I think that it is pretty certain that defined contribution [DC] plans 401(k)s, 403(b)s, 457s, much as they have grown to be dominant, have been a failure.? Many, though not all people like the illusion of control, and seeing their cash balance — makes the pension plan tangible, even if they don’t get what they will really need at retirement.
Pension plan reform has to face three realities.? The first is people don’t know how much to put away for retirement.? I’ll give you a hint: for almost all people, it should be over 10% of your gross pay.? The second is that people don’t know how to invest, so hand it off to advisors who will do it for them, and cheaply.? The third is silent, and leaves a lot of money on the table — most people would be better off taking an annuity from their pension plan than a third party, or trying to manage a lump sum on their own.? This is usually an option only for defined benefit [DB] plans.
On the last point, annuities from insurance companies will almost always be inferior to those from DB plans — the investment policy of the DB plan will likely yield more than the investments of the life insurance company.? The DB plan has more ability to take risk, and its expenses are lower.
And speaking of lower expenses, that’s another reason to replace DC plans.? Not only do DB plans provide better security, they have lower expenses.
But employers don’t want to fund expensive DB plans, particularly in a low interest rate environment.?? Fine, that’s not what I am arguing for.? I am suggesting an odd sort of DC plan:
Participants can contribute what they wish
Employers can contribute what they wish
Professionals manage the assets; no asset management by participants.
During active employment, the cash balance can transfer with a change of employment.
At retirement, it converts to a DB plan, and an annuity is granted, more generous than could be obtained privately.? The retiree does not get the agony of managing a lump sum.
I think this would lead to much better results for plan participants.? The case would have to be made to participants that they have not done well managing their own funds — they will underperform by less through third party managers.? Also, few are good at managing lump sums for income.
This is the sort of plan that would yield better results for most, given that DB plans are out of favor, and participant-directed DC plans lead to high expense lousy results.? Best to have a hybrid plan.? Trustee-directed DC plan for accumulation.? DB plan for distribution.
That’s how I would structure it at present.? Better ideas are welcomed.? Thoughts?
I have long wanted to see a book that would teach ordinary investors how to avoid being cheated by those that create/sell financial products.? If this book isn’t it, the one that surpasses it will be astounding.? If Wall Street is a show, this book gives you a peek behind the curtain.
This book is really four mini-books in one:
1) How the author became a broker, and the ethical difficulties that were forced on him in the process.
2) The difficulties faced by do-it-yourself? investors, and the benefits of exchange-traded funds [ETFs].
3) On Brokerages, and all their conflicts of interest, culminating in the straight line pitch.
4) Investments to avoid, and advice from the wise.
That it is four in one is not a weakness but a strength.? Wall Street has many ways to skin investors, and each section provides insights that different people will benefit from.? It is a more comprehensive book in its short 240 pages as a result.
On Brokers
The first part of the book describes Wall Street as it was and is, with all of the players and their motives.? Josh spares no one; the tone of the book is cynical, but not unduly so, noting all of the problems with a profane sense of humor.? Some of the funniest bits of the book are recollections of conversations with greedy parties seeing an edge.
There is a certain level of despair for young brokers as they “cold call,” knowing that if they don’t succeed, they will be let go, but driven by the possibility of riches should they succeed.? Those who are successful gain money, prestige, bragging rights, and some level of freedom from tight control.
I have my own experience with this. though mostly on the institutional side where I told such brokers “Why would my client want that?!”? It’s astounding what level of deception those who sell investments will engage in, until they realize you can’t be conned, and then they use your ideas to con others.? (The institutional brokers only make money on transactions; if they know you are smart, they facilitate your ideas at the expense of those less talented.? Ugly, I know, but I didn’t invent this.)
On Do-it-Yourselfers
Now, if you are a total “do-it-yourselfer” like I was in the ’90s, where I researched and bought my own stocks for myself, with some success, this is not for you.? This is for those who research and use mutual funds and ETFs.? It goes into the history and development of asset management fund structures, explaining why they are how they are.
He also describes how the modern era came into existence with discount brokerages in the ’70s, and how during the bull of the ’90 it morphed into anyone can make tons of money, just buy stock!? One thing Josh does not talk a lot about, but was significant, was how when fixed commisions ended, the real reason for maintaining research staffs died.? And, when tick sizes moved from a eighth to a sixteenth to a penny, the reasons for having market makers and specialists dried up.? But you can’t cover everything.
One particularly funny part is page 110, with its real-life definitions of fund types.? Josh is at his best in the section where goes after leveraged and inverse ETFs, where a lot of investors lose money because they are meant to track daily performance of indexes, and generally lose money for those that hold them long-term.? He is similarly good when he criticizes the proliferation of ETFs that are too unique, and will never get a broad following.
On Brokerages
Brokers position themselves as experts, when they are really order-takers.? They hire analysts that are not that good on average, and issue more buy than sell opinions, which facilitate the investment banking and trading businesses.? It talks about the stories that brokerages tell in order to captivate people and make them invest.
And then, Josh discloses the “Straight-Line Pitch,” which has been used on many investors to make them invest with the brokerage.? I have to admit, given some of the initial publicity on this point, and my own experience with brokers, I was dubious about this part of the book, and, Josh leaves it to the end — this is the climax!
I was pleasantly surprised, and I would recommend that all investors read chapter 20.? Why?? To immunize yourself from the clever talk that boxes you in as they offer slick answers to your objections.? That is a major reason why I read books on marketing: I can’t be tricked!? (But it does force me to do my own research.)? If you don’t want to be tricked by clever brokers, read chapter 20.? It isn’t necessarily the best chapter of the the book, that will depend on your own needs, but chapter 20 is unique.
Oh, and why have I not experienced this? Being a total do-it-yourselfer, I told brokers that I knew better than they did; it led to some weird conversations as they found I knew more about it than their talking points.
Investments to Avoid — Advice from the Wise
Most bad investments are either volatile or illiquid.? Why do brokers sell illiquid investments?? Because they get high commissions.? Same for insurance agents.
Then there are investments that sneak between the regulatory cracks, like Chinese reverse mergers, Special Purpose Acquisition Corporations, and anything with secondary guarantees, or the sale of options to enhance income.
Ask the broker this: who can I sell this to if I don’t like it someday?? Who makes an active market in this?? Any pause on this, and don’t buy.? No pause, but an answer — write it down, and check it out.
In one sense, part of the answer to the problems this book brings up is to realize there is no urgency.? If it is a good idea today, it will be good a week from now, let me talk with smart friends and figure out if the idea makes sense.
As for advice from the wise, he invites about eight of his friends to opine on a variety of topics.? Most of them are well-known, but at least a few of them are obscure, unless you are in the business.? I found the counsel to be sound, aside from an obscure former actuary who writes on investments.
