Category: Stocks

The Nature of a Nervous Bull

The Nature of a Nervous Bull

Cast your bread upon the waters,
For you will find it after many days.
2 Give a serving to seven, and also to eight,
For you do not know what evil will be on the earth.
3 If the clouds are full of rain,
They empty themselves upon the earth;
And if a tree falls to the south or the north,
In the place where the tree falls, there it shall lie.
4 He who observes the wind will not sow,
And he who regards the clouds will not reap.
5 As you do not know what is the way of the wind,[a]
Or how the bones grow in the womb of her who is with child,
So you do not know the works of God who makes everything.
6 In the morning sow your seed,
And in the evening do not withhold your hand;
For you do not know which will prosper,
Either this or that,
Or whether both alike will be good. [Eccelesiates 11:1-6, NKJV, copyright Thomas Nelson]

The point of Ecclesiastes 11:1-6 is that the farmer in Spring, much as he might be hungry, and want to eat his seed corn, instead has to cast his seed into the muddy soil, perhaps planting 7 or 8 crops, because he doesn?t know what the future may bring. If he looks at the sky, wondering if it will rain enough, or whether the winds might ruin the crops, he will never get a crop in Summer or Fall.

That?s the way that I view investing. You always have to have something going on. You can?t leave the market entirely, because it?s really tough to tell what the market might give you. Typically, across my entire set of investments I run with about 70% equity investments, and the rest cash, bonds, and the little hovel that I live in. Private equity is a modest chunk of my equity holdings, so public equities are about 60% of what I own. Domestic public equities are about 45%.

I don?t think of that as particularly bullish or bearish. Even with public equities trading at high price-to-sales ratios, my portfolio doesn?t trade at high ratios of sales, cash flow, earnings, or book value. Together with industry selection, modest valuations provide some support against bear markets.

My tendency will be if the market moves lower from here to layer in slowly using my rebalancing discipline. That?s what I did in my worst period 6/2002-9/2002, and the stocks that I held at the end were ideally positioned for the turn in the market.

So, I never get very bullish, or bearish. I see the troubles in the markets, and I avoid most problem areas, such as in housing-related areas, but I continue to plug along, doing what I do best — trying to pick good stocks and industries (and occasionally, countries.)

Ave Atque Vale et Mea Culpa

Ave Atque Vale et Mea Culpa

I’m going to be gone Monday through Wednesday of next week on business, and my ability to blog will likely be curtailed.? I would simply like to offer two observations.? The first is on the FOMC.? Given the balance of all of the data, I believe that the FOMC will loosen by 25 basis points on Tuesday.? They will issue the standard “two-handed economist” language about troubles from inflation and financial/economic weakness, indicating that the FOMC is vigilant, and that nothing more is coming given present data, because the FOMC is in control.

The markets will be disappointed by 25 basis points, and will get excited by 50.? Language of the statement will matter some, but I can’t imagine that it will be that amazingly different from before.

One other note: I will write more about National Atlantic at a later date, but for now I am just holding my head in my hands and moaning.? I know there are forced sellers in the name, but to be at 40% of tangible book on a short-tailed name is notable.? It indicates that claim reserves at the end of the second quarter would be 50% light, to justify current valuations.

I’m not suggesting that anyone buy the name; for me, if it stays at these levels, it will be my largest personal loss.? I teach my children about investing through my losses.? If things don’t change, this will be lesson one.

Full disclosure: long NAHC

Book Review: The Aggressive Conservative Investor

Book Review: The Aggressive Conservative Investor

I am a fan of value investing in all of its different variations, and so when I run across a book on the topic, particularly from a skilled practitioner, I buy it. I’ll do more book reviews on value investing, but one of the first that I wanted to do was Value Investing, by Marty Whitman.

So, I start looking around for my copy, and I can’t find it. Arrrgh, I can guess what happened. I lent it out, I can’t remember who I lent it to, but the borrower never gave it back to me. Annoyed at myself, I do notice a book that was just as good, The Aggressive Conservative Investor, by Marty Whitman and Martin Shubik. Even better, it is back in print, after being out of print for 20+ years.

