Photo Credit: amanda tipton || It may not be foreign, and not an ETF, but it IS a small cap


This should be a short post.  When I like a foreign market because it seems cheap (blood running in the streets), I sometimes buy a small cap ETF or closed-end fund rather than the cheaper large cap version.  Why?

  • They diversify a US-centric portfolio better.  There are several reasons for that:
  • a) the large companies of many countries are often concentrated in the industries that the nation specializes in, and are not diversified of themselves
  • b) the large companies are typically exporters, and the smaller companies are typically not exporters. Another way to look at it is that you are getting exposure to the local economy with the small caps, versus the global economy for the large caps.
  • They are often cheaper than the large caps.
  • Institutional interest in the small caps is smaller.
  • They have more room to grow.
  • Less government meddling risk.  Typically not regarded as national treasures.

Now, the disadvantages are they are typically less liquid, and carry higher fees than the large cap funds.  There is an additional countervailing advantage that I think is overlooked in the quest for lower fees: portfolio composition is important.  If an ETF does the job better than another ETF, you should be willing to pay more for it.

At present I have two of these in my portfolios for clients: one for Russia and one for Brazil.  Overall portfolio composition is around 40% foreign stocks 40% US stocks, 15% ultrashort bonds, and 5% cash.  The US market is high, and I am leaning against that in countries where valuations are lower, and growth prospects are on average better.

Full disclosure: long BRF and RSXJ, together comprising about 4-5% of the weight of the portfolios for me and my broad equity clients.  (Our portfolios all have the same composition.)

The future return keeps getting lower, as the market goes higher


Jeff Bezos has a saying, “Your margin is my opportunity.”  He has found ways to eat the businesses of others by providing the same goods and services at a lower cost.  Now, that makes Amazon more productive and others less productive.  The same is true of other internet-related businesses like Google, Netflix, etc.

And, there is a slight net benefit to the economy from the creative destruction.  Old capital gets recycled.  Malls that are no longer so useful serve lower-margin businesses for locals, become homes to mega-churches, other area-intensive human gatherings, or get destroyed, and the valuable land so near many people gets put to alternative uses that are better than the mall, but not as profitable as the mall prior to the internet.

Laborers get released to other work as well.  They may get paid less than they did previously, but the system as a whole is more productive, profits rise, even as wages don’t rise so much.  A decent part of that goes to the pensions of oldsters — after all, who owns most of the stock?  Indirectly, pension plans and accounts own most of it.  As I have sometimes joked, when there are layoffs because institutional investors representing pension plans  are forcing companies to merge, or become more efficient in other ways, it is that the parents are laying off their children, because there are cheaper helpers that do just as well, and the added profits will aid their deservedly lush retirement, with little inheritance for their children.

It is a joke, though seriously intended.  Why I am mentioning it now, is that a hidden assumption of my S&P 500 estimation model is that the return on assets in the economy as a whole is assumed to be constant.  Some will say, “That can’t be true.  Look at all of the new productive businesses that have been created! The return on assets must be increasing.”  For every bit of improvement in the new businesses, some of the old businesses are destroyed.  There is some net gain, but the amount of gain is not that large in aggregate, and these changes have been happening for a long time.  Technological progress creates and destroys.

As such, I don’t think we are in a “New Era.”  Or maybe we are always in a “New Era.”  Either way, the assumption of a constant return on assets over time doesn’t strike me as wrong, though it might seem that way for a decade or two, low or high.

As it is today, the S&P 500 is priced to deliver returns of 3.24%/year not adjusted for inflation over the next ten years.  At 12/31/2017, that figure was 3.48%, as in the graph above.

We are at the 95th percentile of valuations.  Can we go higher?  Yes.  Is it likely?  Yes, but it is not likely to stick.  Someday the S&P 500 will go below 2000.  I don’t know when, but it will.  There are enough imbalances in the world — too many liabilities relative to productivity, that crises will come.  Debt creates its own crises, because people rely on those payments in the short-run, unlike stocks.

There are many saying that “there is no alternative” to owning stocks in this environment — the TINA argument.  I think that they are wrong.  What if I told you that the best you can hope for from stocks over the next 10 years is 4.07%/year, not adjusted for inflation?  Does 1.24%/year over the 10-year Treasury note really give you compensation for the additional risk?  I think not, therefore bonds, low as they may be, are an alternative.

The top line there is a 4.07%/year return, not adjusted for inflation

If you are happy holding onto stocks, knowing that the best scenario from past history would be slightly over 3400 on the S&P 500 in 2028, then why not buy a bond index fund like AGG or LQD that could virtually guarantee something near that outcome?

