Asset Allocation – Page 13

Using Investment Advice, Part IV

Posted on 18 August 2012 by David Merkel

My last point on investment advice is to think long-term and treat it as a business.? You are trying to buy underpriced cash flow streams.

Because it is a business, you must focus on the long term, and downplay short cycle information.? Don’t let the media scare you or make you greedy.? There are bumps and jolts in all investing.? Keep your eyes on the long term.? Always ask yourself when reading news, “What is the long-term effect on profitability?”? Often good companies have bad quarters or years.? The same is true of bad companies having good years.? Look at the long-term profitability, and downplay the short-term noise.

By short-term noise, I largely mean the media.? That includes the web, and those that tout stocks on a short-run basis. There are several problems here:

1) Media investment advice (and that from Wall Street as well) is biased toward buying.? Articles will give you a list of stocks to buy either generally, or in a given industry.? The biggest problem is that they won’t generally follow up on their recommendations, nor will they tell you what the time horizon is for the recommendation, or what catalyst should lead you to sell.

2) You will not see many articles offering a list of stocks to sell.? There are several reasons for this: a) most readers have some cash, which they could use to buy stock.? Most readers do not own the stocks that one might suggest to sell, so unless readers are enterprising enough to sell short, which even fewer are willing to do, your article is of little value to the average person. b) Do you want the possibility of a lawsuit?? Unlikely, but could happen. c) If you rely on advertising, do you want the reputation of shooting companies down?

There is an even bigger reason behind this: the world is designed to be 100% long.? That is the norm.? Shorting is a side-bet.? Even holding cash is a side bet, trusting in the veracity of a central bank that mostly has claims on the taxation power of the government.

3) Most people in the media are not investors.? As journalists, they have to be neutral.? At least there has to be significant disclosure of interests.? Readers should ask themselves, “What does this writer know that I don’t?? Who disagrees with him?”? In good investment shops, they have a process where they challenge opinions.? Rarely do you see that in the media, where two parties present opposite opinions.

4) Even when professionals go on the air or on the web, be skeptical.? (This includes me.)? They may have an interest to mention stocks that are close to their “Sell” level, but they will not mention companies that they are currently acquiring.? Hey, I went through that when writing for RealMoney.? I could write about things only once we had our full position on.? It is normal for firms to not allow their employees to write, ever.? It is second most normal to allow them to write only when the firm’s interests are not affected.

5) There’s no measurement process, no feedback when people give investment advice in the media.? They seem more credible when they are on the Web, TV, Radio, but does that really make them more competent?? It does make them more marketable.

6) Investing is best when it is businesslike.? Good opinions take a lot of time to form within investment firms.? If anyone can do the “lightning round,” Cramer can.? But good investing isn’t typically snap decisions, so we should not give a lot of credence to anyone’s off-the-cuff remarks.

7) Remember, few people writing/speaking on investments are doing you favors.? They have their agenda.? Some make it clearer, like me, and others don’t.? Be aware, you are your own best defender.

8 ) Few writers will urge caution on asset allocation because it is a boring topic, and besides articles on bonds don’t sell.? People read advice that excites, not that which preserves safety, at least not to the same degree.

9) One last note, good value investing is usually boring.? There may be some interesting tales, but who will be good/talented enough to do all of the research and spill it for free?? There are uses for such a person that pay more.

This probably ends my series on Investment Advice, but feel free to send questions, ideas, etc.? Thanks for reading this.

Book Review: Moods and Markets

Posted on 11 August 201213 August 2012 by David Merkel

To my readers: this is the second time I have written this review. When I pushed the “publish” button earlier this evening, WordPress ate the document. That’s never happened before, so I did not have a backup. As a result, this review is entirely different than the prior one, and I did it using DragonDictate, so it may sound a little more colloquial than other reviews of mine. Let me know what you think, and if you like my reviews please vote them up at Amazon. As always, whether you agree or not, thanks for being a reader of mine.

This book is about the questions every investor wants answers to:

Why do I tend to get into and out of the market at the wrong times?
Why are professionals prone to the exact same problems?
Why do financial crises happen?
Is there a way to approximately measure where we are in the overall market cycle?

The author has a theory that he calls “Horizon Preference.” Think of it this way: when the market is near bottom, market players have very short time horizons for investment. They hide in cash. More than that, they choose very generic investments; they stay close to home and keep things simple. Fear drives them back to what they know always works in the very short run, which means any opportunity for gain is lost.

At such a time, only the most risk tolerant and experienced remain holding risky assets. Valuations are low. The party is over, the young have left, and the old guys are cleaning up the room. If you look in a financial newspaper, or out on the web, the headlines you read are pervasively negative. But at a true bottom, you’ll see that things have stopped getting worse.

Then optimism begins. It’s a fitful at first. It is two steps forward and one step back, before it becomes three steps forward and one step back, before it becomes an unrelentingly good trend. But as this happens, moods, headlines, move from disbelief, to doubt, to wonder, to optimism, and to greed. As this happens, market players expand their horizons. They are willing to take on new risks, with new instruments, and in new places. They are willing to pay remarkably higher prices for risky assets. This happens with individual investors, professional investors, bankers make loans, regulators, accountants who have to make the numbers for management, etc.

At the top everything is wondrous. Nothing can go wrong. At the top, the attitude is “We are going to make a lot of money.??It?s as if money is free, and anyone can make it in the markets now. Everyone can be rich, just invest in the market. All of the neophytes are playing in the market. The experienced professionals who have seen a few market cycles have begun to edge out of the market, if not raise significant cash. Risk control is derided as a way of losing money. Real heavy hitters don’t need risk control.

All of the discretionary cash is applied to the markets. Various forms of leverage are applied to personal investments, real estate, and business investments. Because everyone knows things are going to go well, they figure they may as well play it to the hilt.

But at the top, things stop getting better. Then pessimism begins.? It’s a fitful at first. It is two steps back and one step forward, before it becomes three steps back and one step forward, before it becomes an unrelentingly bad trend.? Sadly, during the phase of pessimism, things move down about twice as fast as they went up. It’s frightening, and it should be. Bear markets tend to persist until the bad ideas and investments of the up cycle are liquidated, unless the government steps in to arrest the fall.

The planning horizons of businessmen and investors shrink, as do valuations, until we hit the bottom, and the cycle starts again.

What I have described to you is the basic framework of the book. The author then applies that framework to the housing bubble, the possible higher education bubble, changes to accounting frameworks as rising preferences change, and where we are today in the markets. He gives a tour of the various phenomena inside corporations that take place at different points in the cycle. Optimism breeds complexity, lack of risk management, concept stocks, big projects, and a lot of credit. Pessimism breeds simplicity, renewed risk management, and bankruptcies.

This book will give you a feel for what part of the market cycle we’re in, and how you can profit from it. It is not math intensive; the book has no equations. There are a lot of graphs, but they are simple to understand.

Quibbles

In one sense, this book is about the credit cycle, and how it affects all risky assets. But it is couched in the language of how moods change of market participants, which then drives the market. My view of the matter is slightly different. I see market players making estimates of their future well-being, and as that estimate changes, so do their moods change, and the prices of risky assets. I don’t think this is a big difference from what the author is saying, so I heartily endorse this book.

Who would benefit from this book:?? Inexperienced investors would definitely benefit from this book. Experienced investors who are having a hard time with the unpredictability of the market of late would also benefit.? If you want to, you can buy it here: Moods and Markets: A New Way to Invest in Good Times and in Bad (Minyanville Media).

Full disclosure:?I got this book in a weird way. I don’t know the author, but we have a mutual friend, and he suggested to the publisher that he send me a copy of the book. That’s how I got it.

If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.

