Posts filed under ‘Themes – Trends’

Scrapes on the Sidewalk

Scraped Knees

Baron Rothschild, an 18th century British nobleman and member of the Rothschild banking family, is credited with the investment advice to “buy when there’s blood in the streets.” Well, with the Russell 2000 correcting about -14% and the S&P 500 -8% from their 2014 highs, you may not be witnessing drenched, bloody streets, but you could say there has been some “scrapes on the sidewalk.”

Although the Volatility Index (VIX – a.k.a., “Fear Gauge”) reached the highest level since 2011 last week (31.06), the S&P 500 index still hasn’t hit the proverbial “correction” level yet. Even with some blood being shed, the clock is still running since the last -10% correction experienced during the summer of 2011 when the Arab Spring sprung and fears of a Greek exit from the EU was blanketing the airwaves. If investors follow the effective 5-year investment playbook, this recent market dip, like previous ones, should be purchased. Following this “buy-the-dip” mentality since the lows experienced in 2011 would have resulted in stock advancing about +75% in three years.

If you have a more pessimistic view of the equity markets and you think Ebola and European economic weakness will lead to a U.S. recession, then history would indicate investors have suffered about 50% of the pain. Your ordinary, garden-variety recession has historically resulted in about a -20% hit to stock prices. However, if you’re in the camp that we’re headed into another debilitating “Great Recession” as we experienced in 2008-2009, then you should brace for more pain and grab some syringes of Novocaine.

If you’re seriously considering some of these downside scenarios, wouldn’t it make sense to analyze objective data to bolster evidence of an impending recession? If the U.S. truly was on the verge of recession, wouldn’t the following dynamics likely be in place?

  • Two quarters of consecutive, negative GDP (Gross Domestic Property) data
  • Inverted yield curve
  • Rising unemployment and mass layoff announcements
  • Declining corporate profits
  • Hawkish Federal Reserve

The reality of the situation is the U.S. economy continues to expand; the yield curve remains relatively steep and positive; unemployment declined to 5.9% in the most recent month; corporate profits are at record levels and continue to grow; and the Fed has communicated no urgency to raise short-term interest rates in the near future. While the current headlines may not be so rosy, and the Ebola, eurozone, and Chinese markets may be giving you heartburn, nevertheless, the stock market has steadily climbed a wall of market worry over the last five years.

As the great Peter Lynch stated (see also Inside the Brain of an Investing Genius), “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” Stated differently, Value investor Seth Klarman noted, “We can predict 10 of the next two recessions,” which highlights pundits’ inabilities of accurately predicting the next downturn (see also 100-Year Flood ≠ 100-Day Flood). As Lynch also adds, rather than trying to time the market, it is better to “assume the market is going nowhere and invest accordingly.”

Now may not be the time to dive into stocks headfirst, but many stocks have fallen -10%, -20%, and -30%, so it behooves long-term investors to take advantage of the correction. It’s true that buying when there is “blood in the streets” is an optimal strategy, but facts show this is a difficult strategy to execute. Rather than get greedy, long-term investors may be better served by opportunistically buying when there are “scrapes on the sidewalk.”

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in  certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

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October 18, 2014 at 8:50 pm Leave a comment

The Pain of Diversification

Pressure

The oft-quoted tenet that diversification should be the cornerstone of any investment strategy has come under assault in the third quarter. As you can see from the chart below, investors could run, but they couldn’t hide. The Large Cap Growth category was the major exception, thanks in large part to Apple Inc.’s (AAPL) +8% appreciation. More specifically, seven out of the nine Russell Investments style boxes were in negative territory for the three month period. The benefits of diversification look even worse, if you consider other large asset classes and sectors such as the Gold/Gold Miners were down about -14% (GDX/GLD); Energy -9% (XLE); Europe-EAFE -6% (EFA); Utilities -5% (XLU); and Emerging Markets -4% (EEM).

