Posts filed under ‘Behavioral Finance’

Technical Analysis – Astrology or Lob Wedge?

Investing comes in many shapes and sizes. And like religion (see Investing Religion article), most investment strategies are built on the essential belief that following certain rules and conventions will eventually lead to profit enlightenment. When it comes to technical analysis (TA), a discipline used with the principal aim of predicting future prices from past patterns, some consider it a necessity for making money in the market. Others, regard the practice of TA as a pseudoscience, much like astrology.

I feel  there is a proper place for TA on selective basis, which I will describe later, but for the most part I agree with some of the legendary investors  who have chimed in on the subject:

Warren Buffett: “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.”

Peter Lynch: “Charts are great for predicting the past.”

Technical Analysis Linguistics

Fundamental analysis, the antithesis of technical analysis, strives to predict future price direction by analyzing facts and data surrounding a company, industry, and/or economy. It too comes with its own syntax and versions, for example: value, growth, top-down, bottom-up, quantitative, etc.

I do not claim to be a TA expert, however in my many years of investing I have come across a smorgasbord of terms and flavors surrounding the discipline. Describing and explaining the density of material surrounding TA would encompass too large of a scope for this article, but here are some prevalent terms one should come to grips with if you want to become a technical analysis guru:

Technical Analysis Approaches

  • Elliot Wave
  • Relative strength / Momentum (see Momentum Investing article)
  • MACD (Moving Average Convergence / Divergence)
  • Fibonacci retracement
  • Dow Theory
  • Stochastics
  • Bollinger bands

Price Patterns

  • Head and shoulders
  • Double bottom
  • Cup and handle
  • Channels
  • Breakouts
  • Pivot points
  • Candlesticks
  • Resistance/Support
  • Dead cat bounce (my personal favorite)

Each of these patterns are supposes to provide insight into the future direction of price. At best, I would say the academic research surrounding the subject is “inconclusive,” and at worst I’d say it’s considered a complete “sham.”

The Lob Wedge

As I’ve stated earlier, I fall in the skeptical camp when it comes to TA, since fundamental analysis is the main engine I use for generating and tracking my investment ideas. For illustrative purposes, you may consider fundamental analysis as my group of drivers and irons. I do, however,  utilize selective facets of TA much like I use a lob wedge in golf for a limited number of specific situations (e.g., shots over high trees, downhill lies, and fast greens). When it comes to trading, I do believe there is some value in tracking the relationship of extreme trading volume (high or low), especially when it is coupled with extreme price movement (high or low). The economic laws of supply and demand hold true for stock trades just as they do for guns and butter, and sharp moves in these components can provide insights into the psychological mindset of investors with respect to a security (or broader market). Beyond trading volume, there are a few other indicators that I utilize as part of my trading strategies, but these tactics play a relatively minor role, since most of my core positions are held on a multi-year time horizon.

Overall, there is a stream of wasteful noise, volatility, and misinformation that permeates the financial markets on a daily basis. A major problem with technical analysis is the many false triggered signals, which in many cases lead to excessive trading, transaction costs, and ultimately subpar investment returns.  Although I remain a skeptic on the subject of technical analysis and I may not read my horoscope today, I will continue to keep a lob wedge in my golf bag with the hopes of finding new, creative ways of using it to my advantage.

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

www.Sidoxia.com

DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own exchange traded funds and various securities, including BRK.B, but at time of publishing had no direct position in BRK.A or any company mentioned 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.

July 9, 2016 at 9:45 am 1 comment

EU Marriage Ends in Messy Brexit Divorce

divorce

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (July 1, 2016). Subscribe on the right side of the page for the complete text.

What Just Happened?

Breakups are never easy, especially when they come as a surprise. That’s exactly what happened with last week’s “Brexit” (British exit) referendum results. History was made when 51.9% of the United Kingdom (U.K.) voters from England, Scotland, Wales and Northern Ireland cast their vote to divorce (“Leave”) their country from the European Union (EU). In the end, the 48.1% of U.K. voters could not generate enough support to “Remain” in the EU (see chart below). Despite torrential downpours in southern Britain, voter turnout was extraordinarily high, as 72% of the 46.5 million registered voters came out in full force to have their voices heard.