Is there risk of deflation?  Yes there is.  Indebted economies are very susceptible to deflation risk, because wealthy people with political influence will always prefer an economy that muddles, to higher taxes on them, inflation, or worst of all an internal default.

That is why I am saying don’t assume that the market will go a lot higher.  Indeed, we could hit levels over 4000 on the S&P if we go as nuts as we did in 1999-2000.  But the supposedly impotent Fed of that era raised short-term rates enough to crater the market.  They are in the process of doing that now.  If they follow their “dot plot” to mid-2019 the yield curve will invert.  Something will blow up, the market will retreat, and the next loosening cycle will start, complete with more QE.

Thus I am here to tell you, there is an alternative to stocks.  At present, a broad market index portfolio of bonds will likely outperform the stock market over the next ten years, and with lower risk.  Are you ready to make the switch, or at least, raise your percentage of safe assets?

Photo Credit: Boston Public Library

Well, I never thought I would get this question, but here it is:

Thank you for your dedication to your blog.

I was wondering if you have any skill development advice for recent graduates to gain a job in insurance – is technical or programming skills the most important or perhaps making business cases, or showing that you can make sound and reasonable conclusions?

Thank you for your time.

Kind regards,

There are many things to do in insurance.  Some are technical, like being an actuary, accountant, investment analyst/manager/trader, underwriter, lawyer or computer programmer.  Some take a great deal of interpersonal skills, like being an administrator, marketer or agent.  Then there are the drones in customer service and claims.  Ancillary jobs can include secretaries, janitors, human resources, and a variety of other helpers to the main positions.

Before I begin, I want to say a few things.  FIrst, if you work in insurance, be kind to the drones and helpers.  It is the right thing to do, but beyond that, they don’t have to go beyond their job description — they know their opportunities are limited — it is only a job.  Treat them with respect and kindness, and they will go above and beyond for you.  I learned this positively first-hand, and a few of them 20-30 years older explained it to me when I noticed they weren’t helping others who were full of themselves.

Second, the insurance industry does a lot to train drones, helpers, agents, marketers, underwriters, and younger people generally, if they are willing to work at it.  There are self-study courses and exams that vary based on what part of the industry you are in.  Take the courses and exams, and your value goes up — it is not obvious how that will work, but it often pays off.

Third, it is not a growing industry, but lots of Baby Boomers are retiring, and leave openings for others.  Also, drone and helper positions often don’t pay so well at the entry level, and turnover is somewhat high.  The same is true of agents — more on that later.

Fourth, watch “The Billion Dollar Bubble,” and episodes of Banacek if you want.  The actual practices of how they did things in the ’60s and ’70s don’t matter so much, but it gets the characterization of the various occupations in insurance right.

FIfth, insurance is a little like the “Six Blind Men and the Elephant.”  Actuaries, Accountants, Administrators, Marketers, Underwriters, and Investment Managers (and Lawyers and Programmers) each have a few bits of the puzzle — the challenge is to work together effectively.  It is easier said than done.  You can read my articles on my work life to get a good idea of how that was.  I’ve written over 30 articles on the topic.  Here are most of the links:

DId I leave out the one on insurance company lawyers?  Guess not.

Sixth, it is easier to teach those with technical skills how the business works than to teach drones and helpers technical skills.  It’s kind of like how you can’t easily teach math and science to humanities and social science majors, but you can do the reverse (with higher probability).  It is worth explaining the business to computer programmers.  It is worth explaining marketing and sales to actuaries.  Accountants get better when they understand what is going on behind the line items, and maybe a touch of what the actuaries are doing (and vice-versa).

Seventh, only a few of the areas are close to global — the administrators, the underwriters, the actuaries, and the marketers — and that’s where the fights can occur, or, the most profitable collaborations can occur.

Eighth, insurance companies vary in terms of how aggressive they are, and the dynamism of positions and ethical conundrums vary in direct proportion.

