May 10th, 2017

The Watergate Template

Everybody seems to be talking about today. In the wake of Trump’s firing Jim Comey, head of the FBI, nearly every newscast is comparing the Tuesday Night Massacre with the Saturday Night Massacre of 1973 when Nixon fired independent special prosecutor Archibald Cox, which led to the resignations of Attorney General Elliot Richardson and Deputy Attorney General William Ruckelshaus on October 20, 1973, during the Watergate scandal.

But Stock Chartist was ahead of the curve as subscribers got a “heads-up” about the stock market implications of the emerging White House turmoil in their April 2 issue of the Weekly Recap Report. You can today read what they got … 5 weeks ago.
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The Watergate Template

Two weeks ago, in “Should We Sell Everything“, I offered up a view of the three previous corrections of any magnitude in the bull market we’ve had the benefit of enjoying since 2009 and concluded that since it takes several months for tops to form “all this talk about selling everything in anticipation of a correction that clearly is coming, at some time and at some point in the future is premature.”

Last week’s Recap Report entitled “Politics and the Stock Market” looked at stock market behavior in two previous Presidential Crises and concluded that “The big grey cloud on the horizon is the impact the charged political situation will have on Trump and his anticipated programs.” Today we drill down into the 1972-73 Nixon/Watergate market (click here for a chronology) in the chart below as template of what we might be able to expect should Trump’s Russia problems escalate to such a degree that it actually begins impacting the market (click image to enlarge):

Nixon Impeachment - 2

I know it’s blinding but let me walk you through it. The chart depicts the August 1972-December 1973 S&P 500 Index. This is important because the market advanced 6% between Nixon’s Election and January 11, 1973. The massive 48% crash (third steepest in history) began when the market peaked on January 11, a couple of days after the trial of the Watergate Seven burglars presided over by Judge Sirica began on January 8, 1973; it ended in October-December 1974.

  • At the top, the Market Momentum Meter’s values (e.g., 1234, 12936, 21605) and colors (green, yellow, red)
  • Some of the milestones in the Watergate saga
  • The S&P 500 Index and moving averages

The Watergate took weeks and months to unfold. It involved criminal prosecutions, Congressional inquiries and special prosecutors. It involved a cover-up that was discovered and disclosed, indictments and resignations and immunities granted. Calls for Nixon to resign began in January 1974 (click here for chronology), a House Judiciary Committee began impeachment proceedings on February 6, 1974 with demands for the tapes to be turned over. It continued until August 8 when Nixon announced his resignation.

Market upside momentum slowed dramatically as “breaking news” about the break-in continuously flooded the media so the moving averages began pivoting, first moving horizontally and then turning down. The Meter didn’t turned consistently Bearish Red until mid-April after the Index had already declined 6% below the peak to 110. Even with all the news, the market closed the 1973 with a -17.4% drop. But the meter was solidly Red with a Perfectly Bearish value of 21605. The market dropped another -36% before touching the low of 62.8 on October 3, 1974!

Why dredge up this sad chapter in Presidential history? Because it serves as a template for how investors might react and how the stock market might behave, should questions and inquiries about Trump and his staff’s Russian ties continue and evolve into indictable criminal activity. While the Nixon saga stretched over months, the Trump replay will be in fast-motion Internet time.

Just as athletes or first responders, for example, practice, run drills and watch game replays so as to be prepared for any contingency, stock market participants need to practice and be prepared. No one can predict where we’ll be a year from now. The indexes of confidence are hitting highs for over a decade, if not all time highs internationally and domestically in business, consumers and housing. And yet, like in 1973-74, politics overwhelm economic and market euphoria.

Being forearmed is being forewarned. This is not a prediction of a market crash but rather, using today’s popular jargon, it’s an “alternate narrative” of what did happen and could happen that we need to be ready for. We shouldn’t sell everything today because, if we and Trump are lucky, all this could blow over, the economy will continue plugging along, and the stock market will cross the mid-point trendline in the Reversion to the Mean channel and become support. I suggest, however, that you print the chart above, have it handy nearby, plot emerging events against what did happen and take action as needed depending on your tolerance for risk.

February 11th, 2016

Subscribers Alerted to Imminent Market Sell-off

For those of you who aren’t subscribers, I’m sorry for you.  I’ve been warning my subscribers since last summer about the major correction we’re now suffering through.

You’re skeptical?  Here’s the post sent to members on Sunday, August 16, 2015.  The market closed at 2091.54 the previous Friday and within 7 trading days, on Tuesday, August 25, it closed at 1867.61, or 10.7% lower.

