Monday, December 30, 2013

So easy to lose perspective...

After a year like 2013---assuming the market doesn't drop 30% tomorrow---it's easy for investors to lose perspective. As is always the case after a significant market move (this go-round an advance), folks come out of the woodwork asking me questions, or making statements, such as the following four (these are actual examples). Following each I'll answer, in italics, with what I might have been thinking, but probably didn't say to my inquisitor:

  • I have a little extra cash, is this a good time to invest? Or should I wait, since the market's up so much? I'll tell you later---like, say, in 6 months or so.

  • Shouldn't we take some off the table now, since the Dow's at an all-time high? Let's see, the Dow hit its first all-time high this year back on March 5th. If we took some off the table at every all-time high since, you'd have been all cash months ago.

  • Since I don't see a bubble on the horizon, I'd like you to go ahead and invest my cash allocation into the stock market. So you have the experience, wisdom, extra sensory perception to see bubbles on horizons? Then why the heck do you need me? Especially since I don't.

  • And my all-time favorite: What's the market going to do next year? Yeah, I always know what the market's going to do, that's why I'm taking your call while afloat on my 300 foot yacht in the Mediterranean.

The thing is, we like what we see on our statements. We identify with the price per share of our holdings on the day before our statements were cut, and we forget everything we've read on this blog site: Everything about volatility, about not identifying with our monthly statements (or our account value displayed on our brokerage firm's website), about how down cycles are essential to long-term investment success, about how utterly dangerous it is to try and time the stock market, and about how no human being we see on television possesses the knowledge of all the moving parts---let alone how they interact with one another---to even begin to accurately (with any consistency) predict markets in the short term. We grab our calculators and start playing with numbers: We imagine paying off the house, and what no house payment means going forward. We apply a percentage rate and figure how much income we can take if we retire today. We start fiddling with rates of return and figure that if our portfolio grows by another X% from here for 10 more years, what we'll have if we retire then. And so on...

And, you know, that's all okay. As long as we don't let our fantasies---or our understanding that the stock market has to contract every so often---run away with our investment disciplines.

If you, particularly if you're our client, haven't yet read Our View Going Forward, please do. It offers a fairly in-depth look into how we approach the business of investing.

Sunday, December 29, 2013

The arguments for and against extending extended unemployment benefits. Are we talking compassion, or economics, or both?

Extended unemployment benefits for 1.3 million people expired yesterday. This morning, while thinking about what I might say in a television interview on the topic to be taped later in the day, I jotted down the following questions. This is a little scratching below the surface to offer up more than what much of the media would have you consider:


How can we not continue to provide income for those who've been unable to find work? Of course that one's easy to understand.

How can we continue to pay people when they're not producing anything in return? That one simply sounds cruel. But, upon inspection, perhaps it's not. There are economists on either side of the argument---some say unemployment benefits stimulate job production, others say the opposite---the latter suggest that extending unemployment benefits actually extends the duration and rate of unemployment. If true (intuitive for some), continuing to extend unemployment benefits is morally wrong on behalf of the very people who receive them (counterintuitive for most).

How can we continue to take from people who work to pay people who don't? Easy to understand, but, to many, sounds cruel.

How is it any crueler to allow 1.3 million people's benefits to expire versus when the number is smaller? Were it 0.3 million, or 0.00003 million, would not the same individual suffering exist? Would the 0.3 million, or 0.00003 million, whose benefits cease be somehow better off because they're part of a smaller population? Surely, if cutting unemployment benefits is cruel, it is every bit as cruel for 1 person as it is for 1 million.


Don't unemployment benefits get spent? And don't they, therefore, create jobs as that money flows through the economy? Makes sense to many. But, if true, shouldn't we then double, or quintuple, the benefits and extend them ad infinitum?

Don't unemployment benefits come from somewhere? Don't we have to tax working folks to pay these benefits to nonworking folks? And doesn't that, therefore, neutralize the economic impact of the spending by unemployed folks?

Since unemployed folks will spend most, if not all, of their benefits, while folks with higher incomes are more apt to save at the margin, don't unemployment benefits---having been taken from savers and given to spenders---therefore, create a net economic benefit to society?

If savings and investment provides the capital for businesses to expand, how can society be better off by taking from savers and giving to spenders? Wouldn't that, in the long-run, result in less overall employment?

Wouldn't increased spending increase profits to businesses, profits that can be used to expand? Makes sense. But remember, folks who own businesses must pay increased taxes to fund the increased spending.

Could the uncertainty of those with capital---knowing they'll foot the bill for seemingly never-ending entitlements---result in less long-term investing and, therefore, less business expansion and, therefore, less job opportunities for those who desperately need them?

Is your personal economy healthier when you spend all of your income, or when you save and invest a portion? Most would say the latter. Which begs the question, if your personal economy is better when you keep some of what you earn, how can society be better when other people don't?

Friday, December 27, 2013

Who bears the burden?

In his 2012 book The Sector Strategist, Timothy McIntosh explains who ultimately bears the burden of over-regulation.

From page 130:
Despite this enhanced government regulatory burden, the banking sector is continuing to return to well-being and is now looking outside the box to find new ways to make profits. Today, banks are implementing important modifications to the business models, all of which will ultimately increase costs for consumers. These alterations include higher fees on checking accounts and limitations on debit card use. The cancellation of rewards programs is also being implemented. All of these regulations have driven return on equity and net interest margin lower for most of the major U.S. banking institutions. For example, the FDIC announced that eight out of the10 largest banks in the United States---which together control more than half of all loans in the country---showed a decline in net interest margin during the first half of 2011. During the first quarter of 2011, the value of loans outstanding held by banks declined by nearly $127 billion. Banks are now searching for any alternative to return to higher revenue and profitability, including opening up smaller "lite-branches" (i.e., ATM-only locations) and reducing workforce at many branch locations.

And from pages 136-137:
In mid-2011, The Consumer Financial Protection Bureau released data showing that credit card late fees dropped from $901 million in January 2010 to $427 million in November 2010, due to a cap of $25 on the first late fee on an account and $35 for the second late fee within six months of the first offense. One of the major provisions of the Act was the imposition of new rules that prevented credit card issuers from penalizing cardholders for going over the card's limit amount, unless the cardholder desired that these charges be established. As a result of this alteration, many credit card issuers eradicated over-the-limit fees. These fees were as high as $39 before the new rules were put in place. A major negative for consumers of the Act was that credit card interest rates had risen from 13.26% to 14.27%, making it more difficult to find a card with a low interest rate today.

We all know this, right? Institutions will take whatever measures necessary to maintain their margins in the face of rising costs. Meaning, increased costs get passed on to employees and customers. Now why would an increase in the minimum wage be treated any differently? That's right, it wouldn't be...

Thursday, December 26, 2013

When peck comes to shove...

There are three dozen or so coots foraging for their breakfast this morning about 50 feet beyond the edge of our backyard---I'm guessing the water's around 4 or 5 feet deep. I noticed something this morning for the first time: While all of these funny little waterfowl are after a meal, they don't all employ the same tactics, at least not all at the same time.

At any given moment, one out of maybe four takes it upon himself to hold his breath and get his head wet. He disappears under the surface for about 5 seconds then emerges with a clump of vegetation hanging from his beak. Upon breaking the surface he's greeted immediately by the nearest two or three of his dry-head-feathered brethren hoping to yank away his harvest before he has a chance to chew. I'd say roughly half the time he forfeits a good chunk of his produce to those who, at least at that moment, would prefer not to extend the effort it takes to feed themselves. After a while the working coot, either out of discouragement or sheer exhaustion, stops diving. Moments pass while the fidgety thieves stare at the spent producer, then, finally, one of the ambushers from earlier realizes that if he's going to eat he's going to have to get to work. So he dives, he emerges, he gets the crap pecked out of him (I'm thinking serves you right you little bastard). Even, alas, the bird who was previously doing all the work has now joined in on the plunder.

So these birds have a system. At any given time, there are a few doing the work and, by force, feeding the many. After a while the producer becomes so discouraged that he gives up and joins the many. There never comes a point, however, where any of them go hungry; for when peck comes to shove, if they want to eat and nobody's around to feed them, they go to work. Hmm...

