Asset Allocation – Page 16

Sorted Recent Tweets

Posted on 6 February 2012 by David Merkel

Trying a new format here, I think readers will like it better.? Most things are better after additional effort.? Think of this as a news links by subject post.

Economics

If you look in the back, it seems that there were 58 respondents. From page 13: Methodology & Panel Selection Invi? http://t.co/p8sVZl9g Feb 06, 2012
Will the great interest rate gamble pay off? http://t.co/hgj5XSKc People want to believe that you can get something for nothing; ain’t true. Feb 05, 2012
Central Planning at the Federal Reserve http://t.co/X8qmqU6C Fed: we can create prosperity by holding interest rates down, right? $$ #wishes Feb 05, 2012
Labor Force Participation Rate: 28-year Low http://t.co/kLgQ61iK Everyone still happy about the lower unemployment rate? $$ Feb 05, 2012
Bill Gross: Free Money Ain?t Really Free http://t.co/LXWxpxp5 It will lead to stagflation, IMO, depending on what fiscal policy does $$ Feb 05, 2012
Life & Death Proposition http://t.co/XuZS5Snn Where does credit go when it dies? Back where it came. It delevers, slows & inhibits ec growth Feb 02, 2012
US unemployment ?progress? http://t.co/WoIVZPGp If you add back the discoraged workers, all of the improvement in U-3 goes away $$ Feb 02, 2012
The Perniciousness of ZIRP http://t.co/dYlFMbLe Gonzalo Lira on how ZIRP loses effectiveness b/c people think it’ll b there a long time $$ Feb 01, 2012
Why Neoclassical Economics Doesn’t Work In The Age Of Deleveraging http://t.co/D3IAhTyv Steve Keen explains y Krugman & others r wrong $$ Feb 01, 2012
Warning: Goat Rodeo http://t.co/JQ2FV9LS Hussman makes his case that equities are overvalued and could pull back 25% $$ Feb 01, 2012
Who Owns World’s Financial Assets? & Why R US Households So Fascinated W/Stocks? http://t.co/5rp52OM4 American Exceptionalism in investing Feb 01, 2012
As an aside, that is one reason why the US net foreign debt hasn’t spiraled up. We own equities abroad & they own our debt. $$ declines + Feb 01, 2012
$$ declines reduce the value of our debts, but not the value of r foreign holdings. I think the US will come out of this crisis rel well $$ Feb 01, 2012

Housing

Home Prices Tumble http://t.co/N1gdNslr No surprise here with all of the dark supply; houses come onto mkt when ppl can bear loss $$ Feb 01, 2012
Too lazy to be knowns http://t.co/flXRR6fM I know many who understood what would happen if home RE prices fell, but none who got the size $$ Feb 01, 2012
Freddie Mac’s “inverse floater” allowed more loan origination http://t.co/5devKZ17 Other side to the Propublica story http://t.co/KjXJHU1x Feb 01, 2012
I’m no fan of the GSEs; I think they should be abolished, but the GSEs have always made a variety of bets on prepayment over time. $$ Feb 01, 2012

International

On China, Henry Kissinger and Fareed Zakaria see Domestic Tension and Risk of Geopolitical Conflict http://t.co/1bhvrI3U Ferguson is wrong. Feb 05, 2012
Tightening lending standards vary materially across the Eurozone http://t.co/ciWUK9cm Conditions tight in Italy & France, but not Germany $$ Feb 02, 2012
Japan Auto Sales Notch Record Jump http://t.co/0VzF4WST Another small bright spot. Of course, bouncing back from a low level $$ Feb 02, 2012
Socialist Hollande, Who Wants Full European Treaty Renegotiation, Increases Lead Over Sarkozy http://t.co/J3qCpZZ3 Eurozone Wild Card $$ Feb 01, 2012
Hong Kong Homes Face 25% Drop as Loans Fall in Year of Dragon http://t.co/ifg1146H And this is with wealthy mainlanders fleeing China. $$ Feb 01, 2012

Markets

RBC Takes On High Frequency Predators http://t.co/MfA5qdxm Where there is offense, there will b defense; nothing goes unanswered in the mkts Feb 05, 2012
Global Strategists Abandoning Bearish Views http://t.co/dOXCUMA7 Makes me think we r getting close to a turning point. Feb 02, 2012
Dividend stocks: Buyer beware http://t.co/SvMCHtCj Makes the valid & missed point: high qual div paying stocks r stocks & can lose $$ #yeah Feb 01, 2012

