Portfolio Management – Page 35

Sorted Weekly Tweets

Posted on 22 February 2014 by David Merkel

Facebook & WhatsApp

Rags-To-Riches Tale Of How Jan Koum Built WhatsApp Into Facebook’s New $19B Baby http://t.co/bJs6kQrlMx Background on WhatsApp founders $$ Feb 22, 2014
WhatsApp Shows How Phone Carriers Lost Out on $33B http://t.co/3gOutvRDzK Perhaps consortium of telephone companies should have bot them $$ Feb 22, 2014
Whatsapp and $19B http://t.co/TWI44XfTOC Explains why $FB decided 2 get into mobile, & how WhatsApp may benefit their mobile push $$ $GOOG Feb 22, 2014
Zuckerberg Bonded With WhatsApp CEO Over Coffee and Dinners http://t.co/EZAR7rFAsG Promise made to respect the unique culture of WhatsApp $$ Feb 22, 2014
Facebook?s horrible, stroke-of-genius IPO @felixsalmon http://t.co/9HrdWMd0Fo Makes point that overvalued $FB stock can b currency 4deals $$ Feb 22, 2014
How Much Sequoia Made On WhatsApp http://t.co/SzzdcObDXJ The funny part is how Zuckerberg pranked Sequoia 10 yrs ago, & regretted it $$ $FB Feb 22, 2014
Facebook Investors Shrug Off Concerns About $19B Deal http://t.co/AwON4bV9tU also http://t.co/TItg9AIJfI & http://t.co/vgKAI4w1Ye $$ $FB Feb 21, 2014

US Politics & Policy

Companies bracing for 1-2 retirement punch http://t.co/bVBBRV1ytu Unlikely that Obama’s proposals would b enacted; hurts powerful people $$ Feb 22, 2014
White House to Propose New Limits on Overseas Corporate Tax Avoidance http://t.co/Me6p3WFG9U This will be difficult 2 enforce; complexity $$ Feb 22, 2014
Gold Rush Ghost Town Bodes Ill for California Power Flow http://t.co/fpor2Toct2 Interesting article on how the drought is affecting CA $$ Feb 22, 2014
Peggy Noonan: Whose Side Are We On? http://t.co/5l2dofDbpg We can have a “Cold War” vs those who hate democracy & human rights $$ $SPY $TLT Feb 22, 2014
NSA Official Warned About Threat 17 Years Before Snowden http://t.co/8utCDM2eug Warned computer system administrators had too much power $$ Feb 22, 2014
Fannie Mae Payments to US Will Exceed Bailout http://t.co/aT1Z8jlrW0 2 bad, b/c government owns $FNMA & will keep it as a piggy bank $$ Feb 22, 2014
An anti-tech backlash in San Francisco http://t.co/NYsVvWZUu7 Note to politicians: don’t bite the hand that feeds u 2 support malcontents $$ Feb 21, 2014
Good: Bumper profits threaten US ethanol support http://t.co/UVjiGT68Wr Time to free *all* energy sources from subsidies adj 4 pollution $$ Feb 21, 2014
Bottlenecks along the Industrial Revolution http://t.co/pzxGIC8GjL There is $$ 2b made in expanding energy infrastructure in America $$ Feb 21, 2014
CBO Is Right: Minimum Wage Hike Can Kill Jobs http://t.co/hKL64NzpJw Suggests raising the Earned Income Tax Credit, which would add jobs $$ Feb 21, 2014
Obama Keystone Pipeline Review Roiled by Nebraska Judge http://t.co/PiF9q1F4nE Governor & Legislature bypassed Public Services Commission $$ Feb 21, 2014
Obamacare’s Latest Surprise for Taxpayers? http://t.co/zirjEk1cP0 @Asymmetricinfo says Obama Admin may extend risk corridors past 3 years $$ Feb 19, 2014
Detroiters Without Cars Seek Jobs in Vain as City Shrinks http://t.co/x76RJvkgza Cities r organic & they can die, like Detroit. Give up $$ Feb 19, 2014
UAW’s Devastating Defeat at a Tennessee Volkswagen Plant: 4 Blunt Points http://t.co/ISoUdA2WBZ Give workers credit 4 rejecting bad deal $$ Feb 17, 2014

Market Impact

Frontier-Market Funds Pour in Boosted by Fixed Currencies http://t.co/YwDTW6bccU 2 much $$ flowing into immature mkts via ETFs; avoid $$ Feb 22, 2014
Learning From a Literary Legend: The Importance of History http://t.co/7QqQ9dkiZd Argues that 10-year stock returns will b below average $$ Feb 21, 2014
Income As The Outcome: Reframing the 401(k) Plan http://t.co/bEWsAPSuiK Int rates fall, 401(k) bond values rise, but future income falls $$ Feb 21, 2014
Wall Street Bond Dealers Renounce Treasuries That Lure Pimco http://t.co/uPxeIqN5uE This is a mess, &no one knows, but I remain long $TLT $$ Feb 19, 2014
FX Traders Facing Extinction as Computers Replace Humans http://t.co/CDqoLCjqsn True if all u r doing is matching trades not if profiting $$ Feb 19, 2014
Information asymmetry, bad incentives and Taibbi http://t.co/K9M8pI1vQR @izakaminska does an excellent takedown of Tabibi’s recent piece $$ Feb 15, 2014

Rest of the World

Japan Record Trade Gap Shows Risk of Abenomics Losing Steam http://t.co/Lfqgvay6KL High debts, trade deficit due 2 low yen, disaster $$ $FXY Feb 22, 2014
For Chinese, It’s Going to Cost More to Become Canadian http://t.co/OlBMh7ZpFv Pity those that want to escape China 2 Canada w/their loot $$ Feb 22, 2014
Nigeria’s Delta Oil Thieves Scrape Out a Precarious Living http://t.co/VxknSU5t3Q Long piece shows a vignette of the troubles in Nigeria $$ Feb 21, 2014
Foreign Investors Scoop Up New Treasuries Even as Fed Cuts Buying http://t.co/zgPmG1NIQu Weaken your currency. Help exporters. Buy US Tsys $$ Feb 21, 2014
India Hedging at Two-Year High as Polls Shroud Outlook http://t.co/mBfYH1HNky Fears of a minority govt have hedgers buying puts on Nifty $$ Feb 21, 2014
Samsung Investors May Discover World of Possibilities http://t.co/8DsBUYHKDu Pity about Sarbanes-Oxley. Samsung shares used 2 trade in US $$ Feb 21, 2014
Emerging Stocks Rise to Three-Week High on Record China Lending http://t.co/bukIP0bFPA W/China overlending already a problem, not helpful $$ Feb 21, 2014
Invading Switzerland? Try Before 8 or After 5 http://t.co/jgBHUG6m84 The Swiss Air Force likes to have the evenings off. War can wait $$ Feb 21, 2014
UN warns North Korea’s Kim Jong-un w/a strongly worded letter http://t.co/AlwVjivIO4 Few things crueler than making a Mom kill own child $$ Feb 21, 2014
Bank of Japan Surprises Markets http://t.co/BbVlwTMHVR Expands Loan Programs, Keeps Main Policy Unchanged, builds bigger debt bubble $$ $FXY Feb 21, 2014
Japan?s GPIF Should Own $600B of Stocks, Ito Says http://t.co/YCfIvErZfb Angling 4a nomination 2 the coveted “Putting in the top” award $$ Feb 21, 2014
As World’s Kids Get Fatter, Doctors Turn to the Knife http://t.co/VdTVjqXu0j Bariatric surgery on a 3-yo, as parents can’t say no re food $$ Feb 21, 2014
China Fund Shifts Focus Away From Energy to US, European Recovery Plays http://t.co/h10gQrGrEs CIC shifts out of power & into real estate $$ Feb 21, 2014
Japan Growth Figures Disappoint http://t.co/FsFtS5qaA5 GDP Increase Comes in Well Below Expectations, perhaps Abe will think twice $$ Feb 21, 2014
China Overtakes India as Gold Consumer http://t.co/XV9WA5p8sT When your property can b confiscated by gov’t, helpful 2 have gold 2 carry $$ Feb 21, 2014
US to Face G-20 Pressure Over Tapering http://t.co/dLYU5cbqKd If the emerging market nations are properly financed, US $$ policy won’t harm Feb 21, 2014
At Asia Air Show, Plenty of Competition for Sales of Drones http://t.co/UCxNe9jQP9 Many uses 4 drones to monitor areas that r hard 2get2 $$ Feb 21, 2014
Russians Return to Cyprus, a Favorite Tax Haven http://t.co/qxW0YkMqlK But they won’t put $$ is Cypriot banks after losing much of it b4 Feb 21, 2014
Billionaire Niel Trains Geeks to Fix France?s Talent Mismatch http://t.co/3jSO5yXExl Sets up a school in France that teaches programming $$ Feb 21, 2014
Elliott vs Argentina: 3 possible resolutions @felixsalmon http://t.co/LuxIKbslsj Sovereign immunity, pari passu & bondholders? ransom $$ Feb 20, 2014
Europe Mending as Markets Signal Even Portuguese Get Work http://t.co/OwqyCMKeGh Less clear than it seems, but Europe is getting better $$ Feb 20, 2014
Sochi Olympics: Vic Wild, American-Born Snowboarder Competing For Russia, Wins Gold http://t.co/uKlhwCdHP3 Far better he got a good wife $$ Feb 20, 2014
What the Heck Is Going on in Venezuela? (Could the Maduro Regime Fall?) http://t.co/JknNNCQpm6 Yes, it could fall, but what will replace? $$ Feb 19, 2014
China Digs Itself Deeper Into Dollar Trap http://t.co/VXRPJEt5o2 Buying Dollar assets supports the cronies of the party that export $$ $FXI Feb 19, 2014
Asia Has Crisis to Thank for Gains in Emerging Rout http://t.co/JMyYasAild Emerging Asia, minus China, in better shape than 1997-8 $$ $FXI Feb 19, 2014
Swiss Fault Lines Exposed as Villagers See Risk to Postcard Life http://t.co/55NLuUb7er Urban vs rural & the “last settler” syndrome $$ $FXF Feb 17, 2014
Salmond Says Forcing Scotland to Drop Pound to Hurt UK http://t.co/bQEK4xwTfY Seriously doubt UK would giveup the seigniorage if Scots go $$ Feb 17, 2014
A Rebuke to Japanese Nationalism http://t.co/iZfr1gfeYM Japan needs 2 give up any sense that what they did in WWII was honorable $$ Feb 17, 2014
Indonesia Says Australian Defense of Spying Is ?Mind Boggling? http://t.co/ykT06aSaxe My, but Snowden opened many cans of worms w/leaks $$ Feb 17, 2014
Saudis Agree to Provide Syrian Rebels With Mobile Antiaircraft Missiles http://t.co/vRawuKKAgj Proxy war between Wahabis & Shia continues $$ Feb 15, 2014

