A Fourth Good Year for Stocks?

Posted on January 8, 2015 | Investor Update

It’s been a very good three-year stretch for large-cap stocks. The annual total returns for the S&P 500 index during the 2012-2014 period have been 16.8%, 32.4% and 13.7%. In contrast, the Ibbotson SBBI Classic Yearbook lists the long-term annualized total return for large-cap stocks as being 10.1%.

Not everyone saw those good returns last year. Domestic small-cap stocks lagged and international markets had their own problems. Preliminary data suggests many active managers struggled to keep up. But the headlines focus on large-cap stocks, and last year was the third consecutive good year for the Dow Jones industrial average and the S&P 500.

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14 Investing Resolutions for the New Year

Posted on January 1, 2015 | Investor Update

Do yourself a favor. Find one of the articles discussing how many record highs the S&P 500 set in 2014 (53 as I write this on December 29) and save it. Whenever the next bear market strikes—and it will at some unknown point in time—reread the article to reminder yourself of the upside momentum the market can experience. The record highs are Mr. Market’s way of rewarding those who put up with his temper tantrums.

Last year (2014) was a good year to be in large-cap stocks, with the exception of oil stocks. (We’re just now one slightly better-than-average year away from Dow 20,000!) It was a tough year for small-cap strategies. Early indications suggest that active managers struggled as well.

It was also a good year for those who stuck with higher-quality intermediate and long-term bonds. Yields on the benchmark 10-year Treasury note are ending 2014 approximately 80 basis points below where they started.

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The Implications of Real Estate Becoming a Sector

Posted on December 11, 2014 | Investor Update

There is a change coming in industry classifications: S&P Dow Jones Indices and MSCI are moving real estate out of the financial sector and into its own sector. The change could have a wide-reaching effect. Among those potentially affected by the reclassification are many funds, portfolio allocation models and sector-rotation strategies.

A bit of background will explain why this change is noteworthy. S&P Dow Jones Indices and MSCI oversee the Global Industry Classification Standard, which is more commonly referred to as the GICS (pronounced “gicks”). It currently comprises 10 sectors, 24 industry groups, 67 industries and 156 sub-industries (excluding the forthcoming creation of the new real estate sector as well as the creation of a copper sub-industry). The GICS determines what sector or industry a particular publicly traded company is considered a part of. It underlies various funds, portfolio allocation models and likely sector-rotation strategies. It also used in various screening tools and trading systems.

It’s not the only industry classification system out there. FTSE (the “ICB”), Morningstar and Thomson Reuters, for instance, have their own proprietary classification systems. (We use Thomson Reuters’ classifications in our Stock Investor Pro database and screening program.) There are other organizations with their own classification systems. Though there is some overlap, there are enough differences between them to make apples-to-apples comparisons of results based on the various classification systems difficult.

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Look at the Relative Valuations Before Buying Energy Stocks

Posted on December 4, 2014 | Investor Update

Oil prices have dropped by about 40% over the past six months. Not surprisingly, the decline has led to weakness in oil-related stocks. This weakness intensified last week when shares of many energy companies were assigned Black Friday discounts.

Following the big drop, there have been some calls for investors to start buying these stocks. These calls are based on the assumption that oil prices will rebound in the months to come. Having started my finance career in Houston analyzing energy-related companies, I fully realize the potential profits that can be made from taking a contrarian stance. Being greedy when others are fearful does work in the energy sector. (It also works well in all other sectors too). The challenge is knowing when a discount is a true bargain. A very big secondary challenge is ensuring the longer-term reward is large enough to justify the short-term opportunity cost of a continued drop in the stock price and/or a period of underperformance.

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Debunking 10 Momentum Investing Myths

Posted on November 20, 2014 | Investor Update

Momentum strategies seek out stocks that have done well in the past (winners), though they can also short stocks with past poor returns (losers). The idea is to take advantage of the return premium from favoring winners over losers. Such strategies have their share of critics, however. Among the criticisms are that momentum is not exploitable by the average investor and that such strategies are more volatile.

Clifford Asness, Andrea Frazzini and Ronen Israel of AQR Capital Management and Tobias Moskowitz of the University of Chicago pushed back. In a paper published in the 40th anniversary issue of the Journal of Portfolio Management, they debunk the 10 “myths” they say exist about momentum. I’ll give a summary of their arguments here. For those who want to see the full paper and do not have access to the magazine, a version is available on the SSRN website.

Myth #1. Momentum Returns Are Too Small and Sporadic: Over long periods, momentum has performed better than small company size and value. During the period of 1927 through 2013, the return difference between small stocks and large stocks has averaged 2.9% annually, cheap versus expensive stocks has averaged 4.7% annually and the recent winners over recent losers has averaged 8.3%.

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A New Argument Against Long-Term Care Insurance

Posted on November 13, 2014 | Investor Update


“Most single individuals should not buy [long-term care] insurance given the availability of Medicaid.”

This is what the Center for Retirement Research at Boston College (CRR) wrote in a new research brief. A study from the organization looked not only the chances of needing nursing home care after age 65, but also the average duration of that care. The CRR found that previous research understated the probability of ever needing care, while also overstating the average duration of nursing home care.

The response from the long-term care industry was swift and blunt. A Bloomberg article published this morning quoted the executive director of the American Association for Long-Term Care Insurance as calling the new study “irrelevant.” His reasoning, according to Bloomberg, was that most people take long-term care policies because “they want to remain in their own home.”