Credit

6 High-Yield Canaries-in-the-Coalmine http://t.co/4pz6SSQc 6 reasons y high yield is overheated http://t.co/fKnHmBqD & http://t.co/UPVev0iD Feb 02, 2012
QOTD: Regulators Watching Aggressive Yield Chasing http://t.co/iWimo3eg FINRA warns of undue risk in income seeking. Advisors take note $$ Feb 02, 2012
Contra: The Safest 7% Yield in America http://t.co/VrXoLEFH Poor analysis does not take into account the highish leverage on mtge repo $$ Feb 02, 2012
Shipping Loans Go Bad for European Banks http://t.co/y5Z0wt3R Highly glutted area w/many dead firms walking; how far down will the losses go Feb 02, 2012

Politics

Group lists top stock investments by members of Congress http://t.co/CarxUCjS Top 50 hldgs -> in top 100 cos by mkt cap. Hard2manipulate $$ Feb 05, 2012
Obama Re-Election Odds Versus the Stock Market http://t.co/F5EETcve Example of 2 variables that r correlated b/c they anticipate GDP changes Feb 05, 2012
RE: @abnormalreturns Gold is mostly political philosophy. How much control do you want the government to have over mo? http://t.co/hRxIkaoo Feb 03, 2012
Getting back to the gold standard http://t.co/pCk8Ij6j Gingrich & Ron Paul have said they would like to appoint James Grant as Fed Chairman Feb 02, 2012

Companies

Carlyle’s proposed IPO disaster http://t.co/OqGke8eN So there’s no board. Most boards don’t do much. Mgmt will have no board 2 shield them Feb 05, 2012
For These Fans, a Day With Buffett Offers Wealth of Photo Opportunities http://t.co/UpcwVKe7 I think Buffett is enjoying life more now. Feb 05, 2012
Buffett Railroad Boosts Capital Plan to $3.9B http://t.co/9XEw2gyT Buffett changes; organic investment in capital-intensive biz $$ #olddog Feb 01, 2012
Pep Boys Seen Gaining 27% as Cheapest Value Lures Bids http://t.co/GyfH7qRL Could a bidding war start? Company is undermanaged $$ Feb 01, 2012
Jefferies Allows Bonus Recipients to Swap Stock 4 Cash With 25% Discount http://t.co/pfGB3Vmc Fair way2 let employees disconnect from $JEF Feb 01, 2012

Financial Services

I’ve just started “Acts of God and Man,” by Michael Powers. In the intro, he goes through the various meanings of th? http://t.co/tX7uAlWl Feb 05, 2012
When evaluating Investment Funds, use Dollar-weighted Returns http://t.co/N5g7PI0d This is a neglcted concept that is enjoying a rebirth $$ Feb 02, 2012
After a Delay, MF Global?s Missing Money Is Traced http://t.co/4s6U8yOe Investigation moves to how to recover the $$ and who is at fault. Feb 01, 2012
http://t.co/wBbJTe3D FINRA Alert: Do you use complex products? What additional work do you do 2 assure that they are being used properly? $$ Feb 01, 2012
Banks Need Higher Interest Rates to Start Making Money http://t.co/SneRACCi Flat front end of yield curve squishes bank interest margins $$ Feb 01, 2012
401(k) Plans Step Into the Sunshine http://t.co/fvKeup2L But as with DB plans, as costs rise, companies will offer them less. $$ Jan 31, 2012

Value Investing

The SEC’s “90% Convergence” Fantasy http://t.co/bkWaAS5S US GAAP has many flaws, but we know them. IFRS will introduce abusable flexibility Feb 02, 2012
But on the bright side, value investors may do relatively better as financials become less trustworthy; the accruals anomaly will sing $$ Feb 02, 2012
Need to consider (Cost of goods sold)/user $$ RT @ErikSchatzker: Facebook gets $4.39/yr of revenue per user. ESPN gets $4.69/mo. Feb 02, 2012
Berkowitz: Fund Plunge ?Makes Little Sense? http://t.co/pcoPLahW BB, appoint someone in your group 2 seek out opinions contrary 2 yours $$ Feb 01, 2012
@ADayforRabbit I have argued in the past that BB is not paying attention to the delevering, which is a real headwind for the banks. $$ Feb 02, 2012
New Fund Hopes to Prove Outspoken Analyst?s Thesis http://t.co/cuVpRzvO I bet @rcwhalen does well like my friends @ Hovde or M3 Partners $$ Feb 01, 2012