*Results are for Q3 – 2014 (Source: Vanguard Group, Inc. & Russell Investments)

*Results are for Q3 – 2014 (Source: Vanguard Group, Inc. & Russell Investments)

On the surface, everything looks peachy keen with all three major indices posting positive Q3 appreciation of +1.3% for the Dow, +0.6% for S&P 500, and +1.9% for the NASDAQ. It’s true that over the long-run diversification acts like shock absorbers for economic potholes and speed bumps, but in the short-run, all investors can hit a stretch of rough road in which shock absorbers may seem like they are missing. Over the long-run, you can’t live without diversification shocks because your financial car will eventually breakdown and the ride will become unbearable.

What has caused all this underlying underperformance over the last month and a half? The headlines and concerns change daily, but the -5% to -6% pullback in the market has catapulted the Volatility Index (VIX or “Fear Gauge”) by +85%. The surge can be attributed to any or all of the following: a slowing Chinese economy, stagnant eurozone, ISIS in Iraq, bombings in Syria, end of Quantitative Easing (QE), impending interest rate hikes, mid-term elections, Hong Kong protests, proposed tax inversion changes, security hacks, rising U.S. dollar, PIMCO’s Bill Gross departure, and a half dozen other concerns.

In general, pullbacks and corrections are healthy because shares get transferred out of weak hands into stronger hands. However, one risk associated with these 100 day floods (see also 100-Year Flood ≠ 100-Day Flood) is that a chain reaction of perceptions can eventually become reality. Or in other words, due to the ever-changing laundry list of concerns, confidence in the recovery can get shaken, which in turn impacts CEO’s confidence in spending, and ultimately trickles down to employees, consumers, and the broader economy. In that same vein, George Soros, the legendary arbitrageur and hedge fund manager, has famously written about his law of reflexivity (see also Reflexivity Tail Wags Dog). Reflexivity is based on the premise that financial markets continually trend towards disequilibrium, which is evidenced by repeated boom and bust cycles.

While, at Sidoxia, we’re still finding more equity opportunities amidst these volatile markets, what this environment shows us is conventional wisdom is rarely correct. Going into this year, the consensus view regarding interest rates was the economy is improving, and the tapering of QE would cause interest rates to go significantly higher. Instead, the yield on the 10-Year Treasury Note has gone down significantly from 3.0% to 2.3%. The performance contrast can be especially seen with small cap stocks being down-10% for the year and the overall Bond Market (BND) is up +3.1% (and closer to +5% if you include interest payments). Despite interest rates fluctuating near generational lows with paltry yields, the power of diversification has proved its value.

While there are multiple dynamics transpiring around the financial markets, the losses across most equity categories and asset classes during Q3 have been bloody. Nonetheless, investing across the broad bond market and certain large cap stock segments is evidence that diversification is a valuable time-tested principle. Times like these highlight the necessity of diversification gain to offset the current equity pain.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AAPL, BND, and certain exchange traded funds (ETFs), but at the time of publishing SCM had no direct position in EEM, GDX, GLD, EFA, XLE, XLU, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

October 11, 2014 at 8:55 am Leave a comment

Mathematics 101: The Cheap Money Printing Machine

Woman Using Atm Machine

Like many other bloggers and pundits, I have amply pontificated on the relative attractiveness of the stock market. For years, cash and gold hoarding bears have clung to the distorted, money-losing Shiller CAPE P/E ratio (see CAPE Smells Like B.S.), which has incorrectly signaled investors to stay out of stocks and miss trillions of dollars in price appreciation. Apparently, the ironclad Shiller CAPE device has been temporarily neutralized by the Federal Reserve’s artificially cheapening money printing press policies, just like Superman’s strength being stripped by the nullifying powers of kryptonite. The money printing logic seems so elegantly sound, I felt compelled to encapsulate this powerful relationship in an equation:

Interests Rate Cuts + Printing Press On = Stocks Go Higher

Wow, amazing…this is arithmetic any investor (or 3rd grader) could appreciate! Fortunately for me, I have a child in elementary school, so I became emboldened to share my new found silver bullet equation. I initially received a few raised eyebrows from my child when I introduced the phrase “Quantitative Easing” but it didn’t take long before she realized Rate Cuts + QE = Fat Piggy Bank.

After the intensive tutorial, I felt so very proud. With a smile on my face, I gave myself a big pat on the back, until I heard my child say, “Daddy, after looking at this squiggly S&P 500 line from 2007-2014, can you help my brain understand because I have some questions.”