Sorted Weekly Tweets

Posted on 10 August 2012 by David Merkel

Life Insurance Secondary Guarantees

Hartford Mulls Client Buyouts to Cut Risk Buffett Called Ungodly http://t.co/Nv4jRlUC Advice: don’t take the Variable Annuity buyouts $$ Aug 10, 2012
The original: Buffett Says Insurers Took ‘Ungodly Amount of Risk’ http://t.co/pXfXv8ME Warren Buffett again is prescient cc: @PlanMaestro $$ Aug 10, 2012
@PlanMaestro Thanks4 flagging this. Together w/companies scaling back gtees 4 new prods, the buyout offers show the probs in the life biz $$ Aug 10, 2012
@PlanMaestro I am not in favor of peer review. Actuaries call themselves a “profession,” but they really technicians. Aug 09, 2012
@PlanMaestro Regulators not crazy for this, because they can’t understand it, & almost makes the companies self-regulating. Peer Review? $$ Aug 09, 2012
@PlanMaestro But actuaries are trying to get regulators to cmove to a Canadian-style principle based approach. In Actuaries we Trust! $$ + Aug 09, 2012
@PlanMaestro But the devil is in the details, and GAAP reserving does not always reflect antiselection. Stat tries to do that, but + $$ Aug 09, 2012
@PlanMaestro But you’re right, the 10Ks do contain approximate partial sensitivity data on economic value for most important variables $$ Aug 09, 2012
@PlanMaestro In 1999, I saw a VA that guaranteed 7% minimum return if held till death or annuitization $$ Aug 09, 2012
@PlanMaestro I said “Wow, how do you guarantee the better of 5%/yr and performance of the underlying 4 just 2.25%?” $$ Aug 09, 2012
@PlanMaestro I have a friend who is a $PRU agent. One day he showed me his hottest-selling VA product, and ask me how I liked it. $$ + Aug 09, 2012
@PlanMaestro Acctg can get really screwy if you hedge NPV or FMV; gets really noisy because the results pile up in the current year $$ Aug 09, 2012
@PlanMaestro hedging long-dated options, w/complex contingencies built into them. Do you hedge next few years, or NPV sensitivity? $$ + Aug 09, 2012
@PlanMaestro I was an ALM actuary for many years, typically we hedged partial durations; fixed income hedging is easy, what’s hard is $$ + Aug 09, 2012
@PlanMaestro many exposures are impossible to hedge b/c the contracts r long-term, and hedge instruments r usually far shorter $$ Aug 09, 2012
@PlanMaestro That’s one of my concerns about the life industry; secondary guarantees r virtually impossible to reserve, getting big now $$ Aug 09, 2012

Insurance Industry

@ReformedBroker Good post, same thing happens with young life insurance agents to a degree http://t.co/LbMyo48G $$ Aug 10, 2012
@Bonfire_Sherman P&C – P/TB vs ROTE, adjusted 4 business mix, reserve life & conservatism, mgmt quality, U/W cycle, never premiums $$ Aug 09, 2012
@Bonfire_Sherman Most of it is change in required capital. Life actuaries typically calculate “distibutable earnings” reflting stat & RBC $$ Aug 09, 2012
Anytime anyone talks about Financial Cos & tells u about Free Cash Flow, ask how they did the calc. C if they mention chg in req capital $$ Aug 09, 2012
Wrong: 3 Life Insurance Stocks Undervalued By Levered Free Cash Flows http://t.co/gF5HYRZb GAAP financials don’t have data4 FCF calcs $$ Aug 09, 2012
Aviva profits fall as it cuts the value of its US unit http://t.co/t816IjAZ Amerus IR was annoyed @ me 4saying the orignal deal expensive $$ Aug 09, 2012
@PlanMaestro HIG is next on my list Aug 09, 2012
@PlanMaestro Thanks, I know where to get them, but I have enough GNW on my plate for now, I took me two weeks to write my AIG piece. $$ Aug 09, 2012
@PlanMaestro Have not looked at HIG, after I am done with GNW may take a look. If u r looking at stat acctg, look @ pg 5 indiv annuities $$ Aug 09, 2012
@PlanMaestro That’s the thing, like AIG prior to the crisis, and Scottish Re, they are capital constrained; things have 2go right 4 them $$ Aug 09, 2012
@PlanMaestro & not so sure about the rest if investing for more than five years. $$ Aug 09, 2012
@PlanMaestro Aye, agreed. Oddly, my interest stemmed from a reader who asked me if I would invest in GNW bonds. Yes 4 GIC-MTNs + Aug 09, 2012
@PlanMaestro I’m going to write a broad piece about it, but follow it up, with a narrow piece focusing on the specific problems. $$ Aug 09, 2012
@PlanMaestro Intercompany surplus notes and preferred stock too. Aug 09, 2012
@PlanMaestro There’s a ton. Underreserving, capital stacking, capital interlacing, intercompany reinsurance, & I’ve ony been looking 2 hours Aug 09, 2012
@Bonfire_Sherman Good guess, I need to look at the life co stmts someday, esp. page 5 for Indiv annuities Aug 09, 2012
Ding! We have a winner! RT @RennieScinto: @AlephBlog gnw? Aug 09, 2012
I’m a fun guy, looking @ statutory statements of a major US insurer, though AIG in 2008 looked worse, this company doesn’t look good $$ Who? Aug 09, 2012
Online Dating for Homes Stumps Insurers http://t.co/R2fmztPa Y not have both deposit $$ w/the insurer plus a premium payment? #wouldwork Aug 08, 2012
Regulators Probe ‘Captives’ http://t.co/xbXQ5aYO How to bend life insurance reserves. Catch my comment: http://t.co/9WQWYZ3W $$ Aug 06, 2012
Berkshire Trims Municipal-Debt Bet http://t.co/9zhhbdtD Meredith Whitney, no. Buffett, yes. But even he is only selectively reducing $$ Aug 05, 2012

Poway School District

Article near issuance of Poway School District CAB http://t.co/kxAWCNxT Letter from CA AG: http://t.co/UiZM0j3K cc: @munilass @jamessaft $$ Aug 06, 2012
@jamessaft I’m not a muni expert like @munilass, but no, I would try to find another way to refinance prior debts. $$ Aug 06, 2012
Ideal buyer4the preceding bond would b Buffett, or a P&C company w/long-tail liabilities. Prospectus 4 wonks only http://t.co/nIKJvJje $$ Aug 06, 2012
Where Borrowing $105 Million Will Cost $1 Billion: Poway Schools http://t.co/IPaABoXY Paying 7.6% IRR at a duration of 25. Astounding! $$ Aug 06, 2012
@munilass Also, I found the prospectus here: http://t.co/nIKJvJje Last Q: Do county tax levies into a sinking fund ever fail to work? $$ Aug 06, 2012
@munilass I get the holder taxes now. Poway was structured as a series of zero coupon notes, followed by 2 series of long lottery bonds $$ Aug 06, 2012
@munilass Used to be an asset-liability manager, so I look for that. 1 question: do you know how holders are taxed on a deal like that? Aug 06, 2012
@munilass This is just a crude estimate, but the IRR on the Poway deal is around 7.7%, and is nonrefinancable. Duration estimate 25 years $$ Aug 06, 2012

Rest of the World

China Export Growth Slides as World Recovery Slows http://t.co/u4YEUPQB China sneezes & the world catches a cold? no, important anyway $$ Aug 10, 2012
India?s Biggest Corporate Loss Shows Singh?s Dilemma on Deficit http://t.co/6xl7lsZD Force oil company to lose $$, eventually lose oil co. Aug 10, 2012
Housewives With Frying Pans Protest Japan Tax Hike as Debt Soars http://t.co/z3aeqjEv Taxes to double; can’t keep borrowing 4ever $$ Aug 10, 2012
Virus found in Mideast can spy on finance transactions http://t.co/V2GgyjpV Can spy on financial transactions, email & social networking $$ Aug 09, 2012
Toronto Condo ?Roller Coaster? Peaks as Flaherty Acts http://t.co/c6sJ0CqE Is Canadian housing a basketball (sss) or a bubble (pop)? $$ Aug 08, 2012
Iran?s Big Crisis: The Price of Chicken http://t.co/WXlUIIdL Describes some the economic difficulties of Iran under sanctions $$ Aug 08, 2012
Article makes a good point. The industries where China has overcapacity are power-intensive & are shrinking. Simple. http://t.co/IzyV0Bxe Aug 08, 2012
China’s answer to subprime bets: the “Golden Elephant” http://t.co/MP7LviwT Illiquid investments touting high returns w/lousy business $$ Aug 07, 2012
RE: Things are getting less equal in the US, because we allow more freedom here.? Globally, things are getting more e? http://t.co/WeGEEJF9 Aug 07, 2012
Presidential candidate up by 15%+ in August will win. If merely ahead, 9 times out of 12 he will win the Presidency http://t.co/soCj7Kf9 Aug 08, 2012
Swiss Banks Face Slow Death as Taxman Chases Assets http://t.co/13I9NkiQ Life’s tough when u can no longer help people cheat the taxman $$ Aug 06, 2012
Germany has the most to lose from a meltdown http://t.co/9JTwRfii Basically encourages an inflationary “solution.” Prob won’t work $$ Aug 06, 2012
If policymakers are worried about this, they are worried about the wrong thing. EU does not have that big… http://t.co/eCBlZg5I Aug 06, 2012
Summary: greater structural unity, mutualization of sovereign debts and a weak euro $$ Tough order for the… http://t.co/KN9pc0Pt Aug 06, 2012
Rogoff Sees World Wishing It?s America Year After S&P Downgrade http://t.co/MpStm7ww Relative flexibility pays off $$ Aug 06, 2012

