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Monday, July 7, 2014

Time for Earnings Season Will Disappointments Come...And Would it Even Matter For the Markets

As the WSJ reports in an article with the headline 

Time for U.S. Firms to Earn Stock Investors' Faith

Some Say Revenues and Profits Must Accelerate to Sustain Rally

...we are entering “earnings season” for reports of second quarter earnings of corporations with projected earnings at very high levels:
The Dow Jones Industrial Average broke through 17000 for the first time ever last week, powered by an upbeat jobs report that was the latest in a string of strong U.S. economic indicators. That helped cement investors' view that the weakness caused by severe weather in the first quarter was behind them.
Now, with stocks trading at their highest levels in seven years when compared with expected earnings, some investors say corporate revenue and profits need to accelerate to sustain the rally, especially as the Federal Reserve continues to pare back stimulus measures
To be sure, some investors still consider valuations to be stretched despite selloffs in some corners of the stock market in recent months. The S&P 500 is trading at 15.7 times its expected earnings for the next 12 months, the highest since July
The article cites some favorites among fund managers
Mr. Luttrell is holding on to so-called growth stocks such as Facebook Inc., FB -1.46% PCLN +0.23%  and Google Inc. GOOGL -0.32%  that sold off steeply in March and April amid concerns that the shares were overvalued. Valuations of these stocks have fallen to reasonable levels, and they could start to look more attractive if those companies report strong earnings, he said.
Another manager in the article  cites Kroger and Netflix as his top holdings,
Kroger's second-quarter profits are expected to rise 1.7%, and Netflix's are forecast to more than triple
Tough to consider most of the above as deep value stocks...and their earnings are certainly subject to a fair amount of variance vs expectatons/forecasts.
Good earnings reports are needed to justify current valuations…and the Fed is at the end of its easing cycle….does that equal a positive outlook for a further rally??
Price may eventually return to value, high current returns historically are followed by historically low returns…but also research indicates there is a momentum factor to financial markets….
That is why forecasts of near term market performance is near impossible

Friday, July 4, 2014

Mid-Year Review of the Markets June 30, 2014

The first half of the year ended with virtually all markets around the world --both stocks and bonds showing strong performance. The explanation for most of these moves centered on the “no one else to put your money” rationale with interest rates low around the world.  In early June the European Central Bank began an aggressive policy of unprecedented low interest rates . In the US sentiment in the markets is that the Federal Reserve won’t be raising rates for an extended period of time. As a consequence money flowed into stocks and riskier portions of the bond market.

US Stocks.
·         The broad US stock market once again put in a strong performance the US total market index (ETF ticker VTI) is up 7% ytd. Large cap value stocks and small cap value outperformed the overall market.
·         By virtually all measures the US stock market is highly valued vs historical levels.
The continued strength of the market can be attributed to:
·         Current low interest rates and little indication the Federal Reserve will raise rates in the near future. This is seen as a positive for us stocks.  The low rates also produce a “nowhere else to put your money  movement. The large moves in high dividend stocks such as utilities drawing investor interest and high valuations indicates investors looking for alternatives to low yielding bonds
·         Paradoxically stock prices seem to reflect optimism on the US economy.  But clear signs of a recovery would lead to higher interest rates…a negative for stocks.
·         Momentum: momentum is certainly a factor affecting market returns in the short term. At this point the US market shows strong upward momentum including flows into the market who have missed much of the stock market’s gains by avoiding stocks.
·         The combination of high valuations and a momentum driven market creates the conditions that could easily lead to a market selloff even if only short term. In the long term price reflects value and US stocks carry high valuations.

International Stock Markets
Emerging Markets:
·         After an extended period of underperformance vs the US, emerging markets have had a sharp rebound this year. Emerging Asia (etf GMF) is up a bit more than the US this year although the overall emerging markets still lag (etf IEMG).
  •            With interest rates low around the world the fears associated with the negative impact of higher interest rates has dissipated.
  •          Sentiment towards economic fundamentals in many parts of the emerging economies has turned more positive.
  •          Emerging markets show the most attractive valuations globally trading at a valuation discount of around 25% vs the US and 20% vs the broader European market

Emerging markets are characterized by large “hot money flows” quick to sell in down markets and quick to buy in when performance turns positive. Judging by data on inflows into emerging market stock funds and ETFs this buying cycle seems to be in place. But investors should make sure they understand the volatility of these markets and have a long term commitment to their allocation in these stocks.
European Markets
·         In early June the European Central Bank (ECB) initiated an unprecedented program of low interest rates and other policies for monetary easing. There is every indication that low European rates will continue well after the US enters into any reversal of low interest rate policies.

