in a zone of reasonableness

As bulls and bears fight it out over Dow 16,000 and S&P 1,800, and Carl Icahn says he’s cautious on equities (but doesn’t want to predict where stocks will go in the short term), Warren Buffett is sticking to the middle of the road.

He told CBS This Morning:

“I would say that they’re in a zone of reasonableness. Five years ago, I wrote an article for The New York Times that said they were very cheap. And every now and then, you can see that that they’re very overpriced or very underpriced. Most of the time, they’re in an area where maybe they’re a little high, a little low, and nobody really knows exactly. They’re definitely not way overpriced. They’re definitely not underpriced.”

[via trbabyb]

10 numbers investors should know

Savvy stock pickers know that a few simple formulas and a little math can reveal the difference between a buy and a bust. Here are 10 key investing ratios, what they mean and how to use them.

stocks are cheap? / stocks are expensive?

Despite hovering around record highs, stocks are "cheap on stock valuations alone," said billionaire buy-and-hold investor Ron Baron in a CNBC interview on Friday from his annual investment conference in New York City.

To make his case, Baron provided a history lesson: "From 1999 to now, companies' earnings have about doubled. And the stock market is up 20 or 30 percent. From 2007, it's up maybe 10 percent. People say how much it's up, but it's only up from where it crashed."

As for valuations, he said on Squawk Box that at the height of the Internet bubble "in 1999 the stock market was selling for 33 times earnings." Stocks are now selling for around 14 times, he said. "They're cheap on stock valuations alone."  [well cheaper than 1999 anyway]

*** [11/23/13 from the December Profitable Investing]

Objective signs of an overvalued market have been with us for some time. On a number of occasions, I’ve called your attention to the Cyclically Adjusted Price–Earnings (CAPE) ratio, devised by Prof. Robert Shiller of Yale. To smooth out the sharp earnings fluctuations that occur around recessions, the CAPE ratio takes 10 years of corporate profits and adjusts them for inflation.

As you can see from the chart, the Shiller P/E now stands at more than 24X. Since 1881, this benchmark has averaged 16.5X. Merely to return to fair value, the S&P 500 index would have to drop approximately 32%, to around 1200. An undervalued reading, at 12X, would take the S&P down to less than 900 (from a recent high of 1798).

While I don’t expect to see either 900 or 1200 in the near future, the increasingly noisy “bubble babble” among institutional investors tells us something. Many influential members of the Big Money herd are already nervously pawing the ground. Sooner or later, some incident, perhaps quite minor in itself, will arouse a critical mass of fear among the leading animals. A selling stampede will result.

flashing red

In the go-go days of 1999, Warren Buffett grew very concerned.

Not because his value style of investing had grown unpopular, but because investors were becoming delusional in their zeal for further gains.

In a speech he made to friends, as recounted in a 1999 article in Fortune magazine (that was published just a few months before the market peaked and then plunged), Buffett warned that "once you reach the point where everybody has made money no matter what system he or she followed, a crowd is attracted into the game that is responding not to interest rates and profits but simply to the fact that it seems a mistake to be out of stocks."

A simple test of how much stocks were loved: The aggregate value of the largest 5,000 U.S. companies (as measured by the Wilshire 5000) exceeded the GNP of the U.S. economy. In fact, a market melt-up took this ratio up to 150% by early 2000 (meaning the Wilshire 5000 was 50% larger than the U.S. economy), which set the stage for one of the most painful corrections ever for investors.

This ratio eventually dipped well below 100%, which for Buffett has been seen as a time of deep value for stocks. "If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you," he told Fortune in a 2001 follow-up.

Indeed stocks went on to deliver solid gains into that decade, but by 2007, Buffett's handy ratio again flashed red. Stocks were becoming so frothy that this measure once again exceeded 100%. The resulting market blow-off in 2008 was another painful lesson for investors, but at least put the market deep into value territory, setting the stage for the bull market we've been enjoying ever since.

Yet as we head towards the end of 2013, investors need to once again tread cautiously, because Warren Buffett's market valuation tool is again in the red zone. [109%]

The Wilshire 5000 has risen 68% since the end of 2009. Yet the economy has grown just 17%, throwing this key ratio out of whack.

Action to take: The Wilshire-to-GNP ratio is stretched, but it could well go even higher for a while, as was the case in 1999. Yet a clear margin for error has been removed from this market, and there is ample reason to shift your portfolio into a defensive posture. That means missing out on further upside in the aggressive growth segments of the market, but also means a greater chance of capital preservation.

Principles of Long-Term Investing

This is a basic overview by David Chang, but it doesn't hurt to review...

Part 1

1) Focus on total return

2) Invest for longevity

3) Avoid chasing the crowd

Part 2

4) Be flexible and diversified

5) Buy value, not future economic outlook

6) Take the proper amount of risks

Part 3

7) Learn from your mistakes

the Womack Strategy

Back in 1978, market observer and money manager John Train wrote an article for Fortune magazine titled, How Mr. Womack Made a Killing. The article should be mandatory reading for investors who seem to have an almost desperate need to learn how to buy low and sell high.

The article tells of a young investor meeting a man who never on balance had lost money in the stock market. In fact he had made quite an enormous amount of money over the years. The investor was not a fund manager or trader of great renown, but a farmer who grew rice and raised pigs.

Mr. Womack had a simple approach to the stock market. When he read in the papers that the market was down and the pundits of the day were predicting further collapse and calamity, he would take a break and sit down with a copy of the Standard & Poor's Stock Guide. He would find a bunch of solid dividend-paying companies with strong financials that had dropped to single digits and drive into town and buy a package of them. If they fell a bunch more, he would add to his package.

When he was done buying, Mr. Womack went back to the farm tended the fields and fed the pigs and did not spend much time thinking about stock except to cash his dividend checks. In a few years' time when the daily paper was full of exciting comments about the stock market and predictions of eternal prosperity, he would drive back into town and sell all his stocks.

Mr. Womack told his young friend that stocks were much like pigs. If he could buy them when prices were depressed and keep them until market prices were much higher, he stood to make much more money from his farming operations.

***

I was familiar with this story, but never thought of it as the "Womack strategy" (never realized the guy had a name).  I believe I first read about in John Train's book, The Craft of Investing, where it is included in the appendix.

The other thing I note now, is that in the last paragraph, Train writes "I remind the reader that although this feeling for the rhythm of markets is a useful one to acquire, it is ont the only strategy or even the best strategy.  Probably Mr. Womack would have done just as well by buying and holding growth stocks.  [like Berkshire Hathaway for example, had it been available at the time]

See Grace Groner and Hetty Green and Anne Scheiber as examples of long-term investors.

Joe Granville

When the stock market prognosticator Joseph E. Granville talked, his subscribers listened.

In early 1981, for instance, the Dow Jones industrial average dived 2.4 percent, on what was then the heaviest trading day in history, after Mr. Granville urged his newsletter followers to “sell everything and go short.” It rebounded in the following weeks before tumbling more than 20 percent over the next 15 months.

Mr. Granville, who died on Sept. 7 at 90, was perhaps the most famous of a generation of market seers who made their own fortunes in the less risky venue of the newsletter business, in his case The Granville Market Letter, which he began publishing in 1963.

“I’m paid to put you in at the bottom and take you out at the top,” he declared as he barnstormed the country with a showman’s flair, drumming up subscribers at investment seminars choreographed like Broadway shows.

He once slid to the stage on a 100-foot-long wire wearing his standard After Six tuxedo. He used puppets and clown outfits. He often played a blues song on the piano with lyrics that underscored his contention that Wall Street brokerages were just out to make money off their customers.

Mr. Granville wrote a daily market letter for E. F. Hutton & Company before striking out on his own. At its peak, in the early 1980s, his near-weekly newsletter had 13,000 subscribers. They paid $250 a year — and $500 more for urgent alerts by phone and Telex — as Mr. Granville sought to time the biggest gyrations in the markets.