So, back to your question, and I will go by job category:

  1. Drones and helpers typically don’t need a college education, but if they show initiative, they can grow into a limited number of greater positions.
  2. Computer programmers probably need a college degree, but if you are clever, and work at another insurance job first, you might be able to wedge your way in.  While I was an actuary, I turned down a programming job, despite no formal training in programming.
  3. Lawyers go through the standard academic legal training, pass the bar exams, nothing that unusual about that, but finding one that truly understands insurance law well is tough.
  4. Accountants are similar.  Academic training, pass the accounting exams, work for a major accounting firm and become a CPA — but then you have to learn the idiosyncrasies of insurance accounting, which blends uncertainty and discounting with interest.  The actuaries take care of a lot of it, but capturing and categorizing the right data is a challenge.
  5. Actuaries have to be good with math to a high degree, a college degree is almost required, and have to understand in a broad way all of the other disciplines.  The credentialing is tough, and may take 5-10 years, with many exams, but you often get study time at work.
  6. Agents — can you sell?  Can you do a high quality sale that actually meets the needs of the client?  That may not require college, but it does require significant intelligence in understanding people, and understanding your product.  Many agents can fob some bad policies off on some simpletons, but it comes back to bite, because the business does not last, and the marketing department either revokes your commissions, or puts you on a trouble list.  “Market conduct” is a big thing in insuring individuals.  The agents that win are the ones that serve needs, are honest, and make many sales.  Many people are looking for someone they can trust with reasonable returns, rather than the highest possible return.  One more note: there are many exams and certifications available.
  7. Marketers — This is the province of agents that were mediocre, and wanted more reliable hours and income.  It’s like the old saw, “Those who cannot do, teach. Those who cannot teach, administrate.”  It is possible to get into the marketing area by starting at a low level helper, but it is difficult to manage agents if you don’t have their experience of rejection.  Again, there are certifications available, but nothing will train you like trying to sell insurance policies.
  8. Underwriters — as with most of these credentials, a college degree helps, but there is a path for those without such a degree if you start at a low level as a helper, show initiative, and learn, learn, learn. Underwriters make a greater difference in coverages that are less common.  Where the law of large numbers applies, underwriters recede.  The key to being an underwriter is developing specialized expertise that allows for better risk selection.  There are certifications and exams for this, pursue them particularly if you don’t have a college degree.  Pursue them anyway — as an actuary, I received some training in underwriting.  It is intensely interesting, especially if you have a mind for analyzing the why and how of insured events.
  9. Investment personnel — this is a separate issue and is covered in my articles in how one can get a job in finance.  That said, insurance can be an easier road into investing, if you get a helper position, and display competence.  (After all, how did I get here?)  You have to be ready to deal with fixed income, which  means your math skills have to be good.  As a bonus, you might have to deal with directly originated assets like mortgages, credit tenant leases, private placements, odd asset-backed securities, and more.  It is far more dynamic than most imagine, if you are working for an adventurous firm.  (I have only worked for adventurous firms, or at least adventurous divisions of firms.)  Getting the CFA credential is quite useful.
  10. Administrators — the best administrators have a bit of all the skills.  They have to if they are managing the company aright.  Most of them are marketers, and  a few are actuaries, accountants,or lawyers.  Marketing has an advantage, because it is the main constraint that insurance companies face.  It is a competitive market, and those who make good sales prosper.  VIrtually all administrators are college educated, and most have done additional credentialing.  Good administrators can do project, people and data management.  it is not easy, and personally, few of the administrators I have known were truly competent.  If you have the skills, who knows?  You could be a real success.

Please understand that I have my biases, and talk to others in the field before you pursue this in depth.  Informational interviewing is wise in any job search, and helps you understand what you are really getting into, including corporate culture, which can make or break your career.  Some people thrive in ugly environments, and some die.  Some people get bored to death in squeaky-clean environments, and some thrive.

So be wise, do your research, and if you think insurance would be an interesting career, pursue it assiduously.  Then, remember me when you are at the top, and you need my clever advice. 😉


After almost three years, I returned to RT Boom/Bust on Tuesday.  There are many changes at RT.  Many new people, and a growing effort to put together an alternative channel that covers the world rather than just the US or just the developed world.  They are bursting at the seams, and their funding has doubled, so I was told.

I get surprised by who watches RT and sees me.  My  congregation is pretty conservative in every way, but I have some friends working in intelligence come up to me and say, “Hey, saw you on RT Boom/Bust.”  And then there is my friend from Central Africa who says, “The CIA has you on their list.  Watch out!”  He’s funny, hard-working, but very earnest.

I’ve never seen anything in what I have done where there is any hint of editorial control.  Maybe it is there, but I think I would be smart enough to see it.

Anyway, the topic at hand was alternative monetary systems, and the thing that kicked it off was the Vollgelt in Switzerland, where they are trying to create a monetary system where the banks can’t lend against deposits.  Here were my notes for the show, with a little more to fill in:


  1. Mr. Merkel, what exactly is a sovereign money system?

The banks can’t lend against deposits.  Deposits are segregated, and wait for the depositor to use them.  The deposits no longer can be used by the bank but only the depositor.  There would be no need for deposit insurance, because deposits are off of the bank’s balance sheet.

