Valuation Slump.

Bloomberg article from yesterday about the long valuation slump of US equities.  {Excerpt with my highlights.}

U.S. Stocks in Longest Valuation Slump Since Nixon

QBy Inyoung Hwang and Whitney Kisling 

Valuations for U.S. equities have been stuck below the five-decade average for the longest period since Richard Nixon’s presidency, a sign investors don’t trust earnings even after a three-year bull market.  Analysts estimate profits in the Standard & Poor’s 500 Index will reach a record $104.78 this year after increasing 125 percent since the end of 2009, the fastest expansion in a quarter century, according to data compiled by Bloomberg. American companies are boosting income so much that even after stocks doubled, the S&P 500 hasn’t traded above its 16.4 mean ratio for 446 days, the longest stretch since the 13 years beginning in 1973.

Battered by the 14 percent decline in the S&P 500 since 2000, the worst financial crisis since the Great Depression and the so-called flash crash 21 months ago, investors are staying away from stocks, even after record profits, 10 quarters of U.S. economic growth and promises by the Federal Reserve to keep interest rates near zero through 2014. Of the $37 trillion erased from global equities in the credit crisis, $24 trillion has been restored.....

......The S&P 500 trades for 13.7 times profits. It was last above the mean valuation since 1954 on May 13, 2010, less than a week after $862 billion was erased from U.S. equity values in 20 minutes, data compiled by Bloomberg show. The slump has surpassed the two longest periods of the last quarter century, in 2008 and 1988.

Profits for the 169 companies in the S&P 500 that reported earnings since Jan. 9 have risen 3.2 percent from a year earlier and beat analyst projections by 2.9 percent, the data show......Companies in the S&P 500 earned $657 billion in the first nine months of 2011, including $225.2 billion between April and June, the most for any quarter in at least 12 years. That’s 72 percent more than the comparable period in 2008. U.S. GDP, which grew at a slower-than-forecast 2.8 percent rate in the fourth quarter, totals about $13.4 trillion, data compiled by Bloomberg and the Commerce Department show.....

....The last two times the S&P 500 slumped below its historic average, equities rallied. The benchmark index is up 42 percent since it climbed above the five-decade mean in June 2009. It spent 14 months below the average level from August 1988 through October 1989 before quadrupling within eight years starting in October 1990, data compiled by Bloomberg show.

......Multiples for the benchmark gauge rose as high as 13.82 this year. Should earnings match analyst forecasts and climb to $104.78 a share, the index would have to reach 1,718.39 to trade at the average ratio of 16.4, according to data compiled by Bloomberg. That’s more than 30 percent above its last close.  The U.S. economy has expanded by an average of 2.4 percent a quarter since 2009. While that helped push the S&P 500 up 95 percent, the index’s price-earnings multiple is down 43 percent. The decline is part of a decade-long retreat in U.S. equity valuations since the S&P 500 peaked at 31.2 times earnings in December 1999......

....Customers of U.S. stock mutual funds have pulled out more than $146 billion since May 2010 as the S&P 500’s valuation shrunk by as much as 33 percent.The longest valuation slump lasted from June 1973 through January 1986, according to data compiled by Bloomberg. The start coincided with the Watergate scandal that led to Nixon’s resignation and the Arab oil embargo, marking the end of a three-year bull market as shares declined 32 percent over 16 months.....

......Analysts say the current slump is different from the one that started more than 38 years ago. Equities face less competition from fixed-income investments and inflation compared with the 1970s and 1980s. The yield on the 10-year Treasury note peaked at a record 15.84 percent on Sept. 30, 1981. The consumer price index surged during the oil crisis in 1973, rising from 2.7 percent in June of 1972 to 12.3 by the end of 1974. It peaked at 14.8 percent in March 1980.  Today, the 10-year yield is 1.89 percent and touched an all-time low of 1.67 percent four months ago. Consumer prices increased 3 percent from the previous year in December, according to Labor Department data......

Link:  Bloomberg:  Valuation Slump.

*Long ETFs related to the S&P 500 in client and personal accounts.

PreMarks {01.30.12}

Markets are starting out with a general risk averse tone as market participants remain somewhat disappointed in the progression of the Greek bond swap talks.  Of course we've been highlighting for a while now that the market is very overbought so it's possible that Greece is just the excuse for what now ought to be some consolidation.  Having said that, the markets have started something like 3-5 days in the red only to turn around later in the day as buyers came in.    It's possible that end of the month seasonality will prop us up through tomorrow. We'll just have to wait and see.

Hedge Fund Performance

Good article at the online edition of Forbes on hedge fund performance. 
{Excerpt with my highlights.}

Chasing the Mirage of Hedge Fund Returns

By Gregg S. Fisher, Contributor

Hedge Funds had another rocky year in 2011, down 6.4%, as measured by the Dow Jones Credit Suisse All Hedge Index. And yet industry assets under management have climbed back to $2 trillion, having reached $2.1 trillion in 2007 before plummeting in the 2008 market crash. After reading Simon Lack’s just-published The Hedge Fund Mirage (John Wiley & Sons), one wonders why the assets continue to flow in. Here’s how the book begins: “If all the money that’s ever been invested in hedge funds had been put in treasury bills instead, the results would have been twice as good.”