I’d counter-argue that the CCR’s brief gives interesting insight and its findings should be taken into consideration. Long-term care insurance helps cover the costs of assistance with daily living activities, but premiums have been rising and policies need to be chosen very wisely. Lifestyle and genetics play a role in what type of coverage you may need. An Alzheimer’s disease diagnosis, or another debilitating ailment, could result in a lengthy period of needed assistance. If this occurs, your assets could be drained, leaving you with nothing to pass onto your family. On the other hand, long-term care insurance is use it or lose it; if you aren’t able to utilize the policy’s benefits, you will be out the money you paid for the coverage.

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Are Simpler Stock Strategies Better?

Posted on November 6, 2014 | Investor Update


A member recently asked me if a screening strategy with fewer criteria performs better than one with many criteria. As irony would have it, a few days later after I was asked this question, Wesley Gray and his colleagues at Alpha Architect published a paper on SSRN comparing several of the value-oriented AAII Stock Screens to a simple valuation model. The study’s results are not an apples-to-apples comparison to the way we track the performance of the screens (I’ll discuss the differences momentarily), but it did find that only our Piotroski High-F Score screen fared as well as a screen that simply seeks non-financial stocks with low ratios of EBITDA (earnings before interest, taxes, depreciation and amortization) to TEV (total enterprise value).

Valuation is among the biggest drivers of stock returns. A strategy solely focused on low valuations will have good returns if it identifies enough stocks.

The challenge with any strategy is making it investable. It is quite common for an analysis of indicators to divide the results into deciles, or 10 evenly split groups ranked from lowest to highest. Even if the universe of stocks studied for the analysis is narrowed in some fashion, each decile may still contain far more stocks than the average individual investor is willing to hold or can cost-effectively hold. (In Gray’s study, the EBITDA/TEV screen identified an average of 96 stocks.) There is also a behavioral aspect to consider: How willing are you to hold stocks that are otherwise unattractive?

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I Rebalanced My Portfolio

Posted on October 30, 2014 | Investor Update


I rebalanced my portfolio, or more specifically my 403(b) retirement savings account, this week. The change was made after I conducted my semiannual review. The changes offer some insight into how various asset classes have performed and how I personally manage my portfolio allocations.

Our 403(b) plan, which is the equivalent of a 401(k) plan, is operated through Vanguard. In it, I hold five funds: Vanguard 500 Index Fund (VFINX), Vanguard Small-Cap Value Index Fund (VISVX), Vanguard REIT Index Fund (VGSIX), Vanguard FTSE All-World ex-U.S. Small-Cap Index Fund (VFSVX) and the Vanguard Intermediate-Term Investment-Grade Fund (VFICX). The 500 index fund gives me access to what is arguably the most frequently used benchmark. The domestic small-cap value fund takes advantage of two factors shown to lead to higher returns: value and small company size. The FTSE small-cap fund gives me diversification via international small-cap stocks. Real estate investment trusts (REITs) have had similar long-term returns as small-cap stocks, tend to offer diversification benefits over longer periods of time and are one of the few asset classes to have a higher correlation to inflation. The bond fund provides diversification, buffers the portfolio against volatility and serves as a counter-weight I can rebalance into during bull markets for stocks and out of during bear markets for stocks. (I gave a longer explanation of my allocation, as well as the corresponding Admiral Share mutual fund and exchange-traded fund (ETF) tickers, last year. Vanguard will not allow us to hold the less expensive Admiral Share class funds in our accounts regardless of how much we have saved.)

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The SEC Says “No!” to Next-Generation ETFs

Posted on October 23, 2014 | Investor Update


The exchange-traded fund (ETF) industry was dealt a setback this week. Two applications for next-generation actively managed ETFs were rejected by the Securities and Exchange Commission (SEC). Both applications (one of which iShares owner BlackRock was involved with) were for several ETFs that would have been actively managed but followed the less transparent mutual fund disclosure rules.

Had the SEC given its blessing, several new investment options in the ETF space would likely have been introduced. These ETFs would have provided direct competition to actively managed mutual funds. Presumably, such funds would have given you and me access to active management at a lower cost.

Instead, the SEC adamantly rejected the applications. The agency called the structure of the proposed ETFs “inherently flawed.” Ouch.

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The Markets Had Been Calm Until Recently

Posted on October 16, 2014 | Investor Update


If the volatility we’ve been experiencing as of late feels like a splash of cold water, it’s likely because it’s been a while since we’ve really experienced it. An extended stretch of calm waters preceded the U.S. market’s recent bout of volatility.

I’m going to share with you some updated numbers from what we crunched for last week’s AAII Dividend Investing update to put things in perspective. We use the iShares Dow Jones U.S. Index ETF (IYY) as the benchmark for both our DI and for our Stock Superstars Report portfolios. This ETF tracks the performance of the largest 1,260 U.S. stocks, giving it exposure to a combination of large-, mid- and small-cap stocks. This ETF incurred daily price changes of 1.5% or more 62 times in 2011 (29 days up by 1.5% or more and 32 days down by 2% or more.) For the entire period following 2011, meaning January 3, 2012, through yesterday, October 15, 2014, the ETF experienced a total of 39 days with a daily price change of 1.5% or more (20 down and 19 up). Again, 62 days in 2011 alone versus just 39 days for the nearly three-year period of 2012 through 2014.

Let’s look at the volatility another way. Wayne Thorp, who maintains a dashboard of market indicators for our Computerized Investing service, has been tracking the number of 1% down days for the Dow Jones U.S. ETF since 1999. Through Wednesday, he counted eight 1% down days over the last six months. This is below the median of 17 days and the average of 19 days with drops of 1% or more since 1999. (Wayne elaborates on this indicator in his Editor’s Outlook in the October Computerized Investing email newsletter that is being sent out this weekend.)

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