Who would buy such a thing?

Let's do a little hypothetical: Let's say you own a rental house that you paid $100,000 for back in 2006 and that you receive $425 per month in rent (not that great, I know, but pretend it is), and that the rental market doesn't allow you to raise the rent and retain your tenants. And let's say that, for whatever reasons, the going price for rentals like yours is now $175,000. You're thinking you gotta be kidding me, $425 a month on a $175,000 investment is only 2.9% on your money. Who would buy such a thing? Well, my hypothetical friend, you own such a thing.

If you're a regular reader, I've probably done enough bond-bashing of late to last you through 2014. But every time I read an article making a case for bonds, or some yield-generating, equally-interest-rate-sensitive, alternative, or review some other firm's disenchanted client's "conservative" portfolio and see it bulging with bonds, I feel compelled to reach out and make certain that you understand the inverse relationship between interest rates and bond prices.

I don't know that there's a bond market bubble just waiting to burst all over the world economy. The fact that that's a common concern suggests to me that it may not get as ugly as I once thought it might (although I still believe it gets uglier from here). It's my observation that when the consensus sees a calamity coming, it doesn't. I recall during the bursting of the housing bubble, many an "expert" was telling us that if we thought housing was bad, we ain't seen nothin yet. The coming implosion of the commercial market would make cake out of the housing mess. You remember what happened when the commercial bubble burst? Me neither. And of course the first taper of QE was going to rock the stock market hard. I believe the Dow rose 300 points that day.

But here's thing about bonds, from a risk/reward standpoint, they're not making sense to me these days. Barring a recession sometime soon, there's minimal upside and, particularly if the economy accelerates, plenty of downside. And never forget, the fixed income component of your portfolio is where you mitigate volatility.

The current yield on the 10 year treasury, a bond market benchmark, just about matches the rental scenario in paragraph one. Of course a critic would chastise me for comparing apples and oranges; truly, rental real estate carries substantially more risk than treasury bonds, right? Typically, yes. Today, however, I'm not so sure. 

Saturday, December 21, 2013

The thing about income inequality, and a lot of other things...

...the evidence offered up by those so concerned with income inequality (I’m more concerned with improving the fortunes of the less fortunate without regard to the pace of advancement at the top rung of the income ladder), is, candidly, the definition of dubious.

The above was part of my reply to a recent question from a reader. I directed him to this blog post featuring two short videos. The deafening crescendo of the income inequality chorus inspires me to direct you to it as well. As you'll see, Robert Reich does a perfect political poster-child of a job on (among other things) middle-class stagnation and income inequality. Don Boudreaux, on the other hand, does what good economists do. He takes us below the surface and disabuses us of what politicians and their promoters---seeking to exploit our misconceptions---would have us believe.

One point before you proceed. In his video, Boudreaux states that women and immigrants entering the workforce for the first time brings the average income statistic down, but not the actual pay of actual people. A reader found that statement to be "absurd, even offensive". He somehow took it to mean that Don was discounting women and immigrants to the status of non-actual people. And that not considering their low incomes is just plain wrong. Clearly, my reader misinterpreted the message: When Don made that point, he was in no way disparaging women or immigrants. He was simply making the point that more folks entering the workforce for the first time (thus, with low skills) naturally brings down the average income---as does having a baby bring down the average height of your children (a perfect analogy he illustrates in his video). This point, ironically, also makes Reich's assertions all the more dangerous, in that his argument seems meant to inspire a public response (that could result in hiking employers' tax rates and/or raising the minimum wage) that would hurt the very group he claims to advocate for. You see, when folks enter the workforce for the first time, not only does it not bring down "the actual pay of actual people" it dramatically brings up the pay of the very people who bring down the statistical average. I mean, going from zero to, say, $7.25 an hour is a massive increase in income for low-income individuals. And it's those very individuals who will bear the burdens of policies that would add costs to their employers.

It is so important, for the sake of the neediest among us, that we get this right...

Reich delivers several other statistics that, while I suspect are, in and of themselves, accurate, under even minor scrutiny suggest a likely intent behind the election year presentation. For example:
The economy has doubled since 1980. "Almost all of the gains have gone to the super rich. The top 1% used to take home about 10% of total income, now it takes home 20%".

While disproportionate, doesn't that leave huge gains (the size of the economy has doubled) to everyone else?
The super rich hold 40% of the nation's entire wealth.

I suppose that's why they call them "super rich". I suppose as well that the remaining 60% of the wealth of a country that has doubled the size of its economy over 30 years is a huge amount. And of course you'd expect that the folks who are largely responsible for the growth of the economy, the innovators (the Gates's, Jobs's, etc.), would see their fortunes expand at a greater pace than the rest of us. But, my, how we've benefitted along way! Where Reich and I do agree is where big money buys big favors from politicians. We're on opposite sides, however, as to the fix: Reich would have us vest yet more power in the politician, all the more incentivizing the very cronyism he pretends to despise.  
Before 1980 the top tax rate was up to 70%, now it's down to 35%, and capital gains are only 15%.

Before 1980 you could write off the moon. Not any more. Deductions have declined right along with tax rates. Today's top 1% pays 30% of the total income taxes paid in the U.S.. Guess what that number was in 1980.... it was 19.05%! That's right, Reich would have us believe that the rich are somehow getting away with tax murder. When, in reality, they're paying 50% more of the total tax bill than they did 3 decades ago. 
Government spending is down to 15% of the total economy, the lowest in 60 years. So public services are being cut at all levels of government.

Let's see, the economy has doubled since 1980; to suggest, therefore, that government spending of 15% of today's GDP somehow equates to the devastation of public services is beyond insulting. The federal government spent $591 billion in 1980. It spent $3.4 trillion (nearly a sixfold increase) in 2012. So, again, the economy has doubled (the population btw has grown by 36%) since 1980 and government spending has increased by 6 times. If you don't feel abused by Reich's video, you've totally drunk that Kool-Aid.  
The vast middle class is unable to borrow as it did before.

True, however, much of the vast middle class is unwilling to borrow as it did when the credit bubble was expanding out of control, Hallelujah!


Friday, December 20, 2013

Maintain a healthy perspective...

As I've stated multiple times here recently, stocks today, in my view, are no longer cheap, nor are they expensive. Meaning, if earnings pick up next year against a backdrop of a growing economy and low inflation (yes, the inflation measures are debatable), next year could be decent. And of course, as always, it could be ugly, for reasons we'll only know in retrospect.

The logical question heading into 2014 has to be, forgetting valuations for the moment, who the heck would buy stocks while the major averages are at all-time highs? Well, sadly, an even more logical question probably wasn't asked enough back in March of 2009, which is, who the heck wouldn't buy stocks while the major averages are at multi-year lows?

The answer, alas, to both questions is the same. A good number of the folks who will buy equities here will be those who wouldn't buy them back when they were dirt cheap. Stocks are those curious things that few seem to want when they're on sale.

If you're our client, and this bull market rages into a red muleta-wielding matador of an economy next year (that is, if stocks continue to rise) you'll be accommodating those folks as we sell your holdings back to your target allocation at your rebalancing dates. Should the bull fall prey to an unseen lance, you'll be accommodating the exiters as we buy our way back up to your target at those rebalancing dates. Bottom line: you never want to be the answer to the above questions. Although, you could be a buyer here to the extent you, for some reason (came into some cash perhaps), find your portfolio below your target to equities.

If you haven't yet, please take a few minutes and read our year-end investment letter (it's very important that you maintain a healthy perspective going forward)...

Thursday, December 19, 2013

Our View Going Forward, December 2013...

I began last year's year-end letter with the following: 
I’m not one for making economic or financial-market predictions. There are far too many variables at play for any human being to even begin to accurately predict the future—even (if not especially) the economist with the most complex and tested models. And any investment advisor who would claim predictive talent is either profoundly foolish, or an outright charlatan. Personally, I’m more humble today than I was when I began my career 28 years ago.

