Archive for January, 2017
Investors from around the globe excitedly witnessed the Dow Jones Industrial Average index break the much-anticipated 20,000 level and set a new all-time record high this week. The question now becomes, is this new threshold braking news (time to be concerned) or breaking news (time to be enthused)? The true answer is neither. While the record 20,000 achievement is a beautifully round number and is responsible for a bevy of headlines splashing around the world, the reality is this artificial 20,000 level is completely arbitrary.
Time will tell whether this random numeric value will trigger the animal spirits of dispirited investors, but given all the attention, it is likely to jolt the attention span of distracted, ill-prepared savers. Unfortunately, the median family has only saved a meager $5,000 for retirement. For some years now, I have highlighted that this is the most hated bull market (see The Most Hated Bull Market Ever), and Gallup’s 2016 survey shows record low stock ownership, which also supports my view (chart below). Trillions of dollars coming out of stock funds is additional evidence of investors’ sour mood (see fund outflow data).
While investors have been selling stocks for years, record corporate profits, trillions in share buybacks, and trillions of mergers and acquisitions (in the face of a weak IPO market) have continually grinded stock prices to new record highs.
The maligned press (deservedly so in many instances) has been quick to highlight a perpetual list of dread du jour. The daily panic-related topics do however actually change. Some days it’s geopolitical concerns in the Middle East, Russia, South China Sea, North Korea, and Iran and other days there are economic cries of demise in China, Brazil, Venezuela, or collapse in the Euro. And even when the economy is doing fine (unemployment rate chopped in half from 10%, near full employment), the media and talking heads often supply plenty of airtime to impending spikes of crippling inflation or Fed-induced string of choking interest rate increases.
I fondly look back on my articles from 2009, and 2010 when I profiled schlocks like Peter Schiff (see Emperor Schiff Has No Clothes) who recklessly peddled catastrophe to the masses. I guess Schiff didn’t do so well when he called for the NASDAQ to collapse to 500 (5,660 today) and the Dow to reach 2,000 (20,000 today).
Or how about the great forecaster John Mauldin who also piled onto death and destruction near the bottom in 2009 (see The Man Who Cries Wolf ). Here’s what Mauldin had to say:
“All in all, the next few years are going to be a very difficult environment for corporate earnings. To think we are headed back to the halcyon years of 2004-06 is not very realistic. And if you expect a major bull market to develop in this climate, you are not paying attention.” … “We are going to pay for that with a likely dip back into a recession.”
At S&P 856 (2,295 today) Mauldin added:
“This rally has all the earmarks of a major short squeeze…When the short squeeze is over, the buying will stop and the market will drop. Remember, it takes buying and lot of it to move a market up but only a lack of buying to create a bear market.”
Nouriel Roubini a.k.a. “Dr Doom” was another talking head who plastered the airwaves with negativity after the 2008-2009 financial crisis that I also profiled (see Pinning Down Roubini). For example, in early 2009, here’s what Roubini said:
“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.”
For long-term investors, they understand the never-ending doom and gloom headlines are meaningless noise. Legendary investor Peter Lynch pointed on on numerous occasions:
“If you spend more than 13 minutes analyzing economic and market forecasts, you’ve wasted 10 minutes.”
(see also Peter Lynch video)
The good news is all the media pessimism and investor skepticism creates opportunities for shrewd investors focusing on key drivers of stock price appreciation (corporate earnings, interest rates, valuations, and sentiment).
While the eternally, half-glass full media is quick to highlight the negatives, it’s interesting that it takes an irrelevant, arbitrary level to finally create a positive headline for a new all-time record high of Dow 20,000. Frustratingly, the new all-time record highs reached by the Dow in 2013, 2014, 2015, and 2016 were almost completely ignored (see chart below):
What happens next? Nobody knows for certain. What is certain however is that using the breaking news headlines of Dow 20,000 to make critical investment decisions is not an intelligent long-term strategy. If you, like many investors, have difficulty in sticking to a long-term strategy, then find a trusted professional to help you create a systematic, disciplined investment strategy. Now, that is some real breaking news.
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.
“Why do you buy stocks?” Unfortunately, many people do not truly understand how to answer that particular question. If they were honest with themselves, many stockholders would respond by saying, “Because they are going up in price,” or maybe, “My neighbor told me to buy stock XYZ.” However, if somebody asked the same question regarding the purchase of a real estate property or an apartment building, would the answer be the same? The short answer is…probably not. There certainly could be some people who answer the stock versus real estate valuation question in the same way, but in general, real estate investors understand the tangibility and relevant factors of a property better than equity investors understand the jargon and abstract nature of most stocks.