Financials & Personal Finance

Wall Street Landlords Buy Bad Loans for Cheaper Homes http://t.co/hrf9Ph0RNq Color me skeptical; when investors own homes, mkt overvalued $$ Feb 22, 2014
Energy Holdings Nears Bankruptcy After Creditor Talks Falter http://t.co/MXMolWYXSg They overpaid & the debt was huge, even Buffett lost $$ Feb 22, 2014
Tender Offer for Insurer Divides a Boardroom http://t.co/uaNnWRYPfq $AFG ‘s offer for $NATL is more than generous, just tender yr shares $$ Feb 22, 2014
Putting Your 401(k) on Autopilot http://t.co/Mby8Yf9iQe Would b better if we made plans where employees could buy defined benefit units $$ Feb 22, 2014
The growing case against ETFs http://t.co/dV8fE2563o Makes same point that Jack Bogle & I make, ETFs get traded badly by most investors $$ Feb 22, 2014
Americans Ramp Up Borrowing http://t.co/qApFJ0KESP US Household Debt Posts Largest Quarterly Increase Since Before Recession $$ #seenthisb4 Feb 21, 2014
Has Small-Business Lending Really Improved? http://t.co/NujuTdfGtk Qty available may b high, but yields r steep @ nontraditional lenders $$ Feb 21, 2014
The Current Opportunity Set http://t.co/k1i9NS5nsD Valuation-sensitive mgrs see fewer & fewer places 2 put $$ 2 work, so cash balances grow Feb 21, 2014
These Wells Fargo robbers were also tellers http://t.co/ERo7JVe2X1 Comments, some think if banks r dishonest they should b stolen from $$ Feb 21, 2014
I, Claudius, caller of bank bonds http://t.co/tlXoiypnQV Memo 2 bond investors: if you buy an odd bond, b sure 2 read the prospectus $$ $TLT Feb 15, 2014
When One Spouse Saves and the Other Spends http://t.co/vtJfjX0W8P I do not get how this person can be a financial advice columnist $$ $TLT Feb 17, 2014
Debt-Market Chill May Leave Banks Out in the Cold–Heard on the Street http://t.co/MdpS2KOwSv No January bounceback 2 make up 4 December $$ Feb 15, 2014

Companies & Industries

10-Gbit Google Fiber is already real, just not from $GOOG http://t.co/6d0nEU3ViN $VZ has tested it & others 2, coming 2 biz, not home $$ Feb 22, 2014
Charter Seen Eyeing Cox After Time Warner Loss http://t.co/S2YpktEr5x Cox family is pretty cagey; $CHTR would have 2 pay through the nose $$ Feb 21, 2014
‘Candy Crush Saga’ Maker Files for an IPO http://t.co/TIUYMDKnIE Put King Digital in the “too hard” pile, hard to predict future success $$ Feb 21, 2014
Google to Push Its Fiber Rollout on Comcast’s Turf http://t.co/qStVon4gvq $GOOG experiments, $CMCSA will have hard time competing w/fiber $$ Feb 21, 2014
My Goldman Sachs Post-Traumatic Stress Disorder (And Why I’m Grateful) http://t.co/1cJJpQzreu Toughened her up, made her more cynical $$ Feb 21, 2014
Chevron’s Free Pizza Offer Only Feeds Public’s Distrust http://t.co/xXsFzIgqT4 It was a cheesy way 2 compensate people 4 their troubles $$ Feb 21, 2014
The Coal Plant an Illinois Town Couldn’t Give Away http://t.co/7tMYEXqV8u $AEE pays $DYN to take over a coal plant. Now $DYN wants 2leave $$ Feb 21, 2014
Rarest of Rare Iridium Gains as Growth Spurs Demand http://t.co/2X7P02FFBb Cheaper than gold, Iridium is used in industrial applications $$ Feb 21, 2014
Buffett?s Coca-Cola Complacency Warning Foretells Troubled Year http://t.co/MaoyseiN8O Listen to Buffett, his intuition is sharp $$ Feb 20, 2014
Steve Perlman’s Amazing Wireless Machine Is Finally Here http://t.co/BGpdOactlf If it works, it is a huge increase 4 mobile bandwidth $$ $T Feb 19, 2014
Actavis Agrees to Buy Forest Labs for $25 Billion http://t.co/bv6o4VtRM8 Kudos 2 @Carl_C_Icahn Quite a string of victories $FRX $ACT $IEP $$ Feb 18, 2014

Fed Notes

Fed Puts Rate Increase on the Radar http://t.co/IdvNVpEmDl Move Before 2015 Unlikely, but Minutes Suggest Some Inflation Hawks R Circling $$ Feb 21, 2014
The Key Passages in the Federal Reserve’s Minutes http://t.co/xUpUwu9IZZ Hawks start discussion on when the Fed Funds rate should rise $$ Feb 21, 2014
Yellen Leads Fed Damned Every Way by Emerging Market Angst http://t.co/TApq07VklJ Can’t win b/c developed mkt $$ policy swamps EM policies Feb 21, 2014

US Economics

Worsening US Divorce Rate Points to Improving Economy http://t.co/f5He5DrfuY “We’re finally doing well, honey. Now we can afford2divorce” $$ Feb 21, 2014
Citi’s Economic Surprise Index Hits Zero http://t.co/Z69Vy85Hfi As such, the economy is slowing & bond yields r falling. Who knew? $$ $TLT Feb 21, 2014

Other

‘Downton Abbey’ Is Downright Un-American http://t.co/zGCbFHWzfY If a servant wrote book about how nice her employer was it wouldn’t sell $$ Feb 21, 2014
Go Ahead, Let Your Kids Fail http://t.co/kHSID4NgpT Fail & bounce back -> Kids gain skills & grit @asymmetricinfo is off on her book tour $$ Feb 21, 2014
I Took the GMAT With No Preparation. Here’s What Happened http://t.co/hXwdxNJiub Journalist gets score good enough 2 go 2 biz school $$ Feb 20, 2014
Friedman and Hanke on Bitcoin http://t.co/T4bK693dJ8 But what happens when 1 party gets cheated in a Bitcoin transaction? Caveat emptor? $$ Feb 20, 2014
The Official Forecast of the US Government Never Saw This Winter Coming http://t.co/w3RS18QJJd We don’t understand climate well $$ $TLT $SPY Feb 19, 2014

Wrong

Wrong: In Buffett We Trust as Berkshire Annual Report Lacks Disclosure http://t.co/JP3U63bhnj There is more than adequate info in the 10K $$ Feb 21, 2014
Wrong: Cut Off Harvard to Save America http://t.co/ro9cIOe2ok When u mess w/what is a nonprofit & not, u can’t tell what will b the result $$ Feb 21, 2014
Wrong: Is China at Risk of a Debt Crisis? Not Really,Bank Says http://t.co/erURFnC3g1 China facing domestic banking crisis, like US 2008 $$ Feb 19, 2014

Comments, Replies and Retweets

“From what I glean, Zuckerberg romanced them & told them $FB wouldn’t touch their baby. We’ll see” ? David_Merkel http://t.co/X25hjO1Fxo $$ Feb 20, 2014
“Well said. It is hard for China to give up forced investment and export promotion. It’s economic heroin” Merkel http://t.co/0eH1kgg0lo $$ Feb 19, 2014
Commented on StockTwits: This: http://t.co/D0mIcnLtIP and if I knew Spanish, could have seen it earlier:… http://t.co/lPajNQAc4w Feb 18, 2014

On Emergent Phenomena

Posted on 20 February 2014 by David Merkel

How do you deal with a risk that has never been seen before?? I’m going to focus on financial risks here, but clever people can generalize to other classes of human risk, like war and terrorism.

