Archive for July, 2009
Philosophical Friday: Investing is Like Religion
Nothing like the subject of religion to make people feel uncomfortable, so why not dive in!
Investing Is Like Religion: Everyone believes their religion will lead them down the right path to spiritual prosperity. Adherants.com divides religions into 22 separate groupings. If you look at the loosely grouped big five (Christianity, Judaism, Islam, Hinduism, and Buddhism), these cover the vast majority of religious practitioners globally – an estimated 4 billion to 5.5 billion people.
In investing, most individuals stubbornly believe their philosophy is the right way to make money. With the hopes of creating order, the investment industry relies on tools like Morningstar’s nine style box categories, which places investors in tidy, clean groups. Unfortunately, not every strategy fits nicely into a style box, especially if you try to integrate investment vehicles like hedge funds and quantitative funds.
Can’t We All Just Get Along?: I believe religions can co-exist just like different investing philosophies can co-exist. Certainly there are less worthy religions, for example you can think of cults that prey on vulnerable individuals. The same can be said for investing – as long as greed continues to exist (a certainty), there will be unscrupulous crooks and shady businesses looking to take advantage of people for a quick buck.
Regulation: I suppose our law enforcement agencies and courts serve as regulators over a small minority of churches who break the law, but given the recent collapse of parts of our financial system it makes sense we are retooling and recalibrating our oversight and regulations. There is no doubt that negative trends like the unfettered growth of toxic mortgages (including subprime), over leveraging of investment banks (ala Bear Stearns, and Lehman), and exponential growth of complex derivative products (such as CDS and CDOs) need to be controlled with more oversight. There needs to consequences to improper actions – some religions have been known to discipline their members too.
Investing Takes Faith: We have gone through an extremely trying year and a half and iconic experts like Warren Buffett have had the wherewithal to invest successfully through uncertain economic cycles because of faith in capitalism. Even at the other side of the investing spectrum, in areas like quantitative and technical trading, the practitioner still needs to have enough faith in their systems and models with the belief they have an edge that can help them outperform. Regardless of the approach, one must have faith in their investment philosophy to be successful over the long-term.
Although there countless versions of religions all over the world, I’m confident that the Church of Money Under the Mattress (CMUM) will not lead the majority of investors to the Promise Land. Even for those risk averse savers, there are ways to heighten your expected return without assuming undue risk. Irrespective of your religious beliefs, may your spiritual journey bring you hefty profits…
Wade W. Slome, CFA, CFP® (Sidoxia Capital Management, LLC)
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management and client accounts do not have direct positions in BRKA/B at the time the article was published. 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.
Howard Right on the Mark(s)
Legendary investor Howard Marks opines on the financial markets in his recently quarterly client memo. One should pay attention to these battle-tested veterans with scars to prove their survival skills. Rather than neatly package a common theme from the long document I will highlight a few areas.
Marks is cautious but sees better buying opportunities ahead.
Recent Past vs. Long Past: For most of the 16 page memo Howard Marks reminisces on his 40+ years in the investment industry and contrasts the 2003-2007 period with the majority of his years. He states in the old days, “There were no swaps, index futures or listed options. Leverage wasn’t part of most institutional investors’ arsenal…or vocabulary. Private equity was unknown, and hedge funds were too few and outré to matter. Innovations like quantitative investing and structured products had yet to arrive, and few people had ever heard of ‘alpha.'”
Marks on Siegel: Marks targets Wharton Professor Jeremy Siegel as a contributor to the overly bullish mentality of 2003-2007, “Siegel’s research was encyclopedic and supported some dramatic conclusions, perhaps foremost among them his showing that there’s never been a 30-year period in which stocks didn’t outperform cash, bonds and inflation…but…30 years can be a long time to wait.”