The question now is “Are we close to the bottom?” and “Is this a opportunity to pick up stocks at a discount?”  For my answers to whether the correction has bottomed and other questions, why don’t you join the other lucky investors who subscriber to Stock Chartist.

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Next Chapter In Saga About to Begin

The longest novel, according to Wikipedia, was something called “Artamène ou le Grand Cyrus” written by Georges and/or Madeleine de Scudéry in 1649–53.  It was in 10 volumes, had 13,095 pages and 1,954,300 words.  Reading any long book takes patience and perseverance, about the same patience and perseverance demanded by the flat market we’ve had to work with over the last six month’s.

Even though the market is up 1.59% YTD, almost half of which resulted from last week’s 0.57% increase, I believe it’s the prelude of a “market reversal” that will begin soon after the Labor Day break and after everyone has returned from their summer vacations.  We’re about to open the next chapter in this correction saga (click image to enlarge).

 

S&P 500 - 20150814

 

I know this is beginning to sound like a broken record but there’s clearly been an erosion of bullish momentum.   We’ve can’t predict but what we are seeing is that the market is losing its bouyancy:

  • the lower boundary of the grand channel since the 2009 Crash bottom was broken in May,
  • pivoting channels emerged as the slope (small dashed lines) switched from ascending to horizontal (and looks now to on the verge of pivoting again to fully descending),
  • the 50- and 100-dma’s reversed their direction and are now descending,
  • the 50-dma has reversed alignment crossing under the 100-dma (average of past 50 days is now less than average of past 100 days).
  • Finally, adding to the weight of evidence, the 50- and 100-dma’s last week appeared to be acting as resistance obstacles preventing the market from checking its downward trend.

It seems to be so obvious to the naked eye that the market is losing steam that I can’t imaging anyone not seeing it and acting.  I can’t believe that every day that the market bounces on recovery, the CNBC or CNN Talking Heads are trotted out to give their “stock up on discounted stocks” spiel.  As quoted in a recent CNN Money article, for example:

  • “The U.S. is exhibiting tremendous resiliency and a lot of independence from the rest of the world,” said Seth Masters, chief investment officer at AllianceBernstein, and
  • “It leaves the U.S. looking attractive in relative terms. There’s a valuation premium on U.S. equities but perhaps that valuation is justified,” said David Lebovitz, head of the global market insights strategy team at JPMorgan Funds, and
  • “There’s every reason to believe this bull market continues. Unless you think we’re going to have a bear market soon — which we think is highly improbable — almost by definition the next move is higher” said Troy Gayeski, senior portfolio manager at SkyBridge Capital

We all know that charts reading is subjective but it’s incredible how there can be two so diametrically different interpretations of the same chart.  On the one hand there’s the my view of the chart we’ve been looking at for the past several months shown above.  Then there’s the following comment and chart from StockCharts.com:

“an inverse head-and-shoulders pattern could be taking shape since late May [in the SPY etf whose value is 1/10th of the S&P 500 Index]. With an overall uptrend, the inverse head-and-shoulders represents a consolidation within an uptrend and a bullish continuation pattern. A break above neckline resistance would confirm the pattern and target further gains. Typically, the height of the pattern (213 – 204 = 9) is added to the breakout for an upside target (213 + 9 = 222) [translated into a target of 2220 for the S&P 500 Index]…. The right shoulder looks like a falling wedge, which is typical for corrections after sharp advances. SPY surged from 204.5 to 213 in mid-July and then pulled back with a falling wedge the last few weeks. ”

StockCharts.com Inverse Head and Shoulders

 

An “inverted head-and-shoulders consolidation”?  A wedge after a sharp advance from 204.5 to 213?  Give me a break!  Both interpretations (the short-term StockCharts.com or the longer-term Stock-Chartist.com) can’t be right; one is going to be wrong.  “But that’s what makes a market.”  Obviously, we’re hoping we’re right.

The world economic fundamentals continue to deteriorate.  Oil and other commodities are falling stocking renewed fears of deflation.  And the Fed apparently may be “out of bullets” to fight it.  The Chinese currency revaluation put a scare in many central banks, the most significant of which are their neighbors in the Asian emerging economies, causing new fears of a currency war.  There are also rumblings again about Greece and its negative impact on the Euro and European economies.  Rather than their being a possible silver lining in these clouds, the next shoe to drop will more likely be a negative surprise.