  • ·         The June 2012 ECB declaration of “doing all that it takes” to stabilize the European economies set the stage of a strong rebound of European stocks recovering from losses during the 2011 crisis. It remains to be seen what the effect will be on stock markets. But the move immediately led to strong increases in prices drops in yields.
  •        With valuations in Europe lower than US markets and continued low rates it seems the environment is positive towards European stocks.
  •          Although the Euro area index (ETF ticker  FEZ)has underperformed the US year to date it has outperformed the US over the last 12 months
  •        In 2014 both Italy and Spain have rebounded sharply reflecting sentiment that the worst is over in terms of the crisis conditions in the European financial markets of 2011.
  •      T he US central bank is towards the end of its aggressive low interest rate policy and the ECB committed to expanding its monetary stimulus for an extended period into the future. That might set the stage for outperformance of the European markets.

Returns for Selected Stock ETFs
1 yr
3 yr
Total US
Large Value US
Small Value Us
Emerging Asia
Total Emerging Markets
Euro zone

Bond Markets
The “market consensus” of both traders and economists at the turn of the year was that longer term rates would rise in 2014. Perhaps not surprisingly so far this year the market has moved sharply in the other direction.
  • Ten year US Treasury bond rates were at 2.6% at mid-year and reached just under 2.5% during the first half of the year.
  •    Part of the price movement doubtless reflects the reversal of positions by major short term traders unwinding positions aimed at profiting from higher interest rates. The poor performance by hedge funds and others trading in bonds reflects this.
  • While it is difficult to find a rationale for a long term buy and hold investor to buy a ten year treasury bond with a 2.6% yield it does not mean traders might not push yields even lower.
  • The Federal Reserve has indicated that the move to higher short term interest rates will come slower than some may have expected although it will continue “tapering” reversing its purchases of longer term bonds.
  •   In a search for yield investors have moved large sums into riskier assets such as bank loans, high yield bonds and emerging market bonds. As a consequence interest rate differentials between these instruments (spreads) and treasury bonds has narrowed consistently.
  •  Investors adding these assets to their portfolio should be careful to monitor their risk and balance their portfolio with lower risk short duration bonds despite their unattractive current yields.
  •  Investors in emerging market bonds should take into account the high volatility of these bonds including additional currency and political risk.

1 yr
3 yr
Short Term High Yield
Short Term Inv Grade
Short Term Govt
Aggregate US Bond
US Long Tern treasury

Thursday, July 3, 2014

A Not Surprising Result : Active Underprerforms Passive

I like to call it hope springs eternal, Active fund managers constantly insist it is a stock pickers market" and virtually every time active fund managers underperform the market. The argument for "a stock pickers market" is often based on the argument that "correlation between stocks is high therefore more stocks are likely to outperform. The WSJ reports on the first half highlights in red and comments in bold

The SPIVA report from S+P  which is more accurate since in measures performs vs a more specific benchmark (large cap funds vs large cap index etc). The results at the end of 2013 showed under performance in 1, 3 and 5 year performance. Also remember the report studies the percentage of outperformers not persistence of returns thus the active managers that outperform for 3 years may not be the same that outperformed over 5 years.

