Trends in Stocks

Investing in stocks is always hard.  You are looking at data about the past but you are betting on an individual stock in the future.  In addition, there has been huge correlation among stocks and markets and the impact of currencies and central bankers (often inter-twined) has given various world markets boom and bust qualities.

In the US, there are two markets, the NASDAQ and NYSE.  NASDAQ has traditionally been more technology focused, meaning that when these stocks go up, the NASDAQ soars.   Here is a quote on “the only six stocks that matter” about the NASDAQ from the Wall Street Journal:

Six firms— Inc.,Google Inc.,Apple Inc.,FacebookInc.,Netflix Inc. and Gilead Sciences Inc.—now account for more than half of the $664 billion in value added this year to the NasdaqComposite Index, according to data compiled by brokerage firm JonesTrading.

Thus the bottom line is that if you don’t have these stocks in your portfolio, the overall index may be rising (and our benchmark for performance), but your own returns will be worse.  We do have some of Amazon and Facebook in portfolio 2, but not much of it overall.

Outside the USA, foreign markets have been hurt by the rising US dollar, which makes their market values lower for us here in the USA (where the dollar is our currency).  This hurts stock investments in Europe (the Euro), Canada (the Loonie), and Australia (the Australian dollar) if you are denominated in US dollars (which we are).   The dollar is up significantly vs. almost every other currency in the world with the exception of the Chinese Yuan.

The Chinese market went crazy this year, in what appears to be a major bubble, that recently started crashing and was accompanied by strong intervention from the central authorities, who went after short sellers and even stopped stocks from trading for various reasons.   At one point almost the entire Chinese stock market by valuation (over 80%) was not trading.  The rationale is that if stocks are heading down, and you can stop trading, then this gives the market participants time to stop panicking.  This type of intervention stops the market from functioning efficiently, however, and will have many other unforeseen impacts down the road.

Mergers and acquisitions (M&A) activity also soared in 2015, which is a sign of bullishness and also likely a sign of a market peak.  A Wall Street Journal article recently summed it up:

Companies are merging at a pace unseen in nearly a decade. Halfway through the year, about $2.15 trillion in M&A deals or offers have been announced globally, according to Dealogic. That puts 2015 on pace to challenge the biggest year on record, 2007, when companies inked deals worth $4.3 trillion… In industries ranging from health care to technology to media, chief executives are rushing to make acquisitions, often either in anticipation of takeover moves by rivals or in response to them.

When acquisitions occur, you as a stock market investor typically want to be the “acquired” company, not the “acquirer”.  The “acquired” company receives a premium price to their current market value but the burden of “earning” that higher price falls on to the acquired company, and typically M&A does not pay off long term for most companies (as opposed to internal or “organic” growth).  While there have been many acquisitions, most notably in the health care / insurance / pharma industry which is consolidating under Obamacare, our portfolios had few of these acquired companies in the mix.

Finally, you had a decimation of the commodity indexes.  Commodities such as oil, some foodstuffs, natural gas, iron ore, copper, gold, etc… have seen their prices collapse, which in turn damages the stocks of mining companies, oil companies, and many other participants in the commodity value chain.  Per Bloomberg:

Almost all commodity markets have taken a severe beating lately. The aggregate Bloomberg Commodities Index is down 61 percent from its 2008 peak and 46 percent from the 2011 post-crisis high

These are severe reductions.  They impact entire economies particularly the Arab countries (which make all their export income in oil), Russia (many commodities), Australia and Canada.  There are large “secondary” impacts as well – reduced commodity prices hurt service demand in Canada and Australia and put their housing boom at risk.

So what does this mean for us and our portfolios?  We’ve been hurt by the commodity bust, the rise of the US dollar (on our foreign stocks), and we’ve missed some of the booming stocks because they were narrowly concentrated in a few names and some of the largest M&A was in sectors where we had few investments.

We are now going to look at some of the stocks and cull some prior to our next round of purchases which will occur in August – September as the beneficiaries of the various portfolios head off to school for the year, and will tie new purchases (of the cash) with additional investments that will be made soon.

Overall Themes Impacting Stocks during November – December 2014

There has been a lot of activity in the stock market recently. Rather than put this on the top of every post I am going to summarize and then refer to these themes within each individual portfolio update. Here are some of themes that have hit many of the stocks:

– crude oil prices crashed – the price of crude has gone from $90 – $100 / barrel to $60 and under. This impacts oil and gas related stocks in a negative way. It also has some positive effects on goods that (poorer) consumers spend more on, companies like Wal-Mart
– the US dollar rose – many foreign currencies fell against the rising US dollar. This hits all of these ADR’s since they fall when the dollar rises and vice versa. The amount of the impact depends on their currency’s particular performance vs. the US dollar
– geopolitical risks – stocks in Russia and some other hard hit areas have fallen very hard. We don’t have many of these in our portfolio
– tech continues to rise – among all of these items we have had a rally in some US stocks, particularly tech stocks and some other sectors
– dividend yields are valued – since interest rates are low and continue to fall (measured by yields on US treasuries), companies that pay out income (dividends) are (mostly) well valued by the market. Note that it is unusual for dividend yields to be this high relative to US Treasury yields

The question is – are these short term themes or long term themes, or somewhere in the middle? If oil prices have gone down, do you sell now, at their lower valued state? Or will they come back over some (reasonable) period of time.