The only thing I would change in this year's intro would be to replace 28 with 29. In fact, there's virtually nothing else in last year's entire letter that I would alter. Which makes sense given that the message offered nothing by way of near-term predictions (I did suggest there'd be some sector rotation in 2013, which there was). My aim was, and remains, to offer a long-term macro view of the investment world.

Here's our present (12/2013) view on asset classes and sectors:

First and foremost, we believe that patient, long-term-minded investors should maintain a target mix between equities (stocks, real estate, commodities) and fixed income assets (bonds, cds, cash, etc.). Individuals with high risk tolerance would maintain greater exposure to equities than those who view themselves as moderate or conservative.

I'll begin with a no-brainer, fixed income: We believe strongly that interest rate risk remains very much to the upside. Therefore, assuming we're right, investors should shun all but very short maturity bonds (bond prices fall when interest rates rise, and the longer the maturity the harder the fall). I personally prefer cash and short-term CDs for the time being. There appears, however, to be a fair number of other advisers who are attempting to bring yield to their clients' portfolios by replacing standard, high quality, fixed-income securities with real estate investment trusts, high dividend paying stocks, junk bonds, muni bonds and emerging market bonds. As I stated in A 0% Return Can Be A Beautiful Thing, I completely disagree. In my opinion, the primary objective of the fixed income component of your portfolio should be preservation of principal. High volatility is to be had, and exploited, on only the equities side of your allocation. 

Speaking of equities: As you've noticed---with just a few trading days remaining---2013 has been a very good year for the U.S. stock market. The following returns (of widely used ETFs) are as of 12/18/2013: Broken down by sector, consumer discretionary (+40%), health care (+39%), industrials (+37%) and financials (+33%) have led the way year-to-date. The laggards have been commodities (futures) (-8%), real estate investment trusts (+2%), utilities (+12%), materials (+22%), energy (+23%), consumer staples (+25%) and technology (+27%).*

In terms of market cap and style (excluding mid cap, and blending growth and value for small cap): Small Cap has led the way (+33%), followed by Large Cap Value (+29%) and Large Cap Growth (+28%).*

In terms of global comparisons: The S&P 500 Index (+29%) has handily outperformed the non-U.S. developed market EAFE (Europe, Australia and Far East) Index (+18%) and the FTSE Emerging Mkts Index (-5%).*

*Source of returns data: Morningstar®.

In a recent blog post I offered up my view of sectors from both valuation and cyclical standpoints. I'll expand a bit here by including mutual fund/etf styles, as well as hone in on the division among what we consider to be today's most attractive sectors. Consider this a baseline recommendation. Actual allocations are determined on a client by client basis. 

Equity Mutual Fund/ETF style allocation (as a percent of a portfolio's equity exposure):

U.S. Large Cap Value: 32%
U.S. Large Cap Growth: 31%
U.S. Small Cap: 05%
Developed International: 25%
Emerging Markets: 07%

The above allocation reflects an increase in developed international and emerging markets exposure, a 50% decrease in small cap and slight decreases in the remaining two categories when compared to our year ago targets.

Sectors with 10%+ recommended weightings:

Technology 15-20%
Financials 10-15%
Materials 10-15%
Industrials 10%
Energy 10%
Staples 10%

Now, as scientific as you might imagine our selection process to be, there's no assurance that the above allocation will deliver improved results at the margin (which is what we're after). I can easily articulate a scenario for every one of the above sector picks that would logically counter whatever I believe justifies its 10+% weighting. And that's essential to the process: For me to take, for example, a given client's exposure to materials stocks from, say, 4% to 10%, there has to be investors (holders of materials stocks) out there who think that's a bad idea---who are looking to unload their positions onto fools like me. Without opposing views (buyers and sellers) there'd be no market. You can, therefore, see why diversification is so important.

Beyond asset class and sector selection, there's the real important stuff---the stuff that goes on between the ears: Like maintaining a proper perspective on volatility and asset allocation. Like understanding the opportunities that lie beyond our borders. Like understanding the cyclical nature of the economy and the influence of monetary policy on the cycle and on the pricing of fixed-income securities. Like never making emotionally-based investment decisions. And like understanding that, politics notwithstanding, our future is as bright today as it's ever been. All points I made in last year's letter, and feature once again below. Please read the following in its entirety:

Equity market volatility, as it always has, will present significant opportunities for investors who employ strategic asset allocation in the years ahead. That would be the simple process of targeting an asset mix between equity and fixed income assets and rebalancing to that mix at set intervals. For example: say global equity markets suffer 20% across the board declines over the next six months. The portfolio, all else being equal, with a 60% target to equities would become substantially under-weight. Thus, when it’s time to rebalance, the investor will be selling fixed income securities and buying equities in a quantity sufficient to bring the portfolio’s exposure back to the 60% target—in essence, buying while others are selling (when equities prices are low relative to the previous rebalancing date). If, on the other hand, equities rally, the portfolio will become over-weight. In which case the investor would be selling equities and buying fixed income securities in a quantity sufficient to bring the portfolio’s exposure back down to the 60% target—in essence, selling while others are buying (when equities prices are high relative to the previous rebalancing date).

We see unusual long-term opportunity in non-US economies, particularly emerging markets. During the first quarter of 2012 we recommended a modest move out of developed non-US markets to index funds that track the stocks of companies domiciled in China, Brazil, India, South Korea, Indonesia, Taiwan, Thailand, Malaysia and other emerging nations. The global economic concerns of the past few years have, we believe, offered up an opportunity to buy into those potentially robust economies at extremely attractive valuations. 85% of the world’s population lives in emerging markets and, clearly, western ideals have taken root in the psyche of the citizens and leaders of many of these nations. That said, change can be painful, and we caution investors not to over-indulge in direct emerging markets exposure.

(Note: The opportunity for growth I continue to see in emerging market equities was not nearly realized (in fact share prices declined) in 2013. Here's a recent blog post where I explain how quantitative easing in the U.S. has led to extreme volatility in the emerging markets.)

We believe, geo-politics notwithstanding, that long-term opportunities exist in developed-world equities as well. Particularly in companies with substantial reach into the emerging markets. The relatively young, forward-looking, populations in many of the emerging economies (the average age of an Indian worker is 26)—with their need/thirst for infrastructure—presents opportunities for multinational companies in the U.S. and other developed nations. Think industrials, materials, technology, agriculture, energy and finance.

Economies are cyclical and, again, geo-politics notwithstanding, given where we’ve been over the past few years, a continued pick up in the global economy, however gradual—spurred by the allocation of presently idle capital and pent-up demand—is a distinct possibility in the intermediate-term. We do feel strongly, however, that the present ultra-easy monetary policy of much of the developed world will present longer-term challenges that may impact asset allocation decisions in the years to come. Inflation would be chief among those challenges.

Fixed Income Investing
At the present pace of asset purchasing, the U.S. Fed’s balance sheet will reach $4 trillion by the end of 2013 (it's now there). That’s an expansion of $3.2 trillion over the past 4 years. Consequently, bank excess reserves are approaching a record $3 trillion (the Fed buys assets from banks). The net immediate effect of this activity has been to keep interest rates at utterly frightening lows. Frightening in the sense that when, if not before, the Fed can no longer credibly continue this policy, we should expect interest rates to rise. And with trillions in treasuries earning close to (or less than) zero on a real (inflation-adjusted) basis, we could see the kind of domino exodus from bonds that would force rates substantially higher over a relatively short period of time. They would call it the bursting of the bond bubble. We are, therefore, recommending that investors approach the bond market with extreme caution. Our typical portfolio’s fixed income allocation is presently heavily, if not entirely, in cash. Our best advice is to bite your lip and accept little or no real return, for now, on that portion of your portfolio meant to provide a buffer against volatility. A small consolation, for the yield-hungry investor, comes from the fact that many of the companies comprising, in particular, our clients’ large cap value allocation have recently increased their dividend payouts—providing more of an income element, from equities, than had previously existed.