Fixed Income

Lending in the offshore markets developed because of bad regulations here. It is outside US control & we should not m? http://t.co/C8y9rVFw Aug 10, 2012
In hunt for yield, hybrids flourish anew http://t.co/GCugG6A6 Credit rally revsup ppl grab yield in exchange 4 higher poss loss severity $$ Aug 09, 2012
Please, no $$ RT @CapitalCityIFR: In hunt for yield, hybrids flourish anew http://t.co/ZWbdRRl5 Aug 09, 2012
For a bad 30-yr Tsy auction, nice rally since then $$ Aug 09, 2012
A Greek banker, the Shah and the birth of Libor http://t.co/ibvVs9mE ht: @alea_ Started w/a loan 2 the Shah. Inauspicious start 4a big # $$ Aug 09, 2012
Definitely a weak auction, surprised long end not selling off $$ RT @ritholtz: 30 yr bond auction weak as well http://t.co/1gU89HMb $$ Aug 09, 2012
“Credit default swaps are easily manipulated. Rather, watch the bond market; it’s much bigger. $$” ? David_Merkel http://t.co/tESmTJsK Aug 09, 2012

Politics

The Neocon War Against Robert Zoellick http://t.co/vZreHf1n If Romney wins, pragmatic Zoellick could be influential on foreign policy $$ Aug 11, 2012
Christie Does Tenure http://t.co/J8krPlim Tenure is one of those sacred cows that hides the intellectually weak from consequences $$ Aug 10, 2012
In New York City, Microsoft Really Is Watching You http://t.co/trNOkU2d Interesting partnership w/NYC & $MSFT Civil liberties? $$ Aug 09, 2012
Postal Service $1 Million-an-Hour Loss Puts Abyss in View http://t.co/FVXMn5Di Raise stamp prices & costs 2 $FDX & $UPS $$ #simple Aug 09, 2012
Here’s The Real Reason The Feds Are Furious At The NY Regulator Going After Standard Chartered http://t.co/OmpwBILH Made Feds look dumb $$ Aug 08, 2012
RE: @bloombergview Dream, the Republicans will block this because it favors blue states over Red. $$ http://www.bloom? http://t.co/jT7EmSS0 Aug 08, 2012
I think it is a fair tradeoff to lose 2% of GDP in 2013 in order to get the economy growing. I agree with… http://t.co/mwuvnogX Aug 07, 2012
The Numbers Inside a Hot-Button Issue http://t.co/Fwois4YN Something to make everyone unhappy. Me: Don’t focus on rates, but deferral $$ Aug 07, 2012

Pensions & Endowments

State Pensions Get High Fees, Low Profits-Study http://t.co/3LRIL23c Add to that the lack of adequate funding &you have a serious crisis $$ Aug 10, 2012
Cornell, MIT Scale Back Aid Even as Endowments Rise http://t.co/WUoWDLLB Endowments provide less when rates r low, future cashflows smallr Aug 10, 2012
Defined contribution assets hit all-time high despite conservative shift http://t.co/7s9Stabd Amazing 2c bond alloc rising w/low rates $$ Aug 06, 2012
U can say that again $$ RT @e_d_sanders: @AlephBlog now this is an issue I know something about. Public pensions for execs are a nightmare Aug 05, 2012
Police Chief?s $204,000 Pension Shows How Cities Crashed http://t.co/ZorpuSjX Sloppy pension negotiating leads2 L-T cash flow crises. $$ Aug 05, 2012

Energy

Let the market decide.? If people want to pay a lot for gas, let them.? Why is Obama discouraging consumer spending? http://t.co/VT8xCyU0 Aug 10, 2012
Refiners Awash in Shale Oil Offer 10 Times Exxon Returns http://t.co/IIw9xXlb Buy cheap shale oil, ship to coasts, refine, sell & make $$ Aug 10, 2012
Louisiana sinkhole roils local natural gas network http://t.co/IkZxHLAs Now, who could have seen that coming? Risk is pervasive. $$ #sloorp Aug 09, 2012
Coal stocks typically have a lot of debt, beware $$ RT @MKTWBurton: Don?t mine this coal stock – Chuck Jaffe – http://t.co/nCQWfYzQ Aug 09, 2012

Other

Passed 10,000 tweets today. I quit Twitter after my first month, but came back to it after I saw its usefulness. Thanks 4 reading me $$ Aug 10, 2012
Heavy rain in Baltimore w/sleet and sunshine. Really weird weather. Sleet is neat, is hard to beat & will repeat, to make me tweet. $$ #ugh Aug 09, 2012
After Moods & Markets, Bailout is my next book to review. http://t.co/zkioUQ5N Aug 09, 2012
5 Questions Great Job Candidates Ask http://t.co/JpnpVWtu Questions show initiative, intelligence, & give u good jump pts 2 sell yrself $$ Aug 09, 2012
Novel Cure for Ailing Hearts http://t.co/RAiv4FYj Nanotech combines w/vascular endothelial growth factor to grow new heart muscle $$ Aug 09, 2012
Wrong: Business Is Booming in Empirical Economics http://t.co/aTNu4qfu U might get cute papers out of it, but nothing that generalizes $$ Aug 07, 2012

Companies

Yahoo Reviewing Business Strategy, Alibaba Proceeds; Shares Tumble http://t.co/ikk3dpeC Marissa Mayer has plans, & they require $$ Aug 09, 2012
Why Honda?s New Accord Looks Like the Old One http://t.co/6Ez8uL5i FD: + $HMC Designers tire of their designs long b4 users do $$ Aug 09, 2012
The WARN Act dilemma http://t.co/ilbxFsXD Defense, Fiscal cliff, DOL Guidance Letter saying ignore WARN act on 11/1, & elections $$ Aug 09, 2012
Hewlett-Packard?s Whitman Dismantles Hurd-Era Empire http://t.co/ySeeVM9w FD: + $HPQ She seems 2b evaluating each biz separately $$ #good Aug 09, 2012
The New York Times Is About to Say Goodbye to About,com http://t.co/frzrVlUq gives more details on the lossesv$$ Aug 08, 2012
New York Times Shares Rise on Deal to Sell About,com http://t.co/k5GarxXV Amazing how much $NYT lost on it, capital losses, neg income $$ Aug 08, 2012
Judge in Google, Oracle case seeks names of paid reporters, bloggers http://t.co/7vhmK5N3 Fascinating 4bloggers 2b paid $$ by corps quietly Aug 08, 2012
I do not get how http://t.co/ROsNYak3 could be worth $270M. What’s the revenue model? Ads? $$ http://t.co/n1ddWxvU Aug 08, 2012
Wrong: The PC looks like it’s dying http://t.co/IqeVAbi6 Like most tech, when it matures, it finds & stays there. Think of “dead” radio $$ Aug 07, 2012
Amazon Is No Wal-Mart…Yet http://t.co/cmEjPHHu Relatively neutral article on $AMZN by Martin Sosnoff; prob: treats AMZN as retailer $$ Aug 07, 2012
Why FedEx and UPS Want the Postal Service to Survive http://t.co/MAaCfOXQ Solution: raise stamp prices, and prices to $FDX and $UPS $$ #easy Aug 05, 2012

Monetary Policy

Fisher Says More Stimulus May Overburden Central Banks http://t.co/5ZMlKO5G 3-time winner of coveted “FOMC loose cannon award” speaks $$ Aug 08, 2012
Economic Musings – Fed eyeing a new kind of twist? http://t.co/aUezU2XE $$ Extending duration in MBS; creating larger losses later $$ Aug 08, 2012
RE: @bondtrader83 That’s not all that much different than the 1st Twist. It’s duration extension in MBS. Wait till ra? http://t.co/PrMHBSGh Aug 08, 2012
How about quantitative easing for the people? http://t.co/inHK9NF2 Would work better than current QE/Twist etc, but this frightens me. $$ Aug 08, 2012
Wrong: Bernanke to Economists: More Philosophy, Please http://t.co/9638QlHo Been down this road; utility theory doesn’t explain mankind $$ Aug 07, 2012

