Tag Archives: investing

In a Bull Market Stocks Provide Better Returns than Bonds… Not Always

Thesis: While it is common for investors to prefer higher risk to augment returns in bullish markets, stocks do not always outperform bonds.

The U.S. stock market has been in a bull market for over five years now, rallying from 2009 lows after the Great Recession. The year 2015 has been no exception as stocks have rallied even in the face of a rising U.S. dollar. A weak dollar makes equities look more appealing to increase returns as stock prices are denoted by the dollar, so they have an inverse relationship. The U.S. dollar has seen its largest price rally in a long time as it has rallied over 21.8% in the past 10 months. This odd rally is considered a black swan – an event that is highly unlikely to occur and is multiple standard deviations away from the norm. Black swan events make it possible for unusual returns for investors, kinda like Treasury bills outperforming stocks in a bull market. Treasury bills are considered a safety net, and investors flock to purchase them in times of strife or market decline as they provide a safe, guaranteed return.

In a recent article by the Wall Street Journal titled, “Buying U.S. Currencies with Foreign Denoted Currencies Pays Off,” many trades are highlighted that outperform the U.S. stock market as defined by the returns of the S&P 500. The most profitable trade is buying U.S. 10 year treasuries with the Euro. While the U.S. dollar has prospered, the Euro has had a dramatic decline due to financial turmoil in the region. The article does a good job explaining the unlikelihood of the trade, “Thanks to a roaring dollar rally and a world-wide grab for ultrasafe government bonds, one of the keenest bets in financial markets over the past year has been one that isn’t typically associated with outsize returns: buying U.S. Treasury debt with foreign currencies.” What is even more shocking is the returns that some of these trades have fetched, especially compared to the benchmark index during such a prosperous time. “Investors buying Treasury debt in euros earned a total return of 36.7% over the past 12 months, reflecting price gains and interest payments, according to Barclays PLC. The same investment would have earned 23.9% in Japanese yen, 19.8% in British pounds and 16.9% in Swiss francs.” So not only do the returns either rival or top the benchmark index, but they also carry much less inherent risk. Alpha investors seeking to mimic returns while taking on less risk would be delighted with such returns. For an elaborated definition of alpha, check out Investopedia on the topic. Alpha has become increasingly popular amongst hedge funds, and this trade highlights some of the successes to the strategy.

A Random Walk Down Wall Street: Just The Tip of the Iceberg

Thesis: While Malkiel’s book gives an in-depth look at the basics of the world of financial markets, readers should not treat it as a substitute for professional financial advice.  

Today’s stock market is, to the average American, an incomprehensible mess of quasi-sophisticated terms, incomprehensible charts, and constant breaking news updates.  As Malkiel aptly puts it, “the stock market [is] treated like a sports event with a pre-game show, a play-by-play during trading hours, and a post-game show to review the day’s action”.  This dramatization of the markets, along with the wealth of information readily available on the internet, leads many investors to get caught up in the excitement and make misinformed purchases based on the castle-in-the air theory.  Malkiel’s book equips an investor to think rationally amongst all the madness, providing an overview of the various theories and techniques which investors subscribe to (or used to subscribe to), while including real-world examples of the instances when the public succumbed to the siren’s song.  If the world of investing was the world of mathematics, then A Random Walk Down Wall Street would be like a course in basic algebra: not quite the most fundamental building blocks of theory nor the most advanced, but arguably the most crucial.

Burton Malkiel’s writing style is perfect for the type of book he wrote – a book meant to be understood by a reader coming in with absolutely no prior experience.  He keeps the technical concepts to a bare minimum, periodically dropping jokes while still embedding graphs, charts, and tables that perfectly illustrate the logic he is arguing for (mostly concerning speculative bubbles).  He makes absolutely no assumptions about the reader’s prior knowledge, providing brief explanations of basic financial concepts ranging from fundamental and technical analysis to the fact that risk is correlated with returns.  However, I think this incredibly approachable style is somewhat of a pitfall for the book – some readers may find that they are overly confident and ready to jump in to the market, just as those who think watching CNBC and perusing Bloomberg.com might prepare them for investing.

