Posts tagged ‘Stocks’
Winning the Loser’s Game
During periods of heightened volatility like those recently experienced, it’s easy to get caught up in the emotional heat of the moment. I find time is better spent returning to essential investing fundamentals, like the ones I read in the investment classic by Charles Ellis, Winning the Loser’s Game – “WTLG”. To put my enthusiasm in perspective, WTLG has even achieved the elite and privileged distinction of making the distinguished “Recommended Reading” list of Investing Caffeine (located along the right-side of the page). Wow…now I know you are really impressed.
The Man, The Myth, the Ellis
For those not familiar with Charley Ellis, he has a long, storied investment career. Not only has he authored 12 books, including compilations on Goldman Sachs (GS) and Capital Group, but his professional career dates back prior to 1972, when he founded institutional consulting firm Greenwich Associates. Besides earning a college degree from Yale University, and an MBA from Harvard Business School, he also garnered a PhD from New York University. Ellis also is a director at the Vanguard Group and served as Investment Committee chair at Yale University along investment great David Swensen (read also Super Swensen) from 1992 – 2008.
With this tremendous investment experience come tremendous insights. The original book, which was published in 1998, is already worth its weight in gold (even at $1,384 per ounce), but the fifth edition of WTLG is even more valuable because it has been updated with Ellis’s perspectives on the 2008-2009 financial crisis.
Because the breadth of topics covered is so vast and indispensable, I will break the WTLG review into a few parts for digestibility. I will start off with the these hand-picked nuggets:
Defining the “Loser’s Game”
Here is how Charles Ellis describes the investment “loser’s game”:
“For professional investors, “the ‘money game’ we call investment management evolved in recent decades from a winner’s game to a loser’s game because a basic change has occurred in the investment environment: The market came to be dominated in the 1970s and 1980s by the very institutions that were striving to win by outperforming the market. No longer is the active investment manager competing with cautious custodians or amateurs who are out of touch with the market. Now he or she competes with other hardworking investment experts in a loser’s game where the secret to winning is to lose less than others lose.”
Underperformance by Active Managers
Readers that have followed Investing Caffeine for a while understand how I feel about passive (low-cost do-nothing strategy) and active management (portfolio managers constantly buying and selling) – read Darts, Monkeys & Pros. Ellis’s views are not a whole lot different than mine – here is what he has to say while not holding back any punches:
“The basic assumption that most institutional investors can outperform the market is false. The institutions are the market. They cannot, as a group, outperform themselves. In fact, given the cost of active management – fees, commissions, market impact of big transactions, and so forth-85 percent of investment managers have and will continue over the long term to underperform the overall market.”
He goes on to say individuals do even worse, especially those that day trade, which he calls a “sucker’s game.”
Exceptions to the Rule
Ellis’s bias towards passive management is clear because “over the long term 85 percent of active managers fall short of the market. And it’s nearly impossible to figure out ahead of time which managers will make it into the top 15 percent.” He does, however, acknowledge there is a minority of professionals that can beat the market by making fewer mistakes or taking advantage of others’ mistakes. Ellis advocates a slow approach to investing, which bases “decisions on research with a long-term focus that will catch other investors obsessing about the short term and cavitating – producing bubbles.” This is the strategy and approach I aim to achieve.
Gaining an Unfair Competitive Advantage
According to Ellis, there are four ways to gain an unfair competitive advantage in the investment world:
1) Physical Approach: Beat others by carrying heavier brief cases and working longer hours.
2) Intellectual Approach: Outperform by thinking more deeply and further out in the future.
3) Calm-Rational Approach: Ellis describes this path to success as “benign neglect” – a method that beats the others by ignoring both favorable and adverse market conditions, which may lead to suboptimal decisions.
4) Join ‘em Approach: The easiest way to beat active managers is to invest through index funds. If you can’t beat index funds, then join ‘em.
The Case for Stocks
Investor time horizon plays a large role on asset allocation, but time is on investors’ side for long-term equity investors:
“That’s why in the long term, the risks are clearly lowest for stocks, but in the short term, the risks are just as clearly highest for stocks.”
Expanding on that point, Ellis points out the following:
“Any funds that will stay invested for 10 years or longer should be in stocks. Any funds that will be invested for less than two to three years should be in “cash” or money market instruments.”
While many people may feel stock investing is dead, but Ellis points out that equities should return more in the long-run:
“There must be a higher rate of return on stocks to persuade investors to accept risks of equity investing.”
The Power of Regression to the Mean
Investors do more damage to performance by chasing winners and punishing losers because they lose the powerful benefits of “regression to the mean.” Ellis describes this tendency for behavior to move toward an average as “a persistently powerful phenomenon in physics and sociology – and in investing.” He goes on to add, good investors know “that the farther current events are away from the mean at the center of the bell curve, the stronger the forces of reversion, or regression, to the mean, are pulling the current data toward the center.”
The Power of Compounding
For a 75 year period (roughly 1925 – 2000) analyzed by Ellis, he determines $1 invested in stocks would have grown to $105.96, if dividends were not reinvested. If, however, dividends are reinvested, the power of compounding kicks in significantly. For the same 75 year period, the equivalent $1 would have grown to $2,591.79 – almost 25x’s more than the other method (see also Penny Saved is Billion Earned).
Ellis throws in another compounding example:
“Remember that if investments increase by 7 percent per annum after income tax, they will double every 10 years, so $1 million can become $1 billion in 100 years (before adjusting for inflation).”