Divorce is never cheap, and UK Prime Minister David Cameron paid the ultimate price with his defeat in the Brexit referendum…the loss of his job. Immediately following the release of the referendum results, Cameron, the British Prime Minister since 2010 and leader of the Conservative Party, immediately announced his resignation, effective no later than October 2016 after the selection of his successor.

brexit votes

Source: Bloomberg

One of the reasons behind the shock of the Brexit Leave decision is the longstanding relationship the U.K. has had with the EU. European Union membership first began in 1957 with Belgium, France, Germany, Italy, Luxembourg, and Netherlands being the founding countries of this new political-economic union.

A few decades later, the U.K. officially joined the EU in 1973 with Ireland and the Denmark, shortly before Margaret Thatcher came into power. If you fast forward to today, some 43 years after U.K. originally joined the EU, the Brexit decision represents the largest turning point in European political history. Not since the 1989 falling of the Berlin Wall and the subsequent demise of the Cold War in the Soviet Union has such a large, earth-moving political shift occurred.

Today, there are 28 member countries in the EU with Croatia being the newest member in 2013. Despite the Brexit outcome, there still is a backlog of countries wanting to join the EU club, including Turkey, Serbia, Albania, and Montenegro (and this excludes Scotland, which has voiced an interest in leaving the U.K. for the EU).

What Were Investors’ Reactions?

Financial markets around the world were caught off guard, given many pre-referendum polls were showing the Remain camp with a slight edge, along with British betting parlors that were handicapping an overwhelming victory for the Remain camp. Here’s a summary of stock market reactions around the globe from June 23rd to June 30th:

U.S. (S&P 500): -0.7%

U.K. (FTSE 100): +2.6%

Japan (Nikkei): -4.1%

Germany (DAX): -5.6%

Hong Kong (Hang Seng): +0.4%

China (Shanghai): +1.3%

India (BSE): -0.0%

Surprisingly, modest monthly gains achieved in the S&P 500 prior to the Brexit vote (up +0.8%) were quickly pared after the results came in but remained positive for the entire month (up +0.1%). For the year, U.S. stocks are up a limited +2.7%, which isn’t too bad considering investors’ current mood.

Stocks were not the only financial market disrupted after the Brexit announcement, foreign exchange currency rates were unstable as well. The British pound dived to a 30-year low shortly after the vote to a level of approximately $1.33/£, and was down more than -10% on the day of the announcement (see chart below). UK banks like Barclays PLC (BCS) and Lloyds Banking Group PLC (LYG) also saw their share prices significantly pressured as EU regulatory risks of losing access to European customers and negative global interest rates further squeeze the banks’ profit margins.

To put the currency picture into perspective, the value of the British pound ($2.64/£) peaked in March 1972 at a rate about double the U.S. dollar today. On the positive side of the ledger, a weaker British pound could help boost exports and vacation time to Stonehenge or London, but there is also a risk for a spike of inflation (or stagflation) on the country’s roughly $740 billion in imports (e.g., food, energy, and raw materials).

currency v ppp

Source: Calafia Beach Pundit

Why Did it Happen?

While economically prosperous regions like London and Scotland voted heavily for Remain, the message for change of the Leave camp resonated well with working class towns and rural areas of England (seen here). Besides a geographic split, there was also a demographic divide between voters. As you can see from the YouGov poll below, the majority of younger citizens overwhelmingly voted for Remain, and vice versa for older citizens as it relates to the Leave vote.

18-24: 75% Remain

25-49: 56% Remain

50-64: 44% Remain

65+: 39% Remain

While geography and demographics certainly played a key role in the outcome of the EU Leave referendum result, at the core of the movement also was a populist discontent with immigration and the negative economic consequences created by globalization. There are many reasons behind the sluggish economic global recovery, even if the U.S. is doing best out of the developed countries, but rightly or wrongly, immigration policies and protectionism played a prominent part in the Brexit.

At the heart of the populist sentiment of lost control to Brussels (EU) and immigration is the question of whether the benefits of globalization have outweighed the costs. The spread of globalization and expanded EU immigration has disenfranchised many lower skill level workers displaced by eastern European immigrants, Syrian refugees and innovative solutions like automated machinery, software, and electronic equipment. Economic history clearly shows the answer to the effectiveness of globalization is a resounding “yes”, but the post-financial crisis recovery has been disappointingly sluggish, so a component of the populist movement has felt an urgency to find a scapegoat. The benefits of globalization can be seen in the chart below, as evidenced by the increases in per capita GDP of the UK relative to Germany and France, after joining the EU in 1973. Many observers are quick to identify the visible consequences of globalization (i.e., lower-paying job losses), but fail to identify the invisible benefits (i.e., productivity, lower prices, investment in higher-paying job gains).