By “emergent phenomena” I mean what happens when people act as a group pursuing the same strategy.? One person doing a given strategy means nothing.? But when millions do it, that can be significant.? Same for corporations, but the numbers are lower, because corporations are far bigger economically than the average household.

Here are some examples of emergent phenomena:

1987 — Strategies for dynamic hedging became a large enough part of the market that the market became unstable, where parties would buy as the market rose, and sell as the market fell.
Tech stocks were the only place to be 1998-2000, until they weren’t 2000-2003.
Too much hedge fund money was playing the quantitative value plus momentum trade in 2007.? Many players borrowed money to goose returns in 2006-7.? It blew up in August 2007.
The fear of not getting “free money” caused many to overinvest in residential real estate 2004-7, until the free money was not only not free, but billing you for past indiscretions.
There was a frenzy among commercial real estate investor toward the end of the 1980s, which bid prices up amid more buying power from then-cheap commercial mortgage debt, leading to an overshoot, and fall in property value in the early 1990s.
In 2005, the CDO Correlation Trade led to a panic in the corporate bond market, and in auto stocks.
Into the late 1980s, Japanese households and some foreigners plowed progressively more liquid capital into the Japanese stock and warrant markets.? That was the peak, and few if any have made their money back.

Emergent phenomena stem from:

Many people and institutions doing the same thing at the same time.
Using debt to substitute for equity in a trade that has become a “sure thing.”
Multiple companies and industries pursuing the essentially same trade, but in different corners of the markets.? (Think of the real estate bubble.? There were so many different angles that the bulls played: mortgage insurance, financial guaranty, subprime loans and derivatives thereof, weakened lending standards on prime loans, etc.)
And it is more intense when economic agents borrow short-term to finance their efforts, because when things go wrong, the feedback loop is quick.

Everyone runs to the exits in a burning theater, and so, fewer get out amid the struggle, than if everyone patiently walked out.? In financial terms, this is why markets are more volatile than expected, particularly on the downside.? Too many people want to sell in a panic, after having pursued a well-known strategy that had been successful for quite a while.

But no tree grows to the sky.? The intelligent investor notes several things:

Where is the most new debt being applied, and to increasingly little effect?
What fad are players investing in, that you think can’t be maintained long-run?
What is happening that would not be happening if it were not for price momentum?
Where are players relying on price appreciation or else their levered positions will collapse?
Where is money being borrowed short-term to fund long-term assets?

People are prone to imitate past success, even when a rational person would conclude that it doesn’t make any sense to borrow money and buy an asset at a high price.? It’s easier to imitate than to think independently.

In the present market, I see large increases in government debt and student loans.? Beyond that, there is the income craze in investing.? Don’t look at the yield; look at the underlying business.

Be wary.? The stock market has run hard the last ~5 years, and I see valuation-sensitive investors retreating.? Even with bond rates low, that doesn’t mean stocks are better.

All for now.? Comments welcome.

If Investing Were Free, How Would It Change What You Do?

Posted on 19 February 2014 by David Merkel

Sometimes I think people forget that they are people; they think that somehow technology will eliminate their foibles.? ETFs have lowered costs for investors, but the greater ability to trade has enabled investors to more easily be greedy or panic.

Go ahead.? Make trading free.? Lessen further the frictions that inhibit bad trades.

If investing is free, would we create better asset allocation models?? Costs are pretty low now, and I don’t see many imitating GMO, which has the best models of which I know.

Costs are already low now for common trades, and if you are willing to deal with poor customer service, you can trade cheaply in many places using Interactive Brokers. [I like Interactive Brokers.? They are the cheapest, and where they are good, they are very, very good.? Where they are bad, well…]

There is virtue to having some “sand in the gears,” i.e., things that hold us back from making too many adjustments to investments.? If investing is free, then human nature will lack one more roadblock against bad decision-making.

Investors get fixated on explicit costs, and miss the implicit costs, which are often higher.? Honestly, on any investment decision, you want to take time, and ask whether the change is worth it.? Are you really on the right side of the trade?? Just because there is little to no cost to do the trade, does that mean it is correct to trade?

Over the years, with ETFs, I have found that people trade more, and lose in trading.? Jack Bogle was/is right regarding ETF clones of low cost mutual funds.? To the degree that we encourage people to trade because of low transaction costs, the more we enable unintelligent fear and greed.

But As For Me

How would free trading affect what I do?? It wouldn’t.? The cost of trading for me is so low, that it does not figure into what I do.? It is better in investing to think hard about your decisions, and make fewer of them.? Thus I constrain myself to making major portfolio changes four times a year.? It’s a big process, and I do it at mid-quarter.? I think hard about the changes I make, and I make few of them, realizing that I am not immune to fear and greed.

This was written partially with an eye to an article at Abnormal Returns, which I rarely disagree with.? My main point is that human nature is a much bigger factor in investing than costs.? First learn to control human nature, if you can.? Then control costs.

Why are Pensions so Messed Up

Posted on 18 February 2014 by David Merkel

A few days ago, I was reading Felix Salmon’s piece Pension politics.? (Nice title, the type that Tadas likes — the shorter the better.)? I wrote a short response in the comments, largely agreeing with Felix.? Here it is:

Here are the facts:

1) DB pension funding accounting rules are more liberal than life insurance accounting rules.

2) Pension actuaries have long assumed investment earnings rates well in excess of what can be achieved.

3) Longevity has long been increasing for those that buy annuities, and take pensions.

4) Average people are lousy investment managers, they panic and get greedy at the wrong times. Pension asset managers aren?t great, but they largely avoid panic & greed.

5) The PBGC is horribly underfunded, as are most municipal pension plans.

6) Overseas, things can be bad, like Poland, Argentina, India, etc. In those cases being on your own is better. Our custodial systems here are pretty good. (Please ignore MF Global.)

7) Fees are generally too high in asset management, and most people should go for passive management, or a few clever value investors.

8 ) Hedge funds, commodities, and private equity are not the answer. Analyze the returns on an dollar-weighted [IRR] basis and they will be much lower than the illustrated buy & hold returns.

9) Highly paid workers lose out in bankruptcy. Multi-employer trusts are prone to a run on the pension plan if a major employer goes BK.

10) the average person is at best a budgeter, and not an investor. That said, buying inflation insurance is very expensive, if you can achieve it at all.

Summary: in general, you are right, Felix, but it is a question of cost to the corporations funding the DB plans. I think the cost is worth it, but maybe it needs to be shared with workers, taking pre-tax dollars to buy more future DB plan payments. How many people would do that? Sadly, not many.

Pensions have always been a bit of a compromise.? In order to get employers to create Defined Benefit [DB] pensions, the government allowed for funding methods that were liberal — a plan sponsor wouldn’t have to put in as much at the beginning; it can catch up over time.? More than that, the assumptions that DB pensions could use were far more liberal than what life insurers could use for similar contingencies.? Life insurers had to use best estimates and then add risk margins.? Pensions could dream of returns, with no risk margins.

The 401(k) was an accident.? It was tossed into a much larger bill, and no one noticed.? After passage, some benefits consultants, notably Ted Benna, found ways to use it, creating the boom in Defined Contribution [DC] plans.

Corporations initially added DC plans to their DB plans, but as the 90s ended, and equity performance sank, many terminated their DB plans.? Part of it was the asset markets, but another part of it was aging workforces, because the funding rules were weak (unlike life insurance).? Sponsors realized that they would have to spend a lot more on DB plans in the future than they would otherwise want to.? Now stingy corporations cut back on their DC matches, or accept kickbacks out of investment manager fees.

There are two great virtues in defined benefit plans: 1) Investing is handled by professionals.? 2) Level payments are made.? Most people can budget.? Few can invest.? Yes, there is the problem of inflation, should it occur, but pensioners should have assets outside of their pension to deal with inflation.? They need longevity insurance, so that they avoid outliving their assets.

Though it might be hard managing a fixed income versus uncertain inflation over an uncertain lifespan, it is much harder to manage a lump sum over a full retirement.? When finances are tight, it is much harder to make the right decisions.? Hope biases average investors in favor of taking chances, whether the market favors taking chances or not.