Marks on Risk: “So yes, it’s true that investor’s can’t expect to make much money without taking risk. But that’s not the same as saying risk taking is sure to make you money…If risky investments always produced high returns, they wouldn’t be risky.” On the psychological impacts of risk, Marks goes on to say, “When investors are unworried and risk-tolerant, they buy stocks at high p/e ratios and private companies at high EBITDA multiples, and they pile into bonds despite narrow yield spreads and into real estate at minimal “cap rates.'”
On Quant Models and Business Schools: Marks quotes Warren Buffet regarding the complexity of quantitative models, “If you need a computer or a calculator to make a calculation, you shouldn’t buy it.” Charlie Munger adds his two cents on why quantitative models exist: “They teach that in business schools because, well, they’ve got to do something.”
Investing as a Mixture of Art & Science: In my book I describe investing as a combination of “Art” and “Science.” Marks addresses a s similar insight through an Albert Einstein quote:
“Not everything that can be counted counts, and not everything that counts can be counted.”
Views on the Credit Rating Agencies: To highlight the absurdity of the mortgage credit rating system, Marks compares the agencies’ ratings to hamburger: “If it’s possible to start with 100 pounds of hamburger and end up selling ten pounds of dog food, 40 pounds of sirloin and 50 pounds of filet mignon, the truth-in-labeling rules can’t be working.”
If you would like to access the remainder of memo, click here to read the rest. Overall, Mr. Marks gives a balanced view of the markets and economy, but feels “better buying opportunities lie ahead.” Thankfully, I’m finding some myself.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Calamos Still “Growing” Strong
Calamos Investments recently came out with their quarterly Market Review and Outlook. John P. Calamos, Sr., the Company founder, began investing his family’s money over 50 years ago and is well known for their successful “growth” style of investing. Calamos founded Calamos Asset Management in 1977, and won BusinessWeek’s best manager for 2003 and 2004. Over the years, the company diversified from its bread and butter convertibles into equity, enhanced fixed-income, global and international, core bond, cash management and alternative strategies. Overall, the newsletter offers a fairly sobering outlook (“Longterm Scared”); however there are some excellent investing nuggets, especially when it comes to the firm’s current positioning:
“Because we are not in a secular bull market, investing discipline is even more important. We believe these are the rules for today’s environment”:
1. Washington D.C. is the new growth city
2. Valuations will not get as stretched in the equity markets and growth expectations will be revised down considerably
3. Old-fashioned dividends mean something
4. G7 competitive devaluations and protectionist legislation will become the norm
5. To grow, emerging nations must become consumption driven and attempt to become independent of the developed nations
6. Knowledge is free, but capital may be much harder to get
7. Real returns after tax will take on new meaning
8. Baby boomers will reprioritize spending
9. The rules will change often!
Technology Exposure: For those that have followed my writings in the past, you are familiar with my positive bias towards technology. The technology sector is littered with land mines and risks. Nonetheless, through technology, our country has and will continue to innovate new products and services that will improve our standard of living. The “Technology Revolution” is not only benefiting our society, we are exporting the fruits of our discoveries to developing countries across the world. Take Intel Corporation (INTC) for example – it garnered about 85% of its revenues in 2008 from international markets.
Here is what Calamos has to say about their “Significant Overweight” exposure to the Technology sector:
“Productivity enhancement and cost controls should help technology spending.”
- We see consumers remaining willing to purchase certain “special” products such as iPhones, laptops and flat-screens.
- We have found software companies offering stable revenue streams, strong balance sheets with lots of cash, and products that offer solutions for cost reduction and productivity.
- The sector will also benefit from global infrastructure stimulus spending.
- Stock valuations are attractive and the risk/reward is compelling.
- The sector may be re-establishing its leadership position in the equity market for the first time since last decade’s collapse.”
Materials and Energy Exposure: Developing countries are joining the party too, albeit later than the rest of the partygoers. The price of admission to the party is access to valuable commodities. Calamos has other reasons to be overweight the Materials and Energy sectors:
- Muted recovery implied in stock valuations.
- Further U.S. dollar devaluation and global stimulus spending should help boost commodity prices.
