederhoffer and Laurel Kenner investigate the Magic Formula (see 11/9 and 11/7)

[10/17/06] Says gannononinvesting, Greenblatt considers future growth prospects

[10/9/06] Motley Fool CAPS tracks Greenblatt's picks

[9/27/06] David Meier looks at Greenblatt's portfolio

[9/24/06 MFI] Greenblatt video presentation (1 hour) on the Little Book That Beats The Market

[9/20/06] mechanical-investing's take on the Magic Formula

[7/31/06] That Magic Little Book

[6/7/06] MoneySense Magazine interviews Joel Greenblatt [from falcon880 of magicformulainvesting]

[6/4/06] The Joel Greenblatt Way by Brian Zen [magicformulainvesting, 5/31/06]

[5/29/06] Q. In a nutshell, the formula says buy companies with a good return on capital and a good earnings yield. Is it really that simple, or is there another dimension people should add to it? [via brknews, 5/7/06]

A. What the book was trying to do was show that the principle makes sense. And so the whole back-testing thing to see what would've happened if you invested that way - bought a bucket of securities that had those attributes - showed that it would have done very well. That would tend to validate the principle that buying good companies at attractive prices makes sense, which intuitively it does in the first place.

[5/10/06] Randy Harmelink of magicformulainvesting passes along this analysis of Greenblatt's method

[5/4/06] Joel Greenblatt notices that pricing anomalies are not rare occurrences in the market. Look at the 52-week highs and lows of any stock price, he says, and more often than not you'll see a big spread. Look at the range that General Motors traded over the last year: low of $18; high of $38. IBM: low of $72; high of $95. Abercrombie and Fitch: low of $44; high of $74. Do these prices always reflect business values? No, he says, they reflect the mood swings of Mr. Market, his personification of the broad stock market.

[4/19/06] Roger Lowenstein writes about the book (no, not that book) in his column in the May SmartMoney

[4/19/06] r4austin partially answers the 19.9% question saying Forsythe looked at large cap stocks which had lower return than the 30+% which was based on smaller caps. defender23263 has a more cynical view.

[4/17/06] Greg Forsythe, developer of the Schwab Equity Ratings, has written an article for Schwab Investing Insights saying Greenblatt's formula is a good one. But not as good as Schwab Equity Ratings. This is unsurprising considering the source. Mainly because if Forsythe had found otherwise, the article would not likely have been published.

The question I would have is how hard Forsythe kept searching for a test criteria until he found one that beat the Magic Formula. The other question the people over at the magicformulainvesting group have is how Forsythe arrived at the 19.9% performance for the Magic Formula when the book states 30+%.

[4/13/06] Joel Greenblatt is now officially a guru. Evidently he doesn't follow his Magic Formula precisely for his own investments as his holdings reveal only seven stocks, dominated by Viacom and CBS.

[4/13/06] Professor Joseph Piotroski has come up with a Greenblatt scan based on data from Yahoo

[4/6/06] fatpitchfinancials and portfolio123 tackle the Magic Formula

[3/29/06] Bob Haugen answers Greenblatt's claim.

[3/29/06] Bill Alpert's Barrons article: The Little Book's Little Flaw

[3/24/06] Jack Hough's column in the March 2006 SmartMoney magazine is about Greenblatt's Magic Formula.

[3/23/06] Hedge-fund guru Joel Greenblatt applied Wall Street principles to turn around a struggling Queens elementary school. And it worked.

[1/31/06] Shai's notes from his meeting with Joel Greenblatt

[1/31/06] Some thoughts on the Magic Formula [via brknews]

[1/21/06] Andy Cross uses the magicformula to find small caps

[1/20/06] Morningstar's take on the Magic Formula

[1/13/06] Shai reports on Greenblatt's presentation to the NYSSA

[12/29/05 from dnalur at chucks_angels] High Yield Small Cap Stocks: The Magic Investment Formula

[12/27/05 from chucks_angels] I suppose Mauldin must have the ins with Greenblatt since he published this article in his column.

[12/22/05 email from zenway] David Gardner talks with Joel Greenblatt (audio)

[12/21/05] Bill Mann's look at the book

[12/11/05] Brian Zen and Garret Hamai notes of Greenblatt's lecture at NYSSA

[12/8/05] deanvesuvio at the new magicformulainvesting group takes a look at some companies spit out by the magic formula.

