Sunday, September 19, 2010

Please rethink your bond purchases ... please think ...

We just saw money flow out of domestic funds for 19 straight weeks…who is selling? Those who can’t imagine an improving economy, or better investor sentiment, or new and exciting innovations. Certainly there are hardship cases forcing people to cash in stocks to pay expenses, but with prices the same that tells us someone has accepted the risk that the sellers can no longer take.

Posting here

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Sunday, September 12, 2010

Inflation begins - food inflation is the start

When does serious inflation really start? Well, if you had to pick a point, it might be at a point when many pundits believe deflation is likely, as has been widely discussed this spring and summer by professional money managers.

Two to three years ago, many investment talking heads (myself included) spoke of the potential for emerging and developed countries stock markets to diverge in, at least, the strength of their upward market trend. The idea being that the developed country markets would move sideways, while emerging markets would continue to thrive.

The credit crisis which culminated in the stock market plunge of 2008/2009 of course showed how correlated these markets could be during times of panic. However, there is nothing wrong with the general divergence thesis during normal times, with many emerging markets getting close to re-testing their 2007/2008 price levels. Divergence is or will be here, and remains as real a prospect as ever.

However, there is one place where divergence currently exists: the "anticipation" of inflation/deflation. In developed nations, the worry is that future deflation will set these rich economies on a two-decade Japanese-style slump. In developing economies, the worry is the opposite and, rather than an intellectual debate about the future, the issue is immediate and proximate: inflation, which IS (t)here. Especially food inflation.

Large developing nations, such as India, China, and Russia, have all recently reported jumps in their inflation rates, headlined by significant jumps in food inflation (see here, here, and here). This has even resulted in an overall significant jump in global food inflation too (see here). This is the result of climate change generally, which of course plays out via specific "natural events", such as drought, flooding, and "rainfall dosing" (which is a term I am using to describe the phenomenon of growing season rainfall remaining relatively the same, but is concentrated in far fewer days [but does not consist of "flooding", per se]). This is in addition to the lower yields that are produced from heat-stressed plants. Climate-change induced food issues are here, and they are here to stay for some time.

The only reason that inflation remains off the radar screen of many professional investment types is that, in the western world at least, the food budget typically consists of a very low proportion of overall income. Whereas, however, the opposite is true in the developing world (or more so, even, in the undeveloped world), food budgets constitute a much higher proportion of the total income. So, food inflation has a much greater effect in those countries and feeds into the total inflation picture very quickly. In food, the principle of substitution (the idea that, during inflationary times particularly, folks substitute cheaper but roughly similar items for more expensive ones) has only limited applicability: after all, everyone needs to eat.

Food inflation also enters the general inflation cycle very quickly too (especially farther down the income ladder a country is) because, aside from an inflationary element of its own, the inflation knock-on effect is very pernicious, as the factory worker,, marches into the boss' office, and demands a raise to deal with his deteriorating ability to feed his family. This scene plays out exactly the same way, hundreds of millions times, in hundreds of thousands of bosses offices.

The dream that (some may have that) food inflation emanating in one part of the globe won't spill over somewhere else is likely to be met by the insistent ringing of the morning's alarm clock: free trade in food. As pricing for food rises - there and here - the knock-on effect will also be felt as like looking into a mirror - here and there.

Climate change, and its resultant outputs, will have effects ranging from the evisceration of the capital value of, particularly, long-dated low-yielding stripped bonds, to the more pragmatic, of the renewed popularity of the high-yielding home garden.

So, the weather issues of this summer's northern hemisphere's growing season provide a glimpse into the future: a future which is coming fast. For those who want to understand it better, there's no better place to point your binoculars than at the emerging market countries.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Saturday, September 11, 2010

Emerging Markets - Are you sufficiently exposed?

Pounding the point home, once again.

I have written a great many times (e.g. 1, 2, 3, 4 or all, 5) since this blog started over four years ago, about the need for any forward-looking, growth-oriented investor to have a very serious weighting in emerging markets. A recent article in the Financial Post, highlighting information from Goldman Sachs Global Economics Paper No. 204, makes the point worth repeating, once again.

They point out that the emerging markets now total some 31% of the global stock market capitalization, and suggest that this will expand to 55% by 2030. Is that shocking? Hardly. According to the OECD, a global club of rich countries, emerging markets already have 49% of the global GDP, on a purchasing power parity basis; and they appear slated to continue growing rapidly. Is it a surprise to think that their stock market valuations are slated to follow their growth?

What is shocking, is that against that, Goldman Sachs estimates that developed market investment funds hold just 6% in emerging market equities, out of their total equity allocation. They believe this will rise to 18%, by 2030. In other words, if you are a typical rich country investor, a peek behind the curtain of investments that YOUR investment advisor has gotten you into, would reveal that you are sitting at just 20% the emerging market exposure you should be at, assuming you simply want to mirror the world economic powers (e.g. 6% divided by 31% = 20% exposure). By 2030, the situation gets somewhat better, but your exposure would still be wildly low, compared either to world GDP then, or emerging market stock market capitalizations.