Quibbles
On page 118, he talks about how Vanguard would have been a natural for the ETF business, and how Bogle delayed them from getting in.? This is true, but Bogle resigned in 1999; I was at a dinner for his retirement in 1998 in Philadelphia, and met him and Brennan, his successor.? The first Vanguard ETF was created in 2001, VTI is the ticker.? Vanguard did not play a large role in ETFs until 2005, but to say they weren’t in the business is not correct.
Also, ETFs are not as good as they seem, because average investors in them trade them wrong, buying high and selling low.? ETFs do not correct for bad investor timing, even if they are lower-cost.
Full disclosure: The author is a friend of mine, so I asked for the book.? He said ?yes? and he sent it to me.
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.
This is two books in one, and very well done.? The main part of the book explains risk and uncertainty in general terms, such that most people can understand it.? But for those that can deal with complex math, the latter part of the book offers a lot of additional firepower.
Risk is a tough subject because history only vaguely informs you as to how bad things can get.? Past is not prologue.? There are two possibilities, the past contains and event that was so horrible that it can never happen again, or, the past does not tell you how bad things can be.
Market observers took the first view, that the Great Depression could not repeat.? As a result, few prepared for a situation where there was too much debt, and insufficient ability to service it.
The subtitle of the book is rightly “Uncertainty at the Core of Finance.” Not risk, but uncertainty.? The distinct is important, because risks are things that we know some things about the possible economic outcomes, and can control them to a degree.? Uncertainty is where we don’t really understand the dimensions of the outcomes, and have little if any control.
There is fundamental uncertainty to the simplest aspect of finance, money.? Money seems stable enough in the short-run, but every now and then it fails due to hyperinflation, or the slow steady failure in the store of value sense of moderate inflation over long periods.
Wealth itself is uncertain.? Even if you own it free and clear, there’s no way to tell what it will be exchangeable for next year, much less further out.? There are a lot of people who thought they knew what their homes were worth 5-7 years ago that are decidedly disappointed.
Government debt is uncertain, as governments think they can always roll it over, but political and other obstacles can lead to a refusal to pay when debt service becomes high relative to tax revenues.
Banking is uncertain, mainly because of borrowing short to lend long.? If banks limited themselves to facilitating transactions, a lot of the uncertainty would go away.? Banks would be a lot smaller, less profitable, and there would be fewer of them, and the economy would be more stable.? (Entities with longer liability structures, like pension plans, endowments, and life insurers would become the new source of lending. More would be financed through equity.)
Credit is uncertain.? During boom times, corporate bonds behave independently, and diversification evens out results.? As a result, corporate credit seems safer than it really is, and marginal ideas get to borrow.? During bust times, far more corporate debt defaults than would be expected — there’s almost no such thing as an average year.? It’s either feast or famine.
There are things that can be done to try to mitigate uncertainty: credit ratings, or any scoring system for assets, lending at a more senior level, and Value-at-Risk.? Also using more robust assumptions on possible outcomes, which would lead to smaller position sizes, less leverage, or more cash.
The book has a real strength in showing how the the assumption of normally-distributed risks fails dramatically in many cases, and offers alternatives that would work better.? Trouble is, once you realize how volatile the world really is, a lot of strategies either don’t work, or need to be scaled back.
The book praises actuaries as risk managers, with their ethic codes and stress tests, as opposed to quants with Value-at-Risk and no ethics code.? Banks and Wall Street would be better off in the long run hiring actuaries, who think about risk more holistically, and getting rid of the quants in their risk control departments.? Same for the regulators who evaluate banks.
There are other controversial ideas here: is it possible that the strong economic growth of the past is an anomaly?? Is it possible that growth for nations, and the world as a whole follows S-curves, like products and companies?
This is an ambitious book, and I like it a lot because it is willing to cross boundaries and apply the principles in one? area to another that seemingly should not receive it.? I liked it a lot, and would recommend it to many.
Quibbles
On page 17, he thinks of currency as a put option, but I think of it as 0% overnight commercial paper.? On page 37, he confuses Moses and Joseph, having Moses predict the 7 good followed by 7 bad years, when it was Joseph who did that.
Who would benefit from this book: Every financial regulator should have this book.? Every academic burdened by the lies of Modern Portfolio Theory should get this book.? Anyone who fancies himself to be a risk manager should have this book.? Finally, if you want to understand why financial markets are inherently uncertain, this book will teach you well.? If you want to, you can buy it here: Pandora’s Risk: Uncertainty at the Core of Finance (Columbia Business School Publishing).
Full disclosure: The publisher asked if I wanted the book.? I said ?yes? and he sent it to me.
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.
When I wrote my piece last night, I did not write it to say one ought to buy and never sell.? In investing, I encourage the concept that one must look to relative valuations and trade assets that are worth less for those that are worth more.? In doing so, one maintains exposure to the overall risk of the markets, but shifts to more promising areas.
But what if valuations get so strained that future returns from most risk assets are tepid?? At that point, buy-and-hold turns into sell-and-wait.? It’s like being a bond manager — if the excess returns are small from taking additional risk, you don’t take additional risk.
I tend to turn over my portfolio once every three years.? That to me is a good tradeoff between holding for a long time and recognizing that opportunity changes over time.? But my trading is driven by analyzing relative opportunity, selling what I think are lower future cash flow streams for larger cash flow streams.? Do I have a crystal ball to tell me which is better?? No, just business judgment.? As Buffett says, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.”
My business judgment has done well for me over my career, but I don’t pretend that it is infallible, because I make significant mistakes.? Humility is an asset to the investor, because we don’t always know the right course.? That said, let diversification handle uncertainty, and within risky assets trade away less promising assets for those with more promise.
A reader wrote me, one who works for a prestigious university and he said:
Since 1926, the minimum inflation-adjusted total return of the S&P 500 (or its predecessor index) has been over 4%, annualized, over every 40-year rolling period.? For 20-year periods, the returns are typically either high (say 9%) or low (say 2%).? Thus, the buy-and-hold investor is best off with the 4-decade hold time.? Fortunately, 40 years matches the typical work life of a person, so workers ought to be shoveling retirement money into equities, and leaving there when they retire, if history is any guide.
?Your thoughts?
Yes, so long as your government holds together, over longer periods of time we do better.? But the tough part for retirees is “What is my situation like when I retire?? Yes, I built up a pot of assets, but what will that buy in terms of continuing income, and will that do well against declining purchasing power?”
There is no magic bullet.? I try to solve this by shifting industries over time, aiming at the most promising current opportunities, but not leaving the market in entire.? I limit cash to 20% of the portfolio when valuations are strained for he market as a whole.
Back to the question, yes, I think most people should buy-and-hold, if they can’t analyze the asset markets.? That’s like the Biblical proverb that a fool is counted wise if he is silent.? But for businessmen/investors there are often relative opportunities to do better.? Analyze those opportunities and take the best of them.
Yes, have some exposure to risky assets for your career, but vary the amount of exposure, and where it goes relative to likely opportunity.
I appreciated Jonathan Burton’s piece Speed kills, but so does complacency.? Like me, he is trying to strike a balance between hyper-trading and permafrost.