Sign of a New Peak for Stocks?

Back in the woeful years of the boom and bust I worked for a company with a dubious distinction. The value of that company in the stock market was less than the value of the cash we had on our books. What the market was essentially saying is that the sum total of all our efforts as employees was NEGATIVE – we would be worth more if we just shut down immediately and gave back the cash to investors. The fate of that company, of course, was to go bankrupt.

Today there are some other major signs of froth in the market. Yahoo is a classic web / advertising / technology stock with a solid market capitalization of $40 billion. Yahoo’s CEO, Marissa Mayer, was a Google alumni and has been receiving a lot of press for her intelligence and drive to change the company, as well as her good looks.

Screen Shot 2014-09-20 at 8.43.59 AMHowever, all is not as it seems.  The primary value for Yahoo isn’t its online advertising, email, or users – it is the stakes that they amassed in the hot Chinese e commerce company Alibaba (NYSE: BABA) and also Yahoo Japan.  In fact, the value of Yahoo is less than the value of these stakes, which are approximately $45B, partially due to the reason listed in this Bloomberg article:

While the market value is large for Yahoo’s Asian assets, that doesn’t necessarily reflect the value available to investors and the company because of taxes, said Ben Schachter, an analyst at Macquarie Securities USA Inc. Yahoo, which would have made $8.3 billion by selling Alibaba shares at the IPO, only reaped around $5.1 billion after taxes.

Taxes are ‘‘one of the big issues,” Schachter said.

While it is true that $45B in investment value isn’t worth $45B because of the after-tax implications, it certainly implies that the market isn’t valuing Yahoo at very much at all.  It is also possible that the market thinks that Alibaba is over-valued at its current price of near $100 (after a huge run-up from its IPO price of $68, another huge sign of froth in the market) but the two stocks will generally track closely together now.  Yahoo is sort of a broken “tracking stock” for this value.

Another sign of froth is “spec companies”.  Spec companies are stocks of companies that are created “from scratch” and their value is based on the promise of management to do certain things in the future with money contributed or raised from investors.  Generally you can’t create a spec company – you need to take over an existing listing and then you promise returns to investors who in turn value your company.  Brazil was on a tear earlier in the decade and a flamboyant billionaire created a company OSX whose IPO in 2010 was discussed here:

(Reuters) – OSX Brasil (OSXB3.SA) slashed its initial public offering as investors balked at paying a high price for a start-up company with no revenue.

This too recently came to an end as the company OSX filed for bankruptcy protection, but the ability of a firm to launch a start up planning to build a port and various oil and other assets and receive a high valuation should raise eyebrows.  Like many other similar plans this one ends up in dust with a recent bankruptcy filing.

I don’t have any sort of unique forward looking view on stocks but the eye-popping valuation and initial one-day jump of Alibaba and other signs have been correlated with declines in the stock market in the past.

Cross posted at Chicago Boyz

Stock Selections for 2014 and Diversification

Every year we select stocks right about the time when the summer ends and the kids go back to high school or college.  Doing this at the end of the summer gives them time to earn their $500 for the match and sets up a consistent annual pattern for how we make incremental investments.

Due to Stop Loss orders and other sales there is additional money that we need to put back into more stocks.  Many of the beneficiaries will have to make more selections.

Diversification and the Number of Stocks in Each Portfolio

As the portfolios get bigger, we also try to pick fewer stocks and put more money into each individual stock.  As a rule of thumb you have a “diversified” portfolio if you have about ten or so stocks equally weighted.  This only applies if the stocks themselves are diversified, however, across industries and countries.  Since most of the portfolios have stocks concentrated in a few sectors or countries, my “rule of thumb” is to try to go up to 15-20 stocks to get additional diversification.  At that point if we are buying newer stocks, I will recommend making larger single purchases and we can bring up the average value of stocks in the portfolio.

For example, Portfolio one, which has been growing for almost 13 years, has 17 stocks and about $34,000, with $2000 cash on hand.  Thus of the $32,000 invested in stocks, the “average” balance would be just under $2000 per stock.  While that is true, we still have a few closer to the $1200 mark and some that are larger than $2000.  New purchases will be made in excess of $1500 and as there are sales we will try to keep the portfolio at 20 or less stocks, and even 15 or so is probably about right.

Portfolio Two is also at a level where we have begun consolidating and buying in larger blocks, with 15 stocks, $22,000 invested in stocks, and about $3000 in cash.  Going forward we will also be buying in larger lots of $1500 / each and consolidating through stop loss orders and the like.

The other portfolios, three through six, are still at a level where it makes sense to make smaller purchases to get beyond the 10 or so stocks in the portfolio so that if there is a big drop in a single stock it won’t totally dent the portfolio.

Stock Selection for 2014 – Where to Look?

I follow the markets in general due to my line of work in finance and am aware of most sector trends.  I have some knowledge of foreign markets and macro economic trends but less so the further you move away from the USA.

I use Google stock screeners to look for stocks in the US and abroad, by looking at stocks with certain market caps (above $1B) and with other characteristics like price performance and dividend yield.  Much of the time I am looking for negative performance (i.e. stocks that have declined 0 – 25% over the last 12 months) because I believe that some portion of the portfolio should be tied to “regression to the mean” (i.e. what’s down comes back up) and some on growth stocks.