Here is the subsequent conversation:

Me: “Sure kiddo, go ahead shoot…what can I answer for you?”

Child: “Daddy, if the Federal Reserve is so powerful and you should “not fight the Fed,” how come stock prices went down by -58% from 2007 – 2009, even though the Fed cut rates from 5.25% to 0%?”

Me: “Uhhhh….”

Child: “Daddy, if stock prices went down so much after massive rate cuts, does that mean stock prices will go up when the Fed increases rates?”

Me: “Uhhhh….”

Child: “Daddy, if Quantitative Easing is good for stock prices, how come after the QE1 announcement in November 2008, stock prices continued to go down -25%?”

Me: “Uhhhh….”

Child: “Daddy, if QE makes stocks go up, how come stock prices are at all-time record highs after the Fed has cut QE by -$70 billion per month and is completely stopping QE by 100% next month?”

Me: “Uhhhh….”

Child: “Daddy, everyone is scared of rate increases but when the Fed increased interest rates by 250 basis points in 1994, didn’t stock prices stay flat for the year?”

Me: “Uhhhh….” (See also 1994 Bond Repeat)

What started as a confident conversation about my bullet-proof mathematical equation ended up with me sweating bullets.

Math 101A: Low Interest Rates = Higher Asset Prices

As my previous conversation highlights, the relationship between rate cuts and monetary policy may not be as clear cut as skeptics would like you to believe. Although I enjoy the widely covered Shiller CAPE discussions on market valuations, somehow the media outlets fail to make the all-important connection between interest rates and P/E ratios.

One way of framing the situation is by asking a simple question:

Would you rather have $100 today or $110 a year from now?

The short answer is…”it depends.” All else equal, the level of interest rates will ultimately determine your decision. If interest rates are offering 20%, a rational person would select the $100 today, invest the money at 20%, and then have $120 a year from now. On the other hand, if interest rates were 0.5%, a rational person would instead select the option of receiving $110 a year from now because collecting a $100 today and investing at 0.5% would only produce $100.50 a year from now.

The same time-value-of-money principle applies to any asset, whether you are referring to gold, cars, houses, private businesses, stocks, or other assets. The mathematical fact is, all else equal, a rational person will always pay more for an asset when interest rates are low, and pay less when interest rates are high. As the 200-year interest chart below shows, current long-term interest rates are near all-time lows.

Source: The Big Picture

Source: The Big Picture

The peak in interest rates during the early 1980s correlated with a single digit P/E ratio (~8x). The current P/E ratio is deservedly higher (~16x), but it is dramatically lower than the 30x+ P/E ratio realized in the 2000 year timeframe. If none of this discussion makes sense, consider the simple Rule of 20 (see also The Rule of 20 Can Make You Plenty), which states as a simple rule-of-thumb, the average market P/E ratio should be equal to 20 minus the level inflation. With inflation currently averaging about 2%, the Rule of 20 implies an equilibrium of ~18x. If you assume this P/E multiple and factor in a 7-8% earnings growth rate, you could legitimately argue for 20% appreciation in the market to S&P 2,400 over a 12-month period. It’s true, a spike in interest rates, combined with a deceleration in earnings would justify a contraction in stock prices, but even under this scenario, current index values are nowhere near the bubble levels of 2000.

After six long years, the QE train is finally grinding to a halt, and a return towards Fed policy normalcy could be rapidly approaching. Many investors and skeptical bears have tried to rationalize the tripling in the market from early 2009 as solely due to the cheap Fed money printing machine. Unfortunately, history and mathematics don’t support that assertion. If you don’t believe me, perhaps a child may be able to explain it to you better.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions in certain exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 27, 2014 at 4:19 pm 2 comments

NASDAQ 5,000…Irrational Exuberance Déjà Vu?

Investors love round numbers and with the Dow Jones Industrial index recently piercing 17,000 and the S&P 500 index having broken 2,000 , even novice investors have something to talk about around the office water cooler. While new all-time records are being set for the major indices during September, the unsung, tech-laden NASDAQ index has yet to surpass its all-time high of 5,132 achieved 14 and ½ years ago during March of 2000.