My mother is a good example here, though she does things differently than I do.? She holds stocks for a decade or so on average, and analyzes to see whether they have long-term prospects.?? She buys, holds, and occasionally adjusts.? She spends more time painting, for which she has a degree of reputation.? She beats average asset mangers regularly.
The main idea should be one of relative value: trade to improve.? Look at the underlying cash flow streams if you can, and trade smaller for larger.
Here’s one more tool to help you.? When the amount of money into an asset goes parabolic, it time to leave.? It is rare that large amounts of additional money will yield excess returns.? This simply admits that there are times when it is wise to reduce exposure to risky assets.? just as bond managers look at yield spreads to commit capital, so should investors in risky assets aim for a margin of safety in what they invest.
As a final note, buy-and-hold is a fundamental strategy in investing.? It presumes that you spent the time analyzing whether this asset was undervalued.? If it becomes overvalued, it does not mean you should hold it.? Always look for better relative value.? In the end that leads to better portfolio performance.
There’s this mistaken idea trotting around in the popular media, which usually only shows its face in bear or sideways markets: buy-and-hold investing is dead. This is wrong in several ways:
1) The average investor is horrible at market timing.? They buy high and sell low.? The more volatile the asset subclass the more pronounced this behavior is.? I have witnessed this personally while analyzing the return differences for Bill Miller, Bruce Berkowitz, and the S&P 500 Spider.? There is a profound difference between the returns that a buy-and-hold investor receives, and that which the average investor receives.? The buy-and-hold investor almost always does better; the only exception that may exist are value investors who have learned to resist price trends, painful as that may be.
2) The assets of the market are far less volatile than those that trade them.? Bonds are issued, the grand majority of them mature (pay off).? Stocks are issued, and they pay dividends, get bought out, fail, spin off another company, etc.? Trading activity usually far exceeds the need for financing assets; it becomes a game unto itself, and a zero-to-negative-sum game at that.? When you are playing a game that is overall negative-sum, i.e., the brokers suck cash out of the game proportionate to trading, the better players look for quality assets, and trade less.
3) When a sustained bull market arrives, the other mistake will show up, “Buy-and-hold is the only way to go.”? Risky assets have periods of protracted increases in valuation.? Certainty in the continuation of the process grows as it gets closer to the end of the cycle, when the cash flows of the assets cannot support the cash flows of those who borrowed to buy them.
4) Longer-term investors are often the key to a turnaround in the price of an asset.? Asset prices bottom when longer-term investors see value, and buy-and-hold, waiting out the volatility.? Asset prices crest when long-term investors decide to sell-and-wait, because the prospective returns to a buy-and-hold investor are poor.
This is why the perspective of a value investor can be valuable in approaching markets… are you willing to do a cold hard analysis of the likely cash flows?? You know that it gets harder to maintain high returns on equity [ROEs] as time goes on, and the same for low ROEs — new management arrives, and there is mean-reversion.
Conclusion
Yes, there are clever traders, but by necessity they are few in the market ecosystem, and repeatability is uncertain.? There are far more dumb traders, and repeatability is only limited by their declining capital.? Then there are the value-oriented infrequent traders.? They do best, but second to them are those that buy-and-hold.
In general, the economy rewards those who bear risk over long periods of time.? Thus buy-and-hold does well, usually, over long periods of time.? That time period may be 30-40 years, and may not do well with respect to your retirement date, so take caution, and don’t trust in long-term investing as if it is the force of gravity.? It is more akin to one who realizes the bean farming has become unpopular, and so, he decides to plant beans.? It might not work immediately, but it stands a better chance of working than those who are chasing the current farming fad.
We would all like our practical decisions to go easily, and bear quick positive results.? That’s not reality.? As for me, I needed to decide whether I would:
borrow against my home at 3% for 15 years.
liquidate a portion of my taxable brokerage account
liquidate shares in best private manufacturer of commercial lawn mowers in the world.
I decided on the flexible and probably low-cost solution, selling some of the taxable brokerage account.? I have two accounts, an IRA and the taxable account.? They were invested differently, but my investors get a blend of the two accounts.? I used to put the higher income names into the IRA, while the taxable account would take the lower income names.
That has been changed. Both portfolios have the same proportion of names (companies). In the process, gains have been realized, but not so much as overwhelm the deferred losses of the past.
But for this exercise, one salient result was that both portfolios, which are the model portfolio in aggregate, would become like the model portfolio.?? They are now clones of each other, as is true of all client portfolios that I manage.? My promise to clients is that they get what I get, so I create a clone of my portfolio for each client.? It certainly aligns my incentives with theirs.? Even after today, my next-largest client is 20% of my aggregate portfolio.? So, yes, I eat my own cooking, and in general, my cooking has been tasty over the last twelve years, even though the last year has been less than inspiring.
On the bright side, with the market up, it has allowed me to harvest an amount that will take care of my family for a year, while leaving my portfolio up considerably from one year ago.? That helps a lot when revenues from managing money are still light.
Hopefully, within a year, I will have enough clients that my revenues support my family.?? We’ll see; but if that doesn’t happen I know there are a number of firms that would like to employ me, so my downside is limited.
One final note: one reason why this was a difficult decision was that the low rates for mortgaging my home were more difficult to obtain while self-employed.? Aside from my investments, I am not earning as much as I used to.? The fixed costs of liquidating part of my portfolio were 6% of the fixed costs of obtaining the mortgage.? Beyond that the question remains as to how well equities will do in the future, a question for which I have no good answer.
I think I made the right move here; I usually do, generally, but we will see whether this was the right decision over the next few years.