  1. What is the difference between a sovereign system and the way banks handle your money now?

You would have to pay for your transactional account, because the bank can’t make money off of lending against the deposits. Banks would no longer do “maturity transformation” by lending long against short-term deposits.  Long-term lending would have to be other entities in the economy, such as insurance companies, pension funds, endowments, private individuals, foreign lenders, mortgage REITs, and banks funded by matching sources like CDs, bonds, and equity.

  1. Switzerland is poised to vote on a sovereign money system, or Vollgeld in German. How likely is this vote to pass?

Not likely for three reasons.  First, the Swiss turned down a proposal to back the Swiss Franc with 20% gold.  Not one canton voted for it.  Only 22% of the electorate voted for it.  Second, things aren’t that bad now, and the financial system isn’t that levered.  “If it ain’t broke, don’t fix it.”  Third, this is a total experiment with no real world precedents.  Many criticize economists for imagining what the world should be like and then proposing policy off their unrealistic idealized models.  This is another example of that.  We don’t know what the unintended consequences might be.

Some unintended consequences might be:

  • Transition would be difficult
  • Recession during the transition, because middle and small market lending would likely suffer
  • Pay for transactional accounts – no interest even if inflation is high.
  • Increase in savings accounts, which might be short-dated enough to be transactional
  • Gives a lot of power to the SNB, which might be halfhearted about implementation (Regulators dislike change, and risk).
  • Could be subverted if Government becomes dependent on free money, leading to inflation
  • Moves monetary policy from rate targeting to permanent quantitative monetary adjustment. Unclear how the SNB would tighten policy; maybe issue central bank bonds to reduce money supply?
  1. Could something like this rein in credit bubbles? Are we facing another credit bubble?

Yes, it could.  Most credit bubbles result from short-term lending funding long-term assets.  This would rein it in, in the short-run, but who could tell whether it might come back in another unintended way?  If some new class of lender became dominant, the threat could reappear.

We aren’t facing a credit bubble now, because the last crisis wiped away a lot of private debt, and replaced it with public debt.  Perhaps some weak nations with debts not in their own currency could be at risk, but right now, there aren’t any categories of private debt big enough and misfinanced enough to create a crisis.  That said, watch margin loans, student loans, and auto loans in the US.

  1. Are there any modern day equivalents we can compare Vollgeld to?

None that are currently being used.  There are a lot of theoretical ideas still being tossed around, like 100% reserving, lowering bank leverage, strict asset-liability matching, disallowing banks from lending to financial companies, etc.  These ideas get a lot of press after crises, but fade away afterward.  Most of them would work, but all of them lower bank profits.  Concentrated interests tend to win against general interests, except in crises.

  1. You mentioned there is a similar concept for derivatives that no one is talking about. How exactly would that work?

Derivatives are functionally equivalent to insurance contracts, but they are not regulated.  I believe they should be regulated like insurance contracts, and require that those seeking insurance have an “insurable interest” that they are trying to hedge.  Only direct hedgers could initiate derivative transactions, and financial guaranty insurers would compete to fill the need.

This would prevent the unintended consequences of having multiples of protection written on a given risk, where a weak party like AIG is incapable of making good on all of the derivative contracts that they have written, which could lead to its own systemic risk if other derivative counterparties can’t absorb the losses.


I know that is over-simplified, but I read through the papers of both sides in the debate, and I thought both overstated their cases significantly.

I know fiat money has its problems, and so does fractional reserve banking, but if you are going to propose a solution, perhaps one that fits the basics of how a well-run bank at low leverage would work would be a good place to start.


Fewer laws protect you now. In some ways, the laws are more virtual than real, and only apply to real situations, and not virtual ones.

Let me explain.

Though checks make up an increasingly smaller fraction of transaction volume in the US, they are still a lot higher here than in Europe.  As such, federal and many state legislators have not caught up with the effects of a hybrid system, where they attempt to regulate electronic banking transactions under the same rules as paper checks.

Many people like making mobile deposits, rather than going into the bank, or snail-mailing the deposits in.  But what happens if a check gets mobile-deposited to two banks?  Or, since many banks don’t actively check mobile deposits closely, what if someone repeatedly deposits a check to his bank, while altering the check number?

The latter scenario happened to me, and I am out a considerable amount of money because I was not following my accounts closely.