Louis R. Rukeyser, who often had Mr. Granville on his PBS program, “Wall Street Week,” told People magazine in 1981 that Mr. Granville was “the most controversial man in American finance.”

But while Mr. Granville correctly called a bear market in the late 1970s and the implosion of technology stocks in 2000, he missed other major turns, like the start of an epic bull run in 1982.

And like many other market forecasters, his overall performance was “very poor” compared with that of basic stock index funds, said Mark Hulbert, editor of The Hulbert Financial Digest, which has tracked the performance of investment advisory newsletters since 1980.

Mr. Hulbert said that from 1980 through January 2005, Mr. Granville’s stock tips for investors lost 0.5 percent on an annualized basis, compared with an 11.9 percent average yearly gain for a general stock index. Mr. Granville’s tips for more aggressive traders lost an average 10 percent a year over that period, Mr. Hulbert said.

Mr. Granville, who continued to produce the newsletter until his death, did not provide enough trading details after January 2005 to track his performance as precisely. But he got enough of the broad turns in the market right, Mr. Hulbert said, that if investors had ignored his stock picks and bought or sold an index fund with each major call, they would have earned 8.5 percent a year since 1980.

“He deserves some credit for insight into the market,” Mr. Hulbert said, adding that Mr. Granville created technical indicators still used by many market analysts.

He died in a hospice in Kansas City, Mo., where he was being treated for pneumonia, his wife, Karen E. Granville, said.

Obama to name Yellen as next fed chair

(Reuters) - President Barack Obama will announce his choice of Federal Reserve Vice Chairwoman Janet Yellen to be the next head of the U.S. central bank on Wednesday, putting her on course to be the first woman to lead the institution in its 100-year history.

If confirmed by the U.S. Senate, Yellen would replace Ben Bernanke, whose second four-year term as head of the Fed expires on January 31.

Obama is due to make the announcement at the White House at 3 p.m. EDT, a White House official said on Tuesday. Bernanke is also scheduled to attend.

Yellen has been a forceful advocate of aggressive action to drive down unemployment and would provide continuity with the policies the Fed has established under Bernanke. Now her main challenge will be to steer policy back to a more normal footing and slowly wind down the extraordinary measures taken in the five years since the financial crisis.

does Obama want a market selloff?

President Barack Obama's best friend could be Wall Street's worst nightmare.

A little market crisis -- not enough to crash the economy into recession but enough to stir public fear that would push Republicans to the negotiating table -- could be just what settles the impasse in Washington and reopens the government, according to investing pros and market observers.

In an exclusive interview with CNBC, the president warned Wall Street that this shutdown could be different. Previous halts in nonessential government activities have caused little market reaction, with major averages actually rising most of the time in the month after the shutdowns are settled.

Obama's remarks indicated to some observers that he is trying to push investors out of the relative complacency they have shown so far. Futures were broadly lower Thursday, indicating markets may be taking heed.

"They feel that a severe market selloff would be helpful to break the logjam," said Greg Valliere, chief political strategist at Potomac Research Group in Washington. "It would be helpful in making the Republicans sue for peace. Obama and [Senate minority leader] Harry Reid believe that."

Twitter was abuzz about the interview, with some sharing Valliere's opinion.

car sales rebound to pre-recession levels

DETROIT (AP) — For the U.S. auto industry, the recession is now clearly in the rear-view mirror.

New car sales jumped 17 percent to 1.5 million in August, their highest level in more than six years. Toyota, Ford, Nissan, Honda, Chrysler and General Motors all posted double-digit gains over last August.

The full-year sales pace rose above 16 million for the first time since November 2007, the month before the Great Recession officially started. Exuberant automakers said sales will likely remain at that pace for the rest of this year.

U.S. car and truck sales totaled 16 million in 2007, then plummeted during the recession. They bottomed out at 10.4 million in 2009 and have been rising ever since. In August, they seemed to pick up speed. Mohatarem said he expects the year to end with sales closer to 15.8 million vehicles, which is higher than GM's official forecast of 15.5 million.

home sales on the rise?

Existing home sales increased last month to a seasonally adjusted annual rate of 5.48 million homes. That equates to a 1.7% increase over July and a 13.2% jump over the same month last year. It's the highest level in six and a half years.

While many analysts and commentators had feared that the recent rise in interest rates would weigh on the housing recovery, it now seems as if the trend had an opposite effect. "Rising mortgage interest rates pushed more buyers to close deals," said Lawrence Yun, NAR's chief economist.

The news was similarly upbeat when it came to home prices. According to the trade association's data, the national median existing home price for all housing types was $212,100 in August. That equates to a 14.7% increase on a year-over-year basis and was the strongest such gain since October of 2005, when the median rose by 16.6%.

August marked the 18th consecutive month of year-over-year price increases, and the ninth month in a row that they shot up by double-digits.

***

yeah, but what about new home sales?

New home sales plunged 13.4% in July, in one of the first signs that higher mortgage rates may be cutting into home demand.

Sales fell to a seasonally adjusted rate of 394,000 a year, from 497,000 in June, the Census Bureau reported Friday. Analysts' consensus estimate was 487,000.

Sales were 6.8% higher than last July.

The median price was $257,200, up from $249,700 last month, and there were 171,000 homes for sale at the end of July, representing a five-month supply at the current sales pace, Census said.

The report was concerning because sales fell even though more homes were for sale, said Jed Kolko, chief economist at real-estate Web site Trulia.com. Previously, new home sales have stayed well short of pre-recession highs because of a shortage of homes on the market.

Warren Buffett on the estate tax

Buffett made his position on the estate tax clear when he signed a document stating he believes it is "right morally and economically" because it "promotes democracy by slowing the concentration of wealth and power." In short, he says, dropping the estate tax would wrongly enable the ability to "command the resources of the nation based on heredity rather than merit."

stock performance on the way up

In six weeks, the trailing five-year figures on investments will change dramatically. Today's numbers support the nation's Great Investment Funk.

[For example, U.S. large growth gained 0.70% for the five years ending August 31, 2013]

Once October 2008 disappears off the trailing five-year period, however, the picture will greatly improve.  While I can't provide the figures through Oct. 31, 2013 (that would be a neat trick, wouldn't it?), we can measure the first 58 months of the upcoming 60-month period. They have been kind to stock funds.

[For example, U.S. large growth gained 13.07% for the period November 1, 2008 to August 31, 2013.]

Barring a sudden market collapse, all standardized performance time periods for mutual fund advertisements will soon look strong: one year, five years, and 10 years. (The latter remains burdened with 2008 but no longer carries any trace of the 2000-02 bear market.) In other words, it will become much easier to sell stock funds. When the performance numbers are good across the board, they give the overwhelming visual impression of consistent success.

That strikes me as mixed news. On the one hand, investors could use probably use more stock funds (although recent market action has helped to boost their stock exposure.) Also, I am relatively bullish on long-term stock prospects. But I do admit to feeling a bit nervous about embracing stocks now--especially U.S. stocks. It's been a great run, but, I suspect, the stock market may need to catch its figurative breath. I worry that U.S. stock funds will once again be fashionable just as alternative funds finally become the better performers.

Reitmeister 2013

[12/8/13] Some will argue that stock returns this year are a mirage caused by the extremely accommodative monetary policy of the Fed, specifically QE. Many investors seem to think when QE is taken away, the market will tank and the economy will head back into a recession. I disagree with this notion, as QE has not done what it was intended to do. Certainly it has helped with sentiment, which is part of the reason for the stock rally, but the intent of the Fed was not to just boost sentiment. The purpose was to increase money supply by keeping interest rates low. However, that money has not made its way into the economy because QE has had the effect of flattening the yield curve, which gives banks less incentive to lend, not more.

I believe the stock market rally this year had more to do with improving fundamentals than QE. Heading into 2014, I remain optimistic on stocks and the direction of the economy. I do not see anything on the horizon that should cause an investor to make wholesale changes to their portfolios, as long as the portfolio in question is a well-diversified, properly constructed portfolio. I do not see any major shifts in leadership in the stock market. So, just because it is a new year, I am not changing my forecast, because the date means nothing to me and it should not to you either.

