The Financial Shift

The Stock Market Double Double — Insights from History

Each year I update a chart that shows the percentage annual returns in the S&P 500 for every year since 1926; here’s the version through the end of 2009. Note that 2008 was the second-worst year on record.

Annual Stock Returns Since 1926

Have the patience to let the stock market "double double" work for you.

This chart provides a good visual of what I call the “stock market double double.”

If you look at the chart again, you’ll see that there are approximately twice as many “up” years as “down” years; that’s part one of the double-double. Here’s part two: the “up” bars go up about twice as high as the “down” bars go down.

Part VII - 4th Quarter Investor Letter - “We freak out and then we get over it”

Without dismissing the short-term challenges facing us, it’s important not to lose sight of some important underlying positives.

 

In a recent NY Magazine article that describes James Grant's optimism on the US economy – which is noteworthy since Grant is one of the great pessimists on Wall Street in its history.  Grant is optimistic for two reasons:

 

• Cyclical bounce back - the US economy has usually bounced back as sharply as it fell. In the early eighties the economy was in terrible shape with double-digit unemployment like we have today.  And then the economy staged a steep recovery against most of the pessimistic predictions of the experts.

 

• Human behavior is a reassuring constant - Grant says, "We freak out, then we get over it".  We are just now getting over the panic.

 

This is especially true in the emotional, highly fraught area of unemployment.  With the ongoing transition from an industrial economy to a knowledge economy, professions and trades are dying consistently.  “Though we humans do our best,” he wrote, “we usually underestimate the capacity of market economies to reinvent the nature of work.”

 

The current conventional analysis of the U.S. economy over the last decade was that it was built on the consumer spending of borrowed money and the speculation in homes.

 

Yep, it was.  But the last decade was also about the explosion of information technology, the associated surge in productivity, and unprecedented access to low-cost labor, both domestically (Latin American immigrants) and globally (Chinese), which lowered the prices of goods and services for all Americans.  These conditions, unlike the housing market, have not gone away.

 

Grant’s second cause for optimism is an observation about human nature he borrowed from the late British economist Arthur C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.”  As peculiar as our economic circumstances may seem to us right now, the way people behave has a certain reassuring constancy—which is to say, we freak out, and the fear can last for a long while, but then we get over it.

 

The bottom line is: The positives outweigh the negatives and that the dire predictions about America’s decline are overstated as usual. 

Part V - 4th Quarter Investor Letter - Are Equities Dead? The Public Hates the Stock Market

For the last 9 months since March ’09, the stock market has been climbing a very steep “wall of worry.”  Back in October ’09 Hays Advisory’s sentiment indicators were at their most bullish.  The theory and the evidence suggest you buy stocks when fear is the highest.  Oh yeah, and Warren Buffett says to buy from the fearful and sell to the greedy.  So when investors behave as if they are afraid by pouring money into money market funds yielding close to 0% - less than inflation - we say they are fearful.  It’s down a bit but the amount of cash in money funds and bank accounts is nearly at a high.

 

Until the behavior of the public changes, downturns in the stock market look like they will continue to be head fakes.  Each time the bulls try to get the animal spirits flowing, sentiment has quickly reverted back to a fearful reading, which shows a decent amount of market anxiety, on just the slightest bit of stock market weakness. 

 

Mark Dodson at Hays says this “is consistent with the first year of bull markets, during which a significant correction has never occurred; consider it a 12 month insurance policy.”  More important, this is also consistent with what we see when we step back and look at the big picture of market psychology.

 

Below is a chart of net new money going into stock mutual funds minus the money going into bond funds. When the line goes up more money is flowing into stocks; when it goes down more money is going into bonds.  Certainly, investor money has started to come out of cash, but it has not gone into stocks.  Net new fund mutual fund flows favor bonds over stocks dramatically, so much so that flows are breaking into record territory, with the previous record occurring back in the 2002 bear market.  Dodson continues, “Given nothing but the chart (below) we would never in a million years guess that the stock market has rallied +50-60% off the March lows.  It looks more like what you would see right in the throes of a nasty stock market decline.”