There are many ways to value an asset, but in many cases, the value of an asset is spontaneously left in the eye of the beholder. Nevertheless, there is one common approach, applicable across asset classes, which is the net present value or discounted cash flow approach. This valuation methodology basically states any asset is worth the cumulative value of cash inflows minus the value of cash outflows, after adjusting that netted figure for time and interest rates.
In the case of an apartment building, a layman generally understands the basic valuation concept behind adding up the relevant cash inflows and cash outflows. For example, being a landlord of an apartment building involves simple rent collection (cash inflows) in addition to maintenance, repairs, construction costs, employee wages, taxes, and other payments (cash outflows). After making additional assumptions about future rent increases, occupancy levels, wage inflation, and a few other variables, many outside observers could probably come up with a decent estimated value of the property.
The variables relating to an apartment building may be more stable, predictable, and understandable, if compared with the variables of a stock, but the same exact principles apply to both asset classes. Wal-Mart may not collect stable rent checks, but it does collect money from product sales in its 11,500 stores around the world (cash inflows). Wal-Mart’s cash inflows are much less predictable than real estate rent check inflows due to the many retail-specific variables, such as store openings/closings, online competition, promotions, seasonality, inventory levels, and geographic economics. Expenses (cash outflows) are challenging to predict as well due to wage fluctuations, energy cost variability, capital project timing, erratic raw material prices, and other factors. In the end, stock variables may be more volatile and less predictable, but the valuation process should be the same. Valuing stocks requires estimating the cumulative value of cash inflows minus the value of cash outflows, and then adjusting those results for time and interest rates.
Real estate has its own industry language, but the language of stocks has an endless number of acronyms, which can be quite challenging if you consider the dozens of industries and thousands of stocks. Here are a few of my favorite obscure acronyms used across the technology, healthcare, energy, and retail sectors:
Technology: 4G, CDMA, DSLAM, LTE, MPLS, SaaS, SRAM
Energy: BCF, BOE, BTU, EIA, Gwh, kWh, LNG, MWh, WTI
Healthcare: AARP, CRM, DRG, EENT, FDA, HIPAA, MI, SARS
Retail: B2B, EDI, EDLP, GMROI, POS, RFID, SCM, SKU, UPC
As noted earlier, the language and complexity for valuing stocks may be more complicated than valuing other more straightforward asset classes, but the methodology is essentially the same.
The opportunities and rewards stemming from stock ownership are almost endless. While it’s true that successful long-term stock investing is rarely easy, anything worthwhile in life is never simple. If you are able to understand the principal concepts of how to become an effective landlord of real estate, then applying the same principles on how to become an effective landlord of your stock portfolio is highly achievable.
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 WMT 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.
Paul Meehl was a versatile academic who held numerous faculty positions, covering the diverse disciplines of psychology, law, psychiatry, neurology, and yes, even philosophy. The crux of his research was focused on how well clinical analysis fared versus statistical analysis. Or in other words, he looked to answer the controversial question, “What is a better predictor of outcomes, a brain or an equation?” His conclusion was straightforward – mechanical methods using quantitative measures are much more efficient than the professional judgments of humans in coming to more accurate predictions.
Those who have read my book, How I Managed $20,000,000,000.00 by Age 32 know where I stand on this topic – I firmly believe successful investing requires a healthy balance between both art and science (i.e., “brain and equation”). A trader who only relies on intuition and his gut to make all of his/her decisions is likely to fall on their face. On the other hand, a quantitative engineer’s sole dependence on a robotic multi-factor model to make trades is likely to fail too. My skepticism is adequately outlined in my Butter in Bangladesh article, which describes how irrational statistical games can be misleading and overused.
As much as I would like to attribute all of my investment success to my brain, the emotion-controlling power of numbers has played an important role in my investment accomplishments as well. The power of numbers simply cannot be ignored. More than 50 years after Paul Meehl’s seminal research was published, about two hundred studies comparing brain power versus statistical power have shown that machines beat brains in predictive accuracy in the majority of cases. Even when expert judgments have won over formulas, human consistency and reliability have muddied the accuracy of predictions.
Daniel Kahneman, a Nobel Prize winner in Economics, highlights another important decision making researcher, Robyn Dawes. What Dawes discovers in her research is that the fancy and complex multiple regression methods used in conventional software adds little to no value in the predictive decision-making process. Kahneman describes Dawes’s findings more specifically here:
“A formula that combines these predictors with equal weights is likely to be just as accurate in predicting new cases as the multiple-regression formula…Formulas that assign equal weights to all the predictors are often superior, because they are not affected by accidents of sampling…It is possible to develop useful algorithms without any prior statistical research. Simple equally weighted formulas based on existing statistics or on common sense are often very good predictors of significant outcomes.”