A lot has changed since then. Leading up to the pricking of the technology bubble, talks of an overhyped market started as early as December 5, 1996, when then Federal Reserve Chairman Alan Greenspan made his infamous “irrational exuberance” speech.

“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”    
 -Alan Greenspan (Federal Reserve Chairman 1987 – 2006)

 

On that date, the S&P 500 closed at NASDAQ 1,300. A little over three years later, before values cratered by -78%, the index almost quadrupled higher to 5,132. Looked at from a slightly different lens, here is how the major indexes have fared since Greenspan’s widely referenced speech almost 18 years ago:

Slide1

Despite the world’s most powerful banker calling stock prices irrational, the Dow & S&P have almost tripled in value (+164% & +167%, respectively) and the NASDAQ has almost quadrupled (+251%). The 80%+ outperformance (excluding dividends) is impressive, but reasonable if you consider this increase amounts to about a +7.2% compounded annual appreciation value. Investors have experienced a lot of heartburn over that long timeframe, but for any buy-and-holders, these returns would have trounced returns realized in alternative safe haven vehicles like CDs, savings accounts, or bonds.

Price: The Almighty Metric

There are many valuation metrics to evaluate but the most universal one is the Price/Earnings ratio (P/E). Just as in the process of assessing the value of a car, house, or stock, the price you pay is usually the most important factor of the purchase. The same principle applies to stock indexes. The cheaper the price paid, the greater probability of earning superior returns in the future. Unfortunately for investors in technology stocks, there was not much value in the NASDAQ index during late-1999, early-2000. Historical P/E data for the NASDAQ index is tough to come by, but some estimates pegged the index value at 200x’s its earnings at the peak of the 2000 technology mania. In other words, for every $1 in profit the average NASDAQ company earned, investors were willing to pay $200…yikes.

Today, the NASDAQ 100 index (the largest 100 non-financial companies in the NASDAQ index), which can serve as a proxy for the overll NASDAQ index, carries a reasonable P/E ratio of approximately 20x on a forward basis (24x on a trailing basis) – about 90% lower than the peak extremes of the NASDAQ index in the year 2000.

Although NASDAQ valuations are much lower today than during the bursting 2000 tech bubble, P/E ratios for the NASDAQ 100 still remain about +20% higher than the S&P 500, which begs the question, “Is the premium multiple deserved?”

As I wrote about in the NASDAQ Tech Revolution, you get what you pay for. If you pay a peanut multiple, many times you get a monkey stock. In the technology world, there is often acute obsolescence risk (remember Blackberry – BBRY?) that can lead to massive losses, but there also exists a winner-takes-all dynamic. Just think of the dominance of Google (GOOG/L) in search advertising, Microsoft (MSFT) in the PC, or Amazon (AMZN) in e-commerce.  It’s a tricky game, but following the direction of cash, investments, and product innovation are key in my mind if you plan on finding the long-term winners. For example, the average revenue growth for the top 10 companies in the NASDAQ 100 averaged more than +100% annually from the end of 1999 to the end of 2013. Identifying the “Old Tech Guard” winners is not overly challenging, but discovering the “New Tech Guard” is a much more demanding proposition.

In the winner-takes-all hunt, one need not go any further than looking at the massive role technology plays in our daily lives. Twenty years ago, cell phones, GPS, DVRs (Digital Video Recorders), e-Readers, tablets, electric cars, iPods/MP3s, WiFi mobility, on-demand digital media, video-conferencing, and cloud storage either did not exist or were nowhere near mainstream. Many of these technologies manifest themselves into a whole host of different applications that we cannot live without. One can compile a list of these life-critical applications by thumbing through your smartphone or PC bookmarks. The list is ever-expanding, but companies like Twitter (TWTR), Facebook (FB), Amazon (AMZN), Uber, Netflix (NFLX), Priceline (PCLN), Yelp, Zillow (Z), and a bevy of other “New Tech Guard” companies have built multi-billion franchises that have become irreplaceable applications in our day-to-day lives.

Underlying all the arbitrary index value milestones (e.g., Dow 17,000 and S&P 2,000) since the 1990s has a persistent and unstoppable proliferation of technology adoption across virtually every aspect of our lives. NASDAQ 5,000 may not be here quite yet, but getting there over the next year or two may not be much of a stretch. Speculative tendencies could get us there sooner, and macro/geopolitical concerns could push the milestone out, but when we do get there the feeling of NASDAQ 5,000 déjà vu will have a much stronger foundation than the fleeting euphoric emotions felt when investors tackled the same level in year 2000.