The Bottom Line – investment-wise
The unpredictability of markets, while unnerving to some, forever offers opportunity for the disciplined investor. In fact, long-term investment success is indeed all about discipline. Investment mistakes are typically emotionally-driven. Fear can drive an investor out of equities long before his/her financial plan would have called for. Typically, and ironically, the times of extreme panic have tended to be extreme buying opportunities. Conversely, greed can inspire an investor to overweight—relative to his/her time horizon and tolerance for risk—a given sector, or equities in general. Typically, and ironically, times of investor euphoria (think tech in the late 90s and real estate in the mid 00s) have tended to be ideal times to rebalance out of equities.

Maintaining an asset allocation/rebalancing strategy keeps one from succumbing to the herd mentality. And, as we've discovered, following the herd is generally not your recipe for long-term success—think tech in the late 90s (irrational exuberance), the subsequent market bottom in March 2003 (extreme panic), and real estate in the mid 00s (irrational exuberance), and the subsequent market bottom of March 2009 (extreme panic). I suspect the holders of long-dated bonds have yet to learn that painful lesson.

The Bottom Line – economically, and societally, speaking
While there’s plenty in terms of geo-political risk to concern ourselves with at present, the future holds as much promise today as it has at any time in history. Yes, mistakes, particularly mistakes of policy, will be made. And yes, such mistakes will deliver hurdles and setbacks in the years to come. And yet future generations will witness the advancement of the human condition in ways we can’t even begin to imagine. The ultimate pace of that advancement will be determined by the extent to which we possess the freedom to pursue our individual objectives, and the freedom to conduct business in the global marketplace going forward.

Near-term, I remain cautious. Long-term—bumpy roads notwithstanding—I remain wildly optimistic. That (long-term wild optimism) said, your portfolio must, at all times, reflect your time horizon and your temperament.


Wednesday, December 18, 2013

Yesterday's TV Segment (video)

Yesterday, Zara and I discussed the prospects for a QE taper and how the individual investor might approach his/her portfolio going forward. The knee-jerk reaction to the taper lasted all of a few seconds (the Dow dropped about 60 pts initially), before the market shot higher on Bernanke's dovish comments. He made it very clear that the Fed is not about to entirely remove the punchbowl... Click here to view...

Nothing to celebrate...

Did I say earlier that I'd give the buy-the-news scenario a 50/50 chance. Dang! I meant to say 100%. Truthfully, the only thing I had guts enough to handicap (not counting the zero chance of a complete withdrawal of QE) was the taper, the amount, and the sentiment behind Bernanke's statement. Dang! I meant to say 100% on that :).

Now, 300 points is a big one-day deal, right? Not really. I'd say the proverbial Santa Claus rally had been all pent up over taper fears: Had the Dow risen 30 points a day for the past two weeks, you'd have barely noticed. So what's it all mean going forward? It means the Fed has no intent on leaving after the holidays. Which means we'll be, alas, talking taper well into next year.

Stay tuned...

On the taper...

Hmm... what's the market going to do if the Fed announces today that it's, at last, ready to cut back on the QE? Depends on whom you talk to. My observation is that there's a fairly even division among the "experts": Half predict a sell-off, half predict a yawn. Haven't heard anyone proffer a buy-the-news scenario (doesn't mean there hasn't been one, I just haven't heard it). So then, because I enjoy playing the contrarian, I'll offer one up here.

It goes like this: Bernanke announces that recent data (he'll expound) suggests that the economy has reached a point where the full $85 billion of monthly asset purchases is no longer essential to the recovery. Therefore, the committee has decided to reduce QE by $10 billion per month (could be $5 billion each of treasuries and mortgage backed securities, or could be all treasuries [they're worried about mortgage rates]). He then proceeds to fall all over himself to promise the markets that the $75 billion will remain firm until they're assured that the recovery stands on firm footing, and/or the economy accelerates at a faster pace. He'll add that should the economy begin to turn south, they'll ramp QE back up so fast your head will spin (although, I doubt he'll say "so fast your head will spin"). Traders then look at one another and say "Hey, we knew they'd taper sooner or later, but $10 billion ain't much, and they're in no hurry to take more than that off the table. And they'll ramp it back up if the economy slows. Dang! We better jump in!" 

So there's my buy-the-news scenario. Sound good? Well, it shouldn't. Here's a better, yet, alas, impossible scenario:

Bernanke announces that the Fed has come to the conclusion that while open-ended QE was a worthwhile experiment, it has come nowhere near delivering the kind of results that would warrant its continuation for another day. Therefore, while the Fed will continue its accommodation on the short-end of the yield curve (now that's possible, in fact, definite), it will entirely suspend its quantitative easing program. While they anticipate a violent reaction in financial markets initially (in fact, bonds and stocks started tanking at the conclusion of his first sentence), they believe it will be a small near-term price to pay to avoid the longer-term ramifications of constant money creation and the resulting mispricing of assets. They hope that halting now, and paying a short-term price, will avert bigger problems (like the 2008 real estate/credit market debacle) down the road.

I'm giving the former (the gist of the speech, not the market reaction) a 50/50 chance of occurring today. Zero chance of the latter...

Monday, December 16, 2013

The Market Going Forward...

A guy at the gym approached me early this morning and said "Hey Marty, pretty good year for the market huh... what's next year look like?" I replied "ask me this time next year and I'll tell you for sure." Not pressing for a prognostication, he kindly grinned and headed toward the dumbbells (as in weights, not his fellow weightlifters). Clients, however, are generally not so charitable, they want to know what I really think.

So for you clients, and interested subscribers, out there, here are a few thoughts on just two (brevity for now) tone-setting factors: Sentiment and valuation. I'll characterize each point as bullish, bearish or neutral. At the end I'll tell you what I really think:

(For meatier commentaries from me read Cycles, Sectors and Monetary Policy Confusion, and year-end 2012's Our View Going Forward [which, while I'll update it soon, largely remains our view going forward]).


40% of the participants (everyday folk) in a new Associated Press-Gfk poll say the market will finish next year at about where it is right now. 39% expect it to finish lower (but not crash), 5% expect it to crash, and a mere 14% expect it to rise. That sort of bearishness---as I've explained many times over the years---is a bullish sign.

The latest Investor Intelligence sentiment survey says that better than 50% of advisors are bullish. That sort of bullishness---as I've explained over the years---is a bearish sign.


Trading at 16 times next year's earnings, the S&P 500 (not considering interest rates) is just okay: neither cheap nor expensive. Neutral

Trading at 16 times next year's earnings, while the yield on the 10-year T-bond is below 3%, the S&P 500 is attractive. Bullish

If interest rates (yields) rise, and earnings don't improve, stocks are expensive. Bearish

If interest rates rise, and earnings do improve (as you'd expect if rates rise in response to a faster growing economy), stocks are attractive. Bullish

If interest rates fall, and earnings hold, stocks are attractive. Bullish

If interest rates fall, and earnings fall (as you'd expect if rates decline in response to a slowing economy), stocks are expensive. Bearish

Okay, I'll throw in one economic data point, just because it came out today:

Industrial production for November hit a new all-time high. Suggesting (maybe) that the U.S. economy has finally shifted from recovery to true expansion mode. Bullish

Industrial production for November hit a new all-time high. Another reason why the Fed should start tapering QE now. Bearish (maybe), short-term.

What I really think:

I really think there's cause for optimism going forward. For one, companies have deftly managed their bottom lines throughout the recovery: If indeed the economy is on the verge of reaching escape velocity, efficient businesses (attractive margins) translate a large percentage of revenue (growing in a better economy) to earnings. Higher (than expected) earnings = higher share prices. And I remain in the camp that believes that, to date, the present bull market has lacked participation. I.e., a lot of folks, still shell-shocked from 2008, have yet to engage.

I, sorry, also really think there's cause for pessimism going forward. For one, interest rates have been so suppressed (by the Fed) for so long that there's no telling how aggressively the bond market will seek its long lost equilibrium. A rapid rise in interest rates would surely slow the economy, call earnings into question, and, therefore, do a real number on stock prices. Lack of engagement or not, those still-shell-shocked-from-2008 investors may not be willing to buy the kind of dip such a scenario might inspire.