  • My soon-to-be former bank would not reimburse the losses, citing the account agreement, even though they facilitated the thefts by not checking the drafts against my account.
  • The same was true of the bank of the fraudster, which accepted the same altered check again and again.
  • The state of Maryland would not prosecute fraud charges against the person, because the crime was not committed inside a bank branch, and they could not conclusively prove that the perpetrator did the crime, even though all of the money went to his account.  And,that is even though the perpetrator admitted it to me, and I have it in writing.
  • Thus, I have an informal agreement with the perp to pay me back or face a tort claim.  His situation is not strong, and you can’t squeeze blood from a stone.  I could force him into bankruptcy, but what good would that for me?  I’m not vengeful.

So what is the best defense?  Check your transactional accounts weekly if not daily.  On that level, the banks will take the losses, if you identify them fast enough.

I began doing that recently, and found someone using one of my credit cards to pay his phone bill.  I have since reversed most of those charges.  GIven that many vendors try to induce you into payment plans that auto-renew, it is wise for that reason to do so, that you would cancel services that you no longer use.

So what can I say?  I could have not written this up, but I am not perfect in my personal money management… better that others learn from my mistakes.  Until the state and Federal governments get their acts together, you are your own best defender.  Check your transactional accounts frequently.  The money you save will be your own.

Photo Credit: Steve Rotman || Markets are not magic; government economic stimulus is useless with debt so high

Weird begets weird

I said in an earlier piece on this topic:

I use [the phrase] during periods in the markets where normal relationships seem to hold no longer. It is usually a sign that something greater is happening that is ill-understood.  In the financial crisis, what was not understood was that multiple areas of the financial economy were simultaneously overleveraged.

So what’s weird now?

  • Most major government running deficits, and racking up huge debts, adding to overall liability promises from entitlements.
  • Most central banks creating credit in a closed loop that benefits the governments, but few others directly.
  • Banks mostly in decent shape, but nonfinancial corporations borrowing too much.
  • Students and middle-to-lower classes borrowing too much (autos, credit cards)
  • Interest rates and goods and services price inflation stay low in the face of this.
  • Low volatility (until now)
  • Much speculative activity in cryptocurrencies (large percentage on a low base) and risk assets like stocks (smaller percentage on a big base)
  • Low credit spreads

No one should be surprised by the current market action.  It wasn’t an “if,” but a “when.”  I’m not saying that this is going to spiral out of control, but everyone should understand that The Little Market that Could was a weird situation.  Markets are not supposed to go up so steadily, which means something weird was fueling the move.

Lack of volatility gives way to a surfeit of volatility eventually.  It’s like macroeconomic volatility “calmed” by loose monetary and fiscal policy.  It allows people to take too many bad chances, bid up assets, build up leverage, and then “BAM!” — possibility of debt deflation because there is not enough cash flow to service the incurred debts.

Now, we’re not back in 2007-9.  This is different, and likely to be more mild.  The banks are in decent shape.  The dominoes are NOT set up for a major disaster.  Risky asset prices are too high, yes.  There is significant speculation in areas Where Money Goes to Die.  So long as the banking/debt complex is not threatened, the worst you get is something like the deflation of the dot-com bubble, and at present, I don’t see what it threatened by that aside from cryptocurrencies and the short volatility trade.  Growth stocks may get whacked — they certainly deserve it from a valuation standpoint, but that would merely be a normal bear market, not a cousin of the Great Depression, like 2007-9.

Could this be “the pause that refreshes?”  Yes, after enough pain is delivered to the weak hands that have been chasing the market in search of easy profits quickly.  The lure of free money brings out the worst in many.

You have to wonder when margin debt is high — short-term investors chasing the market, and Warren Buffett, Seth Klarman, and other valuation-sensitive investors with long horizons sitting on piles of cash.  That’s the grand asset-liability mismatch.  Long-term investors sitting on cash, and short-term investors fully invested if not leveraged… a recipe for trouble.  Have you considered these concepts:

  • Preservation of capital
  • Dry powder
  • Not finding opportunities
  • Momentum gives way to negative arbitrages.
  • Greater fool theory — “hey, who has slack capital to buy what I own if I need liquidity?”

Going back to where money goes to die, from the less mentioned portion on the short volatility trade:

Again, this is one where people are very used to selling every spike in volatility.  It has been a winning strategy so far.  Remember that when enough people do that, the system changes, and it means in a real crisis, volatility will go higher than ever before, and stay higher longer.  The markets abhor free riders, and disasters tend to occur in such a way that the most dumb money gets gored.