We believe to be fortunate in having embarked on a conservative plan, taking “risk off” by liquidating positions to add to cash reserves and, selectively as conditions confirm our longer-term view, adding to our index short position.  When the “Death Cross” finally arrives [50-dma crossing under 200-dma], we’ll probably have wiped the Portfolio clean and add to the speculative Index short positions.

Only a few more trading days to suffer through and then, when the page is turned to a new chapter, the story could get really exciting.  At least I hope so because this has been an awfully boring book that I’m just about ready to give up on.

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March 1st, 2015

The Crash is Coming, The Crash is Coming!

The following piece appeared here on March 25, 2013 entitled The Known Stock Market World, almost exactly three years ago. I repeat it here because Paul Farrell just came out with another one of his dire, “end-of-the-market-as-we-know-it” predictions. What prompted Farrell to make his doomsday call in 2013 was the fact that the market was about to cross into all-time new high territory and he, along with many of the other gloom-and-doomers were saying that the market was about to swoon into a major correction. In today’s blast (see today’s MarketWatch), Farrell claims

“the crash of 2016 really is coming. Dead ahead. Maybe not till we get a bit closer to the presidential election cycle of 2016. But a crash is a sure bet, it’s guaranteed certain: Complete with echoes of the 2008 crash, which impacted on the GOP election results, triggering a $10 trillion loss of market cap … like the 1999 dot-com collapse, it’s post-millennium loss of $8 trillion market cap, plus a 30-month recession … moreover a lot like the 1929 crash and the long depression that followed.”

Everyone put a link to this MarketWatch article in your “stocks” Evernote folder, in your electronic calendar, where ever you can so that you’ll be alerted to it then, can quickly retrieve it (unless MarketWatch pulls the story by then) and can lobby to take away Farrell’s soapbox.

Back in 2013, it was clear that the market would be going to new heights, which it did.  In 2015, when we’re in the sixth year of a secular bull market, there’s no question there will be a correction soon.  But no one today can predict when it will begin nor how far it will carry the market down.  Anyone who claims to know, like Farrell, is taking you for a sucker.

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imageI was asked to read Paul Farrell’s most recent blurb on the Wall Street Journal’s blog site Marketwatch.com entitled “New Critical Warning as 2013 shocker looms” in which he enumerates 6 new critical warnings, which added to the 7 he says were issued last year but to which there doesn’t seem to be a convenient link of the site.  This “critical warning” comes from Gary Shilling (the others came from Bill Gross, Nouriel Robini, Reinhart and Rogoff and Farrell himself.

Farrell clearly spells out that their vision of economic and market doom is rooted in their dislike and distrust for Fed Chairman Bernanke and his policies.  Is it professional jealousy?  Does it come from an contest between Keynesian and Austrian monetarist inside schools of economic philosophy?  In Farrell’s own words:

“Timing is critical at a turning point. We warned of the coming crash well in advance in 2008. We picked the bottom in March 2009. We are in the fifth year of an aging bull. These six Critical Warnings tell of a hard turning point dead ahead. Wake up. It takes time to restructure a portfolio. If you think you can do nothing and just wait for another year, you are like most investors: You just “can’t handle the truth.” Or you “have no idea what’s about to happen.” Or you believe “this time really is different.”

But the truth of the matter is that all these perma-bears have continually been calling for the market’s reversal and demise since last year, a 15% missed opportunity had you taken their heed and fled the market.  Was the turning point in 2012, in January 2013 or some undefined point in the future.  Why do these guys want us to sell equities?  Where do they want us to put our money?  Are they gold-bugs in disguise?

I’ve been reading much over the past couple of years from those who view a market reversal at the level of the previous all time high high as indisputable.  The reasons they offer could be technical, like Prechter’s obtuse Fibonacci reckoning, or fundamental economic, like those of Farrell, et al.  To me, it all sounds like a through-back to beginning of the Age of Discovery in the 1500’s when most believed the world was flat and you’d fall off if you sailed to the end.

1500 WorldYou could sail the Mediterranean Sea or Indian Ocean but sailing beyond the sight of land meant sure disaster.  It’s like the course the market’s followed since 2000, the Secular Bear Market seas.

Map of Known Stock Market

So long as we don’t venture outside the bounds, we know the landmarks, the levels at which the market pivoted in the past and has a probability of pivoting again in the future.  If the market reversed direction for a third time, we can guess, by looking at the above “map of the known stock market” where islands of rest might be and where it might reverse direction again.