 

This is not like the investors’ behavior the first year of the 2003 bull market.  The feeling of missing the rally has not really kicked in yet.  It’s understandable though.  If we had to rely solely on headlines, we would have missed the rally too.   The market is up +60% without them. How much will stocks be up with them?

 

Mutual fund investors leave 5.4% per year on the table

.... Most investors in those top 20 funds fared even worse than the funds’ returns would suggest. Clambering aboard only after the great gains had been achieved, they missed the upside and bore the brunt of the downside as the funds’ returns fell. For the 20 years ended 2008, the Dow Jones Total Stock Market Index has provided an annual return of 8.3 percent. The average equity fund has earned 7.3 percent. The average equity fund investor? According to Dalbar, poor timing and suspect decision-making reduced his return to a mere 1.9 percent. To put that in even starker relief, each dollar invested in the index 20 years ago would now be worth $4.95; in the average equity fund, it would be worth $4.06; and the average equity fund investor’s dollar would be worth $1.45, representing just 11 percent of the growth provided by the market index. (my emphasis)

 As Warren Buffett’s investing partner Charlie Munger has said: “Successful funds attract a massive amount of money, and the later performance typically gets mediocre. Then they keep publishing returns for the whole period for someone who started 20 years ago ... The reporting has falsehood and folly in it.”

One of the most famous mutual funds is an excellent example. “If you take something like Fidelity Magellan, which Peter Lynch ran terrifically, a lot of results were achieved with smaller amounts,” added Buffett. A few early investors made out brilliantly, but most were late to the party.

BERK: Once again we find out how poorly the mutual fund industry serves the ordinary investor.  In our opinion, investors do not need funds that advertise recent performance - by the time they advertise that performance it is too late.  Instead, investors need advisors to coach their behaviors to prevent them from making the mistakes like buying after performance has gone up or selling after performance has gone down.

via moneywatch.bnet.com

Part IV - Fourth Quarter Investor Letter - Stock Selection, Valuation and Timing

Stock Selection, Valuation and Timing

I still read that investors believe that 90% of investment returns come from something called “asset allocation” – the choice between rising income investments like stocks and real estate and fixed income investments like bank deposits (CD’s) and bonds (corporate, treasuries or annuities).  That way investment selection (stock picking) and market timing (also known as risk management) are unnecessary.  Don’t buy individual stocks or bonds the argument goes.   You only need to buy “funds”.  It’s convenient that Wall Street makes lots of money from the funds from trading commissions, management fees and distribution fees.

 

Most get this idea that asset allocation is everything from financial advisors, financial planners and/or brokers whose employers want them selling clients a narrow set of products that are already “pre-approved” so the company can control its own business risk, not yours.  That way Merrill Lynch can’t get sued by too many clients.  It’s the same way with pension consultants who use the last 30 years of data to recommend similar asset allocations – tweaked here and there – so when one is wrong, they are all wrong.  This is another form of herd behavior.

 

If you look at the chart above on the top you can see how investors from 1982 – 2000, a great bull market that started from very low valuations (P/E level of about 7x), learned to buy-and-forget (hold).  In general, during this period the fewer decisions made, the better off the investor was.  Selling, even after the 1987 crash, was a “mistake’.

 

But markets are not always like that.  Look at the chart above on the bottom.  Value investor Vitaliy Katsenelson calls this a “range-bound market”.  During the 1966-1982 “range-bound” market, stocks (red line) barely outperformed long-term bonds (blue line) and were just beaten by treasury bills. 

 

What’s the take-away?  The expression 90% of return comes from your choice of asset classes is only true in bull markets – like the one that began in 1982 with a 10-year trailing P/E of only 7x and ended in March of 2000 with a trailing 10-year P/E of 48x (see graph below).  Value investing works in all kinds of markets.  That’s why we buy securities when they are undervalued and sell them when they are fairly valued.

