Archive for February, 2016
Avoiding Automobile and Portfolio Crashes
Personal opinions of oneself don’t always mirror reality. Self perceptions relating to both driving and investing can be inflated. For example, the National Highway Traffic Safety Administration (NHTSA) reports that 95% of crashes are caused by human error, but 75% of drivers say they are better drivers than most.
Contributing factors to crashes include: 1) Distractions; 2) Alcohol; 3) Unsafe behavior (i.e., speeding); 4) Time of day (fatality rate is 3x higher at night); 5) Lack of safety belt; 6) Weather; and 7) Time of week (weekends are worst crash days).
A spokesman for the Insurance Institute for Highway Safety is quick to point out that driving behind the wheel is the riskiest activity most people engage in on a daily basis – more than 40,000 driving related fatalities occur each year. Careful common sense helps while driving, but driving sober at 4 a.m. (very few drivers on the road) on a weekday with your seatbelt on won’t hurt either.
Avoiding a Portfolio Crash
Another dangerous activity frequently undertaken by Americans is investing, despite people’s inflated beliefs of their money management capabilities. Investing, however, does not have to be harmful if proper precautions are taken.
Here is some of the hazardous behaviors that should be avoided by those maneuvering an investment portfolio:
1) Trading Too Much: Excessive trading leads to undue commissions, transaction costs, bid-ask spread, impact costs. Many of these costs are opaque or invisible and won’t necessarily be evident right away. But like a leaky boat, direct and indirect trading costs have the potential of sinking your portfolio.
2) Worrying about the Economy Too Much: The country experiences about two recessions a decade, nonetheless our economy continues to grow. If macroeconomics still worry you, then look abroad for even healthier growth – considerable international exposure should aid the long-term success of your portfolio and assist you in sleeping better at night.
3) Emotionally Reacting – Not Objectively Planning: News is bad, so sell. News is good, so buy. This type of conduct is a recipe for portfolio disaster. Better to do as Warren Buffett says, “Be fearful when others are greedy, and be greedy when others are fearful.” The long-term fundamental prospects for any investment are much more important than the daily headlines that get the emotional juices flowing.
4) Hostage to Short-term Time Horizon: Rather than worry about the next 10 days, you should be focused on the next 10 years. The further out you can set your time horizon, the better off you will be. Patience is a virtue.
5) Incongruent Portfolio with Risk: Many retirees got caught flat-footed in the midst of the global financial crisis of 2008-09 with investment portfolios heavy in equities and real estate. Diversified portfolios including fixed-income, commodities, international exposure, cash, and alternative investments should be optimized to meet your specific objectives, constraints, risk tolerance, and time horizon.
6) Timing the Market: Attempting to time the market can be hazardous to your investment health (see Market Timing article). If you really want to make money, then avoid the masses – the grass is greener and the eating better away from the herd.
Driving and investing can both be dangerous activities that command responsible behavior. Do yourself a favor and protect yourself and your portfolio from crashing by taking the appropriate precautions and avoiding the common hazardous mistakes.
Read Full Forbes Article on Driving Dangers
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 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.
Thank You Volatility
“Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.” -Warren Buffett
We’ve had some choppy markets and that’s fine by me. Great investors love uncertainty because volatility equates to opportunity. Selling or shorting into volatile euphoria and buying into panic is a time-tested, wealth creating strategy. On the other hand, when everything is consistently moving in one direction, either upwards or downwards, investing can be an easy and straight forward momentum game. Buy something and watch it go up…short something and watch it go down.
In tough, choppy, trendless markets, identifying trends by active traders becomes more challenging. During tricky markets like we’re in now is when the wheat gets separated from the chaff. Day traders and speculators act on a zig one day and are forced to zag the next. Because of the volatile, whippy market dynamics, this type of active trading by individuals rapidly destroys portfolios, not only because of the transaction costs and taxes, but also due to impact costs and spread losses (i.e., bid-ask).