So, what’s so great about the book? (Most of this applies to both books.) Marty Whitman has a strong “What can go wrong” approach. He realizes that he, and most other investors, will be outside passive minority investors. We only ride on the bus. The inside active control investors drive the bus, and if we are going to make money with reasonable safety, we have to understand the motives of those that control the companies. They benefit somewhat disproportionately from control. They receive wages and benefits that other shareholders do not receive, can gain cheap outside financing, and limit tax exposures, in addition to other benefits.

Like me, Whitman doesn’t care much for modern portfolio theory. More notable for a value investor, he has a few criticisms for the traditional “Graham-and-Dodd” type of value investing.

  • Typically, it works best for “going concern” situations, and not situations where activism could be necessary to unlock value. (Though, Graham did do things like that in his career; he just didn’t try to teach amateurs about it.)
  • He doesn’t always stick to high quality companies, if enough information can be obtained about the target. Information allows for more risk to be taken.

There are four things that he insists on in equity investments:

  1. Strong financial position
  2. Honest management that is creditor-aware and shareholder-oriented
  3. Adequate disclosure of information relevant to the success of the company
  4. The stock can be bought for less than the net asset value (adjusted book value) of the firm.

If you have these items in place, you won’t lose much, and if the management team makes value enhancing decisions, one can make a lot of money on the stock.

Whitman places a lot of stress on reading through the documents filed with the SEC. They may not be perfect, but managements know that they need to provide adequate disclosure of material information, or they could be sued. A lot gets revealed in SEC filings, and not every investor sees that.

He also places great stress on understanding the limitations of the accounting, whether under GAAP, Tax, or any other basis. Comparing the various accounting bases can sometimes illuminate the true financial well-being of a company. (Note: this is what killed me on Scottish Re. I should have questioned the GAAP profitability, when they never paid taxes.) He lists the underlying assumptions behind GAAP accounting, and explains how they can distort the estimation of economic value. Honestly, it is worse today in some ways than when he wrote the First Edition in 1979. GAAP accounting is more flexible, and less comparable across companies today.

Marty Whitman looks for situations where resources in a company can be used in a better manner, creating value in the process.

  • Is the company too conservatively financed? Perhaps borrowing money to buy back stock, or issuing a special dividend could unlock value.
  • Are there divisions that are undermanaged, or would fit better in another company?
  • Are management incentives properly aligned with shareholders?
  • Would the company be better off going private?
  • Is government regulation a help or a hindrance? (Barriers to entry)
  • Analyzing corporate structures for where the value is.

Beyond that, he explains how to calculate net asset values, as distinct from book values. He describes the problems with earnings as a value metric. He explains the value of dividends and other distributions. He also explains when it can make sense to own companies that are losing money. (Underlying values are growing in a way that the tax accounting basis does not catch.)

It’s a good book. Together with Value Investing, it gives you a full picture of how Marty Whitman thinks about value investing. He is one of the leading value investors of our time, but he has spent more time than most on the underlying theory. For those who want to think more deeply about value investing, Marty Whitman is a highly recommended read. For those wanting still more, read his shareholder letters here.

Full disclosure: if you use the links on this page to buyread books, I receive a small amount of money.

PS — Twelve years ago, I wrote Marty Whitman, begging to be one of his analysts. Though I didn’t get a response, I still admire him and his staff greatly.

Personal Finance, Part 5.1 ? Inflation and Deflation 2

Personal Finance, Part 5.1 ? Inflation and Deflation 2

I wish that I had more time to respond to readers both in the comments and e-mail.? Unfortunately, I am having to spend more time working as I am in transition as far as my work goes.? I’ll try to catch up over the next week or so, but I am behind by about 50 messages, and I hate to compromise message quality just to clear things out.

That said, my inflation/deflation piece yesterday attracted two comments worthy of response.? The first was from James Dailey, who I would recommend that you read whenever he comments here.? We may not always agree, but what he writes is well thought out.? He thinks I attribute too much power to the Fed.? He has a point.? From past writings, I have suggested that the Fed is not all-powerful.? What I would point out here is that the Fed controls more than just the monetary base.? They control (in principle) the terms of lending that the banks employ.? With a little coordination with the other regulators, the Fed could restrict non-bank lenders by raising the capital requirements that banks (and other regulated institutions) must maintain in lending to non-bank lenders.? So, if credit is outpacing the growth in the monetary base, it is at least partially because the Fed chooses to allow it.? Volcker reined in the credit card companies in the early 80s, which was not a normal policy for the Fed; it had a drastic impact on the economy, but inflation slowed considerably.? (Causation?? I’m not sure.? Fed funds were really high then also.)