If you wanted to simply mirror global market returns going forward, then seriously underweighting one of the two most easily visible growth investment themes going forward sure isn't the way to do it. If you wanted outsized returns, then you'd likely seek even more participation in rapidly growing economies, assuming you have decent entry points, e.g. valuations not stretched. (Are they currently too high? Not in my book. They are trading at an average PE ratio of just 12, according to the Financial Times, which compares to a PE on the S&P 500 of 14.7).

The other thing to know here, is that the emerging markets are no longer the wild west. They have solid economic principles they are managing their economies on, and populations of great savers (oh, if only the western world were so lucky now!). This makes it pretty easy to suggest that their stock market volatility is going to continue to move down, especially compared to the overleveraged and overspent rich countries.

If you are a growth investor, go wake up your investment advisor, and demand he or she explain exactly why your emerging market exposure is so darn limited.

Disclosure: Participant in the emerging markets theme via DEM, DGS.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Thursday, September 09, 2010

And this is how inflation starts ... climate related food price increases

The Russians have recently decided to continue the ban on wheat exports, until late 2011, as the Russian heat wave and associated drought have reduced this year's harvest to what is currently estimated to be about two-thirds a normal harvest (of course, once they actually harvest and weigh the harvest, I suspect they'll likely find that the actual harvest is less than that; just as happened in America following the 2009 harvest).

In a climate-changed world, this is just what will be one of many stories about inflation arising from food issues. Current estimates are for Russian inflation to increase to 7% from the current 5.5%, due primarily to a "price shock" associated with the reduced harvest. 

A very broad view of a long-term climate-change investment strategy, would be to go long on soft commodities - however, expect lots of volatility, sometimes wild volatility, as part of this equation.

Reuters story here

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Tuesday, September 07, 2010

Dividend Oriented Portfolio Poised to Outperform?

I've recently written about the relatively high dividend yields available from some of the major S&P 500 companies in comparison to the terrible yields in things like US government bonds (10 years at 2.5%) and municipal bonds.

In my opinion, the bull market in bonds is due to come sliding - possibly crashing - down, just as other inflated investments have in the recent past, eg NASDAQ, peak years 2000-2001, US housing market years 2006-2007. Tears are inevitable.

On the other hand, with the idea in mind that you can construct a reasonably safe dividend-oriented, relatively diversified stock portfolio going forward, which provides a yield well above that, AND with decent potential for dividend growth, I screened the S&P 500 for stocks yielding above 3%, in market-leading names I recognize, and with decent (more than 10%) returns on invested capital (ROIC).

Here's the list I came up with, that I think will outperform the S&P500 significantly in total return over the next two years:

The only name that doesn't strictly meet that criteria is General Electric, which has a relatively low return on invested capital, given the capital intensive nature of its business and its past actions as, effectively, a bank.

The dividends all appear reasonably safe with these companies, as they have either relatively moderate payout ratios, or have recently lifted their dividend payments.

The last thing to consider is the potential impact of climate change on these companies over the short to medium term. In my view, none of them have the potential for short-to-medium term implosion, like I detailed for Compass Minerals.

However, some have a bit of climate-change short-to-medium-term risk as I see it, as discussed below:

Altria is a cigarette manufacturer/retailer. It is possible that climate change could affect their business in two ways:

Firstly, smokers tend to be in the lower economic strata; these are the folks who will be most effected  by potential food inflation. If they are spending more for food, then less is available for things like cigarettes which, despite their addictive qualities, are still a discretionary purchase. Some smokers may choose to quit if their budgets become more squeezed, accelerating the already evident trend of sales degradation, or they may trade down to lower margin brands.

Secondly, its possible that there could be some tobacco crop failures going forward (drought or too much precipitation/at wrong time), resulting in higher input costs. This would put Altria in the unenviable position of a margin squeeze, or having to hike prices (resulting in sales loss), or consumers trading down to cheaper brands.

On balance, I would rate their short-to-medium-term climate risk issues as moderate.

Heinz is a food manufacturer who could also be affected moderately over the short-term in a manner fairly similar to Altria. While consumers are unlikely to quit Heinz's type of product (they still need to eat), they may well trade down to cheaper brands with lower margins. Secondly, crop failures could also have a similar impact as described to Altria, above.

Sysco has moderate short-term climate risk, since they are a food distributor who supplies many restaurants. If food inflation picks up, then the general consumer will spend less on restaurant meals, meaning that many of Sysco clients could reduce volumes/orders (lowered revenue for Sysco) and suffer some financial distress (meaning Sysco's accounts receivables could also balloon).