Housing & Related

Public-Housing Parking Lots Make Everyone Poorer http://t.co/2gensCd8 Set rates to achieve 15% vacancy; Rather than lots, have garages $$ Aug 08, 2012
Home Prices Climb as Supply Dwindles http://t.co/hMoZBsNZ Good news for the low end of the market, high end will take time $$ Aug 08, 2012
Fannie Mae profits rolled into rainy day fund http://t.co/bDWphSuE Good for Fannie & Freddie preferred, not worth anything 4 the common $$ Aug 08, 2012

Financial Companies & Markets

NYSE in talks with SEC to settle data probe http://t.co/FkxBtlbz Wow, faster data feeds 4 some special clients; level the playing field $$ Aug 09, 2012
Are Diamonds an ETF?s Best Friend? http://t.co/RHbSghCw Bad things happen when you take something illiquid and try to make it liquid $$ Aug 08, 2012
Richest Family Offices Seeing Fastest Growth as Firms Oust Banks http://t.co/NqY9650P UberWealthy get $$ talent; tax savings >> costs Aug 07, 2012
4 ETF Lessons From Knight http://t.co/st6wbNgR Lead Market Makers matter, Markets Work, Settlement Works, Illiquid ETFs Need Helpers $$ Aug 06, 2012
Other problem: active etf gives away trading information it might rather not divulge, leading to front-running. $$ http://t.co/q4XXZwRv Aug 06, 2012
A Tale of Two Fund Giants: American Funds vs Vanguard http://t.co/46rFsL9e Key advantage for Vanguard was embracing ETFs early $$ Aug 06, 2012

Repos

Banks? Liquidity Hinges on Risky Assets http://t.co/45Iw5Dz9 Repo lending is subject2runs during credit panics which depress collateral $$ Aug 08, 2012
Good one $$ RT @pdacosta: Watch out for the grim repo-er RT @cate_long Banks? liquidity hinges on risky assets http://t.co/9lk0GjA0 Aug 08, 2012
The danger of repo http://t.co/mZDG9Ocb Repo is weak financing in crisis; 3-mo T-bills would b a better index 4 Tsy floating rate notes $$ Aug 06, 2012

The Equity Premium

That would get the advantage of stocks over high quality bonds down to ~1-2%/year. Outperforms with a *lot* of noise $$ Aug 11, 2012
Bill Gross Is Wrong About Stocks: GMO http://t.co/c6gJwfUB Truth inbetween; have GMO adjust 4 $$ -weighted returns, not time-weighted Aug 11, 2012
Bonds for the Long Run http://t.co/MmkoYk3U @ritholtz nails it. Advantage of stocks over bonds is ~1%/yr over the long haul. Limited data $$ Aug 10, 2012

Comments

@LDrogen After reading this, I have more certainty that airbnb has already worked out some of the bugs http://t.co/Xx3ztVZv $$ Aug 10, 2012
@LDrogen Fine, Leigh, I hope it works. When single party lending gave way to securitization, it was unstoppable, until lending stds died. $$ Aug 10, 2012
RE: @ldrogen Multiple party economic dealings have their issues.? Consider: http://t.co/Z2rRNeTS? http://t.co/gCrEYzX2 Aug 10, 2012
‘ @TheOneDave In a word: depletion. Costs are rising to incremental barrels of oil, and ounces of gold. $$ Aug 09, 2012
@PlanMaestro $CLD LTD/E ~89%, take a look at $HNRG Hallador Energy. I’m not looking @ coal names until I see a few go BK, like steel 2002 $$ Aug 09, 2012
@PragCapitalist Depends on slope of demand curve 4 Tsys. Compare it2the former on-the-run. Jump of 6 bps high for that spot on the curve $$ Aug 08, 2012
@groditi Effective Yield series. Was trying to show that junk yields don’t compress as much when HQ-yields are low. Would have liked OAY $$ Aug 08, 2012
@PragCapitalist If it gets enough assets to survive $$ Aug 08, 2012
@footnoted …and maybe adjs for a year, but large writeoffs mean that prior earnings were overstated; testifies to bad mgmt quality $$ Aug 08, 2012
@footnoted That’s one reason why I tell investors to look at LT growth in BV + Divs rather than op income. I accept adjustments 4 a qtr + $$ Aug 08, 2012
RE: @bloombergview The single period cost to fix might be small, the continuous transfer cost would be considerably l? http://t.co/9gyFVvh4 Aug 08, 2012
RE: @bloombergview When games change from two players to three players, things get messy if no single player has most? http://t.co/TU09OZml Aug 08, 2012
Most pessimistic he’s been on China debts RT @groditi: Wow. I’m used to Pettis’ Euro-pessimism, but he’s not holding back here. U MAD, PROF? Aug 07, 2012
Always a great read RT @groditi: yaaaaaay new Pettis! Aug 07, 2012
@AnaCapMgmt Ain’t true. The foolish models of economists do not take into account political realities, and when inflation runs, no ammo. $$ Aug 05, 2012
@LisaCNBC Ask him how confident he is in India’s power grid. After that, the water supply. $$ Aug 05, 2012
‘ @pvitha Gold moves inversely to real interest rates, a.k.a. cost of carry, that’s all I know. $$ Aug 06, 2012
‘ @WTOP Romney shouldn’t worry about the Fed; they are out of ammo. QE is a joke, as is Operation Twist, and forward fed funds guidance. $$ Aug 05, 2012
+1 I like to say that 🙂 RT @BarbarianCap: “there are more debt claims than resources to pay them at par” Aug 05, 2012

Retail Investors and the Stock Market

Posted on 7 August 2012 by David Merkel

I’ve seen a spate of articles lately on retail investors abandoning the stock market. Here’s a sampling:

Cult Figures — Bill Gross
Stock bulls have a beef with Bill Gross — Jonathan Burton
Why Are Investors Fleeing Equities? Hint: It?s Not the Computers — Andrew Ross Sorkin
Small investors vs high-speed traders — Felix Salmon
AMERICAN IDLE: FIVE REASONS WE HATE THE STOCK MARKET — Josh Brown

I chose these because I think they add to the discussion.? In general, I think there are a decent number of retail investors, that have left the markets, or reduced their exposure.

But I saw this back in 2002, when I saw many friends leave the stock market because of the losses they were taking.? Several said to me, “I am going to invest in what I know — I’m sticking with real estate.”? I winced and stuck with stocks, and had phenomenal performance in 2003.? I paid off my mortgage, and considered selling my house in 2005, but I realized for me, a house is not an investment — it’s a place to live.

After 2008, more people concluded the stock market was rigged.? Why?? Because they lost money, and that couldn’t be their fault.? Sorry, but retail investors, and many professionals too, give way to fear and greed, and chase trends.? They are not invested at the bottom, because they are too scared.? They are invested at the top, because it is the “thing to do if you want to make money.”

Call my point 1 this: People who don’t understand investing buy and sell at the wrong times.? They panic and get greedy.

Point 2: People don’t get that returns are lumpy.? They happen in spurts, over months, years, decades.? This is the big problem with financial planners — they assume smooth returns that will assure a retirement.? Sorry, but market moves in regimes, and is not easily predictable.? There are a few two decade periods where the market goes nowhere.? They are not anomalies; the value of companies are catching up to their prices.

Point 3: The estimates of equity outperformance sold by consultants, financial planners and naive journalists exaggerate the reality.? Here’s the reality: equities perform maybe 1% better than Baa/BBB bonds, particularly when you analyze the investments on a dollar-weighted basis.

Point 4: Everyone loves a winner.? People were spoiled by the returns of the 80s and 90s, and that validated in their minds the idea that more stocks are better; the projections of the financial planners are conservative; equities always beat bonds.