The Lessons of History
As philosopher George Santayana stated – “Those who cannot remember the past are condemned to repeat it.” Details of every market are different, but as Ellis notes, “The major characteristics of markets are remarkably similar over time.”
Ellis appreciates the importance of history plays in analyzing the markets:
“The more you study market history, the better; the more you know about how securities markets have behaved in the past, the more you’ll understand their true nature and how they probably will behave in the future. Such an understanding enables us to live rationally with markets that would otherwise seem wholly irrational.”
Home Sweet International Home
Although Ellis’s recommendation to diversify internationally is not controversial, his allocation recommendation regarding “full diversification” is a bit more provocative:
“For Americans, this would mean about half our portfolios would be invested outside the United States.”
This seems high by traditional standards, but considering our country’s shrinking share of global GDP (Gross Domestic Product), along with our relatively small share of the globe’s population (about 5% of the world’s total), the 50% percentage doesn’t seem as high at first blush.
Beware the Broker
This is not new territory for me (see Financial Sharks, Fees/Exploitation, and Credential Shell Game), and Ellis warns investors on industry sales practices:
“Those oh so caring and helpful salespeople make their money by convincing you to change funds. Friendly as they may be, they may be no friend to your long-term investment success.”
Unlike a lot of other investing books, which cover a few aspects to investing, Winning the Loser’s Game covers a gamut of crucial investment lessons in a straightforward, understandable fashion. A lot of people play the investing game, but as Charles Ellis details, many more investors and speculators lose than win. For any investor, from amateur to professional, reading Ellis’s Winning the Loser’s Game and following his philosophy will not only help increase the odds of your portfolio winning, but will also limit your losses in sleep hours.
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 GS, 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.
Going Shopping: Chicken vs. Beef
The headlines haven’t been very rosy over the last week, but when is that ever not the case? Simply put, gloom and doom sells. The Chinese stock market is collapsing; the Yuan is plummeting; there are rising tensions in the Middle East; terrorism is rising to the fore; and commodity prices are falling apart at the seams. This is only a partial snapshot of course, and does not paint a complete or accurate picture. Near record-low interest rates; record corporate profits (outside of energy); record-low oil prices; unprecedented accommodative central bank policies; and attractive valuations are but a few of the positive, countervailing factors that rarely surface through the media outlets.
At the end of the day, smart long-term investors understand investing in financial markets is a lot like grocery store shopping. Similarly to stocks and bonds, prices at the supermarket fluctuate daily. Whether you’re comparing beef (bonds) and chicken (stocks) prices in the meat department (stock market), or apple (real estate) and orange (commodities) prices in the produce department (global financial markets), ultimately, shrewd shoppers eventually migrate towards purchasing the best values. Since the onset of the 2008-2009 financial crisis, risk aversion has dominated over value-based prudence as evidenced by investors flocking towards the perceived safety of cash, Treasury bonds, and other fixed income securities that are expensively priced near record highs. As you can see from the chart below, investors poured $1.2 trillion into bonds and effectively $0 into stocks. Consumers may still be eating lots of steaks (bonds) currently priced at $6.08/lb while chicken (stocks) is at $1.48/lb (see U.S. Department of Labor Data – Nov. 2015), but at some point, risk aversion will abate, and consumers will adjust their preferences towards the bargain product.
Some Shoppers Still Buying Chicken
While the general public may have missed the massive bull market in stocks, astute corporate executives and investment managers took advantage of the equity bargains in recent years, as seen by stock prices tripling from the March 2009 lows. As corporate profits and margins have marched to record levels, CEOs/CFOs put their money where their mouths are by investing trillions of dollars into share buybacks and mergers & acquisitions transactions.
Despite the advance in the multi-year bull market, with the recent sell-off, panic has once again dominated rational thinking. We see this rare phenomenon (a few times over the last century) manifest itself through a stock market dividend yield that exceeds the yield on Treasury bonds (2.2% S&P 500 vs 2.1% 10-Year Treasury). But if we are once again comparing beef vs. chicken prices (bonds vs stocks), the 6% earnings yield on stocks (i.e., Inverse P/E ratio or E/P) now looks even more compelling relative to the 2% yield on bonds. For example, the iShares Core U.S. Aggregate Bond ETF (AGG) is currently yielding a meager 2.3%.
For a general overview, Scott Grannis at Calafia Beach Pundit summarizes the grocery store flyer of investment options below:
While these yield relationships can and will certainly change under various economic scenarios, there are no concrete signs of an impending recession. The recent employment data of 292,000 new jobs added during December (above the 200,000 estimate) is verification that the economy is not falling off a cliff into recession (see chart below). As I’ve written in the past, the positively-sloped yield curve also bolsters the case for an expansionary economy.
Source: Calafia Beach Pundit
While it’s true the Chinese economy is slowing, its rate is still growing at multiples of the U.S. economy. As a communist country liberalizes currency and stock market capital controls (i.e., adds/removes circuit breakers), and also attempts to migrate the economy from export-driven growth to consumer-driven expansion, periodic bumps and bruises should surprise nobody. With that said, China’s economy is slowly moving in the right direction and the government will continue to implement policies and programs to stimulate growth (see China Leaders Flag More Stimulus).
As we have recently experienced another China-driven correction in the stock market, and the U.S. economic expansion matures, equity investors must realize volatility is the price of admission for earning higher long-term returns. However, rather than panicking from fear-driven headlines, it’s times like these that should remind you to sharpen your shopping list pencil. You want to prudently allocate your investment dollars when deciding whether now’s the time to buy chicken (6% yield) or beef (2% yield).