Breaking Ranks: Former Broker Turns Bomb Thrower http://t.co/q1vpz9dh @reformedbroker interview previews his book: http://t.co/Yigg2sEE $$ Feb 24, 2012
Why CLO managers continue to struggle http://t.co/a13j8jVG Low issuance, warehousing is tough, need more subordination, fewer senior buyers Feb 24, 2012
My Favorite Quote from Baupost’s 2011 Annual Letter http://t.co/VOvbqab3 DIstressed bond mgrs get itchy in bull phase & buy new junk @ par Feb 24, 2012
SEC IFRS Plan Endorsement http://t.co/8xguvs2G IFRS is not worth giving up comparability or sovereignty for. Project is a total loser. $$ Feb 24, 2012
Very cool, congrats RT @Finovate: @AlphaClone to offer Alternative Alpha ETF from U.S. Bancorp http://t.co/srufb3qd Feb 23, 2012
SEC May Ticket Speeding Traders http://t.co/oNCbF7pa Worthy of an experiment like the kind they did to study the “uptick rule” $$ Feb 23, 2012
AQR?s Aaron Brown on Red-Blooded Risk http://t.co/ZM7hn5P4 When I was a bond mgr, could sense some aspects of risk listening 2 broker’s tone Feb 23, 2012
The Volcker Rule is not going to bring your house back http://t.co/ADKMABfE Prop trading was not a leading cause of the financial crisis. $$ Feb 23, 2012
Pimco Said to Quit Mortgage Bond Group http://t.co/YsQZs1IE Feels wrong parties (their clients) r paying 4 bad servicing,instead of banks Feb 23, 2012
?If you want, I can dig up an old research piece on analyst coverage — there are basically 3 factors that explain 70? http://t.co/tBinshJJ Feb 21, 2012
Stressed VAR is still a “protractor in the jungle” http://t.co/GRGgwvsd Risk management sh/not b done w/central measures but stress tests $$ Feb 21, 2012
How One Company Teaches Employees the ABCs of Finance http://t.co/fqO19foq More companies should do this, they would b more profitable. $$ Feb 18, 2012
Gross Fund at 66% Premium Shows Pimco Allure in Quest for Yield http://t.co/LY8Rv4SS Yield illusion distracts many investors. Avoid it. $$ Feb 17, 2012
Read:Which three of DOL’s new 401(k) rules represent the biggest land mines for financial advisors and plan sponsors? http://t.co/ZVoMPmQu Feb 15, 2012
The 400% Man http://t.co/nrRhYIZl Wish I could meet some of his disappointed investors who came to kick the tires and were disappointed. Feb 15, 2012
Contra:Foot-Dragging on IFRS Decision Could Strip SEC of Power http://t.co/VNUFhWD5 The US could lose representation on IASB. Good, drop out Feb 14, 2012
Notes from iGlobal’s Global Distressed Investing Summit: Part 2 http://t.co/9iOty0Iz Leveraged loan market seems to be in decent shape $$ Feb 14, 2012
Pimco: $25 Billion Foreclosure Deal to Hit Pensions Harder Than Banks http://t.co/DKFtMI9B Gives MBS buyers a reason 2 sue originators $$ Feb 13, 2012
Missing at MF: $1.6 Billion http://t.co/QSUMYbNO Included for the 1st time is roughly $700 million in client money residing in the UK $$ Feb 13, 2012
Stockbrokers: A Guide to Private Placement Due Diligence http://t.co/tbwtu6Jy Illiquid investments are ways to cheat average people. $$ Feb 11, 2012
Why illiquid? Can’t recover the commission otherwise.? Can deceive people that their investment is worth more than it? http://t.co/cYjvUhWx Feb 11, 2012
Market Strategy
Jim Stack was right, and he?s still bullish http://t.co/GfEqtTKl Basically a forward P/E plus momentum argument, & lack of sharp falls $$ Feb 24, 2012
S&P 500 Gets 9% Cheaper on Record Profits http://t.co/DWPGz5Y2 Makes a P/E argument; profit mrgns will eventually revert, may take a while Feb 23, 2012
The dangers of dividend-paying stocks http://t.co/FymTmAAi Hint: they are stocks. No maturity date, no certain cash flow, low BK priority $$ Feb 23, 2012
Falkenblog: Low Vol Commodity Timing Strategy http://t.co/M4FFRoCx Low volatility seems to work in a large number of areas, this is one $$ Feb 23, 2012
Retro Investing?Look Back to Get Ahead http://t.co/vYiPCu9J The 50s, w/post-WWII financial repression, recurs as a current investing meme $$ Feb 22, 2012
The Intelligent Investor: Are Index Funds Messing Up the Markets? http://t.co/VAoFtksw May also be traders following each other $$ Feb 21, 2012
If history is any indication, high dividend stock outperformance should continue http://t.co/C5GaWmW8 Uses 40s & 50s as analogy $$ Feb 20, 2012
Breakout or consolidation? http://t.co/GTSkBjIT Many market seem to be at inflection points. Which way will they go? Wildcards: EZone, China Feb 20, 2012
RE: @alea_ Interesting analysis.? I would be wary of teasing too much out of the cluster analysis of sector correlati? http://t.co/zirdOJ8v Feb 18, 2012
MORGAN STANLEY: January Exhibited This Tell-Tale Sign Of A Market Top http://t.co/IQqidpUE When everything rises at once, look out! $$ Feb 18, 2012
Apple Stock May Not Be as Cheap as It Looks http://t.co/2dgfjfPq Earnings quality has declined, and so has the PE multiple $$ Feb 18, 2012
@ampressman Common summary stat 4 acctg quality 4 $AAPL Net Operating Accruals / Assets, has been deteriorating 4 last 7 years + Feb 18, 2012
@ampressman $AAPL acctg used to be very conservative, now modestly liberal by that statistic. It’s a bad direction, not a bad position, yet Feb 18, 2012
Should the Rich Invest Like Colleges? http://t.co/M9OaPEPA Better question: what are your goals? Do you have an infinite horizon? $$ Feb 18, 2012
High Yield Bonds as Equity Indicator | The Reformed Broker http://t.co/OXUtZrWG Meet my friends & former colleagues Ed Meigs & Sean Slein $$ Feb 17, 2012
When Earnings Slow, Focus on Big Cap, Quality http://t.co/zjD3RPKA High quality is the place to be at present, credit cycle shifting some $$ Feb 16, 2012
A Lesser Known Indicator http://t.co/8oivTJFl Cash enters market through IPOs, employee grants, & exits through cash buyouts, buybacks $$ Feb 16, 2012
Parabolas have 2 end somewhere $$ RT @ReformedBroker: $AAPL sold off because people were getting impatient with how slowly it was moving up. Feb 15, 2012
FPA Capital?s Bryan Beats Peers Embracing Oil Volatility http://t.co/7ebuGmrb A clever focus on absolute retruns, w/a long horizon $$ Feb 15, 2012
Paulson Gives Activism a Go http://t.co/dkHb3cht Not as easy as it looks w/ $HIG. Acctg may not fairly capture variable liabilities $$ Feb 15, 2012
RE: @SoberLook DB hedges its bets.? Average years rarely happen in high yield, they are either good or bad. http://t.co/0C51uulu Feb 14, 2012
THE 1987 MYTH?. http://t.co/mHSU4nM3 ?Illusion of stability within disequilibrium? Very well said, in one short phrase. $$ Feb 14, 2012
America Inc. Faces Margin Stall http://t.co/RbqvqbT9 US companies have begun to see rising costs eat into the bottom line. Finally. $$ Feb 13, 2012
Hulbert: Insiders Selling at Heavy Pace http://t.co/qOPk2cbY Just another straw blowing in the wind, but insiders usually have good sense $$ Feb 10, 2012