Point 5: Most ignore long-term valuation metrics, whether professionals or retail.? Whether it is the:

Q-Ratio
CAPE
Price-to-Resources Ratio
Whatever John Hussman has cooked up
Eddy Elfenbein’s view the stock market as a bond measure

they say roughly the same thing at present: equities are overvalued long-term.? Short-term is another matter: P/Es aren’t that high and momentum is running.? But how short is your horizon?? This makes sense if you are willing to play for months, not years.

Point 6: Professionals changed too.? In this market environment many professionals have started to trade more, as if we don’t trade too much already, and I think this is the wrong response.? As professionals, we need to do due diligence, and pick stocks we can be happy with for some time.? High frequency trading affects those who are not clever at trading.? Those who are clever disguise their trades making them look small like retail.

Point 7: But regardless of who holds stocks, they are still held by some entity.? They don’t disappear.? They move from weak hands to strong hands.? The trouble for retail investors is that they are weak hands on average.? They can’t handle disappointment, versus value investors who buy when there is disappointment.

Yes, I understand the frustration of average investors who do not do well; you are novices in a complex market.? Maybe you should just buy BBB bonds.? With the abnormal economic policies of our government, it is difficult to make any decision.

Personally I don’t think that retail investors are abnormally disappointed at present.? This is just market noise — we face overvaluation, but positive momentum.

Me?? I keep owning undervalued companies for myself and clients.

Sorted Weekly Tweets

Posted on 23 June 201223 June 2012 by David Merkel

A note to all of the actuaries in the audience, all three of you 😉 : an old friend from my GIC days is seeking a multi-talented actuary to work in the stable value business.? Must understand how wraps work, etc.? If interested, drop me a note, and I’ll send you the contact info.

On with the tweets:

=-=–=-=-=-=-=-=-=-=-=-=-=-==–=-=-==-=-=-=–==–=-=-=-==–=

Eurozone

May not last long $$ RT @John_Hempton: @AlephBlog Spain imposing on bank junior bonds but prefs in Santander still trading at par! Strange. Jun 23, 2012
Buying Europe Banks Is Easy for Herro as Cheap Stocks Fall http://t.co/gfCOhY8q Key question here is accounting quality; not a buyer $$ Jun 23, 2012
Spain Said to Weigh Imposing Losses on Junior Bank Bondholders http://t.co/cD1hoAVa Fine, but they won’t fund jr debt for 20yrs or so $$ Jun 23, 2012
Spanish Aid Plan Is Flawed, Says IMF http://t.co/9V2FJ0Xc IMF doesn’t like the complexity of the E-Zone, wants it 2 behave like a nation Jun 23, 2012
Debt crisis: Angela Merkel defies Latin Europe and the IMF on bond rescue http://t.co/qTKEAr5O She who pays the $$ calls the tunes Jun 23, 2012
What?s So Special About the Euro Currency Area? http://t.co/oJWyrLAk Currency unions don’t work; must centralize or die $$ Jun 21, 2012
Merkel Balks at Sovereign Debt Purchases to Overcome Crisis http://t.co/UfuN4ae8 Physically, the crisis looks like it is wearing on Angela Jun 21, 2012
Spanish short-term debt costs reach alarm levels http://t.co/Dm8d2bsv Yields high enough that Spain unlikely to grow out of the debt $$ Jun 21, 2012
Cyprus Said to Face Europe Pressure for $13 Billion Aid http://t.co/z0etJBlX Who wants to maintain influence in Cyprus? Russia, E-zone? $$ Jun 20, 2012
‘ @aarontask He might b right. Key Q is how much Germans/Nordics/Dutch view themselves as Europeans 1st rather than Germans/Nordics/Dutch $$ Jun 20, 2012
Greek Leaders Poised to Agree on Three-Way Coalition http://t.co/JvAaPDDj It will be difficult for that coalition 2 hold together $$ Jun 20, 2012
Ma?ana-nomics at Los Cabos http://t.co/GtlAj4lY Weak Europoliticians blame US, when their banking system was overlevered & malregulated $$ Jun 20, 2012
G20 summit: perils of a half-baked rescue for Spain and Italy http://t.co/7E6jPK4W E-zone not ready 2 take strong actions; don’t force it $$ Jun 20, 2012
Is Spain past the point of no return? http://t.co/zCRF7qKo ??I suspect the ECB will have to be the buyer of last resort for Spanish bonds.?? Jun 19, 2012
Saddling Spain With Bank Burden Repeats Irish Error http://t.co/dWgYAUht Protect deposits, not bank bonds, preferreds, or stocks $$ Jun 19, 2012
“Which is why $JPM had the hedge there in the first place $$” http://t.co/o61frAFX Dimon Says ?Firewalls? May Halt Spread of Europe Crisis Jun 19, 2012
Germany set to allow eurozone bailout fund to buy troubled countries’ debt http://t.co/OEFi9UI9 Last refuge of scoundrels:blame speculators Jun 19, 2012
Fran?ois Hollande said meeting btw Ezone & Obama rescheduled4this morning2brief Americans on “mechanisms that allow us to fight speculation” Jun 19, 2012
Spanish Yields at 7% Show Investors Slamming Door http://t.co/JxGxNHDn Spain is slowly passing the “tipping point” into hopelessness. $$ Jun 18, 2012
Where is the relief? RT @jennablan: Where is the relief rally? Jun 18, 2012

FOMC Meeting/Press Conference

Fed Seen Extending Operation Twist and Avoiding Bond Buys http://t.co/qFOSA0rf Fed can’t do nothing, so it does something that is nothing Jun 21, 2012
RT @ezraklein: Hypothesis: Bernanke doesn’t do more because he doesn’t think he can. He says otherwise is because he doesn’t want the ma … Jun 20, 2012
Dr. Bernanke: Couldn?t increased unemployment be structural, after all, there is a lot more competition from labor in emerging markets? Jun 20, 2012
That’s all folks!!! Jun 20, 2012
Dr. Bernanke, Isn?t stagflation a possibility here? I mean, no one expected it in the ?70s either. $$ Jun 20, 2012
Q for Bernanke: If the Fed ever does shrink its balance sheet, what effect will it have on the banks? $$ Jun 20, 2012
Stocks trading off — correlated with future inflation rates; long Treasuries rallying nominal yields falling -> real rates stable-ish $$ Jun 20, 2012
What Bernanke is describing in terms of hedging and risk management has to be done in the insurance industry; actuarial risk analyses Jun 20, 2012
W/MBS rates, those mtges that are underwater don’t benefit, same for Alt-A & Jumbo; low rates don’t help many in residential real estate $$ Jun 20, 2012
Effect of Tsy ylds on corporate yields is stronger 4 AAA-A bonds, moderate 4 BBB bonds, little 4 junk & the effects get weaker w/maturity $$ Jun 20, 2012
That’s the wrap up for the central tendencies and averages of the FOMC’s additional data release. Anyone find those summaries useful? $$ Jun 20, 2012
Changes in Avg Target Federal Funds Rate at Year-End 2012-2014, Longer -0.07%, -0.10%, -0.22%, -0.09% $$ Levels: 0.30%, 0.50%, 1.11%, 4.11% Jun 20, 2012
Average appropriate timing of policy firming moved out 1.6 months to November 2013 $$ Jun 20, 2012
Changes in PCE Inflation central tendency 2012-2014, Longer -0.4)%, -0.07%, -0.12%, 0% $$ Levels: 1.48%, 1.76%, 1.77%, 2.00% Jun 20, 2012
Changes in unemployment central tendency 2012-2014, Longer +0.18%, +0.20%, +0.24%, +0.03% $$ Levels: 8.10%, 7.71%, 7.28%, 5.60% Jun 20, 2012
Changes in real GDP growth central tendency 2012-2014, Longer -0.50%, -0.37%, -0.11%, -0.04% $$ Levels: 2.13%, 2.57%, 3.28%, 2.44% Jun 20, 2012
+1 RT @bondscoop: Steve Liesman is the Fed’s Helen Thomas Jun 20, 2012
Fed wants to see long TIPS up in price relative to long nominal Treasuries. http://t.co/X5Gjt6jI Jun 20, 2012
@TheStalwart #FOMCGuesses OT extended, no QE3, central tendencies move back to where they were in January, shades lang down GDP, CPI, etc $$ Jun 20, 2012
C?mon, Ben, Just Say It; Please, Just Say QE3 http://t.co/ksIKxZ6C Sad that equity guys beg 4 stimulus; think OT extends; no QE3 yet $$ Jun 20, 2012