- The small capitalization of this sector and volatility of commodity prices will again make it prone to large price swings.
- U.S. dollar devaluation should help support energy prices.
- Mid-East turmoil adds to the attractiveness of this sector as it can hedge unforeseen energy price spikes.
- Stock valuations appear reasonable but government intervention will make this a difficult sector to value.
Like all great managers, Calamos has taken his lumps, but through it all his firm is still “growing” strong.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Bill Miller: Revenge of the Dunce?
Bill Miller’s Legg Mason Value Trust Fund (LMVTX) was down more than -55% in 2008 and many people considered him the industry dunce – due in part to his heavily concentrated stock positions and stubborn belief of holding onto his sinking “Financial” picks. Unfortunately this stance cratered results to abysmal depths – earning his fund the infamous Morningstar 1-Star Rating. But let’s not forget Mr. Miller did not become stupid over night. From 1991 through 2005 he beat the S&P 500 every year before hitting a rough patch in 2006-2008. His previous 15 year streak was the equivalent of me hitting .400 off Randy Johnson – very few, if any, can replicate. So, is the dunce back? Thus far in 2009, his fund is up about 25% through July 26th, handily trouncing the S&P 500 by more than 14% (Morningstar). Miller remains bullish on his outlook for financial markets although he caveats his prediction with three endogenous risks:
“Rising interest rates, a sharp rise in commodity prices (especially oil), and policy errors.”
Miller also brings up a topic I have brought up on numerous occasions in my monthly newsletter, which is that investors are sitting on piles of low earning cash:
“Assets in money market funds recently exceeded those in general equity funds for the first time in over 15 years. In contrast, at the market peak in October 2007, assets in equity funds were more than 3x greater than the assets in money market funds. The return on this mountain of cash rounds to zero, which is good when stocks and bonds are falling, but far from optimal when they are rising. Although I expect credit spreads and risk aversion to remain well above the averages of the past decade, there is plenty of room for them to narrow and for equities to move higher as this cash gradually moves out the curve in search of better returns.”
Smart guy, but could use a little help in the hair style department.
The average investor is late to both coming and going from the game. Don Hays, Strategist at Hays Advisory Services, notes, “We believe all good news at the top, and we doubt and disbelieve any good news at the bottom.” I think Bill concurs when he states the following:
“The psychological cycle goes something like this: first it is said the fiscal and monetary stimuli are not sufficient and won’t work. When the markets start up and the economic forecasts begin to be revised up — where we are now — the refrain is that it is only an inventory restocking and once it is over the economy will stall or we may even have a double dip. Once the economy begins to improve, the worry is that profits will not recover enough to justify stock prices. When profits recover, it is said that the recovery will be jobless; and when the jobs start being created, the fear is that this will not be sustained.”
Miller also makes some thoughtful points on the attractiveness of the financial sector, pointing to the disappearance of many competitors, appealing valuations, and rising pre-provision earnings. On the topic of inflation, Miller remains unworried about prices spiking up. He argues, logically, that rising unemployment and excess capacity will keep a lid on prices. True, however, with exploding debt levels and deficits, coupled with the insatiable appetites of emerging markets for commodities, not to mention spiraling healthcare prices, I believe inflation concerns may be here sooner than anticipated. Let’s not forget the stagflation experienced in the 1970s.
Read the Whole Bill Miller Newsletter Here
Bill Miller is still in a deep hole that he dug for himself, but I would not count this dunce out. Mean reversion is one of the most powerful principles of finance and if you ride Bill Miller’s coat-tails on any continued rebound, it could be a prosperous, memorable ride.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Quarterly Earnings Avalanche – What the %&*$# is Going On?
Last week we received an avalanche of earnings reports (with a ton more reporting this week) and investors are now interpreting the data.