Greece
Greek PSI outcomes tree: credit event probability at 93% http://t.co/jcLBc04c Clever grraphic shows high likelihood of Gk CDS triggering. $$ Feb 23, 2012
The market is now pricing in Greek sovereign CDS trigger http://t.co/w5vJ42Fa Upfront prices for Greek CDS moving up $$ Feb 22, 2012
Despite Pact, Unease Lingers for Greece http://t.co/Urp7mmag “Many Problems Remain Even Under Best-Case Scenarios” Shrink, shrink… $$ Feb 22, 2012
Greek Rescue Is Not the End of the Story http://t.co/IOCVcCTb Won’t save Greece on its own & there r other fringe nations 2 deal with $$ Feb 20, 2012
ECB Greek Plan May Hurt Bondholders While Triggering Debt Swaps http://t.co/Aya9urfV ECB may get better treaqtment than private holders $$ Feb 20, 2012
So, what would your plan for Greece be? http://t.co/SAd2f28O Play the game, and let Keynes sneer @ u as u attempt 2 solve the impossible $$ Feb 18, 2012
Greek Economy Shrinking Rapidly http://t.co/VzXi375M And it may shrink more rapidly depending on what the rest of Europe does $$ Feb 14, 2012
Eurozone
ECB’s Mario Draghi magic corrupts bond markets http://t.co/r0ZCmYpb Banks become dependent on ECB, bank bondholders more subordinated $$ Feb 24, 2012
European Banks May Tap ECB for $629 Billion Cash http://t.co/Re5TjLR5 ?There is a ?lose-lose? air around the ECB?s auction next week,? $$ Feb 24, 2012
The Eurozone should be prepared for a new government in France http://t.co/qGFPC20S And that govt will be more hostile to current actions $$ Feb 22, 2012
Spain Sinks Deeper Into Periphery on Debt Rise http://t.co/wkuef6tS As debts grow higher, the probability of escape gets lower. $$ Feb 22, 2012
Iron Lady Merkel Bucks German Street on Greek Aid http://t.co/Wc95xI47 Strategy working 4 now, but what if colleagues lose their seats? $$ Feb 20, 2012
Moody?s Cuts European Sovereigns http://t.co/GvJuES7t Spain, Italy, Portugal, Slovakia, Slovenia & Malta all cut. France & UK -> neg outlook Feb 15, 2012
Unlisted in euroland http://t.co/AQQrJMUf Didn’t catch this in Jan. Private bonds can offered 2 ECB as collateral; helps French banks $$ Feb 13, 2012
The Well-off Fringe Nations
Icelandic Anger Brings Debt Forgiveness http://t.co/P4BH8HKN If the debt problem is not severe, austerity. If it is severe (Iceland) default Feb 22, 2012
Nordic Currencies Stung in Crisis http://t.co/teorxG1P Much of the world, looking for a store of value, drive fringe currencies up $$ Feb 21, 2012
Canada housing market: poised 4 ‘severe correction,’ George Athanassakos says http://t.co/05kaVIAD Canada is used to the boom/bust cycle $$ Feb 21, 2012
@joshuademasi You’re right, but most of the fringe currencies are facing the same dilemma; who to favor, consumers vs exporters, etc… $$ Feb 21, 2012
Israel Safest as Investors Discount War Threat http://t.co/3oXTlILj Well-capitalized banks & balanced economy w/much high tech $$ #warrisk Feb 20, 2012
A hedge fund bets big on a Canadian mega quarry http://t.co/k7OZBC9u Property rights r tough here. What if an existing farmer tried this? $$ Feb 18, 2012
Australia?s Gillard Urged to Increase Mortgage Purchases http://t.co/ylsCuvq4 A mistake, far better to let the market fail. $$ Feb 17, 2012
You’re right, reminds me of an old piece I wrote: http://t.co/XkgO7z7A Thanks $$ RT @joshuademasi: The 5 stages of USD grieving ! Feb 15, 2012
Plan B for China’s Wealthy: Moving to the U.S., Europe http://t.co/X9jRPy6q Wealthy Chinese know their govt, thus the need for flight $$ Feb 22, 2012
China?s FDI and Trade Outlook Horrible Says Commerce Spokesperson http://t.co/LIlvmxIL Hard 4 Comm Party 2command domestic consumption up $$ Feb 18, 2012
‘Mother of all bubbles’ will pop China stocks: GMO http://t.co/OMENKZOI Low prob: China successfully navigating soft landing out of a bubble Feb 18, 2012
China’s excess exports turn negative http://t.co/CiLgTKqC Key Q: how will China grow its economy by stimulating domestic consumption? $$ #uh Feb 18, 2012
Too many bearish on China, but I’m bearish also.? What to do? Seek out China bulls.? If their arguments sound dumb, d? http://t.co/vrhUIdsh Feb 17, 2012
The Silent Victims of the U.S.-China Currency War http://t.co/6DXAnE3m Smaller nations get caught in crossfire of competitive devaluation $$ Feb 17, 2012
China’s Military Spending to Double by 2015 http://t.co/5Va8kiLr I think it take some losses before DC takes this seriously. $$ Feb 17, 2012
China?s Tenuous Hold on Peace http://t.co/dOFr68tL Tibet is restive, China blames its problems on the economic mismanagement of foreigners Feb 14, 2012
Glimpses of a Chinese Town Under Lockdown http://t.co/AFoW0zsM some reporters managed to get there to document the heavy security presence Feb 14, 2012
Liu Mingkang Outlines the Reforms China needs to Undertake http://t.co/L0cXMoIf Will the communist party willingly reduce its power in China Feb 13, 2012
Japan
Japanese Equities Herald Return to Inflation http://t.co/rxlt5OhI If Japan bond market breaks, ructions will be felt the world over. $$ Feb 23, 2012
Energy imports will pressure Japan’s trade deficit http://t.co/lieDm3T4 But, Japan has a current account surplus from its net foreign assets Feb 23, 2012
Japan Suggests No Quick G-20 Deal on IMF Funding http://t.co/RZYF5EB2 non-European members of the IMF waiting on the Europeans to act $$ Feb 22, 2012
Tokyo Small-Caps Set for Longest Win Streak http://t.co/mD3ySrzh Unnoticed but true, look @ this CEF: http://t.co/VcdMQDxL FD: long $JOF Feb 22, 2012
Yen Slumps After Japan Expands Bond Buying http://t.co/L6yImwzC Competitive currency devaluations driving Forex $$ #beggarthyneighbor Feb 15, 2012
Iran
Japan Refiners Said to Stall on Iran Deals http://t.co/uEq1DYtb Life is harder on those that need Iranian oil, like India, China, Japan $$ Feb 21, 2012
Iran Says It Loaded Locally Made Fuel to Nuke http://t.co/6HkMaEFj Not sure I believe this, but if it’s true, the Israelis will know 😉 $$ Feb 15, 2012
Iran presses ahead with dollar attack http://t.co/Hd4Qtnvz Unlikely to work, but it’s all they can do w/oil transport shut down $$ Feb 14, 2012
Letter Writers Break Iranian Taboo http://t.co/M3NMfmk1 They are so desperate that they write the Ayatollah and criticize conditions. $$ Feb 14, 2012
Record Redemptions Loom Amid Akbank $1.3 Billion Loan Talks http://t.co/x5iDTSwE Never knew Turkish firms financed w/so much Short debt $$ Feb 18, 2012
Chavez Missing $10 Billion a Month by Curbing State Oil Investment http://t.co/uTG1Z8d8 PDVSA falls behind Pemex? How low can you go? $$ Feb 15, 2012
Ch?vez Opposition Faces Hard Election http://t.co/YBWi9PaW Chavez controls media & oil wealth; tough for Capriles, but he can still win. Feb 14, 2012