Often, the greater losses come from the behavioral aspects of active trading. Performance chasing and/or the pursuit of overzealous loss mitigation frequently are driven by the destructively entrenched emotions of fear and greed. In the past, I can’t tell you how many times I have rushed into a highflying stock, only to see it pull back down -15-20%, in short order. On the flip side, how often have stocks bounced significantly, after I’ve made a panicked sale? Too many, unfortunately. Most investors don’t take to heart the fact that whenever you initiate a trade, you need to be right twice to optimize your profits. In other words, the security you initially sell needs to go lower (i.e., you should have kept the original investment), AND the security you subsequently buy needs to go higher (i.e., you shouldn’t have purchased the new investment in the first place).
Even in the cases in which the balance of the buy/sale trades becomes a wash, the trading costs and taxes will eat the active trader alive. Unfortunately, the other outcome of losing on both sides of the trade (the purchase goes lower and sale goes higher) is all too common. For example, the purchase you falls by -3%, and the investment you sold climbs +10%. Doing nothing would have been the best outcome!
All this investment tail-chasing inevitably results in a lot of portfolio bloodletting. There is plenty of academic research that shows practically all day traders lose money. Terrance Odean from Cal-Berkeley used 14 years of day trader data to conclude that more than 98% of day traders lose money. Even for those traders able to make a profit in the short run, usually the success doesn’t last very long:
- 40% of day traders quit within a month
- 87% of traders quit within 3 years
- 93% of traders quit within 5 years
Other sources besides Odean show the percentage of day trading losers as greater than 95%, and if you don’t trust the academic data, then simply ask your accountant what percentage of his/her active trading clients make a profit, after considering all taxes and trading costs.
While I may not necessarily fully rejoice in the pain and carnage of day traders, I am always thankful for these choppy markets. Without volatility, anybody can make money in upward trending markets (e.g., day traders did better in the mo-mo 1990s), but in those markets long-term opportunities become sparse. Without the transitory headlines of tightening Federal Reserve policy, negative interest rates, a strong dollar, and political dysfunction, I would not have a professional investing job. And for that blessing, I want to sincerely say, “Thank you volatility.”
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 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.
Shoot Now, Ask Later
![940614_83408820[1]](https://sidoxia.files.wordpress.com/2011/08/940614_834088201.jpg?w=311&h=230)
Since the start of 2016, investor sentiment has led to a shoot now, ask questions later mentality. In the court of economic justice, all stocks have been convicted guilty of recession despite the evidence and defense that proves the economy innocent. Even the Federal Reserve Chair Janet Yellen did not prove to be a great public defender of the economy with her comments that negative interest rates are on the table.
With large cap stocks down -13% and small cap stocks losing -25% from 2015, there are a mixture of indicators suggesting a looming recession could be coming. For example, banking stocks, the beating heart of the U.S. economy, saw prices collapse almost -30% from the 2015 highs this week. As CNBC pointed out, “American Airlines (AAL), United Continental (UAL), General Motors (GM) and Ford (F) all sell for five times 2016 earnings” – about a 70% discount to the average S&P 500 stock. As a group, these economically sensitive cyclical stocks grew earnings per share greater than 50%, while their stock prices are down by more than -30% from their 52-week highs. In general, the cyclicals are serving jail time, even though growth has been gangbusters and the current valuations massively discounted.
On the flip side, defensive stocks with little-to-no revenue growth like “Campbell Soup (CPB) trade at 20 times earnings, Kimberly-Clark (KMB) is at 21 times earnings, Procter & Gamble (PG) is at 22 times earnings and Clorox (CLX) is at 25 times earnings. All of these stocks are near 52-week highs.”
Confused? Well, if we are indeed going into recession, than this valuation dichotomy between cyclicals and staples makes sense. Stocks can be a leading indicator (i.e., predictor) of future recessions, but as the famed Nobel Prize winner in economics Paul Samuelson noted, “The stock market has forecast nine of the last five recessions.”