Investment Questions Border

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

 

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own AAPL, GOOG/L, AMZN, NFLX bonds (short the equity), FB (non-discretionary), MSFT (non-discretionary), PCLN (non-discretionary) and a range of positions in certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, Uber, YELP, Z, or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

September 13, 2014 at 10:21 am 2 comments

Got Growth?

Slide1

Investing in the stock market can be quite stressful, especially during periods of volatility…but investing doesn’t have to be nerve-racking. Investing legend T. Rowe price captured the beneficial sentiments of growth investing beautifully when he stated the following:

“The growth stock theory of investing requires patience, but is less stressful than trading, generally has less risk, and reduces brokerage commissions and income taxes.”

 

What I’ve learned over my investing career is that fretting over such things as downgrades, management changes, macroeconomic data, earnings misses, geopolitical headlines, and other irrelevant transitory factors leads to more heartache than gains. If you listen to a dozen so-called pundits, talking heads, journalists, or bloggers, what you quickly realize is that all you are often left with are a dozen different opinions. Opinions don’t matter…the facts do.

Finding Multi-Baggers: The Power of Compounding

Rather than succumbing to knee-jerk reactions from the worries of the day, great long-term investors realize the benefits of compounding. We know T. Rowe Price appreciated this principle because he agreed with Nobel Prize winning physicist Albert Einstein’s view that “compounding interest” should be considered the “8th wonder of the world” – see also how Christopher Columbus can turn a penny into $121 billion (Compounding: A Penny Saved is Billions Earned).

People generally refer to Warren Buffett as a “Value” investor, but in fact, despite the Ben Graham moniker, Buffett has owned some of the greatest growth stocks of all-time. For example, Coca Cola Co (KO) achieved roughly a 20x return from 1988 – 1998, as shown below:

Source: Yahoo! Finance

Source: Yahoo! Finance

If you look at other charts of Buffett’s long-term holdings, such as Wells Fargo & Company (WFC), American Express Co (AXP), and Procter & Gamble – Gillette (PG), the incredible compounded gains are just as astounding.

In recent decades, there is no question that stocks have benefited from P/E expansion. P/E ratios, or the average price paid for stocks, has increased from the early 1980s as long-term interest rates have declined from the high-teens to the low single-digits, but the real lifeblood for any stock is earnings growth (see also It’s the Earnings, Stupid). As growth investor extraordinaire Peter Lynch once said:

“People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.”

 

As Lynch also pointed out, it only takes the identification of a few great multi-bagger stocks every decade to compile a tremendous track record, while simultaneously hiding many sins:

“Fortunately the long-range profits earned from really good common stocks should more than balance the losses from a normal percentage of such mistakes.”

 

The Scarcity of Growth

Ever since the technology bubble burst in 2000, Growth stocks have felt the pain. Since that period, the Russell 1000 Value index – R1KV (Ticker: IWD) has almost doubled in value and outperformed the Russell 1000 Growth index – R1KG (Ticker: IWF) by more than +60% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Although the R1KG index has yet to breach its previous year 2000 highs, ever since the onset of the Great Financial Crisis (end of 2007), the R1KG index has been on the comeback trail. Now, the Russell 1000 Growth index has outperformed its Value sister index by an impressive +25% (see chart below):

Source: Yahoo! Finance

Source: Yahoo! Finance

Why such a disparity? Well, in a PIMCO “New Normal & New Neutral” world where global growth forecasts are being cut by the IMF  and a paltry advance of 1.7% in U.S. GDP is expected, investors are on a feverish hunt for growth. U.S. investors are myopically focused on our 2.34% 10-Year Treasury yield, but if you look around the rest of the globe, many yields are at multi-hundred year lows. Consider 10-year yields in Germany sit at 0.96%; Japan at 0.50%; Ireland at 1.98%; and Hong Kong at 1.94% as a few examples. This scarcity of growth has led to outperformance in Growth stocks and this trend should continue until we see a clear sustainable acceleration in global growth.