Trust me, I can take any other factor---the dollar's potential reaction to less QE, the recovery in Europe, capital controls in emerging markets, the trend in gold, politics, national debt, potential inflation, potential deflation, mid-term election prospects, the U.S. energy boom, Mexican manufacturing expansion, the Affordable Care Act, a hike in the minimum wage, etc.---and paint red, green and grey pictures ad infinitum. The fact of the matter being, while because the clues are so numerous---actually, innumerable---I don't have one as to what the near-term might bring. Which is why I am such a critic of outright market timing (that is, moving in and out of the market itself, as opposed to rotating among sectors).

Bottom line: The long-term investor's allocation to the stock market should reflect his/her temperament and time horizon, never his/her own, or someone else's, glomming onto one, or one hundred, data points and trying to guess what might happen over the course of any 12 month period. 

Saturday, December 14, 2013

Does Capitalism Exploit Workers? (video)

As you might expect, I have received a little pushback from my recent post where I attempt to put Wal-Mart CEO Mike Duke's $23.2 million (2012) pay into perspective. One gentleman sees Walmart as a union-suppressing, tax-break-receiving institution unworthy of his, or, per his plea, his Facebook friends' business. Another understands that the CEO of the world's largest employer has to possess unique abilities, $23.2 million is, however, over the top.

$23.2 million is, undeniably, a very large compensation package. It is, in fact, 1,034 times the pay of the average Wal-Mart employee. Surely, such a number comes at great expense to Wal-Mart's staff. And, besides, who on earth needs that kind of money? I mean, there's got to be some law against such waste, particularly when it occurs at the expense of hardworking folks. Just imagine how much better off Walmart's employees would be if its board would cut its CEO's salary to, say, a million a year (of course that would deny its access to the pool of Mike Dukes and Doug McMillans [their new CEO] of the world). That would leave $22.2 million a year to be divvied up among Wal-Mart's $2.2 million employees. And since equality is what we're after, we should divvy it up, not by merit, but in equal shares. My, how better off all those hardworking folks would be with that extra $10 PER YEAR to spend. Which begs the question, is adding a mere $10 per year to each employee's paycheck worth the risk inherent in so limiting Wal-Mart's options? I don't think so.

Now, don't get me wrong: I honestly sympathize with the gentleman who complains about Wal-Mart's gifts from government (not so much with the other's "over the top" complaint). Wal-Mart is indeed run by profit-seeking---at all costs---capitalists. I wrote, just last year, with disgust, about Wal-Mart's dealings in Mexico, as well as its dealing to Senator Richard Durbin. But, you see, the issues that disgust you and me are anything but issues involving capitalism, they involve pure cronyism. Which---as this must-watch video from illustrates---is forever facilitated by government.

This Week's TV Segment (video)

This week Zara and I discussed why, in my view, recent economic indicators, along with a budget deal, should be a green light for the Fed to begin tapering QE as early as next week. Click here to view...

Thursday, December 12, 2013

The Wealth Effect Conundrum...

Alan Greenspan is a believer in the wealth effect: The idea that when the value of one's assets grows, one feels confident and becomes a more active economic agent. Thus, if a given growth rate is to be achieved, asset inflation is a worthy objective.

Today's Fed's wealth effect enthusiasts---who, we may assume, constitute a voting majority---take responsibility (assuming Bernanke was speaking for his team a couple of years ago) for the bull market in stocks. I disagree. While I can't deny that monetary policy has all but eliminated the stock market's competition, were it not for the post-recession thrift of corporate America---leading to record profits in a tough environment---the Fed could've QE'd till the cows came home and we would not be seeing the major averages at these record highs.

Ben Bernanke, as I suggested, pointed to the stock market's gains as evidence of the efficacy of modern Fed policy, and therein lies his problem. Since, in the Fed's view, the wealth effect influences economic action---and that their own actions built this bull market---they have to be one nervous bunch right about now. With the market at an all-time high, and the pace of recovery at an all-time low, how on earth can they cut QE? In their minds an ill-timed taper would pull the rug right out from under the market, and, therefore, the recovery as well. 

But here's the thing, they're (I believe) wrong: they can absolutely cut QE---to the, alas, limited extend their stomachs will allow (they could have a long time ago)--without destroying the stock market and, with it, the economy. Sure, stocks (and bonds) may take a hit---yet, at the end of the day, QE infinity, as the critics call it, is not an option. The FOMC's members, as Keynesian as they may be, have to know that the greater the QE the greater the risk that bubbles will form, then pop.

There was a time, I'm sure, when they all aspired to the status of Alan Greenspan. Those days, however, are over (the Greenspan Fed's policies are widely believed to have been a major contributor to the "Great Recession"). And while they may outwardly agree with the basis of his denial (watch this Greenspan/Taylor debate), inwardly they have to know that the real estate and credit bubbles could not have formed (to the extent they did) without Greenspan's ultra easy monetary policy.

My, therefore, what a sticky wicket they've gotten themselves into. On the one hand, they're at the mercy of their belief in the wealth effect, and the asset inflationary (wealth) effect of QE. On the other, history is telling them that they must back off before their own policy destroys any semblance of a respectable legacy.

Wise long-term investors, unconcerned with short-term volatility, should wish for taper round one to begin next week. However, alas, I wouldn't hold my breath...  

Market Commentary (audio)

Click the play button below (then wait a second) for today's commentary:

(note: if you're having trouble playing this audio on your device [as a couple of subscribers have reported], send me an email and forward you the audio file)...

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Wednesday, December 11, 2013

Market Commentary (audio)

Click the play button (you may wait a few seconds) for today's commentary:

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Tuesday, December 10, 2013

A golden opportunity for the Fed...

As I've shared, I agree with the consensus view that good news remains bad news because good news means the tapering of QE may emerge sooner than later. I.e., traders are, or were, ignoring the improved corporate profit implications of a growing economy and focusing on the potentially adverse effects of rising interest rates.

Then came last Friday's jobs number, 203,000, which was 18,000 better than the consensus estimate, and the Dow rallied 200 points. Some pundits were claiming that Friday's rally marked a change of attitude, that, at last, good news is good news. As I suggested yesterday, I remain skeptical, largely based on the fact that Wall Street was handicapping a 230 to 240k (the whisper number) jobs number. Anything under that would keep the Fed on hold, or so traders were thinking.

Another development Friday was the rumor (now confirmed) that the house and senate budget committees were very close to a deal: One that would essentially avert the pending January standoff. Now that would be the kind of good news Wall Street would welcome. In fact, stock index futures rallied this afternoon on reports that it might very well be a passable deal. However, as I type, futures have retreated to about the flatline.

Now here's the thing, I'm thinking that a passable budget deal, along with recently improved economic data, opens the door for the Fed to do a little QE tapering as early as next week. I don't know that they will, but if they don't I think they'd be passing on a golden opportunity to at least get started on doing what is entirely necessary. In essence, I'm thinking that a small cut in QE, at this juncture, may not completely derail the stock or bond markets (not that a correction here would be at all a bad thing), which is, in my opinion, what's been keeping the Fed on the fence.

Frankly, I wish they'd go big, let the markets adjust as necessary (would be short-term ugly) and meander their way into next year without the dreaded taper looming overhead. But, alas, that for sure ain't happening...

Monday, December 9, 2013

Finally, good news is good news! Well, not so fast...

After last Friday's 200 point Dow rally following a 200k+ jobs number, is it safe to say that the market is finally beginning to make a little sense? I.e., is good news good news?

Well, it depends on the news. The problem with Friday's action is that---if financial markets indeed traded on a good jobs number---we should have seen bonds sell off in a big way. Why? Because good news spells less QE and, consequently, higher long-term interest rates/lower bond prices.

Save for a brief spike in yields (that quickly settled back) Friday clearly did not produce a good-news style reaction in the bond market. Could be---as I read somewhere---that the whisper jobs number (what Wall Street really thought) was much higher than the reported number. In which case Friday's number was not a good number.