Add in the troubles with defaults of DB plan sponsors, and significant benefits can be lost, particularly if you have been highly paid.

I would want to tell most asset allocators that there is little to no magic in alternative investments.? The alternatives face the same risk factors as ordinary investments, and they are not underinvested by pension investors.

Closing Notes

Sorry, I forgot to blame the IRS for limiting overfunding for tax reasons, when the overfunding was really funding, and would have been useful today.

Even without the introduction of the 401(k), corporations would have cut back on DB pensions because of costs.? A lot of that was due to bad funding methods, but without those bad funding methods, many DB plans would never have been done.

Just be grateful you don’t live in other parts of the world, where governments are more graspy, and pension assets are a target to plug holes in the government deficit.

This May Be Gold, But It Is Not Golden

Posted on 16 February 2014 by David Merkel

I’ve done a number of articles on dollar-weighted returns in mutual funds.? There are rare cases where the shareholder base is smart, usually in value funds, where the shareholders add more money on declines, and lighten up when things are going too well.

Tonight’s target is the Gold ETF SPDR Gold Shares [GLD].? As with most volatile mutual funds, people tend to get greedy or panic.? They chase performance.? Consider this list of inflows and outflows from GLD. Cash flows are assumed to occur at mid-period.

Date	Cash Flow
9/30/2004	???????????? 13,081
3/31/2005	?????? 2,902,381
3/31/2006	?????? 3,152,826
3/31/2007	?????? 4,129,118
3/31/2008	?????? 5,163,301
3/31/2009	??? 10,326,761
3/31/2010	?????? 8,197,457
3/31/2011	??? (3,046,769)
3/31/2012	?????? 5,499,978
3/31/2013	? (18,958,700)
11/15/2013	??? (4,320,084)
12/31/2013	? (30,887,920)

Dollar-weighted	8.20%
Time-weighted	11.13%

Difference	-2.92%

Versus a buy-and-hold investor, the average holder gives up almost 3% of returns via market mistiming.? Technicians may talk down buy and hold, but buy and hold usually outperforms the average trader.? This is similar to what my friend Josh Brown talks about in his article Flows Don?t Follow Value, They Follow Performance.? Very few investors are rational businessmen, estimating likely returns over their funding horizon.? Rather they chase past success, and flee past failures.

Such has been true of the SPDR Gold Shares ETF.? Say what you will about the cheapness of large ETFs, people will still misuse them.? They will buy late in a bull phase, and sell late in a bear phase.

And so I say to all: Guard your emotions.? Be forward-looking.? Analyze likely value five years out.? Don’t make snap decisions out of regret.? Think about risk control before you buy shares, bonds, whatever.

Now, as a personal aside, it took me around eight years to learn to control my emotions.? Over the last 20 years, I have made at most a handful of errors reacting to bad market events.? I learned to analyze rather than panic back in the 90s.? It doesn’t mean that I am always right, but it does mean that I act.? I almost never react.

As for GLD, be wary about paper gold.? Is it really fully collateralized by audited gold in a warehouse?? There are lots of promises of gold being traded, but how much physical gold could you have delivered to you, should you want it?

That’s all for now.? Be careful in all of your investing; it is easy to err.

Sorted Weekly Tweets

Posted on 15 February 2014 by David Merkel

Market Impact

Companies Squeeze 401K Plans From Facebook to JPMorgan http://t.co/2glTizHOjm This should not surprise, many companies shrink labor costs $$ Feb 15, 2014
Wells Fargo edges back into subprime as US mortgage market thaws http://t.co/s8AJCKuzOH Isn’t a problem now, problem comes w/imitators $$ Feb 15, 2014
Homebuyers Get Break as Loan Rates Defy Fed Tapering http://t.co/i7PdmGThdz Housing & general economy weakened, so mortgage rates fell $$ Feb 13, 2014
Pension politics http://t.co/3NaaI61AxM @felixsalmon points out how defined benefit plans r in general better 4 workers. Mind the PBGC $$ Feb 13, 2014
Colleges Raise Record $33.8B Exceeding US Peak in 2009 http://t.co/PRjlMrKM9i Donations always follow creation of unrealized cap gains $$ Feb 12, 2014
Some Lines Say Maybe the Stock Market Will Go Down http://t.co/FdkJdRT9qe @matt_levine correctly criticizes the 1928-9 $SPY graph overlay $$ Feb 13, 2014
1929 Stock Market Crash Chart Is Garbage http://t.co/PyPIulerCH Unequal left & right scales make the relationship look tighter than it is $$ Feb 12, 2014
?When to Ignore the Investment Experts http://t.co/K2vyHgb1gv ?When all the experts &forecasts agree ? something else is going 2 happen.? $$ Feb 11, 2014
Comparing Economic Recoveries http://t.co/5za6QtEFKD In 1984-2006, growth was borrowed from future by increasing debt levels-> #payback $$ Feb 11, 2014
Aluminum Lines Still Trouble the London Metal Exchange http://t.co/f5OyWC5EHC Aluminum inventories will b a prob, til short intrates rise $$ Feb 11, 2014
Top Anecdotal Signs of a Market Bubble http://t.co/MavPhxB6vZ Good piece, like one of mine: http://t.co/bON7nJJFfk Watch the credit cycle $$ Feb 11, 2014
Ten Stocks to Own During a Market Correction http://t.co/RzBdaNf1ff Good list. I own a few of them. $$ Feb 11, 2014
Does trend-chasing explain financial markets? http://t.co/3Mkg4R99dx Partly. Difference between investment IRR and total return is big $$ Feb 10, 2014
?Security. Safety. Stability.? http://t.co/VfKVcGgMRJ from @reformedbroker Gold is useful at certain points, but only when it is hated $$ Feb 10, 2014
Flows Don?t Follow Value, They Follow Performance http://t.co/9oIJ4M7HMo @reformedbroker wrote this little gem. Learn & internalize it $$ Feb 10, 2014
Long Term Charts 2: Western Markets Since The Middle Ages http://t.co/lsBfIot8pi Interesting charts from very messy data at Zero Hedge $$ Feb 10, 2014
Most Expensive Place to Find Out Who You Are http://t.co/szQfeKFZxT @jasonzweigwsj : Your reaction 2 minor crisis shows yr risk tolerance $$ Feb 10, 2014

Companies & Industries

AIG Takes $832 Million Charge on Death Bets as Hedge Funds Gain http://t.co/JmI7hBy9MH Life settlements should b illegal $$ $MET $AIG $PRU Feb 14, 2014
To Stop the Coffee Apocalypse, Starbucks Buys a Farm http://t.co/CPkyVAUnsR $SBUX helps create a variety of rust resistant Arabica trees $$ Feb 13, 2014
Former BlackRock Manager Finds Billions on Rice Energy http://t.co/aBPTo3u4Ky Few investment mgrs have operating talent; Daniel Rice does $$ Feb 13, 2014
Buffett’s Pal Munger Heads a Very Weird Company http://t.co/ztr3XizpKM Growth of $DJCO thru investing leads 2 # of growing pains & 13F $$ Feb 13, 2014
Here?s Why the Biggest Cable Company in the Country Thinks It Can Get Bigger http://t.co/04cdg1J9VP Feds tolerant of cable re antitrust $$ Feb 13, 2014
Why AOL ended up spending millions on ‘distressed babies’ http://t.co/d2lWs8eJit $AOL chose 2b in healthcare biz 4 its employees & lost $$ Feb 13, 2014
3 High-Yielders To Buy On The Pullback http://t.co/8SUBI1M0ut In total $SNH issues more stock than it pays in divs. Divs -> cap losses $$ Feb 13, 2014
Who is John Thompson? A look at Microsoft’s new chairman http://t.co/W7SrXqxtwm May have right stuff to protect new CEO from meddling $$ Feb 10, 2014