Gunfights in Saudi Arabia Show Spread of Tensions http://t.co/dNxhg2ij Shia in Saudi Arabia fight the govt. Biggest split in Mideast $$ Feb 14, 2012
The Real Reasons the Rich Are Moving Cash to the Caymans http://t.co/gh7d85ZA Litigation risk, and US political risk; diversify yr govts Feb 13, 2012
Federal Reserve / Monetary Policy / Fiscal Policy
Those believing the Fed is on hold for the next 3 years will be in for a rude awakening http://t.co/VYggm431 FF futures & TIPS betray mkt $$ Feb 24, 2012
Exported Inflation to Return Home, but When and in What Form http://t.co/UHT61w4Y The Fed will find it hard to shrink its balance sheet $$ Feb 24, 2012
Healthcare expenses will overwhelm the US federal budget http://t.co/lLUABMYy Suspect a deal will b driven 2 reduce benefits somehow $$ Feb 23, 2012
?Fiat Money and Collective Corruption? http://t.co/lRAa2xnG Hard money would help, the bigger problem is light regulation of banks/credit $$ Feb 23, 2012
Fed Writes Sweeping Rules From Behind Closed Doors http://t.co/UtozNgly Q: Why? 2 avoid bank influence, or 2 hide bank influence? $$ Feb 21, 2012
The Race To Debase In All Its Glory http://t.co/rPtS9EqD Balance sheets of major central banks expand rapidly $$ #racetothebottom Feb 21, 2012
Wealthy Enriched by Double-Dipping U.S. Plan http://t.co/YtGTfakC Long article describing unethical use of SBA $$ . #eliminatetheSBA Feb 21, 2012
Over-regulated America http://t.co/uMKtg2W0 The home of laissez-faire is being suffocated by excessive and badly written regulation $$ Feb 18, 2012
Geithner: GOP Walked Away From Tax Overhaul – Bloomberg http://t.co/yupPqVeO Articles like this indicate another stalemate in the making $$ Feb 17, 2012
Potomac Divide Shows Foreclosures Thru Courts Slow Home-Price Recovery http://t.co/kilW75GM MD has slow foreclosures, housing mkt lags VA Feb 16, 2012
Sober Look: Regulate it all, ask questions later http://t.co/qnpfakfJ New regulations reduce the liquidity of the corporate bond market $$ Feb 16, 2012
FHA is almost broke. What will DC do when it goes critical? RT @HousingWire: FHA defaults up for ninth straight month http://t.co/TSZFHCeD Feb 15, 2012
Pentagon May Oust Troops Involuntarily to Meet Reductions in Budget Plan http://t.co/VnY4At7J Tough time 2b let go if you r a veteran $$ Feb 14, 2012
What a surprise! $$ RT @pdacosta: Bernanke’s big housing speech makes no mention of the Fed’s regulatory laxity in run-up to the crisis. Feb 10, 2012
Bonds
Contra: Should Mortgage Rates Even Be Lower? http://t.co/lODEFb1P Mortgages do not price off of Tsys, but swaps and bank bond yields $$ Feb 22, 2012
Wall Street Crowds Into Trader Joe?s http://t.co/dHZT83VK CMBS mkt getting heated; loans linked 2 retail rose to 45% 4 bonds sold in 2011 Feb 22, 2012
?Have a lot of friends who have lost a lot of money waiting for $TLT to break. FD: long TLT http://t.co/Lw6Rqn02 Feb 21, 2012
A $360 trillion confidence trick http://t.co/Kar0f3Cz I have argued that LIBOR should be based off of binding offers to borrow/lend $$ Feb 14, 2012
http://t.co/VOIG2gUk W/TIPS NY Fed concentrates on the long on-the-run & nearby, w/nominals opposite. Makes implied inflation look higher $$ Feb 10, 2012
Muni Bonds
Stockton, CA, to Weigh First Steps Toward Bankruptcy http://t.co/d2lsCmx8 Start of negotiations to reduce emplyee pensions & healthcare $$ Feb 24, 2012
Good piece, thx RT @munilass: Evaluating Chapter 9 Bankruptcy for City of Detroit: Reality Check or Turnaround Option? http://t.co/PxWo5qHA Feb 21, 2012
Yes. http://t.co/4DUVVTKi $$ RT @BarbarianCap: @munilass isn’t this the muni book that @AlephBlog reviewed very favorably a few days ago? Feb 20, 2012
Pensions
New Rules Wreak Havoc forRetirement-Plan Sponsors http://t.co/HzHWTTtL I would expect rules to be modified, else headaches 4 DC plans $$ Feb 24, 2012
@BarbarianCap Looking at the RFP, that is one of the few things *not* under consideration, pity too, because it is more important. #DumbOCPP Feb 23, 2012
@BarbarianCap The audit is a test of methods and data, not assumptions. That’s actually pretty normal unless you an assumptions outlier $$ Feb 23, 2012
@BarbarianCap I’ve said it many times b4, if life insurers have 2b conservative in accounting, DB plans s/b more so, but they r less so $$ Feb 23, 2012
@BarbarianCap Some cases, deals will be driven to reduce benefits, depends on state/muni laws, Ch 9 allowable; not protected by ERISA/PBGC Feb 23, 2012
Stocks
The Capabilities Premium in M&A http://t.co/9CdZIugk Long piece that explains why some mergers work; they aid organic growth & r small $$ Feb 22, 2012
Elemental to Raise $1.7 Billion Next Year to Mine Potash http://t.co/w7GNsA2H Potash pricing has been volatile lately, cross-currents $$ Feb 22, 2012
Gamestop to J.C. Penney Shut Facebook Stores: Retail http://t.co/zSui0fCf $FB may have a more difficult time w/retail than some expect $$ Feb 20, 2012
Hewlett-Packard’s Message: We’ve Been Here All Along http://t.co/vU8piGMt Note: long $HPQ . HPQ definitely sounds more certain now. $$ Feb 16, 2012
Icahn Pushing CVR?s Sale Means $1 Billion Gain for Shareholders http://t.co/TfBKGErf What refiner wants more capacity now & fertilizer? $$ Feb 16, 2012
Hedge Funds Switch Positions, While Paulson Switches Investing Style http://t.co/MznmLhci Issue w/ $HIG is value of Variable product biz $$ Feb 15, 2012
Miscellaneous
The Control Revolution And Its Discontents http://t.co/FY4XgPde There is a “sweet spot” for market efficiency, too much & things get chaotic Feb 24, 2012
The Decline In Inventory Right Now is NOT a Good Sign http://t.co/Ra1Iz65H Fall in seller confidence & decline in new distressed inventory Feb 23, 2012
Spring Lambing in UK Turns Deadly as New Virus Kills Young http://t.co/PrO4neT1 Infects pregnant sheep, cows and goats, 5% infection rate Feb 22, 2012
Midwest Farmland Prices Update for the Year 2011 http://t.co/se9DbEgB Good discussion after a good article; things r getting a little bubbly Feb 22, 2012
Finding Treasures Among Insurer’s Wreckage http://t.co/jiFZiydE Never bot Atl Mutual’s Surplus Notes, but historical curiosities, wow $$ Feb 18, 2012
@StockTwits Insurance is boring, but antiquities at the oldest companies are fascinating. Wonder what Nationwide did w/Provident Mutuals? $$ Feb 18, 2012
@StockTwits I would hold meetings every now and then in Provident Mutual’s underused antiquities room; would start good conversations $$ Feb 18, 2012
Why Is Violent Crime Declining in US Cities? http://t.co/SLgD8bEL & http://t.co/RRRI2m8X Smarter law enforcement makes DC safer. Wow! $$ Feb 18, 2012
Thanks, liked it. RT @onwrdnupwrd: you will like this one from this weeks economist http://t.co/DMqhgXBB Feb 18, 2012