Lack is an industry insider,.........he eventually came to the conclusion that: “While the hedge fund industry has generated fabulous wealth and created many fortunes, it has largely done so for itself.”

Lack notes that the industry is full of super-smart investors, some of whom have been able to generate superior returns. The problem is that a few dozen have produced most of investors’ returns, and as with actively managed mutual funds, it’s difficult to identify the strong performers in advance. Moreover, the persistence of compelling relative performance is not strong, market inefficiencies can quickly disappear, and the investing rewards are heavily skewed in favor of the managers. As a result, the average hedge fund investor has not done as well over the years as the numbers might suggest.

Funny Numbers

To test his thesis, Lack deconstructed industry performance data.

The HFR Global Hedge Fund Index puts the industry’s annualized return from 1998 to 2010 at 7.3%. In Lack’s mind, those return figures are distorted by several factors. One is that these returns are calculated on a time-weighted, rather than asset-weighted basis. As he shows repeatedly in the book, both fund and industry performance suffers with growth in size.....In other words, the index numbers overstate the strength of hedge fund performance due to stronger results in the early years when hedge funds and the industry itself were both smaller.

So Lack performs his own asset-weighted calculations (similar to the internal rate of return methodology of measuring private equity or real estate fund performance) using BarclayHedge data to measure how the average investor—as distinct from the average fund—has done. He argues that hedge funds are similar to private equity funds in that the hedge fund manager (who holds himself out as providing absolute, uncorrelated returns) has control over when to take clients and to commit their capital. Therefore, he feels that returns should be calculated using private equity industry standards versus mutual fund industry ones.

His conclusion: from 1998-2010 the index returned only 2.1% annualized on a money-weighted basis, not 7.3%. During that time frame, he estimates that hedge fund managers earned $379 billion in fees, while “real investors” earned only $70 billion in profits. Thus, the operators earned 84% of the investment profits and investors only 16%. But wait, there’s more. These figures don’t account for fund of funds, which add another layer of fees and through which around one-third of hedge funds are purchased. Including these brings industry fees up to $440 billion, or a whopping 98% of the profit pool, leaving only $9 billion for investors.

And to add insult to injury, Lack notes that HFR Global Hedge Fund Index returns are also overstated due to statistical biases such as “survivorship” (lousy performers shut down or stop reporting) and “backfill” (strong performers start to report). Academic estimates are that these statistical biases of self-selection (reporting is optional for the largely unregulated hedge fund industry) add 3-5 percentage points to index returns. Adjusting for these biases, Lack estimates that from 1998-2010 investors collectively lost $308 billion in hedge funds while the industry earned fees of $324 billion......

Link:  Chasing The Mirage of Hedge Fund Returns

PreMarks {01.27.11}

Some thoughts as we end the week and close in on the end of the month.

Stocks are up nearly 5% for January.  Now I'll make the argument that stocks basically waited until January to achieve what should have been their 2011 fair value.  In other words if 2011 had thirteen months we would have been where we should have been at years end.  Having said that 5% is an awful lot in a very short period of time.  Annualized, markets are looking at a nearly 60% gain run rate for 2012.  That's probably not going to happen.

Stocks are very overbought by our shortest term readings.  Some other statistics that are short term negative.  Both the percentage of stocks that are trading above their 200, 50 and 40 day moving averages have now reached levels that have historically been troublesome for stocks advancing.  At the least stocks usually need a pause at these levels.  Investor sentiment has also shifted much more bullish in the past two weeks. 

Markets opened higher yesterday and then reversed pretty hard.  That's often not a good sign.  Earnings season has been mixed although much of this was probably already factored in.  Investors have also likely brushed off corporate cautiousness so far this year as that had been telegraphed in the past few months.

Stocks are showing a lower open today.  The official reason will be that the 4th quarter GDP print at +2.8% was below expectations of +3.0%.  However, it is the mix of those components that is likely the cause of the disappointment and not the slight miss.  Inventory accumulation accounted for a far greater contribution to the final number and final sales were up by only 0.8%.  That is the real reason that we're going to start the day lower. 

While news out of Europe has been mostly positive since we turned the calendar, the fact that there is no settlement to the Greek negotiations looks like it is starting to wear on investors over there.

The playbook says that it is prudent to play a bit more defense in the next few weeks as markets are showing every indication that they ready for a pause.  I still think that dips in the markets should be bought in 2012 because I think longer term on both a fundamental and valuation basis stocks are attractive.  However, nothing goes up in a straight line.  In terms of market direction, we'll wait and see what our indicators say in the days and weeks ahead.  Shorter term though these are flashing caution.

How Investment Pros Should Think About The Future

Saw this over at the The Big Picture Blog  the other day and thought I would quote it.  This is a common sense approach since all investing is the process of making certain bets about the future.  Marks succinctly says what most of us try to convey to clients all the time.  