US Politics & Policy

Runaway Drones Map Land, Film ‘Wolf,’ Knock Down People, FAA Gives Chase http://t.co/rcTnjug8w1 Drones r here 2 stay; time license them $$ Feb 15, 2014
Teacher Tenure Put to the Test in California Lawsuit http://t.co/XP5fx6HpR3 Tenure has outlived its usefulness; older teachers can b lazy $$ Feb 15, 2014
Lincoln’s Foreign Policy in Today’s World http://t.co/t2RELj7uRB Kept England & France from joining Civil War; otherwise pragmatic $$ $SPY Feb 15, 2014
What Would Lincoln Do? http://t.co/hi6n4Rb8hl A clever man w/principles, who did not cease to be pragmatic pursuing 1 main goal – Union $$ Feb 15, 2014
Harvard Professor Attacking Google Thrives as Web Sheriff http://t.co/g1W7KXH94K At some point, lack of disclosure will blow up on him $$ Feb 14, 2014
The $2.2B Bird-Scorching Solar Project http://t.co/hIYWhJpUwQ Get used 2 idea: almost every form of energy imposes environmental costs $$ Feb 13, 2014
Obamacare Damage-Control Teams Seek to Calm Complaints http://t.co/bPU95rVMxM Things r tough when u r trying to avoid media embarrassment $$ Feb 13, 2014
Billionaire Musk Gets Brownsville to Pay for SpaceX http://t.co/eoAiygs9mq Like a football owner bargaining 2 get taxpayers buy a stadium $$ Feb 13, 2014
Snowden Swiped Password From NSA Coworker http://t.co/1mJ5D6vGH3 & it cost him his job. Snowden denies it; NSA is Not Saying Anything $$ Feb 13, 2014
Puerto Rico Legislators Amend Bill Calling for Bank-Deposit Shift http://t.co/fMaCvMi7ab Provincial govt’s attempt 2raid cookie jar stopd $$ Feb 13, 2014
Obamacare Will, in Fact, Encourage Employers to Cut Jobs http://t.co/D3vaCFHOZY As the employer mandate comes into force, jobs will b cut $$ Feb 12, 2014
Tea Party Scorns Republicans as House Lifts Debt Ceiling http://t.co/fPohsF6Kbi t-party can b “pure” as Dems raise ceiling w/few GOP $$ $TLT Feb 12, 2014
A Lame Duckish Calm Falls Over the Capital http://t.co/u6bG2cg1nL Parties in DC act as if the next event is the November elections $$ $TLT Feb 12, 2014
Obama Rewrites ObamaCare http://t.co/Ym3CtHt3pI Another day, another lawless exemption, once again for business; WSJ bangs populist drum $$ Feb 11, 2014
The US Senate Again Insists on USPS Saturday Mail Delivery http://t.co/YnzmKE5Xrh 2 timid; end Wednesday & Saturday delivery $$ $UPS $FDX Feb 11, 2014
US firms ?paid effective tax rate of 2.2% in 2011? http://t.co/f2T5Qnrhri More than a tax haven, Ireland helps insurers shave reserves $$ Feb 11, 2014
No Honeymoon for Janet Yellen http://t.co/86QPfTcVE0 QE withdrawal will bite, & what will become of all the deposits? $$ Feb 11, 2014
Please Hold Your Bernanke Applause http://t.co/DCKPttFHNU Remember, when Greenspan left, he was viewed as a success, same as BB now $$ $TLT Feb 11, 2014
Sounding the Tax Alarm, to Little Applause http://t.co/r9JQmmaeLB IRS stiffs whistleblowers who often lose employability 4 being a tipper $$ Feb 10, 2014

Rest of the World

Putin is Playing a Game of His Own http://t.co/19Arh0aJOH Not so fast. Russia has significant resources & influence in Eastern H’sphere $$ Feb 15, 2014
Boy?s Life Hanging on 8-Hour Trip Shows Why Venezuelans Protest http://t.co/8G8CgGwGST Socialism is like a cancer that spreads til death $$ Feb 14, 2014
Let’s Watch Venezuela Destroy Itself http://t.co/g1Uy3zk1W3 Logical extreme of Socialism falls apart; pity that Chavez never lived 2c it $$ Feb 14, 2014
Chinese Join Winklevosses in L.A. Luxury Home Hedges http://t.co/TUdw4AItw8 Amazing what the wealthy will pay 4a fancy foreign retreat $$ Feb 14, 2014
Next crisis won?t come from the emerging markets http://t.co/Jei7oKJ8BD Argues France, Germany, Britain, Australia & Canada-> 2 much debt $$ Feb 13, 2014
Mister Donut, Pan Am and Friendster Found Alive and Well http://t.co/vDaGi33cEN Old brands never die, they just move overseas & make $$ $SPY Feb 13, 2014
Bank of England points to 2015 rate rise, blurs guidance http://t.co/AWhyd8GZmd More precision than 1 can know; the world is messy $$ $FXB Feb 13, 2014
Italy Pays Record Low to Sell 3-Year Debt at Auction http://t.co/PWmUhXufjb Let the leverage build for the next crisis $$ Feb 13, 2014
Fink to Mobius Touting Emerging Stocks Fails to Stem Outflow http://t.co/8PFKbOH8Lg A time 2 nibble, not a time 2 gulp $$ $EEM Be wary Feb 13, 2014
Greek Truckers Show Plight as Groceries Show Up Frozen http://t.co/XgAM737A7h Freeing up the labor market will work as attitudes change $$ Feb 13, 2014
Tunisians Bolt Doors Even After New Constitution Passed http://t.co/lBhXz8iqWb Constitutions cannot create cultural change; asks 2 much $$ Feb 13, 2014
Israel Desalination Shows California Not to Fear Drought http://t.co/BFidhnEF7S When resources r tight there are incentives 2 create tech $$ Feb 13, 2014
London Walkie Talkie Owners to Shield Car-Melting Beam http://t.co/76TP0u2tuT Reflective parabolic curve of building melts cars @ a spot $$ Feb 12, 2014
Rouhani Seeks Economic Fix as Iran Commemorates Revolution http://t.co/EDNL5WLOvB Will have to get the agreement of unelected true rulers $$ Feb 11, 2014
Argentina to Replace Bogus Inflation Index to Mend IMF Ties http://t.co/iSzQizrgnF Argentina tries 2 find cheapest way out of this mess $$ Feb 11, 2014
Who Should Pay for Trusts that Go Bust? http://t.co/aOXFbDltCZ If China is smart, protect depositors, but let banks & WMP holders fail $$ Feb 11, 2014
Iceland Girds for Fight as Suit Targets Half $14B GDP http://t.co/hX6M12PZ48 Icelandic taxpayer will refuse the bill; UK will b stiffed $$ Feb 11, 2014
Mobius Says Emerging-Market Rout Near End as Valuations Lure http://t.co/MMLjlAmN49 I dunno, a 4% earnings yield premium seems small $$ $EEM Feb 11, 2014
Rehabilitating Portugal http://t.co/tFy3GnIwRQ Long; Argues that a Greek-style bailout should b done, or Portugal will eventually default $$ Feb 11, 2014
Iranian TV Shows Rare Broadcast of Band Playing Music http://t.co/jTBFNcRsHJ Christianity has always been easier on music than Islam $$ Feb 11, 2014

Work Trends

Sheep-Shearing Wells Fargo Banker Bridges US Income Gap http://t.co/utMe1ekmir Sells coffeemakers too; many in US work multiple jobs $$ $TLT Feb 13, 2014
Workers Shed Caution, in a Healthy Sign for Labor Market http://t.co/zTq0NgbO0f When workers r willing 2 quit, labor mkt is healthy $$ $TLT Feb 11, 2014

Practical

A Little Valentine’s Day Straight Talk http://stks.co/j0I6p Sage counsel 2 younger women if they want to get married: start early $$ Feb 15, 2014
The Sex Question Readers Want Answered Most http://t.co/kRhYIgwI2Z Even Long-Married Happy Couples Ask, ‘How Can We Have Sex More Often?’ $$ Feb 11, 2014
Ten Ways You’re Probably Leaving Money on the Table http://t.co/KkjetkJsp9 Simple list of ways to save money for avg upper-middle class $$ Feb 11, 2014
Why Mom’s Time Is Different From Dad’s Time http://t.co/0Xr4IMsFfs Husbands, u can win if u reduce chaos for your overburdened wives $$ Feb 11, 2014

Other

US Scores Fusion-Power Breakthrough http://t.co/h6wDtXHcVj Bad news is Tritium very expensive @ $100K per gram; takes much energy 2 make $$ Feb 13, 2014
If Ocean Heat Pump Switches On, Expect to Feel It http://t.co/FlsYni5c62 Speculative; we don’t understand climate or hurricanes well $$ Feb 11, 2014
Who is Steven Reisman? Meet Hip-Hop VIPs’ Favorite Lawyer, The Man With The $2 Bills http://t.co/B3v87YDWrt Weird. Very, very weird $$ $SPY Feb 11, 2014
What Really Happened to Flappy Bird? http://t.co/3IiBxSIhYx Beware the success u wish 4? Also: http://t.co/ld6A2XaiKs Still a puzzle $$ $SPY Feb 11, 2014

Wrong, etc.