But if half the stocks break into their own all-time new high territory and cause the index, by definition, to also begin to venture into uncharted territory then where will the first island be?  Where might we hit and wreck on a market/economic shoal or reef?

Bottom line: are you someone who has the confidence to sail where no one has ever sailed before to discover new lands and new wealth?

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February 18th, 2015

Biggest Up and Down Days

An extremely important piece of information (click on image to enlarge) from Barry Ritholtz is this graphical comparison of the impact on your portfolio of missing the biggest down days, of missing the biggest up days and of missing both down and up days.

What the article didn’t mention was that the biggest up and down days tend to be clustered together around bear market/crash bottoms rather than randomly during any time period so missing them both is a challenge but not impossible.

Only missing only the biggest up days produced returns less than the buy-and-hold strategy during the time covered.  My goal is to capture the most number of biggest up days with the fewest number of big down days through our Market Momentum Meter technique.

 

Ritholtz

 

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January 6th, 2015

Forget Oil, Go Lithium

GigafactoryOil prices has tumbled more than 50% since the beginning of last summer so many investment advisers are recommending today that investments be made in the energy sector, arguing that the stocks have fallen so that many represent the best bargains in many years.

If you had been able to predict the oil price rout in July and sold short, you would have discovered that not all energy-related stocks and ETFs acted uniformly. Some actually went up (EEP up 12.49%, VLO up 1.68%) while others dropped anywhere from -5% to
-70%. For example, CVX decline -16.81%, COP declined -19.33, OIL -49.48, RIG -56.39 and CRK -73.99.

If you believe that oil prices can’t go much lower and will soon rebound then it would seem logical that buying an oil-related stock is a “sure thing”. But how does one select among the more than 300 energy stocks of all sizes, dividends, volatility, growth.

Oil Prices

Should you select those that performed the “best” over the past 4-5 months under the assumption that they will perform best in the future. Or, conversely, should you buy those that performed the worst because they could possibly bounce back the most. If you’re looking to put money to work, though a better strategy than catching one of 300 “falling knives” might be to look someplace totally different, someplace that will be “driving the future” rather than the energy that has “driven the past” (no pun intended).

Rather than betting on a recovery in oil prices, why not take out a stake instead in the industry making possible electric transportation – lithium, one of the most valuable natural resources of the new electronic world thanks to its unique and extremely valuable characteristics:

Lithium

As described in a recent Mauldin Economics report:

  • Lithium has such a low density that it floats on water and can be cut with a butter knife. When mixed with aluminum and magnesium, it forms lightweight alloys that produce some the highest strength-to-weight ratios of all metals.
  • Lithium tolerates heat better than any other solid element, melting at 357°F.
  • Lithium batteries offer the best weight-to-energy ratio, making lithium batteries ideal for any application where weight is an issue, such as portable electronics.
  • That same high energy density and low weight characteristic makes lithium batteries the best choice for electric/hybrid vehicles due to car gas mileage. A car’s biggest enemy is weight.
  • Lithium has a very high electrochemical potential, meaning that it has excellent energy storage capacity.

The lithium market is dominated by only three publicly-owned producers:

  1. Chemical & Mining Company of Chile (SQM);
  2. FMC Corp. (FMC);
  3. Rockwood Holdings (ROC)

Lithium Industry

In addition to its excellent dividend yield and relatively low (as compared to the pure-play ROC) price-earnings ratio, the SQM chart is most volatile and shows promise to bounce off the bottom of the horizontal channel it’s formed since late 2013 and attempt to cross above the upper boundary at 33, a 40% move.

SQM - 20150105

Tesla has just completed a gigafactory that exceeds all comparisons in the belief that the lithium-ion battery will be the power source for many more battery powered cars, drones, toys and power grid storage.  I’m hoping that SQM will benefit from that future.

January 2nd, 2015

BIIB’s Second Act

imageAre you one of those who missed the biotech burst, especially the 375% run-up from a leader like BIIB (Biogen-Idec) since its breakout on March 11, 2011?  You can’t make up the “opportunity costs” of not having bought but you have an opportunity in what may be left in the stock’s upside move by jumping on the stock as it looks to complete a easily identified year-long consolidation in the form of an ascending triangle, the first since beginning its run almost four years ago (to enlarge, click on image below).