I believe 2014 will be a year of accelerating growth in the economy and another up year for stocks. Since WWII, the S&P 500 has had 18 annual gains of 20% or more and 78% of the years immediately following those great years have been positive.

-- Mitch Zacks

[9/20/13] Investors partied all day and into the night on Wednesday thanks to the No Taper Parade. As they woke up Thursday morning they took a couple aspirins, looked in the mirror and decided they would do it all over again. Meaning that no taper = plenty of reason to rally in the short run.

Very little was given back Thursday as investors digested recent gains and are likely building up the energy to move towards 1750. Recent economic reports add to the luster of this rally such as evident in another very low Jobless Claims report and a Philly Fed report more than double its expected level.

Here is my prediction. I expect stocks to rush up to 1800 this year and then go a bit flat next year. Which is not such a bad thing 5 years into a bull rally. We had a flat year like that in 2011 and stock pickers like us did just fine.

Interestingly, there are parts of the globe where stock markets will push ahead 20%, 30%, even 50% next year. And many of the top stocks there will double and even triple that mark. If you have a good track record chasing down these top opportunities around the globe, then you are all set.

[9/16/13] Stocks are up for 8 out of the last 9 sessions including Friday the 13th in the plus column. And this is on top of a bull rally that has been charging ahead since March 2009.

Too often people underestimate how hard it is to turn a bull into a bear. You need much stronger ammo then what is available right now... especially as economic data is pointing to an accelerating economy.

Reity, any worries about the start of QE tapering at the 9/18 Fed meeting?

NO!!!

My guess is the QE taper will be announced at the 9/18 meeting. And given all the forewarning and market movement to date, then there should be NO reaction to the news. My guess is that the slate of Fed Governor speeches on Friday are there just in case investors get the wrong idea about their policy changes. So they will be at the ready to smooth out the message.

As you know I have no problem with the QE taper and continue to have my pedal on the floor as stocks are still the most attractive investment option at this time. Thus, I will be miffed if the weak hands loosen their grip on the bull once again.

Regardless, I am playing the obvious trend in front of me. If further gains get delayed, then I can patiently wait for them to come around.

[8/30/13] Recently strong economic activity has been met with lower stock prices because it meant the QE taper is coming sooner rather than later. Now we all know the taper is on the way. And so we can get back to a more NORMAL reaction to positive economic news as we did with Thursday's gains.

In particular, I am talking about Q2 GDP being revised up from 1.7% to 2.5%. That's a big deal. Also we got another printing of the weekly Jobless Claims under 350K which bodes well for another month of 150-200K jobs added. That will hopefully be on display next week when the key employment reports come out.

With Syria, the debt limit and a new Fed chair still unknowns, the market may not roar higher just yet. That is why choppy, range bound activity is likely in the of fing. But beyond this period of uncertainly lies greater odds for stocks to move higher.

I am 100% long in preparation for whenever other investors want join me in this logical conclusion.

[9/15/13 Mitch Zacks] There are plenty of reasons to believe the bull market that's been in place since March, 2009 is about to come to a crashing end. The market is up almost 150% since hitting a bottom. The earnings growth last quarter was sluggish. The Fed is about to begin the end of its third iteration of Quantitative Easing ( QE ). Energy Prices are rising. The uncertainty surrounding the situation in Syria, which could end without any military action taken against Bashar al-Assad's regime, is still fluid and could escalate further. Even without military intervention from the U.S. or its allies, the Syrian civil war that started in 2011 will continue. Investors pulled more than $20 billion from ETFs in August, the largest monthly outflow since the first ETF was launched 20 years ago. Historically bull markets last five years on average and were not too far away from hitting that mark. The unemployment number is staying stubbornly high.

Pessimism Reigns

Any investor could be forgiven for wanting to sell their stocks and flock to the comfort of cash or short-term treasuries given all the pessimism that abounds right now. But right now might be time to be a contrarian.

The items mentioned above have made for scary headlines, which the media is won't to do. But there are also many positives regarding the economy and global markets that are being ignored, or at least not talked about much in the media. Not to mention the fact that these reasons for the market and economy to crash have been talked and written about for a some time now. At this point, they are most likely already priced into the market.

Overlooked Positives

You'd have a hard time finding the following positive developments in the mainstream media. Europe's economies rose out of a 22-month recession two months ago. July's manufacturing PMIs broke 50, the expansion number. August PMI's were even stronger. Japan's QE has rekindled strong GDP growth. China's +7.5% annual growth is picking up retail and industrial strength. Stock market highs have stimulated discretionary purchasing.

Furthermore, the August JP Morgan Global Composite Output Index rose 1.2 points to 55, hitting a two and a half year high. The August U.S. employment report showed aggregate hours worked rising 2.4% from last year, despite disappointing job creation. The boost in hours worked is consistent with the strength in the U.S. ISM production indices which were the strongest since 2011. U.S. banks are healthy, with strong balance sheets and rising profits. The U.S. is producing its own energy resources and could become energy independent due to new technologies in oil extraction and our huge supply of natural gas. Corporate profits are at all-time highs and continue to rise. In the U.S. and abroad, manufacturing is improving and retail sales are growing. Falling inventories and rising new factory orders suggest growth is poised to continue.

Putting it All Together

At the end of the day, there will always be weakness somewhere in the economy. Right now however, I believe the positives far outweigh the negatives and thus feel the economic expansion and bull market should continue for the foreseeable future. I don't believe a full-blown market crash is imminent, but you should expect more volatility ahead. When we do finally see a correction, the headlines will get even scarier and natural instinct will be to sell your stocks and take a defensive position. It will be difficult but try to deny that urge and stick with your long-term investment plan.

[8/28/13] Just as stocks seemed ready to head back to 1700+, investors got spooked by a new boogeyman... that being a potential armed conflict with Syria. The investment concern of such a venture, would be that oil prices would likely rise creating a burden for the economy. Also a new debt limit debate is starting to escalate.

Add the two together and it decreases visibility, which leads to greater caution, which leads to a pullback as you have seen the past two sessions.

Reity, how low do we go?

I remain long term bullish, but appreciate there is some short term concern. Tuesday's drop could be the end with a bounce coming. However, a quick shot down to 1600 followed by a bounce is probably more likely. If that doesn't hold, then the next serious level of support is the 200 day moving average at 1560. I am not terribly concerned about heading lower than that at this time.

However, as stated in the past... I don't want to bet on that happening. Too often we see the market jump a lot sooner as investors are still generally in a bullish mood (as they should be 4.5 years into a bull market). So I am willing to suffer the potential for some short term loss in my portfolio, just so the market doesn't jump higher without being properly 100% on board.

You can time the market if you like... I just won't be joining you at this stage for the reasons provided above.

[8/15/13] Bass Ackwards

I thought we were done with this backwards thinking. Yet it reared its ugly head again on Thursday as solid economic data means QE taper coming sooner which means that more chumps are bailing out of stocks.

AND WHERE WILL THEY GO?

Bonds offer too low of a yield. And their value will slip further as rates rise. NO THANKS.

Cash is still paying nothing. NO THANKS.

Gold is a store of money and with no inflation, then not much reason to rise. NO THANKS.

Real Estate has been tempting some folks out of the wood works. But rising mortgage rates may likely stall the advance in prices and thus dampen the investment returns. Plus not everyone enjoys the complications of this illiquid asset. NO THANKS.

So we are back to stocks being the belle of the investment ball. And when this consolidation is over, expect the bull market to continue with 1700 being a weighing station... not final destination.

[7/9/13] Friday's Government Employment Situation did the trick to get stocks back above their 50 day moving average for the first time since mid-June. And that bullish continued on Monday. 

This begs the question: Is the Correction Over?

I believe the answer is YES based upon 3 simple, yet powerful reasons.

1) US economy continues to grow which will aide corporate earnings.

2) Bonds finally losing money with investors moving more money to stocks.