“I confess, I think about the future. So do my colleagues. If someone who’s spent decades investing doesn’t have an opinion about what lies ahead, there’s something wrong. I believe our clients want us to apply the benefit of our experience in gauging and reacting to the opportunities and risks that lie ahead.

But I have a mantra on this subject, too: “It’s one thing to have an opinion; it’s something very different to assume it’s right and act on that assumption.” We have views on the future. And they can cause us to “lean” toward offense or defense. Just never so much that for the results to be good, our views have to be right.”

-Howard Marks, Oaktree Capital Management

January 10, 2012

Link:  The Big Picture-Opinions About The Future

BTW posting may be a bit light over the next couple of days as I have to be out quite a bit seeing people.

A Decade of Earnings PE and Earnings Yield Comparisons

Here's a decade's worth of Price to Earnings ratio {PE}comparisons and earnings yield comparisons for the S&P 500.  A few things.

1.  I didn't include it on this chart but the comparable numbers for year end 2011 likely were a PE ratio between 12.5 & 13 times 2011 earnings.  The Earnings yield was likely between 7.7% and 8%.  These are estimates as the final S&P earnings will depend on the 4th quarter results which are still being reported.  

2.  Historically since about 1980 studies suggest that stocks have traded between 14 and 16 times their forward looking estimates on a PE basis.  Since year 2000 the average earnings yield on the S&P 500 has been 5.695.  Using these metrics and a midpoint 2012 earnings estimate of $103.00 on the S&P 500 then the historical looking value of the market would be between 1,442 and 1648.  To bring the earnings yield back down to its historical levels the S&P 500 would need to trade this year to around 1750. 

Keep in mind that these are historical observations, likely skewed by the fact that stocks were very overvalued throughout the first half of the last decade.  Probability suggest that a year end 2012 price value north of 1600 is highly unlikely.  In other words don't use this sort of backward looking analysis to project some pie in the sky end of the year number for stocks that likely will not occur.   However, doing this sort of exercise does show you that based on we know today the valuation potential for equities is still very attractive on a multi year basis.   

See here for my source of the S&P data.  I'm assuming this information is accurate but I cannot guarantee the source.   

*Long ETFs related to the S&P 500 in client and personal accounts.

Earnings: A Follow-up To Yesterday

As a follow-up to yesterday's post the folks over at Chart of the Day show in the chart above the earnings projection for year end 2012 S&P 500 earnings.  Note how quickly profits recovered from their cyclical lows in 2008-09.    Here's their take on this:

"Today's chart provides some further perspective into the past and future trends of 12-month, as-reported, inflation-adjusted S&P 500 earnings. Today's chart illustrates how earnings declined over 92% from its Q3 2007 pre-financial crisis peak and then, beginning in Q1 2009, quickly surged back to near record levels. This begs the question; will corporate earnings make new record highs? As today's chart illustrates, based on the latest S&P 500 earnings estimates (see red line), earnings are expected to make new, inflation-adjusted record highs during the first half of this year. Considering the current global economic environment, this is indeed quite an achievement."

Link:  Chart of the Day: Earnings

*Long ETFs related to the S&P 500 in client and personal accounts.

an tSionna {01.20.12}

Here's an updated chart on the S&P 500.  In regards to our earnings targets for last year, I thought I'd do a quick review.  We started the year in an essay on whether stocks were cheap by thinking that stocks could trade by year end 2011 between 1350 and 1400 on the S&P 500.  We lowered that end of year projection back in early October to a range of 1250-1300.  The S&P 500 reached its high water mark for the year in early May when it closed at 1362.  From there stocks declined almost 20% into the fall and ended virtually unchanged around 1260.  Since October, stocks have retraced much of that decline and are now trading around 1315. 

Humans divide time periods into things like years and decades but markets are not bound by such things.  They will get to where they need to be in fits and starts {both good and bad} and only a higher power {or randomness if you don't believe in such things} knows when that might occur.  There may have been artificial constraints such as tax selling and year end window dressing that held the market back in the last few weeks of 2011.  Certainly there has not been enough different news so far that warrents why the market would have kicked up over 4% since we've turned the pages into 2012.  Ultimately things like valuation and fundamentals matter to investors.  Stocks came into this year cheap, trading somewhere between 12-13 times what ought to be the final S&P 500 earnings number for 2011.  They have simply now started to play catch up to where they likely should have been a few weeks or months ago.

Back in that December 2010 piece linked above we said the following: 

"One final thought. If we assume that the economy continues to grow at these projected rates then you are looking at 2012 estimates of potentially $100 and $104. Should these numbers come to pass then you are looking at fair value estimates out there of $1,350-1,550 by year's end 2012." 

If anything consensus estimates are even higher now for 2012, so we'll stand by that range for now by year's end with a current midpoint estimate of 1475.  We'll detail how we are getting there and introduce a 2013 estimate at a later date.   