Biogen Idec Inc. discovers, develops, manufactures and markets therapies for the treatment of neurodegenerative diseases, hemophilia and autoimmune disorders with such products as AVONEX, TYSABRI, FAMPYRA, FUMADERM and RITUXAN.  One of the reasons for the pause in BIIB’s upward trajectory was the uncertainties surrounding the company’s prospects as it faced expiration of its AVONEX patent at the end of 2013.  Articles like this one from May 2013 entitled “3 Bio Companies Facing The Patent Cliff” didn’t help.

But companies of BIIB’s caliber don’t just roll over when they face a challenge like major patent expirations.  It takes a while for them to regroup and for investors to regain their confidence,  Hence a consolidation in the form of an ascending triangle.  Apparently, the consensus among the majority of the stock’s investors is that BIIB has successfully weathered the storm with sufficient existing products and products in the pipeline that growth can be expected to resume.  Hence, a likely breakout from the consolidation pattern.

Some investors balk at buying and owning stocks with triple-digit price tags because of the fear of less volatility and more limited upside (BIIB is the 10th highest priced stock among the S&P 500 behind such leaders as NFLX (Netflix), ISRG (Intuitive Surgical), PLCN (Priceline) and CMG (Chipotle Mexican Grill).  But those concerns should be alleviated by knowing that BIIB ranks 71th among the S&P 500 stocks in 5-year average annual earnings growth of nearly 25%.

BIIB - 20150102

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July 11th, 2014

Lists of “Value” Stocks Often Miss Target

image“After 5 years of a bull market, the only place left to invest is in value names”
“The best protection in this volatile market are value stocks”

But how reliable are these sorts of claims?  Those promoting the approach offer lists of stocks that are considered undervalued typically when they meet such financial criteria as low price/sales, low price/book value, or high, stable and growing dividends. However, they rarely attach timeframes or price targets.

So I decided to do some “back testing”.  By searching the term “value stock lists”, I gathered a small random sample of such lists published in 2012-13; stocks in these lists met one or more of criteria that qualifies them as “value stocks” at the time.  I then compared their stock price on the publication date with that of twelve months later; as a benchmark, those changes were compared with against the S&P 500 change over the same period.  These were selected at random and space limitations prevented including more, I suspect others would show similar results:

  • MagicDiligence.com: “Top 10 Dividend Yields, Lowest P/S, and Lowest P/B Stocks” – 1/5/2012: “Every so often, MagicDiligence compiles a list of Magic Formula® Investing stocks sorted by their dividend yield, price-to-sales ratio, and price-to-book ratio for investors that like to use those metrics. The result produces a list of attractive value stocks for additional research.” The top 10 in each of the three metrics were:
    Value MagicDiligence
  • Valueline: “Value Line’s 6 Safe Dividend Stocks” – 11/22/12 : “Value Line is an independent investment research and analysis company that has developed a safety ranking methodology which focuses on the long-term stability of company’s stock price and financial standing.  The fund invests in companies that carry Value Line’s ratings of 1 and 2, representing the most stable and financially-sound dividend-paying companies and higher-than-average dividend yield, as compared to the indicated dividend yield of the S&P 500 Composite Stock Price Index.”  The top picks were:Value - Valueline
  • Forbes: “Return To Value Stocks: Cisco And Three Others To Buy” – 10/7/13 : “At ValuEngine.com we show that 77% of all stocks are overvalued, 40.8% by 20% or more. 15 of 16 sectors are overvalued 13 by double-digit percentages, seven by more than 20%.  This week there are four Dow components on this week’s ValuTrader watch list.”  The list included:Value - Fobes
  • SeekingAlpha: “12 Large-Cap Stocks Selling Below Book Value” : “Price-to-book ratio is used to compare a stock’s market value to its book value and it is calculated by dividing the stock price by the book value per share. The higher the price-to-book ratio, the higher the premium the market is willing to pay for the company above its assets. A low price-to-book ratio may signal a good investment opportunity, as book value is an accounting number and rarely represents the true value of the company.”Value - SeekingAlpha
  • 24/7 Wall St.: “Value Search: Dirt Cheap Tech Stocks” – 7/10/10:…” when you get companies that trade under 10-times believable forward earnings expectations and which have low multiples of sales and even a low implied book value, this is where value investors tend to focus.  Whether a turnaround comes or not might not even matter if stocks get “cheap enough” for the value investors.”Value - 24x7

The hit rate (performance exceeding that of the benchmark S&P 500 Index) of the 60 stocks for this random sample of five lists was 50%, not much better than randomly selecting 60 stocks from any or combination of the major Indexes.