UK GDP Ratio

Source: The Wall Street Journal

What happens next?

While some EU leaders want to accelerate the Brexit transition, in actuality, this will require a long, drawn-out negotiation process between the still-unnamed new UK Prime Minister and EU officials. The complete EU-Brexit deal will take upwards of two-years to complete, once Article 50 of the EU Lisbon Treaty has been triggered – likely in October.

In light of the unchartered nature of the Brexit Leave vote, nobody truly knows if this decision will ultimately compromise the existential reality of the EU. Time will tell whether Brexit will merely be a small bump on the long EU road, or the beginning of a scary European domino effect that causes the 28 EU country bloc to topple. If the U.K. is successful in negotiating EU trade agreements with separate European countries, the Brexit even has a longer-term potential of benefiting economic activity.  Regardless of the EU outcome, the long-term proliferation of capitalism and democracy is likely to prevail because citizens vote with their wallets and capital goes where it is treated best.

What does Brexit Mean for Global Markets?

The short answer is not much economically, however there have been plenty of less substantial events that have roiled financial markets for relatively short periods of time. There are two basic questions to ask when looking at the economic impact of Brexit:

1) What is the Brexit impact on the U.S. economy?

If you objectively analyze the statistics, U.S. companies sold approximately $56 billion of goods to the U.K. last year   (our #7 trading partner). Even if you believe in the unlikely scenario of a severe U.K. economic meltdown, the U.K. trade figure is a rounding error in the whole global economic scheme of things. More specifically, $56 billion in trade with the U.K. equates to about .003 of the United States’ $18+ trillion GDP (Gross Domestic Product).

2) What is the Brexit impact on the global economy?

The U.K.’s GDP amounts to about $3 trillion dollars. Of that total, U.K. exports to the EU account for a reasonably insignificant $300 billion. As you can see from the chart below, $300 billion in UK exports to the EU are virtually meaningless and coincidentally equate to about .003 of the world’s $78 trillion estimated GDP.

global gdp

Source: The National Archives

What to Do Next?

Like many divorces, the U.K. Brexit may be messy and drawn out, until all the details are finalized over the next couple years. It’s important that you establish a strong foundation with your investments and do not divorce the sound, fundamental principles needed to grow and preserve your portfolio. As is usually the case, panicking or making an emotional decision relating to your investments during the heat of some geopolitical crisis rarely translates into an optimal decision over the long-run. As I repeatedly have advised over the years, these periods of volatility are nothing new (see also Series of Unfortunate Events).

If you catch your anxiety or blood pressure rising, do yourself a favor and turn off your TV, radio, or electronic device. A more productive use of time is to calmly review your asset allocation and follow a financial plan, with or without the assistance of a financial professional, so that you are able to achieve your long-term financial goals. This strategy will help you establish a more durable, long-lasting, and successful marriage with your investments.

investment-questions-border

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.

July 2, 2016 at 9:00 am Leave a comment

Cleaning Out Your Investment Fridge

moldy cheese

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 1, 2016). Subscribe on the right side of the page for the complete text.

Summer is quickly approaching, but it’s not too late to do some spring cleaning. This principle not only applies to your cluttered refrigerator with stale foods but also your investment portfolio with moldy investments. In both cases, you want to get rid of the spoiled goods. It’s never fun discovering a science experiment growing in your fridge.

Over the last three months, the stock market has been replenished after a rotten first two months of the year (S&P 500 index was down -5.5% January through February). The +1.5% increase in May added to a +6.6% and +0.3% increase in March and April (respectively), resulting in a three month total advance in stock prices of +8.5%. Not surprisingly, the advance in the stock market is mirroring the recovery we have seen in recent economic data.

After digesting a foul 1st quarter economic Gross Domestic Product (GDP) reading of only +0.8%, activity has been smelling better in the 2nd quarter. A recent wholesome +3.4% increase in April durable goods orders, among other data points, has caused the Atlanta Federal Reserve Bank to raise its 2nd quarter GDP estimate to a healthier +2.9% growth rate (from its prior +2.5% forecast).