Malkiel champions indexed mutual funds and ETFs, broadly diversified funds that allow an investor to capture the market’s returns while minimizing risk, which is certainly sound advice.  He consistently returns to the efficient market hypothesis, which I interpret as his way of constantly reminding the reader how hard it is to beat the market – also sound advice.  And he lays out wise principles in part four of the book (which, by the way, contains the vast majority of the information in the book that is truly useful to the average investor – though part one is a very entertaining read) such as how risk tolerance will vary by investor, how diversification between fixed-income securities and equities is crucial, and how important it is to start saving as early as possible.  But even if a person were to diligently read this book cover to cover and use it as their investment bible, I would not trust them to manage any significant portion of my wealth based on that alone – so why should a person trust themselves after reading just this book?  The bottom line is that while Malkiel’s advice is excellent, it is not a replacement for professional financial advice.  For example, the book claims that one should hold on to larger cash reserves as they grow older, but does not get any more specific than that, because one’s investment needs vary so much from person to person.  In reality, financial goals and needs are incredibly diverse, and cannot be grouped into a few brackets of different portfolio holdings based on age and income.  Malkiel has quite a pessimistic view of financial advisers and I think he dismisses them with too much ease.  While it is true that their fees can be high, any adviser worth his/her salt will not push their clients into funds for personal benefit.  And the personalized advice they can provide, not only on investments but on legal and tax matters, is well worth the fee.

A Random Walk Down Wall Street

Burton G. Malkiel’s best seller, A Random Walk Down Wall Street, makes an argument for the efficient market hypothesis and argues that individual investors have no better chance of beating the stock market than a monkey throwing darts at a dart board. His advice is for investors to just buy into funds that replicate the overall markets returns. This advice will ensure an individual of moderate returns over an extended period of time, which Malkiel claims is the best on average that individuals can do.

Burton Malkiel defends his claims by providing evidence that no other strategy has, nor will ever consistently beat these index funds that track the overall stock market as a whole. While I agree with this assertion, because as he stated, “that any truly repetitive and exploitable pattern that can be discovered in the stock market and be arbitraged away will self-destruct.” This is because as more and more people find out about this technique, such as the Dogs of the Dow, the January effect, or the Monday Afternoon pattern, then the gains will be wiped away as more people try to exploit these patterns. This will lead to investors bidding up the prices until there is no gain to be made from these trading techniques.

One point that I contest with of Malkiel’s is that all of the studies he uses to support his data incorporate trading fees which essentially wipe out the possible gains for individual investors. With the creation of websites such as Robinhood that offer $0 trades, it would be very interesting to conduct these same studies, but without the trading fees to see if his theory about individual investor never (or hardly ever) being able to beat the market as a whole. Removing these expenses will save the users tons of money and may change the results of some studies claiming that beating the market is all luck.

The main premise behind Malkiel’s book is to help individual investors maximize their potential returns of saving their money, and there is some very good advice that should be followed by all investors (such as diversification and determining appropriate risk allocation), but I do believe that there are ways in which individuals can beat the market. Investing is a gamble, and all investors must understand that they could lose some or all of their money, but by following some of the techniques Malkiel outlines, anyone can start adequately preparing for their retirement. This book is one that I recommend anyone interested in investing reads before doing so.

Why Educational Investment is Non-Negotiable

When addressing current economic issues one cannot ignore human capital, specifically investment in education. Educational outcomes strongly affect the economic growth of a country. George P. Shultz and Eric A. Hanushek, contributors for The Wall Street Journal, compared the GDP-per-capita growth rates between the years 1960 and 2000 with achievement results as determined by an international math assessment test. The majority of countries followed a straight line that revealed that as the scores on the assessment test increased so did economic growth. Although the U.S. remained above the average, this position will not hold strong for long in the future. Students of today, the labor force of the future, are no longer competitive in comparison to other developed countries. The U.S. was ranked 31st in math according to the OECD’s Programme for International Student Assessment, an alarming statistic.