From the WSJ


Stock Pickers Have Tough Time in 2014


Despite the cry of a "stock pickers" market "dispersion of returns another factor that would increase relative returns of active investors  has been low as well
Correlations between individual shares in the S&P 500, measured over a 60-day period, have fallen to 0.31 this year, according to research firm Axioma. This month, they fell to a three-year low of 0.27. A correlation of 1 means all stocks trade in the same direction. In late 2011, as the euro-zone debt crisis intensified and the U.S. credit rating was downgraded, the measure rose above 0.7.
Still, that hasn't been enough for active managers. Other, more-fundamental missteps have fed into their market-trailing returns: The economy hasn't accelerated as quickly as many had anticipated, and investors overall have gravitated toward larger stocks, rather than the small stocks that many active pickers tend to buy.
As for the future...yes hope springs eternal
Fund managers say that a rebound in smaller stocks would help active-management returns. Others are looking to the resurgence in mergers and acquisitions this year, which allows portfolio managers to make bets on potential buyout targets.

Tuesday, June 24, 2014

Keeping It Simple Seems The Best Approach

Investors especially "sophisticated" ones seem to perennially be in search of "alternative " assets particularly hedge funds. Yet over and over again these funds show poor performance.
Furthermore with their 2+ 20" standard fee structure (2% management fee and 20% of profits) the hurdle for even a successful hedge fund manager to produce superior returns for clients is quite large.

But the WSJ reports the hunt for alernative assets particularly hedge funds keeps growing among pension funds and endowments.

Consider this: investing in an ETF with a management fee of .20%  (many can be found for half that fee) a 10% gain in the underlying assets held by the etf would mean a 9.8% return to the investor.

On the other hand for the investor paying "2+20" the 10% return on the underlying portfolio of the hedge funds would mean 6% net return for the investor.

And that is even without the dismal performance described here

Corporate pension funds and university endowments in the U.S. have missed out on much of the rally for stocks since 2009, following a push to diversify into other investments that have had disappointing performances.
The institutions, ranging from large corporations such as General Motors Co.GM +0.44% to big universities such as Harvard, have been shifting to hedge funds, private equity and venture capital. But while these alternative investments outpaced stocks during 2008's market meltdown and are seen as potentially less volatile, they have badly lagged behind the S&P 500 since 2009, a period in which U.S. stock indexes have more than doubled.....
The shifts haven't worked out lately. Since the start of 2009, when the market began rallying, the S&P 500 has climbed 137%, including dividends, to record levels. By contrast, the average hedge fund is up 48%, according to research firm HFR Inc., while the average hedge fund that is focused on stocks has risen 57%. Over that same time, private-equity funds have climbed 109% on average, while venture-capital funds rose 81%, according to Cambridge Associates.
I must say I was shocked at the high percentages allocated to alternatives relative to stocks particularly among college endowments:
The average college endowment had 16% of its investment portfolio in U.S. stocks as of the end of June 2013, the most recent academic year, according to a poll of 835 schools conducted by Commonfund, an organization that helps invest money for colleges. That is down from 23% in 2008 and 32% a decade ago. The 18% allocation to foreign stocks didn't change in that period. Schools in the poll, which collectively manage nearly $450 billion, had 53% of their funds in alternative strategies, up from 33% in 2003.
The pension fund numbers are shocking as well:
Among large U.S. companies with small allocations to stocks in their pensions, shareholdings ranged from 5.2% at NCR Corp.  to 14% at Prudential Financial Inc.and TRW Automotive Holdings Corp to 15% at Ford Motor Co. to 18% at General Motors to 19% at Citigroup Inc., as of the end of fiscal 2013, according to Milliman and data provided by the companies.
At one time use of alternatives if at all was seen as a complement to a more straight forward allocation to stocks and bonds offering lower fees and more liquidity....things have changed radically.
I dont know who is managing the money managers here...but it seems to me as fiduciaries of these monies...somebody should be taking a closer look. Maybe old fashioned boring common stocks merit a bigger allocation in these portfolios.

Some Wisdom From the WSJ on How to Deal With the Surging Stock Market....

Some wisdom from the weekend WSJ

Brett Arends on ways of coping with the large gains in the US stock market my highlights in red All quotes in italics

The Surging Stock Market: Too Late to Buy?

How to Think About Investing When Prices Are This High

Main Street is starting to stampede. As the stock market surges to new highs, ordinary investors who missed a lot of the rise have been rushing to jump on board.....
It's easy to see why. Most people find it very hard to resist a crowd. (Economists call this "herd behavior.") And with the Dow Jones Industrial Average nearing 17000 (compared with less than 7000 in 2009) it can seem like everybody is making easy money except you.