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) including AGG, 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.
The Fallibility of Tangibility
Why do so many star athletes end up going bankrupt? Rather than building a low-cost, tax-efficient, diversified portfolio of stocks and bonds that could help generate significant income and compounded wealth over the long-term (yawn…boring), many investors succumb to the allure of over-exposing themselves to costly, illiquid, tangible assets, while assuming disproportionate risk.
After all, it’s much more exciting to brag about the purchase of a car wash, apartment building or luxury condo than it is to whip out a brokerage statement and show a friend a bond fund earning a respectable 4% yield.
Many real estate investors in my Southern California backyard (epicenter of the 2008-2009 Financial Crisis) have experienced both ruin and riches over the last few decades. The appeal and pitfalls associated with owning tangible assets like real estate are particularly exemplified with professional athletes (see also Hidden Train Wreck). Consider the fate suffered by these following individuals:
- Mike Tyson: Famous boxer Mike Tyson tore through $300 million on multiple homes, cars, jewels and pet tigers before filing for bankruptcy in 2003.
- Julius Erving: Hall of Fame NBA player Julius “Dr. J” Erving went financially belly-up in 2010 after his Celebrity Golf Club International was pushed into foreclosure. Dr. J. was also forced to auction off coveted NBA memorabilia (including championship uniforms, trophies, and rings) along with foreclosing on his personal $2 million, 6,600-square foot Utah home.
- Mark Brunell: Pro Bowl quarterback Mark Brunell was estimated to have earned over $50 million during his career. Due to failed real estate ventures and business loans, Brunell filed for bankruptcy in 2010.
- Evander Holyfield: Heavyweight boxing champion Evander Holyfield burned through a mountain of money estimated at $230 million, including a 235-acre Utah estate, which had 109 rooms and included at least one monthly electric bill of $17,000.
Caveat Emptor
Inclusion of real estate as part of a diversified portfolio makes all the sense in the world – this is exactly what we do for clients at Sidoxia. But unfortunately, many investors mistake the tangibility of real estate with “lower risk,” even though levered real estate is arguably more volatile than the stock market – evidenced by the volatility in publicly traded REIT share prices. For example, the Dow Jones SPDR REIT (RWR) declined by -78% from its 2007 high to its 2009 low versus the S&P 500 SPDR (SPY) drop of -57% over the comparable period. Private real estate investors are generally immune from the heart-pumping price volatility rampant in the public markets because they are not bombarded with daily, real-time, second-by-second pricing data over flashing red and green colored screens.
Without experiencing the emotional daily price swings, many real estate investors ignore the risks and costs associated with real estate, even when those risks often exceed those of traditional investments (e.g., stocks and bonds). Here are some of the important factors these real estate investors overlook:
Leverage: Many real estate investors don’t appreciate that the fact that 100% of a 10% investment (90% borrowed) can be wiped out completely (i.e., lose -100%), if the value of a property drops a mere -10%. Real estate owners found this lesson out the hard way during the last housing downturn and recession.
Illiquidity: Unlike a stock and bond, which merely takes a click of a mouse, buying/selling real estate can take weeks, if not months, to complete. If a seller needs access to liquidity, they may be forced to sell at unattractively low, fire-sale prices. Pricing transparency is opaque due to the variability and volume of transactions, although online services offered by Zillow Group Inc. (Z).
Costs: For real estate buyer, the list of costs can be long: appraisal fee, origination fee, pre-paid interest, pre-paid insurance, flood certification fee, tax servicing fee, credit report fee, bank processing fee, recording fee, notary fee, and title insurance. And once an investment property is officially purchased, there are costs such as property management fees, property taxes, association dues, landscaping fees and the opportunity costs of filling vacancies when there is tenant turnover. And this analysis neglects the hefty commission expenses, which generally run 5-6% and split between the buying and selling agent. Add all these costs up, and you can understand the dollars can become significant.
Concentration Risk: It’s perfectly fine to own a levered, cyclical asset in a broadly diversified portfolio for long-term investors, but owning $1.3 million of real estate in a $1.5 million total portfolio does not qualify as diversified. If a portfolio is real estate heavy, hopefully the real estate assets are at least diversified across geographies and real estate type (e.g., residential / commercial / multi-family / industrial / retail mall / mortgages / etc).
Stocks Abhorred, Gold & Real Estate Adored
With the downdraft in the stock market that started in late August, a recent survey conducted by CNBC showed how increased volatility has caused wealthy investors to sour on the stock market. More specifically, the All-America Survey, conducted by Hart-McInturff, polled 800 wealthy Americans at the beginning of October. Unsurprisingly, many investors automatically correlate temporary weakness in stocks to a lagging economy. In fact, 32% of respondents believed the U.S. economy would get worse, a 6% increase from the last poll in June, and the highest level of economic pessimism since the government shutdown in 2013 (as it turned out, this was a very good time to buy stocks). These gloom and doom views manifested themselves in skeptical views of stocks as well. Overall, 46% of the public felt it is a bad time to invest in stocks, representing a 12% gain from the last survey.
With investor appetites tainted for stocks, hunger for real state has risen. Actually, real estate was the top investment choice by a large margin, selected by 39% percent of the investors polled. Real estate has steadily gained in popularity since the depths of the recession in 2008. Jockeying for second place have been stocks and gold with the shiny metal edging out stocks by a score of 25% to 21%, respectively.