 

We always start with price relative to valuation.  When prices rise faster than valuation rises, risk increases and we take note.  But when prices fall, even when they crash, we get excited because valuations do not fall as fast.  Our margin of safety grows. 

Part III - 4th Quarter Investor Letter - Is Long-Term Investing Dead?

Is Long-Term Investing Dead?

No, long-term investing is still very much alive.  The problem is that most people do not mean “long-term value investing” when they say “long-term” or its close cousin “buy-and-hold” – they mean “buy-and-hope”.

 

Yes, “buy-and-hope” is dead.  In the professional value investors’ mind it was never even born.  It has never worked for the long-term or for any-term for that matter.  Unfortunately, what most baby boomers learned about the long-term turned out to be a special case.  The twenty years between 1980 and 1999 was an extraordinary period for stocks – and if an investor bought and held through those years they did well, of course.  There was a notion that stocks were special and should be the centerpiece of an asset allocation – no matter the price!

 

Others say buy-and-hold doesn’t work because some investors are forced to liquidate (perhaps you are entering into retirement, for example) during the crash at the bottom.  Time is not always on our side like it was in the 80’s and 90’s.  While time can provide an opportunity to recover from a decline, as we saw in the above example of how stocks have grown despite 13 temporary interruptions lasting at most three years, it also gives you more time to get squished in a crash.  Buy-and-hold has come to mean something that it was never meant even to imply; the longer you hold stocks, the risk of selling during the crash is eliminated.  No it’s not.  Never was – that’s what goal-oriented financial planning is for. 

 

Also, all through December, as the decade came to a close, we heard this annoying fact; “If you bought the S&P 500 index a decade ago, you would have lost money even with the huge rally since March 2009.”  But this does not mean long-term investing or buy-and-hold is dead. 

 

Why? This argument does not take into account the number one most important investing principle there is:  Buy securities at prices well below their intrinsic value.  Buy an undervalued security.  Hold it.  Wait patiently.  Monitor it.  And regardless of short-term price fluctuations, eventually the value will be recognized.

 

The naysayers have missed that the prices paid relative to value at the starting point is the dominant determinant of rates of return.  Show me a decade where stocks went nowhere or even down like the decade just past, and I’ll show you a decade whose starting prices were well above intrinsic value.  The long 20 year run-up in stock prices that ended at the beginning of 2000 with the beginning of the technology, internet and media crash, gave an incorrect impression that long-term returns were guaranteed if you simply owned stocks for a long enough time period, regardless of purchase price.

 

Overpay for a security and you increase your risk.  Time will not fix that mistake – but it might compound it.  For example, despite their growth, the technology stocks that successfully survived the past decade but were purchased at the peak of the dot.com era may never see those peak prices again.  Buy-and-hold simply makes no sense when a stock price jumps way ahead of its value.  This is why the theory appears dead.  Investors have been overpaying for stocks and mutual funds for over a decade!

 

Investing as you did during the long bull market between 1982 and 1999 will NOT work.  You need to modify your analysis and strategy.

Don’t Avoid Stocks: Most People Don't Have Enough in Stocks

BERK:  I have been warning investors to be wary of following the herd into fixed income and cash as a long term allocation decision.  But if you were in cash or bonds or bond funds since last March because you were afraid of the volatility of the stock market, then you missed out on 60%+ gains in stocks.  And you earned a lousy 0.3% to 3.0% in "safe" bank accounts or bond funds.  What's safe about losing all that purchasing power in retirement?  Nothing.  But don't sit on your hands in regret.  As famed value investor Bill Nygren says below - valuations are reasonable now, and stocks will earn more than bonds and cash from these levels.  "Safety" is over priced now,  just like"was" underpriced in 2007-2008.  

Back to basics will work.  It has always worked.  That's why Bill and I recommend a focused portfolio of undervalued stocks of great companies.