The other comment came from Bill Rempel.? He objected more to my terminology than my content, though he disliked my comment that “Inflation is predominantly a monetary phenomenon.”? I think we are largely on the same page, though.? I know the more common phraseology here, “Inflation is purely a monetary phenomenon,” and I agree with it, but with the following provisos:

  • If we are talking about goods, services, and assets as a group, or,
  • If the period of time is sufficiently long, like a century or so, or,
  • If we are talking about monetary inflation.? (Who disagrees with tautologies? 🙂 Not me.)

Part of my difficulty here, is that when we talk about money, we are talking about something that lies on the spectrum? between currency and credit.? By currency I am talking about whatever physical medium can be commonly deployed to effectuate transactions.? By credit, anything where the eventual exchange of currency is significantly delayed, and perhaps with some doubt of collection.? Because of the existence of credit, over shorter periods, the link between monetary inflation and good price inflation is more tenuous, which leads people to doubt the concept that “Inflation is purely a monetary phenomenon.”? My post, rather than weakening that concept, strengthens it, because it broadens the concept of inflation, so that the pernicious effects of monetary inflation can be more clearly seen.? I wrote what I wrote to distinguish between monetary, goods and asset inflation.? I think it is useful to make these distinctions, because most people when they hear the word “inflation” think only of goods price inflation, and not of monetary or asset inflation.

Now, onto today’s topic: how to protect ourselves from inflation and deflation.? With goods price deflation (should we ever see that under the Fed), the answers are simple: avoid debt, lend to stable debtors, and make sure you are economically necessary to the part of the economy that you serve.? You want to make sure that you have enough net cash flow when net cash flow is scarce.? You can use that cash flow to buy distressed assets on the cheap.? Economically necessary and low debt applies to the stocks you own as well.

On goods price inflation, take a step back and ask what is truly in short supply, and buy/supply some of that.? It could be commodities, agricultural products, or gold. ? As a last resort you could buy some TIPS, or just stay in a money market fund.? You won’t get rich that way, but you might preserve purchasing power.? In stocks, look for those that can pass through price inflation to their customers.? In bonds, stay short, unless they are inflation-protected.

This is not obscure advice, but there is an art to applying it.? There comes a point in every theme where prices of the most desirable assets discount or even over-discount the scenario.? Safe assets get overbought in a deflation toward the end of that phase of the cycle.? Same thing for inflation-sensitive assets during an inflation.? As for me at present, you can see my portfolio over at Stockpickr; at present, I split the difference, though my results over the last five months have been less than stellar.? I have companies with relatively strong balance sheets, and companies with a decent amount of economic sensitivity, whether to price inflation or price inflation-adjusted economic activity.

I don’t see the global economy heading into recession; I do see price inflation ticking up globally, and also asset inflation in some countries (China being a leading example). ? But we have a debt overhang in much of the developed world, so we have to be careful about balance sheets.

I may have it wrong at this point.? My equity performance over the last seven-plus years has been good, but the last five months have given me reason for pause.? Well, things were far worse for me 6/2002-9/2002; I saw that one through.? I should survive this one too, DV.

Personal Finance, Part 5 ? Inflation and Deflation

Personal Finance, Part 5 ? Inflation and Deflation

This is another in the irregular series on personal finance.? This article though, has implications beyond individuals.? I’m going to describe this in US-centric terms for simplicity sake.? For the 20-25% of my readers that are not US-based, these same principles will apply to your own country and currency as well.

Let’s start with inflation.? Inflation is predominantly a monetary phenomenon.? Whenever the Fed puts more currency into circulation on net, there is monetary inflation.? Some of the value of existing dollars gets eroded, even if the prices of assets or goods don’t change.? In a growing economy with a stable money supply, there would be no monetary inflation, but there would likely be goods price deflation.? Same number of dollars chasing more goods.

Let’s move on to price inflation.? There are two types of price inflation, one for assets, and the other for goods (and services, but both are current consumption, so I lump them together).? When monetary inflation takes place, each dollar can buy less goods or assets than in the absence of the inflation.? Prices would not rise, if productivity has risen as much or more than the amount of monetary inflation.