Skeptical: Blackstone-Fueled Single-Family Home Boom Lifts Chicago http://t.co/sETcWifBGx In past hi levels of investor ownership bearish $$ Feb 15, 2014
Wrong: Pros Panic, Retail Investors Stay Cool on Emerging Markets http://t.co/QXXpOcqKYw Too short a period time to judge $$ Feb 14, 2014
Wrong: Social norms: The indignity of no work http://t.co/6isHJo9fkw New technologies will create new jobs & make the whole world better $$ Feb 13, 2014
Wrong: Warren Buffett is laughing at you for selling http://t.co/S5LFS3jUk5 Poorly thought-out piece glues 2unrelated ideas together $$ $EEM Feb 13, 2014
Wrong: The #1 High-Yield Investment Of America’s Elite http://t.co/FUVyBblQpZ Spammy article that talks about REITs as if they r a secret $$ Feb 11, 2014

Replies, Retweets & Comments

10 miles west of Baltimore, MD, we got ~15 inches of snow over the last last 2 days. #snow #weather #pax $$ Feb 14, 2014
“I made this comment six months ago: http://t.co/a82j8TRxm1… & then, I tipped the SEC. ?” ? David_Merkel http://t.co/gthPe5eQoA $$ $DJCO Feb 13, 2014
“Administrative Services Only” plus individual stop loss protection is in general the smart way2?” ? David_Merkel http://t.co/fPV6fQo1i1 $$ Feb 13, 2014
“This is a common confusion in statistics — you can have a high correlation and a low beta. Second?” ? Merkel http://t.co/sa6PLqEhdU $$ Feb 13, 2014
RT @Pawelmorski: Scary parallel my foot. http://t.co/omyovAKQaX Feb 12, 2014
@davidgaffen that would only be a temporary fix. I wrote this 3.5 yrs ago on the topic: http://t.co/q3lbyELN9d The internet eats USPS Feb 11, 2014
@quakkelaar I miss you too. If you are ever near Baltimore/DC, let me know; we can get together, brother. Last few years have been hard Feb 11, 2014
RT @ReformedBroker: Please explain how the wording of this investment advertisement on the Washington Post site could be legal: http://t.co? Feb 10, 2014
‘ @quakkelaar Hail old friend. Yes, same old mistakes, b/c those wishing to retire are making the money sweat, until it rebels on them $$ Feb 09, 2014

Mimicking the 1980s Value Line Contest

Posted on 11 February 201411 February 2014 by David Merkel

A letter from a reader:

Dear Mr. Merkel,

I am organizing an investment contest in my university and I want to do it properly. Can you provide me with data of stock divided into 10 groups based on volatility? I searched for it in Yahoo Finance, but if you have it compiled in a better way, it would be really helpful.?

Also, what do you mean when you say a minimum capitalization limit? Do you mean that the students should hold a certain amount of cash, that they are not allowed to invest?

Sometime in 1985-1986, [Corrected from 1983-1984 — DM] Value Line held a contest where it asked participants to pick ten stocks, one from each of ten price volatility groups, ranked from lowest to highest.? Why such a contest design?? Well, with most stock picking contests, the winner picks a really volatile stock, it soars, and he is the winner by accident.? I say “by accident” because there were others with similarly volatile stocks that lost.

Forcing players to pick a portfolio of stocks, including less volatile stocks, creates a real challenge that resembles real portfolios.?? Even though the contest will still run over 6 months[Corrected from 3-6 months — DM], the luck component is substantially reduced, even though results over a short time horizon are highly affected by luck and momentum.

Well, I’ve created a file that divides the US-traded market into 10 volatility buckets for you, using data from a screening package.?? Here’s the link.

3,589 stocks made the cut.? No ETFs, closed-end funds, etc.? No market caps below $100 million. No stocks with less than 3 years of trading history.? The market cap limit is there because really teeny stocks can fly, and skew the results.? And no, no cash is in the results, just the average returns of 10 stocks.

Here are the average price volatilities by bucket.? [Volatility is actual price volatility for 36 trailing months]

Bucket	Avg Price Volatility
1	15.04
2	19.80
3	23.28
4	26.67
5	30.01
6	33.69
7	38.16
8	44.38
9	54.21
10	107.02

As for industries, the volatilities are what you might expect:

Ten Least Volatile

1206 – Natural Gas Utilities
1203 – Electric Utilities
1209 – Water Utilities
0512 – Fish/Livestock
0506 – Beverages (Non-Alcoholic)
0524 – Tobacco
0715 – Insurance (Property & Casualty)
0503 – Beverages (Alcoholic)
0933 – Real Estate Operations
0730 – S&Ls/Savings Banks

Ten Most Volatile

0912 – Casinos & Gaming
0930 – Printing Services
0124 – Metal Mining
0409 – Audio & Video Equipment
0427 – Photography
0969 – Schools
0118 – Gold & Silver
0803 – Biotechnology & Drugs
0966 – Retail (Technology)
0424 – Jewelry & Silverware

That said, such a contest would force some choices from both safe and volatile investments.

Smaller stocks are a lot more volatile than large stocks on average:

Mkt Cap Bucket	Average Vol Decile
100-300M	7.03
300M-1B	6.58
1-3B	5.36
3-10B	4.47
10-30B	3.90
30-100B	3.40
Over 100B	2.61

Finally, some countries are more or less volatile than others.? Of the 50 countries represented, trading on US exchanges, here are the most and least volatile:

Least Volatile

Colombia
Denmark
Panama
Philippines
Turkey
Belgium
United Kingdom
Chile
Switzerland
Japan

Most Volatile

Israel
Bahamas
Finland
Portugal
Russian Federation
India
Monaco
Greece
China
Argentina

Summary

My point in showing some of the divisions is to give an idea of ways to analyze and play the game.? You could also do it by momentum or valuation variables.? Momentum would probably work best in a short contest.

As for me in the early ’80s, I was a busy graduate student, so I looked at the stocks rank ed highest for Timeliness by Value Line in each volatility group, and selected the one for each group that I thought was the most promising.? As it was, I finished in the top 1%, but not high enough to win a prize.

Anyway, I think this is a great contest design, because it minimizes the ability of players to pick volatile stocks.? With ten stocks of varying volatility in the portfolio, stock-picking skill has a greater chance of being revealed.? Better would be a longer-term contest, but few have the patience for that, and players will argue that they should be allowed to trade, making for a more complex contest.

Industry Ranks February 2014

Posted on 9 February 201411 May 2014 by David Merkel

My main industry model is illustrated in the graphic. Green industries are cold. Red industries are hot. If you like to play momentum, look at the red zone, and ask the question, ?Where are trends under-discounted?? Price momentum tends to persist, but look for areas where it might be even better in the near term.

If you are a value player, look at the green zone, and ask where trends are over-discounted. Yes, things are bad, but are they all that bad? Perhaps the is room for mean reversion.

My candidates from both categories are in the column labeled ?Dig through.?

You might notice that? I have no industries from the red zone. That is because the market is so high. I only want to play in cold industries. They won?t get so badly hit in a decline, and they might have some positive surprises.

If you use any of this, choose what you use off of your own trading style. If you trade frequently, stay in the red zone. Trading infrequently, play in the green zone ? don?t look for momentum, look for mean reversion. I generally play in the green zone because I hold stocks for 3 years on average.

Whatever you do, be consistent in your methods regarding momentum/mean-reversion, and only change methods if your current method is working well.

Huh? Why change if things are working well? I?m not saying to change if things are working well. I?m saying don?t change if things are working badly. Price momentum and mean-reversion are cyclical, and we tend to make changes at the worst possible moments, just before the pattern changes. Maximum pain drives changes for most people, which is why average investors don?t make much money.

Maximum pleasure when things are going right leaves investors fat, dumb, and happy ? no one thinks of changing then. This is why a disciplined approach that forces changes on a portfolio is useful, as I do 3-4 times a year. It forces me to be bloodless and sell stocks with less potential for those with more potential over the next 1-5 years.

I like some technology stocks here, some industrials, some consumer stocks, particularly those that are strongly capitalized.

I?m looking for undervalued industries. I?m not saying that there is always a bull market out there, and I will find it for you. But there are places that are relatively better, and I have done relatively well in finding them.

At present, I am trying to be defensive. I don?t have a lot of faith in the market as a whole, so I am biased toward the green zone, looking for mean-reversion, rather than momentum persisting. The red zone is pretty cyclical at present. I will be very happy hanging out in dull stocks for a while.

That said, some dull companies are fetching some pricey valuations these days, particularly those with above average dividends. This is an overbought area of the market, and it is just a matter of time before the flight to relative safety reverses.

The Red Zone has a Lot of Financials; be wary of those. I have been paring back my insurers, but I have been adding to P&C reinsurers.? What I find fascinating about the red momentum zone now, is that it is loaded with cyclical companies.

In the green zone, I picked almost all of the industries. If the companies are sufficiently well-capitalized, and the valuation is low, it can still be an rewarding place to do due diligence.

Will cyclical companies continue to do well?? Will the economy continue to limp along, or might it be better or worse?

But what would the model suggest?

Ah, there I have something for you, and so long as Value Line does not object, I will provide that for you. I looked for companies in the industries listed, but in the top 5 of 9 balance sheet safety categories, and with returns estimated over 12%/year over the next 3-5 years. The latter category does the value/growth tradeoff automatically. I don?t care if returns come from mean reversion or growth.

But anyway, as a bonus here are the names that are candidates for purchase given this screen. Remember, this is a launching pad for due diligence, not hot names to buy.