Like Bill says: “Ballpark, we like to pay $0.60 on the dollar for what we think a business is worth today. When the price gets to $0.90, we sell it. Buying at a discount lowers the cost of your mistakes and it increases the returns, when you analyze the fundamentals correctly.”  So do we.

In a new interview with Minyanville.com, Oakmark fund manager Bill Nygren — whose fund is up 50% in the past year and ahead of the S&P 500 over the past 3, 5, and 10 years — says investors need to get back to basics. And for most, that means returning to stocks.

“The thoughtful investor today, rather than thinking about how they missed the rally or remaining afraid of another lost decade, needs to get back to basics,” Nygren said in a wide-ranging interview. “They need to think about what target equity allocation makes sense for them. For most investors, equities are still the asset class of choice. They should still have long-term returns exceeding fixed-income returns. Most investors today are still beneath their target allocations.”

Nygren says that with corporate earnings rebounding and P/E ratios starting out at reasonable levels, the biggest risks to investors now aren’t company-specific — the biggest risk involves the anti-business tone coming from Washington.

via theguruinvestor.com

"Destructive Myopia": Invest for the Next Decade, Not the Last One

Stocks still look more attractive than bonds right now, says Morningstar director of equity research Pat Dorsey in this video.  Many investors are afraid of stocks now, especially stock mutual funds, because investors are still reeling from the volatility and uncertainty of the past two years. 

 

But that's a big mistake.  We recommend that clients increase their allocations to stocks relative to bonds - all else being equal.  Here's why: 

 

Below is a chart of net new money going into stock mutual funds minus the money going into bond funds. When the line goes up more money is flowing into stocks; when it goes down more money is going into bonds. 

 

Investors' money has started to come out of the safety of the banks (and from under the mattresses), but it has not gone into stocks.  Net new mutual fund flows favor bonds over stocks dramatically, so much so that flows are breaking into record territory, with the previous record occurring back in the 2002 bear market.  Mark Dodson of Hays Advisory explains,

 

“Given nothing but the chart (below) we would never in a million years guess that the stock market has rallied +65% off the March 2009 lows.  It looks more like what you would see right in the throes of a nasty stock market decline.”

This is not like investors’ behavior in the first year of the 2003 bull market.  The feeling of missing the rally has not really kicked in yet.  It’s understandable though.  If we had to rely solely on headlines, we would have missed the rally too.   The market is up +65% without them.

 

How much will stocks be up with them?

 

Generational lows in interest rates and a US government "gone wild" with spending makes chasing fixed income (bonds and bond funds) dangerous here.  Don't follow the herd - buy stocks.

 

BERK

There's More to Investing Than Yield

There's More to Investing Than Yield.

There's More to Investing Than Yield Focusing too closely on income could leave you poorer in the end.

These days, income-oriented investors are a lot like the proverbial man in the desert, who is thirsty but short on water. With interest rates at ultra-low levels, bond yields are generally pretty paltry. Stock investors have felt the pain too, as the recession has forced many companies to slash or eliminate their dividends. And after last year's stock market rally, there are just fewer high-yielding stocks around.

To be sure, income-focused investors are pursuing a reasonable strategy.Historically, dividends have accounted for at least 30% of the S&P 500 Index's average 10% annual return. And in a slower-growth environment, they could play an even bigger role. Income also provides stability to a portfolio--a benefit both equity and fixed-income investors can enjoy.

But are investors making a mistake by obsessing over yields? To answer that question, let's first take a look at what yield actually is and a couple different ways of measuring it. Lastly, I'll explain why yield shouldn't be the only thing income-oriented investors care about.

BERK: Instead of chasing after yield, as the crowd has been doing by pouring money into bond funds lately, look for investments that you expect to deliver strong total returns - dividends/interest plus appreciation - over long periods of time.