Now, the incremental dollars from monetary inflation can go to one of two places: goods or assets.? Assets can be thought of? as something that produces a bundle of goods in the future.? Asset inflation is an increase in the prices of assets (or a subgroup of assets) without equivalent improvement in the ability to create more goods in the future.? How newly printed incremental dollars get directed can make a huge difference in where inflation shows up. Let me run through a few examples:

  1. ?In the 1970s in the US, the rate of household formation was relatively rapid, and there was a lot of demand for consumer products, but not savings.? Money supply growth was rapid.? The stock and bond markets languished, and goods prices roared ahead.? Commodities and housing also rose rapidly.
  2. In? the mid-1980s the G7 induced Japan to inflate its money supply.? With an older demographic, most of the excess money went into savings that were invested in stocks that roared higher, creating a bubble, but not creating any great amount of incremental new goods (productivity) for the future.
  3. In 1998-1999, the Fed goosed the money supply to compensate for LTCM and the related crises, and Y2K.? The excess money made its way to tech and internet stocks, creating a bubble.? On net, more money was invested than was created in terms of future goods and services.? Thus, after the inflation, there came a deflation, as the assets could not produce anything near what the speculators bid them up to.
  4. In 2001-2003 the Fed cut rates aggressively in a weakening economy.? The incremental dollars predominantly went to housing, producing a bubble.? More houses were built than were needed in an attempt to respond to the demand from speculators.? Now we are on the deflation side of the cycle, where prices adjust down, until enough people can afford the homes using normal financing.

I can give you more examples.? The main point is that inflation does not have to occur in goods in order to be damaging to the economy.? It can occur in assets when people and institutions become maniacal, and push the price of an asset class well beyond where its future stream of cash flow would warrant.

Now, it’s possible to have goods deflation and asset inflation at the same time; it is possible to save too much as a culture.? The boom/bust cycles in the late 1800s had some instances of that.? It’s also possible to have goods inflation and asset deflation at the same time; its definitely possible to not save enough as a culture, or to have resources diverted by the government to fight a war.

The problem is this, then.? It’s difficult to make hard-and-fast statements about the effect of an increasing money supply.? It will likely create inflation, but the question is where?? Many emerging economies have rapidly growing money supplies, and they are building up their productive capacity.? The question is, will there be a market for that capacity?? At what price level?? Many of them have booming stockmarkets.? Do the prices fairly reflect the future flow of goods and services?? Emerging markets presently trade at a P/E premium to the developed markets.? If capitalism sticks, the premium deriving from faster growth may be warranted.? But maybe not everywhere, China for example.

The challenge for the individual investor, and any institutional asset allocator is to look at the world and estimate where the assets generating future inflation-adjusted cash flows (or goods and services) are trading relatively cheaply.? That’s a tall order.? Jeremy Grantham of GMO has done well with that analysis in the past, and I’m not aware that he finds anything that cheap today.

We live in a world of relatively low interest rates; part of that comes from the Baby Boomers aging and pension plans investing for their retirement.? P/E multiples aren’t that high, but profit margins are also quite high.? We also face central banks that are loosening monetary policy to reduce bad debt problems.? That incremental money will aid institutions not badly impaired, and might eventually inflate the value of houses, if they get aggressive enough.? (Haven’t seen that yet.)? In any case, the question is how will the incremental dollars (and other currencies) get spent?? In the US, we have another demographic wave of household formations coming, so maybe goods inflation will tick up.

We’ll see.? More on this tomorrow; I’ll get more practical and less theoretical.

On the Value of Secondary and Primary Markets

On the Value of Secondary and Primary Markets

My main thesis here is that secondary and primary markets benefit investors in different ways, but that they are equally valuable to investors, and the public at large. Government policy should not discriminate in favor of one or the other.

I come at this topic from the point of view of someone who has been both a bond and stock investor professionally. When managing bonds, one boss of mine would say, “Primary market levels validate trading levels in the secondary market.” His point was that in the bond market, since a large proportion of the dollar value of transactions came from new issues, those deals in the primary markets were a good indication of where trades should go on in the secondary market for similar pieces of paper. He had a point; bigger markets should dominate smaller similar markets in discerning overall price/yield movements.