[12/8/05] Shai passes along Rajeev's well-written article on ROIC + Earnings Yield

[12/3/05] Interesting. I now see that James O'Shaughnessy (author of What Works on Wall Street) has reviewed the book at Amazon.

[11/26/05] Bill Barker says they (the fools) have been advocates of return on invested capital for a long time.

[11/12/05] brknews mentions that Shai discussed the book in his blog which mentions that Andrew Tobias (who wrote the foreword to the book) discussed the book in his column.

* * *

This book by Joel Greenblatt (more accurately the WSJ article about the book) was discussed over at chucks_angels. Here's the article in case the link breaks one day.


LONG & SHORT
By JESSE EISINGER

Magic Formula
Of Little Book
Just May Work
November 9, 2005; Page C1

As hard as it is to envision, hedge-fund titans and other masters of the universe soon will be tucking themselves into bed with a thin tome bearing a cutesy title: "The Little Book That Beats the Market."

Here's why: The author is Joel Greenblatt, a former hedge-fund manager. His first investment guide, published in 1997, also sported a hokey title, "You Can Be a Stock Market Genius (Even If You're Not Too Smart)," and sold about 38,000 hardcover and softcover copies.

Not bad as first books go, but it also became a cult hit in the insular world of hedge funds, passed like samizdat from manager to manager. A book of war stories and case studies written clearly and laced with jokes, it had two profound insights, say hedge-fund managers who have pressed the book on me.

One was that there are secret hiding places in the stock market, like spinoffs and restructurings, where bargains tend to lurk. The other was there wasn't any compelling reason to have a giant portfolio of dozens of stocks when a well-designed, concentrated portfolio could accomplish the same goal of achieving high returns without adding risk.

"His book on investing is by far the most valuable thing I have read," says David Einhorn, who manages a large, successful hedge fund, Greenlight Capital.

But hedge-fund managers "were not quite the underprivileged group I was shooting for when I wrote it," he says. So for his second book, Mr. Greenblatt says he wanted to write an even more basic and fundamental book on investing that would appeal beyond Wall Street. Think Benjamin Graham does Borscht Belt.

Mr. Greenblatt, 47 years old, says his goal was to provide advice that, while sophisticated, could be understood and followed by his five children, ages 6 to 15. They are in luck. His soon-to-be-released "Little Book" is one of the best, clearest guides to value investing out there. I have some minor quibbles, but in a world where individual-investor advice is dominated by jargon-filled short-termism on the one hand and oversimplified throw-up-your-hands indexing on the other, Mr. Greenblatt's approach is valuable.

It is so simple and cute that an investor with a little bit of knowledge might mistakenly dismiss it. Mr. Greenblatt titles his investment approach a "magic formula." His tongue is in his cheek, but not entirely. He writes as if he were J.M. Barrie spinning a Peter Pan-esque fairy tale, but with the fervor of a true believer:

"You have to take the time to understand the story, and most important, you have to actually believe that the story is true. In fact, the story concludes with a magic formula that can make you rich over time. I kid you not."

What is the magic formula? Invest in good companies when they are cheap. As Mr. Greenblatt might say: See? We told you it sounded obvious. Yeah, so what's "good"? And what's "cheap"?

Good companies earn high returns on their investments, he explains, while cheap companies sport share prices that are low (based on past earnings). His proxies for these criteria are return on capital (operating profit as a percentage of net working capital and net fixed assets) and earnings yield (pretax operating earnings compared with enterprise value, which is the market value plus the net debt). To his credit, however, Mr. Greenblatt explains all that parenthetical jargon in terms that shouldn't insult his peers but that will ring a bell for the unschooled masses.

To make things simpler still, his free Web site, www.magicformulainvesting.com, screens companies using his criteria. He advises individual investors to buy a basket of top stocks and turn them over on a strict schedule, depending on how they perform. (For maximum tax advantage, sell losers just before a year's up, and winners just after a year.)

It sounds too easy. But in fact, his approach is difficult not because it is hard to understand, but because it requires patience and faith that you are right when the market is saying you're wrong.