3) The trend is your friend til proven otherwise. Meaning the 4 year bull rally needs to be pushed out of the way for good reason... and that reason doesn't currently exist.

Fight the trend at your own risk.
[6/7/13] There are many ways to access value. But one of best time tested methods is reviewing the earnings yield of stocks versus Treasury bonds.

Traditionally there is a 3% spread between the 10 year Treasury and the earnings yield of the stock market. Right now the 10 year is only at 2.1%. However, I suspect that as QE melts away the rate will float up to more like 3%.

So that would mean that stocks should have a 6% earnings yield, which translates into PE of 16.7 as fair value. Now multiply that by the $115 per share estimate I gave you for next year = 1920 fair value for the S&P 500.

I am not saying it is worth that today. I am saying that is a reasonable target for next year given the likely inputs on earnings and bond rates.

[6/5/13] The see-sawing market continues as we just endured our 7th straight session without stocks moving in the same direction for two consecutive days. Plus the decline on Tuesday marks the end of a 20 week streak of positive gains for stocks. That is the longest such streak since 1900 (not a typo). 

Here is what I see happening now. The Fed is being incredibly transparent about their future intentions. Investors are making most of their portfolio changes now so there will be little disruption when the actual QE tapering begins.

When the smoke clears investors will realize that QE will be removed S-L-O-W-L-Y as to insure that each incremental reduction does not derail economic expansion or employment gains. And even with 10 year Treasury rates floating back up to around 3%, stocks will be hard to overlook given a healthy combination of dividend income and capital appreciation. That is why I took Tuesday's dip as an opportunity to get back to 100% long.

Note that the long term bull market is still intact. We are just going range bound for a little while. However, if you focus on stocks with ingredients to outperform (like Zacks #1 Ranks) then you can produce attractive returns while most other investors come away empty handed.  
[6/3/13] Kevin Cook here to start the week off for Steve...

Last week I made the argument that all the Fed QE3 "taper talk" would bring enough worry and volatility to equity markets to make June the worst month of the year (so far) for stocks. But this was also in the context of one of the best bull runs ever for the first 5 months.

It seems the last day of May got a jump on June with a 1.4% kerplunk. So does Friday's sell-off and crack of short-term support at 1635 mean the big correction is finally coming? I still don't think so.

There is STILL pent-up demand for stocks in an environment where the US growth story is the best place on the planet for investors' money. This means that a dip to S&P 1600 will be bought aggressively after the weak hands are shaken out.

Bottom line: Yes, there will be more worry and caution as we head into the Fed meeting in 2 weeks. But my bet is that 1560 will mark the lows for the summer and therefore building positions anywhere near 1600 will be a good buy.

[5/28/13] Friday was the second straight session that started in a deep hole. Then tick by tick stocks worked their way back to nearly breakeven. There are 2 ways to interpret this action: 

1) Last Throes of this Bull Rally: Often when you have a market that has been on a long bullish run, you will have a couple days just like these. And when the bull has to fight back this hard, it often runs out of steam leading to further declines in the days ahead.

2) Bullish Bias Continues: Sometimes these tea leaves mean that investors REFUSE to become bearish. So they turn every dip into a buying opportunity with more upside on the way.

Reity, which is it?

I have to admit that it's a close call. But if you put a gun to my head and demanded answers I would say 55-60% odds that the bullish bias is the right choice. Unfortunately that means decent odds that we could be in for a more prolonged pullback.

[5/26/13 Mitch Zacks writes] Japanese shares experienced their biggest drop since the Fukushima nuclear disaster in March of 2011. There were two forces spurring the sell-off. Most importantly, Chinese manufacturing data unexpectedly contracted. Additionally, Bernanke indicated that the quantitative easing, like all good things, must eventually come to an end. The result was that the TOPIX Japanese index fell a disconcerting 6.87% in a day.

The magnitude of the selling in Japan shows investors are having trouble believing in the staying power of the rally. There is nothing that happened fundamentally in one day to justify a nearly seven percent downward movement in the Japanese market. With the TOPIX index up around 40% year to date, what essentially happened is that Japanese investors are nervous because of the run-up and were looking for a reason to sell.

There is an undercurrent of skepticism built into this market. This skepticism extends from institutional investors to individual investors. Almost every investor I come in contact with believes, at some level, that the current rally is not sustainable and that a sell-off is due. My belief is that until this skepticism recedes, the market will continue to move higher. What we saw in Japan on Thursday is this skepticism combined with profit taking. It was not a rational response to what Bernanke said, and it wasn’t a rational response to the Chinese manufacturing data. It was selling based on a catalyst because investors believe the market has come too far too fast.

The wall of worry that has been built using the bricks of the 2008 financial crisis remains strong. This bull market will likely continue to climb this wall of worry until there is an almost euphoria regarding the stock market. We are not even close to being there yet. Bull markets don’t end with a bang but with a whimper. Bull markets, in my experience, end when there is almost universal acceptance that the market is heading higher. For this reason, I am far more concerned by the growing herd of Wall-Street strategists raising their end of the year price-targets than with the Japanese sell-off.

Most substantial bull markets are also accompanied by new theories trying to explain why the market should be hitting all-time highs and why traditional P/E multiples are no longer a valid valuation metric. If you think back to the bull market of the late 90’s there was an attempt to try to find a means of valuing stocks that justified the high prices. Even with the current rally, P/E multiples remain in line with average levels. Although the market is hitting new highs, valuation multiples are not hitting new highs.

As a result, if the economic recovery in the U.S. continues, then the market should continue to appreciate at its annual historical rate of roughly six percent above the risk-free rate of return. While some consolidation would not be unheard of, as trees never grow to the sky, ultimately the selling is relatively healthy and the events in Japan do not change the underlying fundamentals of the U.S. recovery.

[5/20/13] At this stage we would need a clearly negative catalyst to stop the market from advancing to 1700 which is only 2% above Friday's close. 

My sense is that stocks will make it there and then a consolidation will ensue with stocks trading in a range between 1600 and 1700. That means you should start taking some trading profits as we approach 1700. Then buy back lower in the range.

[5/5/13] Stocks blasted above 1600 on a strong monthly jobs report. Not only was this month above expectations, but even more impressive, last month was revised higher by 50,000 jobs. This had stocks off to the races. 

I know it is hard to fathom how a higher than normal 7.5% unemployment rate translates into stocks reaching record highs. That boils down to the following:

1) The direction of the economy is more important than the absolute strength of the economy. It has been improving for 4 years and that creates a positive investment environment.

2) Don't Fight the Fed: QE has effectively pushed down bond rates to levels that make all other forms of investment more attractive. Namely real estate and stocks.

These are the trends that matter. It doesn't mean that stocks will go up every day or week or month. And yes, this bull may tire soon. But with the evidence in hand, then I will not be selling this May. Nor will I be walking away. I am here for the stay.

[4/10/13] The S&P 500 climbed to its third highest close in history in eager anticipation of Q1 earnings. Making new highs should be a good thing, but why am I still so uneasy?

•  Soft Economic Reports: Last week provided a Royal Flush of 5 soft economic reports including services, manufacturing and, most importantly, jobs.

•  Every Bull Must Rest: The market is up 10% year to date. Yet earnings growth will only be in the mid-single digits. Yes, stocks can go up by more than earnings growth as long as PE's expand. But there is only so much elasticity in that equation.

•  History Repeating Itself: In 2010, 2011 and 2012 the market raged higher up til April earnings season only to get thwarted. And here we are in April 2013 sitting on a fat 10% gain. It is eerily too similar to the recent past.

•  Large Caps Leading the Way: That is not a positive sign. Rather it says investors are more interested in safety than risk taking. That is often a harbinger of a bearish turn on the way.

This is my short term view of a consolidation or modest correction in the midst of a long term bull rally. Get ready to buy on forthcoming dips.

[2/7/13] Breakeven is Better Than ... Down.

That is the lesson from Wednesday's breakeven showing for US stocks. Even better is that shares were actually down a good spot early in the session before rising to the second highest close since the Great Recession.