Successful long-term investors like Warren Buffett understand the best returns are earned by going against the grain. As Buffett said, “Be fearful when others are greedy and greedy when others are fearful,” and we know stock investors are fearful. Along those same lines, Bill Miller, the man who beat the S&P 500 index for 15 consecutive years (1991 – 2005), believes now is a perfect time to buy stocks. Investing in real estate is not a bad idea in the context of a diversified portfolio, but investors should not forget the fallibility of tangibility.
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) including SPY, but at the time of publishing, SCM had no direct position in Z, RWR, 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.
Inside the Brain of an Investing Genius
Photo Source: Boston.com
Those readers who have frequented my Investing Caffeine site are familiar with the numerous profiles on professional investors of both current and prior periods (See Profiles). Many of the individuals described have a tremendous track record of success, while others have a tremendous ability of making outrageous forecasts. I have covered both. Regardless, much can be learned from the successes and failures by mirroring the behavior of the greats – like modeling your golf swing after Tiger Woods (O.K., since Tiger is out of favor right now, let’s say Jordan Spieth). My investment swing borrows techniques and tips from many great investors, but Peter Lynch (ex-Fidelity fund manager), probably more than any icon, has had the most influence on my investing philosophy and career as any investor. His breadth of knowledge and versatility across styles has allowed him to compile a record that few, if any, could match – outside perhaps the great Warren Buffett.
Consider that Lynch’s Magellan fund averaged +29% per year from 1977 – 1990 (almost doubling the return of the S&P 500 index for that period). In 1977, the obscure Magellan Fund started with about $20 million, and by his retirement the fund grew to approximately $14 billion (700x’s larger). Cynics believed that Magellan was too big to adequately perform at $1, $2, $3, $5 and then $10 billion, but Lynch ultimately silenced the critics. Despite the fund’s gargantuan size, over the final five years of Lynch’s tenure, Magellan outperformed 99.5% of all other funds, according to Barron’s. How did Magellan investors fare in the period under Lynch’s watch? A $10,000 investment initiated when he took the helm would have grown to roughly $280,000 (+2,700%) by the day he retired. Not too shabby.
Background
Lynch graduated from Boston College in 1965 and earned a Master of Business Administration from the Wharton School of the University of Pennsylvania in 1968. Like the previously mentioned Warren Buffett, Peter Lynch shared his knowledge with the investing masses through his writings, including his two seminal books One Up on Wall Street and Beating the Street. Subsequently, Lynch authored Learn to Earn, a book targeted at younger, novice investors. Regardless, the ideas and lessons from his writings, including contributing author to Worth magazine, are still transferable to investors across a broad spectrum of skill levels, even today.
The Lessons of Lynch
Although Lynch has left me with enough financially rich content to write a full-blown textbook, I will limit the meat of this article to lessons and quotations coming directly from the horse’s mouth. Here is a selective list of gems Lynch has shared with investors over the years:
Buy within Your Comfort Zone: Lynch simply urges investors to “Buy what you know.” In similar fashion to Warren Buffett, who stuck to investing in stocks within his “circle of competence,” Lynch focused on investments he understood or on industries he felt he had an edge over others. Perhaps if investors would have heeded this advice, the leveraged, toxic derivative debacle occurring over previous years could have been avoided.
Do Your Homework: Building the conviction to ride through equity market volatility requires rigorous homework. Lynch adds, “A company does not tell you to buy it, there is always something to worry about. There are always respected investors that say you are wrong. You have to know the story better than they do, and have faith in what you know.”
Price Follows Earnings: Investing is often unnecessarily made complicated. Lynch fundamentally believes stock prices will follow the long-term trajectory of earnings growth. He makes the point that “People may bet on hourly wiggles of the market, but it’s the earnings that waggle the wiggle long term.” In a publicly attended group meeting, Michael Dell, CEO of Dell Inc. (DELL), asked Peter Lynch about the direction of Dell’s future stock price. Lynch’s answer: “If your earnings are higher in 5 years, your stock will be higher.” Maybe Dell’s price decline over the last five years can be attributed to its earnings decline over the same period? It’s no surprise that Hewlett-Packard’s dramatic stock price outperformance (relative to DELL) has something to do with the more than doubling of HP’s earnings over the same time frame.
Valuation & Price Declines: “People Concentrate too much on the P (Price), but the E (Earnings) really makes the difference.” In a nutshell, Lynch believes valuation metrics play an important role, but long-term earnings growth will have a larger impact on future stock price appreciation.
Two Key Stock Questions: 1) “Is the stock still attractively priced relative to earnings?” and 2) “What is happening in the company to make the earnings go up?” Improving fundamentals at an attractive price are key components to Lynch’s investing strategy.
Lynch on Buffett: Lynch was given an opportunity to write the foreword in Buffett’s biography, The Warren Buffett Way. Lynch did not believe in “pulling out flowers and watering the weeds,” or in other words, selling winners and buying losers. In highlighting this weed-flower concept, Lynch said this about Buffett: “He purchased over $1 billion of Coca-Cola in 1988 and 1989 after the stock had risen over fivefold the prior six years and over five-hundredfold the previous sixty years. He made four times his money in three years and plans to make a lot more the next five, ten, and twenty years with Coke.” Hammering home the idea that a few good stocks a decade can make an investment career, Lynch had this to say about Buffett: “Warren states that twelve investments decisions in his forty year career have made all the difference.”