Hedge Funds

Are Hedge Funds Worthwhile Investments? http://t.co/Lw2EhRPr Yet another “Hedge Fund Mirage” citation; the book is having a lot of influence Feb 02, 2012
Are the hedge fund and private equity boys pulling a fast one? http://t.co/TNXFJo62 Beginning 2c the args of “Hedge Fund Mirage” everywhere Feb 02, 2012
Did Hedge Funds Trigger the Financial Crisis? http://t.co/lNIb2dgF Secured asset classes can be overlevered; when they collapse, big mess $$ Feb 01, 2012

Miscellaneous

Do the Job You’re Meant to Do http://t.co/wR3OX20N LIfe is too short to work with people you don’t respect, or tasks unfit for you $$ Feb 02, 2012
Millionaire adopts girlfriend as daughter http://t.co/zffGCWbu Asset shelter. Does incest rely on consanguinity or on legal relationship? Feb 02, 2012
Charles Murray Reiterates Willpower http://t.co/smeXZKNh Lack of self-control can destroy relationships, jobs, firms & lives $$ Feb 02, 2012
I ran into @twitalyzer today. Lots of interesting analytics for tweeting. Here are some for me: http://t.co/HDdcFYaU & http://t.co/8uFFOMuP Feb 01, 2012
At the first blogger summit at the UST, I recommended to the powers that be that they issue floaters. I also recommen? http://t.co/R3U8OHSi Feb 01, 2012
California Faces Cash Shortfall by March on Low Receipts, Controller Says http://t.co/QxH1a6Re Could be interesting given the elections $$ Feb 01, 2012

Against Risk Parity

Posted on 4 February 20125 February 2012 by David Merkel

Many investment ideas are promising so long as few do them.? Yes, there is an opportunity, but it is limited.? “Shh, don’t tell everyone about it.”

Thus, the concept of “risk parity.”? Lever every asset class up until it has the same volatility as common stocks. Under theoretical conditions, one could make extra money doing this, and with less risk than just a common stock portfolio.

That makes sense when few are doing it, but not when many are doing it.? When I worked for Hovde Capital Advisors, I highlighted to the group how hedge funds were forcing every asset class to the same level of riskiness.? A Grants Interest Rate Observer article on Leveraged Non-prime Commercial Paper is etched on my mind as emblematic of that era.

Risk parity can work so long as the total riskiness of the system does not get too high, as it did in 2007-8.? But if it does get too high, the assets that are levered face disadvantages versus volatile unlevered assets.? Failures of leverage feed on themselves, and lead to a real washout.? Failures of growth stocks don’t do that to the economy.

Risk parity turns managers into bankers, or worse yet, asset managers that specialize in non-AAA investment grade portions of structured securities deals.? Most asset managers are not used to thinking like bankers, largely because they think in terms of total return, and because they don’t have a balance sheet.? Their capital can run at will, unlike banks that have deposit stickiness, savings accounts, CDs, ability to borrow from the FHLBs, etc.? The banks can hold the assets to maturity, they have a buffer against losses in their capital, and don’t have to mark to market in an assiduous manner (though they *should* have to do so).

Think of the mortgage REITs in the most recent crisis — the ones that did the best were the least levered and had the longest terms for their repo lines.? In the short run, that costs more than the vain idea that one can roll over their repo lines every night, and that repo haircuts won’t rise.? Crises lead to a failure of both ideas, together with a set of forced sellers driving down the price of assets being repo-ed, which sometimes leads to a cascade where repo terms get progressively tighter, and only those that were the most conservative at the start of the crisis survive.

There is a Wall Street aphorism, “The fool does at the end of a bull market what the wise man does at its beginning.”? Risk parity falls into that bucket.? Early adopters of new asset classes and liability structures typically do well, but when they become mainstream, the dynamics can be ugly, as we learned in 2007-present.