Procter and Gamble is the final one which I believe also has some short-to-medium term climate risk. If food inflation occurs, and leaves fewer dollars on the table of their customers, then their customers may very well trade down from the PG family of premium products, to more economically priced ones.

On balance, I would say that this portfolio probably has average climate-change risk on a go-forward basis.

Disclosure: No positions.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Sunday, September 05, 2010

End of the Equity Cult? Maybe - but don't buy bonds!

Citigroup says that it's the end of the equity cult ...

It has taken 10 years, and two 50% bear markets, to reverse this cult. European and Japanese equities are already trading on dividend yields above government bond yields. US equities are almost there as well. An immediate reincarnation of the equity cult seems unlikely. Global corporates, especially the mega-caps, rushed to exploit cheap financing as the equity cult inflated. They have been slow to redeem equity now that the cult has deflated. Equity oversupply remains a drag on share prices."


The investing buying public is now pouring into bonds, with tragically low yields, at a fraction of the purchase volumes for equities, a ratio signalling a top for bond prices, unless long-term deflation really is coming.

My question is ... how can deflation truly be on the long-term horizon, in the face of obvious and growing disparities between food production, and consumption? Food inflation, always and inevitably, leads to all other kinds of inflation. Long term deflation like Japan - not a chance! (Post-script addition: this food inflation will be caused by, mainly, climate change as the primary driver).

So what piling into bonds will get you, over the medium to longer term (5-10 years), is a yield unlikely to keep pace with inflation, or a price which virtually ensures that you suffer a capital loss if you sell early.

Instead, you can take a dividend yield for a great many S&P 500 stocks which are well above the 10 year US government bond rate, something that hasn't happened for a very long time.

Bonds or stocks? Well, at the yields offered, bonds are now very risky.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Monday, August 30, 2010

A cautionary tale for bubblicious portfolios

What chart is this?

I am sure that a lot of you are thinking that it must be some internet stock.

Well, it could be: the chart resembles many which peaked in the 1999-2001 period. I recently looked at the stock prices for Microsoft (MSFT) - it peaked around $59 back then, and is currently in the $25-$30 range - about half its peak value. Intel (INTC) peaked in the $75 range, and is now in the $25-$30 range. Cisco (CSCO)? $77 then and $21-$28 recently.

But no, this is not from the tech sector. This is a cautionary tale of how inflated prices can get in one, or many, sectors during a bubble.

No, this is the behemoth drug maker Merck & Co (MRK). which peaked around the same era at $94 and is now in the $35-$40 range. You can pull up the charts for the other pharmaceutical giants, then and now, like Pfizer (PFE), Abbott Labs (ABT), Novatis (NVS), etc. and find the same cratering effect: most of these still haven't reached the halfway point of their bubble prices.

Have some things changed for both sectors? Sure - but not nearly to the extent implied by both a lost decade of price appreciation and, worse, price declines that could have eviscerated some over weighted portfolios.

One thing remains constant - investors, whether buying single companies or weighing into sectors via ETF's etc., have to be very cautious on the flavour of the year. Avoiding the most popular sectors, especially after several years of popularity, can be one of the best things you can do for your portfolio's health - and can help you get a good night's sleep too.

Disclosure: No positions.
On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Thursday, August 26, 2010

Investment Earworm Contest Winner - Rick

A fairly recent posting of mine challenged readers to identify the speaker of the following comment, together with the asset class he was speaking of.

The comment is, essentially, this:

Commodities wins both the optimistic and the pessimistic scenario."

Rick has correctly identified the speaker and the asset class as being Jim Rogers (the commodity guru) and speaking of the commodity asset class.

What Rogers is saying here, is that if the emerging economies continue their assent - and with it demand for commodities - then commodities prices will continue rising, even if inflation is benign. This is the optimistic scenario.

On the other hand, if inflation starts to run away, due to the extremely high levels of monetary and fiscal stimulus with continuing budgetary deficits (the pessimistic scenario), then the only thing that'll hold their value, are "real" assets, namely commodities and possibly real estate.

Congratulations Rick. You will receive your book choice, The Ultimate Dividend Playbook, shortly.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Tuesday, August 24, 2010

Compass Minerals International Inc (CMP) likely a future victim in climate change?

As this blog begins to grow its focus on climate change investment strategy, I thought I'd highlight a company that was mentioned in the fine Josh Peters book, The Ultimate Dividend Investor Playbook, which I recently reviewed.  In the book, Mr. Peters, of Morningstar, mentions Compass Minerals International Inc. (CMP) as then (sometime in 2006 or 2007) perhaps being a candidate worthy of consideration for addition to a dividend stock portfolio.

Compass' main business then, as now, "is highway deicing salt, so its profitability is determined by cold, snowy, or icy winter weather." So says Morningstar. 