You Don’t Need Perfect Batting Average: In order to significantly outperform the market, investors need not generate near perfect results. According to Lynch, “If you’re terrific in this business, you’re right six times out of 10 – I’ve had stocks go from $11 to 7 cents (American Intl Airways).” Here is one recipe Lynch shares with others on how to beat the market: “All you have to do really is find the best hundred stocks in the S&P 500 and find another few hundred outside the S&P 500 to beat the market.”
The Critical Element of Patience: With the explosion of information, expansion of the internet age, and the reduction of trading costs has come the itchy trading finger. This hasty investment principle runs contrary to Lynch’s core beliefs. Here’s what he had to say regarding the importance of a steady investment hand:
- “In my investing career, the best gains usually have come in the third or fourth year, not in the third or fourth week or the third or fourth month.”
- “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.”
- “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.”
- “The key to making money in stocks is not to get scared out of them.”
Bear Market Beliefs: “I’m always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession,” says Lynch. The media responds in exactly the opposite manner – bear markets lead to an inundation of headlines driven by panic-based fear. Lynch shares a similar sentiment to Warren Buffett when it comes to the media holding a glass half full view in bear markets.
Market Worries: Is worrying about market concerns worth the stress? Not according to Lynch. His belief: “I’ve always said if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.” Just this last March, Lynch used history to drive home his views: “We’ve had 11 recessions since World War II and we’ve had a perfect score — 11 recoveries. There are a lot of natural cushions in the economy now that weren’t there in the 1930s. They keep things from getting out of control. We have the Federal Deposit Insurance Corporation [which insures bank deposits]. We have social security. We have pensions. We have two-person, working families. We have unemployment payments. And we have a Federal Reserve with a brain.”
Thoughts on Cyclicals: Lynch divided his portfolio into several buckets, and cyclical stocks occupied one of the buckets. “Cyclicals are like blackjack: stay in the game too long and it’s bound to take all your profit,” Lynch emphasized.
Selling Discipline: The rationale behind Lynch’s selling discipline is straightforward – here are some of his thoughts on the subject:
- “When the fundamentals change, sell your mistakes.”
- “Write down why you own a stock and sell it if the reason isn’t true anymore.”
- “Sell a stock because the company’s fundamentals deteriorate, not because the sky is falling.”
Distilling the genius of an investing legend like Peter Lynch down to a single article is not only a grueling challenge, but it also cannot bring complete justice to the vast accomplishments of this incredible investment legend. Nonetheless, his record should be meticulously studied in hopes of adding jewels of investment knowledge to the repertoires of all investors. If delving into the head of this investing mastermind can provide access to even a fraction of his vast knowledge pool, then we can all benefit by adding a slice of this greatness to our investment portfolios.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own certain exchange traded funds, including KO, but at time of publishing had no direct positions in DELL, HPQ or any other security mentioned. 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.
Supply & Demand: The Key to Oil, Stocks, and Pork Bellies
Commodity prices, including oil, are “crashing” according to the pundits and fears are building that this is a precursor to another stock market collapse. Are we on an irreversible path of repeating the bloodbath carnage of the 2008-2009 Great Recession?
Fortunately for investors, markets move in cycles and the fundamental laws of supply and demand hold true in both bull and bear markets, across all financial markets. Whether we are talking about stocks, bonds, copper, gold, currencies, or pork bellies, markets persistently move like a pendulum through periods of excess supply and demand. In other words, weakness in prices create stronger demand and less supply, whereas strength in prices creates weakening demand and more supply.
Since energy makes the world go round and the vast majority of drivers are accustomed to filling up their gas tanks, the average consumer is familiar with recent negative price developments in the crude oil markets. Eighteenth-century economist Adam Smith would be proud that the laws of supply and demand have help up just as well today as they did when he wrote Wealth of Nations in 1776.
It is true that overall stagnation in global economic demand in recent years, along with the strengthening of the U.S. dollar (because of better relative growth), has contributed to downward trending oil prices. It is also true that supply factors, such as Saudi Arabia’s insistence to maintain production and the boom in U.S. oil production due to new fracking technologies (see chart below), have arguably had a larger negative impact on the more than -50% deterioration in oil prices. Fears of additional Iranian oil supply hitting the global oil markets as a result of the Iranian nuclear deal have also added to the downward pressure on prices.
Source: Scott Grannis
What is bad for oil prices and the oil producers is good news for the rest of the economy. Transportation is the lubricant of the global economy, and therefore lower oil prices will act as a stimulant for large swaths of the global marketplace. Here in the U.S., consumer savings from lower energy prices have largely been used to pay down debt (deleverage), but eventually, the longer oil prices remain depressed, incremental savings should filter into our economy through increased consumer spending.
But prices are likely not going to stay low forever because producers are responding drastically to the price declines. All one needs to do is look at the radical falloff in the oil producer rig count (see chart below). As you can see, the rig count has fallen by more than -50% within a six month period, meaning at some point, the decline in global production will eventually provide a floor to prices and ultimately provide a tailwind.
Source: Scott Grannis
If we broaden our perspective beyond just oil, and look at the broader commodity complex, we can see that the recent decline in commodity prices has been painful, but nowhere near the Armageddon scenario experienced during 2008-2009 (see chart below – gray areas = recessions).
Source: Scott Grannis
Although this conversation has focused on commodities, the same supply-demand principles apply to the stock market as well. Stock market prices as measured by the S&P 500 index have remained near record levels, but as I have written in the past, the records cannot be attributed to the lackluster demand from retail investors (see ICI fund flow data).