Consumer spending, which accounts for roughly 70% of our country’s economic activity, has been on the rise as well. The improving employment picture (5.0% unemployment rate last month) means consumers are increasingly opening their wallets and purses. In addition to spending more on cars, clothing, movies, and vacations, consumers are also doling out a growing portion of their income on housing. Housing developers have cautiously kept a lid on expansion, which has translated into limited supply and higher home prices, as evidenced by the Case-Shiller indices charted below.

case shiller 2016

Source: Bespoke

Spoiling the Fun?

While the fridge may look like it’s fully stocked with fresh produce, meat, and dairy, it doesn’t take long for the strawberries to get moldy and the milk to sour. Investor moods can sour quickly too, especially as they fret over the impending “Brexit” (British Exit) referendum on June 23rd when British voters will decide whether they want to leave the European Union. A “yes” exit vote has the potential of roiling the financial markets and causing lots of upset stomachs.

Another financial area to monitor relates to the Federal Reserve’s monetary policy and its decision when to further increase the Federal Funds interest rate target at its June 14th – 15th meeting. With the target currently set at an almost insignificantly small level of 0.25% – 0.50%, it really should not matter whether Chair Janet Yellen decides to increase rates in June, July, September and/or November. Considering interest rates are at/near generational lows (see chart below), a ¼ point or ½ point percentage increase in short-term interest rates should have no meaningfully negative impact on the economy. If your fridge was at record freezing levels, increasing the temperature by a ¼ or ½ degree wouldn’t have a major effect either. If and when short-term interest rates increase by 2.0%, 3.0%, or 4.0% in a relatively short period will be the time to be concerned.

10 yr

Source: Scott Grannis

Keep a Fresh Financial Plan

As mentioned earlier, your investments can get stale too. Excess cash sitting idly earning next-to-nothing in checking, savings, CDs, or in traditional low-yielding bonds is only going to spoil rapidly to inflation as your savings get eaten away. In the short-run, stock prices will move up and down based on frightening but insignificant headlines. However, in the long-run, the more important issues are determining how you are going to reach your retirement goals and whether you are going to outlive your savings. This mindset requires you to properly assess your time horizon, risk tolerance, income needs, tax situation, estate plan, and other unique circumstances. Like a balanced diet of various food groups in your refrigerator, your key personal financial planning factors are dependent upon you maintaining a properly diversified asset allocation that is periodically rebalanced to meet your long-term financial goals.

Whether you are managing your life savings, or your life-sustaining food supply, it’s always best to act now and not be a couch potato. The consequences of sitting idle and letting your investments spoil away are a lot worse than letting the food in your refrigerator rot away.

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 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.

June 4, 2016 at 8:00 am Leave a comment

Want to Retire at Age 90?

sleep sit 90

Do you love working 40-50+ hour weeks? Do you want to be a Wal-Mart (WMT) greeter after you get laid off from your longstanding corporate job?  Do you love relying on underfunded government entitlements that you hope won’t be insolvent 10, 20, or 30 years from now? Are you banking on winning the lottery to fund your retirement? Do you enjoy eating cat food?

If you answered “Yes” to one or all of these questions, then do I have a sure-fire investment program for you that will make your dreams of retiring at age 90 a reality! Just follow these three simple rules:

  • Buy Low Yielding, Long-Term Bonds: There are approximately $7 trillion in negative yielding government bonds outstanding (see chart below), which as you may understand means investors are paying to give someone else money – insanity. Bank of America recently completed a study showing about two-thirds of the $26 trillion government bond market was yielding less than 1%. Not only are investors opening themselves up to interest rate risk and credit risk, if they sell before maturity, but they are also susceptible to the evil forces of inflation, which will destroy the paltry yield. If you don’t like this strategy of investing near 0% securities, getting a match and gasoline to burn your money has about the same effect.