In the primary markets, deals have to come a little cheap on average in order to get deals done. That cheapness is necessary in order to get a lot of liquidity from investors at once. But that level of cheapness attracts flippers, i.e., people who buy the cheap new issue, and sell it away for a quick profit in the secondary markets. Bond underwriter syndicates do what they can to detect flippers, but some almost always get in. Even so, the flippers have some value. They reveal the level of discounting inherent in the offering process; when the discounting is high, there’s a lot of fear in the marketplace, and new deals stand a decent chance of performing well. Vice-versa when discounting is low, or even worse, when a new deal “backs up” and closes below the IPO price.

One way to tell how hot the market is, is how rapidly deals close. Seven minutes? Days?? Mania and Lethargy are common attitudes for the market.? Normal behavior is, well, abnormal.? Abnormal behavior provides clues into what is likely to happen next, even if the timing is difficult.? Hot IPO markets eventually go cold, and vice-versa.

The secondary markets provide valuable clues for the primary market as to where deals should be priced, whether equity or debt.? Even if the primary market were dominated by buy-and-hold investors (more common in bonds, less common in stocks), the speculation inherent in much secondary trading provides real value to the IPO syndicates, and longer-term investors.

Longer-term investors who buy-and-hold, or sell-and-sit-on-cash provide clues to speculators as well. The longer-term investors are the ones who create “support” and “resistance” levels.? They care about valuation.

Secondary markets need primary (IPO) markets also.? Without the possibility of a company being bought out, share prices tend to suffer.? When few new companies go public, it is often a sign that the secondary markets are cheap.

My main point here is both markets are valuable, and they need each other.? Speculation is an inescapable part of the capital markets, and it should not be legally discouraged.? (Note: I am not about to become a speculator; I am a longer-term investor, and will stay that way.)

How does the system discourage speculation?? There are differential rates of taxation based on holding period, or investment class. My view is that all income, no matter how generated, should be taxed at the same rate.? All income generation is equally valuable, whether it comes quickly or slowly.

So, when I read drivel like this fellow Lawrence Mitchell is putting out, advocating high taxes on short-term investing, I sit back and say, “You’re not thinking systematically.? You’ve only thought through the first order effects; the remaining effects have eluded you.”? Imagine a system where we are all forced to become buy-and-hold investors through tax policy.? Where would the price signals for the primary markets come from?? Where would liquidity come from?? Would activist investing shrink, with the honesty that it helps to bring?? Who would be willing to step up to an IPO if he knew that tax policy favored him holding for ten years?? What would happen to venture capital if the secondary markets dried up because of tax policy?? Where would their exit door be?

A world composed of only long-term investors would not be as rich of world as we have now.? Though many short-term investors are only “noise traders,” the ability of short-term investors to take advantage of market dislocations helps stabilize the markets.? There should be no penalty to short-term investing versus long-term investing.

Now, if that’s not controversial enough, perhaps I will write a post where I say that tax policy should not favor savings over consumption.? Let people make their own decisions on buying and selling, and let the IRS take a consistent cut, but social policy through tax preferences is for the most part not a good idea.

Seven Observations From Barron’s

Seven Observations From Barron’s

  1. Kinda weird, and it makes you wonder, but on the WSJ main page, I could not find a link to Barron’s. I know I’ve seen a link to Barron’s in the past there; I have used it, which is why I noticed its absence today.
  2. I found it amusing that the mutual fund that Barron’s would mention on their Blackrock interview, underperformed the Lehman Aggregate over 1, 3 and 5 years. Don’t get me wrong, Blackrock is a great shop, and I would work there if they offered me employment that didn’t change my location. Why did Barron’s pick that fund?
  3. I’m not worried about the effect of a financial guarantor downgrade on the creditworthiness of the muni market. Munis rarely fail. Most of those that do fail lacked a real economic purpose. What would be lost in a guarantor downgrade is liquidity. Muni bond insurance is a substitute for analysis. “AAA insured, I’ll buy that.” Truth, an index fund of uninsured munis would beat an index of insured munis, because default rates are so low. But the presence of insurance makes the bonds a lot more liquid, which makes portfolio management easier.
  4. I’ve been a US dollar bear for the last five years, and most of the last fifteen years. Though we have had a little bounce recently, the dollar has of late been at record lows against currencies that trade freely against the dollar. I expect the current bounce to persist in the short term and fail in the intermediate term. The path of the dollar is lower, unless the Fed decides to not loosen more. Balance needs to be restored in the global economy, such that the rest of the world purchases more goods and services, and fewer assets from the US.
  5. I don’t talk about it often, but when it comes up, I have to mention that municipal pensions in the US are generally in horrid shape. The Barron’s article focuses on teachers, but other municipal worker groups are equally bad off. The article comments on perverse incentives in teacher retirement, which leads older teachers to retire when it is feasible to do so. For older teachers, I would not begrudge them; they weren’t paid that well at the start, and the pension is their reward. Younger teachers have been paid pretty well. I would not expect them to get the same pension promises.
  6. I like Japan. I own shares in the Japan Smaller Capitalization Fund [JOF]; it’s my second-largest position.