On the other hand, if this current correction is a false recession scare, then now would be a tremendous buying opportunity. In fact, over the last five years, there have been plenty of tremendous buying opportunities for those courageous long-term investors willing to put capital to work during these panic periods (see also Groundhog Day All Over Again):
- 2011: Debt Downgrade/Debt Ceiling Debate/European PIIGS Crisis (-22% correction)
- 2012:Arab Spring/Greek “Gr-Exit” Fears (-11% correction)
- 2013: Fed Taper Tantrum (-8% correction)
- 2014: Ebola Outbreak (-10% correction)
- 2015: China Slowdown Fears (-13% correction in August)
- 2016 (1st Six Weeks): Strong Dollar, Collapsing Oil, interest Rate Hikes/Negative Rates, Weakening China (-15% correction)
- 2016 (Next 46 Weeks): ??????????
Today’s threats rearing their ugly heads have definite recession credibility, but if you think about the strong dollar, collapsing oil prices, Fed monetary policies, weakening Chinese economy, and negative global interest rates, all of these threats existed well before stock prices nose-dived during the last six weeks. If the economic court is judging the current data for potential recession evidence, making a case and proving the economy guilty is challenging. It’s tough to find a recession when we witness a low unemployment rate (4.9%); record corporate profits (ex-energy); record car sales (17.5 million); an improving housing market; a positively sloped yield curve; healthy banking and consumer balance sheets; sub-$2/gallon gasoline; and a flattening U.S. dollar, among other factors.
Could stock prices be clairvoyantly predicting Armageddon? Sure, anything is possible…but this scenario is unlikely now. Even if the U.S. economy is headed towards a recession, the -20% plunge in stock prices is already factoring in most, if not all, of a mild-to-moderate recession. If the economic data does actually get worse, there is still room for stock prices to go down. Under a recession scenario, the tremendous buying opportunities will only get better. While weak hands may be shooting (selling) first and asking questions later, now is the time for you to use patience and discipline. These characteristics will serve as bullet proof vest for your investment portfolio and lead to economic justice over the long-term.
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) and non-discretionary positions in PG, and KMB, but at the time of publishing had no direct position in AAL, CLX, CPB, F, GM, UAL, 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.
Invest with a Telescope…Not a Microscope
It was another bloody week in the stock market (S&P 500 index dropped -3.1%), and any half-glass full data was interpreted as half-empty. The week was epitomized by a Citigroup report entitled “World Economy Trapped in a Death Spiral.” A sluggish monthly jobs report on Friday, which registered a less than anticipated addition of 151,000 jobs, painted a weakening employment picture. Professional social media site LinkedIn Corp. (LNKD) added fuel to the fire with a soft profit forecast, which resulted in the stock getting almost chopped in half (-44%)…in a single day (ouch).
It’s funny how quickly the headlines can change – just one week ago, the Dow Jones Industrial index catapulted higher by almost +400 points in a single day and we were reading about soaring stocks.
Coherently digesting the avalanche of diverging and schizophrenic headlines is like attempting to analyze a windstorm through a microscope. A microscope is perfect for looking at a single static item up close, but a telescope is much better suited for analyzing a broader set of data. With a telescope, you are better equipped to look farther out on the horizon, to anticipate what trends are coming next. The same principle applies to investing. Short-term traders and speculators are great at using a short-term microscope to evaluate one shiny, attention-grabbing sample every day. The investment conclusion, however, changes the following day, when a different attention-grabbing headline is analyzed to a different conclusion. As Mark Twain noted, “If you don’t read the newspaper, you are uninformed. If you do read the newspaper, you are misinformed.”
Short-termism is an insidious disease that will slowly erode short-run performance and if not controlled will destroy long-run results as well. This is not a heretic concept. Some very successful investors have preached this idea in many ways. Here are a few of them:
‘‘We will continue to ignore political and economic forecasts which are an expensive distraction for many investors and businessmen.” –Warren Buffett (Annual Newsletter 1994)
‘‘If you spend more than 14 minutes a year worrying about the market, you’ve wasted 12 minutes’’ –Peter Lynch
“Excessive short-termism results in permanent destruction of wealth, or at least permanent transfer of wealth” -Jack Gray Grantham
On the flip side, those resilient investors who have succeeded through investment cycles understand the importance of taking a long-term view.