We’re continually subjected to academic studies purporting to show the failure of technical analysis.  For example, Stockopedia had a piece entitled “Technical Analysis? 5 Reasons To be Sceptical about Charting in which they quoted an academic study that back tested the effectiveness of “5000 technical trading rules” grouped into four categories:

  • Filter Rules – prices move of various percentages.
  • Moving Average Rules – prices move above or below a long moving average
  • Channel Break-outs – prices move above or below a channel (trading range)
  • Support or Resistance Rules – prices move a certain percentage above or below a maximum or minimum price a number of periods back.

;The study concluded that “no evidence that the profits to the technical trading rules we consider are greater than those that might be expected due to random data variation.”

I’ve now turn the tables and measured the effectiveness of some fundamental trading rules.  Although perhaps subject to criticism for being insufficiently rigorous, I convinces me that there is “no evidence that the profits to the fundamental trading rules are greater than those that might be expected due to random data variation“.

August 8th, 2013

Portfolio Management: Part 4 – “Preservation” or “Growth”? Why Not Have Both

Asset Allocations

 

The debate about portfolio management centers on whether one needs to “predict” or “react” for good performance.  The professionals settle that for themselves by claiming that since no one can predict the future, the best anyone can do is to diversify into many different asset classes (i.e., equities, fixed income, commodities, currencies, domestic and foreign, income and growth, large and small capitalization).  Economists like John Mauldin fall into this camp.  He and other perma-bear economists have been seeing top for most of the last 10-15% of the market’s move.  Mauldin recently wrote:

“This is a terrific time to take some profits and diversify away from the growth-oriented risk factors that dominate most investors’ portfolios. Instead of concentrating risk in one asset class or one country, investors can boost returns and achieve more balance by taking a global view, by broadening the mix of core asset classes, and by weighting those return streams to achieve balance across potential economic outcomes (rather than trying to predict the future) …..

 

broadening this mix of core assets – so that you have some element of your portfolio that responds positively to every potential economic season – and managing the relative allocations to each economic scenario may be your biggest opportunity to add value in the investing process.  You have a lot to gain from diversifying as broadly as possible, eliminating unrewarded costs, reducing your reliance on equity risk, and reining in the emotional mistakes that often lead investors to dramatically underperform.”

What these portfolio managers don’t understand is that one doesn’t necessarily have to predict where the market will be next week, next month or next year.  They claim that the only way to protect a portfolio against uncertainty when funds need to be withdrawn is to allocate assets among different classes based on today’s predictions and then rebalance periodically.  But an alternative approach is to aim for the highest returns while at the same time reacting and responding to abnormal and unexpected volatility immediately after it occurs.

In the previous article about the “Ultimate Buy-and-Hold Strategy” , the basic premise was that by assembling a specific mix of asset classes for a very long time (actually, 42 years) you would have reduced the volatility of a portfolio without significantly and not reduced its return.  However, nearly everyone would agree that, looking back with the benefit of hindsight, it would have been wonderful to have had the foresight to assemble a portfolio in 1970 and hold it until today, or 42 years.  But would that same approach produce the best results if you were to assemble the portfolio today, at the end of a 13-year secular Bear Market?  Thirteen years hence would we be better off if we assumed today that the next 13 years would be more similar to the 1982-2000 Bull Market than either the secular Bear Markets of the 1970’s and 2000’s?

We can’t predict the future but the odds are that the next 13 years won’t be even similar to the past 13 years.  Using the same data as Merriman’s, the “Buy-and-Hold” portfolio management approach delivers much different results had the portfolio started at different points and had different end dates?  As an alternative test, four hypothetical $200,000 portfolios were split into two parts, 60% in equities and 40% in fixed income, and rebalanced annually.  The annual returns since 1970 for equities and fixed income securities came from the St. Louis Federal Reserve Bank.  The four test portfolios were:

  • 1970-2012 (the 42 year “buy-and-hold” base case),
  • 1982-1999 (the last 17 year secular bull market),
  • 2000-2012 (the current 12-year secular bear market) and
  • 1970-1982 (the previous 12-year secular bear market).

There’s no question that, regardless of when the Portfolio was originally created, the 60/40 blended portfolio would always have been less volatile (as measured by the standard deviation of the portfolio’s annual change in value) than a 100% stock portfolio but more volatile than a 100% fixed income portfolio (click on images to enlarge).