This is based on Warren Buffett's investment principles. But they bear repeating. Even a die-hard value investor like Mr. Greenblatt says he didn't realize that trying to find cheap, good companies, rather than just cheap ones, was so important until the 1990s. While Mr. Graham, Mr. Buffett's mentor, was looking for starkly cheap companies, Mr. Buffett wants only the great ones.

"I didn't get Buffettized until the early 1990s," says Mr. Greenblatt. "I wish it happened earlier."

Looked at retroactively, the returns of the "magic formula" beat the market handily. From 1988 through 2004, according to Mr. Greenblatt's book, the high-return/low-price stocks of the largest 1,000 companies had returns of 22.9% annually, compared with 12.4% for the S&P 500.

The most convincing part of Mr. Greenblatt's argument is that when 2,500 companies are ranked for price and returns (based on the formula), the top 10% outperformed the second 10%, which outperformed the third 10% and so on. "The darn thing works in order," he says.

There are some limitations to the approach. It seems prone to tossing up stocks whose high returns and growth may be in the past. Magic-formula stocks with more than $1 billion in stock-market value include lots of fast-growing specialty retailers and niche pharmaceutical companies. Some of these will flame out.

That's why Mr. Greenblatt argues that novice investors buy at least 20 or 30 of them. For himself, he buys a smaller number that he can know deeply. But that requires something not easily taught in a book: good instincts and judgment to distinguish true cheap gems from one-hit wonders.

Though he always was a value investor, his hedge-fund firm, Gotham Capital, wasn't always run on his magic formula, especially in the early years, when he tended toward complex arbitrage. He started Gotham in 1985 and ran it for outside investors for 10 years, achieving compounded annual returns, before fees but after expenses, of 50%. He started with $7 million, mostly raised through junk-bond king Michael Milken. After five years, he returned half the outside capital. He finished with more than $350 million and returned all the remaining outside capital.

These days, he spends his time teaching at Columbia Business School and helping run a Web site for pros, the Value Investors Club. His wealth is mostly tied up in Gotham Capital, which manages $1.6 billion, including some outside money in a fund of hedge funds he started a few years back.

His home cooking isn't just good enough for Mr. Greenblatt. He's got his kids eating it, too. His eldest son is doing well following the book's advice. A daughter, at it for two months, is having a rougher time. "I'm not sure if she didn't have me as her daddy she'd be hanging in there," he says.

URL for this article:
http://online.wsj.com/article/SB113149105486391586.html

controlling your emotions

I had the honor and privilege of introducing this year’s luncheon keynote speaker, Rob O’Neill. He was a SEAL Team Six leader and is one of the most highly decorated combat veterans of our time--a true American hero. O’Neill’s mantra is “never quit.”

For an hour and 15 minutes, O’Neill held our attention (not a fork dropped, not an email checked) with his stories from SEAL training and special operations.

The key lessons O’Neill shared during his talk were the importance of preparation, of controlling your emotions, and of never giving up. According to O’Neill, the best plan ceases to be the best plan as soon as it leaves the planning room. Faced with uncertainty, chaos, and extreme emotional stress, it is critical to keep one’s emotions in check.

O’Neill said that our first instincts are typically our worst. Only countless hours of training and emotional discipline can help us overcome these instincts. Per O’Neill, panic breeds panic and calm breeds calm. The former is unproductive, and the latter will keep you on track. Above all else, O’Neill urged his audience to never quit.

My Take-Away:
O’Neill learned these lessons in the highest-stakes scenarios imaginable. However, they’re every bit as relevant in the much lower-stakes setting of investing to reach your financial goals. Particularly relevant is the importance of controlling your emotions and remembering that your first instinct is typically your worst.

Buffett-like funds

while every manager desires Buffett’s results, most do not mimic his investment approach. Concentrated, low-turnover portfolios are not for everybody. There are, however, two dozen U.S. stock mutual funds that could reasonably be called Berkshire Hathaway hopefuls. They have large-value or large-blend investment styles, fewer than 25 stock positions, and annual turnover of less than 50%.

Their collective results stink.

*** [10/1/16]

Well, how about YAFFX (Yackman Focused Fund), which is a fund I own?  I'm looking at the semi-annual report (and data from Morningstar).