From where we started the year, a market that has the potential to trade around 1475 by year's end has the potential to increase about 17% on a price basis.  If you add in expected dividends for 2012 and dividends received in 2011 and divide that return by two {in order to make up for our basically lost 2011}, then stocks over that period of time have the potential to compound at around a 10% rate for both 2011 and 2012. 

We'll see what happens.  More on this subject soon.

*Long ETFs related to the S&P 500 in client and personal accounts.

Two Articles Everybody Should Read!

A couple of articles I think you should read!  Neither of these pieces will make you a dime today but both are important in my opinion as I think they go a long way towards laying bare some of the major problems in both our economy in the country today.  Both are too long for me to put on the blog.  I'll give you the main thesis as an excerpt below but you need to read the articles to get the full flavor.   

The first from the New York Times  discusses how the US lost out on iPhone work.  What this says about American economic competitiveness versus Asia is disconcerting. 

"When Barack Obama joined Silicon Valley’s top luminaries for dinner in California last February, each guest was asked to come with a question for the president.  But as Steven P. Jobs of Apple spoke, President Obama interrupted with an inquiry of his own: what would it take to make iPhones in the United States? Not long ago, Apple boasted that its products were made in America. Today, few are. Almost all of the 70 million iPhones, 30 million iPads and 59 million other products Apple sold last year were manufactured overseas. Why can’t that work come home? Mr. Obama asked.  Mr. Jobs’s reply was unambiguous. “Those jobs aren’t coming back,” he said, according to another dinner guest.  The president’s question touched upon a central conviction at Apple. It isn’t just that workers are cheaper abroad. Rather, Apple’s executives believe the vast scale of overseas factories as well as the flexibility, diligence and industrial skills of foreign workers have so outpaced their American counterparts that “Made in the U.S.A.” is no longer a viable option for most Apple products......."

The second article deals with the new American divide.  It is a Saturday essay in the opinion section of the Wall Street Journal.  In an essay entitled  The New American Divide, author Charles Murray discusses how the "American Dream" seems to have gone away as the working class falls further away from institutions like marriage and religion and the upper class becomes more isolated.   While I'm not sure how new the divide between American social classes is and I'm not sure that the article {which is a preview of a book the author has written on the same subject} covers all these bases, I do think he hits on some major themes that on a societal basis are hurting us.  An excerpt that basically states his thesis:

"When Americans used to brag about "the American way of life"—a phrase still in common use in 1960—they were talking about a civic culture that swept an extremely large proportion of Americans of all classes into its embrace. It was a culture encompassing shared experiences of daily life and shared assumptions about central American values involving marriage, honesty, hard work and religiosity.

Over the past 50 years, that common civic culture has unraveled. We have developed a new upper class with advanced educations, often obtained at elite schools, sharing tastes and preferences that set them apart from mainstream America. At the same time, we have developed a new lower class, characterized not by poverty but by withdrawal from America's core cultural institutions."

At any rate go read these articles.  Like I said they won't make you any money in the markets today but they should at least get you thinking. 

an tSionna {01.21.12}-Technology

In a post on Thursday, the folks over at Bespoke Investment Group noted that "the S&P 500 Technology sector has gotten off to a great start to 2012. While it has gotten a bit overbought in the short term, the sector is closing in on a key resistance level that bulls would love to see broken. This resistance level is the sector's pre-financial crisis closing high of 441.36, which is just 1.59% away from where the sector is currently trading."

*Long various technology ETFs in client accounts.

Link:  Bespoke & Technology.

A Kodak Moment

Eastman Kodak filed for bankruptcy yesterday.  Kodak was done in by the digital age.  But for many of us over say age 40, Kodak prints and films defined our lives.  Here are a couple of old Kodak commercials that eulogizes a bygone era.  If the young man in the first commercial looks familiar that's because later in life Mark Hamill became Luke Skywalker in Star Wars.

an tSionna {01.20.12}-Gold

*Long GLD in certain client accounts.

It's an RIA World!

Great article on the growth of the RIA industry.  An RIA stands for Registered Investment Advisor.  That's what I am!  {Excerpt with my highlights.}

It’s Our World, Everyone Else Just Lives In It.”

By Josh Brown

......Investment Advisory in general, and the independent variety in particular, is the only finance-related business that’s seen assets under management (and by extension – fees) grow over the last five years. Like a gleaming, late-model luxury sedan casually rolling past the flaming wreckage of post-credit crash Wall Street, our disassociation with the broken down vehicles littering both sides of the highway is simply impossible to ignore.

We are doing better than the bankers (who are being laid off by the tens of thousands globally) and better than the traders (who are having their lungs ripped out by algo-driven toaster ovens five days a week) and better than institutional brokers (who are watching their per-trade commissions now dwindle down into strange, new increments like nano-pennies per share).

And we are most certainly prospering more than retail brokerage. A casual look at the DART reports (daily average revenue trades) from the major online brokerage firms paints a picture of apathy and non-engagement now that all the really active amateurs have moved on to currency and forex as their poison of choice.