“Whatever method you use to pick stocks or stock mutual funds, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed.” –Peter Lynch
“The farther you can lengthen your time horizon in the investment process, the better off you will be.” – David Nelson (Legg Mason)
“Long term owners are more relaxed, more informed, more patient, less emotional.” –John Templeton
“If you are really a long-term investor, you will view a bear market as an opportunity to make money.” –John Templeton
“Long term is not a popular time-horizon for today’s hedge fund short-term mentality. Every wiggle is interpreted as a new secular trend.” –Don Hays
“In the long run, one of the greatest risk to your net worth is not owning stocks. Bonds do not grow. They can only return their face value at maturity…Inflation is a silent, insidious tax that erodes your net worth…Fortunately, there is an easy way to keep pace with and even beat inflation, and this is stocks.” – John Spears
“In the short-term, the stock market is a voting machine; in the long-term a weighing machine.” -Benjamin Graham
There has been a lot of pain experienced so far in 2016, and there may be more to come. However, trying to time the market and call a bottom is a fruitless effort. Great companies and investments do not disappear in a bear market. At times like these, it is important to stick to a systematic, disciplined approach that integrates valuation and risk controls based on where we are in an economic cycle. Despite all the recent volatility, as I’ve repeated many times, the key factors driving the direction of the stock market are the following: 1) Corporate profits; 2) Interest rates; 3) Valuations; and 4) Sentiment (see also Don’t Be a Fool, Follow the Stool). Doom and gloom “Death Spiral” headlines may currently rule the day, but the four key stock-driving factors on balance remain skewed towards the positive…if you have the ability to put away your microscope and take out your telescope.
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 had no direct position in LNKD 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.
Groundhog Day All Over Again
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (February 1, 2016). Subscribe on the right side of the page for the complete text.
It’s that time of the year when the masses gather in eager anticipation of Groundhog Day to predict whether the furry rodent will see its shadow in 2016, thereby extending winter for an additional six weeks.
In the classic movie Groundhog Day, actor Bill Murray plays character Phil Connors, an arrogant, self-centered TV weatherman who, during an assignment covering the annual Groundhog Day event in Punxsutawney, Pennsylvania, finds himself stuck in a time loop, repeating the same day over and over. With a feeling of nothing to lose, Phil repeatedly decides to indulge in reckless hedonism and criminal behavior. After being resigned to perpetually reliving the same day forever, Phil begins to re-examine his life and falls in love with his co-worker Rita Hanson (see scene here). Ultimately, Phil’s pure focus on the important priorities of life allows himself to break the painful monotonous time loop and win Rita’s love.
Stock market investors are lining up in a similar fashion to predict whether the financial winter experienced in January will persist through the rest of the year. The groundhog, equipped with a thick fur coat, certainly would have been more optimally prepared for the icy January financial market conditions. More specifically, the S&P 500 index declined -5.1% for the month and the Dow Jones fell -5.5%.
Unfortunately for many investors, they too have been trapped in a never-ending news cycle, which painfully buries the public with a monotonous loop of daily pessimistic headlines. As a result of the eternally distorted media cycle, many investors have lost sight of important priorities like Phil Connors. Since the beginning of 2011, the investors who have endured the relentless wave of media gloom have been handsomely rewarded. From 2011-2016, the S&P 500 stock index has ascended approximately 54%, even after accounting for the significant January 2016 decline.
Unless you were burrowed in a hole like a groundhog, you will probably recognize a number of these ominous headlines spanning across the 2011 – 2015 headlines:
- 2011: Debt Downgrade/Debt Ceiling Debate/European PIIGS Crisis (-22% correction)
- 2012: Arab Spring/Greek “Gr-Exit” Fears (-11% correction)
- 2013: Fed Taper Tantrum (-8% correction)
- 2014: Ebola Outbreak (-10% correction)
- 2015: China Slowdown Fears (-13% correction)
Similar to the Groundhog Day movie, the headlines of 2016 match the tone and mood we’ve seen in recent years. Here’s an abbreviated list of the recurring worries-du-jour in January:
China Slowdown: Is this something new? As you can see from the chart below, China has been slowing since 2010. Due to the law of large numbers, and as the second largest economy on the globe, it is natural to see such an enormous economic engine eventually slow. Rather than panic over China’s slowing, observers should be applauding. China’s Q4 GDP growth recently came in at +6.8%, almost 10x the level recorded by the U.S. in Q4 (+0.7%). Even if you mistrust the official Chinese government’s reported data, our economy would kill for the still impressive independently reported growth statistics (see chart below). While the concerted effort of the political regime to migrate the country from an export-driven economy to a consumption-based one has caused some growing pains, nevertheless in recent months we have seen China report record automobile purchases, retail sales, oil consumption, and industrial production.