Interracial Marriages in US Reach a Record http://t.co/RJjWnTso Interesting that it is more prevalent with college educated people. $$ Feb 18, 2012
Harvard Mapping My DNA Turns Scary http://t.co/m5stl0d2 Journalist learns hard things about his DNA. Would he be better off not knowing? $$ Feb 18, 2012
Groupthink: The brainstorming myth http://t.co/7VBlhzKC People do better solving problems on their own, and sharing ideas w/the group $$ Feb 18, 2012
Fear, Submission, and Authoritarianism; a Disturbing Trend http://t.co/0lb32tOw Negative social mood leads to loss of liberties $$ Feb 16, 2012
Santorum?s Electability Pitch Undermined by 2006 Senate Re-Election Loss – Bloomberg http://t.co/8xglQQPJ Shouldn’t be an issue, here’s why: Feb 15, 2012
As the late Bob Casey said, “You can’t lose if you are a pro-life Democrat.” This is true, and it is why Santorum lost to his son. $$ Feb 15, 2012
Cracking the Long-Jump Code http://t.co/MN9d9EdJ Fascinating science applied; the key seems 2b2 jump higher, not just longer $$ Feb 15, 2012
The Best Foods for Thought, Literally http://t.co/tMyLW9E2 Perhaps the Mediterranean diet can aid brain function, or a lowcal diet $$ Feb 14, 2012
Contra: Almost Half the Price of Oil is Speculative Premium http://t.co/z8t51JOl It should be impossible to so overprice such a large mkt $$ Feb 14, 2012
The Hunt Brothers thought they could corner a much smaller silver market, and were not able to do it.? The oil compan? http://t.co/MLYVH5w3 Feb 14, 2012
So, What’s Your Algorithm? http://t.co/lC4voWCI Being able 2 crunch large amounts of data can lead to more objective decisions $$ #ornot Feb 13, 2012
There are obvious many disparate approaches to asset allocation.? Similar to the disparate approaches of any style of investing, each asset allocation approach has its own particular pitfalls.? Some of these you can plan for and perhaps hedge against or at least mitigate the potential negative impact from those pitfalls, while some booby traps spring up out of nowhere.? Risk Parity issues revolve around leverage, negative skew, and potential negative returns from certain levered asset classes.? Long-term strategic asset allocation may suffer from the quality of initial assumptions and typically relies on stable volatility profiles and correlations between asset classes.? And so on.? Every professional investor ? let?s take an endowment for instance ? diversified its portfolio among several asset classes and styles of management.? But what is interesting to me is that I?m not sure I?ve ever seen an institutional (or even HNW) investor diversify its portfolio among multiple asset allocation approaches.? Theoretically, splitting up a portfolio between 3-5 different AA approaches (strategic, risk-based, tactical with an opportunistic value lens, tactical with a momentum/trend-riding lens, etc.) mitigates the pitfalls of each one.? What are your thoughts here? ?I have a few of my own, but I don?t want to muddy your own intellectual waters ahead of time.? 🙂
My personal approach to asset allocation is similar to Warren Buffett, or Value Line.? I invest mostly in stocks, and keep a bunch of safe assets for liquidity.? As the market rises, I add to my safe assets.? As the market falls, I buy stocks.? In October of 2002, things were so bad that I depleted my safe assets, an everything was in stocks.
In general, I think most complex asset allocation strategies are overly complex.? In general, there are safe and risky assets.? Asset allocation should first focus on the division between the two.? Typically the safe assets are high quality bonds and cash equivalents.? Sometimes there are more opportunities, sometimes fewer.? Safe asset levels should reflect that.
The second focus of asset allocation should be liquidity needs.? Even if there are a lot of promising opportunities to deploy cash, if the liability that funds the assets needs cash, have cash ready for it.? If you invest in limited partnerships or private companies where the assets are locked up for a period of time, have a sense of what your maximum level of illiquidity is (what will you with certainty never need to tap?), and ladder the investments so that like a laddered bond portfolio, you always have some illiquid investments maturing each year, providing fresh cash for deployment where current opportunities are most promising.? These top two ideas are very basic, but even experts neglect them at times.
The third focus of asset allocation is choice of risk assets, which is how I view your question.? There my view of asset allocation is like that of GMO.? Forecast future returns off of free cash flow yields; invest accordingly.
Don’t pay much attention to volatility, but aim for what is most likely, and bend a little in the direction of what can go wrong.? Most of the time, over longer periods of time, what is most likely happens on average; that’s why it is most likely.
Maybe “Too many cooks spoil the broth.”? I have enough trouble trying to work with momentum versus mean reversion.? I would lean toward having one AA strategy that fits with my broader asset management practices.? But on the other hand…
Suppose we did have five asset allocation models, and what their results were encouraging various investors to do.? If we thought that one of the models had been too hot of late, and was attracting too much money, and distorting ordinary market relationships, maybe that could give us a signal to make sure our asset allocation de-emphasized the results of that method.? Timing of course would be difficult, it always is, but seeing the results of the five methods could provide a fuller view of choices faced by our competitors.
I’m not sure that using the average of a number of asset allocation models will provide the best result, but I think that understanding what other players in the market are doing could lead to better decisions.
I’m open to your thoughts, and the thoughts of other readers here.? Anyone have a better idea?
I have great admiration for Warren Buffett, even though I am critical of him at a number of points.? When I read the piece in Fortune where he talks about asset allocation issues, I agree with him 75%.? Where should money be invested?? Stocks.? And as for me, 75% of my net worth is there.? Nonetheless, I see value in bonds, gold, and cash, even though I don’t own any gold, aside from my wedding ring.
Gold is valuable because of its scarcity, and that it is beloved by most cultures in the world.? Gold is beautiful.? Compare it with other metals, gold stands out because it has little economic usefulness.? But that is a feature, not a bug, because it makes gold immune to economic cycles.