I’d also note that we are doing far better than our second cousins in full service retail brokerage in the asset-raising department, but that would be like me telling you that water’s wet – no need to rehash the undeniable secular shift happening there. Jeff Benjamin from Investment News tells us that by the end of 2010, total industry assets were above 2007 pre-crisis levels ($11.2 trillion) but that wirehouses have seen their assets drop during that same period from $5.5 to 4.8 trillion. Five years ago the wirehouse held 50% of the industry’s total AUM {my note-AUM stands for Assets Under Management}, today it’s 43% and dropping – and this includes the $300 billion from BofA that became wirehouse assets as a result of the Merrill Lynch acquisition, without those the picture would be even worse!

But here in RIA-land we’re the Belle of the Ball right now....A recent report and breakdown of new client assets at TD Ameritrade really hammers this home…

From Registered Rep:

TD Ameritrade continued to rack up double-digit asset growth in the first quarter ending Dec. 31, the company said today. TD Ameritrade Holding Corp.,.....reported $10.2 billion in net new assets for the quarter, up 11 percent on an annualized basis…60 percent of those assets came from new advisors on TD’s institutional platform…

Meanwhile, RIAs appear to be contributing to higher revenues at the custodian. TD said asset-based revenues accounted for 55 percent of last quarter’s $653 million in net revenues;....

I can’t think of an example of this kind of growth happening anywhere else in the realm of finance – at least on this scale.......

Now, there is a great deal of irony in the fact that the online brokers have become an indispensible tool for the brokers-turned-advisers they used to do battle with. Having put the retail broker out of business thanks in part to commission deflation, firms like Schwab and TD and others have now become the custodian partner to those former brokers, many of whom are now at RIA firms serving as investment adviser representatives (Series 65′s).

But this partnership between former foes has allowed RIAs to raise more new money than hedge funds, mutual funds, broker-dealers.....

Link:  It's an RIA world!

My note:  Perhaps it has something to do with the fiduciary aspect that RIAs bring to the table.  We serve no masters but our clients!

an tSionna {01.19.12} Bonds-A Topping Pattern?

This is a chart of the iShares 20 year + treasury ETF {TLT}.  I put this up because it comprises a treasury portfolio of the longest dated bonds an investor could hold.  You can see that back in the summer the price of TLT exploded to the upside as investors fled from risk assets into the perceived safety of US Government bonds.  Interesting isn't it that investors went here to hide even as S&P downgraded US debt in the fall!

Since then though TLT has spent all this time going nowhere.  In fact it's chart characteristics and money flow data are strongly suggestive of a security in a topping pattern.  That is it is trading in a manner where there is a higher probability that its next move will likely be a decline.  Year to date it has now fallen a little over 1.5% while stocks on average are up 3%.  

Intuitively this makes sense simply given how low yields are and how much money {read trillions of dollars} have moved into perceived safer assets.  Some German Bunds for example currently have a negative yield.  The current yield on 30 year treasuries is just a bit over 3%.  I've stated this before but here is what a low yield like that means.  Investors are so worried about economic growth and how it will affect their capital that they are willing to take a rate of return over the next 30 years that on an after tax basis and when adjusted for inflation will likely give a negative return.  Meanwhile there are many good quality stocks and ETFs that yield as much as the 30 year treasury or even more. 

So far stocks have had a pretty good January.  What we may finally be seeing is a shift in asset allocation into more riskier assets.  That is a move away from bonds and into stocks.  It's early in the game but if this is starting to occur and especially if the economy truly is on the mend then expect to see interest rates start to rise this year.  If that is the case then this security is vulnerable to a correction.

*Long TBT- the Proshares Ultrashort 20+ year treasury ETF in certain client and personal accounts.

an tSionna {01.18.12}

Look at what has quietly been pushing up against a post 2008 crash high.  It's the Nasdaq 100 {Symbol QQQ}  You can see this pretty clearly in this weekly chart below: 

Here's the daily view of the same thing going back about 18 months.  Remember you can double click on these charts to make them larger.

*Long ETFs related to the Nasdaq 100 in client accounts.

an tSionna {01.17.12}: Two Charts

Weekly Chart of the S&P 500 as represented by its ETF-SPY.  You can doubleclick on these charts to make them larger.

*Long ETFs related to the S&P 500 in client and personal accounts.

Virus

Came in this morning to find that some of my systems had been invaded by a virus.  No posting today as a result.  I have a few things in the hopper for the next couple of weeks that I hope you find of interest.  Next post will be Tuesday as the markets are closed on Monday for the Martin Luther King holiday.

Performance in 2011-More Numbers

More numbers from the year that wasn't.

"Equity mutual funds had their worst year since 1997 relative to the Standard & Poor’s 500 Index, as record-high correlation and price swings made it harder for money managers to pick stocks.

Among about 4,100 funds that invest in large-cap stocks, 17 percent beat the benchmark index for U.S. equities last year, the least since the 12 percent recorded in 1997, based on data from Chicago-based Morningstar Inc."