For foreign stocks I look at those that trade ADR’s in the US, generally on the bigger exchanges (NYSE or NASDAQ).  I usually don’t buy ADR’s on the “pink sheets” or OTC markets, although Siemens recently moved away from US accounting and consequently was de-listed from NYSE and picked up on the OTC markets, so I ended up buying one, anyways.  I don’t think it will trade that much differently than on NYSE but this is something to watch.

I have a lot of friends in the markets and ask them about stocks or types of areas that they find interesting.  Sometimes they laugh at me and tell me everything is overvalued but I usually can get some good ideas.

Barrons and some of the online sources also have interesting information, although I would never just buy something based on a single article.  No one should just buy based on something that they’ve seen on the Internet or based on a “tip”.

The standard boiler-plate warning is to “read the financials”.  This is true, although slogging through 10-k and annual reports with footnotes can be mind numbing.  They have to make so many disclosures of potential risks and there are reams of footnotes and much of this doesn’t directly impact the stock price.  On the other hand, I will look at their power point presentations available that the company makes to investors on quarterly calls or conferences where the company actually tries to explain “in english” what their strategies are and why their company is strong (which indirectly goes to valuation).  I also will look at various analyst reports on stocks, although once again this is more about sentiment in the market than any particular insight since those reports are often notoriously un-correlated with investor success.

In the end I thing through all this information, pick a bunch of stocks to watch for a while, and then cull this down to my list.  Sometimes I even re-recommend stocks’ I’ve previously had on the list, since many of the beneficiaries don’t pick them (if there are 8 stocks on the list often they only take 2).


Valuation is difficult right now with the markets hitting new highs.  For an individual, I wouldn’t recommend putting all of your money into stocks (especially individual stocks) like I do in this portfolio.  However, this money is different than a standard “nest egg” in that it is an investing vehicle for kids where they put in some money with additional money added that is designed to teach them about saving, investing, and the stock market.  It is “real” money and they either win or lose depending on what happens in the market, just like real life.  These lessons are sound and something that they will take with them through their whole life going forward.

While the portfolios have benefitted from rising values, they will now be putting money to work on new stocks with high valuations.  This cannot be avoided.  We will do our best to consider valuation with our new investments, and put in “stop loss” orders on stocks that are getting either too frothy or when we don’t necessarily want to ride all the way down if we’ve had big gains.  With this model, however, we do eventually put all the money back to work on new stocks, so overall valuation is always an issue.  This is a real-life investing lesson for all.

Timing of the List and Selections.

I will get these items selected in the next couple of weeks and start working with everyone on investing.  The kids need to get me a check and the money gets deposited and then they need to make the selection.  Everyone comes to the selection in different ways and it can be tough for them to make a decision about real money with real consequences.  But this is real life and decisions need to be made, which is a lesson in and of itself.  I want to get this done before they start going back to school by the middle or end of August.

The other thing that I have to do before then is update all the portfolios with the latest prices and valuations and dividends, as well as buys’ and sells’.  This also takes me a while because I comb through the statements and do it by hand as well as in excel.  Maybe someday I will farm out this process or create a system but for now I am doing it manually.  Maybe this is a 2015 project.  At least with google finance I can see the portfolios daily without doing much work and this is a big help for monitoring moves.


Stock Selection Analysis for 2013

Here are the stocks I am considering for the 2013 selections. I will get this list down to six stocks for the beneficiaries to choose from. The best and simplest way to get updated statistics and simplified financial ratios on these stocks is to go to Yahoo! Finance at this link or and type in the ticker symbol, then hit “key statistics” on the left under company information.

I have 8 here instead of 6 because some portfolios might need more than 2 stocks because we have some other sales on companies that we’ve given up or sold previously and / or cash accrued from dividends.

US companies are very hard to pick from right now because in general there has been a run-up in the market and valuations are very high. As a result we are focusing on stocks that have not gone up a lot recently or even may have declined but have the potential to rise in value.

Foreign Companies:

SSW (Seaspan) – $21 / share, $1B market cap, 5.8% dividend yield (52 week range $14-$23) Hong Kong Exchange, $4B of debt. Seaspan charts container ships and owns a fleet mainly moving goods from China through to North America. They have a very high dividend and appear to be reasonably well run, with a newer fleet.

YNDX (Yandex) – $33 / share, $11B market cap, no dividend (52 week range $20-$34) Russian Exchange, little or no debt. Yandex runs most of the Russian internet search, advertising and email businesses. The Russian internet sector is surprisingly modern and well run and (relatively) free of government interference (so far). The price has come up recently.

INFY (Infosys) – $47 / share, $27B market cap, 2% dividend yield (52 week range $38-$55) Indian Exchange, no debt. Infosys is a major outsourcer and international company, who stand to benefit from the falling Indian currency since they mainly earn their revenues in dollars and Euros but pay out the majority of their costs in local Indian currency to staff. More information – Here is a summary of their business from their corporate web site.

IBA (Industrias Bachoco) – $40 / share, $2B market cap, 1.4% dividend yield (52 week range $21-$43) Mexican Exchange, $180M debt. Mexican poultry processor, one of the largest chicken companies in the world.