The recent stock market rally can be simply boiled down to companies releasing better than expected quarterly earnings. As my great pal Peter Lynch says, “People may bet on hourly wiggles of the market but it’s the earnings that waggle the wiggle long term.” A whopping 77% of S&P 500 companies that have reported Q2 (June) earnings thus far have reported earnings results better than Wall Street expectations. Earnings estimates are being ratcheted up for the first time since August 2007. Intel got the party started in the technology world, trouncing both top and bottom line estimates. Certainly, overall, the top line results for corporations have been more challenging and mixed. However, with additional earnings available to companies, more resources can be plowed back into future marketing and revenue generating activities. Moreover, due to the extreme cost-cutting measures taken, once the economy recovers, corporations will be able to tap into the enormous earnings power potential created.
Click Here for CNBC Quarterly Earnings Recap
Across all industries, whether it’s Fred Smith (CEO at FedEx) or Eric Schmidt (CEO at Google), we’re hearing a common theme that although the environment remains challenging, we have stabilized with the worst behind us. When and by what degree the economy turns around is still unclear, but all I know is that great companies don’t disappear in bear markets and as a country we have persevered through many, many recessions and financial crises in our history. In times like these, market leaders and industry innovators use their competitive advantages to step on the throats of their competitors and do whatever it takes to gain market share, so that when things actually do turn, the tide will carry them to the front of the pack.
Although the quarterly reported earnings coming out have in general been relatively anemic, investors should not sit idle. I continue to scour income statements, balance sheets, and cash flow statements to see who is gaining share at the expense of their peers. At the end of the day those share gainers are the ones that will be growing earnings and cash flows the fastest when the economy turns. Investors shouldn’t forget the lessons of 2008 and 2009. Although not all the economic news headlines were bad in the first half of 2008 (as the stock market began its rapid descent), the same principle applies in reverse – as the market has rebounded from the March lows, not all the economic news has been encouraging. Volatility can in fact be a beautiful thing, if you have a disciplined systematic approach in place that opportunistically takes advantage of appealing prospects as they arise. Without doubt, the relative attractiveness of the overall market is less than it was in March 2009, but let’s not forget the stock market is still more than 35% below the market highs of late 2007.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Praying for a Better Market with Pope Benedict XVI
As reported on Bloomberg, the pontiff called for a new era of economic justice and for a new global authority to regulate financial institutions. Pope Benedict XVI weighed in on the markets with a 150 page document demanding a retooling of the economic and financial models that got us into this financial crisis.
In a conflicted dilemma, the video clip above ponders the question of whether sinners or saints perform better in the stock market? Unfortunately for church-goers, sin appears to perform better. The indulgent Vice Fund (VICEX) outperformed the virtuous Ave Maria Catholic Values Fund (AVEMX) for the period discussed.
Chomping at the bit to open up that margin account??
I’m not sure if the Pope is going to open a margin account at Scottrade, and start day-trading levered inverse ETFs and options, but perhaps he will be praying for a better market and performance for us honest, trustworthy and faithful investors.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Studies Show Investors Ready to Look at New Advisors
Breaking Up a Relationship Doesn't Have to be Difficult
Breaking up is tough to do, especially when you’ve had a chummy relationship with your financial advisor. BusinessWeek recently ran an article urging investors to seek a second opinion, much the same way people do when they request opinions from more than one doctor.
Read BusinessWeek Article: Thinking of Switching Financial Planners?
“Just as a good doctor should respect your decision to see a second opinion, so should your financial adviser be open to review.”
Unfortunately, when it comes to money, the average investor focuses more on the emotional aspects of the client –advisor relationship rather than the objective facts. Given the volatility in the financial markets, investors continue to sift through the rubble over the last 18 months, only to find commissions, fees, taxes, and misallocated portfolios.
A Wall Street Journal article in April highlighted the survey from Prince & Associates Inc., which showed more than 75% of investors with more than $1 million to invest plan to move some money away from their investors – more than 50% intend to leave their advisors altogether. According to the Spectrem Group (July 2009 BusinessWeek article), only 36% of millionaires believe their advisors performed well through the financial crisis of 2008-2009. Another study done by the Wharton School of Business and State Street Advisors showed that only 31% of investing clients are extreme satisfied, even though their Advisors think 65% of the clients are very satisfied.