If we dig a little deeper, you can see the 25% premium in the R1KG P/E ratio of 20.8x vs. 16.7x for the R1KV is well deserved. Historical 5-year earnings growth for the R1KG has been +52% higher than R1KV (17.8% vs. 11.7%, respectively). Going forward, the superior earnings performance is expected to continue. Long-term growth for the R1KG index is expected to be around 55% higher than the R1KV index (14% vs 9%).

In this 24/7, Facebook, Twitter society we live in, investing has never been more challenging with the avalanche of daily news. The ultra-low interest rates and lethargic global recovery hasn’t made my life at Sidoxia any easier. But one thing that is clear is that the investment tide is not lifting all Growth and Value stocks at the same pace. The benefits of long-term Growth investing are clear, and in an environment plagued by a scarcity of growth, it is becoming more important than ever when reviewing your investment portfolios to ask yourself, “Got Growth?”

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in KO/PG (non-discretionary accounts) and certain exchange traded fund positions, but at the time of publishing SCM had no direct position in TWTR, FB, WFC, AXP, IWF, IWD or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 16, 2014 at 6:18 pm 1 comment

Is the Stock Market Rigged? Yes…In Your Favor

ace of hearts

Is the Market Rigged? The short answer is “yes”, but unlike gambling in Las Vegas, investing in the stock market rigs the odds in your favor. How can this be? The market is trading at record highs; the Federal Reserve is artificially inflating stocks with Quantitative easing (QE); there is global turmoil flaring up everywhere; and author Michael Lewis says the stock market is rigged with HFT – High Frequency Traders (see Lewis Sells Flash Boys Snake Oil). I freely admit the headlines have been scary, but scary headlines will always exist. More importantly for investors, they should be more focused on factors like record corporate profits (see Halftime Adjustments); near generationally-low interest rates; and reasonable valuation metrics like the price-earnings (P/E) ratios.

Even if you were to ignore these previously mentioned factors, one can use history as a guide for evidence that stocks are rigged in your favor. In fact, if you look at S&P 500 stock returns from 1928 (before the Great Depression) until today, you will see that stock prices are up +72.1% of the time on average.

If the public won at such a high rate in Las Vegas, the town would be broke and closed, with no sign of pyramids, Eiffel Towers, or 46-story water fountains. There’s a reason Las Vegas casinos collected $23 billion in 2013 – the odds are rigged against the public. Even Shaquille O’Neal would be better served by straying away from Vegas and concentrating on stocks. If Shaq could have improved his 52.7% career free-throw percentage to the  72.1% win rate for stocks, perhaps he would have earned a few more championship rings?

Considering a 72% winning percentage, conceptually a “Buy-and-Hold” strategy sounds pretty compelling. In the current market, I definitely feel this type of strategy could beat most market timing and day trading strategies over time. Even better than this strategy, a “Buy Winners-and-Hold Winners” strategy makes more sense. In other words, when investing, the question shouldn’t revolve around “when” to buy, but rather “what” to buy. At Sidoxia Capital Management we are primarily bottom up investors, so the appreciation potential of any security in our view is largely driven by factors such as valuation, earnings growth, and cash flows. With interest rates near record lows and a scarcity of attractive alternatives, the limited options actually make investing decisions much easier.

Scarcity of Alternatives Makes Investing Easier

U.S. investors moan and complain about our paltry 2.42% yield on the 10-Year Treasury Note, but how appetizing, on a risk-reward basis, does a 2.24% Irish 10-year government bond sound? Yes, this is the same country that needed a $100 billion+ bailout during the financial crisis. Better yet, how does a 1.05% yield or 0.51% yield sound on 10-year government treasury bonds from Germany and Japan, respectively? Moreover, what these minuscule yields don’t factor in is the potentially crippling interest rate risk investors will suffer when (not if) interest rates rise.

Fortunately, Sidoxia’s client portfolios are diversified across a broad range of asset classes. The quantitative results from our proprietary 5,000 SHGR (“Sugar”) security database continue to highlight the significant opportunities in the equities markets, relative to the previously discussed “bubblicious” parts of the fixed income markets. Worth noting, investors need to also remove their myopic blinders centered on U.S. large cap stocks. These companies dominate media channel discussions, however there are no shortage of other great opportunities in the broader investment universe, including such areas as small cap stocks, floating-rate bonds, real estate, commodities, emerging markets, alternative investments, etc.