Some of the strategies he mentions with those sitting with cash on the sidelines...but they apply to all investors in my view:

"Be fearful when others are greedy, and greedy when others are fearful," advises Warren Buffett, the most successful investor in history. His meaning: The market is never so dangerous as when everyone else is optimistic and share prices have already risen a long way. Indeed, historically, you could have made money by investing in stocks when the public was selling, and selling only when the public was buying.
At current levels U.S. stocks in particular are very expensive by long-term measures, such as those which compare stock prices to dividends, the value of company assets or average earnings from the past 10 years. Many on Wall Street say a correction is long overdue. The Federal Reserve is winding down the easy-money policy which has helped drive up stock prices....

. Keep your balance
It is a beginner's mistake to put too much money into the stocks or assets that have already risen the most. During a boom, that typically includes the most volatile assets, such as small-company stocks and the stocks of companies hoping for the most growth. Those are the assets most vulnerable to a pullback.
Investors can reduce the dangers by committing in advance to a balanced portfolio that includes less-volatile assets, such as government bonds, which offset high-volatility stocks....
 Look for value
During every boom there are always some who lose sight of what a stock really is. They talk about "beta," "growth stories" and "blue sky valuations," forgetting that a stock is simply a claim on a company's future cash flows.
The less you pay for those cash flows, the better the deal. The more you pay, the worse the deal. Decades of research shows that those who invest by this principle earn superior returns with lower risk. Stocks that are cheap in relation to their net assets, per-share earnings and dividends have proved the best investments over time....
Go global
U.S. stocks have risen much further lately than those of other countries, including many in Europe and Asia. At current levels U.S. investments may entail higher risk, and possibly lower long-term returns.
Focusing your investments too much on your home country's market is a common beginner's mistake. Professional money managers often go along with this in order to get along. But it has no justification in theory or practice.
You can lower your risk by investing in global stock funds rather than in the U.S., giving yourself adequate exposure to developed overseas markets such as Japan, Germany and the U.K. and so-called emerging markets such as Brazil and those in Southeast Asia.

Friday, June 20, 2014

Israeli Shekel/US $ Exchange Rate Update

The shekel/$ rate moved under 3.45 considered an important psychological and technical level(i.e. technical analysis) it also has been a level in the past where the Bank of Israel has intervened however there has been no intervention so far to slow the strengthening of the shekel.


Israeli business newspaper The Marker (Haaretz) reports:

Dollar sinks to lowest level in more than three years
The dollar dropped to its lowest level against the shekel in more than three years Thursday as the greenback weakened globally. The dollar fell 0.38% to a Bank of Israel rate of 3.4450 and was down to 3.4360 in late trading. The euro edged 0.08% higher to a Bank of Israel rate of 4.6941. The dollar was driven lower around the world after the U.S. Federal Reserve signaled that over the long run interest rates would be lower than it had previously indicated. Since March 27, the shekel has strengthened 1.7% against the dollar. “Without government involvement besides that of the Bank of Israel, it’s only a matter of time before a wave of layoffs and business closings hit the headlines,” said Yossi Fraiman, CEO of Prico Risk Management. (Shelly Appelberg)

Thursday, June 19, 2014

The Value Outperfromance Persists...Buy You Need to Have a Long Term View to Benefit From It

The Value Premium is Alive and Well

John Rekenthaler of Morningstar wrote an interesting piece on value and small cap investing and the data of the outperformance of these sectors of the market. He was also commenting on an article over at Advisor Perspectives. 
On small cap outperformance he writes:
Actually, there is some question whether small-company stocks really do all that well. The "small-company effect" was the first academically documented anomaly, as Rolf Banz’s 1981 paper predated the initial academic research on value investing, and was once widely believed. It stands to reason that smaller companies are riskier businesses than are larger firms, and thus deliver higher returns. But performance over the past 35 years has been disappointing, particularly when the theoretical gains are adjusted for the hard reality of transaction costs.