The importance of education on the economy cannot be understated. Better education leads to a faster growing economy. Over the next 80 years improvements in GDP could ultimately exceed $70 trillion, which plays out to be an average boost of 20% for every U.S. worker each year over the course of his or her career. In addition, education directly correlates to higher wages. The median weekly earnings in 2013 were $472 for someone with less than a high school diploma compared to $1,108 for individuals with a bachelor’s degree. Educational disparities lead to economic disparities that without new reform will maintain and foster the inequality problems that continue to hurt the economy for decades to come.

Noah Berger and Peter Fisher, researchers from the Economic Policy Institute, investigated how the state government can boost the economic well-being of their people. Berger and Fisher revealed that high-wage states are the same states with well-educated workforces, which reveals a strong correlation between educational attainment of a state’s workforce and median wages. Therefore, investing in state-wide education is necessary to build a strong foundation for economic prosperity. In addition to building a strong base, investing in education upfront will show a greater return in the long run in terms of state budgets. Since individuals with higher levels of educational attainment will ultimately have higher incomes, these individuals will therefore contribute more to the state’s taxes over the course of their lifetime.

The students of today are the laborers of the future. The need to invest in education is non-negotiable when considering the investment that is being made. Without an educated labor force our economy will suffer, but with an increased investment in education the possibilities look promising. Just imagine if our GDP could exceed $70 trillion and what that amount of money could do to help pay off the U.S. debt.

The Fed’s Static January Press Release

The Federal Reserve Board’s January 28 press release released no concrete timeline for when they plan to begin raising rates. The statement has a positive economic outlook, claiming that the Fed’s data since December suggests that “economic activity has been expanding at a solid pace” (http://www.federalreserve.gov/newsevents/press/monetary/20150128a.htm). Investors are analyzing this announcement closely to determine what it might imply for rate raising. The announcement reads: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy…  the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.”

According to Paul R. La Monica’s article for CNN Money titled “Fed stays ‘patient’ but rate hikes are coming,” economists such as Michael Gapen for Barclay’s believe the first rate hike will come in the summer (http://money.cnn.com/2015/01/28/investing/federal-reserve-statement-patient/). The announcement led to slips in the Dow Jones, the S&P 500, and the Nasdaq, with the latter falling almost 200 points.

The announcement explains that this expected stagnation is flexible to the natural timeline of recovery of the economy.

“However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated.  Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”

The above sentence seems to me to have been included to give the OMC the leeway to keep decisions to raise rates flexible.Professor Kimball posted a guest blogger’s post on his blog Confessions of a Supply Side Liberal titled “Greg Shill: So What Are the Federal Reserve’s Legal Constraints, Anyway?” in which the flexibility of the Fed in making decisions on monetary policy are discussed. Shill believes “the bank has significantly more monetary policy discretion than is commonly assumed. I personally believe this expansive power is a good thing: the Fed is charged by statute with a dual mission of promoting full employment and “price stability” (http://blog.supplysideliberal.com/post/109369743080/greg-shill-so-what-are-the-federal-reserves).

All in all, this report seems to be one of unvarying progress. This could be because the Fed believes they are on the best possible trajectory or because they are confined by the Zero Lower Bound problem. Either way, I do not believe too much should be read into this announcement as I think it was meant to tell investors that the Fed will not be raising rates any time in the immediate future.

The Waiting Game

“The Federal Reserve signaled this past week that it is unlikely to raise short-term interest rates until at least June” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

This came as a surprise to most people, it seems, but I am not completely surprised based on the underlying motivation of the Fed.

“…The Fed will raise interest rates only when it is confident that the economic recovery is robust and companies have regained the ability to raise prices” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although it seems that the Fed is not in touch with everyday citizens, like you and I, I believe their decision to delay the rise of interest rates is in tune with the best interests of everyday citizens. Although we have been told for a while that the recession is over, it seems that from the perspective of everyday people that is not necessarily the case. It seems like the wealth of the upper class has been rising since post recession, but the middle class and below has not had the same fortune.

The Federal Reserve clearly believes that the economy is not in full rebound yet, hence the delay of raising rates until mid summer. I am happy with the decision the Federal Reserve made, their focus seems to be more on the well being of everyday Americans, rather than worrying about creating high returns for investors. This is not really the common perception of the Federal Reserve; most people seem to think they do not have to best interest of the people in mind. There seems to be this notion or belief that the Federal Reserve is just a group of wealthy bankers in an ivory tower playing with everyone’s money, acting according to the best interest of a few. Their recent decision, however, points to the opposite.