What it tells you is that investors can’t find many good reasons to sell stocks. Even when they have rallied almost continuously for the last 3 months. The natural outcome of shares not wanting to go down is that they will probably keep heading higher.

1500 is becoming solid support. Next stop is likely the all-time highs at 1565. At that time I suspect stocks will be ready to rest.

[2/4/13] Friday provided a Royal Flush of economic data to push stocks to a new closing high at 1513. Most important of the bunch was impressive revisions to November and December job adds that proves to be a very positive trend. Then ISM Mfg told a tale of a re-accelerating manufacturing sector. 

Simply the bears are finding fewer reasons to stay committed to their ill-fated cause. Plus fresh investor money is starting to come off the sidelines. This likely spells more upside.

We are only 3.4% away from the all-time highs at 1565. There seems to be a tractor beam pulling us in that direction. Yet when we do arrive, expect serious resistance and a likely good spot to take profits.

[1/16/13] Stocks started in the dumps Tuesday thanks to bad news from across the Atlantic. There we find that Germany is not immune to the economic malaise happening in the rest of Europe. Yes, their economy contracted -0.5% in the most recent quarter.

US investors saw the red from overseas' markets and decided that was the place to start for the States. Yet as the day progressed, stocks moved back into the black. And now we find ourselves just 2 S&P points away from the highs.

Typically a market that fights back from the red intraday is often on its last legs. Then add in the uncertainty coming down the pike from the Cliff 2 debt debates and it makes a case for a consolidation or contraction period. As such, I started taking some profits on Tuesday.

Note this is just my short term read for the market. I still expect the long term bull rally to continue once we get through the debt debates. Trade accordingly to your investment time horizon.

[1/11/13] On Thursday we enjoyed the highest close since the Great Recession at 1472.12. That's just a smidge below the intraday high made on September 14th of 1474.51. We'll be there, and above, soon enough.

So Reity, it's just up and up and up from here?

Not so fast my friends. The next round of concerns will come when the Fiscal Cliff 2 debates heat up in a couple weeks. That being the government cost cutting measures, we should have tackled already, and hitting the debt ceiling once again.

I suspect we will have more of the same kind of kerfuffle as with the Cliff 1 discussions. That being a lot of faux anger and mock gnashing of teeth by both political parties. Then in the final hours a deal will be struck. During this "play fight" investors may get a little spooked with a modest pullback in the works.

Likely stocks will continue their rise towards 1500 in the short run. Then we might want to lighten the load a notch as the Cliff 2 theatrics commence. And then we buy the dips with full expectation for the 4 year bull market to continue on its merry course.

[1/3/13] Stocks soared to start off the New Year thanks to a Cliff deal finally being in hand. The basic construct seems like a reasonable compromise between the desires of the two parties. For me the spending cuts are too light, hopefully we can see the appropriate level of belt tightening in the next round of discussions.

All in all, this deal allows the US economy to stay on its Muddle Through course. That, in conjunction with the attractive valuation of stocks, should equate to more upside in 2013. That's because the market will keep on the long term bull run until a recession is on the horizon or stocks become overpriced.

why be an optimist?

The 2002 book Bringing Down the House told the true story of how six MIT math geniuses mastered blackjack card counting and took Las Vegas for millions. It had money, sex, drugs, and power. People loved it.

But part of the story often went misunderstood. The card-counters didn't win every hand of blackjack, or anything close to it. The casino normally has a slight edge over players. The MIT crew's strategy tipped those odds just barely in their favor. That meant they still lost a lot of bets. "Even the most complex systems seemed to aim at an overall edge of around 2 percent," author Ben Mezrich wrote.

But that tiny edge was all the crew needed to succeed, provided they played long enough. When the odds are even slightly in your favor, you will win over time, even if you lose often in between.

That's why I'm an optimist on the economy and the market. Maybe even a permanent optimist.

Take a look at this chart, showing GDP per capita adjusted for inflation since 1850:

Do you know what happened during this period?

• 1.3 million Americans died while fighting nine major wars.
• Four U.S. presidents were assassinated.
• 675,000 Americans died in a single year from a flu pandemic.
• 30 separate natural disasters killed at least 400 Americans each
• 33 recessions lasted a cumulative 48 years.
• The stock market fell more than 10% from a recent high at least 97 times.
• Stocks lost a third of their value at least 12 times.
• Annual inflation exceeded 7% in 20 separate years.
• The words "economic pessimism" appeared in newspapers at least 29,000 times, according to Google.

And yet our standard of living increased 20-fold.

Being an optimist doesn't mean I don't think bad things will happen. They will. Like the MIT players, I'm going to lose a lot of hands. But also like them, I'm confident that the long-term odds are in my favor.

"Count the perma bears on the Forbes 400 list or the amount of pessimists who run companies in the Fortune 500," Josh Brown writes, "You will find none."

***

Warren Buffett had this wonderful take in the midst of the 2008 crash when everyone around him was losing their minds and preparing for the end of capitalism as we know it:

During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

Buffett was busy buying stocks as he wrote those words in the depths of the crisis and sowing the seeds for huge future gains. What were you doing?

Philip Fisher's other list

If you spend enough time scrolling through the various value investing blogs, you are bound to come across a few lists time and time again; one of those lists is Phil Fisher’s “Fifteen Points to Look for in a Common Stock” (they’re even outlined on Wikipedia here). However, Fisher has also supplied investors with another list that I’ve never seen profiled on these blogs.

1. Buy into companies that have disciplined plans for achieving dramatic long-range growth in profits and that have inherent qualities making it difficult for newcomers to share in that growth.

2. Focus on buying these companies when they are out of favor; that is, when, either because of general market conditions or because the financial community at the moment has misconceptions of its true worth, the stock is selling at prices well under what it will be when its true merit is better understood.

3. Hold the stock until either (a) there has been a fundamental change in its nature (such as a weakening of management through changed personal), or (b) it has grown to a point where it no longer will be growing faster than the economy as a whole. Only in the most exceptional circumstances, if ever, sell because of forecasts as to what the economy or the stock market is going to do, because these changes are too difficult to predict. Never sell the most attractive stocks you own for short-term reasons.

3 changes to the Dow

It doesn't happen often that the folks who bring us the Dow Jones Industrial Average ($INDU +0.85%) bring in three new components.

But there's a reason for the fresh players: They're growing and have less of a chance to be sunk by global forces they can't possibly control.

Those coming in on Sept. 23: investment bank Goldman Sachs (GS +3.54%), athletic equipment maker Nike (NKE +2.17%) and transaction company Visa (V +3.38%).

Saying goodbye to the Dow after Sept. 20 are Alcoa (AA -0.31%), a Dow component for 54 years; Bank of America (BAC +0.90%), which has struggled mightily since the 2008 crash; and Hewlett-Packard (HPQ -0.40%), a tech giant from the 1970s on and inventor of the laser printer.

wars and the stock market

The U.S. and its allies are under increasing pressure to take some action other than humanitarian aid ever since the chemical attack took place. However, overthrowing Syrian President Bashar al-Assad could create a vacuum that Al-Qaeda or some other hard line Islamist group would be happy to fill. Any military action could be a show of force to punish, rather than remove al-Assad. Nobody in the West wants the Syrian civil war to spill over into other countries, which could lead to a much larger conflict and cause oil prices to spike. This in turn would be a negative for the market and for corporate earnings.

Equity Returns Following Wars

I don’t mean to sound callous about any of this but my job is to look at it from an economic perspective. The historical performance of the market following the outbreak of both major and minor wars seems to indicate that, regardless of the actions taken by the U.S. or UN forces, there will likely not be a lasting effect on global equity markets.

For the moment, assume these recent developments drag the U.S. into the middle of another civil war in the region and ground forces are brought in to stop the killing of Syrian civilians. History teaches us that wars are not harbingers of bear markets. Certainly in the short run conflicts can cause the market to drop as people fear the worst and investors’ risk aversion tends to increase.