Although U.S. stock fundamentals remain relatively strong (e.g., earnings, interest rates, valuations, psychology), much of the strength can be explained by the constrained supply of stocks. How has stock supply been constrained? Some key factors include the trillions in dollars of supply soaked up by record M&A activity (mergers and acquisition) and share buybacks.
In addition to the declining stock supply from M&A and share buybacks, there has been limited supply of new IPO issues (initial public offerings) coming to market, as evidenced by the declines in IPO dollar and unit volumes in the first half of 2015, as compared to last year. More specifically, first half IPO dollar volmes were down -41% to $19.2 billion and the number of 2015 IPOs has declined -27% to 116 from 160 for the same time period.
Price cycles vary dramatically in price and duration across all financial markets, including stocks, bonds, oil, interest rates, currencies, gold, and pork bellies, among others. Not even the smartest individual or most powerful computer on the planet can consistently time the short-term shifts in financial markets, but using the powerful economic laws of supply and demand can help you profitably make adjustments to your investment portfolio(s).
See Also – The Lesson of a Lifetime (Investing Caffeine)
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing, SCM had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC Contact page.
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.
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.
The Bunny Rabbit Market
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (April 1, 2015). Subscribe on the right side of the page for the complete text.
With spring now upon us, we can see the impact the Easter Bunny has had on financial markets…a lot of bouncing around. More specifically, stocks spent about 50% of the first quarter in negative territory, and 50% in positive territory. With interest rates gyrating around the 2% level for the benchmark 10-Year Treasury Note for most of 2015, the picture looked much the same. When all was said and done, after the first three months of the year, stocks as measured by the S&P 500 finished +0.4% and bonds closed up a similarly modest amount of +1.2%, as measured by the Total Bond Market ETF (BND).
Why all the volatility? The reasons are numerous, but guesswork of when the Federal Reserve will reverse course on its monetary policy and begin raising interest rates has been (and remains) a dark cloud over investment strategies for many short-term traders and speculators. In order to provide some historical perspective, the last time the Federal Reserve increased interest rates (Federal Funds rate) was almost nine years ago in June 2006. It’s important to remember, as this bull market enters its 7th consecutive year of its advance, there has been no shortage of useless, negative news headlines to keep investors guessing (see also a Series of Unfortunate Events). Over this period, ranging concerns have covered everything from “Flash Crashes” to “Arab Springs,” and “Ukraine” to “Ebola”.
Last month, the headline pessimism persisted. In the Middle East we witnessed a contentious re-election of Israeli Prime Minister Benjamin Netanyahu; Saudi Arabia led airstrikes against Iranian-backed, Shi’ite Muslim rebels (Houthis) in Yemen; controversial Iranian nuclear deal talks; and President Barack Obama directed airstrikes against ISIS fighters in the Iraqi city of Tikrit, while he simultaneously announced the slowing pace of troop withdrawals from Afghanistan.
Meanwhile in the global financial markets, investors and corporations continue to assess capital allocation decisions in light of generationally low interest rates, and a U.S. dollar that has appreciated in value by approximately +25% over the last year. In this low global growth and ultra-low interest rate environment (-0.12% on long-term Swiss bonds and 1.93% for U.S. bonds), what are corporations choosing to do with their trillions of dollars in cash? A picture is worth a thousand words, and in the case of companies in the S&P 500 club, share buybacks and dividends have been worth more than $900,000,000,000.00 over the last 12 months (see chart below).
Source: Financial Times
Case in point, Apple Inc (AAPL) has been the poster child for how companies are opportunistically boosting stock prices and profitability metrics (EPS – Earnings Per Share) by borrowing cheaply and returning cash to shareholders via stock buybacks and dividend payments. More specifically, even though Apple has been flooded with cash (about $178 billion currently in the bank), Apple decided to accept $1.35 billion in additional money from bond investors by issuing bonds in Switzerland. The cost to Apple was almost free – the majority of the money will be paid back at a mere rate of 0.28% until November 2024. What is Apple doing with all this extra cash? You guessed it…buying back $45 billion in stock and paying $11 billion in dividends, annually. No wonder the stock has sprung +62% over the last year. Apple may be a unique company, but corporate America is following their shareholder friendly buyback/dividend practices as evidenced by the chart below. By the way, don’t be surprised to hear about an increased dividend and share buyback plan from Apple this month.
Source: Investors Business Daily
Despite all the turmoil and negative headlines last month, the technology-heavy NASDAQ Composite index managed to temporarily cross the psychologically, all-important 5,000 threshold for the first time since the infamous tech-bubble burst in the year 2000, more than 15 years ago. The Dow Jones Industrial also cracked a numerically round threshold (18,000) last month, before settling down at 17,779 at month’s end.
While the S&P 500 and NASDAQ indexes have posted their impressive 9th consecutive quarter of gains, I don’t place a lot of faith in dubious, calendar-driven historical trends. With that said, as I eat jelly beans and hunt for Easter eggs this weekend, I will take some solace in knowing April has historically been the most positive month of the year as it relates to direction of stock prices (see chart below). Over the last 20 years, stocks have almost averaged a gain of +3% over this 30-day period. Perhaps investors are just in a better mood after paying their taxes?
Source: Bespoke
Even though April has historically been an outperforming month, banker and economist Robert Rubin stated it best, “Nothing is certain – except uncertainty.” We’ve had a bouncing “Bunny Market” so far in 2015, and chances are this pattern will persist. Rather than fret whether the Fed will raise interest rates 0.25% or agonize over a potential Greek exit (“Grexit”) from the EU, you would be better served by constructing an investment and savings plan to meet your long-term financial goals. That’s an eggstra-special idea that even the Easter Bunny would want to place in the basket.