Morningstar currently provides a three star (average) rating to Compass, meaning they perceive its total stock return outlook to be approximately comparable to the universe of stocks they cover. Owing to a wide economic moat (in this case, a low cost to bring the salt to market), balanced against other factors, is what produces the overall three star average rating.

Me - I think that Compass is an implosion waiting to happen, whether it's this coming winter season, the next year, or in three of the next six years. This is not owing to any prescient thoughts on my part about debt, customer loss, or competitors acting irrationally by pricing below the cost of production. No, I worry about the climate. Notwithstanding occasional contrary hickups, winters are growing shorter and less severe. The scientists say so, and it matches the global warming theory (first postulated by Nobel Prize winner Svante Arrhenius, in 1896).

Trying to continue to maintain salt volumes in the face of this reality, is the investment equivalent of expecting buggy whip makers to continuing to pump out similar volumes, something Morningstar apparently expects, as their quote in their outlook on growth states ...

Growth: We expect long-run demand growth for Compass' salt to be quite minimal. Earnings growth will depend on increasing sales prices and cost efficiencies. (emphasis not in original)

Note that they do NOT say they expect growth for salt to actually decline for Compass, something that can realistically be expected, unless competitors throw in the towel, and they gain a larger share of a shrinking pie. Even if that were to occur, most investors recognize the futility of fighting a secular "headwind". No pun intended.

Climate change investment strategy, as I will begin to explore over the coming while, involves a very few great opportunities, some good opportunities, and a whole lot of businesses to stay away from, unless you have the stomach for shorting stocks.

Compass is one example of a stock I'd be extremely cautious of getting involved with, especially since it is priced at roughly the same PE ratio as the S&P500.

No, if I were you, and thinking of holding Compass for a year or more, I would take Morningstar's rating, in this case, "with a grain of salt".

Disclosure: CMP - no investment position.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Sunday, August 22, 2010

Book Review - The Ultimate Dividend Playbook

Any investor worth his or her salt, who doesn't want to rely on the vagaries of capital appreciation to grow their net worth, and who would readily lean on the best shortcut in the world to wealth creation, dividends, simply must seek to understand them. Numerous studies have shown that dividend paying stocks outperform all other stock classes, and usually by a wide margin of 2% or more annually.

This book, by Josh Peters of Morningstar, helps the investor understand the case for dividends, and how to select individual stocks for a modestly diversified portfolio. While many investors may think dividends are suitable for income investors only, the fact is that dividend paying stocks should be a or the major stock holding style in most investors' portfolios.

Why? Well, as Josh points out, it's very simply because they outperform most other stocks, and generally with reduced volatility. So, it's a more stable, higher-returning investment. What could be better than that?

As Josh points out, dividends are a sign of many things investors like to see:
  • An alignment of managements and the investors interest (return of, and return on, cash);
  • Corporate self-discipline (have to keep grinding out the cash to pay and grow the dividend);
  • Financial strength;
  • And a Valuation basis (dividends can show when a stock is overpriced, and underpriced).
Josh covers economic moats, which he likes all his dividend-paying stocks to have, as well as return on equity (see his book, or mine, on why this is important). He suggests looking at the trend of the dividend (the trend is your friend, in terms of projecting the future), so see how the dividend might grow into the future.

He covers handy items like payout ratios, high yielding stocks (generally, be careful) and high payout ratios (look out if ratio has been continuing to rise).

In the book, Josh covers especially two items that make the book an entirely worthwhile addition to any investors bookshelf: the dividend drill, and the dividend drill return model.

The dividend drill focuses on three items;
  1. Is the dividend safe;
  2. Will the dividend grow;
  3. What does the dividend stream tell me the stock is likely to return to me as a shareholder?
Attempting to answer these questions will help you decide whether or not a prospective stock investment is one that you can or should add to your portfolio.

In relation to #3 above (the total return from the stock), he also introduces one very handy shortcut (and investing is full of them, from PE ratios, to inventory turns, to PEG ratios). Think about the potential of the total return of the stock as the sum of the actual dividend yield, plus the likely growth rate of dividend over the next while, say ten years.

A couple of simple examples showing how the total return might be different for two stocks, is that one might be yielding a 5% return, and has recently been increasing the dividend by about 4% annually. If you think that increase would continue over the next decade or so, then the likely total return on that stock would be about 9% annually (5%+4%). In the case of a stock which has a lower initial yield, but is increasing the dividend more rapidly, the projected return might look like this; a 3% dividend yield, plus expected future dividend increase at 8% annually, suggests an 11% (3%+8%) total return.  The book is full of handy advice like this, written in a straightforward and uncomplicated style.

The book also details the more complicated (but not complex) Dividend Drill Return Model, which encourages you to think more deeply about the company and its prospects. Yes, it's more work, but relies only on elementary/grammar school arithmetic, so it's within the reach of virtually any investor.