Again, when the big volatility spike hits, remember, I warned you.  Also, for those playing long on volatility and buying protection on credit default — this has been a long credit cycle, and may go longer.  Do you have enough wherewithal to survive a longer bull phase?

To all, I wish you well in investing.  Just remember that new asset classes that have never been through a “failure cycle” tend to produce the greatest amounts of panic when they finally fail.  And, all asset classes eventually go through failure.

So as volatility has spiked, perhaps the free money has proven to be the bait of a mousetrap.  Do you have the flexibility to buy in at better levels?  Should you even touch it if it is like a knockout option?

There are no free lunches.  Get used to that idea.  If a trade looks riskless, beware, the risk may only be building up, and not be nonexistent.

Thus when markets are “weird” and too bullish or bearish, look for the reasons that may be unduly sustaining the situation.  Where is debt building up?  Are there unusual derivative positions building up?  What sort of parties are chasing prices?  Who is resisting the trend?

And, when markets are falling hard, remember that they go down double-speed.  If it’s a lot faster than that, the market is more likely to bounce.  (That might be the case now.)  Slower, and it might keep going.  Fast moves tend to mean-revert, slow moves tend to persist.  Real bear markets have duration and humiliate, making weak holders conclude that will never touch stocks again.

And once they have sold, the panic will end, and growth will begin again when everyone is scared.

That’s the perversity of markets.  They are far more volatile than the economy as a whole, and in the end don’t deliver any more than the economy as a whole, but sucker people into thinking the markets are magical money machines, until what is weird (too good) becomes weird (too bad).

Don’t let this situation be “too bad” for you.  If you are looking at the current situation, and think that you have too much in risk assets for the long-term, sell some down.  Preserving capital is not imprudent, even if the market bounces.

In that vein, my final point is this: size your position in risk assets to the level where you can live with it under bad conditions, and be happy with it under good conditions.  Then when markets get weird, you can smile and bear it.  The most important thing is to stay in the game, not giving in to panic or greed when things get “weird.”

Hey, it only took 18 years to eclipse the prior high in purchasing power terms! Better than the Great Depression!


This is an update of a post I did less than three years ago.  In that relatively short time, the NASDAQ Composite hit an all-time record in purchasing power adjusted terms.  Quite an ascent in the last two years.  I never would have predicted it.  If you took the other side of my advice you did better.

That said, the S&P 500 is forecast to return 3.4%/year prior to inflation for the next ten years.  Aside from one quarter during the go-go years (1968), the only period with lower anticipated returns was during the dot-com bubble.  The levels you see today will be revisited going the other way.

Are you too “chicken” to buy the NASDAQ Composite? Then you are like me.

The last time I wrote on this, I asked whether it would be better the NASDAQ Composite [IXIC] or Industrias Bachoco [IBA].  IBA is the second largest producer of chicken in North America, and is now expanding in the US.  From the time I wrote the last article it has returned 20%.  NASDAQ Composite? 47%.

That said, I still prefer IBA for the future.  Strong competitive position, little debt.  Intelligent tuck-in style of M&A, showing intelligent capital allocation.  1.7x book.  12-13x earnings.  If it weren’t a Mexican firm, it would be valued a lot higher.  IXIC’s valuation metrics are roughly double those.

All that said, IBA beat IXIC over the 12.5 years I have owned it.  487% vs 401%.  And if you were measuring from the top of the dot-com bubble the return difference is 1460% vs 71%.

IBA still has a lot of room to expand, and is subject to less competition and antitrust threats than many large technology companies.

Not that you should run out and buy IBA (caution: thin market), but what do you do if you are looking for ideas that could be good, but not as much in the spotlight as the companies that make up the bulk of the NASDAQ Composite?  I’ll quote the end of my last article, because the ideas are good, and will likely do better than buying hot ideas now.

…where are the good assets that few are looking at?

Tough question.  I’ll give you a few ideas, but then you have to work on it yourself.

1) Look at higher quality names in out-of-favor industries.  The advantage of this approach is that your downside is likely to be limited, while the upside could be significant.  I’ve seen it work many times.  Note: avoid “buggy whip” industries where the decline is final; the internet is eating a lot of industries.

2) Look at companies outside the US that act in the best interests of outside, passive, minority investors like you and me.  There is less competition there from analysts and clever US-focused investors.  Note: spend extra time analyzing how they have used free cash flow in the past.  Is management rational at allocating capital, or even clever?