While I suspect we'll ultimately get there, in my view, we're not yet in a good news is good news environment. Except (like I said, depends on the news), that is, when we're talking about "good" news (or at least what short-term bulls would consider good news) out of Washington. The respective house and senate budget chairpersons, Paul Ryan and Patty Murray, are reportedly close to a deal (don't hold your breath just yet---although it could happen) that would fund Washington for another year. Thus, sidestepping the political circus scheduled to begin in January. This was in the rumor mill last Friday.

So then, some good news is bad news and some "good" news is good news. The lesson being, never trade the news.

Saturday, December 7, 2013

Skinny fries, the new normal...

According to economist Ed Lazear, it takes 120,000 new jobs each month to keep pace with U.S. population growth. At 200,000---an 80,000 surplus---we'll be back to "normal conditions" in 7 years. Ugh!

So, what do "we" do about it?

Before I respond to my own question, let me tell you about Ashley, my now 18 year-old, college freshman, eager to acquire new skills, daughter. Her first official job---one where she received a paycheck with all the requisite withholdings (delivering that first paycheck shock)---was with a small mom-n-pop burger joint, we'll call it Mom-n-Pop's Burger Joint, Mom-n-Pop's for short. Her hourly pay was the California (a state where restaurants do not enjoy a lower mandated wage) minimum wage of $8. As you may know, Mom-n-Pop's owners, we'll call them Mom and Pop, are about to see an increase in their cost of labor---California's minimum wage is rising to $10/hour between now and January 1, 2016. I've done a little figuring as to what the hit to overhead would amount to (all things [number of employees] remaining) when the full increase takes effect: Based on what I'm guessing to be Mom-n-Pop's number of minimum wage-earners on site during its hours of operation, I estimate (conservatively) that Mom and Pop are going to have to generate another $2,200 per month to maintain present profitability. Which happens to be the equivalent of the monthly pay of about 3---20 hour/week---Ashleys.

I listened to a bright young analyst engaged in a minimum wage debate last Wednesday (the day a noteworthy number of fast food workers publicly demanded $15/hour) on CNBC. He voiced his frustration with the whole argument: In condescending fashion, he chastised the likes of yours truly for reverting to Econ 101 (never took it, by the way) textbooks to justify our concerns for the pernicious effects of raising the minimum wage. He says that the studies are, in fact, mixed (some say it helps employment, some say it hurts). That there's essentially no strong evidence that raising the minimum wage hurts or helps the overall employment picture. I say hmm?

All those studies notwithstanding, I find the mere notion that raising the minimum wage would help overall employment to be entirely implausible. I mean, how can raising the price of something, even especially low-skilled labor, not ultimately reduce the demand for that something? That's, forgive me, basic economics, isn't it?

Oh, I do understand the argument---it goes like this: Raising the minimum wage will put more money in the pockets of workers. Workers, having a higher marginal propensity to consume (they spend a greater portion of their income) than do employers, will circulate that money throughout the economy, increase business and, therefore, increase the demand for labor. Mom-n-Pop's will experience a pick up in burger sales (it'll have to be several hundred sandwiches a month just to break even btw) that will not only cover its overhead, it'll be so great that Mom and Pop will need to hire additional workers to meet all that new demand. Plausible? Well, no! Not even remotely. For one, Mom and Pop, and the vast majority of other employers of low-skilled workers, won't buy that argument for a second. They'll adjust immediately just to stay in business: which means fewer Ashleys with jobs and, therefore, no net increase in income for that population of spenders with which to buy burgers.

Maybe next time we'll delve into additional measures Mom and Pop might deploy (say they determine that they can't cut 3 Ashleys and serve their customers), such as changing the thermostat's setting (making conditions less comfortable for those higher-earning employees---not to mention the customers who we'll assume will be willing to bear a less hospitable environment), raising prices, opting for lower-quality beef, serving fewer, and skinnier, french fries, changing the oil in the fryer less often, charging employees full price to eat their own cooking during their lunch break, making them purchase their own uniforms, etc, etc, etc.

So back to my question, what to do about our unusually slow rate of job creation? Well, I have a few ideas, each of which involves reducing government's reach into the private sector. For today, however, let's keep it simple and just go with what not to do, which would be to engage in any act that would make matters worse, such as raising the minimum wage...

Friday, December 6, 2013

This Week's TV Segment (video)

This week Zara and I discussed the market's seeming obsession with the Fed, and how the monster 2008 bear market is the best thing going for the present bull market: Click here to view...

Thursday, December 5, 2013

No pain, no gain...

Here's paragraph one from a CNBC market update this morning:
U.S. stocks opened lower on Thursday after data had the economy growing more rapidly than expected, adding to thoughts that the Federal Reserve would begin to reduce stimulus sooner than speculated.

Here's a snippet from this afternoon's CNBC article titled Good news or bad? Street expecting strong jobs report: 
November's employment report could be good news for the economy but bad news for stocks.

Economists expect to see about 180,000 jobs added in November, off from October's 204,000 level, and the unemployment rate a 10th lower at 7.2 percent.

Traders, however, are discussing higher whisper numbers well above 200,000, and that has been weighing on stocks and sending bond yields higher on speculation a strong number would speed up the timetable on the Fed's wind-down of its quantitative easing program.

Let's see now, when the economy picks up, corporate earnings pick up, jobs materialize and stocks rise---or at least that's what commonsense would dictate. But here we are, seeing, at last, a number of back-to-back economic indicators (nuances notwithstanding) suggesting that the economy may be finally getting its feet under itself, yet the headlines tell us that that's bad news for the stock market. What gives?

Well, as the article states, it appears as though stocks have sold off (a wee bit) on speculation that the Fed---in light of the economic data---might taper QE sooner than later. Bad news? Well, yeah, but only to the extent that traders (who I distinguish from investors) anticipate that other traders will sell on the news. I've stressed here recently that, in my view, the dreaded QE taper won't be so dreadful for the simple fact that it remains so dreaded. I'll say it again, history suggests that it won't be the punch the market sees coming that'll put it down for the count. More likely that the QE taper, if anything, wobbles its legs a bit. But we'll see---and, please, don't trade on that opinion. In fact, don't trade at all, invest for the long-term.

Speaking of the long-term, yes, a good economy is good for the market. Never forget, however, that whether it's too-tight (or too-loose) Fed policy or some other excuse, gleaned only in hindsight, some event---or, more likely, some flurry of (unforeseen) events---will indeed bring this bull market to its knees. And that is perfectly okay, for it is utterly impossible to achieve long-term investment gains without enduring the occasional pain.

Lastly, if the prospects for the inevitable makes you the least bit anxious, please read again No Do-Overs in Life, or Investing.

Wednesday, December 4, 2013

Market Commentary (audio)

Click the play button below for today's commentary:

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Tuesday, December 3, 2013

Market Commentary (audio)

Click the play button for today's commentary:

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Monday, December 2, 2013

Bummer for the hardworking standout and the would've been new hire...

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups. Henry Hazlitt

So what do you call an economist who claims to have looked at the longer and indirect consequences of a proposed course, but who---based on his assertions---clearly has not? An economist who claims to inquire into what the effect of a given policy will be on all groups, but discards all studies that conflict with his bias? I could come up with a choice adjective or two, however, so as to not stoop to the level of my subject, I'll keep them to myself.

Here's a snippet from Paul Krugman's column featured in this morning's NY Times:
When it comes to the minimum wage, however, we have a number of cases in which a state raised its own minimum wage while a neighboring state did not. If there were anything to the notion that minimum wage increases have big negative effects on employment, that result should show up in state-to-state comparisons. It doesn’t.

Oh it does! As good economist Don Boudreaux---pointing to a 2013 study---exposes in his response (a letter to the NY Times) to Krugman's glaring omissions. Here's a snippet:
He asserts, for example, that “If there were anything to the notion that minimum wage increases have big negative effects on employment, that result should show up in state-to-state comparisons. It doesn’t.”