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) including BND and AAPL (stock), 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.
March Madness – Dividend Grandness & Volatility Blandness
March Madness has arrived once again. This NCAA basketball event, which has been around since 1939, begins with a selection committee choosing the top 68 teams in the country. These teams are matched up against each other through a single-elimination tournament until a national champion is throned. The stock market does not have a selection committee that picks teams from conferences like the SEC, Big East, Pac-12, and ACC, but rather millions of investors select the best investments from asset classes like stocks, bonds, real estate, commodities, venture capital, and private equity.
In the investment world, there are no win-loss records, but rather there are risk-return profiles. Investors generally migrate towards the asset classes where they find the optimal trade-off between risk and return. Speculators, day-traders, and momentum traders may define risk differently, but regardless, over the long-run, capital goes where it is treated best. And over the last six years, the U.S. stock market hasn’t been a bad place to be (the S&P 500 has about tripled).
Why such outperformance in stocks? Besides a dynamic earnings recovery from the 2008-2009 financial crisis, another major factor has been the near-0% interest rate environment. When investors are earning near nothing in their bank and savings accounts, it is perfectly rational for savers to look for riskier options, if they are compensated for that risk. In addition to loose central bank and quantitative easing policies fueling demand for stocks, rising dividends have increased the attractiveness of the stock market. In fact, as you can see from the chart below, dividends have about doubled from 2008-2009 and about tripled from the year 2000.
Source: Buy Upside
Stock prices have moved higher in concert with rising dividends, which, as you can see from the chart below, has kept the dividend yield flat at around 2% over the last few years. Treasury bond yields, on the other hand, have been on steady declining trend for the last 35 years. So, while coupons on newly issued bonds have been declining for virtually the last three and a half decades, stock dividends have been on a steadily upward moving rampage, excluding recessions (up +13% in the most recent reported period).
Source: Avondale Asset Management
Declining interest rates have made stocks look attractive relative to investment grade corporate bonds too as evidenced by the chart below. As you can see, over the last half-century, corporate bond yields have predominantly offered higher income yields than the earnings yield on stocks – that is not the case today.
Source: Calafia Beach Pundit
What does all this stock dividend, earnings yield stuff mean? In the grand scheme of things, income starving Baby Boomers and retirees are slowly realizing that stocks in general stack up favorably in an environment in which interest payments are going down and dividend payments are going up. One of the areas highlighting the underlying demand for stocks is the Volatility Index (VIX) – a.k.a., the “Fear Gauge.” Despite Greece, Russia, ISIS, the Fed, and the Dollar dominating the headlines, the hunger for yield and growth in a declining interest rate environment is cushioning the blow during these heightened periods of volatility (see also A Series of Unfortunate Events).
Since the end of 2011, the monthly close of the VIX has stayed above its historical average of approximately 20 only two times (see chart below). In other words, over that timeframe, the VIX has remained below average about 95% of the time. When the VIX has spiked above 20, generally it has only been for brief periods, until cooler heads prevail and bargain hunters come in to buy depressed stock bargains.
Source: Barchart
I’m not naïve enough to believe the bull market in stocks will last forever, but as long as interest rates don’t spike up and/or corporate earnings crater, underlying demand for yield should provide a floor for stocks during heightened periods of volatility. We may be in the midst of March Madness but volatility blandness is showing us that investors are paying attention to dividend grandness.
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 SPY, 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.
Ceasefires & Investor Quagmires
This article is an excerpt from a previously released Sidoxia Capital Management complementary newsletter (March 1, 2015). Subscribe on the right side of the page for the complete text.
Considering the following current event headlines, who would have guessed the stock market is trading near record, all-time highs and the NASDAQ index breaking 5,000 for the first time since the year 2000?
- Russia Lies Over Ukraine Ceasefire
- ISIS Beheadings and Jihadi John
- Strong Dollar, Weak Global Economy
- Fed’s Yellen: Rate Rise & Inflation
- Iranian Negotiations & Nuclear Weapons
- Grexit: The Likelihood of Greece’s Exit from the Euro
- The Chinese Bubble Pops
- Ebola and the Fear Epidemic
After reading all these depressing stories, I feel more like taking a Prozac pill than I do venturing into the investing world. Unfortunately, in the media world, the overarching motto driving the selection of published stories is, “If it bleeds, it leads!” Plainly and simply, bad news sells. The media outlets prey on our human behavioral shortcomings. Specifically, people feel the pain from losses at a rate more than double the feelings of pleasure (see Controlling the Lizard Brain and chart below).
This phenomenon leaves Americans and the overall investing public choking on the daily doom and gloom headlines. Investor skepticism caused by the 2008-2009 financial crisis is evidenced by historically low stock ownership statistics and stagnant equity purchase flow data. Talk of another stock bubble has been introduced again now that the NASDAQ is approaching 5,000 again, but we are not seeing signs of this phenomenon in the IPO market (Initial Public Offering) – see chart below. IPOs are on the rise, but the number of filings is more than -50% below the peak of 845 IPOs seen in the late 1990s when former Federal Reserve Chairman Alan Greenspan made his famous “irrational exuberance” speech (see also Irrational Exuberance Deja Vu and chart below).
Uggh! 0.08% Really?