The results of Dawes’s classic research have significant application to the field of stock picking. As a matter of fact, this type of research has had a significant impact on Sidoxia’s stock selection process.
How Sweet It Is!
In the emotional roller-coaster equity markets we’ve experienced over the last decade or two, overreliance on gut-driven sentiments in the investment process has left masses of casualties in the wake of losses. If you doubt the destructive after-effects on investors’ psyches, then I urge you to check out my Fund Flow Paradox article that shows the debilitating effects of volatility on investors’ behavior.
In order to more objectively exploit investment opportunities, the Sidoxia Capital Management investment team has successfully formed and utilized our own proprietary quantitative tool. The results were so sweet, we decided to call it SHGR (pronounced “S-U-G-A-R”), or Sidoxia Holy Grail Ranking.
My close to two decades of experience at William O’Neil & Co., Nicholas Applegate, American Century Investments, and now Sidoxia Capital Management has allowed me to build a firm foundation of growth investing competency – however understanding growth alone is not sufficient to succeed. In fact, growth investing can be hazardous to your investment health if not kept properly in check with other key factors.
Here are some of the key factors in our Sidoxia SHGR ranking system:
- Free cash flow yield
- Price/earnings ratio
- PEG ratio
- Dividend yield
- Financials: Profit margin trends; balance sheet leverage
- Management Team: Track record; capital stewardship
- Market Share: Industry position; runway for growth
Contrarian Sentiment Indicators:
- Analyst ratings
- Short interest
- Earnings growth
- Sales growth
Our proprietary SHGR ranking system not only allows us to prioritize our asset allocation on existing stock holdings, but it also serves as an efficient tool to screen new ideas for client portfolio additions. Most importantly, having a quantitative model like Sidoxia’s Holy Grail Ranking system allows investors to objectively implement a disciplined investment process, whether there is a presidential election, Fiscal Cliff, international fiscal crisis, slowing growth in China, and/or uncertain tax legislation. At Sidoxia we have managed to create a Holy Grail machine, but like other quantitative tools it cannot replace the artistic powers of the brain.
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.
Why would I and 175,000 other humans from over 150 countries possible gather in one spot to look and play with a bunch of toys and gadgets? The answer can be explained with three letters…CES, otherwise known as the Consumer Electronics Show, which has been held primarily in Las Vegas, Nevada since 1967 – a few years before I was born. More than 7,500 media professionals from around the world also attended the world’s largest consumer technology tradeshow to write millions of online articles and messages about the latest and greatest hardware, software, and services.
I have attended CES multiple times, but more amazing than the massive scale of the 2.5 million square feet of exhibition space is the pace and magnitude of the innovation.
With approximately 4,000 exhibiting companies showing off their gadgets and services, you can probably imagine there were quite a few categories flaunted, including the following:
- Augmented & Virtual Reality
- Internet of Things (IoT) and Smart Home Technologies
- Televisions, Televisions, and more Televisions
- Driverless Cars
- 3D Printers
- Electronic Gaming
- Automobile Entertainment/Audio
As I point out in the Birth of Silicon Valley – Traitorous 8, even after 50 years, “Moore’s Law” is still alive and well today. Moore’s Law, which was established by the Intel Corporation (INTC) founder Gordon Moore, states the number of transistors (i.e., a chip’s computing power) generally doubles every 1-2 years. CES epitomized the Moore’s Law trend, which has allowed technology companies to make hardware exponentially faster, smaller, and more battery efficient (i.e., longer life).
Moore’s Law has contributed to the acceleration of innovation by driving storage costs down a constant path towards zero, while semiconductor technology continues to explode computing power at the edge of networks (cell phones) and at the core of networks (the “cloud”). There are already approximately five billion cell phone subscribers worldwide, and two billion of those are effectively supercomputers in the form of smartphones. This global mobile computing explosion has opened up an infinite number of potential applications, limited only by the number of creative ideas. Many new and existing killer applications are being created by the multi-billion dollar cloud-based data centers that Amazon Web Services (AWS) and other competing tech behemoths are creating. The glue necessary to connect the explosion of computing power at the core and edge is software, which is why there is such massive demand for software programmers (“coders”) in Silicon Valley.