Yet it does – at least in many studies that Mr. Krugman would have your readers believe do not exist. The most well known of these state-by-state comparison studies that find negative consequences of minimum-wage legislation are by economists David Neumark and William Wascher.*

I have a client who owns a California-based business employing approximately 150 workers at the $8/hour minimum wage. Recently passed legislation (minimum wage in California goes to $9 July 1st of next year and $10 in 2016) adds labor costs (assuming they're all full-time) to the tune of $150,000 for 2014, double that in 2015, then double that in 2016. Ultimately, it's $600,000 per year (not accounting for the increased payroll taxes [Hmm? Ever think about that incentive to legislators?]) that my client is trying to figure out how, what and whom to cut to make it work. Bummer for the hardworking standout striving to ascend beyond the (even the $10) minimum wage ranks---assuming, that is, he keeps his job (or all of his hours). Bummer as well for the would've been new hire.

Seriously, you shouldn't have to know a soul who employes low-skilled individuals, or be an employer of low-skilled individuals yourself---or, goodness, have been awarded a Nobel prize---to understand that a hike in the minimum wage stands to do real harm to the very group its politically-motivated proponents pretend to concern themselves with.

No do-overs in life, or investing...

I can't tell you how many times I've told a client, or a live or television audience over the years that virtually every investment mistake that I have personally observed has been the result of a pure act of emotion (there's an essay in my 2007 book titled "Never Trust Your Instincts When it Comes to Investing"). That would be greed (or the emotions that lead to greed), as in abandoning one's allocation target and/or overweighting a given stock, commodity or sector during a bull market. Or fear, as in abandoning one's allocation target and---rather than buying asset classes on the cheap (the refusal of which is bad enough by itself)---panic-selling and tucking everything away in a money market account.

I don't know how I missed this one back in 2005 (HT Charles Wheelan); when a team of researchers from Carnegie Mellon University, the Stanford Graduate School of Business and the University of Iowa, published a study finding that folks who have suffered brain damage resulting in impaired emotional capacity, but with their logic and cognitive reasoning intact, are better investors than folks with fully functioning brains. The authors of the study believe that the emotionally-impaired investors experienced better results due to their lack of experiencing fear or anxiety. They took more risks when it made sense and suffered no emotional scarring when experiencing losses.

Here's a snippet from the linked WSJ article:
Some neuroscientists believe good investors may be exceptionally skilled at suppressing emotional reactions. "It's possible that people who are high-risk takers or good investors may have what you call a functional psychopathy," says Antoine Bechara, an associate professor of neurology at the University of Iowa, and a co-author of the study. "They don't react emotionally to things. Good investors can learn to control their emotions in certain ways to become like those people."

As bias-confirming for me as that study was, there'll be no outright fist-pounding on my part over a study comprised of only 41 subjects. That said, and I reiterate, my anecdotal findings---over 29 years of first-hand experience with better than a thousand investors---is that folks who stick to a disciplined asset allocation strategy, through the ups and downs of every business cycle, see vastly better results than those who let their emotions dictate their investment decisions.

Look at it this way: How many times has someone pushed your button, you emotionally react, and later---after your blood stops boiling---you find yourself wishing do-overs were possible? You know that had you thought before acting, you (and the object of your aggression) would have had a much healthier, far less destructive, experience. That's what can happen when you catch some Dr. Doom (there are several pundits who wear that moniker) on CNBC telling the world that stocks are on the precipice of a bear market that'll make cake out of 2008; I've received anxious phone calls from clients---asking for an emergency exit strategy session---on such occasions. Or when some Dr. Sunshine tells the world that stocks are about to embark upon an advance that'll make chopped liver out of the 90s; I've received anxious phone calls from clients---asking whether we should abandon their cash (or bond, CD, etc.) position and go all in---on such occasions. In both instances the investors' emotional buttons had been pushed, and, consequently, they had lost complete sight of the fact that no mere mortal, or algorithm, can know the market's near-term direction. It's the instances where they followed through on their emotional impulses and, thus, abandoned their disciplines, that the damage was done. Not, mind you, that the market didn't sometimes collapse, or advance, as guessed (which, on occasion, had brought other clients' emotions to the brink); the damage was nonetheless done even in those instances---it's just that the realization was delayed until the inevitable next emotionally-inspired investment decision was executed.

Keep this in mind as the market meanders its way into 2014...

Friday, November 29, 2013

Crecencio Part 2

Got to thinking more about that Wal-Mart story: Here's a snippet from the IBT article:
Incidentally, it would take the average worker around 750 years to earn the $23.2 million that CEO Mike Duke earned in 2012, approximately 1,034 times more than the company’s average worker.

I suspect that Crecencio suspects that our household income is higher by some multiple than his. And I suspect his employees suspect that his is some multiple higher than theirs'. I don't suspect, however, that Crecencio nor his workers resent the signers of their paychecks good fortune. Of course the multiple in either instance comes nowhere near 1,034 times. Then again, neither Crecencio nor myself possess the skills to manage the largest distributor of low-cost consumer goods (and, btw, the largest single employer) on the planet. That job is reserved for the rarest and, therefore, the highest paid talent.

Speaking of high-paid talent, according to Forbes, Steve Jobs's average yearly income from 2002 to 2007 was $130 million. That would be 3,250 times the average pay of today's Apple Store genius---and, by the way, many many times more than yours truly's. Which doesn't bother me in the least, as I type this on my iPhone while waiting in the car for my wife while she patronizes Bed Bath and Beyond---a retailer (not nearly the largest on the planet mind you) that paid its CEO, a rare talent for sure, $5.5 million more than Wal-Mart paid its last year.

Crecnecio is working today...

Last night my wife and I drove past our local Wal-Mart store; its huge parking lot was packed. We didn't happen to notice (we were a ways away) any picketers. If there were any, it was nothing like the scene pictured in this International Business Times article. "I want to work full time", "Wal-Mart Always Low Wages", "Stop Cutting Hours" and "Stand Up Live Better" were the slogans I could make out in the picture.

The din of the leaf blower outside our front door poses a little distraction as I effort to articulate this morning's message---our yard guy is working today. I haven't bothered to calculate what we pay Crecencio by the hour, but apparently it's as much or more than he would receive by bumping us for another customer. Surely, if he is underpaid he would approach me, make his demand and, depending on my response, either keep me on or move on to the opportunity that signaled him that there's more to be made elsewhere. The last thing in the world Crecencio would do---regardless of his estimation of our annual income---is publicly protest the Mazorra family's stinginess.

The fact that some of Wal-Mart's employees are choosing to demonstrate tells you that Wal-Mart pays a very competitive wage for low-skilled work. The folks dawning the aforementioned slogans are receiving the best the marketplace has to offer for their skill-set (otherwise they'd be working elsewhere). If they're to improve their lot, they'll produce stand-out work---and thus work their way up Wal-Mart's ladder---or devote their time off to learning the skills that would one day garner them better wages with another employer. Publicly complaining---in a personal plea or at the behest of a union---is clearly not a productive use of their spare time.

Thursday, November 28, 2013

Give thanks for what you hold most dear, and the conveniences that make it easy....

"Forever on Thanksgiving Day
The heart will find the pathway home."
Wilbur D. Nesbit

The poet indeed captured the essence of this day. It's all about home and celebrating the love of family---Thanksgiving Day is beautifully simple.

Beautifully simple, that is, until we stop and consider the miracle of the marketplace. The system that somehow delivers the basic amenities we so readily take for granted---the conveniences that allow us to relax and celebrate the things we hold most dear.

Take, for example, the turkey; how does that happen? Where the heck do all those birds come from? There has to be millions of them brought to market. That's right, and the operative word there is "market"---the place where people exploit their property rights and pursue their own objectives. Thank goodness they do!

A virtually uncountable number of profit-pursuing folks, most remaining strangers to one another, organized to bring you today's main course: From the land owner to the fertilizer producer to the farm equipment maker to the fuel provider to the feed farmer to the turkey farmer to the turkey processor to the freezer manufacturer to the truck manufacturer to the trucking company to the grocery store (and, yes, I skipped myriad relationships in between). And of course all the workers who freely bargain the terms of their production, their labor, with the individuals who, while focusing merely on their respective specialties, miraculously got that butterball rolling. Not to mention the cranberries, the cranberry sauce, the potatoes, the gravy, every ingredient in the stuffing, the pies, the pie pans, the plates, the utensils, your kitchen appliances, your fuzzy slippers, the thread that holds your fuzzy slippers together, the thin rubber soles of your fuzzy slippers, the etc, etc, etc, etc, ad infinitum... As Adam Smith put it:

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."