US Companies:

CLF (Cliffs Natural Resources) – $22 / share, $3B market cap, 2.6% dividend yield (52 week range $15-$46), $3B debt. Cliffs is an iron ore and coal mining company with operations in the US, Canada and Australia. The company has been hit hard with the recent decrease in steel production and this has been incorporated into the stock price and it is a good entry point to get into this market. Competitors have also been hit hard and have other operating and country specific difficulties.

DVN (Devon Energy) – $58 / share, $23B market cap, 1.5% dividend yield (52 week range $50-$63), $10B debt. Devon has US and Canadian resources for drilling oil and natural gas. Their stock has come down recently but they seem disciplined as far as investments and have a focus on raising their enterprise value

GRPN (Groupon)- $10 / share, $7B market cap, no dividend (52 week range $3-$11), no debt. Groupon is an internet shopping company with discounts that rose immensely but then fell and their CEO departed. They made a big run up in 2013 already.

YHOO (Yahoo!) – $27 / share, $27B market cap, no dividend (52 week range $14-$29), no debt. Yahoo! is one of the most trafficked web sites in the world and owns significant stakes in valuable overseas web companies in Asia. I am optimistic about their new CEO Meyer from Google. Their stock has had a big run up but still seems to be a solid company for the long term if aggressively managed.

PM (Philip Morris International) $85 / share, $138B market cap, 4% dividend yield (52 week range $82-$96), $25B debt. PMI sells cigarettes world-wide (non US). There are less headwinds selling cigarettes world wide then there are in the USA.

Buy And Hold Works… Sometimes

For these trust funds we work to link stock selections with long-term thinking. These portfolios start when the beneficiary is 11 or so years old so they have a long time horizon.

With that, there are times that it is wise to sell. If you believe that a stock has been part of a huge run-up and gains are not sustainable, you should sell. We sold a number of stocks in 2007 when valuations were insanely high (such as China Mobile (CHL), which peaked near $100 in 2007-8 and now is settled back in around $50 / share) and many of them have not recovered back to those levels. Unfortunately, we re-invested the proceeds into new stocks which promptly went down with the rest of the market but it still was the right thing to do.

On the other hand, some stocks seem to get permanently impaired or on a downward spiral from which they never recovered. We bought Nokia (NOK) and then sold at a loss – and the stock has kept dropping since, damaged by their dismal position in the smart phone market. We also did the same with Cemex (CX) which also had a high near $40 in the 2007-8 time frame but has settled to around $10 / share.

It is hard to know when to capitulate, and when to hold on to wait for the rebound. Urban Outfitters (URBN) was selected because it had low debt and seemed well run – until they had a bad earnings report and the stock tanked. We held onto it for over a year after it had lost about a third of its value, and then a lot of their top management resigned. Yet recently it came back and is now above its original purchase price. Other stocks that we waited on until they came back include Comcast (CMSCA) and Ebay (EBAY). On the other hand, we are still waiting for recovery on Canon (CAJ), Riverbed (RVBD), WYNN, Exelon (EXC), and Alcoa (AA). I am bullish EXC in the long term as well as RVBD; I think there is hope for CAJ because they are well run; and watching WYNN and AA.

Difficult (short-term) Time for Stocks

The markets have been selling off lately. Since these portfolios are a mix of US and non-US companies there aren’t “simple” indexes that I can use to compare them. But in general, the US markets which by various measures had been up in the 10-20% range are mostly back down to where they were in the beginning of the year and European and Asian markets are about the same or mostly worse.

These portfolios are meant to be long equity-only vehicles for young individuals with a very long time horizon in front of them (50+ years). They are “part” of a total portfolio and meant for a specific purpose; no one should just put all their wealth into a long-only stock fund.

Thus based on these elements I am loathe to do specific buys and sells based on total market conditions, because you are often selling off one stock for another stock with similar characteristics. Our markets today have very high “correlation”, meaning that almost all of the stocks tend to go up or down on a single day, especially when big market events occur. Correlation has been increasing over the years, meaning that even if you have a diversified fund (a rule of thumb is that you have 10 or more instruments that aren’t similar to one another) that doesn’t necessarily “save” you if they all move together.

The nature of the stock markets have been changing in the eleven years since I started this effort with Portfolio One, right around 9/11. There are many trends, but here are the key ones in my opinion:

  • Rise in international markets – international markets have always been important, even to US-centric investors, but today they are even more critical.  A stock market is fundamentally about “growth”, and most of the real growth is occurring off US shores.  Thus to not invest internationally, even with all their structural differences from the US market and other risks, is to miss out on the future
  • Reduction in IPO’s – the number of companies listed on exchanges has fallen as the number of IPO’s hasn’t kept pace with companies being acquired either by other companies or “going private”.  Also the IPO’s are later (see FB) meaning that a lot of the “upside” is gone when they launch, or there often is no upside at all if they are being sold out of a private equity fund (they already captured that)
  • Focus on Dividends – some of the dividend focus is due to favorable tax treatment (the limits on double taxation of dividends) and their 15% rate rather than as ordinary income and some is due to the gradual dawning on more investors that a substantial part of the total return is due to dividends and not just share price appreciation (unrealized)
  • Increased government intervention – in order to understand markets today you need to anticipate government moves to a greater degree than in the past.  Our large banks might never have survived the 2008 crisis without government intervention, and today they exist.  Will the government let them survive the next crisis, or will equity holders be wiped out like their were for Fannie Mae and Freddie Mac or Lehman?  Now you need to anticipate government reaction
  • Increasing Currency gyrations – for many years we had currency stability but we may be entering an era of less stability, especially in the key currencies the dollar, Euro, pound, yuan, etc…  This has many effects on competitiveness and immediate valuations
  • Low interest rates – a low interest rate policy has many effects on the market.  It depresses interest earnings (which impacts some equities) but also makes equities more attractive relative to debt instruments, especially when the chance of default rises.
  • The rise of Chinese stocks – while the US market went (mostly) moribund a whole host of Chinese companies came onto US exchanges or were accessible to US investors.  A lot of the “froth” and potential “boiler room” activities went into those stocks instead of US stocks

