Archive for May, 2009
It has already been more than a year since the humble beginnings of Sidoxia Capital Management, LLC in April 2008 (here in lovely Newport Beach, California). Since then, I have written a successful book, How I Managed $20,000,000,000.00 by Age 32, appeared on ABC News, spoken on numerous radio shows, and traveled around to more than a dozen speaking engagements. Now, I am opening the next exciting chapter in my life journey – the launch of my new blog, Investing Caffeine.
Investing Caffeine will wake up your investment brain by tackling the complex issues of investing and financial planning, with the goal of educating and entertaining your mind. You can be the ultimate judge by posting your comments onto Investing Caffeine’s website. Financial topics can be boring, so make Investing Caffeine a part of your routine by injecting a jolt of financial knowledge. See you at my café!
In this stress-filled society dominated with endless amounts of information, and where the masses chase instant gratification, it is difficult to find the time, energy, and focus to curl up to a good book. But in life, knowledge acquisition requires more than a quick keyboard dance on Google.com, or a fleeting skim of a Wikipedia passage. Mastering a subject requires in-depth, nuanced analysis, and books are ideal vehicles used to achieve this aim.
When it comes to the topic of equity investing, it feels as though there are an infinite number of books scattered on the investment menu. Investing in many ways is like religion – there are so many different styles to choose from, even if many of them strive for the same or similar goals. Therefore, I believe if investors are fine-tuning or shopping for an investment philosophy, it makes sense to explore a cross-section of investment styles/religions.
In my view, successful equity investing integrates a balanced mix of “art” and “science.” Too much emphasis on either aspect can be detrimental to investors’ financial health. Although understanding the science takes time, training and patience, generally a committed student can learn the nuts and bolts of investing by mastering the key financial equations, ratios, and concepts. However, becoming a fluent investment artist requires the adept understanding and prediction of human behavior – no easy task.
Having logged thousands of hours and decades of years, my blood shot eyes and finance-soaked brain came up with a balanced mix of “art” and “science” in what I call my, “Top 5 Stock Book Starter Kit”:
A Random Walk Down Wall Street by Burton Malkiel
A great foundational investment book that tackles the major internal and external factors impacting our complex financial markets.
Beating the Street by Peter Lynch
A “Hall-of-Famer” growth investor, Lynch successfully managed the Fidelity Magellan Fund from 1977 to 1990 and averaged a +29% annual return. This book provides countless pearls of wisdom for both the seasoned pro and the bushy-tailed novice.
The Intelligent Investor by Benjamin Graham
When Warren Buffet pronounces this, “By far the best book on investing ever written,” people should pay attention. Graham is considered by many to be the father of “value” investing.
Reminiscences of a Stock Operator by Edwin Lefevre
This book profiles the life and times of early 20th century trader Jesse Livermore, commonly believed to be the greatest trader of all-time. Livermore provides a view into the “fast money” approach that contrasts the traditional “growth” and “value” investment styles.
Common Stocks and Uncommon Profits by Phil Fisher
A Wall Street legend that explains the key factors of superior stock returns.
There you go…upon completion, you will have officially become a stock guru!
Investing can make for a bumpy ride. What can investors do to smooth out the rough financial journey? The simple answer: diversification. If you consider your investment portfolio as a car, then the process of diversification acts like shock absorbers. Those shocks make for a more comfortable ride while preventing potential disasters – like accidentally driving your investments off a cliff.
People generally understand the concept behind, “not putting all your eggs in one basket.” However, once introduced to financial theory terms such as correlation, covariance, and the efficient frontier, people’s eyes begin to glaze over…and rightfully so!
So what are some of the key points one should understand regarding diversification:
- Lunch CAN Be Free! There are very few free lunches in life, but with “diversification” you can indeed get something for nothing. For example, let’s assume you are approached with two investments, ski hats and sun visors, and each investment is expected to deliver a 5% annual return. Furthermore, let’s suppose that zero ski hats are sold in Spring and Summer (and zero sun visors in Fall and Winter). If you merely own one investment, that investment will be more risky (volatile) than a combo portfolio for half the year. Although any combination of two investments will create a 5% return, by diversifying (owning both investments), you can smooth out the ride. There’s your free lunch – the same return achieved for less risk (volatility)!
- Gravity Holds True For Investments Too! Nothing goes up forever, so do not concentrate your portfolio in sectors that have wildly outperformed other sectors/asset classes for long periods of time. Lessons learned over the last 10 years in the areas of technology and real estate highlight the dangers of over-exposure to any one sector in the economy.