    Japan is cheap, and small cap Japan is even cheaper. I would expect a modest bounce on Monday.

  7. We still need a 15-20% decline in housing prices to bring the system back to normal. There might be an undershoot in price from the sales that forced sellers must do. Hopefully it doesn’t turn into a self-reinforcing decline, but who can be sure about that? At that level of housing prices, man recent conforming loans will be in trouble, much less non-conforming loans.


Full disclosure: long JOF

Book Review: What Works on Wall Street

Book Review: What Works on Wall Street

This book was really popular in 1996, when it was published. James O’Shaughnessy gained access to the S&P Compustat database, and tested a wide variety of investment strategies to see which ones worked the best over a 43-year period. Unlike most books I will review at my site, this one does not get wholehearted approval from me. My background in econometrics makes me skeptical of some of the conclusions drawn by the book. There are several valuable things to learn from the book, which I will mention later; whether they justify purchase of the book is up to the reader.

My first problem is the title of the book. It should have been titled “What Has Worked on Wall Street.” Many analyses of history suffer from the time period analyzed. The author only had access to data from a fairly bullish period. Had he been able to analyze a full cycle that included the Great Depression, he might have come to different conclusions.

My second problem is that he tests a number of strategies that should yield similar results. One of them will end up the best — the one that happened to fit the curiosities of history that are unlikely to repeat. (That’s one reason why I use a blend of value metrics when I do stock selection. I can’t tell which one will work the best.) The one that works the best just happens to be the victor of a large data-mining exercise. Also, when you test so many strategies, and possibly some that did not make it into the book, the odds that the best strategy was best due to a fluke of history rises.
Now, what I liked about the book:

  1. Combining growth and value strategies produced the best risk-adjusted returns. The growth and value strategies that did the best embedded a little value inside growth, and a little growth inside value.
  2. Avoiding risk pays off in the long run, for the most part. If nothing else, one can maintain the strategy after bad years.
  3. Value and Momentum both work as strategies. They work best together.
  4. He did try to be statistically fair, avoiding look-ahead bias, diversifiying into 50 stocks, avoiding small stocks, and rebalancing annually.

Now, two mutual funds based on his “cornerstone growth” and “cornerstone value” strategies have run since the publication of the book. The value strategy has not worked, while the growth strategy has worked. Go figure, and it may reverse over the next ten years.

Now for those that like data-mining, and don’t want to pay anything, review Tweedy, Browne’s What Has Worked in Investing. This goes through the main factors that have worked also. Theirs are:

  1. Low P/B
  2. Low P/E
  3. Net Insider Buying
  4. Significant Declines in the Stock Price (anti-momentum)
  5. Small Market Capitalization

Either way, pay attention to value factors, and if you trade often, use momentum. If you don’t trade often, avoid momentum.

Book Review: Triumph of the Optimists

Book Review: Triumph of the Optimists

Good investors are typically skeptical. They don’t buy every idea that comes their way, but they test and probe to find ideas with compelling value that are misunderstood by others. That said, the best investors are prudent risk-takers. They continue to search for good investments even in environments that seem to have a negative investing climate.

Skepticism can degenerate to permanent pessimism, particularly because most news coverage tends toward the negative. How does an investor remain bullish in the face of news flow that is predominantly negative? By looking at the broader tendencies of equity markets to flourish in the face of troubles over the long run. One good book for that is Triumph of the Optimists. [TOTO]
TOTO points out a number of things that should bias investors toward risk-bearing in the equity markets:

  1. Over the period 1900-2000, equities beat bonds, which beat cash in returns. (Note: time weighted returns. If the study had been done with dollar-weighted returns, the order would be the same, but the differences would not be so big.)
  2. This was true regardless of what presently developed nation you looked at. (Note: survivor bias… what of all the developing markets that looked bigger in 1900, like Russia and India, that amounted to little?)
  3. Relative importance of industries shifts, but the aggregate market tended to do well regardless. (Note: some industries are manias when they are new)
  4. Returns were higher globally in the last quarter of the 20th century.
  5. Downdrafts can be severe. Consider the US 1939-1932, UK 1973-74, Germany 1945-48, or Japan 1944-47. Amazing what losing a war on your home soil can do, or, even a severe recession.
  6. Real cash returns tend to be positive but small.
  7. Long bonds returned more than short bonds, but with a lot more risk. High grade corporate bonds returned more on average, but again, with some severe downdrafts.
  8. Purchasing power parity seems to work for currencies in the long run. (Note: estimates of forward interest rates work in the short run, but they are noisy.)
  9. International diversification may give risk reduction. During times of global stress, such as wartime, it may not diversify much. Global markets are more correlated now than before, reducing diversification benefits.
  10. Small caps may or may not outperform large caps on average.
  11. Value tends to beat growth over the long run.
  12. Higher dividends tend to beat lower dividends.
  13. Forward-looking equity risk premia are lower than most estimates stemming from historical results. (Note: I agree, and the low returns of the 2000s so far in the US are a partial demonstration of that. My estimates are a little lower, even…)
  14. Stocks will beat bonds over the long run, but in the short run, having some bonds makes sense.
  15. Returns in the latter part of the 20th century were artificially high.

The statistical chapters on the 16 developed markets are amazing, but now almost seven years dated. Still, you can glean a lot from them.

This is an expensive book, and one that may not be for everyone. A cheaper book that covers many of the same issues is Stocks for the Long Run, by Jeremy Siegel. Now going into its fourth edition (I have a signed first edition), it covers many of the same issues, but with more of a US-centric approach, and going back another 100 years (with spotty data).

As I like to say, stocks do well, absent war on your home soil, out-of-control socialism, and severe recession/depression. These books will help you stay in the market even when times are hard. After all, who can tell when the market will turn up? Or down?

Dimson, Marsh and Staunton

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Jeremy Siegel

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Book Review: The Intelligent Investor

Book Review: The Intelligent Investor

Fifteen years ago, my mom gave me a book that would change my life: The Intelligent Investor, by Benjamin Graham. Prior to that time, I was primarily investing in mutual funds, and did not have a coherent investment philosophy. The Intelligent Investor provided me with that philosophy.

What are the main lessons of this book?

  1. Don’t overinvest in equities. Markets wash out occasionally, and it’s good to have some bonds around.
  2. Don’t underinvest in equities. Bonds can only do so much for you, and it is good to deploy capital into equities when they are out of favor.
  3. Stocks provide modest compensation against inflation risks.
  4. Avoid callable bonds. Avoid preferred stocks.
  5. Be conservative in bond investing. Read the prospectus carefully. Often a bond is less safe than one would expect, and occasionally, it offers more value than one would expect.
  6. Purchase bargain issues on a net asset value basis when you can find them, but be careful of quality issues.
  7. Volatility of stock prices can be your friend if you understand the underlying value of a well-financed corporation.
  8. Having a longer-term investment horizon is valuable, because one can take advantage of short-term fluctuations in price.
  9. Growth is worth paying up for, but be disciplined. Don’t overpay.
  10. Be wary of mutual funds.
  11. Be wary of experts.
  12. Pay attention to the balance sheet; don’t invest in companies that are inadequately financed.
  13. Review average earnings of cyclical companies.
  14. Buy them safe and cheap. Don’t overpay for growth and trendiness.
  15. Avoid highly acquisitive companies.
  16. Watch cash flow, and question unusual accounting treatments.
  17. Be careful with unseasoned (new) companies.
  18. Strong dividend policies, in companies that can support the dividends, are an indicator of value.
  19. Aim for a margin of safety in all investing.

That’s my quick synopsis of the book. Though I am not a strict Graham-and-Dodd investor (who is?), I apply the basic principles to most of what I do. This is still a relevant book today because the principles are timeless. If you want the updated version with writing from Jason Zweig, that’s fine. You gain in current relevance, and lose a little in nuance. Graham was a very bright guy. I give Zweig credit for trying, but aside from Buffett or Munger, who would really be adequate to revise The Intelligent Investor? I don’t think I would be adequate to the task….
Classic:

As Revised by Jason Zweig:

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