The fund has 20 stock holdings with turnover of 6%.

The fund has returned 15.38%, 11.74%, 10.02%, 12.29% for 1, 5, 10, 15 years.
The S&P 500 has returned 15.43%, 16.37%, 7.24%, 7.15%.
Berkshire Hathaway has returned 10.75%, 15.15%, 8.48%, 7.81%.

Morningstar rates the fund three stars silver.

John Szramiak

Who is John Szramiak?  I never heard of him before.  He writes the Vintage Value Investing blog and Gurufocus saw fit to ask him 15 Questions.

1. How and why did you get started investing? What is your background?

I got started investing in a sort of roundabout way... actually, I owe it all to Google. In middle school and high school I was probably on Google for several hours every day - searching different topics and learning about whatever I was curious about that day (it was basically my equivalent to hanging out in a library and trying to read every book). I loved Google the search engine and how you could think of any question and then find the answer to it within a few seconds. And I also loved Google the company - its vision, its culture, its philosophy, its other products, and its success.

So when the financial crisis hit in 2008, I remember looking up Google stock on Google Finance. And it was trading somewhere around $150 per share (adjusted for stock splits) compared to a high of $357. I knew next to nothing about investing, but I knew enough to think to myself "there must be something wrong here" So I did a little research and it didn't take long to figure out that (a) Google as a company was doing fine, but (b) we were in a recession - the worst recession since the Great Depression! So I opened a brokerage account and bought as many shares as I could using all the money I had saved from birthdays and summer jobs.

The stock must've gone up a bit soon after I bought it, because I then became very excited about investing and started doing research (using Google of course) about how to become a better investor. And if you want to teach yourself about investing (and you want to do it for free), then you're pretty much required to start with the writings of Warren Buffett - who just so happens to be the greatest teacher of investing of all time, as well as the greatest investor of all time. In college I studied finance and economics, but I continued to read and teach myself all about value investing outside of class (most value investing concepts are actually never even mentioned in business schools), and I would research stocks and manage my portfolio in my spare time.

As it turns out, I still own all the Google shares I bought and have no plans of selling.

2. Describe your investing strategy

I'm a long-term value investor. What does that mean exactly? Well, first it means that I think that every investment decision absolutely must be based on the comparison of price vs. intrinsic value, and that intrinsic value must be calculated using conservative, fundamental analysis. And second, it means that I like to buy-and-hold for very long periods of time.

On a more tactical level, I really try to follow Warren Buffett's strategy as much as possible: find stocks that are attractively priced, with good free cash flow characteristics, with good long-term prospects, and that I'd be happy to own if the stock market shut down for 5 years starting tomorrow.

3. What drew you to that specific strategy?

I think for some people, when they first learn about value investing, it either clicks right away and makes total sense, or it doesn't and they never really get it. I think it might come down to how some people's brains are hardwired. For me, it just clicked. I'm always baffled when I see people trying to time the stock market, or day trading, or speculating - even the people that end up making tons of money using those strategies, because I have no idea how they do it (in my opinion most of these people end up being lucky, rather than good). So I think intrinsically I've always been a value investor.

10. What kind of checklist do you use when investing?

I don't have a standardized checklist, although I recognize the importance of having one and I plan on writing one out for myself in the near future. But I do have a checklist in my head when I invest. Some of the questions I ask myself are: Is the stock attractively priced? Do I have a margin of safety? Does the company generate strong FCF? Will the company be able to generate as much or more annual free cash flow going forward as it has in the past? Would I be happy to own this stock if the stock market shut down tomorrow and didn't reopen for 5 or 10 years?

Finally, and this is my most important piece of advice, I would recommend that you read everything written by and written about Warren Buffett. Like I said before, he is the greatest investor of all time and the greatest teacher of investing of all time - surpassing even his own mentor, Ben Graham, in my opinion. Buffett has also written so extensively on so many topics and has given so many interviews on current events that you could spend almost a lifetime just reading his works.

So always keep price vs. value in mind, invest for the long-term, and read everything by and about Warren Buffett. Do that, and keep learning, and you'll be a successful investor in no time!

Where are the customer's yachts?