Link:  Bloomberg: Mutual Funds

An Interesting Statistic

CNBC just reported that through yesterday the markets are up year to date the most since 2006.  That was a pretty good year for stocks as I recall

A Thought About Financial Advisors

From a blog I've started to follow called iheartwallstreet.com: {Excerpt with My highlights}

Seduced By Complexity

Advisors propose complex solutions that raise more questions, making people feel like they’ve opened a Pandora’s box. But why?

By Carl Richards, CFP

Making smart decisions about money is rarely easy. It’s why people look to advisors in the first place. But often we as an industry make things worse. Instead of making things simpler, we propose complex solutions that raise more questions, making people feel like they’ve opened a Pandora’s box. But why?

The financial-services industry uses complexity as a sales tool. Like other sales-oriented industries, it uses the tactic of creating a problem, then providing the solution. To that end, the industry has identified as its main value proposition access to information and transactions, then presents this access as the solution to clients’ money questions. Think back to the early 1990s, before the Internet. It was a challenge to get basic information like a stock quote and almost impossible for people to calculate how their investment accounts had done at any of the major brokerage firms. The financial-services firms were the gatekeepers to information, and they’d set themselves up as the interpreters of that information.

Often, we think that if we have a complex problem, the solution should be complex, too. Some people in professional service industries view complexity as some sort of intellectual gift.....{T}he goal isn’t to search for the simplistic answers but instead to avoid being seduced by the idea of complexity. For too long, we’ve been accustomed to the idea that financial products, financial plans, and investments need to be complex in order to be effective. So, we start to reject some of the simple, basic concepts that will actually be far more effective in helping people make smart decisions about money.

.....I’ve noticed that despite claiming the goal of simplifying people’s lives, we sometimes are scared that people won’t value and pay for that type of advice.....Often the very things that will make the biggest impact on our clients’ financial lives are simple, but not easy. Saving more, spending less, even asking for simpler solutions are all things we can do. But we often pass them by because we’ve bought into the idea that our value hangs on being the gatekeeper to the complex. But complexity isn’t the silver bullet to financial questions. Isn’t it time we help people discover the simplicity on the other side of complexity?

Link:  Seduced By Complexity

Comment:  I will return to this theme later this year as I think this is a very important concept for investors to understand.

an tSionna {01.09.12}

Chart of the S&P 500 ETF Spyder trust-SPY.  While it may not feel like it to most of us given the fact that there was so much churning around last year, the index has actually been in a bullish mode since it bottomed out last summer.  In fact SPY is up over 13% since it bottomed back in the first of October and is up over 6% since Mid-December. 

The fact that the market has entered a previous level of congestion from where it's had trouble advancing and the fact that it is now overbought in nearly every time frame we measure suggest the probability of at least a pause or a slight pullback in this current advance.  On the other side of this argument would be the seasonal factors currently at play as January is typically a strong month for stocks.  We will let our indicators be our guide and watch to see how this develops in the next few weeks.  I think though {for reasons that I'll detail in the next few weeks and also based on what we currently know} that pullbacks in the market are better to be bought in the next few months than to be sold. 

However given the move we've had and the nature of the markets at this juncture we will move our shortest term indicator down a notch to Net Market Neutral.  We have been Net Market Positive on the markets short term since October 6, 2011 . Please go here for a definition of what these terms mean.  Please also note that this change only reflects our thinking to our shortest term indicator and that both are intermediate and longer term indicators are still Net Market Positive.  This also currently reflects that we are pretty fully invested for clients at this time.  It does not necessarily mean that we are sellers here or that we have developed a negative view of the markets.

Happy Birthday Davie!

David Bowie turns 65 today.  Bowie is perhaps not known for traditional music but back in 1977 he teamed up with Bing Crosby for this Christmas classic.  Since we're still close enough to the holidays, I thought we'd throw this out there for your entertainment.  Happy Birthday David and Merry Christmas Mr. Lawrence. 

"The truth is of course is that there is no journey. We are arriving and departing all at the same time. "  David Bowie

Performance in 2011-Some Notes.

A few other factoids and performance figures on the year that wasn't.

Hedge Funds- in aggregate data through November, 2011, multi-strategy hedge funds had lost 4.7% for the year.  {Source Goldman Sachs Investment Outlook-page 33, data supplied by Investment Strategy Group, Barclay's Capital}.

Mutual Funds- CNBC reported on Friday that 48% of  portfolios missed their benchmarks by over 2 1/2% or 250 basis points in 2011.

Berkshire Hathaway- {Warren Buffet's holding company as measured by the A shares} lost 4.72% in 2011.

General Electric- on a price basis lost 1.53% in 2011.

*Long shares of GE for certain clients in portfolios, Berkshire Hathaway is a component of various ETFs we own for clients and personally.

Performance in 2011 World Stock Markets

From The Economist  website:  "IT HAS been a poor year for the markets. The MSCI world stockmarkets index fell by 8.5% in 2011, and the index for developed markets fell by 7.6%. The euro area's biggest economies fared particularly badly, with markets in Italy, France and Germany down by 25%, 17% and 15% respectively. But the prize for the worst performing of the stockmarket indices we track each week goes to Greece, which decreased by over 50% during the year. Venezuela's stockmarket did best, thanks to economic growth, high inflation (consumer prices increased by over 28% in the year to November), a thin market and the hope that Hugo Chávez’s presidency is reaching its end. Only four other markets, in Indonesia, America (Dow Jones Industrial Average and S&P 500) and Malaysia, ended 2011 higher than they started it."