I?ve loosened my criteria a little because the market is so high, but I figure I will toss out lot when I do my quarterly evaluation of the companies that I hold for clients and me.

Sorted Weekly Tweets

Posted on 8 February 2014 by David Merkel

?Note: this is the 100th weekly edition of sorted weekly tweets.

Market Impact

Standing Out from the Crowd: Measuring Crowding in Quantitative Strategies http://t.co/MRjZ8d8GGL Overinvestment in strategy precedes losses Feb 08, 2014
Does Fair Value Accounting Contribute to Market Price Volatility? An Experimental Approach http://t.co/YQqQPrwMwr Short answer: no $$ $XLF Feb 08, 2014
The Deeper Causes of the Financial Crisis: Mortgages Alone Cannot Explain It http://t.co/0P7fMrQWKn But they were the leading cause $$ $XLF Feb 08, 2014
Contagion Rejected as Biggest Bond Buyers Double Down on Junk http://t.co/5wm1k4Ghlw Makes me think the correction will b another crisis $$ Feb 08, 2014
Hedge Funds Preparing for $1T Property Bill http://t.co/RRQN992uat Key Q: Will they limit their risks prior to the next commercl RE bust? $$ Feb 08, 2014
Apollo Credit Twice Size of LBOs Shows Private-Equity Shift http://t.co/J69eh3TPTn Not a good sign, nonstandard lenders r fragile $$ $APO Feb 07, 2014
Five Pointers on Floating-Rate Funds http://t.co/sV6JtizBlN Don’t chase performance, rates may not rise, nor yields, adds credit risk $$ Feb 05, 2014
Inverse VIX Fund Gets Record Cash on Calm Market Bet http://t.co/YSHGpON0DE Be careful to not hold it long $$ $VXX http://t.co/qGCycKbPsX Feb 05, 2014
World’s cheapest stock markets: Where are shares cheap? http://t.co/3Uvq1HZfSF Gives u a rough idea as 2 where values may b found $$ $SPY Feb 04, 2014
Gundlach Shows Why Betting Against Treasuries Is a Fool?s Game http://t.co/R0s4wQLcbu Interesting that he is in long Tsys $$ FD: + $TLT Feb 03, 2014
Monday?s Selloff, by the Numbers http://t.co/LseNtCUEXz That’s 2 large >2% down days in less than 2 weeks $$ $SPY Feb 03, 2014

Companies & Industries

Big Pizza Chains Use Web to Slice Out Bigger Market Share http://t.co/C6xQeSWmlr Easier 4 large chains 2 implement online ordering $$ $PZZA Feb 08, 2014
SodaStream?s New Mainstream Rivals: Coke and Green Mountain http://t.co/zOkwpBpOiK All the more reason 4 $PEP 2 buy $SODA $$ Feb 07, 2014
Why Discount Airlines Draw Fewer Complaints (Hint: It’s Not Better Service) http://t.co/a8rzqrf0DU Friendlier attitudes r better service $$ Feb 07, 2014
Satyajit Das: The Truth About Bank Earnings http://t.co/9FzkPbbyIm Bank earnings r lower quality; getting harder to increase them $$ $XLF Feb 05, 2014
Experts testify on true cost of Target breach http://t.co/FGVRFBvc6K Magnetic stripes will go away, & chips &/or PINs will appear $$ $TGT Feb 05, 2014
Apple Quietly Builds New Networks http://t.co/bncx84P4RW $AAPL certainly has spare $$ to throw at it, enhancing service quality $NFLX $GOOG Feb 04, 2014
H-P Finds Accounting Errors at Autonomy Unit http://t.co/9cQFBamwpI We knew it was a dumb deal at the time, now $HPQ shows just how dumb $$ Feb 04, 2014
Prophet of No Profit: How Jeff Bezos won the faith of Wall Street. http://t.co/eaZmKgfnir Moats, operating leverage, pricing power $$ $AMZN Feb 01, 2014
Ask Buffett what he would be willing 2pay 4 $AMZN — after all, it has significant moats. I think he would put it in the “too hard” pile $$ Feb 01, 2014

Rest of the World

China, the Death Star of Emerging Markets http://t.co/zFmo0RkXva @williampesek points at financial bubble in China; what will make it pop $$ Feb 08, 2014
Scandal Tests Chinese President’s Standing With Military http://t.co/cHGvLtROFE Corruption is a major issue 4 China, between Party & Army $$ Feb 08, 2014
Saudi Twitter Debate as Citizens Criticize Government http://t.co/quwkxpkHDX Social media allows criticism tht would not b done in public $$ Feb 05, 2014
China Savers? Penchant for Property Magnifies Bust Danger http://t.co/yrfDYQK5KH Anytime a single investment strategy dominates -> worry $$ Feb 05, 2014
Pimco?s Bill Gross Says He Avoids China ?Mystery Meat? http://t.co/My6P5x1jE0 Great phrase as we do not know much about indebted China $$ Feb 05, 2014
Sao Paulo Biggest Water-Supply System May Run Dry Within 45 Days http://t.co/fEcioInfjX Many water systems r near their limits globally $$ Feb 05, 2014
Emerging Stocks Drop to 5-Month Low Led by China as Ruble Gains http://t.co/aWgDSdVBUt Not all emerging mkts r equal, some financed wrong $$ Feb 04, 2014
Japan Sees Worst Developed-Stock Rout as Nikkei 225 Drops http://t.co/UQDhX1a3XL Current mkt reveals weak underlying fundamentals $$ $FXY Feb 04, 2014
Dad Can?t Buy Daughter Shoes as Argentine Currency Falls http://t.co/WTnUn1Okf0 ?Do you know how I feel buying my daughter used shoes?? $$ Feb 04, 2014
Argentina Scrambles To Raise $10B, Avoid Reserve Collapse; BONARs Bidless http://t.co/Xx4t0dFqCk Only hold hard assets in Silverland $$ Feb 04, 2014
EM rout? Or Intervention Sunday? http://t.co/d54Qjj4X2S Difficult to tell what Developed Mkt policymakers will do, they r strapped @ home $$ Feb 04, 2014
Argentina Bust Lures Investors After 200 Years of Defaults http://t.co/YoWjotidcp Invest in the hard stuff, land does not depreciate $$ $IRS Feb 04, 2014
Emerging-Market Rout Seen Enduring on Low Real Rates http://t.co/RTxP6GjMVw Funding structures of some emerging markets fall, $$ goes 2 $TLT Feb 04, 2014
Canadian Oil Rises as California Ships in Record Amount by Rail http://t.co/CKvu4BEqJl Retweet after me: Pipelines r cleaner & safer $$ Feb 04, 2014
Analysis: Emerging markets outlook not rosy, but valuations tempt http://t.co/hADIRvUK5g This may b a time 2nibble, not a time 2gulp $$ $EEM Feb 04, 2014

US Politics & Policy

AOL is leading the way to make 401(k)s worse for everyone http://t.co/AnlQ1Ud6Ds Meh; new employers will compensate workers that lose $$ Feb 08, 2014
‘Six Californias’ plan difficult but doable, assessment shows http://t.co/nuw3S6rLVl Ideas like this come & go in a fragmented California $$ Feb 08, 2014
No, CBO did not say Obamacare will kill 2M jobs http://t.co/RHsSai7rwv Rather, will discourage 2M from working full-time; big deal $$ Feb 08, 2014
Ex-NSA Chief Details Snowden’s Hiring at Agency, Booz Allen http://t.co/EWRuqlViXW Snowden set back US intelligence by 20+ yrs. Good. $$ Feb 06, 2014
The Tyranny and Lethargy of the Times Editorial Page http://t.co/hbW20h6Vjn Inside baseball, picture sums up story http://t.co/USlMTh4Bm0 $$ Feb 05, 2014
Puerto Rico Has Credit Rating Cut One Step 2Junk by S&P http://t.co/4Av3ftwL8q also http://t.co/QkwCnXQdcy Well-deserved, default coming $$ Feb 05, 2014
Going on 30, Living With Mom and Dad http://t.co/Wo4YB74mKo Part is being slow 2 marry, then education, poor career choices, motivation $$ Feb 04, 2014
Crop Insurers Win as Congress is Poised to Pass Farm Law http://t.co/rFNrEDhYkZ If we can’t reduce ag subsidies when ag is healthy… $$ Feb 04, 2014
Obamacare Wonks Flunk Data Analysis http://t.co/Ss2Tc3q2e9 You can show lots of savings if u show your winners & hide your losers $$ $SPY Feb 04, 2014
CBO: Obamacare Will Lead To 2M Fewer Workers In Labor Force By 2017 http://t.co/OsCrQOUORb Unintended consequences; fix this, break that $$ Feb 04, 2014
Fed Presidents Say Stock Decline Unlikely to Derail QE Taper http://t.co/pdoloENc9L In the short-run true, but if the decline persists… $$ Feb 05, 2014
Investment Manager Explains Why 99.5% Of Americans Can Never Win http://t.co/MqngZy7zZW Tax code is cockeyed, wealthy can avoid taxation $$ Feb 04, 2014
How Feds? Double Standard Enables Bad Bankers http://t.co/AGok7eeqdU Simple: little bankers get prosecuted; big banks get fined $$ $BNK $XLF Feb 04, 2014
Early Drive for Hillary Clinton Unsettles Democrats http://t.co/Hb3lJnpnr6 Some Worry It Will Siphon $$ from Candidates in Midterm Elections Feb 04, 2014
You Can Thank or Blame Richard Stanger for Writing 401(k) http://t.co/wX38lGA4m4 Many important laws r accidental; killed DB pensions $$ Feb 04, 2014
ISM Miss Is Ugly All Around http://t.co/Px97nGSccl I’ve been arguing that the economy is weaker than it looks 4 a while; here’s a clue $$ Feb 04, 2014
US Banks Ease Loan Standards in Fed Survey as Demand Rises http://t.co/etkDJPLLhN Can inflation b far behind if this persists? $$ $TLT $TIP Feb 04, 2014
California Dries Up as Brown Pushes $15B Tunnel http://t.co/r4boO9Tzzo If u don’t allocate water economically, becomes a political fight $$ Feb 04, 2014