However, when you look at historical equity returns following the outbreak of a war, you’ll find the wars seem to have a slightly positive impact on the equity markets. There are many examples of this throughout history. One year after the start of WWI in 1914, the Dow Jones Industrial Average (the Dow) dropped 0.98%. Five years after the start of the war to end all wars, the Dow was up 25.54%. From the start of WWII on September 1, 1939, the Dow increased 11.95% after the first month and five years after the outbreak of WWII the Dow was up 8.81%.

These were the two biggest wars of the century and the market shrugged them off and continued higher, although at an annualized rate of appreciation that was lower than the historical average. If you look at some of the smaller wars, the return of the market following the start of fighting is more positive.

In a small conflict the increase in government spending likely helps push GDP growth and corporate earnings higher and is generally positive for the market.

After the start of the Korean War, which like the Vietnam War, was a proxy conflict between the United States and the U.S.S.R, the Dow was up 4.17% after 3 months, 7.36% after 6 months, 15.13% after one year and 110.30% after 5 years. The time period following the start of the Vietnam War in 1962 was not a particularly good time for stocks but not terrible either. Six months after it began, the Dow decreased by 17.56%, but after one year the market was down only 5.15%. Five years after the conflict began the Dow was up 20.11%.

Recent Conflicts

The results are similar for more recent wars. One year following the start of the first Gulf War on August 2, 1990, the Dow was up 4.95% and five years after the start it had increased 63.73%. One year after the start of the war in Afghanistan on October 8, 2001 the Dow had decreased 17.27%, but that had more to do with the tech-led bear market than the war. Five years after the start, it was up 30.77%. The start of the Iraq War in March, 2003 didn’t rattle the market at all as we were in the early stages of a five-year bull market. One year after the start, the Dow was up 23.24% and five years after the start it was up 43.46%.

Since a ground assault at this point seems unlikely, the most similar situation we can compare it to is the Yugoslavian Civil War. When I say similar, I am referring to the military action taken by the U.S., not the reason for the initial conflict. The Civil War started in 1991 but didn’t end until NATO forces ended the war with an air campaign designed to destroy the Yugoslav military infrastructure in 1999. If you’ll recall, 1999 was a great year to be invested in stocks with the Dow rising 25.22%. As I stated earlier, any military action taken against Syria will most likely be a targeted bombing campaign, and based on the historical data it appears that even when the conflict has the potential to drive oil prices higher as was the case in the Gulf Wars, the market does not necessarily perform poorly in the five years following the start of the conflict.

Putting it All Together

It is still unknown how world governments will respond to the tragedy happening in Syria. There is always the possibility that the conflict could lead to a large scale confrontation, with Russia and China intervening on behalf of their commercial ally Syria. Such an event would be a worst-case scenario and would cause the market to sell-off. I feel though that such a scenario is highly unlikely to occur as it is in no country’s best interest for the conflict to escalate. In the current globally interconnected world, no country benefits from the higher oil prices that result from instability in the Mid-East.

I do believe some form of military action will almost assuredly be taken against al-Assad’s regime. If the goal of such action is to punish Assad or just take out his chemical weapons facilities, it will most likely be a non-event as far as the stock market is concerned. I remain far more concerned about the lack of robust corporate earnings growth than the fallout from increased military actions in Syria.

-- Mitch Zacks, ZIM Weekly Update

Factor Investing

Unless you like to open the occasional dusty academic tome, chances are you're not intimately familiar with factor investing. It's really not as esoteric as it sounds. You've heard of style investing--small cap versus large cap, or value versus growth. If you've ever tilted to a particular style, you've engaged in factor investing. Style investing is a kind of factor investing, dealing with only two factors: size (large-small) and value (value-growth).

A working definition of a factor is an attribute of an asset that both explains and produces excess returns. Factor investing can be thought of as buying these return-generating attributes rather than buying asset classes or picking stocks.

None of this is new. The original factor theory, dating back to the 1960s, is the capital asset pricing model, or CAPM, which predicts that the only determinant of an asset's expected return is how strongly its returns move (or, in technical terms, covary) with the market's. The strength of the relationship is summarized in a variable called beta. A beta of 1 indicates that for each percentage point the market moves, an asset's price moves in the same direction by a percentage point. CAPM predicts asset returns are linearly related to market beta. However, since the 1970s, academics have known that stock returns don't seem to be related to beta. This finding spurred many fruitless or convoluted attempts to explain how market efficiency could be squared with a world in which CAPM didn't work.

Eugene Fama and Kenneth French "fixed" the CAPM, at least for stocks, by adding two factors: size and value. They observed that smaller stocks outperformed larger stocks and stocks with high book/market outperformed stocks with low book/market. More importantly, the relationships were smooth; the smaller or more value-laden the stock, the higher its return. Fama and French interpret the smoothness of the relationship as indicating the market is rationally "pricing" these attributes, which implies that size and value strategies enjoy higher expected returns for being riskier.

Further research has uncovered more stock factors, including momentum, quality, and low volatility, in nearly every equity market studied. They also display the same smooth relationship: The stronger the factor attribute, the higher the excess returns. The interpretation of these factors depends on whether you believe the market is efficient. In an efficient market, they must be connected to risk. However, if the market is not perfectly rational, some may represent quantitative strategies that exploit mispricings to produce excess returns.

I don't believe value, quality, momentum, and low-volatility strategies work because they are riskier. The strategies were exploited by investors before academics triumphantly published them in journals as "discoveries." It's also hard to reconcile them all as representing risk because if you lump them all together, you get an eerily smooth return stream.

7 reasons for a September crash

Think last week's 2% decline in stocks was annoying? Get ready for worse.

The reason: September is historically the cruelest month in the stock market. Several potential shockers and market dynamics are aligned to suggest that this year will be no different.

"Late August through roughly the end of September is going to be a difficult period," predicts Fred Dickson, a veteran market commentator whom I've watched make many good market calls in his role as a strategist at Davidson, a brokerage.

"We have a convergence of perfect-storm factors," says Dickson. They include the age of the current bull market, investor complacency, signs of consumer weakening  an imminent change in Federal Reserve strategies, unrest in the Middle East and budget bickering in Washington.

Dickson predicts that major U.S. indexes will fall roughly 5% to 6% from their 200-day moving averages, a common support point in pullbacks. That would be a drop to around 1,554 for the Standard & Poor's 500 Index ($INX) and 14,376 for the Dow Jones Industrial Average ($INDU). But pullbacks of 10% are common in corrections for bull markets as powerful as this one (up about 19% this year alone).

inverted questions

Here are the top 5 inverted questions I like to ask myself when looking at stocks. It helps me break up the mindset of trying to find bullish reasons.

    How can I lose money? vs How can I make money?
    What is this stock NOT worth? vs What is this stock going to be worth?
    What can go wrong? vs What growth drivers are there?
    What is the market implied discount rate? vs What is a fair discount rate?
    What is market implied growth rate? vs What is the future growth rate?

and a bonus question.

    If this drops 50% today, will I buy more? vs When will I sell?

Thank you Charlie Munger for teaching me to “Invert, always invert”.

-- by Jae Jun

value investing is not for everyone

The simple truth is that value investing, especially asset based deep value investing, is not for everyone. For obvious reasons, I am grateful that so few people actually invest this way.

Deep value investing is simply not enough of an action sport for many people. I do not trade every day, or even every week or every month. I hold positions until they work. Sometimes this happens in a few months usually because of a takeover offer or restructuring proposal. Most of the time I end up holding the shares of an undervalued company for several years. I have held positions for over a decade during my career.

Deep value investors do not feel the need to play just because the casino is open. The ringing of the bell at the NYSE does not hold the same significance for me that it does for my more trading oriented friends. Daily market movements are more a curiosity than a matter of life, death, and profit and loss. Quarterly earnings reports are just a checkpoint and not the end all and are all of trading existence. I buy when I identify a solid value that passes my screens and checks. I sell when a holding becomes fairly or overvalued depending on the quality of the underlying business. The rest is just noise.