Compounding the never-ending pessimism problem is the near-0% interest rate environment. Times are long gone when you could earn 18% on a certificate of deposit (see chart below). Today, you can earn 0.08% on a minimum $10,000 investment in a Bank of America (BAC) Certificate of Deposit (CD). Invest at that rate for more than a decade and you will have almost accumulated a $100 (~1%) – probably enough for a single family meal…without tip. To put these paltry interest rates into perspective, the U.S. stock market as measured by the S&P 500 index was up a whopping +5.5% last month and the Dow Jones Industrials climbed +5.6% (+968 points to 18,133). Granted, last month’s S&P 500 percentage increase was the largest advance since 2011, but if I wanted to earn an equivalent +5.5% return by investing in that Bank of America CD, it would take me to age 100 years old before I earned that much!
Globally, the interest rate picture doesn’t look much prettier. In fact, the negative interest rate bonds offered in Switzerland and other neighboring countries, including France and Germany, have left investors in these bonds with guaranteed losses, if held to maturity (see also Draghi Beer Goggles).
Money Seeking Preferred Treatment
Investors and followers of mine have heard me repeatedly declare that “money goes where it is treated best.” When many investments are offering 0% (or negative yields), it comes as no surprise to me that dividend paying stocks have handily outperformed the overall bond market in recent years. Hard to blame someone investing in certain stocks offering between 2-6% in dividends when the alternative is offered at or near 0%.
While at Sidoxia we are still finding plenty of opportunities in the equity markets, I want to extend the reminder that not everyone can (or should) increase their equity allocation because of personal time horizon and risk tolerance constraints. Regardless, the current, restricting global financial markets are highlighting the scarcity of investment alternatives available.
As we will continue to be bombarded with more cease fires, quagmires and other bleeding headlines, investors will be better served by ignoring the irrelevant headlines and instead create a long-term financial plan with an asset allocation designed to meeting their personal goals. By following this strategy, you can let the dooms-dayers bleed while you succeed.
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 BAC, 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.
Santa and the Rate-Hike Boogeyman
Boo! … Rates are about to go up. Or are they? We’re in the fourth decade of a declining interest rate environment (see Don’t be a Fool), but every time the Federal Reserve Chairman speaks or monetary policies are discussed, investors nervously look over their shoulder or under their bed for the “Rate Hike Boogeyman.” While this nail-biting mentality has resulted in lost sleep for many, this mindset has also unfortunately led to a horrible forecasting batting average for economists. Santa and many equity investors have ignored the rate noise and have been singing Ho Ho Ho as stock prices hover near record highs.
A recent Deutsche Bank report describes the prognostication challenges here:
i.) For the last 10 years, professional forecasters have consistently been wrong on their predictions of rising interest rates.
Source: Deutsche Bank via Vox
ii.) For the last five years, investors haven’t fared any better. As you can see, they too have been continually wrong about their expectations for rising interest rates.
Source: Deutsche Bank via Vox
I’m the first to admit that rates have remained “lower for longer” than I guessed, but unlike many, I do not pretend to predict the exact timing of future rate increases. I strongly believe inevitable interest rate rises are not a matter of “if” but rather “when”. However, trying to forecast the timing of a rate increase can be a fool’s errand. Japan is a great case in point. If you take a look at the country’s interest rates on their long-term 10-year government bonds (see chart below), the yields have also been declining over the last quarter century. While the yield on the 10-Year U.S. Treasury Note is near all-time historic lows at 2.18%, that rate pales in comparison to the current 10-Year Japanese Bond which is yielding a minuscule 0.36%. While here in the states our long-term rates only briefly pierced below the 2% threshold, as you can see, Japanese rates have remained below 2% for a jaw-dropping duration of about 15 years.
Source: TradingEconomics.com
There are plenty of reasons to explain the differences in the economic situation of the U.S. and Japan (see Japan Lost Decades), but despite the loose monetary policies of global central banks, history has proven that interest rates and inflation can remain stubbornly low for longer than expected.
The current pundit thinking has Federal Reserve Chairwoman Yellen leading the brigade towards a rate hike during mid-calendar 2015. Even if the forecasters finally get the interest rate right for once, the end-outcome is not going to be catastrophic for equity markets. One need look no further than 1994 when Federal Reserve Chairman Greenspan increased the benchmark federal funds rate by a hefty +2.5%. (see 1994 Bond Repeat?). Rather than widespread financial carnage in the equity markets, the S&P 500 finished roughly flat in 1994 and resumed the decade-long bull market run in the following year.
Currently 15 of the 17 Fed policy makers see 2015 median short-term rates settling at 1.125% from the current level of 0-0.25%. This hardly qualifies as interest rate Armageddon. With a highly transparent and dovish Janet Yellen at the helm, I feel perfectly comfortable the markets can digest the inevitable Fed rate hikes. Will (could) there be volatility around changes in Fed monetary policy during 2015? Certainly – no different than we experienced during the “taper tantrum” response to Chairman Ben Bernanke’s rate rise threats in 2013 (see Fed Fatigue).
As 2014 comes to an end, Santa has wrapped investor portfolios with a generous bow of returns in the fifth year of this historic bull market. Not everyone, however, has been on Santa’s “nice” list. Regrettably, many sideliners have received no presents because they incorrectly assessed the elimination impact of Quantitative Easing (QE). If you prefer presents over a lump of coal in your stocking, it will be in your best interest to ignore the Rate Hike Boogeyman and jump on Santa’s sleigh.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients own a range of positions, including certain exchange traded fund positions, but at the time of publishing SCM had no direct position in DB 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.
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