I don’t mind listening to the bearish equity market calls for stock market collapses due to an inevitable Fed stimulus unwind, mean reverting corporate profit margins, or bubble bursting event in China. Nevertheless, when it comes to investing, there is always something to worry about. While there is always some uncertainty, the best investors love uncertainty because those environments create the most opportunities. Stocks can and eventually will go down, but rather than irresponsibly flailing around in and out of risk-on and risk-off trades to time the market (see Market Timing Treadmill), we will continue to steward our clients’ money into areas where we see the best risk-reward prospects.

For those other investors sitting on the sidelines due to market fears, I commend you for coming to the proper conclusion that stock markets are rigged. Now you just need to understand stocks are rigged for you (not against you)…at least 72% of the time.

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold a range of exchange traded fund positions, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 9, 2014 at 5:18 pm 3 comments

Psst…Do You Want to Join the Club?

psst
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (August 1, 2014). Subscribe on the right side of the page for the complete text. 
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Investing is a tough game, and if you want to join the SIC (Successful Investors Club) there are a few top secret concepts you must learn and follow. Here are the all-important, confidential words of wisdom that will gain you entrance into the SIC:

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#1. Create a plan and stick to it.

#2. Don’t waste your time listening to the media.

Like dieting, the framework is simple to understand, but difficult to execute. Theoretically, if you follow Rule #1, you don’t have worry about Rule #2. Unfortunately, many people have no rules or discipline in place, and instead let their emotions drive all investing decisions. When it comes to following the media, Mark Twain stated it best:

“If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.”

 

It’s fine to be informed, as long as the deluge of data doesn’t enslave you into bad, knee-jerk decision-making. You’ve seen those friends, family members and co-workers who are glued to their cell phones or TVs while insatiably devouring real-time data from CNBC, CNN, or their favorite internet blog. The grinding teeth and sweaty palms should be a dead giveaway that these habits are not healthy for investment account balances or blood pressure.

Thanks to the endless scary headlines and stream of geopolitical turmoil (fear sells), millions of investors have missed out on one of the most staggering bull market rallies in history. More specifically, the S&P 500 index (large capitalization companies) has almost tripled in value from early 2009 (666 to 1,931) and the S&P 600 index (small capitalization companies) almost quadrupled from 181 to 645.

The Challenge  

Source: FreeImage.com

Becoming a member of the Successful Investors Club (SIC) is no easy feat. As I’ve written in the past, the human brain has evolved dramatically over tens of thousands of years, but the troubling, emotionally-driven amygdala tissue mass at the end of the brain stem (a.k.a., “Lizard Brain“) still remains. The “Lizard Brain” automatically produces a genetic flight response to perceived worrisome stimuli surrounding us. In other words, our “Lizard Brain” often interprets excessively sensationalized current events as a threat to our financial security and well-being.

It’s no wonder amateur investors have trouble dealing with the incessantly changing headlines. Yesterday, investors were panicked over the P.I.I.G.S (Portugal, Italy, Ireland, Greece, Spain), the Arab Spring (Tunisia, Egypt, Iran, etc.), and Cyprus. Today, it’s Ukraine, Argentina, Israel, Gaza, Syria, and Iraq. Tomorrow…who knows? It’s bound to be another fiscally irresponsible country, terrorist group, or autocratic leader wreaking havoc upon their people or enemies.

During the pre-internet or pre-smartphone era, the average person couldn’t even find Ukraine, Syria, or the Gaza Strip on a map. Today, we are bombarded 24/7 with frightening stories over these remote regions that have dubious economic impact on the global economy.

Take the Ukraine for example, which if you think about it is a fiscal pimple on the global economy. Ukraine’s troubled $177 billion economy, represents a mere 0.29% of the $76 trillion global GDP. Could an extended or heightened conflict in the region hinder the energy supply to a much larger and significant European region? Certainly, however, Russian President Vladimir Putin doesn’t want the Ukrainian skirmish to blow up out of control. Russia has its own economic problems, and recent U.S. and European sanctions haven’t made Putin’s life any easier. The Russian leader has a vested economic interest to keep its power hungry European customers happy. If not, the U.S.’s new found resurgence in petroleum supplies from fracking will allow our country to happily create jobs and export excess reserves to a newly alienated EU energy buyer.

