Fifteen Thoughts on Advantage in the Markets
1) I made the point last week when I talked about my experiences in the pension division of Provident Mutual. The investment choices of 90% of individuals follows recent performance. This is another factor in why markets overshoot, and why mean-reversion is a weak tendency. Thus when I see many leaving the stock market for absolute return, bonds, cash, commodities, it makes me incrementally more bullish, though I am slightly bearish at present.
2) Has this been a “suckers rally?” That’s too severe, but there is some truth to it. Many of the large financials may be safe, but at a cost of higher taxes and inflation. Also, the losses on commercial real estate have not been felt yet on the balance sheets of banks. I think we will break the recent lows on the S&P 500 before this is all done. Debt deflation and dilution continues on. We have an overhang in residential housing that will require prices to go below equilibrium in order to clear. Global growth is anemic, even if some of the emerging markets are doing well.
3) When writing for RealMoney, I was usually diffident about buybacks, because I liked to see strong balance sheets. Now in this era, those that bought back a lot in the past are paying the price. Buy high, dilute low is a recipe for big underperformance, and we are seeing it in financials now. (The comments about pension design in the article are spot-on as well.)
4) Behavioral economics does justice to what man is really like, both individually and collectively. We are prone to laziness, greed and fear. There is a weak tendency for a minority of individuals to break free from the fads and fashions of men, and pursue profit exclusively. Remember, thinking hurts, so people conserve on it, unless the reward for thinking exceeds the pain.
5) Quantitative managers have gotten whacked, and few more than Cliff Asness of AQR. It doesn’t help that you are outspoken, or that you took time away to aid the CFA Institute. When the business goes south, thereare no excuses that work. In times like this, be quiet, analyze failure, and stick to your knitting.
6) Ken Fisher made an argument like this in his book The Wall Street Waltz. Eddy’s argument is ordinarily right; buy during bad times. The only time that is not true is when you are in a depression, and there is much more debt to be liquidated, and more jobs to be lost.
7) From Quantifiable Edges, there is some evidence that the ratio of the Nasdaq Composite to the S&P 500 can be used as a timing indicator. Nasdaq Composite outperformance presages more positive returns in the S&P.
8 ) I read the article on the “purified VIX” and other “purified” indicators, and I get it. Adam is still correct that periods where the VIX and SPX move in the same direction tall you something about future SPX performance. If both are up, then the trend for the SPX tends to be up. Vice-versa if both are down.
9) Regarding this article on David Rosenberg, I think the earnings are too optimistic, but the P/E multiple is too pessimistic. Things may be ugly for a while, but I can see an S&P 500 above 1000 in 2011. (That may be inflation.)
This phrase is problematic “As for the multiple, Rosie believes the P/E should approximate a Baa bond yield, leading to an “appropriate” multiple of 12x.” E/P on average should be equal to a Baa bond average less 4%, making a fair P/E at 20+.
10) Beta stinks. You knew that. Here’s more ammo for the gun. I have doubted the CAPM for almost 30 years. It’s only value is to confuse other wise intelligent comptetitors.
11) Is small cap value still relevant? Is winning relevant? Please ignore the studies that use betas that adjust for small cap, value, and momentum — using each of those is a management choice, and those of us that choose to be smart take credit for following research, not that research should discount our actions.
12) Yes, the Q-ratio works. Don’t tell anyone about it, though. Shh…
13) Dow 36,000. Yes, in 2030. Glassman and Hassett were sensationalists that pushed an idea of rationality too hard, suggesting that people could accept a near-zero risk premium to invest in stocks, versus treasury bonds. Bad idea. The E/P of stocks averages near the Baa bond yield less 4%. Stocks need 4% earnings growth to compete with bonds on average.
14) Homes are for living in; they are only secondarily investments, if you know what you are doing. Compared to TIPS, gains in homeowning, less expenses, are comparable.
15) As this post points out, and I have said it before, “The vast majority of currency ETFs represent stakes in an interest-bearing bank account denominated in a foreign currency. They derive all their return from two sources: the cash yield of the foreign currency over the expense ratio of the fund and changes in the exchange rate against the dollar.” Be careful with foreign currency funds; they often embed financial credit risk.