- Vary Your Investment Diet! In the Oscar-nominated documentary Super Size Me, Morgan Spurlock decides to eat McDonald’s fast-food for breakfast, lunch, and dinner for thirty days. As a result, his cholesterol levels sky-rocket, he gains over 24 pounds, and his liver function deteriorates significantly. When it comes to your investment portfolio, you should balance it across a wide range of healthy options, including domestic and international stocks and bonds; large and small capitalization stocks; growth and value styles; cash and low-risk liquid investments; and alternative asset classes, such as real estate, commodities, and private investments.
The benefits of diversification will fluctuate under different economic climates. During our recent financial crisis, especially in late 2008, the correlation ratio (the degree that different asset classes move together) unfortunately was very high. However, those investors who were exposed to areas such as Treasury securities, gold, cash, and bonds generally fared better than those who did not. Subsequently, in the early part of 2009, the benefits of diversification shined through as outperformance in emerging markets, technology, consumer discretionary and growth stocks balanced the weakness suffered in banking, transportation, healthcare, bond and value segments.
Diversification helps on the rough roads of investing, so make sure to check those shocks!
The Government, including the Federal Reserve and U.S. Treasury department, is conducting a review of the 19 largest banks that pose “systemic” risk to the overall financial system. Although there will be no “Pass” or “Fail” grade given to the institutions, the government will clarify whether capital-raising will be necessary to weather a worsening economic storm. Scenarios under the stress test will contemplate the impact on the banks’ balance sheets and request capital increases for the weaker banks. The pessimistic case for the banks considers the following hypothetical setting:
Gross domestic product (GDP) declining by -3.3 percent in 2009 and growing by +0.5 percent in 2010.
Unemployment rate reaching 10.3 percent
Home prices to fall by another 29 percent, by 2010.
Right now the government is negotiating with the bank management teams regarding how much, if any, capital-raising will be necessary over the next six months. If the banks are unsuccessful raising capital on their own, then the government will standby to inject government money in to the banks. Rather than using tax-payer dollars, I’m in the camp that the banks’ bondholders should share the pain by converting their debt into equity – thereby relieving the burden on our debt-strapped government and taxpayers. Larry Summers, the Director of the White House’s National Economic Council, has hinted the administration is exploring this route. Regardless, the government needs to strengthen the equity positions of the banks if Bill Ackman at Pershing Square Capital Management is correct in estimating the financial system needing to repay $300 billion in debt coming due in 2009; $280 billion in 2010; and $250 billion in 2011.
In some respects this “Stress Test” is a “Lose-Lose” proposition because if certain banks are forced to raise large sums of capital, then the public will lose confidence in the banks. Conversely, if all the banks come out of the test with a clean bill of health, then the public will lose all confidence in the credibility of the tests themselves. Results will arrive soon enough – let’s hope the stress-test provides relief, not a migraine!
Experts are debating whether the recent bounce experienced in the equity markets is a function of a fundamental turnaround in the economy, or is this more a function of wearing rose-colored glasses after extreme price declines. Irrespective of your view, the S&P 500 Index rose +9.4% in April; the Dow Jones Industrials +7.3%; and the NASDAQ Composite Index +12.4%. After wholesale panic began last September green shoots now appear to be budding through the ashes:
Healthier Than Anticipated Corporate Earnings: Company earnings reports are beating expectations. A +17% bounce in the KBW Bank Sector Index during April is one validating piece of evidence. “The earnings season in general has been better than expected, with 68% of the S&P 500 reporting upside surprises, and we’re three-quarters of the way done,” said Art Hogan, chief market strategist, Jefferies & Co.
Improving Consumer Spending: Despite significant job losses and weak economic activity, consumer spending, which accounts for about 2/3 of Gross Domestic Product (GDP), was up +1.5% in the first quarter of 2009.
Stabilization in Home Prices: Although housing prices continue to decline, existing home unit sales have stabilized over the last four to five months at around 4.5 million homes.
Merger Marriages On the Rise: Merger activity is perking up now that a market bottoming process appears to have commenced. Oracle/Sun Microsystems in technology; Merck/Schering Plough in healthcare; and Pulte Homes/Centex in homebuilding are just a few examples of recent merger marriages.
Capital-Raising on the Rise: Capital markets are functioning much better with bond spreads tightening and the cost of issuance declining for corporations. Beyond the hundreds of billions raised through new bond deals, we are seeing troubled areas like the REITS (Real Estate Investment Trusts) raising vital equity capital as well. Prologis (PLD), Chimera (CIM), Kimco (KIM), Vornado (VNO), AMB (AMB), and Simon Property Group (SPG) have raised over $4 billion in the last few months.