So ignore the idea of risk parity.? Risk managers are not bankers, they don’t have the capacity to play leveraged spread games to maturity.? Risk parity if practiced on a large scale will produce wipeouts akin to the recent crisis.

The Rules, Part XXVIII

Posted on 13 January 2012 by David Merkel

Rebalancing of any sort in investing presumes an underlying stability to the economic system, and thus, market returns.? Rebalancing will not protect against socialism, war, or an overleveraged position.

The concept of rebalancing requires the idea of reversion to mean.? It will not protect you when profound shifts are happening, where the market are moving to a new equilibrium different from the old one.

Many shifts in the markets are precipitous; they don’t allow for slow adjustment.? That’s why many lose out when sharp shifts occur.? Especially in leveraged positions, the question comes: “Do I take my loss, invest more, or just let it ride?”

The best answer is forward-looking, only asking what is most likely.? The best preparation is also forward-looking, but with a glance to the past, asking what could happen at worst, which is worse than the worst of the past.

There are times when it seems that stability is no more, or that the boundaries for stability are far larger than normal, such as now.?? At such a time, it may pay to follow market trends, realizing that there many participants like you that are struggling to figure out the situation that everyone is in.

The point is to be forward-looking.? Ignore the past.? Ask what is most promising over your favored time-horizon.

So when it makes sense, add to a position that has lost money.? When it doesn’t make sense, sell the whole position and realize the loss.? Could this be simpler?

Permanent Asset Allocation

Posted on 6 January 2012 by David Merkel

	Short run		Intermediate		Long Run
	Nominal	Real	Nominal	Real	Nominal	Real
Stocks	+	–	+ small	– big	+	0
Bonds	–	0	0	0	+	0
Cash	+	–	+	–	+	–
Gold	0	–	+ small	–	+	–




	Short run		Intermediate		Long Run
	Inflation	Real	Inflation	Real	Inflation	Real
Stocks	+	0	– small	– big	+	+
Bonds	–	–	0	0	+	+
Cash	+	0	+	0	+	0
Gold	0	–	+ small	– small	+	0

(Note: Nominal = Real + Inflation)

This article is meant to tie up some loose ends, and suggest the outline of what might be a clever way to do asset allocation.? Who knows?? At the end, there might be a surprise.

I’ve done two articles recently on the effects of inflation expectations and real interest rates on two asset classes in the short run — gold and stocks.? Tonight, I want to extend that two directions, to bonds and cash, and whether the effects aren’t different in the long run.

First, bonds in the short run.? Interest rates rise, bond prices fall.? Interest rates fall, bond prices rise.? Doesn’t matter whether that comes from real rates rising, or inflation.? That’s pretty simple, because most bonds are mostly interest-rate driven.

Second, cash in the short run.? Leaving aside financial repression, for the most part cash assets return in line with inflation.? Cash is simple… so what happens in the short run is also what happens in the long run.

Okay, now let’s lengthen the time horizon.? In the long run, gold keeps pace with inflation, nothing more, nothing less.? Bond returns rise if interest rates rise over the long term because of higher reinvestment rates for cash flow, and again, it doesn’t matter whether that comes from inflation or real rates.? Opposite if interest rates fall.

Think of 1979-82: by the time bond yields were nearing their peak levels, bond managers were making money in nominal terms with rates rising because the income from the coupons was so high, and it set up the tremendous rally in bonds that would last for ~30 years or so.

In that same era, stock multiples collapsed.? But eventually stock prices stopped going down even with competition from bond yields, because the earnings yields were so large that book values roared ahead, supporting prices.? That also set up the tremendous rally in stocks that would last for 18 years, until it finally overshot, giving us the present lost decade-plus.

But high rates, whether from inflation or real rates, presage high future bond and equity returns.

One nonlinearity here: in the intermediate-term, rises in real rates kill stocks, but rises in inflation nick stocks.? Why?? Inflation may improve nominal revenues at the same time that it raises the cost of capital, but rises in real rates indicate capital scarcity, raising the cost of capital with no increase in revenues.