This is the world we live in: 

Wednesday, November 27, 2013

A 0% return can be a beautiful thing...

Those who track mutual fund investment flows tell us that, based on flows out of bond funds and into stock funds, the individual investor is beginning to join the party---although just barely beginning. In terms of market implications, the "just barely" part is music to the bulls' ears. There's this widely-held view---one I sympathize with---that heavy retail (individual investor) participation is a classic warning sign that the party's nearing its end. But, honestly, that's not what troubles me most about individuals reallocating their long-term money. What troubles me is the switching from fixed income assets to equities, when it's done for reasons other than periodic rebalancing.

I've maintained, for an embarrassingly (in that I've been wrong till recently) long time, that bonds are no place to be when interest rates are at record lows. One of the few things we know for sure about markets is that when interest rates rise bond prices fall (we just don't know how long interest rates will stay low [or how long the Fed can successfully keep them low]). Hence, my concern for the individual investor who tracks the track records displayed on his quarterly 401(k) statement. When the government bond fund that served him so well after the drubbing he endured in 2008 delivers a negative 4% year-to-date return, and the U.S. equity fund posts a 25% gain, he can't help but wonder if a change is in order.

While I entirely understand how the individual investor with a day job can come to that wonder, I'm less understanding of investment advisors, Princeton professors and best-selling authors who suffer the same temptations. In a recent CNBC interview, Burt Malkiel (he's all three rolled into one) offers an alternative allocation for those who've stuck with the traditional 60% stocks/40% bonds mix to this point. While he and I are on the same page when it comes to bonds, we go to entirely different places when it comes to what to do instead. He recommends the following: 

55.0% Stocks
27.5% Dividend growth stocks, emerging market bonds and tax-exempt bonds
12.5% Real Estate Investment Trusts (REITs)
05.0% Cash

That, in my view, is in no way a reasonable alternative for investors who wish to maintain a moderate risk profile. It's like taking what was a traditional bond allocation (the 40%) from the frying pan and throwing it into the proverbial fire.

Here's how those "bond substitutes" performed (according to Morningstar) during a recent period of rising interest rates (5/22/13 - 6/30/13):

Dividend stocks (S&P 500 Dividend TR Index): -12%
Emerging market bonds (BofA ML Glbl Emerg Mkt Credit Index): -4%
Tax-exempt bonds (S&P Muni Yield TR): -5%
REITs (MSCI U.S. REIT PR Index): -12%

And here's how the remaining two asset classes performed during the same period:

Stocks (S&P 500 TR Index): -4%
Cash: 0%

Ironically, during that brief period, three of the four asset classes replacing the conservative allocation declined further than the not-conservative allocation.

As you can plainly see, trading bonds for other interest rate sensitive asset classes in no way mitigates potential risk. In fact, when you consider the economic (and business) risks inherent in stocks, real estate and emerging markets, it exacerbates it.

Here's my suggestion:

60% Stocks (diversified globally and across sectors)
40% Simple, safe, CASH

Rest assured, there will come a day when bonds once again make perfect sense. In the meantime, a zero rate of return (on the "safe" part of your portfolio) is a beautiful thing.

Today's TV Segment (video)

This morning's conversation with Zara was purposely short on market outlook and long on practical advice to the individual investor. Click here to view...

Bring us your huddled masses, and their dollars...

Does it bug you (as it does a lot of Americans) that Americans buy substantially more stuff from the Chinese than the Chinese buy from Americans? And how does that happen? If we spend, say, $40 billion in a month on China-made stuff, and they only spend $10 billion on U.S.-made stuff, what are they doing with their leftover $30 billion? Well, as you may know, they buy lots of U.S. treasury bonds, but that's not all---they also invest in U.S. assets. Back in June, I wrote about the good fortune that trade with China brought to the owners of a hog farm in Virginia. Here's that brief essay:
Worried about the dollar? Worried about jobs? Worried about national security? Well then, you should feel very very good about a Chinese company buying Smithfield foods. Counterintuitive? Perhaps for some, but I’m hoping not so for my regular readers.

Here’s a little refresher course:

The dollar: China goes to great lengths to compete for our business—making us wealthier in the process (we enjoy more of life’s amenities as the world competes on price for our business)—because they love U.S. dollars. They love U.S. dollars because we apparently yet produce goods (like hogs) and services they deem valuable. The Smithfield Foods acquisition proves it. Thank goodness we have more than just federal debt to offer the world.

Jobs: Trust me, Chinese management and workers are not about to descend upon tiny Smithfield, Virginia. Shaunghui bought Smithfield Foods to exploit, and export (or import), its business model (along with its hogs). But we’re not talking merely the preservation of Smithfield jobs, we’re talking $4.7 billion U.S. dollars (a few of them you sent to China to buy the monitor, tablet, or cell phone you’re staring at right now*) flowing back to the U.S. You think Smithfield’s largest shareholders might be looking to grow other successful enterprises with their proceeds — creating jobs in the process? Yyyyep!

(So the next time you cringe before buying an item made in China, remember all those U.S. jobs you helped create when Shaunghui bought Smithfield Foods.)

Worried about national security? This one’s the easiest: Nobody ever shoots their customer (or supplier). Or, as an intuitive individual (most often ascribed to Frederic Bastiat) once said:

“If goods don’t cross borders, soldiers will.”

Today's post was inspired by This CNBC video on the benefits of trade bestowed onto California home-sellers. 

Here's economist Scott Sumner on the same thing going on in Australia:
Chinese are snapping up a lot of properties in Sydney. Aussie labor is employed building houses. The houses are traded for Chinese goods. The only special feature is that the houses don't physically leave Australia. Chalk up one more reason why current account deficits are an utterly meaningless number.

Monday, November 25, 2013

Have a Healthy Thanksgiving...

Dang! I'm running out of market stuff to write about. I've already told you that valuations, while no longer cheap in my view, look okay (some sectors more okay than others). That there's enough bearishness out there to probably support the market's upward momentum (at least for the moment). That the notion that a knockout punch will ultimately come from the Fed tapering QE has become too anticipated to come true: As S&P's Sam Stovall puts it "A boxer is rarely felled by the punch he expects." So I guess today's message is simply about you relaxing and enjoying the season. The market looks to bring you holiday cheer and a happy ringing in of the new year.

Relieved? Since you were thinking the Dow's been floating in some pretty thin air up there at 16,000. That the walls of that balloon have---sooner or later---got to give way to the pressure at that altitude. And of course the last thing you want to see is a big market correction hitting your monthly statement this time of year. You like the market calm. Is that a fair assessment?

Well, shoot, if you can indeed relate to the above you're either not reading, or not believing, my stuff. You see, my friend, there is no such thing as a calm market. In fact I would argue that when the action is light, the uncertainty is palpable. If the players all believed that the market will ride the currents higher into 2014---with little turbulence---believe me, the Dow wouldn't have risen 7.77 points today, it'd be up 777. Conversely, if the players were certain there's a coming shoe to drop that would drop the bottom out of the market, well, the bottom would be dropping as I type. Clearly, at this juncture, there is little conviction one way or the other.

But that's not at all my concern. My concern is that you can relate to paragraph two. That maybe your holiday season could be less cheerful amid a falling stock market. That while you probably get, intellectually, that corrections---and bear markets---are essential to the long-term success of your portfolio, it's a different story emotionally. But that (your emotional ties to the market) is simply not healthy, at so many levels. Seriously, we in no way want the market rising in perpetuity. Why? Because that is pure fantasy. All things are cyclical: Imagine the Earth without rain---that would be the market without corrections. And, more importantly, the chemicals released by negative emotions don't mix well with cranberry sauce and turkey gravy in the tummy.

So, please, forget about the market---and go have yourself a happy and emotionally-healthy Thanksgiving!