Now is the time to check under the hood to review advisor fees and performance
Over our lives, we have switched CPAs, attorneys, hair-stylists and auto-mechanics, so why the difficulty in considering advisor change? The emotional aspects and uncertainty of the financial markets can cloud the decision making process. That’s why now, better than ever, it is an ideal time to ask tough questions and shop around for the top advice you deserve. In addition to bad advice, commissions and fees could be eating away at your investment returns, forcing a later than anticipated retirement or a lower quality of life. I myself prefer filet mignon over macaroni & cheese.
Given the unabated free-fall of last fall appears to have abated and the economy appears to be finding firmer footing, do yourself a favor and get a second opinion – there’s not a lot of downside.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
Ron Baron Swinging for Long Term Home Runs
Growth Guru Ron Baron
Click Here to Watch Ron Baron CNBC Interview
The CNBC interview is a tad long with the first eight minutes better than the last eight. I can’t say I agree with a lot of his political rants, but his long-term success (BPTRX) is difficult to argue with despite his challenging track record over the last few years.
Ron Baron is considered one of the greatest growth investors of all-time, but unlike many of his modern growth peers he chooses not to play the quick trigger, momentum-based, “buy high, sell higher” strategy that merely purchases what’s working and sells what’s not. Rather he is investing in growth businesses that create long-term value, and focusing on those securitities trading at attractive prices. Seems like a very reasonable strategy to me, and an approach other historic investors like Peter Lynch followed. Like Lynch, Baron appreciates the impact of long-term home run stocks (Lynch called them “multi-baggers”). For example, in the interview Baron talks about the 30x return he earned on his Devry (DV) investment from the early 1990s; his 50x return on Charles Schwab (SCHW) from 1990; or Manor Care, up 100x from 1969 to its acquisition. Lynch enjoyed similar successes, but had an itchier trading trigger finger – his multi “bucket” strategy was quite unique (another day, another blog post).
When it comes to passive investing, Ron Baron like other active fund managers discredits the powers of index investing:
“With index funds, you are going to be investing in the most successful businesses at that point in time, and at the top of the market you will be massively over-weighted in those companies.”
Like the scarce number of .300 hitters in baseball, I believe there are a select few investment managers who can consistently outperform the market (a study in 2007 showed only 12 active career .300 hitters in Major League Baseball). I believe Baron is one of those .300 hitters in the investment world. The problems with analyzing manager performance are luck and “law of large numbers.” These phenomena wreak havoc on the examinations of short-run performance. The wheat ultimately gets separated from the chaff over the long-haul, but with the “Great Recession” of 2008-2009, many long-term investors are still hiding or shaking in their boots.
Ultimately, I believe the horse trading game of actively managed funds is a tough game to win. Most investors end up chasing performance and rotating in and out of positions at the wrong times. Nonetheless, Ron Baron has proved his ability to generate above average returns over the long haul. Taking a swing with Ron Baron might not be a bad idea.
Wade W. Slome, CFA, CFP
Plan. Invest. Prosper.
Ooops…Siegel Data Questioned
Professor Jeremy Siegel is well-known in large part due to his famed book, “Stocks for the Long Run,” which Siegel uses as a foundation for his assertion that stocks have dramatically outperformed bonds since 1802. Siegel has four versions of his book, but the basic conclusion is that stocks have averaged about a 7% annual return (approximately 10% after accounting for inflation) versus around 4% for bonds, over a two hundred plus year timeframe. One problem – the validity of 69 years of the data (1802 – 1870) are now being questioned.