I highly recommend this book, and thank Josh Peters for writing it. The information is handy, practical, simple, and timeless.

The Confused Capitalist

Monday, August 16, 2010

Retail Investors Indicate Bonds are lousy deal right now ....

The retail investor has long been a contra-indicator of what's truly both a timely and good investment ...

Firstly, they often have trouble knowing the difference between a savings vehicle (holding time frame of under five years, generally; and very low expected return) and an investment vehicle (holding time frame of over five years; and relatively high expected return).

Add to that the mistiming of buying and the comedy of errors reaches Shakespearean proportions. 

Municipal bond mutual funds that report their figures weekly reported $953.9 million in new money from investors during the week ended Aug. 11, according to Lipper FMI. That was the biggest weekly inflow since March, and heavier than all but 33 inflows since Lipper started tracking the data in 1992 — 970 weeks ago.


Solender said because expectations are that the Federal Reserve’s target for interest rates will remain near zero well into next year, people are growing increasingly comfortable with the yields offered on municipal bonds — even though they have never been lower. (highlighting not in original)

The yield on a 10-year triple-A rated municipal bond sank below 2.5% for the first time last week, according to Municipal Market Data.

Article here


As opposed to that, IndexArb reports that the current average dividend yield of all the S&P500 dividend-paying stocks is 2.51% (with a reasonable expectation of future dividend growth), yet the retail investor saver piles into the bond market, potentially locked into a 2.5% yield for 10 years.


The Confused Capitalist

Friday, August 13, 2010

Management Tinkering

The management of this blog is tinkering with the layout ... feel free to comment and let me know what you think ...

The Confused Capitalist

Thursday, August 12, 2010

Commodities Report

As predicted, wheat prices did indeed jump following the latest USDA report. Given the issues with flooding (1, 2, ) in other parts of the planet, eg South-East Asia, we can probably expect more upward price pressure on foodstuffs in the short-term.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JW The Confused Capitalist

Investment Earworm Contest

Ever get a music earworm? Sometimes it happens with other things too.

As readers of this blog may suspect, my most prolific posting often comes when I am also doing the most investment reading. Obviously, one of those times is now.

The many earworms of Warren Buffett have worked on my investment thinking over the years. However, I recently caught another investment earworm which I just can't shake, because it seems to make far too much sense.

The investment earworm is, essentially, this:

.... (this asset class/type/sector/leaning) wins both the optimistic and the pessimistic scenario."

This was a recent utterance of a well known investor. The first one to name both the asset class/type/sector etc. and the investor, wins their choice of either of the two following good investment books:

Please post in the comments section, and I will monitor for the winner. The contest is open for the next two weeks - limit of one entry per day per person.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

Wednesday, August 11, 2010

Outperformance comes many ways

There are many ways to outperform the general market, some adding incremental value here and there, such as finding undervalued individual companies, or staying away from seemingly overvalued sectors (bearing in mind of course, that over [under] valuations can stay that way for very long periods of time).

However, the one of the seemingly most riskiest ways is to find an unacknowledged secular tailwind, and ride it to outperformance. These are always present, but difficult to figure out how much return they'll produce, and how long the ride will go on for, or even when it will begin.

In some cases, like the tech sector beginning in the late 1980's, should have been very visible to figure out, and ride it for a very long period of time. Some, like the hard commodities boom, beginning in the very late 1990s, were a bit tougher to figure out, given the nearly two decades of very weak performance in that sector. Even if you figured it was on the cusp of a long term revival, it would have taken considerable courage to move against the thinking that had solidified over two decades: namely, that this was a poor investment area.

Today, soft commodities (eg foodstuffs, generally) and emerging markets (both personal holdings; GRU, RJA, DEM), seem like excellent bets to overweight a portfolio in, something I have been writing about for three years or more now. Will these bets produce the outperformance I think is available there?

When thinking about these types of potentially big portfolio moves, it might hearten you to think about what one of the deep management thinkers of the last century, Dr. W. Edwards Deming had to say about the unknowability of things .... which can reverberate in investment thinking ....

"The most important things cannot be measured."

"The most important things are unknown or unknowable."

Given that Dr. Deming was a statistician who preached quality improvement through process management and statistical output measurement to the ready post-war Japanese, the first comment might seem surprising, but he is simply acknowledging a fundamental truth. The quality of management, their philosophy, for example, simply can't be directly measured. These are, however, long-term drivers of corporate success.

The second comment simply builds on the first, and speaks to the relative unpredictability of the future, trends that may be building below the surface, or simply events that are virtually not predictable.

If you can keep these thoughts in mind, long enough to take advantage of the trend you have researched, thought about, and are willing to take a flyer on, then you too might enjoy outperformance in this way.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Tuesday, August 10, 2010

John Hussman - Valuator extraordinaire?