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

Harry Browne proposed a “permanent portfolio” back in 1981, composed of equal portions of cash, bonds, gold, and stocks.? Reading about the idea in Barron’s in the late 1980s, I did not think much of the idea.? I think differently now.? After my last few articles on related issues, mentioned above, I realize that each of the four asset classes react differently to macroeconomic stimuli in the short run, with a lot of overshooting.? A mean-reverting strategy has a lot of power in this context, and it is double-barreled, in that it lowers volatility and raises returns.

My clients will receive the full details on this as an asset allocation strategy, but my readers have enough from this that if you want to do a little work you can figure this all out yourselves.

All that said, I am surprised at how well the strategy works.? Too easy, and easy strategies rarely work.

Stock Prices versus Implied Inflation

Posted on 5 January 2012 by David Merkel

Eddy Elfenbein wrote a good post recently on the stock market versus inflation expectations.? When I read it, I said to myself, “Wait, is the relationship between nominal and real rates really 1:1, or is it more complex?”? Though it is not certain, the regressions that I ran indicated that 1:1 was not falsified by the data.? The regression:

Inflation expectations determined the much of the value of the S&P 500 for the last nine years.

And you can see the relationship here as well:

The short answer is “yes, inflation expectations have driven stock valuations for the last nine years.”

I’ve been spending time on issues like this for a variety of reasons, and I’ll try to explain them in the near term, but that’s all for now.

Advice to a Friend, Again

Posted on 22 September 2011 by David Merkel

A friend of mine asked me the following:

I read an article or a comment from a blog that inked to your sight.? the statement was akin to this. ” The market is dead.? The lack of growth over ten years shows the deadness of the market.? If the market had kept pace with inflation over the last ten years it would be at 32,000 not the 11,000 we see today.”

I am not all that concerned that this is a true statement, nor am I convinced that their is any better long term investment then a good market strategy.? but I do not have the wisdom to know how to answer this sort of claim in my mind.

The Other Question also comes from a blog that linked to your site:? http://pragcap.com/the-importance-of-understanding-macro

“Whitney Tilson?s latest monthly letter provides us with some insightful lessons for the current market environment. ?Regular readers will know that I believe there is no such thing as a one size fits all investment strategy or a holy grail approach. ?Instead, investors must understand the macro environment and apply the correct strategy to fit that particular environment. ?That micro approach could involve buy and hold, trading, value investing, etc. ?But the likelihood of success using one strategy in all environments is unlikely. The current turmoil and unusual asset class correlation is making for a very difficult environment for value investors. ?Tilson explains (thanks to Zero Hedge):”

Later on he states the following: “Value investing might not be dead (it?s certainly not dead for those who have the ability to implement it in the actual way that Warren Buffett implements it ? no, not the ?buy and hold? myth that Wall Street has sold to everyone), but we can be almost certain that it?s more important than ever to understand the macro. ?If there?s one great lesson to learn from the recent turmoil that should be it?.”

Is the above author stating the difficulty of being a value investor, or is this a man trying to validate his own lack of plan or strategy in a difficult market?? Besides a difficult month for some value investors what is their augment against it.? Would your “bloodless” strategy of quarterly trading be the answer their the accusation of the “buy and hold myth.”

With respect to the tripling of the index level due to inflation, that seems really high to me, akin to a 10% inflation rate.? I think that government inflation statistics are biased low, but by 1-2%/year not 6-8%/year.

On value investing, I rely on Ben Graham’s dictum that the stock market is a voting machine in the short run, and a weighing machine in the long run.? Periods of high correlation where the voting machine dominates eventually go away, and when they go away the weighing machine comes back and patient holders of cheap quality stocks get rewarded.

Value investing has gone through far deeper periods of underperformance such as the one in the late ’90s where many famous value investors got fired, just before the paradigm was about to shift, and value outpace growth by more than the underperformance.

“Buy and hold” is always lionized in a bull market, and castigated in a bear market.? That’s normal.? I grew up in the ’70s watching Wall Street Week with Louis Rukeyser, and at that time, traders were dominant in a static market.? That was not true in the ’80s and ’90s.

My quarterly trading strategy strikes a balance between too-frequent trading that most mutual fund managers do, and the never trade strategies that those who misunderstand value investing do.? Most investors trade at the wrong times, giving up on a stock merely due to bad performance, or buying because it is fashionable.? But if the business is fundamentally sound, it can be held through periods of weakness, and even add to the position.