And pay special attention to costs. Morningstar research indicates that bond funds with higher costs tend to be more volatile because managers try to overcome their expense hurdle by investing in higher yielding (and riskier) bonds, for instance. Hidden expenses in your bond mutual funds, stock mutual funds plus brokerage fees, advisor fees plus commissions can kill long-term real life returns.

Check out our one simple fee - no commisions or layered fees - transparent and educational FOLIOAdvisor account. 

Does your financial advisor engage in “fee-ing frenzy”? « The Investment Fiduciary

BERK: This is just one of the many stories I will be posting here about how fees can kill the best investment plans.  Make sure that your advisor is aligned with your interests.

 

Let's be clear - Wall Street (brokers, financial advisors, money managers, mutual funds, hedge funds, financial planners and investment bankers) - makes money by taking commissions, fees or spreads (someone tell me what the difference is between these things cause it all seems like paying a toll to me). 

 

It takes a chunk out of transactions - it always has and I guess it always will. But we can beat all the layered fees on top of the layered fees (see story below). 

 

How? By owning a portfolio of the stocks of the great companies - make your financial advisor and your money manager the same person (How about me?) 

 

That's right - don't own mutual funds or pay someone to recommend someone else and pay fees on top of fees.  No - you should directly own your own diversified portfolio of stocks, actively managed, but paying nothing, zip-po, nada in commissions for buying or selling or re-balancing those stocks.  How do we do it?

 

We charge 1% per year of the value of the account for our advice, stock picking and portfolio management.  And that is all you will pay - no commissions, no extra fees and no hidden fees that eat into your real-life returns.  Plus you get to see everyday exactly what you own! And at tax time there will be no surprises like you get with funds - you will be able to harvest tax losses just like the super wealthy do! - cause you own the stocks directly.

 

This is the way to cut out Wall Street.  Call us at 732-632-8835 to start your own account like this today!

Does your financial advisor engage in "fee-ing frenzy"?

“Avoid the fee-ing frenzy,” says David Swensen.

A woman banks at Wachovia. Let’s call her Marion. When Marion needs to rollover her 401(k) into an IRA account, she naturally asks a Wachovia financial advisor for help. He helps her open an account and recommends she buy the Evergreen Asset Allocation Fund (EAAFX). Is there anything wrong with this picture? Plenty!

First, the fund has a sales charge (front-end load) of 5.75%. Her 401(k) balance is $100,000. This means, the advisor takes $5,750 just for the act of opening the account for her.

Second, the fund has an expense ratio of 1.27%. This expense ratio includes a 12b-1 fee of 0.25%. This means the advisor will continue to collect about $250 every year for as long as Marion is invested in the fund. The fund manager will collect $1,020- every year!

Third, the fund is actually a fund of funds. Money in the fund is simply divided up and invested in a numbers of other funds, each of which has another layer of managers and fees ranging from 0.39% to 1.02%.

In fact, there are superb funds that don’t charge front-end load and have low expense ratios. But financial advisors who work on commission may never tell you about what’s a better choice for you. No wonder Jack Bogle, founder of the Vanguard Group laments, “Too much salesmanship and too little stewardship.”

Ninety percent of financial advisors are ‘product pushers’ on commission. Conflict of interest runs rampant. How can people like Marion, and people like you, protect themselves against what David Swensen calls a fee-ing frenzy? The answer is, by going with a fee-only advisor.

What is fee-only?

Fee-only means the advisor doesn’t take commissions, product incentives, or third-party payments as hidden compensation.

Why fee-only?

If Marion had met a fee-only advisor, he would have charged her $200 (hourly fee) to set up her IRA account and selected a few Vanguard index funds with expense ratios ranging from 0.09% to 0.19%.  A fee-only advisor is not incentivized to sell high-cost products.

Just because someone is a fee-only advisordoesn’t make his or her advice automatically good. But at least it is not tainted by self-interest. Beware of fee-based advisors, who want the good name of “fee-only” and the reward of commission at the same time.

via investment-fiduciary.com