You will not own exciting stocks. While others chatter at the water cooler or cocktail party about Apples newest phone, surgical robots and other exciting products you will not garner the same attention with your stocks. Asphalt plants, safety garments, and staffing companies are just not going to be as sexy. Although in all probability they will end up making you big money without the risk of permanent loss of capital, no one else will care. You will own stocks no one has ever heard of and for the most part do not want to know about. Deep value investors need to become well versed in literature and sports so as to not be totally ostracized at public gathering.

You have to be able to be a buyer when others around you are selling in a panic. Bargains are not created in a vacuum so you will be buying stuff no one else wants. Your busiest buying binges will come after market meltdowns. John Templeton called this buying at the moment of maximum pessimism. It takes some courage and conviction to be a buyer of bank stocks in a credit crisis or tech stocks after a crash but it works. A deep value investor will often be buying stocks that others are puking up as a result of margin call. Seth Klarman refers to this as being the buyer of last resort and once again it is not easy but it does work. Value types look at corrections and crashes as inventory creation events and not catastrophes

The other side of this is that you will be selling when others are starting to get excited about stocks. It can be frustrating to hold cash balances when others are bragging about huge day trading profits and new paradigms. As market rally to the frothy point and everyone is excited your stocks will become overvalued and you will be selling. It is not market timing so much as a natural part of the value cycle. Cash balances will rise as you are unable to find suitable new bargains to replace stocks you have sold. It will be frustrating until it is rewarded by the inevitable decline and birth of a new value cycle.

Value investing is not for everyone. You will not trade all the time. Your stocks are almost never on TV. You will be selling when friends and neighbors are excited about the market and buying when they are depressed. There is lots of reading involved. It is more like an extra innings pitcher’s duel than a sudden death overtime football game. It has been proven to be wildly profitable over time but many people just do not have the discipline and patience. Fortunately I do.

-- by Tim Melvin

Buffett on cash

Warren Buffett, the largest shareholder of Berkshire Hathaway (NYSE:BRKA), once explained how investors should view cash. He said, “The one thing I will tell you is the worst investment you can have is cash.

Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time. But good businesses are going to become worth more over time. And you don’t want to pay too much for them so you have to have some discipline about what you pay. But the thing to do is find a good business and stick with it.

We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time. But you always want to have enough so that nobody else can determine your future essentially.”

***

Inflation is a major risk of cash. With inflation averaging 3 percent, the value of cash decreases over time. Over 10 years, your money is worth almost half of what it is worth today if only invested in cash. Cash is a great place to store your money for a short period of time until you make your next investment. Cash in itself should not be an investment. Warren Buffett says, “The one thing I will tell you is the worst investment you can have is cash.”

Cash has averaged a negative return. If you look at annual returns for the past 86 years and taking into account inflation and taxes, cash has returned -0.8 percent, where the stock market as returned 4.5 percent and bonds have returned 0.6 percent.

Motley Fool 1-2-3

Good old-fashioned buy-and-hold investing might not be exciting enough to interest daytraders. But it can nevertheless produce exciting longer-term returns — and beat out newfangled strategies.

Consider this: The three top spots in the Hulbert Financial Digest’s five-year rankings of more than 200 investment-advisory services all buy and hold quality companies. Remarkably, all three are subscription newsletters published by the same advisory firm, the Motley Fool in Alexandria, Va., which was founded by brothers Tom and David Gardner in 1993.

The newsletters’ names are Inside Value, Rule Breakers and Stock Advisor, and their model portfolios have produced average annual returns over the period of 18%, 16% and 15%, respectively, each more than doubling the 7.2% return of the overall stock market over the same period, as measured by the Wilshire 5000 index, with dividends reinvested.

Andy Cross, the firm’s chief investment officer, wrote in an email that the firm’s Inside Value service, which focuses on value stocks, searches for “great businesses at beaten-up or misunderstood stock prices.” In contrast, the Rule Breakers newsletter, which focuses on high-growth stocks, searches for “the most innovative companies, often early in their history, that are in disrupting industries.” Finally, the Stock Advisor service searches for “winning businesses with a special edge to keep them winning.”

Since very few stocks are held in common by these three top-ranked services, one must credit the firm’s underlying investment approach for their stellar performance. That philosophy, Mr. Cross said in an interview, is to invest in “great and amazing growth-opportunity businesses” whose full potential “other investors are ignoring,” typically holding them for three to five years.

One particular challenge that investors face in following the Motley Fool’s investment approach is that it requires the all-too-rare discipline of holding on to recommended stocks through bear markets. Mr. Cross points out that investors who bail out of stocks during declines seldom get back into equities in time to participate in the bulk of the subsequent recovery.

“Trying to figure out when to invest is a fool’s errand,” he says, and therefore his firm urges investors to get into “the practice of regularly investing as much as they can” in the stock market.

When questioned about the specific parameters the firm’s investment team uses when picking stocks, Mr. Cross wrote back that it focuses “on where the company, not the stock, will be in the next 3-5 years, and even beyond.” He called the approach “a business-owner mentality more than a ‘stock-buyer’ one,” listing such criteria as assets, competitive advantages, boards and managers and market opportunities.

HFT and the Flash Crash

Boyle and McDougall’s hedge fund doesn’t do high frequency trades, so to find out more I meet Simon Jones, who was running the quants desk at a major bank up until a few months ago. He is 36 years old.

“The guys and women who worked with me were the best of the best. They came from all over the world: from India, Russia and China.” The job was intense and highly competitive. “Let’s say I have noticed that the moment the Dow goes up the FTSE goes up,” says Jones. “The first person to notice that and make a trade can make money but to do that means getting the data from New York to London and then getting my trading decision across the Atlantic and me buying my FTSE before anyone else does.”

In this game speed is critical and that has led to what has been dubbed an arms race between firms. It has got to a point where firms have actually started moving their servers nearer to an exchange to speed up connection times.

In 2010, a company called Spread Networks laid a new direct cable between New York and Chicago, going straight through the Allegheny mountains, which shaved a little bit more than 1,000th of a second off the transmission time between stock exchanges.

For the opportunity to use a similarly fast tube between New York and London, Jones’s old bank was asked to pay $50 million. “It would have given us an advantage over others of about a six thousandths of one second,” says Jones.

This focus on the shortest of short-term gains has vastly increased volatility. “Warren Buffett owns shares in Coca-Cola and when they go down he says 'I’m holding on to them because I think they will go back up’,” says Jones. “But the HFT guy, all he cares about is the next millisecond. And when too many people start panicking about the next millisecond that’s when you have a crash.”

The perfect example of such a crash took place on May 6 2010. So many shares were traded that day that the online trading section of the New York Stock Exchange temporarily froze and between 2.30pm and 3pm the Dow Jones lost and then regained nearly $1 trillion. In what became known as the “Flash Crash”, shares in the management consultancy firm Accenture plummeted to a fraction above zero . Apple shares went up to $100,000.

“None of us knew what to do or what would happen next,” says Dave Lauer, a quant who was working on a HFT desk that day. “It was terrifying.”

For Lauer, the Flash Crash was a wake-up call. “I started to see how the race to be fastest had left things in a very fragile state,” he tells me. The following year his wife revealed she was pregnant which prompted him to make a big decision. “I remember thinking, 'How will I explain to my future child what I do for a living?’” Lauer quit his job and last year told the Senate Banking committee that High Frequency Trading had brought the market to crisis point.

The Flash Crash was partly caused by the HFT strategy of “spoofing”; making bogus offers to buy or sell shares to flush out the intentions of rivals. On the day, an astonishing 19.4 billion shares were traded, more than were traded in the entirety of the Sixties, but hundreds of millions of them were never actually sold; they were merely held for a few thousandths of a second as traders tested the waters.