Portfolio 1970-2012
Portfolio 1970-1982
Portfolio 2000-2012
Portfolio 1982-1999 But what is also true is that at end of the holding period, your portfolio would be worth more if you had been 100% in stocks than if you had blended in a percentage of fixed income …. sometimes much more.  As a matter of fact, if you had started your portfolio at the beginning of 1982 and held it somewhere close to the top of the Secular Bull Market when the Tech Bubble burst, then your portfolio would have delivered an average annual 19.12% and wound up worth 166% of the 60/40% mix and 388% of a fixed income only portfolio.  [Due to the spectacular decline in interest rates since the crash of the real estate bubble in 1977 – a trend that was as unprecedented as the secular bull market of the 1980-90’s – a fixed income portfolio would have out-performed an equity portfolio by 152% but neither delivered much more than 7.2% average annual return for the 12 years.]

As I see it, you shouldn’t have to pick a single goal.  Are you wealthy enough to focus on “preservation” rather than “growth” in your portfolio?  Are you so preoccupied in other matters than you can’t react to changes in trend of any particular asset class; remember, both the Tech Bubble burst and the Financial Crisis evolved over 6 months.  Catch up on the major economic and business news once a week, make only incremental adjustments (i.e., not more than 10% of the portfolio at each decision) and you’ll be able to manage your portfolio.  You don’t need to predict the future you only need to review, react and respond as changes demand.  Portfolio management shouldn’t be day-trading but it can be more than just a “buy-and-hold” portfolio.  You can generate growth as well as preserve your capital.

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July 29th, 2013

Portfolio Management: Part 3 – Is Passive or Active Better?

Portfolio Management Action Reaction

In the previous article, I accused investment managers of encouraging their clients to “focus on the risks of losing principal rather than on opportunities for portfolio growth“.  I suggested that their aim was to match what you identified as future demands on your finances “with various funds they believe will minimize the risk of your not having the full amount when it was needed.”

This was reinforced to me when I came across an article in MarketWatch, entitled “The Ultimate Buy-and-Hold Strategy” by Paul Merriman in which the author states that his approach works “in portfolios big and small, doesn’t rely on predictions or require a guru or special knowledge of the markets or economy.”  He claims that his overriding goals are to build portfolios that deliver returns that exceed those available in “industry standard 60%stock/40% fixed income allocation” portfolios while subjecting investors to no additional risk as measured by the standard deviation of the Portfolio’s fluctuations.

To prove that his portfolio had returns greater than 8.5% and a standard deviation of no more than 11.6% (the long-term experience of a typical “industry standard portfolio”), Merriman assumed creating a hypothetical $100,000 in 1970 and allocating the funds into index funds and exchange-traded funds.  He concluded that over 40 years, “by far the biggest contributor to investment success (or lack of it) is your choice of asset classes.”  In other words, it’s not when you bought but what you you bought and that you not trade any of the individual securities during the period that improved results.

The conclusion sounded similar to notions I’ve heard over the years from the Efficient Market Theory crowd, the folks I wrote about extensively in my book, Run with the Herd.  According to the theory,

“Many investors think success lies in buying and selling at exactly the right times, in finding the right gurus or managers, the right stocks or mutual funds.  But being in the right place at the right time depends on luck, and luck can work against you just as much as for you.  Your choice of the right assets is far more important than when you buy or sell those assets.  And it’s much more important than finding the very ‘best’ stocks, bonds or mutual funds.”

Merriman takes a step-wise approach to assembling his “ultimate” portfolio by starting at the 60/40 mix and then adding higher return, lower volatility asset classes in relatively arbitrary proportions.  He then measures how much $100,000 would have grown to over 42 years, rebalancing the portfolio annually to keep the percentages fixed and what the volatility (how much the portfolio might have fluctuated over the period) might be.   The process results in the following model portfolio (right column is the end result):Buy and Hold Portfolio

The advice offered by most investment advisers is similar to  Merriman’s Ultimate-Buy-and-Hold Portfolio: assemble a portfolio of a diversified list of ETFs or mutual funds (which translates into hundreds or thousands of individual securities) and hold it for the long run (20 to 30 years).  It doesn’t matter when you by only that you hold the portfolio long enough for economic growth to make up any and all bear market draw downs (i.e., losses).   So the trickiest part of the Ultimate Buy-and-Hold Strategy is matching the right level of risk for each individual investor’s financial needs, in other words, the most important asset-class decision an investor makes is what percentage that investor should have in stocks and how much in bonds to his portfolio’s volatility to his future financial needs.