Rest of the World

Glencore Protests Bolivia’s Move on Mine http://t.co/OcIzatJ5 Bolivia has Venezuela envy; won’t end until Morales is shown 2b a fail. $$ Jun 23, 2012
Children of Mao’s wrath vie for power in China http://t.co/pWzj4Dbq All of the current ruling class survived the Cultural Revolution $$ Jun 22, 2012
Riskier Bets Pitched to Asia’s Rising Rich http://t.co/P6PjFqyR Yield is the oldest scam in the books; Asia’s brokers fleece clients $$ Jun 21, 2012
China warns its rare earth reserves are declining http://t.co/ve2e6PQq I doubt this, but if true -> significant scarcity of rare earths $$ Jun 20, 2012
Britain doomed, apparently http://t.co/WdvPCsxs Countries that don?t reset their systems through default, will experience money decay $$ Jun 20, 2012
Suicides, Arrests Show Trouble at Korean Savings Banks http://t.co/aP1fu6KS Pride drives suicides, rather than confession of wrongdoing $$ Jun 19, 2012
The UN’s Internet Power Grab http://t.co/LE704S74 Never surrender an advantage for no gain; does the Obama administration get that? $$ Jun 18, 2012
The Return of Egypt’s ‘Deep State’ http://t.co/i1IkbmMq Islamists & liberals checkmated by Egyptian Army 4 now. Liberals s/b glad $$ Jun 17, 2012
@dpinsen Agreed, better H/L would have been: “Egyptian Army reveals full control, ends show that played w/democracy 2 smoke out enemies” $$ Jun 17, 2012
Noda Ends Japan Nuclear Freeze, Risking Voter Backlash at Polls http://t.co/Jcoxl91Z He does the right thing, but will the voters agree $$ Jun 17, 2012

Banks

A History of Money Funds http://t.co/KXCpfCDz Let the critics of money market funds apply the same2banks; mark2market accounting. $$ Jun 23, 2012
Bank Investors Dismiss Moody?s Cuts as Years Too Late http://t.co/5cOsGOyG True. Moody’s should’ve done it in 2008; did politics stopthem? Jun 23, 2012
Citigroup Faces $5 Billion on Dollar?s Rise, Peabody Says http://t.co/5HZtJfvx So, on the heels of $JPM, $C has a currency mismatch? $$ Jun 21, 2012
Eminent domain for underwater mortgages could have biggest impact on banks http://t.co/NK9W0PyO Comments at end; disagreement welcomed $$ Jun 20, 2012

Central Banking

Bernanke Acknowledges Tsy Strategy @ Odds W/Fed Policy http://t.co/MqW6qda2 “Thx, Unca Ben 4letting us issue morre 30s” Ben:”Arrrgh!” $$ Jun 23, 2012
The Fed?s second best solution http://t.co/YJhiHbNd “collateral damage will mount, making the next policy steps even more excruciating.” Jun 21, 2012
Fed Born of Morgan?s Bailout Under Scrutiny After Dimon?s Loss http://t.co/7EHPlSvM How significant is it 4 Jamie D 2b on NY Fed board? $$ Jun 19, 2012
Krugman’s Intellectual Waterloo http://t.co/brrRB3CP Suggested possible Fed stimulus: blow housing bubble 2replace tech bubble $$ Jun 17, 2012
Also, the last H/L could have been: “Bernanke?s GDP View Invalidated as Economy Slows” FOMC has been lousy economic forecasters lately $$ Jun 17, 2012
Bernanke?s Inflation View Validated as Commodities Fall http://t.co/pjRKhXWv Median & Trimmed mean CPIs mot falling, better measures $$ Jun 17, 2012

Asset Management

Pimco?s Gross Warns of Risk Assets as Aberdeen Avoids Stocks http://t.co/pcqnMis6 Bill Gross signs on to deflation late & promotes it $$ Jun 23, 2012
Private Equity Has Too Much Money to Spend on Homes http://t.co/VPToSU8I Big buyers need to stay quiet if they want 2 make good returns $$ Jun 22, 2012
Simon Lack responds to AIMA’s hedge fund cheerleading http://t.co/VQq4s1O8 Backfill bias, IRR vs Buy&Hold, high fees, survivor bias $$ Jun 21, 2012
At 40,000 feet, Fidelity’s Danoff ponders Groupons http://t.co/BwOKJR8X Danoff is a survivor; he’s right it’s lonely 2b a stockpicker $$ Jun 21, 2012
Very good point. Wall Street is a 1-note Sam RT @chadstarliper: Has there ever been a time when Wall St didn’t think stocks were “cheap?” $$ Jun 20, 2012
Wall Street says stocks are bargains, but that assumes surging profits http://t.co/0c0iDdK6 Or at least growing sales w/flat profit mgns $$ Jun 20, 2012
America?s $8T corporate debt market faces liquidity drought as banks retreat from the trade http://t.co/rvXwFsjW Shouldn’t b that bad $$ Jun 19, 2012
Equities entail less risk than ?haven? investments http://t.co/u3befAMT Ain’t necessarily true; think of the Great Depression or 1871 $$ Jun 19, 2012
Valuation Matters…. Equity vs Bonds Edition http://t.co/23IikMDJ Earnings ylds v Tsy ylds unstable; Q-ratio, CAPE10, Price/resources bettr Jun 19, 2012
Biggest Stocks Beat S&P 500 Most in 13 Years as Valuations Fall http://t.co/7vLxG6VN Once valuations get so low, they must go up $$ Jun 18, 2012

Companies

DuPont selling Conoco at oil mkt trough $$RT @BarbarianCap: “Delta seals deal to buy Pennsylvania refinery” > hasn’t that been tried before? Jun 23, 2012
DuPont buying Conoco at oil mkt peak $$ RT @BarbarianCap: “Delta seals deal to buy Pennsylvania refinery” > hasn’t that been tried before? Jun 23, 2012
J.C. Penney Falls After Francis Leaves Amid Strategy Flop http://t.co/jfAVGj3V Rare setback 4 Ackman/Pershing on $JCP; retail is tough $$ Jun 20, 2012
Buffett Extends Real-Estate Bet With ResCap Pursuit http://t.co/ZsN6J0Pm Buffett is early, in my opinion, but has the capital to do it $$ Jun 18, 2012

Pensions

US public retiree benefits gap grows to $1.38T http://t.co/7bZ18GRB Gap widened by $120 billion since last year; thx Ben 4 low discnt rates Jun 20, 2012
Joe Nocera Is Wrong About Woonsocket’s Crisis http://t.co/Z3RM9UGO Harder2discharge muni “pension” bonds than renegotiate muni pensions $$ Jun 20, 2012
GM Seen Fueling Pension Deals as Employers Face Shortfall http://t.co/noz9auU0 Hope $MET & $PRU survive; guaranty funds limited in size $$ Jun 19, 2012
Terminal funding of DB pension plans will be a growing phenomenon if corps/states bite bullet and kick in more $$ to fund annuity purchases Jun 19, 2012
Problem to annuitants is companies can go broke; no PBGC coverage of annuities, and state guarantees r usually limited 2 $100,000 total $$ Jun 19, 2012

Media

Love the Leaker, Hate the Leak http://t.co/wiY7RwJU Value of releasing sensitive govt data to the public is in the eye of the beholder $$ Jun 21, 2012
How David Weidner Changed My Life http://t.co/g9LVJIWD @reformedbroker – how getting on @davidweidner ‘s Top 10 list gave him a big boost $$ Jun 19, 2012
+1 won’t watch RT @ReformedBroker: Bloomberg PR pushing their Meredith Whitney interview video hard today. They haven’t gotten the memo yet. Jun 19, 2012
Wrong: 20 rules that can save you from the Doomsday Cycle http://t.co/jLB0s2pL Why does Marketwatch give Paul Farrell space 2 write? $$ Jun 19, 2012
So long, suckers ? I?m leaving Wall Street http://t.co/x1Ju1fmZ David Weidner: Some lessons from 15 years observing the industry $$ Jun 19, 2012