Here at Trust Funds for Kids we try to look at the long time horizon and make decisions accordingly.  This doesn’t mean that short term gyrations aren’t painful, as well.

Investing and Politicians

Traditional stock picking focused on various fundamentals:

– the “value” of the stock taking into account the discounted cash flows of future profits
– what the assets of the company was worth after liabilities were removed
– how the technical characteristics of the market as a whole impacted the stock price

In addition “macro” items such as interest rates and inflation, too, impact the market as a whole.

While politics has always been part of the equation, today the market seems to be moving more than ever based on what the politicians are saying they’ll do. A recent WSJ article titled ‘CEO’s Message – Fix Europe, Or Else” had this great quote from an the CEO of Kingfisher, a UK company:

The outcome is very binary. It’s up to politicians

In order to invest in this sort of climate you need to be kind of like a “Kremlinologist”, or an analyst that used to attempt to decrypt what was going on inside the USSR’s communist party leadership, based on arcane clues and utterances.

Unfortunately guessing on what politicians will say or do is a new dimension of investing, and if it is moving markets, we all need to either get better at predicting their next reaction (since they rarely seem to plan ahead and mostly react when events are far gone) or stay out of the market.

All active investors are effectively “Kremlinologists” now.

Faith vs. Experience and the Young

A recent Wall Street Journal titled “The Young and the Riskless” details how “twentysomethings” are not investing in stocks, but instead are putting their savings into less risky investments.  The tag line on the article is:

Twentysomethings are seeking safety from market volatility at precisely the wrong moment in their investing lives.  Here’s how to get back on track.

From the outset I was struck by the author’s presumptuous and scolding tone. I also like their strategic use of the word “volatility” instead of the more appropriate term of “losses” when describing market events over the twentysomething’s financially sentient lifetime, which would be something like the last 10-15 years.

Per the charts in the article

The percentage of young investors who say they’re willing to take above-average or substantial risk has declined from 52% in 1998 to 31% in 2011. 52% of investors in their 20’s who say they will “never feel comfortable in the stock market”. 33% of 20-somethings’ non-401(k) portfolios held in cash, versus 27% for all investors.

It is important to understand how “faith” in the market is typically defined in the popular financial press. Faith usually means putting your money in an index fund (or ETF), with low fees, continuing to do so regardless of market conditions, and relying on the belief that “in the long run” it will all turn out alright and you will be able to retire rich. The “financial calculators” have an assumed rate of return that you receive on your money, similar to the same calculators that public pension funds use, and they are typically “set” between 6% and 10%. Due to the “miracle of compounding returns” you can amass large sums of money in the future.

The problem with this mantra is that NO ONE has been winning with this strategy for a LONG time. What you see, instead, is that money put into the market is often battered immediately by volatility and is worth a fraction of what you put in only months prior. If you change jobs regularly (once every 2-3 years, as younger people often do) and are an avid 401(k) saver (which is recommended), many times when you pull out your money it will be valued far less than what you put in, or about even when the company match is taken into effect (depending on vesting). This can be demoralizing. I know that when I left companies in the late nineties and after the dot-com collapse I started putting more of my money into cash-like investment selections (despite warnings from my employers’ 401(k) educational materials) just because I hated moving balances worth a fraction of what I held back out of my pay when I left to start with a new company.

Also, in order to win “in the long run”, you have to stay with it in the short run. This means that when stocks plummet, you need to stay in the market and keep investing. If you decide to cut your losses and run, or stop putting new money in during market troughs, you don’t get the same benefits when the stocks rise later. This post I wrote basically said that no matter what you did in 2007, it turned out to be a loser, but if you bought during the trough in 2008 (or held throughout) you saw big gains later as the market turned back around (to where it was before). BUT if you didn’t stick with the markets, you didn’t benefit from these gains and ended up as a net loser. It is VERY HARD mentally to keep investing when markets are going down, but if you don’t buy low there is no way you can even conceptually win in the “long run”. If you bail, for sure you are going to fail, assuming you are following the mantra (which is what the WSJ article’s author was lamenting).

Kids see their parents’ struggles. Their parents have been believers in the markets, since the bear markets of the 70’s were replaced by the bull markets of the 80’s and 90’s. If you retired in the 90’s, after years of investing in the doldrums, you not only benefited from high interest rates which appeared to “goose” the compounding effect, but you also essentially did some great “market timing”, buying low and selling high. But the parents of today’s twentysomethings didn’t retire in the early 90’s, they kept working, and watched their investments suffer along. Now the parents’ are in a bind.