That’s what I do, and it has worked well for me.? May it work so well for my clients.

I lead a finance class for church.? I think we have talked of it before.? I do not deal much with investing. Mostly I work with cleaning up the personal finances of the families.? Paying down debt, increasing savings, Setting and living below your income, budget, basic investing, using your tax shelters, and avoiding risky investments.

I have a family who some years ago purchased $8000 worth of Microsoft stock.? This has over the course of their holdings dropped between $8-10 a share.? Their financial situation requires cash, cash they do not have.? They need to pay off debts, and their current income gives them very little wiggle room to pay extra on debts.? They asked me what to do with the Microsoft stock, that is now down about $1500 from when they purchased it.? Microsoft stock has remained at a price of $23-29 a share for over a year now.? with the average being somewhere around $24-27 My thoughts have been: That the stock has corrected for the time being and

$25 is probably the true value.? IF $6500? would make a big diffrence in you budget, let you pay down alot of debt and free up some extra cash in your budget to pay off other debts, then sell the stock now.? $1500 is a cheap price to pay for a not so wise investment decision, if it can be use to improve your overall financial standing.? I told him he might ask his broker to sell as soon as it hits $26.

I have however read that Microsoft is a company that has put up good sales and profits in the past few years and that their stock price might be well undervalued.? should I encourage him to hold or sell.? Not asking you to predict the future, simply wanting to get counsel on the advise I have given.

If you think this is good advice let me know.? He is able to get by without the funds immediately, but it will be best if he sell them and use them eventually.

Microsoft is a test for value investors.? What do you do with a company that is cheap on a price-to-earnings basis, but tends to waste free cash flow on foolish acquisitions, investments, and stock buybacks?? My view is that you reject Microsoft; there are better things to buy.

But what of the decision of Microsoft versus cash?? Look, one of the first principles of investing is never invest what you can’t afford to lose.? If you might need the money to spend in the near term, don’t invest it in stocks.

Reconsider my article, Build the Buffer.? Until someone can meet all cash needs easily, including small disasters, he should not be investing in stocks.

With that, I would say that he should sell the stock to the degree that he needs liquidity.? Ability to pay cash in advance is worth far more than equity market returns.

Beggar Thy Neighbor Correlation

Posted on 19 September 2011 by David Merkel

This should be a short post.? There are many reasons proffered for the increase in global equity market correlations — I would like to offer one more: competitive devaluation of currencies, a.k.a., the race to the bottom.? Almost all nations are looking to cheapen their currencies in order to encourage exports.? There is a a global “conspiracy” where consumers are discriminated against by producers and their governments.

The US is involved in this but is more willing to absorb foreign goods than most, making the US is the main reserve currency.? Send us you neomercantilistic goods and services, we will give you promises of future payment.

But when everyone wants to do the same thing, cheapen currencies to promote export-led growth at home, that same thing is impossible, because not all currencies can be cheap at the same time.

But as the process goes on, with so many of the world’s large countries engaged in similar policies at their Treasuries and Central Banks, it is no surprise that with one dominant global policy, there is one global market behavior, oscillating rapidly from panic to euphoria as stimulus measure go from less to more certain.

On Long Only Equity Investing in Bear Markets

Posted on 22 August 2011 by David Merkel

A reader sent me the following question:

Hi David, this is shall be link to your impossible dream part 2 question.

You mention in the article date May13 that we are probably at #4 part of cycle (looking back great called) Where are we in the part of the cycle? ( I would assume we are in #5) if that is the cast..why you added large 5 of your cash in this sell off? (for trading or for investing) Hope I am not asking too much since I am not a client, only long time reader whom respect your opinion.

Here’s the article he was referencing.? There is a tension between my equity management and the switching strategy I proposed in the first Impossible Dream question.? If we are in a market where we should be allocating asset to safe areas, why am I buying more equities here?

It’s a question of time horizon.? The switch model tells you what will do well for the next month.? I am playing for longer horizons.? That’s why I have my seventh portfolio rule:

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.

My best purchases occur in bear markets.? I buy things that are safe but way out of favor, and they rocket back when the market finally turns.? That adds a lot to my alpha, which is more than the advantage of switching, historically.? That’s why I average down in bear markets, if the thesis behind the investments is still valid.