Miscellaneous

Liquidity, Noise, and Signal http://t.co/cV15Mr2z Shorter the time period-> higher ratio noise/signal; leads2bad trades @ turning points $$ Jun 21, 2012
‘ @JATranfo Never criticized ECRI when out of favor; FWIW, I reverse-engineered their main model: industrial commod pxs & credit spreads $$ Jun 21, 2012
Lawmakers Push for Overhaul of IPO Process http://t.co/qhh7tX1V Every “fix” creates its own set of problems. Mania can hit auctions 2 $$ Jun 21, 2012
Yes $$ RT @Fullcarry: A point I have made many times in the past: the drop in yields the past decade is mostly due to a drop in real rates. Jun 20, 2012
Housing Starts in U.S. Fall 4.8% in May on Apartments http://t.co/PhMFwHQL Interesting contrary data; $EQR chart http://t.co/vleXkVAM $$ Jun 19, 2012
Asians Top Immigration Class http://t.co/Sir2IFxQ Certainly noticeable here in Ellicott City; most businesses have signs in Korean $$ Jun 19, 2012
Poorly reasoned: Court-Ordered Care ? A Complication of Pregnancy 2 Avoid http://t.co/DqmhsvkU Mothers w/child in womb uniquely affect child Jun 18, 2012
Please follow @jarrodwilcox, He has taught me many things, and I respect him a great deal #FF Jun 17, 2012
A Jewish-Asian Couple?s Union Leads to a Scholarly Interest in Intermarriage http://t.co/U3jfPkyK Both ethnic groups prize education $$ Jun 17, 2012

Comments

DavidMerkel’s discussion on “The New Yorker’s Newest Writer Is a Big Self-Plagiarist” http://t.co/g1i0YeF4 Writing belongs2those that paid Jun 20, 2012
“High energy particle physics is only a small part of science, and not adequate to measure the?” ? David_Merkel http://t.co/T4BrvWBj Jun 20, 2012
“Please, accidents per passenger mile would be better, rather than: “He also pointed to the fact?” ? David_Merkel http://t.co/Yg6r5N3X Jun 20, 2012
RE: @bloombergview Maybe DC city govt should start a reality TV show, w/prizes 2 the official who commits the most cr? http://t.co/lIXL6eMi Jun 20, 2012
RE: @bloombergview ?How will you deal with deferral of individual taxes on investment from DC plans, unrealized CGs, ? http://t.co/NY0Q3Ia5 Jun 20, 2012
“Cool picture, Ed. Thanks for sharing it.” ? David_Merkel http://t.co/Mg9lx0ij Jun 19, 2012
“Hitting the fiscal cliff won’t happen, and that’s too bad, because we need to discuss long-term imbalances” ? D_Merkel http://t.co/csiaLXlV Jun 19, 2012
“Here is a proposal for how rating agencies could be eliminated: http://t.co/rLrOK4vu…” ? David_Merkel http://t.co/q2mxmhpW Jun 19, 2012
“I trust ratings agencies more than mismanaged governments. Ratings are needed to provide?” ? David_Merkel http://t.co/vOdPJvzv Jun 19, 2012
“If this is representative of what the ruling Greek coalition will do, the government will fail?” ? David_Merkel http://t.co/HEe4GwHt Jun 19, 2012
“Much as we may dislike financial fraud, suggesting that those in the US that mismanaged their banks?” ? David_Merkel http://t.co/fEZQIo0h Jun 19, 2012
‘ @FilmCriticOne You say u want tax reform, but ur willing2let value grow untaxed through deferral? Get real; ability2defer is the issue $$ Jun 16, 2012

Dimon for Fed Secretary

@dlevineMW @moorehn and pay cut. The same rumors were applied to Hank Greenberg $AIG 4 Tsy Secretary user Bush, Sr. Said the same then $$ Jun 19, 2012
Jamie kind2let us live in his world 😉 RT @ReformedBroker He’s hedging the Senate w/the House right now, y’all r just pawns in a bigger game Jun 19, 2012
Why should Jamie accept the demotion? $$ RT @moorehn: This is just Jamie practicing for confirmation hearings as Treasury Secretary, right? Jun 19, 2012

Tax Policy

Tax Panels Turn Focus to Investments http://t.co/sq6AnHdE Best poss is lowering corp tax rates, equalizing all tax rates for individuals Jun 23, 2012
How to Kill the Corporate-Income Tax http://t.co/T5MgnVuD Evens out personal income tax rates by class. Good, but what about deferral? $$ Jun 20, 2012

Works if Small, Fails if Large

Posted on 3 June 2012 by David Merkel

The Wall Street Journal had an article on risk control that had the attitude of “here are some silver bullets.”? Ugh.? When will journalists learn that there are no simple solutions to portfolio management?

“Risk-allocation turns 50 years of portfolio theory on its head.”

Ain’t true.? Modern Portfolio Theory is garbage, but so is this.? So volatility is more stable than returns.? Volatility can be up or down, and you want to buy volatile asset classes that have gotten trashed.? You won’t do it because you are scared, but that is part of why you aren’t a good investor.? Good investors make the “pain trades.”

Here’s the question to ask: What would happen if everybody did this?? Unlike share-weighted indexing, not all strategies can be applied by everyone at the same time.? I have written about risk parity before:

So long as there are few using the strategy, it may work well, but it will not scale because volatility does not match the proportion of assets available to be purchased.? The same is true of “risk control” and “risk budgeting” strategies.? They will be “flashes in the pan;” there is no necessary reason why they will work.? There is no such thing as risk, but there are risks.

Avoid faddish ideas as described in the WSJ article.? Far better to focus on what risks you face in the investment markets, and choose assets that will not be affected by those risks,or, might even benefit from them.

Using volatility as a guide to investing will fail if it gets large enough, and during bull markets, it will be forgotten.? Non-scalable strategies work if there is a barrier to entry, and there is no barrier here.? Thus I see no long term value in the strategies proposed.

Aim for the Middle

Posted on 1 June 2012 by David Merkel

“Ya gotta take more risk to get more return.”? That’s the street language version of what is commonly trotted out, but it is only half true.

The truth is that moderate risk taking outperforms taking no risk or taking high risks.? This is true in bonds.? BBB bonds return best of all — they are the middle of credit risk.? There is no native group that wants to own them exclusively.? Higher-rated bonds do next best, and junk bonds do worse still on average.

Think of it this way: Those that invest in cash get a low return.? But those that invest in high-risk growth companies also get a low return, on average.? Those that take moderate risk have the best potential of making money.? That is why I focus on investors that take moderate risk relative to their peers.

Moderate risk taking does best on average, at least as far as public capital goes.?? Private capital may have more control and expertise, and can take more risk as a result.? In general, the less control and expertise, the less risk should be taken. With private equity, this is one of the tough truths: Private capital can change matters if it is large enough. Then it has to deal with changing the management of the business.? Public equity does not get there, except in rare cases.

That is a major reason why moderate risk-taking wins on average. In one sense, it is why low volatility investing and value investing work.? You are putting your money at risk, but you are doing so with a margin of safety.? Part of making money is survival; if you don’t survive round one, you won’t make money in round two and the rounds that follow.

That’s why swinging for the fences with stocks doesn’t work.? You get too many strikeouts, and few home runs.? Personally, I try to be a singles hitter in investing.? It’s doable, both intellectually and financially.

This applies to asset allocation as well. 60/40 stocks/bonds does as well as 100% stocks, and with less volatility.? 80/20 stocks/bonds did best the last time I tested — perhaps the true ratio is 70/30 given the outperformance of bonds over stocks over the last decade, but I am reluctant to think so because over the long haul, the best a bond can do is pay its coupon and return the principal.? Even in the case of premium calls, you get your principal back at what is typically an unfavorable time to reinvest.

Another reason to aim for the middle is that you will not get jolted hard during downdrafts, and be tempted to trade out at the maximum point of pain, or, buy in near the peak when the bulls are running their last lap.? A lot of money gets lost that way.

It’s also a reason to hang onto some slack cash or other safe assets, like high-quality noncallable bonds lacking weird features.? It may diminish returns in the short run, but it allows you to stay in the game of investing.? Too many people give up at the wrong time — many friends that I had that gave up on stocks in late 2002 – early 2003, deciding to focus on “what they knew”: residential real estate.? Another group gave up on stocks late 2008 – early 2009, with no place to go with their cash.

Realistic expectations are needed as well.? If you earn more than the growth rate of GDP plus a few percent, count yourself blessed and realize that it is very hard to do that consistently over the long-term.

So aim for the middle: take moderate risks, diversify, be realistic, and adjust your portfolio slowly as conditions change.? Then you can stay in the game, and compound your returns.