Any Utopian study or mathematical model is only as valuable as the data that goes into it. “Garbage in” will result in “garbage out.” According to a Wall Street Journal article (Does Stock-Market Data Really Go Back 200 Years?) written by Jason Zweig, the index data used by Siegel was too narrow on an industry basis and involved too few stocks (e.g., primarily banks, insurance and transportation stocks). In addition, the reliability of the conclusions is being second guessed because the data used by Professor Siegel starting back as far as 1802 were compiled decades ago by two separate economists, Walter Buckingham Smith and Arthur Harrison Cole.
According to Zweig, another area of concern is the fluctuating dividend yield used by Professor Siegel:
In an article published in 1992, he estimated the average annual dividend yield from 1802-1870 at 5.0%. Two years later in his book, it had grown to 6.4% — raising the average annual return in the early years from 5.7% to 7.0% after inflation. Why does that matter? By using the higher number for the earlier period, Prof. Siegel appears to have raised his estimate of the rate of return for the entire period by about half a percentage point annually.
I’m sure Professor Siegel has a rebuttal to all these accusations, but we’ll just have to wait and see how credible the response is. Maybe Siegel’s next book will be entitled, “Bonds for the Long Run”?
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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.
Pinning Down Roubini Requires a Lasso
Pinning down a Nouriel Roubini forecast is like lassoing a frenzied cow. They say a broken clock is right twice a day, and maybe the same principle applies to renowned economist, Professor Roubini (NYU)? Sure, credit should be given where credit is due. He nailed the forecast relating to the housing led financial bubble and subsequent financial collapse – even if the prediction was years early.
Here’s where I have a beef. Now that Roubini has become a celebrated rock star with frequent television interviews and speaking engagements, his touring views are becoming more fluid and slippery as time progresses. Sure it’s more comfortable to ride the fence and lean in whatever direction the weekly economic winds are blowing. I suppose if you throw out enough changing viewpoints, which adjust to evolving moods, you can never be wrong.
Let’s examine some of his views:
- Out of Context: Just last week, Mr. Roubini said the “worst is behind us,” but in order to retain his “Dr. Doom” celebrity status he felt compelled to issue a press release clarifying his statements. He noted his “views were taken out of context,” and added, “I have said on numerous occasions that the recession would last roughly 24 months.” That’s funny, because he just stated last year it would be 12-18 months (Click Here for Video).
- Sweating Out Rebound: Maybe the 41% bounce in the S&P 500 or the 49% jump in the NASDAQ from March 9th lows compelled Roubini to make the “worst is behind us” comments, but why then at the beginning of this year did he say, “We are still only in the early stages of this crisis. My predictions for the coming year, unfortunately, are even more dire: The bubbles, and there were many, have only begun to burst.” Hmmm…excuse me while I scratch my head.
- Alphabet Soup Recovery: Also frustrating are the John Kerry-esque waffling comments relating to whether this economic recovery will be a U, W, or L-shaped economic recovery. Last April he was in the U-camp: “My view is closer to a U-shaped recession as I expect that the economic contraction will last at least 12 months and possibly as long as 18 months through the middle of 2009.” Now, as early as last month Roubini is warning of a double dip or “W-shaped” recovery with the rising possibility of a “perfect storm” in 2010 (Click Here for Video). He sees the expiration of tax cuts, rising oil prices, inflating debt and interest rates leading to another downturn. So is it U or W, or will we hear more about an “L” shaped recovery? Maybe the worst is not behind us? I’m confused.
- Doomsday Earnings Yet to Arrive: Still early in the quarterly earnings reporting season but Roubini’s call for a downside in corporate earnings has yet to materialize. As a matter of fact, Zacks Investment Research reported last week that early second quarter upside surprises are beating downside surprises by a ratio of 7 to 1. So far not too “Doom-full.”
I’m no economist or recovery expert, but what I do know is that I’m having difficulty pinning down Professor Roubini’s ever-changing views. I suppose I will just mail CNBC, Bloomberg, or the bevy of other Roubini media groupies a lasso in hopes they will pin Mr. Roubini down.
Wade W. Slome, CFA, CFP®
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, 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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