Indicators for Assessing the Market’s Risks and Rewards

Posted on January 29, 2015 | Investor Update

Though I don’t put much weight on forecasts and I invest for the long term, I do keep an eye on how attractive or risky the market appears to be. Partially, I do this because I work in the investment industry and am periodically asked what I think about the market. But I also do this because I think an awareness of the current market conditions can help with portfolio decisions.

None of this is about market timing. Market timing involves buying and selling securities based on what you think will happen. While I have spoken to some investors who say they avoided the last bear market, far more have told me that they have missed out on part or most of the current bull market out of fear about what they thought might happen. I don’t think investors, individual or institutional, should use market timing strategies, and the reason is simple: The future typically unfolds in ways we do not expect it to.

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Oil Shows the Folly of Forecasts

Posted on January 22, 2015 | Investor Update

Whenever Mr. Market wants to change something, he can turn the dials pretty swiftly and cause prices to move significantly. The speed and the magnitude of the changes are often greater than many investors realize while the price adjustments are occurring.

Oil provides a good example. At the end of last June, oil traded at $105.37 per barrel. Over the next three months, the price declined to $91.16. Then, in the fourth quarter, oil plunged by more than 41% to $53.27 on December 31, 2014. Oil has continued to fall this month, trading at $46.50 per barrel today. Put another way, oil has fallen by 56% since the end of June and 49% during the 16-week span starting at the end of September.

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The Tools I Use for Managing My Finances

Posted on January 15, 2015 | Investor Update

A change in TurboTax regarding Schedule D: Capital Gains and Losses gave me the inspiration for this week’s commentary. Since I’m switching tax software programs, you might appreciate me expanding the conversation from merely TurboTax to discussing the tools I use to manage my finances. None of what I am going to say should be construed as either being the best way or the only way to do it, but rather as just a method that works for me and food for thought about how you approach your personal process.

But, first a few words about TurboTax, since many of you likely use it. I’ve used TurboTax for possibly close to 20 years, and Quicken even longer. For as long as I can recall, Schedule D was included in the Deluxe version of TurboTax’s desktop software. Not anymore. Now taxpayers have to buy the more expensive Premium version. “This will be a surprise” is how a spokesman for Intuit described the change to Matt Krantz at USA Today.

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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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