Elderly Poor?

Posted on 17 May 2012 by David Merkel

There will be elderly poor.? Look at page 26 of this PDF.? I interpret those that don’t know or declined as being well below $50K in assets.? That means 60% of those reaching “retirement age” will have less than two years income stored up.

That said I feel more sorry for younger workers who have to pay high amounts into Social Security/Medicare, and they will not get out of program what they put in.? There’s a longish article here, excerpting from a recently released book on the topic.? In general, the older you are, the sweeter the deal was for those who received payments from Social Security, at least until 2026 when benefits will be cut by 25%, or taxes raised.

What this means is that in aggregate, Americans don’t save enough, particularly the Baby Boomers, of which I am one, but not a negligent one.

We are heading for elderly poverty/work for a large portion of Americans.? I suspect that many older people will continue to work, solving their problem but taking jobs from those who are younger.

This should be no surprise.? Incomes should be declining for lower skilled people in the US, because there are more people who can do that work abroad.? My advice to all readers is to make sure you cannot be obsoleted by foreigners.

One more note: don’t expect the asset markets to bail you out.? Returns to financial assets will do poorly as so many begin to sell them to pay for living expenses, whether directly as individuals, or indirectly as defined benefit plans pay retirement benefits.

This is on top of the problem that when high-quality long interest rates are so low, it is typically a bad time to try to make money in financial assets, because returns on risky assets are typically only 0-2% percent higher than the yield on long BBB/Baa debt over the long run.

All for now…

The Best of the Aleph Blog, Part 15

Posted on 10 May 201220 June 2017 by David Merkel

This stretches from August 2010 to October 2010:

The Education of a Corporate Bond Manager, Part VII

On the value of credit analysts.

The Education of a Corporate Bond Manager, Part VIII

On price discovery in dealer markets, and auctions gone wrong.? I never knew that I could haggle so well.

The Education of a Corporate Bond Manager, Part IX

On the vagaries of bulge-bracket brokers, and how a good reputation helps on Wall Street.

The Education of a Corporate Bond Manager, Part X

On how we almost did a CDO, and how it fell apart.? Also, how to make money in the bond market when you reach the risk limits. 😉

The Education of a Corporate Bond Manager, Part XI

On my biggest mistakes in managing bonds.? Also, on aggressive life insurance managements.

The Education of a Corporate Bond Manager, Part XII (The End)

On bond technical analysis, and how to deal with a rapidly growing client.?? Also, the end of my time as a bond manager, and the parties that came as a result.?? Oh, and putting your subordinates first.

Queasing over Quantitative Easing

Queasing over Quantitative Easing, Redux

Queasing over Quantitative Easing, Part III

Queasing over Quantitative Easing, Part IV

Queasing over Quantitative Easing, Part V

Queasing over Quantitative Easing, Part VI

The problems with the Fed’s seemingly “free lunch”strategy.? Pushes up asset prices and commodity prices, benefiting the rich versus the poor.

The Economic Geography of Publicly-Traded Companies in the United States by Sector

The Economic Geography of Publicly-Traded Companies in the United States by Sector (II)

Shows what US states have diversified vs concentrated economies by sector, and what states dominate each sector.

Portfolio Rule One

Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.

Portfolio Rule Two

Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.

Portfolio Rule Three

Stick with higher quality companies for a given industry.

Portfolio Rule Four

Purchase companies appropriately sized to serve their market niches.

Portfolio Rule Five

Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.

Portfolio Rule Six

Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.

Portfolio Rule Seven

Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.

Portfolio Rule Eight

Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.

The Portfolio Rules Work Together

How the portfolio rules work together to create a “margin of safety.”

The Rules, Part XVIII

When rules become known and acted upon, the system changes to incorporate them, making them temporarily useless, until they are forgotten again.

When a single strategy becomes dominant, it can become temporarily self-reinforcing.? Eventually, it will become self-reinforcing on the negative side.

A healthy market ecology has multiple strategies that are working in separate areas at the same time.

The Rules, Part XIX

There is room for a new risk model based on the idea that risk is unique among individuals, and inversely related to the price paid for an asset.? If a risk control model has an asset becoming more risky when prices fall, it is wrong.

?The Rules, Part XX

In the end, economic systems work, and judicial systems modify to accommodate that.? The only exception to that is when a culture is dying.

?Managing Illiquid Assets

Illiquidity is an underrated risk.? Most financial company failures are due to illiquidity, which usually takes the form of too many illiquid assets and liquid liabilities.? Adding to the difficulty is that it is generally difficult to price illiquid assets, because they don?t trade often.

Of Investment Earnings Assumptions and Century Bonds

If we could turn back the clock 65 or so years and set up a more conservative method of accounting for pension liabilities, we would be much better off today.

Who Dares Oppose a Boom?

This piece won a small prize, and in turn, I received three speaking engagements.

Fairness Versus Economics

Fairness Versus Economics (2)

People care more about fairness than improving their own economic/social position.

Earnings Estimates as a Control Mechanism, Flawed as they are

Earnings Estimates as a Control Mechanism, Flawed as they are, Redux

Earnings estimates have their problems, but they exist to give us a flawed method of estimating the future performance of companies.

-==-=-=-=-=–=-=

That’s all for now.? Never thought I would do so many long series when I started blogging.

Book Review: The Little Book of Bull’s Eye Investing

Posted on 9 May 2012 by David Merkel

Before I start this evening, if you like my reviews generally, please go to Amazon and tell them that my reviews are helpful.? From this link, it does not take long to do so.? Thanks.

This was one of those books that grew on me.? The author, the well-known John Mauldin, strings together a bunch of ideas originated by others.? That’s not much different than what Tadas Viskanta does at Abnormal Returns.? He brings us the best ideas that he has culled from others.? That is a significant piece of work that should not be denigrated by others.

The beginning of the the book is consumed with 12-20 year market cycles.? There are times when investing in risky assets where you face headwinds and tailwinds. The headwinds and tailwinds are driven by valuation, often expressed through Q-ratio, CAPE, or Michael Alexander’s Price-to-Resources ratio, out of which the book makes a lot (link here for an example).? It’s a Price-to-Adjusted Book value ratio as I see it.

Regardless of the method, if you buy in at high valuations, the wind is in your face, and you are not likely to earn much.? The opposite is true for low valuations, but at the valuation trough, everyone is disgusted, and few are willing to buy.

So it takes a strong stomach and mind to follow a method like this.? Strong stomach, because when it is time to buy one will fear that the money will be lost.? Strong mind, because near valuation peaks people will tell you that you are nuts to leave the party — it’s just getting started.

But what if a decent sized portion of institutional money did this?? The cycles would go away, or be muted.? That’s not likely to happen in my opinion: some men may change, but you can’t change mankind.? Emotions of fear and greed dominate over clear thinking.

The book touches on many other topics:

Why strategies go in and out of favor
Why to be skeptical of those who give investment advice (including Mauldin & me)
That the growth rate of the economy eventually limits the growth rate of any company.
The effect of demographics on the markets
Why chasing performance doesn’t work.
Why most newsletter writers strategies could never be as good as they state, or they manage money in tiny niches.
How to detect value in stocks.
How to use bonds and commodities in asset allocation.

I say “touches on” because in line with its title, it is a “little book.”? You are only getting a taste of what an intelligent investor who hires other managers to manage money for clients thinks.? This is especially true as you go through the section on value investing, which does not get much beyond dividend yield, dividend growth, and price-to-book (common equity).

As such, this book will not be a complete answer to any investor wanting to learn about the markets.? It introduces basic concepts in ways that most ordinary people could learn.? Reading time should be less than two hours.? One more thing, the book has very little in the way of math.

I appreciated the short summaries at the end of each chapter.? If someone wanted to get the gist of the book, they could read all of the short summaries in about 10 minutes, and then they would have the skeletal ideas of the book, allowing them to read all or part of the book with greater understanding.

Quibbles

The book could have used an index.

Who would benefit from this book:People who want an introduction to investing, including long-term market cycles would benefit from this book.? It would be of modest help to experienced investors who understand market cycles.? If you want to, you can buy the book here: The Little Book of Bull’s Eye Investing: Finding Value, Generating Absolute Returns, and Controlling Risk in Turbulent Markets (Little Books. Big Profits).

Full disclosure: This book was sent to me without my asking for it.