Not only did the markets get hit, but there isn’t really an underlying foundation of belief in WHY the market should do so great “in the long term”. In the past you could look at the track record of the US and show how we weathered recessions, panics and depressions, wars whether declared or un-declared, and always came out ahead. But today everything seems to be static or declining; our unemployment rate is high, we have high “real” inflation from commodity price increases (oil, food), and the cost of services like a college education or health care (if you can get insurance at all) is very difficult to bear. In order for the market to rise, the country needs to be productive, well run, and growing – does this seem to be today’s perception of American performance? This lack of an underlying narrative in why markets should rise of the long term (other than it has happened in the past), combined with the miserable ACTUAL performance during the last decade and a half, is killing confidence in the “long run” hypothesis that markets go up.

Another element of caution is that not only did stocks crater (or stay flat), but everything else fell apart too, in defiance of what the typical financial media said would occur. Housing became a miserable investment, rather than the guaranteed path to wealth that was painted in the press. Can’t you remember people saying that renting was “throwing your money away”? I remember having many, many people look at me in a dumbfounded fashion when I told them that I rented for over a decade when I could have easily bought. This thinking has obviously changed radically, despite record low interest rates (high rates would have made the housing problems unimaginably worse, at least in the short and medium term).

If kids travel, they can see how the “US Peso” doesn’t go far overseas. The dollars is worth a fraction of what it used to buy vs. the Euro, the Canadian dollar, the Australian dollar, or the Japanese Yen. The devaluation of the US dollar is another signal of our relative decline, along with our equity markets and housing markets.

The popular press’ scolding is going to fall on deaf ears until young adults see something out of their own experience that would convince them that stock investing is a winning strategy. The lack of anything except (comparatively) ancient charts of a world before the cell phone and the internet won’t sway them.

It really comes down to faith vs. experience. And among the young, experience is winning.

Generation X Addendum

This wasn’t mentioned in the article but a parallel trend I personally have noticed is that people of my generation (Gen X) are taking charge of their finances in their own way. Those with means tend to personally select stocks and get involved directly in their investing rather than “passively” investing through indexes (although ETF’s are part of their portfolio). While I am in the finance industry, many of my friends and acquaintances are not, but they have grown tired of bad and counter-intuitive advice and are taking matters into their own hands, in a variety of ways. Their particular strategies aren’t important – what is important is that they don’t believe the common wisdom and are taking responsibility for their own investment outcomes. In my opinion this is another manifestation of what the twentysomethings are doing, except by people with more assets to invest in the first place.

Cross posted at Chicago Boyz

The Long Run

The portfolios that we run on this site coincide with a market that effectively is a “do nothing” market.  We are basically flat over the last 13 years, meaning that there hasn’t been growth in the indexes since 1998.

The money that an index investor would have earned (i.e. if you put $100,000 in the SPY ETF or a mutual fund such as Vanguard’s VFINX) would have come through dividends, which averaged about 2% / year during the period.  Thus every year you received $2,000 in dividends (taxable each year) which means over the 13 year period you made roughly $30,000 (adding in compounding of interest) before taxes or maybe $24,000 after taxes depending on your bracket (and whether or not the 15% dividend received deduction applied during the period).

This is reflected in our results; while valuations fluctuate about 1/2 the total return of portfolio one, our longest lasting portfolio at over 10 years, is due to dividends.  When we look to select stocks a strong (and sustainable) dividend yield is an important, although not the only factor we look for in the “list of six stocks” that we pick from each year.

In the October 24, 2011 issue of Barron’s there is an article titled “It’s Cheaper the Second Time Around” that discusses the fact that indexes have been flat for the last 13 years.

The fact that we are struggling daily to hold above a level first reached nearly 13 years ago is both sobering and, viewed in the proper light, profoundly encouraging for true long-term investors… we are finally returning to a time of ‘stocks for the long run’… anyone who believes in mean-reversion investing has to consider the current starting point for equities at least somewhat attractive…

Jim Paulsen of Wells Capital was kind enough to calculate the 10-year forward return from all points in historry when the market was flat or down over the priod 12 yars.  The result: a 7.2% annual gain, versus 4.7% for all other times, not including dividends.

It is good that this analysis disclaimed the impact of dividends and yet noted that they are important, although if the yield is relatively consistent over time (which isn’t true, since yields go down when stocks go up, and vice versa) the analysis should hold true.

This type of investing approach is also a version of “market timing” – you should buy when items are cheap, and sell when they are expensive.  The most obvious example of this is housing; if you bought in 2007-8 you probably are regretting it right now – that same house probably would cost you a lot less to buy in 2011 then it did back then, for the same exact house.  It isn’t obvious HOW to do market timing, but the effects are real for anyone struggling to pay on an underwater mortgage today.

Like every good investment analogy, there is a counterpoint – Japan.  Japan peaked long ago, in 1989, and still hasn’t recovered to the highs.  In order to be a long-run investor in Japan you apparently have to be very patient, indeed.  Of course at some point investors are entering the market and they don’t care about recovering 1989 highs anyways.