3) Look at firms that can’t be taken over, where a control investor seems savvy, and acts in the best interests of outside, passive, minority investors.  Many won’t invest in those firms because they are less liquid, and a takeover is very unlikely.

4) Look at smaller firms pursuing a growing niche in an otherwise dull industry.  Or smaller firms that have good finances, but have some taint that keeps investors from re-examining it.

5) Look through 13F filings for new names that look promising, before too many people learn about the company.  Or, IPOs and spin-offs in industries that are dull.

6) Analyze stocks that are in the lowest quartile of performance over the last 3-5 years.

7) Or, go to Value Line, and look at the stocks with the highest appreciation potential, with an adequate safety rank.

I use a variety of these ideas.  If I see somethings interesting, I will dig deep and sometimes I get a real gem.  Sometimes not.  But with an adequate margin of safety, I don’t get killed.

Full Disclosure: long IBA

This should be a brief article.  I remember back in 1999 to early 2000 how P&C insurance stocks, and other boring slower-growth industries were falling in price despite growing net worth, and reasonable earnings.  I was working for The St. Paul at the time (a Property & Casualty Insurer), and for an investment actuary like me, who grew up in the life insurance business it was interesting to see the different philosophy of the industry.  Shorter-duration products make competition more obvious, making downturns uglier.

The market in 1999-2000 got narrow.  Few groups and few stocks were leading the rise.  Performance-conscious investors, amateur and professional, servants of the “Church of What’s Working Now,” sold their holdings in the slower growing companies to buy the shares of faster growing companies, with little attention to valuation differences.

I remember flipping the chart of the S&P 1500 Supercomposite for P&C Insurers, and laying it on top of an index of the dot-com stocks.  They looked like twins separated at birth, except one was upside down.

When shares are sold, they don’t just disappear.  Someone buys them.  In this case, P&C firms bought back their own stock, as did industry insiders, and value investors — what few remained.  When managed well, P&C insurance is a nice, predictable business that throws of reliable profits, and is just complex enough to scare away a decent number of potential investors.  The scare is partially due to the effect that it is not always well-managed, and not everyone can figure out who the good managers are.

So shares migrate.  Those that fall in the midst of a rally, despite decent economics, get bought by long-term investors.  The hot stocks get bought by shorter-term investors, who follow the momentum.  This continues until the gravitational effects of relative valuations gets too great — the cash flows of the hot stocks do not justify the valuations.

Then performance reverts, and what was bad becomes good, and good bad, but as with almost every investment strategy you have to survive until the turn, and if the assets run from the prior migration, it is cold comfort to be right eventually.

As an aside, this is part of what fuels dollar-weighted returns being lower than time-weighted returns.  The hot money migration buys high, and sells low.

Thus I say to value investors, “Persevere.  I can’t tell you when the turn will be, but it is getting closer.”

Photo Credit: jessica wilson {jek in the box}


It’s been a while since we last corresponded.  I hope you and your family are well.

Quick investment question. Given the sharp run-up in equities and stretched valuations, how are you positioning your portfolio?

This in a market that seemingly doesn’t go down, where the risk of being cautious is missing out on big gains.

In my portfolio, I’m carrying extra cash and moving fairly aggressively into gold. Also, on the fixed income side, I’ve been selling HY [DM: High Yield, aka “Junk”] bonds, shortening duration, and buying floating rate bank loans.

Please let me know your thoughts.



Dear JJJ,

Good to hear from you.  It has been a long time.

Asset allocation is always a marriage between time horizon (when is the money needed for spending?) and expected returns, with some adjustment for risk.  I suspect that you are like me, and play for a longer horizon.

I’m at my lowest equity allocation in 17 years.  I am at 65% in equities.  If the market goes up another 4-5%, I am planning on peeling of 25% of that to go into high quality bonds.  Another 20% will go if the market rises 10% from here.  At present, the S&P 500 offers returns of just 3.4%/year for the next ten years unadjusted for inflation.  That’s at the 95th percentile, and reflects valuations of the dot-com bubble, should we rise that far.

The stocks that I do have are heading in three directions: safer, cyclical and foreign.  I’m at my highest level for foreign stocks, and the companies all have strong balance sheets.  A few are cyclicals, and may benefit if commodities rise.

The only thing that gives me pause regarding dropping my stock percentage is that a lot of “friends” are doing it.  That said, a lot of broad market and growth investors are making “new era” arguments.  That gives me more comfort about this.  Even if the FAANG stocks continue to do well, it does not mean that stocks as a whole will do well.  The overall productivity of risk assets is not rising.  People are looking through the rearview mirror, not the windshield, at asset returns.