On the value outperformance he notes

Has the value premium dissipated over time?
Happily--as I did not have the data immediately at hand--Huebscher answers his own question. He cites Ken French’s research as showing that value stocks outperformed by 4.57% annually before 1992, and by 2.78% annually since. 
The surprise is not that the advantage declined, but that it continued to exist at all. After all, the market risk associated with value stocks appears only rarely. In addition, that danger is moderate rather than severe because the alternative to value investing, growth stocks, also gets whacked by a market crash. Yes, growth stocks figure to lose somewhat less under such circumstances, but smacking into the pavement after a 35-foot fall, rather than one of 40 feet, offers scant consolation.
I would agree even at 2.78% that outperformance is quite large considering the research on this is so well known. I think the explanation here can only be behavioral what Bill Bernstein calls “the bozo effect”. But those Bozos” don’t only include individual investors but fund managers as well.

The fund managers may not be Bozos in the sense that they are behaving rationally based on their personal rewards. Such managers are fearful of “tracking error” underperforming the market which leads to outflows from their funds…which reduces their compensation and even puts their job in jeopardy.  And value strategies work in the long term. Price eventually returns to value but by that time has come plenty of short term performance chasing cash has moved out of the mutual fund that has been buying value stocks. And fund managers are paid according to assets in their funds. In other words in career management the managers may not be such “Bozos” they are maximizing their wealth if not that of the investors in their fund.

In any event I don’t think the evaluation of the small cap portion of strategies is sufficient. Small cap growth stocks are consistently the worst sector of the market in terms of risk/return. This is the domain of bubble stocks.

When one looks at the outperformance of small value stocks the data shows the small value premium effect is alive and well.

Below  is a graph of growth of wealth for the last 20 years for the S+P 500 and the msci small value index, the Russell 300 small value index and the DFA (Dimensional) Small Cap Value fund as well as a table of returns. The outperformance of small value is clear.
You can click to enlarge either of these:

But the value investor must be patient and willing to tolerate periods of underperformance. During the tech boom of the late 1990s there probably wasn’t a strategy that looked worse than tilting to value stocks. Kudos to John Rekenthaler for admitting he was among those who had a negative view of value tilted indexing investors. From a recent article of his over at Morningstar advisor: Rekenthaler writes:

Last week, I exchanged emails with an investor named Alex Frakt, who mentioned that I had addressed one of his questions in an earlier version of this column, way back at the start of the New Millennium. What question, I asked. Which was the better fund company, Vanguard or DFA, he responded. 
Oh, dear. I do recall. This was what I wrote, in May 2000:
DFA’s position is illogical. Effectively, DFA believes that when allocating among investment styles, one should ignore the market’s judgments, but that when making stock-by-stock decisions, one should strictly obey them. Curious. 
"At heart, DFA is by and for engineers. The company collected a ton of data, analyzed it extensively, and came up with an indexing scheme that it views as better and more-sophisticated than "naive" indexers like Vanguard. All this analysis is predicated on the premise that the future will mimic the past and, therefore, that the initial inputs are correct. I dispute the premise and therefore I dispute the results. More to the point, so has the market. In its 18 years of existence, DFA’s small-value tilt has harmed it more than helped. You would have made a lot more money following Vanguard’s cap-weighted approach. Surely that’s gotta account for something, too." …
Although I couldn't have predicted that DFA's small-company and value-stock tilt would thrive from that day forward, thereby propelling the company’s lineup to spectacular gains, I certainly should not have implied otherwise. There was nothing wrong in contrasting DFA’s claims with its then-lackluster results. But I should not have left the analysis at that. Quite the contrary. Early 2000 was the ideal time to mention that, at long last, DFA might be ready to fly. …
In explaining what was wrong with his analysis he notes that one reason was ::
 Succumbing to the recency effect 
That one hurts. I knew very well that the most common investment mistake was assuming that the future would resemble the recent past. After all, I had been in the business for 12 years, had made my share of such assumptions, and had watched many others make the same error. For that reason, I had become quite the contrarian. I also knew that small-company and value stocks were desperately out of favor and were priced for a rebound. But even so, I stepped into the trap. The force is strong with the recency effect.  

I give Mr. Rekenthaler a lot of credit for writing about his error…it is a lesson for all investors.