negative bonds apr 16

Source: Financial Times

  • Speculate on the Timing of Future Fed Rate Hikes/Cuts: When the economy is improving, talking heads and so-called pundits try to guess the precise timing of the next rate hike. When the economy is deteriorating, aimless speculation swirls around the timing of interest rate cuts. Unfortunately, the smartest economists, strategists, and media mavens have no consistent predicting abilities. For example, in 1998 Nobel Prize winning economists Robert Merton and Myron Scholes toppled Long Term Capital Management. Similarly, in 1996 Federal Reserve Chairman Alan Greenspan noted the presence of “irrational exuberance” in the stock market when the NASDAQ was trading at 1,350. The tech bubble eventually burst, but not before the NASDAQ tripled to over 5,000. More recently, during 2005-2007, Fed Chairman Ben Bernanke whiffed on the housing bubble – he repeatedly denied the existence of a housing problem until it was too late. These examples, and many others show that if the smartest financial minds in the room (or planet) miserably fail at predicting the direction of financial markets, then you too should not attempt this speculative feat.
  • Trade on Rumors, Headlines & Opinions: Wall Street analysts, proprietary software with squiggly lines, and your hot shot day-trader neighbor (see Thank You Volatility) all promise the Holy Grail of outsized financial returns, but regrettably there is no easy path to consistent, long-term outperformance. The recipe for success requires patience, discipline, and the emotional wherewithal to filter out the endless streams of financial noise. Continually chasing or reacting to opinions, headlines, or guaranteed software trading programs will only earn you taxes, transaction costs, bid-ask spread costs, impact costs, high frequency trading manipulation and underperformance.

Saving for your future is no easy task, but there are plenty of easy ways to destroy your savings. If you want to retire at age 90, just follow my three simple rules.

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 had no direct position in WMT or any 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.

April 16, 2016 at 11:00 am 1 comment

Bargain Hunting for Doorbuster Discounts

This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (December 1, 2015). Subscribe on the right side of the page for the complete text.

It’s that time of year again when an estimated 135 million bargain shoppers set aside personal dignity and topple innocent children in the name of Black Friday holiday weekend, doorbuster discounts. Whether you are buying a new big screen television at Amazon for half-off or a new low-cost index fund, everyone appreciates a good value or bargain, which amplifies the importance of the price you pay. Even though consumers are estimated to have spent $83 billion over the post-turkey-coma, holiday weekend, this spending splurge only represents a fraction of the total 2015 holiday shopping season frenzy. When all is said and done, the average person is projected to dole out $805 for the full holiday shopping season (see chart below) – just slightly higher than the $802 spent over the same period last year.

While consumers have displayed guarded optimism in their spending plans, Americans have demonstrated the same cautiousness in their investing behavior, as evidenced by the muted 2015 stock market gains. More specifically, for the month of November, stock prices increased by +0.32% for the Dow Jones Industrial Average (17,720) and +0.05% for the S&P 500 index (2,080). For the first 11 months of the year, the stock market results do not look much different. The Dow has barely slipped by -0.58% and the S&P 500 has inched up by +1.01%.

Given all the negative headlines and geopolitical concerns swirling around, how have stock prices managed to stay afloat? In the face of significant uncertainty, here are some of the calming factors that have supported the U.S. financial markets:

  • Jobs Piling Up: The slowly-but-surely expanding economy has created about 13 million new jobs since late 2009 and the unemployment rate has been chopped in half (from a peak of 10% to 5%).

Source: Calafia Beach Pundit

  • Housing Recovery: New and existing home sales are recovering and home prices are approaching previous record levels, as the Case-Shiller price indices indicate below.

Source: Calculated Risk Blog

  • Strong Consumer: Cars are flying off the shelves at a record annualized pace of 18 million units – a level not seen since 2000. Lower oil and gasoline prices have freed up cash for consumers to pay down debt and load up on durable goods, like some fresh new wheels.

Source: Calculated Risk Blog

Despite a number of positive factors supporting stock prices near all-time record highs and providing plenty of attractive opportunities, there are plenty of risks to consider. If you watch the alarming nightly news stories on TV or read the scary newspaper headlines, you’re more likely to think it’s Halloween season rather than Christmas season.

At the center of the recent angst are the recent coordinated terrorist attacks that took place in Paris, killing some 130 people. With ISIS (Islamic State of Iraq and Syria) claiming responsibility for the horrific acts, political and military resources have been concentrated on the ISIS occupied territories of Syria and Iraq. Although I do not want to diminish the effects of the appalling and destructive attacks in Paris, the events should be placed in proper context. This is not the first or last large terrorist attack – terrorism is here to stay. As I show in the chart below, there have been more than 200 terrorist attacks that have killed more than 10 people since the 9/11 attacks. Much of the Western military power has turned a blind eye towards these post-9/11 attacks because many of them have taken place off of U.S. or Western country soil. With the recent downing of the Russian airliner (killing all 224 passengers), coupled with the Paris terror attacks, ISIS has gained the full military attention of the French, Americans, and Russians. As a result, political willpower is gaining momentum to heighten military involvement.