Review the gold medal gold model.? The price of gold reacts to real interest rates.? When they are low, the price of gold flies because the cost of carrying gold is negative.? If I could say one thing to Buffett on the topic, I would say read this article, and you will learn why the price of gold is rational and correct in this environment.? Negative real interest rates means the government does not care about the value of its currency, and thus scarce things (think of truly scarce collectibles in the 70s) appreciate in value dramatically versus the depreciating dollar.
Gold is valuable, very valuable when governments and central banks are profligate.? But what of bonds?? Those are the opposite.? They are valuable when governments get more serious about their finances, or when people are scared about the future, and buy long bonds because they want certainty of cash flows in the future.
Also, be for real, Warren.? The dominant asset class inside BRK is bonds.? You hold a lot of them in your insurance companies.
Do I believe in stocks?? Yes, if they are my stocks — the value premium of buying beaten-down companies is dependable.? It doesn’t work every year, but it works most years.
My main point is this: stocks are great, but they are not a panacea.? Gold and things like it are needed for inflation.? Bonds are needed for deflation.? Cash offers flexibility.? These are all useful to investors at the right times.
And, Warren, you have done better than most.? Your stock portfolio has beaten others over the last 40 years.? Most stock portfolios have not beaten bond portfolios, though admittedly by a smidge.
So, is this the time to buy stocks?? I am more bullish than bearish, so yes, but edge in, and be ready to adjust.
I’m on the “con” side of this argument, because I am a risk manager, and have traded a large portfolio of complex bonds.? For additional support consider my article Risks, Not Risk.? Or read the second half of my article, “The Education of a Corporate Bond Manager, Part X.” There is no generic risk in the markets.? There are many risks.? Interest rate risk and credit risk are different topics.?? There are bonds that have interest rate risk but not credit risk — long Treasuries.? There are bonds that have credit risk but not interest rate risk — corporate floating rate notes, my favorite example being floating rate bank trust preferred securities.
It is not raw price volatility that drives investment results as much as the underlying drivers of the volatility.? For fixed income, I described those in the two articles linked in the last paragraph.? During non-credit-stressed times, a bank’s 30-year floating rate trust preferred security is roughly as volatile as a five-year noncallable bond that it issues.? But during times of credit stress, the first security becomes volatile, whereas the second one doesn’t.? The first moves in line with 30-year swap yields, LIBOR, and long junior bank spreads.? The second moves in line with 5-year Treasury yields, and short senior bank spreads.? The underlying drivers have little in common, and when things are calm, their volatilities are similar, because the drivers aren’t moving.? But when the drivers move, which in this case is one correlated driver, credit stress (30-year swap & junior bank spreads go a lot higher), the volatilities are very different, the first one being high and the second one low.
Thus equating volatilities across a bunch of asset subclasses, investing less in the volatile, and levering up the non-volatile, is hard to do.? History embeds all the curiosities of the study period, and calls them normal, and that past is prologue.
From the Pick Your Poison article above, what I think is the (lose) money quote:
Gundlach insists most money managers misunderstand junk bonds, comparing them to 5-year Treasurys to determine how rich their yields are, when the correct comparison should be to 30-year Treasurys.
How can Gundlach compare junk bonds, which do better when the economy heats up, with long-term Treasurys, which get killed when the economy revs up and the Fed raises interest rates?
That?s irrelevant, he responds. The thing to look at is volatility, because that tells you the odds you will have to sell at a loss when you need to raise cash in an emergency. On that basis, junk bonds that were trading at a seemingly reasonable spread of 5 percentage points, or 500 basis points, to 5-year Treasurys in mid-2011 were actually trading at an intolerably low 250-basis-point spread to the proper bond. (By then DoubleLine had cut its junk bond allocation from 10% to 1%.) Sure enough, junk fell 12% as the year went on, and the spread to 30-year Treasurys has doubled since mid-2011.
?It?s called risk parity,? Gundlach says. ?There?s only two investors who seem to understand it?me and Ray Dalio,? the highly successful manager of $122 billion (assets) Bridgewater Associates.
Personally, I don’t think Gundlach makes his money that way for his funds, but in case he does, how should a good bond manager view junk bonds?
First, ignore Treasuries — they aren’t relevant to the price performance of junk bonds.? I’ve run the regression of Treasuries vs junk bond index yields many times.? It’s barely significant for BBs, and insignificant thereafter.? Second, look at stock market indexes of industries that lever up and issue junk debt.? Junk corporate debt is a milder version of junk stocks, i.e., the stocks that issue junk debt.
Third, a corollary of my first reason, realize that risks with junk aren’t driven by spreads, but yields.? With highly levered, or very junior debt, it does not trade on a spread basis, but on a price basis.? Anyone looking at spreads will see too much volatility versus yields and prices.
But mere volatility won’t tell you the riskiness.? Indeed, when economic times are good, junk will do well, and long Treasuries do poorly.? Now, maybe that makes for a very noisy hedge, but I wouldn’t rely on it.
And, volatility is a symmetric measure, which as bond yields get closer to zero, the symmetry disappears.? Most asset classes display negative skew and fat tails, which also makes volatility problematic as a risk measure.
Going back to my first piece on the topic, if I were applying risk parity to a bond portfolio, it would mean that I would have to buy considerably more of shorter and higher quality instruments, and lever them up to my target volatility level, somehow with spreads large enough that they overcome my financing costs.? Now, maybe I could do that with mispriced mortgage securities, but with the problem that those aren’t the most liquid beasties, particularly not in a crisis if real estate is weak.
I guess my main misgiving is that levered portfolios are path-dependent, as pointed out in the GMO piece above.? You can’t be certain that you will be able to ride through the storm.? The ability to finance short-term disappears at the time it is most needed.
Now, if you can get leverage after the bust, and invest in beaten-up asset classes, you can be a hero.? But that’s a time when only the most solvent can get leverage, so plan ahead, if that’s the strategy.? If an investor could consistently time the liquidity/credit cycle, he could make a lot of money.
As the GMO piece concludes, the only benchmark that everyone could hold would be a proportionate slice of all of the assets in the world, which implicitly, would strip out all of the leverage, because one would own both the shares of the company, and the debt it owes, and in the right proportion.
So I don’t see risk parity as a silver bullet for asset allocation.? I think it will become more problematic, as all strategies do, as more people show up and use it, which is happening now.?? First in the hands of the master, last in the hands of a sorcerer’s apprentice.? Be careful.
PS — I have respect for the skills of Gundlach and Dalio.? I’m just skeptical about what happens to risk parity when too many use it, and use it without understanding its limitations.? And, here is a nice little piece about Bridgewater and its strategies.
This is two books in one, and very well done.? The main part of the book explains risk and uncertainty in general terms, such that most people can understand it.? But for those that can deal with complex math, the latter part of the book offers a lot of additional firepower.