For our portfolios here at the site flat returns mean a few things:

1) we don’t feel so bad at our struggles to raise values since the market has been poised against us

2) we have been right to focus on dividends, since they have been the only reliable source of cash over the period (relative to stock values)

3) while the analysis is more complex many of the overseas indexes weren’t flat over the same time frame; we have been putting up almost 1/2 our picks from overseas companies (US based ADR’s to keep it simple) in that same time frame

4) there is some hope that our patience will be rewarded if values increase in the next decade


At various times they call markets a “stock pickers market” meaning that if you could pick a decent stock out you would make money by going against the herd. At other times the whole market just moves in unison, meaning that whatever you pick (as long as the industry isn’t going down the drain) it doesn’t matter that much.

Yesterday this was the status of the 15 stocks in portfolio one. EVERY ONE of the stocks went down, and they represent a reasonably broad spectrum of industries and countries (US and overseas). On a grand scheme this happened when the market cratered in 2007-8; everything went down the drain but if you bought low at the nadir and held on the way up you basically doubled your money.

Co-variance is definitely on the rise, and US and foreign markets are generally moving together. There are always exceptions but when you see every stock moving in unison that is pretty much the definition of co-variance.

Do Your Own Research

If we had a motto here at “Trust funds for kids” I am sure that part of it would be “Do your own research” and another element would be “Don’t believe the so-called experts”. This was put on amazing display recently in a Bloomberg article (really, if you just look to one place for financial information and analysis, it probably should be Bloomberg) titled “Equity Analysts Prove Hazardous to Returns As Contrarian Stocks Rise 165%“. From the article:

Following the advice of equity analysts may be perilous for your profits. Companies in the Standard & Poor’s 500 Index that analysts loved the most rose 73 percent on average since the benchmark for U.S. equity started to recover in March 2009, while those with the fewest “buy” recommendations gained 165 percent, according to data compiled by Bloomberg.

The equity analysts are “professionals” that rate a stocks’ prospects using a variety of mechanisms, including modeling their financial results into the future to determine if the stock is over or under valued. In the past the analysts had blatant conflicts of interests (i.e. they would recommend that customers purchase a stock in print while they were privately telling other customers via email that it was a piece of sh*t or while selling their own or company’s stake) but this has mostly been fixed; now they are just terrible in their collective recommendations.

Analysts use a scale from “sell” to “hold” to “buy”. If the analysts are generally bullish on a stock and most of them recommend purchasing that stock to investors than this stock is favored. Analysts usually review and recommend stocks that are already moving up.

In a recent post I described the massive run-up in equity values in the US market from the nadir in 2009; if the analysts were going to prove their mettle an excellent time would have been to provide advice when markets were at their (in hindsight) low point.

Instead, from that critical moment, the Bloomberg article proves that the analysts were almost completely WRONG from that point forward. If you BOUGHT the stocks the analysts told you to SELL, then you did well, and if you followed their recommendations and loaded up on those stocks you actually did WORSE than the benchmark.

Remember this as you pay for advice or read through the detailed analyst reports. From the nadir, when the analysts’ advice would have been most valuable, they have been virtually, completely, wrong. It is as if someone predicted the Buffalo Bills to win the Super Bowl at the start of the 2010 season; they could not have been wrong-er.

Lack of New IPO’s and Impact on Performance

If you read typical finance articles out in popular media you commonly see facts and figures about how US stocks outperform other investment classes over “the long term”.  As I do my own research I tend to see threads leading back to the premise that US stocks are entering a new environment going forward and past results are going to be less and less relevant in predicting future performance.  One of the reasons for this is the fact that the United States has ceased to be a dominant player in launching new public companies, and in fact is now mostly an also-ran when compared to Chinese markets or even Brazil as of late.

The Agricultural Bank of China is about to come out as an Initial Public Offering next week that will be one of the largest IPO’s of all time.  Per this article:

Hong Kong and China have dominated the global IPO market. That dominance will only increase when Agricultural Bank of China starts publicly trading next week.  In 2009, Hong Kong was the world’s largest IPO market, with companies raising a combined $32 billion in capital, according to Dealogic, a data-tracking firm. This year, China is on track to assume the mantle, with $31.7 billion raised by early July.

The Wall Street Journal had a recent article titled “How to Fix the IPO Market” by Jason Zweig.  I didn’t agree with their analysis or recommendations but the article did have a lot of useful facts and figures that illuminate the changes in the public markets in the United States, such as the following:

Ten years ago, around 9,100 companies filed annual proxy statements with the Securities and Exchange Commission. Last year, roughly 6,450 did; so far in 2010, only about 4,100 have, estimates Wharton Research Data Services.  In two-thirds of the years from 1960 through 1996, the number of initial public offerings exceeded the number of stocks that dropped out. Since then, however, there have been more deaths than births among stocks every year: 7,725 stocks have disappeared over that period, while just 4,299 new ones have arisen to replace them, according to Wharton.

What is happening is that existing companies are swallowing up smaller companies and other ones went bust during the market tumult.  New companies, however, haven’t joined them.  Recently there was a bit of a hoopla about a recent IPO for Tesla Motors, which raised $266M.  However, prospects for the car maker are cloudy and the stock has declined below its offering price since then.  If Tesla, a loss making niche enterprise is the future of our growth companies, we are in trouble.