Link: The Economist-World Markets

See my disclaimer below for this post as well.

Performance in 2011-Average Stock

One thing I should have highlighted in that previously posted table that the NYSE Composite has traditionally been associated with the average stock.  Bespoke's data shows that the average stock as represented by that index lost 5.93% this year.

No positions in stock index mentioned in this post.

Performance of ETFs In 2011

The folks over at Bespoke Investment Group  published last week a handy year end performance matrix for many of the major asset classes represented by their ETFs.  

They have put it together this way. "The left side of the table highlights all US based ETFs, which clearly outperformed the foreign ETFs shown in the top right corner of the table. The top performing ETF on the entire list was the 20-Year+ Treasury ETF (TLT) with a gain of 28.82% in 2011. The worst performing ETF was natural gas (UNG) with a decline of 46.09%."

Link:  2011 Key ETF Performance

A note:  We own many of the ETFs listed in this table in both client and personal accounts.  It would be too cumbersome for us to list every single security.  You can contact us if you would like to know whether we own certain issues at this time. 

Bear Markets

Chart of the Day work from a couple of weeks ago:

"{This} chart illustrates rallies that followed massive bear markets. For today's chart, a 'massive' bear market is defined as a decline of greater than 50%. Since the Dow's inception in 1896, there have been only three bear markets whereby the Dow declined more than 50% (early 1930s, late 1930s until early 1940s, and during the very recent financial crisis). Today's chart also adds the rally that followed the dot-com bust during which the Nasdaq declined 78%. The current Dow rally has followed a somewhat middle of the road path and has most closely followed the post dot-com bust rally of the Nasdaq that began back in 2002. If the current rally were to continue to follow the post-massive bear market rally pattern, the market would have to work its way higher during much of 2012."

Link:  Bear Market Rallies

*Long ETFs related to the Dow Jones Industrial average in certain client accounts.  Long ETFs related to the NASDAQ composite in client accounts.

10 Things Investment Pros Do That Amateurs Don't! {Repeat}

This advice I think it also bears repeating at least annually.


1. Pros always have cash

2. Pros tend to worry less about the day to day with stocks and try to focus longer term.

3. Pros try not to invest in things they don't know.

4. Pros recognise that not everything is analyzable.

5. Pros are as concerned with the downside as the upside.

6. Pros always look; they never avert their eyes from a downturn.

7. Pros accept that not everything works or is going to work at once.

8. Amateurs are worried that they aren't making enough but pros are worried that they are making to much money.

9. Pros do their homework.

10. Pros know things go wrong. They are more likely to cut losses and let profits run.

Bogle Editorial {Repeat}

We ran this editorial article written by John Bogle a few years ago in the Wall Street Journal here is a link to the original article.  I think this bears repeating about once a year as it's advise is classic. {Highlights are mine!}

Six Lessons for Investors

Be diversified and don't assume past performance will continue.

There is almost no limit to the ability of investors to ignore the lessons of the past. This cost them dearly last year. Here are six of the most important of these lessons:

1) Beware of market forecasts, even by experts. As 2008 began, strategists from Wall Street's 12 major firms forecast the end-of-the-year closing level and earnings of the Standard and Poor's 500 Stock Index. On average, the forecast was for a year-end price of 1,640 and earnings of $97. There was remarkably little disparity of opinion among these sages.

Reality: the S&P closed the year at 903, with reported earnings estimated at $50. Strategists aren't always wrong. But they have been consistent, betting year after year that the market will rise, usually by about 10%. Thus, they got it about right in 2004, 2006 and 2007, but also totally missed the market declines in 2000, 2001 and 2002, and vastly underestimated the resurgence in 2003. Ignore the forecasts of inevitably bullish strategists. Bearish strategists on Wall Street's payroll don't survive for long.

2) Never underrate the importance of asset allocation. Investing is not about owning only common stocks. Nor are historical stock returns a sound guide to future returns. Virtually all investors should keep some "dry powder" in their portfolios.....With all the focus on historical returns that greatly favor stocks, don't ignore bonds. Consider not only the probabilities of future returns on stocks, but the consequences if you are wrong.

3) Mutual funds with superior performance records often falter. Last year was an extreme example. With the S&P 500 off 37% for the year, Legg Mason Value Trust fell by 55%. Fidelity Magellan Fund, after a good 2007, was off 49%. Funds managed by proven long-term pros felt the pain -- Dodge and Cox Stock down 43%; Third Avenue Value down 46%; CGM Focus down 48%; Clipper down 50%; Longleaf Partners down 51%. (Full disclosure: Four of Vanguard's actively-managed equity funds also lagged the market by wide margins.) Only time will tell whether the disappointing shortfalls experienced by these and other funds will be recovered in the future, whether the skills of their managers have atrophied, or whether their luck has run out. Whatever the case, chasing past performance is all too often a loser's game. Managers of funds seeking market-beating returns should make it clear to investors that they must be prepared to trail the market -- perhaps substantially -- in at least one year of every three.