A short while ago, I chided Dr. John Hussman for not properly considering the increased demand for stocks in a posting of his, and for suggesting that a 6.7% annual return was inadequete for stocks.

However, I also have to note that some of his prior predictions are, so far, spot on track. In February 2005, John suggested that a valuation trend for the next decade, suggested a potential return, based on historical average and median trends, portended a 2 to 3% annual return over the next decade. To date - five and a half years in - after adjusting for dividends, the SPY SPDR (S&P500 index) has produced an annual return of under 1%, while the DIA SPDR (Dow Jones index) has produced just 2.5% annually. While John may seem like a perma-bear, you would be unwise not to consider his thoughts on various valuation issues.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Thursday, August 05, 2010

Big price jump following next crop report

The next major USDA international crop report is due August 12, 2010. Watch for a big jump in prices thereafter ... surprise to the upside folks (unless you are a humanitarian, in which case you'll consider it as a crash to the downside) ...

The classic definition of inflation, as I remember it from my college days, is "Too much money, chasing too few goods." Most concerned with inflation these days have all the argument on the "too much money" side of the equation - does it arise from monetary issues, or fiscal imprudence? They totally forget the other side of the equation, because it rarely is the problem - the "too few goods." Watch for this to be the difference in the coming years, as agricultural production declines ("too few goods") begin to become part of the "new normal".

Quote of the day:

Global warming will be the most important investment issue for the foreseeable future. But how to make money around this issue in the next few years is not yet clear to me. In a fast-moving field rife with treacherous politics, there will be many failures. Marketing a “climate” fund would be much easier than outperforming with it.
- GMO's Jeremy Grantham

As a side-bar note, I get tired of dealing with dum-dums who, for reasons of mental and emotional convenience, want to continue denying global warming. The comment forum is open as always, but if you disagree with what real, professional climate scientists say, please take it up directly with them. If you have a stunning piece of scientific evidence that disproves one side or the other, don't waste time on my channel, write a paper, get it peer-reviewed, and then published in a reputable journal.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Tuesday, August 03, 2010

Wheat Prices Jumpin' - Global Warmin' to blame

Has anyone been checkin' the news lately 'bout wheat prices - they's a jumpin'.

Hello people - is anyone really gunna start to take gobal warming seriously - like the massive crop failures; forests a burnin' everywhere... Or are we gunna continue to pretend everything is alright?

We are a seriously fussked up species ... not a happy camper today ... no ... just start clicking on the various weather network reports, and crop reports ... you wouldn't be too happy either ... if any of us had half a brain, or half a heart ... we might be inclined to takle this problem ... strawberry fields forever people ...

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Monday, August 02, 2010

Can't see the forest for the trees

I couldn't decide what to entitle this post, but ultimately settled on the above caption. Leading contenders were ... Looking backwards doesn't help you going forward ... Driving by the rear view mirror a recipe for disaster ... I'm a tree hater ...

Anyway, the theme here is trees and thinking about the future ... I've recently read many articles suggesting forest land has historically been a good investment, and is a good hedge against inflation. The fact that big institutions like Harvard and various hedgies like it, obviously isn't too bad for leading the "me too" crowd to think it might be a good investment. I have to say though, that trees scare the crap out of me.

With global warming accelerating, as anyone who lives in a moderately dry forest belt can tell you, the idea that you can get a reliable return from forest land/trees is an open question in my mind. As I have watched our summer "weather" grow to include a period of smoke haze for one or two weeks, from fires near and far, I have to tell you I don't think the prospects are promising. If invested in a single specific company, you could well see your total investment wiped out or severely impaired by a major forest fire; the number and severity of fires seems to be rising rapidly. The open question relating to risk/reward in my mind is this:

  • Will the increased prices for the remaining trees be sufficient to offset the obvious forest wipe-outs that are going to occur?
I am doubtful that sufficient price escalation will occur (or if it does, it'll be so high that it will foster the production of substitute products) and is contrasted against the possibility of severe value impairment on any particular specific forest asset as it burns down. In my mind, on a go-forward globally-warmed planet, I can't think this is an investment I want any part of, at this time.

However, if you are only thinking about the past, driving by the rear view mirror as it were, then you would be likely to miss the impact that global warming might have on such an investment.

NEWS FLASH: Russia is dealing with its' hottest recorded summer temperatures, and one-quarter of a million people have now been deployed to fight forest and peat fires.

As a side-bar note, I get tired of dealing with dum-dums who, for reasons of mental and emotional convenience, want to continue denying global warming. The comment forum is open as always, but if you disagree with what real, professional climate scientists say, please take it up directly with them. If you have a stunning piece of scientific evidence that disproves one side or the other, don't waste time on my channel, write a paper, and get it peer-reviewed and published in a reputable journal.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Sunday, August 01, 2010

Employee compensation still seriously messed up

No, this isn't an issue with your average unionized or non-unionized shmo worker. It's a complaint about the "man at the top", the CEO, CFO, CIO, CCO, CRO ... (OK, I made the last one up) ...