“…Investors seemed mildly disappointed when the Fed reiterated on Wednesday that it would remain “patient”” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

Although investors seem to be upset with the Federal Reserve’s decision. Most people are not investors so this decision by the Fed to not act does not affect them in the same way as those who speculate based on the Fed’s actions.

“More than three-quarters of Americans say the five-year bull market in U.S. stocks has had little or no effect on their financial well-being, according to a Bloomberg National Poll” (http://www.bloomberg.com/news/articles/2014-03-12/stock-market-surge-bypasses-most-americans-poll-shows).

Bull market is a term used to signal positive beliefs about the market, while bear market is used to signal the exact opposite, pessimism towards the market. Although the stock market, like explained above has been labeled a bull market for the past five years, this has not improved the financial well being of everyday Americans, most who do not own stocks, or at least not a significant amount anyways. With the lower and middle class of America still struggling, it seems that the fed made the appropriate decision to delay raising interest rates.

“Don’t worry about the Fed; be happy” (http://blogs.wsj.com/moneybeat/2015/01/30/fed-up-do-rising-rates-matter-after-all/).

You can be happy; the Fed seems to be thinking about you and I, not just the wealthy elite.

Timing the Bottom: Two Perspectives

I have always been a contrarian investor and close follower of Warren Buffet. Some of my favorite quotes by him (often known as Buffetisms) include “If you like a stock at $8, then you should love it at $6” and “When others are fearful, be greedy; when others are greedy, be fearful.” Such logic and wisdom has led me to love turnaround stocks, or for the purposes of this blog post, commodities. After the Great Recession, commodities experienced a tremendous rise in prices like many other assets and enjoyed years of gains. Recently, however, commodities across the board have sold off. Many commodities are even hitting fresh 5 year lows trading around the same prices of 2009. Each commodity has its own story for its decline such as the major oversupply of oil and OPEC refusing to cut production – sending crude from $100 a barrel to $45 a barrel real quick. But what all commodities have in common is that their prices are in terms of U.S. dollars. Therefore, the recent rise in the U.S. dollar has put downward pressure on commodity prices in general. But with prices so low, is it time for a rebound or is there further selling to go? Moreover, should individual investors even be concerned with such a question?

An article by Leslie Josephs of the Wall Street Journal discusses how the recent plunge in commodity prices serves as a buying signal to many investors. The article cites many investor sentiments, that I share, such as crude being an attractive buy at current levels as half of the world’s production is not profitable at current levels. So my long term views are that many commodities are oversold, and I believe in attempting to enter the market at the proper timing. For example, although I view the broader market commodity indexes to rise long-term, I have also been short gold at $1,300 per ounce via calls expiring in February. I believe that if you do you due diligence and invest without emotion, you can be a successful investor. Furthermore, although timing the market may not be plausible, being familiar with general price ranges and entering at the right moment is feasible.

Many, however, will disagree with my thesis. In Burton Malkiel’s A Random Walk Down Wall Street, which can be purchased here, he discusses how Wall Street behaves more like a random walk (or stochastic variable for those familiar with stochastic calculus) than following patterns or what not. Malkiel does cite that the market does experience momentum, as positive (or negative) earnings are not reflected in the share price immediately, but rather gradually over a period of time. Furthermore, he believes that one cannot time the market, denoting poor performance of fund managers relative to the benchmark index. Malkiel actually suggests a buy-and-hold method of an index fund as the best way to grow and protect capital. While I do not disagree with Malkiel, I also believe that if an investor is confident and closely follows the market, they may be select times when he can outperform. Definitely not all the time, but on a few occasions this can occur. Which is why I agree with the buy-and-hold index fund mentality for a large portion of personal investing, but some powder such remain dry for speculative play. Furthermore, since that small portion of your portfolio would be speculative, I would recommend buying options, which has a leverage factor and added timing component due to the option’s expiry.