4) Owning the market remains the strategy of choice. Such a strategy guarantees a return that lags the market return by a minuscule amount, and exceeds the return captured by active equity-fund managers as a group by a substantial amount. Why? Because the heavy costs incurred by investors in actively managed equity funds can easily amount to 2% to 3% annually.....As a group, investors are by definition indexers. (That is, they own the entire market.) So indexing wins, not because markets are efficient (sometimes they are, sometimes they are not), but because its all-in annual costs amount to as little as 0.1% to 0.2%. Indexing won in 2008 by an especially wide margin. Low-cost, low-turnover, no-load S&P 500 index funds outpaced nearly 70% of all equity funds, and (admittedly a fairer comparison) more than 60% of all funds focused on large-cap U.S. stocks.

5) Look before you leap into alternative asset classes. During 2006-07, equity mutual funds focused on developed international markets and emerging markets provided strong relative returns to U.S. stocks. During that period, U.S. investors made net purchases of $285 billion in mutual funds investing in non-U.S. stocks, and liquidated on balance some $35 billion from funds focused on U.S. stocks. This extreme example of "performance chasing" at its worst is hardly defensible. But, disingenuously, it was touted by fund marketers as adding "non-correlated assets," or "reducing volatility risk." In 2008 -- with non-U.S. developed market funds falling by 45% and emerging market funds tumbling by 55%, we learned once again that, just when we need it the most, international diversification lets us down. Commodities were no different. As the global recession developed, commodity funds sank, the largest such fund tumbled 50%. Always keep in mind: When the investment grass looks greener on the other side of the fence, look twice before you leap.

6) Beware of financial innovation. Why? Because most of it is designed to enrich the innovators, not investors.....Our financial system is driven by a giant marketing machine in which the interests of sellers directly conflict with the interests of buyers. The sellers, having (as ever) the information advantage, nearly always win. ....While the events of 2008 reinforced that message, perhaps these stern and oft-repeated lessons of experience will help investors avoid similar mistakes in 2009 and beyond.

My Comment: I'm not sure I completely agree with Bogle on point six. After all it was financial innovation that gave us index funds of which his Vanguard group is a huge investor. I think I'd rather say beware of financial innovation that has not been around long enough to withstand the test of bull, bear and sideways markets.

*Long ETFs related to the S&P 500 in client and personal accounts.

Solas! Republishing Introduction. {Revised}

Solas!

Hello and Welcome! At least once a year I will republish the introduction to this blog and my general disclaimer..

As stated way back when, this is an experiment and Solas! so far seems to me to be the best opportunity to focus on what I want to write in a time efficient and hopefully interesting manner. However, please keep in mind that so far this is a hit or miss experiment. I don't yet know if this is going to work, how it's going to look or even if I am going to be satisfied with the end product. As a work in progress, especially at its inception, this may be a hit or miss endeavor. I don't know how and may never have time to do many of the things that make this look pretty or more professional. Nor am I going to take time away from my business to become an expert blogger. I do over time hope to make this better. I welcome your comments and suggestions.

What this is:

A learning experience. A way for me on occasion to make a point.

A way for me on occasion to discuss markets and investing.

A place for me on occasion to discuss the vagaries of life and perhaps editorialize.

A place to discuss the investment process.

What this is not:

A forum to tout any form of individual investments. (Particularly individual stocks or ETFs). We do not make recommendations on this blog! If we do discuss individual sectors or securities it will be solely in the context of a learning experience. You should understand that any individual sector or security that may be discussed here has the possibility of loss of principal.

A place for me to give individual investment advice. (Call me or others for this).

A theatre for me to tell you how wonderful I am.

An environment for me to make stock valuation claims i.e. "XYZ is worth 50 dollars!" If & when we do discuss valuations, that will be an opinion and nothing there should be construed as a guarantee of return or a guarantee that a stock will ever trade to an actual price.

And anything else that I might think of going forward.

One other thing. Where I discuss any individual security I will disclose whether I or clients currently own that stock or ETF. That disclosure is only valid for the day of the post as investments can change at any time. Any person who reads this blog and is not a client of Lumen Capital Management, LLC should either do their own research, give us a call or talk to their own investment advisor before making any investment based on anything written within the confines of this blog.

Oh and a final disclaimer!!! I write principally for the clients and friends of my firm, Lumen Capital Management, LLC. It is a way for them to get a quick read on my thoughts about the markets and any other subject I might cover. I do so after understanding to the best of my ability their unique risk/reward criteria. As such any casual or outside reader of this blog should understand that I am not writing for them! Therefore I or my firm takes no responsibility for any actions overt or otherwise a casual reader of this blog might take based on our discussions here. Casual or outside readers should do their own homework, discuss our articles with their own investment advisors or better yet hire us.

In short if you're not a client and you read this you're on your own.