I can endorse some gold, even though it does nothing.  Nothing would have been a good posture back in the dot-com bubble, or the financial crisis.  Commodities are undervalued at present.  I can also endorse long Treasuries, because I am not certain that inflation will run in this environment.  When economies are heavily indebted they tend not to inflate, except as a last resort.  (The wealthy want to protect their claims against the economy.  The Fed generally helps the wealthy.  Those on the FOMC are all wealthy.)

I also hold more cash than normal.  The three of them, gold, cash and long Treasury bonds form a good hedge together against most bad situations.

The banks are in good shape, so the coming troubles should not be as great as during the financial crisis, as long as nothing bizarre is going on in the repo markets.

That said, I would be careful about bank debt.  Be careful about the covenants on the bank debt; it is not as safe as it once was.  I don’t own any now.

Aside from that, I think you are on the right track.  The most important question is how much you have invested in risk assets.  Prudent investors should be heading lower as the market rises.  It is either not a new era, or, it is always a new era.  Build up your supply of safe assets.  That is the main idea.  Preserve capital for another day when risk assets offer better opportunities.

Thanks for writing.  If you ever make it to Charm City or Babylon, let me know, and we can have lunch together.



Credit: Roadsidepictures from The Little Engine That Could By Watty Piper Illustrated By George & Doris Hauman c. 1954


I wish I could have found a picture of Woodstock with a sign that said “We’re #1!”  Snoopy trails behind carrying a football, grinning and thinking “In this corner of the backyard.”

That’s how I feel regarding all of the attention that has been paid to the S&P being up every month in 2017, and every month for the last 14 months.  These have never happened before.

There’s a first time for everything, but I feel that these records are more akin to the people who do work for the sports channels scaring up odd statistical facts about players, teams, games, etc.  “Hey Bob, did you know that the Smoggers haven’t converted a 4th and 2 situation against the Robbers since 1998?”

Let me explain.  A month is around 21 trading days.  There is some variation around that, but on average, years tend to have 252 trading days.  252 divided by 12 is 21.  You would think in a year like 2017 that it must  have spent the most time where 21-day periods had positive returns, as it did over each month.

Since 1950, 2017 would have come in fourth on that measure, behind 1954, 1958 and 1995.  Thus in one sense it was an accident that 2017 had positive returns each month versus years that had more positive returns over every 21 day period.

How about streaks of days where the 21-day trialing total return never dropped below zero (since 1950)?  By that measure, 2017 would have tied for tenth place with 2003, and beaten by the years 1958-9, 1995, 1961, 1971, 1964, 1980, 1972, 1965, and 1963.  (Note: quite a reminder of how bullish the late 1950s, 1960s and early 1970s were.  Go-go indeed.)

Let’s look at one more — total return over the whole year.  Now 2017 ranks 23rd out of 68 years with a total return of 21.8%.  That’s really good, don’t get me wrong, but it won’t deserve a mention in a book like “It Was a Very Good Year.”  That’s more than double the normal return, which means you’ll have give returns back in the future. 😉

So, how do I characterize 2017?  I call it The Little Market that Could.  Why?  Few drawdowns, low implied volatility, and skepticism that gave way to uncritical belief.  Just as we have lost touch with the idea that government deficits and debts matter, so we have lost touch with the idea that valuation matters.

When I talk to professionals (and some amateurs) about the valuation model that I use for the market, increasingly I get pushback, suggesting that we are in a new era, and that my model might have been good for an era prior to our present technological innovations.  I simply respond by saying “The buying power has to come from somewhere.  Our stock market does not do well when risk assets are valued at 40%+ of the share of assets, and there have been significant technological shifts over my analysis period beginning in 1945, many rivaling the internet.”  (Every era idolizes its changes.  It is always a “new era.”  It is never a “new era.”)

If you are asking me about the short-term, I think the direction is up, but I am edgy about that.  Forecast ten year returns are below 3.75%/year not adjusted for inflation.  Just a guess on my part, but I think all of the people who are making money off of low volatility are feeding the calm in the short-run, while building up a whiplash in the intermediate term.

Time will tell.  It usually does, given enough time.  In the intermediate-term, it is tough to tell signal from noise.  I am at my maximum cash for my equity strategy accounts — I think that is a prudent place to be amid the high valuations that we face today.  Remember, once the surprise comes, and companies scramble to find financing, it is too late to make adjustments for market risk.