Rise of the U.S. Dollar: This is a legitimate concern that has had tangible negative impacts on the U.S. economy. As you can see from the chart below (blue line), in less than one year, the value of the U.S. dollar spiked by approximately +25%. If you are a multinational company exporting a product to Europe for $100, and consumers wake up a year later having to pay $125 for the same product, it should come as no surprise to anyone that this phenomenon is squeezing profits. The good news is that U.S. corporations have already absorbed the worst of this currency pain dating back to early 2015, so if the stabilizing foreign exchange trends remain near current levels, as they have over the last year, there should be no additional economic drag.
Oil Prices Down: Somehow the U.S. media is trying to convince the public that lower oil prices are bad for the economy. Yes, it is true, the financial restructurings and lost jobs associated with oil price declines will hurt the economy and the banks overall. However, the benefits of lower oil prices on the broader economy (i.e., more money in consumers’ pockets) is unambiguously positive and will overwhelm any indirect damage. Every penny decrease in gasoline prices (now roughly $1.83 per gallon nationally) equates to about a $1 billion tax cut for consumers (see chart below). Many people are worried about oil prices being a signal of weakness, but if you look at the last few recessions, they were all preceded by an oil price spike, not a price collapse.
Source: AAA
Federal Reserve Monetary Policy: The first interest rate hike in nine years took place in 2015, but that did not prevent investors from fretting about the timing of the next interest rate hike. As I’ve written many times (see Fed Fatigue Setting In), the Fed has barely budged its target rate to 0.375%, so this is much to do about nothing. Wake me up when we get to 2.00%, at which point we will still be far below the long-term average but at a more meaningful level (see chart below).
Source: The Wall Street Journal
Presidential Elections: Congress’s approval rating is abysmal, but like it or not, primary season is just starting and we are stuck in a presidential election cycle until the second Tuesday of November. Guess what? If you want to know the impact of the elections on the financial markets, then I will give you the short answer…it just does not matter who gets elected. History shows us that the markets go up and down under both Republican and Democratic parties. If you are comparing the track record on the political parties’ track record on debt creation, it is a mixed bag as well (see chart below). Arguably, in half the cases, the nomination of the Federal Reserve chairs will have as large (or larger) an impact than the elected president. If you were to factor in the inevitable splits in Congress to the equation, the result is gridlock. I have contended for some time that gridlock is a positive outcome because it structurally forces a lid on disciplined government spending (see Who Said Gridlock is Bad?). If this isn’t a good enough explanation, see Barry Ritholtz’s take on the subject of politics and the stock market…I couldn’t sum it up any better (click here)
Source: Calafia Beach Pundit
Fortunately for groundhogs, and long-term investors, dealing with challenging and volatile climates is nothing new. Both burrowing marmots and emotional investors need to adapt to ever-changing environments…sunny or overcast. In addition to a cold 2016 start, January was also a chilly month in 2014 and 2015, with the S&P 500 down -3.6% and -3.1%, respectively. Despite this seasonal sour sentiment, there is a silver lining. In both instances (2014 & 2015), the market rebounded significantly in subsequent months after the slow start at the beginning of the year. For the remainder of the year, the S&P advanced +15.5% in 2014, and +2.5% in 2015.
In Groundhog Day the movie, Bill Murray relived the same day over and over again, and repeated the same missteps until he learned from his mistakes. Long-term investors will be served best by applying this same philosophy to their investments. Like a groundhog, investors have a tendency to become scared of their own shadows. It’s easy to succumb to the infinite time loop of worrisome headlines, but rather than burrowing away in hibernation, creating a diversified, low-cost, tax-efficient portfolio customized for your specific time horizon, risk tolerance, and liquidity needs is a better way of celebrating this year’s Groundhog Day.
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 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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