Isn’t there something wrong with a system that promotes so much volatility to the benefit of no one except a handful of hedge funds? Can it be a meaningful investment of time and technology? Warren Buffett’s business partner, Charlie Munger, has described High Frequency Trading as “basically evil”. “I think it is very stupid to allow a system to evolve where half of the trading is a bunch of short-term people trying to get information one millionth of a nanosecond ahead of somebody else,” he said earlier this year. “It’s legalised front-running.” HFT is certainly of no clear benefit to everyday investors - savers in pension funds and life policies.

The quants I meet don’t believe what they do is necessarily dangerous but they do voice some doubts.

“Some of the guys who come from pure science and maths backgrounds are used to solving a problem and it works,” Patrick Boyle says. “They think they can find a formula that will perfectly describe how the market moves. That is the philosopher’s stone – it is utterly impossible.”

[via ScaleNet]

Jim Simons, the most famous quant of all

Since the 1969 moon landing, the American government had cut funding for science programmes and diverted it to the war in Vietnam.

“A generation of physicists who had gone to graduate school left with their PhDs and entered a severely depressed job market,” explains James Owen Weatherall, author of The Physics of Finance. They had to earn a living somehow, and, seeing how much money that there was to be made on Wall Street, many decided to move into finance.

In Britain, the fall of the Soviet Union led to an influx of Warsaw Pact scientists. In both cases, these scientists brought with them a new methodology based on analysing data and also a faith that, using sufficient computing firepower, it was possible to predict the market. It was the start of a new discipline, quantitative analysis, and the most famous “quant” of all was a shambling donnish maths genius with a scraggly beard and aversion to socks called Jim Simons.

For those who know their physics, Simons is a living legend. A piece of mathematics he co-created, the Chern-Simons 3-form, is one of the most important elements of string theory, the so-called “theory of everything”. Highly academic, Simons never seemed the sort of person who would gravitate to the earthy environs of Wall Street. But in 1982, he founded an extraordinarily successful hedge fund management company, Renaissance Technologies, whose signature fund, Medallion, went on to earn an incredible 2,478.6 per cent return in its first 10 years, way above every other hedge fund on the planet, including George Soros’s Quantum Fund.

Its success, based on a highly complex and secretive algorithm, continued in the Noughties and over the lifetime of the fund, Medallion’s returns have averaged 40 per cent a year, making Simons one of the richest men in the world with a net worth in excess of $10 billion.

Of his 200 employees, ensconced in a fortress-like building in unfashionable Long Island, New York, a third have PhDs, not in finance, but in fields like physics, mathematics and statistics. Renaissance has been called “the best physics and mathematics department in the world” and, according to Weatherall, “avoids hiring anyone with even the slightest whiff of Wall Street bona fides. PhDs in finance need not apply; nor should traders who got their start at traditional investment banks or even other hedge funds. The secret to Simons’s success has been steering clear of the financial experts.”

Detroit files for bankruptcy

The city of Detroit filed for federal bankruptcy protection on Thursday afternoon, making the automobile capital and one-time music powerhouse the country's largest-ever municipal bankruptcy case.

  The case filed in U.S. District Court for the Eastern District of Michigan came after Kevyn Orr, the emergency manager, failed to reach agreements with enough of the bondholders, pension funds and other creditors to restructure Detroit's debt outside of court. The final decision rested with Republican Gov. Rick Snyder, who had appointed Mr. Orr as Detroit's overseer in March.

It was expected that the city would report long-term liabilities close to $20 billion. The city's assets were less clear, but Mr. Orr had called the city functionally insolvent and recently missed a payment to the city's pension system of nearly $40 million.

The financial outlook has never been bleaker for the Motor City, which has shrunk from its peak of nearly two million people in 1950 to 700,000 today.

[wonder if the market will go down tomorrow now]

budget deficit shrinking

Here is a story still under-told. The US federal budget deficit is plunging. It's been in a steady decline for over four years; but the pace at which it's improving has really picked up in the past year, particularly last month. About two-thirds of the improvement has come from the spending side, with the remainder on the revenue (tax receipts) side.

 I suppose that's good relatively speaking, but only in comparison.  It's not that 700 billion in the hole (per year) is good.  It just that it was so horrendously bad at 1.5 trillion in 2010. I guess that's what fighting two wars will do.

I see we were running a surplace in the late 1990's/early 2000's.  I wonder who was president then, in sayy 1998 through 2002.

Let's see.  According to wikipedia, Bill Clinton served from 1993-2001.  That's when the deficit went from negative to positve.  Then George W. Bush from 2001-2009.  And the bottom fell out.  (Bush gets blamed for everything.)  Coincidence of course.

the 1%?

The Koch brothers can get left-leaning Americans' blood boiling just by drawing breath. Imagine the rage when they actually poke the bear a bit.

In its continued bid to leave its liberal counterparts as red-faced, flustered and hyperventilated as George Soros leaves his conservative detractors, the Charles Koch Foundation recently released a commercial that suggests an annual income of $34,000 puts a worker among the wealthiest 1% -- in the world.

The basic premise is that Americans don't need things like food stamps or the minimum wage to help them, because they're already so much better off than poor people in the world around them. The Economic Policy Institute can't help but disagree. Its Family Budget Calculator notes that a family of three would require an income of $45,000 a year to cover basic needs in Simpson County, Miss., the U.S. region with the lowest cost of living for a family of that size.

Bloomberg puts Charles Koch's wealth alone at $43.4 billion. His brother and Koch Industries partner, David, is worth just as much. While that might jaundice their view of what a person on minimum wage needs to survive, Charles Koch insisted to the Wichita Eagle last week that the minimum wage is just one of the items that need to be removed:

We want to do a better job of raising up the disadvantaged and the poorest in this country, rather than saying, "Oh, we're just fine now." We're not saying that at all. What we're saying is we need to analyze all these additional policies, these subsidies, this cronyism, this avalanche of regulations, all these things that are creating a culture of dependency. And like permitting, to start a business, in many cities, to drive a taxicab, to become a hairdresser. Anything that people with limited capital can do to raise themselves up, they keep throwing obstacles in their way. And so we've got to clear those out. Or the minimum wage. Or anything that reduces the mobility of labor.

In Koch's view, these factors put the hurt on "economic freedom." His ad cites a report from the Koch-funded Fraser Institute showing that the "United States used to be a world leader in economic freedom but our ranking fell. And it's projected to decline even further."

predicting the future (is what people want)

Carl Richards writes about our abysmal ability to predict the future:

Forecasts about the future of the market are very likely to be wrong, and we don't know by how much and in which direction. So why would we use these guesses to make incredibly important decisions about our money?

Jason Zweig tries to save investors from themselves:

And while people need good advice, what they want is advice that sounds good. 

The advice that sounds the best in the short run is always the most dangerous in the long run. Everyone wants the secret, the key, the roadmap to the primrose path that leads to El Dorado: the magical low-risk, high-return investment that can double your money in no time. Everyone wants to chase the returns of whatever has been hottest and to shun whatever has gone cold. Most financial journalism, like most of Wall Street itself, is dedicated to a basic principle of marketing: When the ducks quack, feed 'em.

Eddy Elfenbein writes on the amazing growth of dividends in the S&P 500 (SNPINDEX: ^GSPC  ) :

S&P reported that dividends for the S&P 500 grew by 15.49% in the second quarter. This was the tenth-straight quarter in which dividends have risen by more than 12%. 

This is especially impressive because it comes after the dividend surge from Q4 when dividends rose by 22.77% in an effort to beat higher taxes. 

For Q2, the S&P 500 paid out index adjusted dividends of $8.61. Think of it this way: The S&P 500 is currently about 1,625. Every month, it pays out about three points' worth of dividends. For all of 2013, the dividends paid out will be roughly double what was paid out ten years ago.

The Wall Street Journal writes about what falling gold prices are doing to gold miners:

On top of falling metals prices, miners face rising costs. The cost of mining an ounce of gold rose to $775 in 2012 from $280 in 2005, according to BMO. That has left many miners spending more money than they are earning. The shortfall was addressed by raising funds with bonds and shares, but those markets are getting increasingly harder to access.

and four more