Source: Wikipedia

Investor anxiety isn’t solely focused outside our borders. The never ending saga of when the Federal Reserve will initiate its first Federal Funds interest rate target increase could finally be coming to an end. According to the CME futures market, there currently is a 78% probability of a 0.25% interest rate increase on December 16th. As I have said many times before, interest rates are currently near generational lows, and the widely communicated position of Federal Reserve Chairwoman Yellen (i.e., shallow slope of future interest rate hike trajectory) means much of the initial rate increase pain has likely been anticipated already by market participants. After all, a shift in your credit card interest rate from 19.00% to 19.25% or an adjustment to your mortgage rate from 3.90% to 4.15% is unlikely to have a major effect on consumer spending. In fact, the initial rate hike may be considered a vote of confidence by Yellen to the sustainability of the current economic expansion.

Shopping Without My Rose Colored Glasses

Regardless of the state of the economic environment, proper investing should be instituted through an unemotional decision-making process, just as going shopping should be an unemotional endeavor. Price and value should be the key criteria used when buying a specific investment or holiday gift. Unfortunately for many, emotions such as greed, fear, impatience, and instant gratification overwhelm objective measurements such as price and value.

As I have noted on many occasions, over the long-run, money unemotionally moves to where it is treated best. From a long-term perspective, that has meant more capital has migrated to democratic and capitalistic countries with a strong rule of law. Closed, autocratic societies operating under corrupt regimes have been the big economic losers.

With all of that set aside, the last six years have created tremendous investment opportunities due to the extreme investor risk aversion created by the financial crisis – hence the more than tripling in U.S. stock prices since March 2009.

When comparing the yield (i.e., profit earned on an investment) between stocks and bonds, as shown in the chart below, you can see that stock investors are being treated significantly better than bond investors (6.1% vs. 4.0%). Not only are bond investors receiving a lower yield than stock investors, but bond investors also have no hope of achieving higher payouts in the future. Stocks, on the other hand, earn the opportunity of a  double positive whammy. Not only are stocks currently receiving a higher yield, but stockholders could achieve a significantly higher yield in the future. For example, if S&P 500 earnings can grow at their historic rate of about 7%, then the current stock earnings yield of 6.1% would about double to 12.0% over the next decade at current prices. The inflated price and relative attractiveness of stocks looks that much better if you compare the 6.1% earnings yield to the paltry 2.2% 10-Year Treasury yield.

Source: Yardeni.com

This analysis doesn’t mean everyone should pile 100% of their portfolios into stocks, but it does show how expensively nervous investors are valuing bonds. Time horizon, risk tolerance, and diversification should always be pillars to a disciplined, systematic investment strategy, but as long as these disparities remain between the earnings yields on stocks and bonds, long-term investors should be able to shop for plenty of doorbuster discount bargain opportunities.

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 AMZN and 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.

December 1, 2015 at 1:06 pm 1 comment

Playing the Field with Your Investments

For some, casually dating can be fun and exciting. The same goes for trading and speculating – the freedom to make free- wheeling, non-committal purchases can be exhilarating. Unfortunately the costs (fiscally and emotionally) of short-term dating/investing often outweigh the benefits.

Fortunately, in the investment world, you can get to know an investment pretty well through fundamental research that is widely available (e.g., 10Ks, 10Qs, press releases, analyst days, quarterly conference calls, management interviews, trade rags, research reports). Unlike dating, researching stocks can be very cheap, and you do not need to worry about being rejected.

Dating is important early in adulthood because we make many mistakes choosing whom we date, but in the process we learn from our misjudgments and discover the important qualities we value in relationships. The same goes for stocks. Nothing beats experience, and in my long investment career, I can honestly say I’ve dated/traded a lot of pigs and gained valuable lessons that have improved my investing capabilities. Now, however, I don’t just casually date my investments – I factor in a rigorous, disciplined process that requires a serious commitment. I no longer enter positions lightly.

One of my investment heroes, Peter Lynch, appropriately stated, “In stocks as in romance, ease of divorce is not a sound basis for commitment. If you’ve chosen wisely to begin with, you won’t want a divorce.”