The Solution

Source: The Geek

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Rather than be hostage to the roller coaster ride of rising and falling economic data points, it’s better to follow the sage advice of investing greats like Peter Lynch, who averaged a +29% return per year from 1977 – 1990.

Here’s what he had to say about news consumption:

“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”

&nbsp

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Rather than fret about the direction of the market, at Sidoxia Capital Management we are focused on identifying the best available opportunities, given any prevailing economic environment (positive or negative). We assume the market will go nowhere and invest our client assets (and personal assets) accordingly by focusing on those areas we see providing the most attractive risk-adjusted returns. Investors who try to time the market, fail miserably over the long-run. If timing the market were easy, you would see countless people’s names at the tops of the Forbes billionaire list – regrettably that simply is not the case.

Since “fear” sells in the media world, it’s always important to sift through the deluge of data to gain a balanced perspective. During panic periods, it’s important to find the silver linings. When everyone is euphoric, it’s vital to discover reasons for caution.

While a significant amount of geopolitical turmoil occurred last month, it’s essential to remember the underlying positive fundamentals propelling the stock market to record highs. The skeptics of the recovery and record stock market point to the Federal Reserve’s unprecedented, multi-trillion dollar money printing scheme (Quantitative Easing – QE) and the inferior quality of the jobs created. Regarding the former point, if QE has been so disastrous, I ask where is the run-away inflation (see chart below)? While the July jobs report may show some wage pressure, you can see we’re still a long ways away from the elevated pricing levels experienced during the 1970s-1980s.

 


Source: Calafia Beach Pundit

A final point worth contemplating as it relates to the unparalleled Fed Policy actions was highlighted by strategist Scott Grannis. If achieving real economic growth through money printing was so easy, how come Zimbabwe and Argentina haven’t become economic powerhouses? The naysayers also fail to acknowledge that the Fed has already reversed the majority of its stimulative $85 billion monthly bond buying program (currently at $25 billion per month). What’s more, the Federal Open Market Committee has already signaled a rate hike to 1.13% in 2015 and 2.50% in 2016 (see chart below).

 


Source: Financial Times

 

The rise in interest rates from generationally low levels, especially given the current status of our improving economy, as evidenced by the recent robust +4.0% Q2-GDP report, is inevitable. It’s not a matter of “if”, but rather a matter of “when”.

On the latter topic of job quality, previously mentioned, I can’t defend the part-time, underemployed nature of the employment picture, nor can I defend the weak job participation rate. In fact, this economic recovery has been the slowest since World War II. With that said, about 10 million private sector jobs have been added since the end of the Great Recession and the unemployment rate has dropped from 10% to 6.1%. However you choose to look at the situation, more paychecks mean more discretionary dollars in the wallets and purses of U.S. workers. This reality is important because consumer spending accounts for 70% of our country’s economic activity.

While there is a correlation between jobs, interest rates, and the stock market, less obvious to casual observers is the other major factor that drives stock prices…record corporate profits. That’s precisely what you see in the chart below. Not only are trailing earnings at record levels, but forecasted profits are also at record levels. Contrary to all the hyped QE Fed talk, the record profits have been bolstered by important factors such as record manufacturing, record exports, and soaring oil production …not QE.

 Source: Dr. Ed’s Blog
 

Join the Club

Those who have been around the investing block a few times realize how challenging investing is. The deafening information noise instantaneously accessed via the internet has only made the endeavor of investing that much more challenging. But the cause is not completely lost. If you want to join the bull market and the SIC (Successful Investors Club), all you need to do is follow the two top secret rules. Creating a plan and sticking to it, while ignoring the mass media should be easy enough, otherwise find an experienced, independent investment advisor like Sidoxia Capital Management to help you join the club.

 

www.Sidoxia.com

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold long positions in certain exchange traded funds ans securities, but at the time of publishing SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.

August 2, 2014 at 9:00 am 4 comments

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