The reason that this matters is that the entire “stocks outperform over the long run” is based on data from a few markets that haven’t suffered major disruptions (war, occupation) which pretty much brings you down to US and UK market data, mostly US data.  And this data was based on a continuous growth in companies launched through IPO’s with a growing market for companies; today the market for US based companies is small and much of the new and larger IPO’s are happening overseas.

There is nothing wrong with overseas markets growing; it is just that the US markets seemed to have stopped, and investor money (both US and foreign based) is going where the IPO’s are.  While we do not see the “full” effect of this trend, because many large multinationals are still US based and doing well, we will see it in the future as the newer companies don’t fill in the gaps and come through the ranks at some point in the future.

This doesn’t mean that I am saying that US markets will go up or go down as a result of this; I am just saying that the long term data was based on a premise that new companies would grow to replace the old (“creative destruction”) but in fact the new companies aren’t coming up in the footsteps. Perhaps stocks are best in the “long run” in aggregate across all markets but it may not be US based stocks if we just have aging companies and the young, growth companies are nurtured elsewhere.

Cross Posted at Chicago Boyz and LITGM

Along For The Ride

As retail investors, we are pretty much along for the ride as far as the stock market goes.  That purchase you make today of 500 shares of xyz company doens’t do squat to move the big numbers.  The institutional and commercial accounts who are moving millions of shares daily are the ones moving the needle.

At The Big Picture, Bill King puts up an interesting column today about how the end of this month might be “gamed” and could be good for a short term pickup in stocks.

Between now and the end of June, traders, wise guys and PMs will try to manipulate stocks higher to game Q2 performance – especially with May being the worst month for stocks in decades.

This week is option and futures expiration. Normally there is a triple-digit DJIA rally for expiration week; and Bernanke pours liquidity into the system for expiration week.

If stocks would have declined last week, this week would have been a layup for a rally – as long as no new negative news surfaced. Ergo, the expiration rally this week might be more tepid than usual.

Another bullish factor for some stocks is the June 25 Russell rebalancing. So, barring ugly news or developments, the bias for the next few weeks should be to the upside for stocks.

Interesting stuff.  I recommend you read the whole thing.  Always remember that for investors on our level, we are along for the ride.

Almost Time For Stock Picking Season

As a brief overview again of how my trust funds work:

  1. I set up individual trust funds for my nieces and nephews when they are around 11-12
  2. Every year I contribute $500 / each, they contribute $500 each, and then I match $500 more, for a total of $1500 / year
  3. I select 6 stocks a year and each niece or nephew selects 2 of them from that list (for about $750 / each)
  4. We make the stock purchase around September of each year; this gives them the summertime to earn enough money doing work or odd jobs to get the $500 for the additional match
  5. I watch the funds and if certain events occur and I think it is time to buy or sell a particular stock I will let them know and we can discuss and then I execute the trade.  When this money is reinvested then sometimes we purchase more than 2 stocks at a time or we increase the purchase amount of each above $750

From a portfolio perspective, once you get to 10 or so stocks (assuming that they aren’t in the same industry) you have a reasonably diversified portfolio.  Portfolio One (the longest term portfolio, at about 9 years) is at that state; the other portfolios may swing significantly in value based upon the performance of a single stock.

So it is now time for me to begin researching the stocks that I want to consider for my list of 6 stocks.  Dan, our newest contributor here, asked in semi-jest if I just threw a dart at the dartboard.  We are a little bit more sophisticated than that, although we realize that selecting individual stocks is a difficult business and not recommended fora large portion of your total portfolio.

Here is a mix of the principles that I use and what I look for in a stock:

  1. Value not Momentum – given that these are long term investments and I don’t want to terrify the kids with wide, gyrating swings I tend to look more at value type stocks and not chase faddish or momentum stocks
  2. Stocks I understand – I don’t expect them to fully understand everything (or I’d be forced to just let them pick from consumer products, which is a bad plan) but I want a stock that I understand.  Sometimes when I understand an industry (like the financial industry) it is strongly tied to me NOT recommending stocks from that industry.  I do try to explain every stock to them, what it does, and why it is on the list, because I want them to inspire to investing in this manner as they gain more experience over the years
  3. Seek international diversification – through ADR’s there are a large number of individual foreign stocks that can be purchased and I try to have half or so (all else being equal) of the stocks on the list as non US stocks
  4. Try to have a mix of large and smaller market cap stocks – there is nothing on the list that is typically less than $1B or so in market value but I want to have a mix of large and small stocks, especially since smaller stocks generally have more room to “run” than a behemoth
  5. Dividends are preferred – I don’t want a stock whose entire value is dependent upon a dividend stream but I think that paying some sort of reasonably large, regular dividend is associated with better management and dividends do make up a significant percentage of the return in the long term.  On the other hand, high dividend paying stocks are likely to be hit hard should the tax laws on dividends be significantly impacted

Since Dan has joined and he is a pretty sophisticated guy (and I have some other friends whom ultimately I will try to twist their arms to join, too) I will put up some of the stock ideas I have in an earlier, less-final manner and see what I get in terms of comments and suggested alternatives.

I generally keep up to date on companies through the Wall Street Journal, Barrons (although I don’t subscribe to the paper version anymore because it got expensive), Investors’ Business Daily (which I periodically pick up, although their stock selections are usually too small and fast-moving for my purposes), Financial Times, and then the large general business magazines like Forbes, Fortune and Business Week.