[a book review by Kyle Ferguson]

Earlier this year, I attended my first Berkshire Hathaway meeting that was held in Omaha. During the meeting, Warren Buffett described a book, which he claimed that he read back in 1940 when he was 10 years old, called “Where are the Customers' Yachts?" or "A Good Hard Look at Wall Street."

The book is a fairly fast read at 170 pages. The book was originally published in 1940. It is interesting to note that certain human behavioral tendencies remain the same some 76 years after the book was originally published.

The author, Fred Schwed Jr., challenges the reader early on in the book to answer six questions to determine whether or not they could handle a career on Wall Street.

1. Do you perceive quite clearly what is the objection to playing a roulette wheel that has two zeros on it? (If not, don’t bother to be a financier; be a roulette player.)
2. If a man has tossed a coin “heads” four times in succession, which do you think he is more likely to toss the fifth time, heads or tails? (If you think he is more likely to toss either heads or tails, look into the interior-decorating game. You have that instinctive type of mentality which might do very well at that.)
3. When do you consider that it is a good purchase to draw one card to an inside straight? (Answer when you are playing for soybeans.)
4. If you have answered (3) correctly, do you find that when you are actually playing poker for money, you can always resist making that draw? (If not, stay home with your money and start practicing being a miser.)
5. If a stock which is not paying any dividend is split two for one, how much good does that do the stockholder? (If you think it does him any real good come down and join our sales department, but steer clear of our trading department.)
6. What is the primary purpose of a business enterprise? This question is specifically for young men considering entering the banking field, where they will have a constant parade of business propositions passing before them, and they will be required to plump for a few of them and say “no” to the others. The answer is elementary and obvious: the primary purpose of a business is to make money.

At the time the book was written, there wasn’t the same modern day information that we have available today. During the 1920’s-1930’s, many people irrationally believed that the best stocks were the ones that were the most talked about and the most expensive. These thoughts occurred before a lot of modern day ratios were invented. A time before modern technology had evolved, and before financial ratings such as the Piotroski F-Score, the Altman Z-Score, and the Beneish M-Score were all invented. These scores and rating give modern day investors a much bigger advantage, which allows them to use rational thought, as well as statistical analysis on their investments that enable them to make the “best” most calculated decisions. Instead of irrationally believing that a company is the “best” because it is trading at a high in price or because it is the most talked about security.

Schwed talks about a large number of people set to play a game of pure chance against each other.

“Let us have 400,000 men (and women) engage in this contest at one time. (Something like the number in this country who try being speculators.)

We line them up, facing each other in pairs, across a refectory table miles long. Each player is going to play the person facing him a series of games, the game chosen being a matter of pure luck, say matching coins.  Two hundred thousand on one side of the table face 200,000 on the other side.

If the reader is at all mathematically inclined he should cease reading and work out for himself what is now bound to occur. Otherwise:

The referee gives a signal for the first game and 400,000 coins flash in the sun as they are tossed. The scorers make their tabulations, and discover that 200,000 people are winners and 200,000 are losers.

Then the second game is played. Of the original 200,000 winners, about half of them win again. We now have about 100,000 who have won two games and an equal number who have been so unfortunate as to lose both games. The rest have so far broken even.

The simplest thing from now on is to keep our eyes on the winners. (No one is ever much interested in the losers, anyway)

The third game is played, and of the 100,000 who have won both games half of them are again successful. These 50,000, in the fourth game, are reduced to 25,000, and in the fifth to 12,500. These 12,500 have won five straight without a loss and are no doubt beginning to fancy themselves as coin flippers. They feel they have an “Instinct” for it. However, in the sixth game, 6250 play on and are successively reduced in number until less than a thousand are left. This little band has won some nine straight without a loss, and by this time most of them have at least a local reputation for their ability.

People come from some distance to consult them about their method of calling heads and tails, and they modestly give explanations of how they have achieved their success. Eventually there are about a dozen men who have won every single time for about fifteen games. These are regarded as the experts, the greatest coin flippers in history, the men who never lose, and they have their biographies written.”

I have been studying Warren Buffett for more than 5 years now. After I read Where are the Customers' Yachts?" I remembered that had his own version of a coin flipping story that can be read here.