The final makeup of the Ultimate Buy-and-Hold Strategy is in the right-hand column and this hypothetical portfolio would have generated an average annualized return of 10.5% (compared with the 60/40% portfolio return of 8.0%) with a much lower volatility (11.7% vs. the standard portfolio of 17.0%) over 42 years.  However, at the end, Merriman discloses the caveats (my emphasis added):

“Every investment and every investment strategy involves risks, both short-term and long-term.  Investors can always lose money.  The Ultimate Buy-and-Hold Strategy is not suitable for every investment need.  It won’t necessarily do well every week, every month, every quarter or every year.  As investors learned the hard way in 2007 and 2008, there will be times when this strategy loses money….. this strategy requires investors to make a commitment.  If you are the kind of investor who dabbles in a strategy to check it out for a quarter or two, this strategy probably isn’t for you.  You may be disappointed, and you’ll be relying entirely on luck for such short-term results….. [the strategy] is not based on anything that happened last year or last quarter.  It’s not based on anything that is expected to happen next quarter or next year. It makes no attempt to identify what investments will be “hot” in the near future…. strategy is designed to produce very long-term results without requiring much maintenance once the pieces are in place.”

But here’s another catch!  According to Merriman, ” the best way to implement this strategy is to hire a professional money manager who has access to the institutional asset-class funds offered by Dimensional Fund Advisors (DFA).”  So is the study unbiased?  Is it self-serving?  Was there be any doubt as to what the study’s conclusions would say?

There’s wisdom in the saying “timing is everything” or it wouldn’t have survived for as long as it has?  You could still be trying to break even on a portfolio of large tech stocks like Cisco, Oracle, Microsoft, Ebay and Amazon had you bought them in 2000, at the peak of the Tech Bubble.  If you had bought your home in 2006 hoping that it would continue increasing in price and some day be your retirement nest egg then you’d have to put off retirement since it fetches a 10% lower price today.  You could have sold the gold coins inherited from a grandparent for $750/ounce in 2009 thinking the precious metal prices just couldn’t possibly continue increasing but recently discovered that it hit a peak of $1700 just two years later.  Or you might be that person who continues buying long-term government bonds today without questioning whether the secular bull market in fixed income securities be close to peaking; let’s ask them whether timing is important 3-5 years from now when his principal had declined 35% in value.

Timing does matter for individual securities, it matters when it comes to your portfolio and it matters for your financial well-being.  Portfolio management should be an active process not a passive one.  It’s a cop-out for investment advisers to tell you to predict your financial needs but not to try to predict the returns and future value of your investments.  There is an alternative.  There is a difference between predicting and reacting and it’s the same as the difference between gambling and managing your investments.  Market timing isn’t predicting the market’s future direction, it’s reacting to changes in the market’s trend as you see them taking place.  Strategies like the Ultimate Buy-and-Hold Portfolio doesn’t sound like management to me.  It sounds more like gambling that my portfolio isn’t depressed due to a bear market just when I need to unexpectedly withdraw funds or for planned needs.

The next article will focus on various types of risks and their relationship to portfolio management.

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May 16th, 2013

Healthcare Providers and Suppliers

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When it comes to stock selection I usually fall back on the following slogan: “50% of a stock’s price movement can be attributed to the overall movement in the market, 30% to the movement in its sector and only 20% on its own”.

I believe the stock market is in the early phase of a major secular bull market.  This is when you want to jump on a trend early and stick with your proven winners for the long haul and earn those large percentage gains.  To do this, you want to try to identify industry groups that contain many individual stocks.  Finally, you use charts to identify those stocks that have had large percentage moves in the (long-term) past but have been held back in consolidation zones for a number of years.

There are many stocks that meet these criteria but the few shown below are representative.  Granted, these charts cover eight years but they are similar to how the financial and homebuilder stocks look several years ago before their run.

In short, there seems to be something dramatic building in a wide range of stocks in the healthcare field over the past several years that could lead to a large number of breakouts across levels that could lead to significant price appreciation for some time:

 

  • HMA,HMA - 20130515
  • UNH,UNH - 20130515
  • AMSG,AMSG - 20130515
  • BKD,BKD - 20130515
  • HGR,HGR - 20130515
  • MD,MD - 20130515
  • BRLI,BRLI - 20130515
  • OMI,OMI - 20130515
  • LH,LH - 20130515
  • ESRX,ESRX - 20130515
  • DGXDGX - 20130515