It's about board's doing their duty to the owners of the company, even if they are transitory traders, and making sure that the pay of the high level executives are reasonable. What is reasonable? Weeeell, if you need an executive compensation firm to provide you some base thinking around that, then you are too dumb to be a director. So please quit now.

When the compensation levels begin to look like some stratospheric sports hero - overpaid but at the peak of his game - you are paying far, far, too much. Pay them in shares that must be held for long periods of time, in addition to a reasonable base salary. And everything measured on performance, relative ONLY to the industry they are in. Did I really need to tell you this? Grow some balls, as my kids say, and do what is right. Stop looking for an executive compensation firm to give you the dirty, so you can continue do what is wrong about Wall Street.

Want to feel good about yourself? Stand up for a principle for a change. Me, and other shareowners, are begging for it. Stop gold-bricking - both the board, and for the overpaid executives.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Friday, July 30, 2010

Financial Advisors/Blogosphere asleep to global warming

With a notable few exceptions (1, 2, 3) the impact of global warming on future returns of virtually all investment activities remains un-noted and undiscussed by financial advisors and the financial blogosphere. They are generally asleep - or worse - unconscious to the threat to global warming. Even from the strictly narrow and selfish point of view of market returns, they are failing their clients and readers in not discussing this widely and frequently.

The cause of my latest missive was the front page of Canada's Globe & Mail yesterday, replete with charts, graphs and discussion of the latest release (July 28th) of the annual State of the Climate report by the National Oceanic and Atmospheric Administration (NOAA) (complete report [224 pages], or highlights [10 pages]). Given that all 10 indicators pointed to continued global warming, would it have been unreasonable to expect that at least a few financial bloggers/advisors to discuss this, and the short, medium and long term portfolio implications?

Apparently. A quick search around various financial blog aggregators revealed a collective yawn - nothing, or virtually nothing. A collective sigh went out, and the children all went back down for their afternoon naps.

Unfortunately, we have now reached a point where the temperature of each year as it passes, is now higher than the average year of the past decade. Further, each passing decade is now setting new records for warming, compared with the prior decades. Here's a couple of highlights from the highlight report:

Continued temperature increases will threaten many aspects of our society, including coastal cities and infrastructure, water supply and agriculture. People have spent thousands of years building society for one climate and now a new one is being created – one that’s warmer and more extreme.

The report noted some of the extreme events during the past year:

• In Brazil, extreme rainfall in the Amazon basin caused the worst flood in a century. Forty people were killed and 376,000 were left homeless.
• In southeastern South America, the wettest November in 30 years displaced thousands of people.
• In northwest England, heavy rainfall flooded the Lake District, setting new records for river flows and damaging 1,500 properties.
• In northern Iberia and southern France, a North Atlantic storm raked the land with record winds, downed power lines, closed airports and blocked railroads.
•Three intense heat waves broke temperature records in Australia. One of them was accompanied by high winds that fanned bushfires, killing 173 people.
By the way, with it all the rage to talk about the possibility of deflation (a distinct short term possibility, I admit), I will go out on a limb and say that the longer term picture is very disturbing, and includes the very high possibility for runaway inflation. All starting at the beginning of all stored wealth - food. Watch for it there first.

In defence of saying nothing however, these are the kind of dummies they have to deal with ... contrast and compare kids ...

Scientists views
Investors views

At the end of the day, however, you are supposed to either a) inform and challenge your audience (bloggers) or b) protect and grow assets (advisors). Your silence embarrasses you.

Well, now that this commercial intermission has awoken a few fellow bloggers and perhaps to a financial advisor or two, the rest of you can fall back to sleep to la la land, where the sky is beautiful all day long and nothing ever changes. Strawberry fields forever.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JWThe Confused Capitalist

Tuesday, July 27, 2010

Insurance costs money

Portfolio insurance, e.g., hedging, costs money.

Warren Buffett has said in the past that he'd prefer a company that can grow its earnings at an average, but lumpy, 12% per annum, compared to one that can grow its earning a smooth 10%.

That's because he's well aware that the compounding effect of the two rates over a long period of time will produce significantly different end values.

In a similar vein, I want to discuss the cost of portfolio insurance. This can be considered to be anything that smooths out the rate of return for the investor. For most of us retail folks, and for most brokers, this insurance comes in the form of inverse ETFs.

Inverse ETFs are usually bought when the market is trending downwards, and many brokers use some sort of technical signal, like when the 200 day moving average falls below some other shorter term average (notwithstanding that these signals no longer appear to work 1, 2).