Conclusion

I thought that "Where Are The Customers Yachts?" was a good book, and I believe that it was a great help in Buffett’s ability to think rationally starting at the age of 10. The book is filled with wisdom, has some comedic value and I understand why it is one of Warren Buffett’s all time favorite books.

8 biggest mistakes investors make

In the stock market, as in life, nothing is certain. The vast opportunities for creating wealth by investing come with plenty of risks, such as the 2008-2009 stock market collapse and plenty of sharp contractions since.

Mistakes? Investor, behold thyself. Here are the most common investing screw-ups, along with advice on how to avoid them.

1.  freaking out in market drops
2.  getting swept up in market euphoria
3.  trading too frequently
4.  putting all your eggs in one basket
5.  treating your home as an investment
6.  failing to rebalance your portfolio regularly
7.  borrowing against stocks
8.  miscalculating a fund's tax basis

How Wells Fargo’s High-Pressure Sales Culture Spiraled Out of Control

Hourly targets, fear of being fired and bonuses kept employees selling even when the bank began cracking down on abuses; ‘not a team player’

By Emily Glazer

Sept. 16, 2016 3:10 p.m. ET

At a sales meeting in Florida in 2014, Wells Fargo & Co. regional executives scolded lower-level managers about an obvious problem that kept cropping up at the bank. Managers were told that their employees should never open accounts for people who don’t exist, people familiar with the meeting recall.

One manager in the room saw things differently. In an email peppered with exclamation points and capital letters, she urged her employees to ignore the bosses and get sales up at any cost, says someone who saw the email.

For more than 15 years, selling more products to customers has been a driving force of the San Francisco company. The term “cross-sell” appears 20 times in the latest annual report by Wells Fargo, which calls its branches “stores” and has the highest return on equity of any large U.S. bank.

The sales culture rooted itself so deeply among employees in Wells Fargo branches that it eventually spiraled out of control. Federal regulators and the Los Angeles City Attorney’s office announced last week that Wells Fargo opened as many as two million deposit and credit-card accounts without customers’ knowledge. The problems affected most of the product types sold in the bank’s 6,000 branches, but few of the accounts made money because customers rarely used them.

“If you could sell, you had a job,” says Scott Trainor, who worked at Wells Fargo in several different jobs until he quit in 2014. He says he was fed up with sales pressure and unethical practices. Managers suggested to employees that they hunt for sales prospects at bus stops and retirement homes, according to Mr. Trainor and other former Wells Fargo employees.

John Stumpf, Wells Fargo’s chairman and chief executive, denies that the company’s culture is obsessed with nonstop selling that ran amok. “Could we have done more, faster, better? Of course,” he says. Mr. Stumpf says he “feels accountable” but adds that some employees didn’t honor the bank’s values.

The scandal mars the reputation of a bank so renowned for its sales prowess that rivals have long tried to emulate it. Large banks have become far more sales-conscious in hopes of squeezing additional revenue from customers.

The mess at Wells Fargo isn’t likely to change that. The bank said this week it will make major changes to its incentive system but won’t back away from cross-selling.

Wells Fargo declined to comment on current and former employees’ descriptions of sales practices at the bank. “We never want a customer to receive a product they do not want or value,” spokeswoman Mary Eshet said Friday. “We are committed to fixing this issue, to strengthening our culture throughout the company and taking the necessary actions to begin restoring our customer’s trust.”

For five years, Wells Fargo conducted investigations into improper practices, hired consultants and tinkered with sales and compensation incentives. Its efforts typically focused on specific offices and regions, but some employees say they got mixed signals, including at the Florida sales meeting in 2014.

The manager who encouraged subordinates to defy their superiors was fired in a crackdown that cost about 5,300 employees their jobs over five years, according to a person familiar with the matter.

The firings were disclosed last week when Wells Fargo was fined $185 million for what regulators called “widespread illegal” sales practices. The bank neither admitted nor denied the allegations.

Questionable sales tactics persisted, though, and were an open secret in Wells Fargo branches across the country, according to interviews with more than three dozen current and former area presidents, district managers, branch managers and other bank employees.

They say many branch managers routinely monitored employees’ progress toward meeting sales goals, sometimes hourly, and sales numbers at the branch level were reported to higher-ranking managers as many as seven times a day. Tension about how to meet the sales targets was common.