Charles Ellis shared these thoughts on relationships with mutual funds:

“If you invest in mutual funds and make mutual funds investment changes in less than 10 years…you’re really just ‘dating.’ Investing in mutual funds should be marital – for richer, for poorer, and so on; mutual fund decisions should be entered into soberly and advisedly and for the truly long term.”

No relationship comes without wild swings, and stocks are no different. If you want to survive the volatile ups and downs of a relationship (or stock ownership), you better do your homework before blindly jumping into bed. The consequences can be punishing.

Buy and Hold is Dead…Unless Stocks Go Up

If you are serious about your investments, I believe you must be mentally willing to commit to a relationship with your stock, not for a day, not for a week, or not for a month, but rather for years. Now, I know this is blasphemy in the age when “buy-and-hold” investing is considered dead, but I refute that basic premise whole-heartedly…with a few caveats.

Sure, buy-and-hold is a stupid strategy when stocks do nothing for a decade – like they have done in the 2000s, but buying and holding was an absolutely brilliant strategy in the 1980s and 1990s. Moreover, even in the miserable 2000s, there have been many buy-and-hold investments that have made owners a fortune (see Questioning Buy & Hold ). So, the moral of the story for me is “buy-and-hold” is good for stocks that go up in price, and bad for stocks that go flat or down in price. Wow, how deeply profound!

To measure my personal commitment to an investment prospect, a bachelorette investment I am courting must pass another test…a test from another one of my investment idols, Phil Fisher, called the three-year rule. This is what the late Mr. Fisher had to say about this topic:

“While I realized thoroughly that if I were to make the kinds of profits that are made possible by [my] process … it was vital that I have some sort of quantitative check… With this in mind, I established what I called my three-year rule.” Fisher adds, “I have repeated again and again to my clients that when I purchase something for them, not to judge the results in a matter of a month or a year, but allow me a three year period.”

Certainly, there will be situations where an investment thesis is wrong, valuation explodes, or there are superior investment opportunities that will trigger a sale before the three-year minimum expires. Nonetheless, I follow Fisher’s rule in principle in hopes of setting the bar high enough to only let the best ideas into both my client and personal portfolios.

As I have written in the past, there are always reasons of why you should not invest for the long-term and instead sell your position, such as: 1) new competition; 2) cost pressures; 3) slowing growth; 4) management change; 5) valuation; 6) change in industry regulation; 7) slowing economy; 8 ) loss of market share; 9) product obsolescence; 10) etc, etc, etc. You get the idea.

Don Hays summed it up best: “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.”

Peter Lynch shares similar sympathies when it comes to noise in the marketplace:

“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.”

Every once in a while there is validity to some of the concerns, but more often than not, the scare campaigns are merely Chicken Little calling for the world to come to an end.

Patience is a Virtue

In the instant gratification society we live in, patience is difficult to come by, and for many people ignoring the constant chatter of fear is challenging. Pundits spend every waking hour trying to explain each blip in the market, but in the short-run, prices often move up or down irrespective of the daily headlines. Explaining this randomness, Peter Lynch said the following:

“Often, there is no correlation between the success of a company’s operations and the success of its stock over a few months or even a few years. In the long term, there is a 100% correlation between the success of a company and the success of its stock. It pays to be patient, and to own successful companies.”

Long-term investing, like long-term relationships, is not a new concept. Investment time horizons have been shortening for decades, so talking about the long-term is generally considered heresy. Rather than casually date a stock position, perhaps you should commit to a long-term relationship and divorce your field-playing habits. Now that sounds like a sweet kiss of success.

investment-questions-border

Wade W. Slome, CFA, CFP® 

Plan. Invest. Prosper. 

www.Sidoxia.com

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.

August 9, 2015 at 12:33 pm Leave a comment

Digesting Stock Gains

This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (June 1, 2015). Subscribe on the right side of the page for the complete text.

Despite calls for “Sell in May, and go away,” the stock market as measured by both the Dow Jones Industrial and S&P 500 indexes grinded out a +1% gain during the month of May. For the year, the picture looks much the same…the Dow is up around +1% and the S&P 500 +2%. After gorging on gains of +30% in 2013 and +11% in 2014, it comes as no surprise to me that the S&P 500 is taking time to digest the gains. After eating any large pleasurable meal, there’s always a chance for some indigestion – just like last month. More specifically, the month of May ended as it did the previous six months…with a loss on the last trading day (-115 points). Providing some extra heartburn over the last 30 days were four separate 100+ point decline days. Realized fears of a Greek exit from the eurozone would no doubt have short-term traders reaching for some Tums antacid. Nevertheless, veteran investors understand this is par for the course, especially considering the outsized profits devoured in recent years.