Other

Financial Blogging: How to Write Powerful Posts That Attract Clients http://t.co/fxmxkLJKbS My longer review: http://t.co/lOqexXT7RO $$ Feb 08, 2014
Why I Did Not Go To Jail http://t.co/4EtyFFyTyg @bhorowitz good read on the importance of proper company, legal, & incentives structure $$ Feb 08, 2014
Daniel Suarez Sees Into the Future http://t.co/kkLkxcmvnv ‘Influx’ may propel sci-fi writer in2 void left by Tom Clancy &Michael Crichton $$ Feb 08, 2014
Why Melted Cheese Does the Trick http://t.co/ZACj1EaWKB Creaminess enhances the textures and flavors of other foods $$ $KFT $DF Feb 06, 2014
Deadly New Bird Flu Strain Spawned by Virus Behind H5N1 http://t.co/b0fLG89fkg This is overblown. People die from the flu each year $$ $SPY Feb 05, 2014
Young Bankers Seek ?Good Yield? With Their Own Nonprofits http://t.co/gJZVwJ5lse Wealthy & powerful like 2b thought benefactors $$ Lk 22:25 Feb 04, 2014
How the Seattle Seahawks solved Peyton Manning http://t.co/0P0kiHnddI Even if u r not into football, interesting 4 understanding strategy $$ Feb 04, 2014
Super Bowl Safety Is Blow for Broncos and Las Vegas Sportsbooks http://t.co/2vXpm4IRbl The odds r interesting to read 4 unusual bets $$ $SPY Feb 04, 2014
Microsoft Adds Momentum to ?Open Science? |http://t.co/Ar6WCDKNug Understand that scientists r not neutral observers; they have 2 publish $$ Feb 04, 2014
Carney leaving CNBC for WSJ?s ?Heard on the Street? |http://t.co/dRNtplkOQB @carney gets a significant promotion! Congrats! $$ $SPY $TLT $GE Feb 01, 2014

Other Economics

Free Checking Is Disappearing Perk http://t.co/pZwsA0u3sl Smaller banks often offer better deals than big banks on checking $$ $XLF $SPY Feb 08, 2014
More Men in Prime Working Ages Don’t Have Jobs http://t.co/YmAjNcQrc5 1 of the qualitative factors that show how punk the economy is $$ $SPY Feb 08, 2014
An International Gold Standard Beats The Rule Of The Governing Elite http://t.co/GoTHUVusXK Old, makes point gold standard was better $$ Feb 05, 2014

Wrong

Wrong: High unemployment putting the ECB in isolation http://t.co/wlBQOP7JqM Loose monetary policy doesn’t lower L-T unemployment $$ #global Feb 08, 2014
Wrong: America The Startup http://t.co/C0Rax7KPJP Worth a read, but the writer does not really understand the Pilgrims or the Puritans $$ Feb 04, 2014

Retweets, Replies, & Comments

@HistoryInPix Cemented the creation of the graphical user interface, buggy in prior versions, aside from pricey Macintosh ghetto Feb 06, 2014
‘ @catofwallstreet the credit cards will have chips, not us- already have these in Europe. Also, consider amillenialism or postmillenialism. Feb 05, 2014
RT @PUMPSandDUMPS: This fan says it all http://t.co/MryfT9l04a #pennystocks Feb 05, 2014
Ice falling, branches too, west of Baltimore — kind of pretty $$ #weather Feb 05, 2014
@DavidSchawel The difference between dollar-weighted & Time-weighted returns is crucial but few get that. Good tweet on $DBLTX $$ Feb 05, 2014
RT @DavidSchawel: Retail psychology: chasing performance, then puking the bottom & missing the bounce-DBLTX Fund assets vs adjusted NAV htt? Feb 05, 2014
RT @cate_long: Cheers! “@carney: Thanks everyone! Very excited to be joining the @wsjheard team! Some details here http://t.co/sjLSyTMIEH Feb 01, 2014
@dpinsen not all, but a majority Feb 01, 2014

An Expensive Kind of Insurance

Posted on 6 February 20146 February 2014 by David Merkel

Strategy One: “Consistent Losses, with Occasional Big Gains when the Market is Stressed”

Strategy Two: “Consistent Gains, with Total Wipe-out Risk When Market is Highly Stressed”

How do these two strategies sound to you?? Not too appealing?? I would agree with that.? The second of those strategies was featured in an article at Bloomberg.com recently — Inverse VIX Fund Gets Record Cash on Calm Market Bet.? And though the initial graph confused me, because it was the graph for the exchange traded note VXX, which benefits when the VIX spikes, the article was mostly about the inverse VIX?exchange traded note XIV.

Why would someone pursue the second strategy?? Most of the time, it makes money, and since January 2011 we haven’t a horrendous market event like the one from August 2008 through February 2009, it makes money.

I would encourage you to look at the decline in the second half of 2011, where it fell 75% when the VIX briefly burped up to around 50.? But given the amazing comeback as volatility abated, the lesson that some investors drew was this: “Volatility Spike? Time to buy XIV!”? And that explains the article linked above.

You might remember a recent book review of mine — Rule Based Investing.? In that review, I made the point that those that sell insurance on financial contracts tend to win, but it is a volatile game with the possibility of total loss.? To give another example from the recent financial crisis: most of the financial and mortgage insurers in existence prior to 2007 are gone.? Let me put it simply: though financial risks can be insured, the risks are so volatile that they should not be insured.? You are just one colossal failure away from death, and that colossal failure will tend to come when everyone is certain that it can’t come.

But what of the first strategy?? How has it done?

Wow!? Look at the returns over the last few weeks!? Rather, look at a strategy that consistently loses money because it rolls futures contracts for the VIX where the futures curve is upward-sloping almost all the time, leading to buy high, sell low.

Does it pay off in a crisis?? Yes.? Can you use it tactically?? Yes.? Can you hold it and make money?? No.

Back to the second strategy.? People are putting money into XIV because they “know” that implied volatility always mean-reverts, and so they will make easy money after a volatility spike.? But what if they arrive too early, and volatility spikes far higher than expected?? Worse yet, what if Credit Suisse goes belly-up in the volatility?? After all, it is an exchange-traded note where owners of XIV are lending money to Credit Suisse.

Back to Basics

Do I play in these markets?? No.

Do I understand them?? Mostly, but I can’t claim to be the best at this.

What if I try both strategies at the same time?? You will lose.? You are short fees and trading frictions.

What if I short both strategies at the same time?? Uncertain. It comes down to whether you can hold the shorts over the long term without getting “bought in” or panic when one side of the trade runs the wrong way.

Recently, someone pinged me to speak to CFA Institute, Baltimore, where he wanted to talk about “not all correlations of risky assets go to one in a crisis” and pointed to volatility investing as the way to improve asset allocation.? Sigh.? I’m inclined to say that “you can’t teach a Sneech.”

I favor simplicity in investing, and think that many exchange traded products will harm investors on average because the investors do not understand the underlying economics of what they own, while Wall Street uses them as a cheap way to hedge their risk exposures.

There may be some value to speculators in using “investments” like strategy one for a few days at a time.? But holding for any long time is poison.? Worse, if you are accidentally right, and the world comes to an end — this is an exchange-traded note, and the bank you lent to will be broke.? That will also kill strategy two.

So, my advice to you is this: avoid either side of this trade.? Stick with simple investments that do not invest in futures or options.? Complexity is the enemy of the average investor.? I can understand these investments and they don’t work for me.? You should avoid them too.

PS — before I close, let me mention:

A Google search that I did: “why does vxx always go down“
And the article: VXX: Where Wealth Goes to Die

Good article in both places.