“If somebody said: ‘This doesn’t make sense. Where are you getting these sales goals?’ then [the response] was: ‘No, you can do it’ or ‘You’re negative’ or ‘Oh, you’re not a team player,’” says Ruth Landaverde, a former Wells Fargo credit manager in Palmdale, Calif.

She says she often got the same response whenever she said a customer didn’t need another credit card. “The answer was: ‘Yes, they do,’” she says. She quit after being warned she wasn’t reaching her sales goals, she says.

Employees at a Wells Fargo branch in Lincoln, Neb., had a daily goal to open two new checking accounts and make eight other product sales, says Steven Schrodt, who worked there from 2010 to 2012.

Managers asked employees who had fallen short of the targets if they could open accounts for their mother, siblings or friends, according to Mr. Schrodt and other former employees. He says he opened about 15 accounts for friends and family members. Mr. Schrodt says he decided to leave Wells Fargo because the sales pressure was too stressful. He is now in law school.

Bankers in branches who hit sales targets could earn bonuses of $500 to $2,000 per quarter, while district managers could get $10,000 to $20,000 a year, according to six Wells Fargo employees.

Bonuses made a big difference in the paychecks of branch employees, whose base salaries often were about $30,000 a year. According to the bank, tellers are paid $12 to $16.50 an hour, depending on location and experience.

In Tucson, Ariz., some bankers met sales goals by using a list of wealthier, existing customers who were preselected for credit cards, according to a banker who was fired last year for what the bank called unethical behavior.

The customers were told in phone calls that Wells Fargo planned to send them a new credit card as a “thank you” for their business. If a customer didn’t want the card, he was told to cut the card when it arrived in the mail, according to the former banker.

She says those customers weren’t told that issuing each new card required a credit check, which can lower a person’s credit score.

At the end of last year, the average Wells Fargo retail customer had 6.3 products, according to the company. Inside the bank, cross-selling was the brainchild of Mr. Stumpf’s predecessor, Richard Kovacevich, when he led Norwest Corp., which merged with Wells Fargo in 1998.

Mr. Kovacevich wasn’t aware of any cross-selling problems before he retired as CEO in 2007 or left Wells Fargo’s board of directors at the end of 2009, according to a person familiar with the matter.

In the 2010 annual report, Mr. Stumpf said he often was asked why Wells Fargo had set a cross-selling goal of eight. “The answer is, it rhymed with ‘great,’ he wrote. “Perhaps our new cheer should be: ‘Let’s go again, for ten!’

Former branch manager Rasheeda Kamar says her Wells Fargo office in New Milford, N.J., had a goal of selling about 15 new products or services a day. If the branch didn’t hit the goal, the shortfall would be added to the next day’s goal, she says.

Ms. Kamar says laggards were threatened with termination and sometimes criticized in conference calls. In February 2011, she wrote to Mr. Stumpf in an email: “For the most part funds are moved to new accounts to ‘show’ growth when in actuality there is no net gain to the company’s deposit base.” She says she got no reply.

After working for Wells Fargo and its predecessor banks for 22 years, she was let go in 2011 for failing to meet sales targets, she says.

The high-pressure sales environment defied the bank’s official policy. A 2007 internal document titled “Sales Quality Manual” said customer consent “for each specific solution or service is required every time (including each product in a package).”

The document also said “splitting a customer deposit and opening multiple accounts for the purpose of increasing potential Incentive Compensation (IC) is considered a sales integrity violation.”

Despite the warnings, some bank executives noticed around 2009 and 2010 an uptick in bad sales behavior, according to people familiar with the matter. They noticed a rise in activity when the bank was running its “Jump into January” sales program, which set big goals in a month that usually was slow.

About a year later, employee-satisfaction surveys done for Wells Fargo by research firm Q & A Research Inc. showed that some bank employees felt uncomfortable about what managers had asked them to do or when pushing customers to buy products, says Shannon Purvis, who reviewed some of the surveys while working at Q & A. She no longer works there. The research firm’s chief executive, Warren Pino, says its findings are confidential.