The profits have been sweet, but not everyone has been at the table gobbling up the gains. And with success, always comes the skeptics, many of whom have been calling for a decline for years. This begs the question, “Are we in a stock bubble?” I think not.

Bubble Bites

Most asset bubbles are characterized by extreme investor/speculator euphoria. There are certainly small pockets of excitement percolating up in the stock market, but nothing like we experienced in the most recent burstings of the 2000 technology and 2006-07 housing bubbles. Yes, housing has steadily improved post the housing crash, but does this look like a housing bubble? (see New Home Sales chart)

Source: Dr. Ed’s Blog

Another characteristic of a typical asset bubble is rabid buying. However, when it comes to the investor fund flows into the U.S. stock market, we are seeing the exact opposite…money is getting sucked out of stocks like a Hoover vacuum cleaner. Over the last eight or so years, there has been almost -$700 billion that has hemorrhaged out of domestic equity funds – actions tend to speak louder than words (see chart below):

Source: Investment Company Institute (ICI)

The shift to Exchange Traded Funds (ETFs) offered by the likes of iShares and Vanguard doesn’t explain the exodus of cash because ETFs such as S&P 500 SPDR ETF (SPY) are suffering dramatically too. SPY has drained about -$17 billion alone over the last year and a half.

With money flooding out of these stock funds, how can stock prices move higher? Well, one short answer is that hundreds of billions of dollars in share buybacks and trillions in mergers and acquisitions activity (M&A) is contributing to the tide lifting all stock boats. Low interest rates and stimulative monetary policies by central banks around the globe are no doubt contributing to this positive trend. While the U.S. Federal Reserve has already begun reversing its loose monetary policies and has threatened to increase short-term interest rates, by any objective standard, interest rates should remain at very supportive levels relative to historical benchmarks.

Besides housing and fund flows data, there are other unbiased sentiment indicators that indicate investors have not become universally Pollyannaish. Take for example the weekly AAII Sentiment Survey, which shows 73% of investors are currently Bearish and/or Neutral – significantly higher than historical averages.

The Consumer Confidence dataset also shows that not everyone is wearing rose-colored glasses. Looking back over the last five decades, you can see the current readings are hovering around the historical averages – nowhere near the bubblicious 2000 peak (~50% below).

Source: Bespoke

Recession Reservations

Even if you’re convinced there is no imminent stock market bubble bursting, many of the same skeptics (and others) feel we’re on the verge of a recession  – I’ve been writing about many of them since 2009. You could choke on an endless number of economic indicators, but on the common sense side of the economic equation, typically rising unemployment is a good barometer for any potentially looming recession. Here’s the unemployment rate we’re looking at now (with shaded periods indicating prior recessions):

As you can see, the recent 5.4% unemployment rate is still moving on a downward, positive trajectory. By most peoples’ estimation, because this has been the slowest recovery since World War II, there is still plenty of labor slack in the market to keep hiring going.

An even better leading indicator for future recessions has been the slope of the yield curve. A yield curve plots interest rate yields of similar bonds across a range of periods (e.g., three-month bill, six-month bill, one-year bill, two-year note, five-year note, 10-year note and 30-year bond). Traditionally, as short-term interest rates move higher, this phenomenon tends to flatten the yield curve, and eventually inverts the yield curve (i.e., short-term interest rates are higher than long-term interest rates). Over the last few decades, when the yield curve became inverted, it was an excellent leading indicator of a pending recession (click here and select “Animate” to see amazing interactive yield curve graph). Fortunately for the bulls, there is no sign of an inverted yield curve – 30-year rates remain significantly higher than short-term rates (see chart below).

Stock market skeptics continue to rationalize the record high stock prices by pointing to the artificially induced Federal Reserve money printing buying binge. It is true that the buffet of gains is not sustainable at the same pace as has been experienced over the last six years. As we continue to move closer to full employment in this economic cycle, the rapid accumulated wealth will need to be digested at a more responsible rate. An unexpected Greek exit from the EU or spike in interest rates could cause a short-term stomach ache, but until many of the previously mentioned indicators reach dangerous levels, please pass the gravy.

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 SPY and other 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.

June 1, 2015 at 12:31 pm 1 comment

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