As for what phase we are in, I would say 5 or 6. Cycles aren’t neat.? In this case, we don’t have a lot of defaults, but we do have a lot of negative momentum in equities. In four months we have moved from top momentum, top valuation, to bottom momentum middling valu1ation.? That is pretty deep in the don’t buy stocks region, but it often offers the best opportunities to long only investors, if one is buying for three years, rather than one-to-six months.

So I continue to buy equities that are attractive, even in a market where bonds might be favored in the short run.? As for my clients, it is a question of investment horizon.? Short-term: bond strategy.? Long-term: equity strategy.

In general, I aim for the long term.

Book Review: The Era of Uncertainty

Posted on 19 August 2011 by David Merkel

Many fundamental investors have been shaped by Peter Lynch.? Invest from the bottom up.? Analyze companies, not the economy. Time spent on analyzing the economy is wasted time.

This book takes the opposite approach.? If you understand the economy, and think you know how GDP growth and inflation will go, you have a better chance of choosing the right industries and outperforming.

Like my methods of investing, he looks to understand where we are in the business cycle.? After that, look for good companies that exploit the tailwind.

I became familiar with the main author in the mid-2000s, when he worked for ISI Group.? I appreciated his approach to the markets, which was similar to mine, as the bubble grew, and he and I warned about it.

Think of it this way.? If you had been reading the main author in mid-2006, and had listened to him, how much better off would you be now?? Considerably better off and I offer many warnings over at RealMoney.com before the crisis emerged.

The book will help you understand the sectors and factors in the market that affect returns, and what elements lead those returns.

Beyond that the book expresses skepticism over many of the current economic policies of the US and other governments amid the overindebtedness of much of the world.

At the end, rather than saying, “This is what you should do,” the book asks what your views are, and says if you believe in “such and so” as an economic future, this is what you ought to do.

I liked the book a lot.? I think it is of value to most fundamental investors.

Quibbles

None

Who would benefit from this book: Most fundamental investors could benefit from this book.? If you want to, you can buy it here:?The Era of Uncertainty: Global Investment Strategies for Inflation, Deflation, and the Middle Ground.

Full disclosure: The publisher sent me a copy of the book for free.

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.

Book Review: Expected Returns

Posted on 12 August 2011 by David Merkel

How do we estimate what returns are reasonable to expect?? Most investment counselors fall back on easy rules of thumb, but is there a way of doing better?

In this book, the author takes academic research on investment returns, and tries to make it practical.? What are the main findings of the book?

Momentum works.
Value works.
Illiquid assets can work very well if you have a balance sheet that can hold them.
Carry strategies work most of the time, but when they fail, they fail big.? Same for strategies that sell volatility.

The book does a very good job in establishing that the excess returns of stocks over bonds are a lot lower than most believe.? It also supports the idea that moderate risk taking is the superior strategy.? Those that take high risks lose too often.? Those who take no risk don’t make anything significant.? Moderate risk-taking is the sweet spot.

One of the strengths of the book is that it considers almost all assets, and analyzes how many factors affect those asset classes.? The book is comprehensive; it covers everything, even if it is only an inch deep in spots.

I liked this book a lot, but it’s not for everyone.? You won’t find a lot of difficult math here, but you will find a lot of numbers.

Quibbles

I don’t agree with the idea of levering up low risk assets.? Yes, if you are? the only one doing it, fine, be a non-regulated pseudo-bank.? The trouble comes when many do it.? Eventually a liquidity crisis hits, and those levering up low risk assets get hosed.

The same is true of university endowments.? Too many thought it was easy money to invest in illiquid assets, and when the liquidity panic came in 2008-2009, they were forced to borrow, and/or sell illiquid assets at an inopportune time.

The book does cover everything, but it doesn’t cover everything deeply.? I think it is a valuable book to most who do asset allocation, but the author knows his limits, and does not claim to be expert in a number of areas.

Who would benefit from this book: Fundamental investors who want to understand the factors behind return generation can benefit from this book.? If you want to, you can buy it here: Expected Returns: An Investor’s Guide to Harvesting Market Rewards (The Wiley Finance Series).

Full disclosure: The publisher sent me a copy of the book for free.