I found the advancements in augmented reality, connected homes, and drones to be especially fascinating areas at the show, but here are a couple of the more quirky finds I discovered:
One S1 Segway: Yes, it’s true that Hoverboards literally caught fire last holiday season, but CES highlighted a sister product, the One S1 Segway at the show. Essentially the gadget is a miniature unicycle that meets mobile phone app. I captured a brief video here:
Petcube: As a pet owner, I was also intrigued by Petcube, a cloud-based interactive pet monitor service that allows consumers to remotely communicate and play with their pets through their phones. In addition to speaking to the pet through the Petcube, the user can also remotely play with their pet by activating a moving laser. The company also has made a remote treat-dispensing device to reward and feed lonely pets. Here is a video summary:
If you have never been to CES and are contemplating a visit, please be aware the sheer size and magnitude of the event can be a bit overwhelming for newcomers. However, the benefits far outweigh the costs, and any preconceived notions that the pace of technology is slowing will quickly be dispelled. Of course, I would never consider mixing business with pleasure while in Las Vegas (cough, cough), however if you do decide to attend, you will have an opportunity to partake in some of the local eating, gaming, shopping, and entertainment after you get burnt out on all the gadgets and technologies. Thanks again CES, and goodbye…for now!
*See also, CES Summary from last year: CLICK HERE*
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in AMZN, INTC and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in Segway, Petcube, 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.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (January 3, 2017). Subscribe on the right side of the page for the complete text.
The page on the calendar has turned, and we now have a new year, and will shortly have a new president, and new economic policies. Although there is nothing magical about starting a fresh, new year, the annual rites of passage also allow investors to start with a clean slate again and reflect on their personal financial situation. Before you reach a desired destination (i.e., retirement), it is always helpful to know where you have been and where are you currently. Achieving this goal requires filtering through a never-ending avalanche of real-time data flooding through our cell phones, computers, TVs, radios, and Facebook accounts. This may seem like a daunting challenge, but that’s where I come in!
Distinguishing the signals from the noise is tough and there was plenty of noise in 2016 – just like there is every year. Before the S&P 500 stock index registered a +9.5% return in 2016, fears of a China slowdown blanketed headlines last January (the S&P 500 fell -15% from its highs and small cap stocks dropped -26%), and the Brexit (British exit) referendum caused a brief 48-hour -6% hiccup in June. Oil was also in the news as prices hit a low of $26 a barrel early in the year, before more than doubling by year-end to $54 per barrel (still well below the high exceeding $100 in 2014). On the interest rate front, 10-Year Treasury rates bottomed at 1.34% in July, while trillions of dollars in global bonds were incomprehensibly paying negative interest rates. However, fears of inflation rocked bond prices lower (prices move inversely to yields) and pushed bond yields up to 2.45% today. Along these lines, the Federal Reserve has turned the tide on its near-0% interest rate policy as evidenced by its second rate hike in December.
Despite the abbreviated volatility caused by the aforementioned factors, it was the U.S. elections and surprise victory of President-elect Donald Trump that dominated the media airwaves for most of 2016, and is likely to continue as we enter 2017. In hindsight, the amazing Twitter-led, Trump triumph was confirmation of the sweeping global populism trend that has also replaced establishment leaders in the U.K., France, and Italy. There are many explanations for the pervasive rise in populism, but meager global economic growth, globalization, and automation via technology are all contributing factors.
The Trump Bump
Even though Trump has yet to accept the oath of Commander-in-Chief, recent investor optimism has been fueled by expectations of a Republican president passing numerous pro-growth policies and legislation through a Republican majority-controlled Congress. Here are some of the expected changes:
- Corporate/individual tax cuts and reform
- Healthcare reform (i.e., Obamacare)
- Proposed $1 trillion in infrastructure spending
- Repatriation tax holiday for multinational corporate profits
- Regulatory relief (e.g., Dodd-Frank banking and EPA environmental reform)
The chart below summarizes the major events of 2016, including the year-end “Trump Bump”:
While I too remain optimistic, I understand there is no free lunch as it relates to financial markets (see also Half Trump Full). While tax cuts, infrastructure spending, and regulatory relief should positively contribute to economic growth, these benefits will have to be weighed against the likely costs of higher inflation, debt, and deficits.
Over the 25+ years I have been investing, the nature of the stock market and economy hasn’t changed. The emotions of fear and greed rule the day just as much today as they did a century ago. What has changed today is the pace, quality, and sheer volume of news. In the end, my experience has taught me that 99% of what you read, see or hear at the office is irrelevant as it relates to your retirement and investments. What ultimately drives asset prices higher or lower are the four key factors of corporate profits, interest rates, valuations, and sentiment (contrarian indicator) . As you can see from the chart below, corporate profits are at record levels and forecast to accelerate in 2017 (up +11.9%). In addition, valuations remain very reasonable, given how low interest rates are (albeit less low), and skeptical investor sentiment augurs well in the short-run.
Regardless of your economic or political views, this year is bound to have plenty of ups and downs, as is always the case. With a clean slate and fresh turn to the calendar, now is a perfect time to organize your finances and position yourself for a better retirement and 2017.
Wade W. Slome, CFA, CFP®
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in FB and certain exchange traded funds (ETFs), but at the time of publishing had no direct position in TWTR 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.