In 2012, Wells Fargo’s community-banking unit assembled a special task force to look for suspicious patterns in sales practices and examine areas of the U.S. where customer complaints were prevalent, such as Southern California, according to current and former bank executives.

A former Wells Fargo human-resources executive says the review found that a local management team in the Los Angeles area was “very aggressive” in the use of questionable tactics to do better on sales goals.

In early 2013, Wells Fargo fired about 200 employees. The firings rattled some directors and executives who worked in other parts of the country. Some executives wondered if sales goals were too high or if cross-selling was an underlying problem, the former human-resources executive says.

The conclusion was no. “When we first started looking at it, we didn’t think it was anything other than rogue junior players and a few rogue managers,” says someone involved in the bank’s internal discussions.
Nevertheless, the community-banking unit’s risk-management team increased its oversight and audit capabilities. Wells Fargo also changed parts of the compensation structure.

“We were making changes as quickly as we could, as incrementally as we could, without blowing things up,” one Wells Fargo executive says.

In December 2013, the Los Angeles Times reported questionable sales practices at Wells Fargo offices in Southern California. Los Angeles City Attorney Michael Feuer launched an investigation, and the Office of the Comptroller of the Currency asked the bank to hire consultants to dig deeper.

Wells Fargo hired consulting firm Accenture and law firm Skadden, Arps, Slate, Meagher & Flom LLP to conduct an internal investigation, and Wells Fargo’s board was briefed regularly about the investigation’s progress, according to people familiar with the matter.

As a result, the bank lowered some sales goals and toughened procedures to ensure that new accounts were legitimate. At regional sales meetings, executives stressed the need to make sales properly.

Despite the edicts, the daily routine and pressure to drum up sales in branches didn’t change much, says Randy Holbrook, a personal banker who worked at two Wells Fargo branches in Florida from 2012 to earlier this year.

“Every day around 3 p.m., all the personal bankers were looking at each other and saying: ‘Who are you going to call?’” he says. Mr. Holbrook says missing targets meant working extra hours when the branch was closed to make more calls.

In weeks when the office was closed for a holiday, all of the bankers would have to come in Saturday, Mr. Holbrook says. He says the branch manager shut off his access to the internet when she saw him looking at a sports website instead of hunting for customers. He says the sales pressure caused him to quit.

Higher-ranking executives didn’t realize how much their strategic planning and goals were based on exaggerated numbers, according to people familiar with the matter. A Wells Fargo executive says the person in charge of creating a yearly sales plan for the community-banking unit “had no idea of what was real and what wasn’t in the prior year’s performance.”

In May 2015, the Los Angeles city attorney’s office alleged in a lawsuit that Wells Fargo pressured retail employees to commit fraud. The allegations included opening accounts for people who didn’t exist and charging customers for products without permission. Wells Fargo said it would defend itself.

Wells Fargo hired consulting firm PricewaterhouseCoopers to do an in-depth analysis. About a dozen PwC employees worked on the project for about a year, discovering fraudulent sales practices that were prominent in Phoenix, Miami and Newark, N.J.

Throughout last year, the Consumer Financial Protection Bureau and OCC kept pressing the bank for answers. Earlier this year, Wells Fargo’s top executives and directors were told that the number of employee firings added up to 5,300. The firings peaked in 2013.

“We knew we had problems [and] knew investigations were going on, but we didn’t know it was that many people,” says one person familiar with the matter. “How did this get this far?”

The fired Wells Fargo employees include personal bankers, branch managers, district managers overseeing about a dozen branches each and area presidents overseeing regions. It isn’t clear if any higher-ranking executives were fired or implicated in the sales scandal.

Earlier this year, retail-banking chief Carrie Tolstedt told Mr. Stumpf that she planned to retire after 27 years at Wells Fargo and Norwest. He didn’t object, and Wells Fargo made it clear to regulators that she would be leaving, according to people familiar with the matter. Her retirement was announced in July. She didn’t respond to requests for comment.

The bank said Tuesday it will scrap all product-based sales goals in its retail branches starting Jan. 1, but Mr. Stumpf remains steadfastly committed to cross-selling. “That’s how we’ve grown so much,” he says.

—Christina Rexrode, AnnaMaria Andriotis and Jim Oberman contributed to this article.