If you accept the general premise that the stock market virtually always ends up higher after long periods of time, e.g. 10-20 years, then buying inverse ETFs can only have a adverse effect on your return rate over time, especially if they are bought midway through a downtrend. Inverse ETFs explain this themselves in their prospectus' and there are the trading costs themselves to also consider.

The problem is usually further exacerbated since most folks have no idea of how far the market is going to decline and, with all due respect to brokers and their technical signals, neither do they. Using a 200 day moving average as your sell signal, usually means that the market has already been drifting (or vomiting) downwards for some period of time, so you would be buying insurance when its utility is already lessened.

The only reason to buy it, is if it helps you stay in the market, and earn a long term average of 8%, as opposed to buying some other smoother, but inferior returning, investment vehicle.

Myself, I'd prefer a lumpy 9%, to a smooth 8%, thank you very much.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content! JW The Confused Capitalist

Sunday, July 25, 2010

Is 6.7% inadequete return for stock investments?

John Hussman, in his latest missive, suggests that the S&P500 is poised to return about 6.7% annually over the next ten years, based on historical averages, etc. Furthermore, based on other historical averages, eg the return from the stock market itself, he suggests that this isn't an attractive valuation, and the S&P500 could very well breach the March 2009 lows (not all that an attractive valuation in his viewpoint either).

I certainly don't argue with the idea of 10 year normalized earnings producing a better indication of total return on a forward basis. However, to point at some of these historical examples of market lows and suggest that they might be reasonably attainable, isn't probably all that thoughtful.

Thirty or forty years ago, the average middle class person was not involved in the stock market whatsoever. Period.

That simply is not the case today, and it's doubtful those days would return soon, if ever. Financial advisors, for all their warts, have served a large purpose in educating the public to accept that ownership of a business/share ownership, is a lasting and real way to create wealth. Many savers of yesteryear have been replaced by investors of today.

Therefore, the underlying demand curve is different today - so it isn't logical to expect valuation metrics of the market to be reproduced today - sans very extreme market events, which would need to last a considerable period of time.

Finally, while 6.7% may seem too low for Mr. Hussman, what are the alternatives to that?

  • Real estate - dead money for 5-10 years;
  • Bonds - much lower returns;
  • CD's - don't even go there;
  • T-Bills?
  • Mortgage backed securities - please ...
  • Commodities - perhaps, but very volatile and, realistically, subject to contago for the average investor.

In this environment, 6.7% isn't actually as bad as it may have sounded historically and, anyway, those days are gone, and have been gone for some period of time now. In my book, I suggested some 13 years ago, that having an average S&P 500 return of more than 5% over T-Bills (the then historical average), probably over-stated the risk profile of those companies in their aggregate.

Of course, there are ways to increase your chances of exceeding 6.7% but, realistically, this is the context to think about stocks over the next decade. Does that make them a bad deal? Not when you consider the alternatives. Mr. Hussman needs to tune himself in to the new reality (15 years and counting now).

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JWThe Confused Capitalist

Morningstar ... Hello, hello .... HELLO?

Long-time readers here know that I am a bit of a Morningstar fan, appreciating their truly independent coverage, and an unconflicted (eg investment banking activities) viewpoint, that so tainted any so-called independent research that emanated from the so-called major institutions.

Nevertheless, I have to call them out today. Came across a residential apartment owner, Equity Residential (EQR), to whom they assign a "three-star" rating (average). They estimate the fair value of the shares at just $35 (last traded at one-third OVER than level, at $45). They also say the business has no moat, and say their valuation is subject to high uncertainty (two factors that usually lower their star rating). Furthermore, they estimate the forward PE as 64, and the current price/cash flow as 19.

They also add...

In the near term, Equity Residential's main geographies are suffering from high unemployment, and a deteriorated housing market. All else equal, high unemployment and consequential lower job mobility lowers housing demand, and makes it difficult for landlords to increase rents. Equity Residential's ownership share of a given metropolitan area is, by and large, less than 3%, so it can't readily affect the sector's pricing discipline.
On the positive side, they note that EQR has above-average balance sheet strength, leading to the potential for future residential "trophy" acquisitions. However, they also say ...

While we think this environment will present the firm with more attractive acquisition opportunities, we do not bake unannounced acquisitions into our valuation model ...
The final kick is the closing statement that they think EQR can earn 7% on its capital over the next ten years, LOWER than their estimated cost of capital at 7.9%.

So, let's see if I have this all correctly: overvalued, no moat, trading at high income/cash-flow metrics, weak "same-store" price increase income prospects going forward from existing portfolio, no pricing pricing power in the market, and can't earn its cost of capital.

Jack ... JACK ... assign this one an "average" rating, on the account of the "magic beans" that the CEO has in his pocket.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content! JW The Confused Capitalist

Saturday, July 24, 2010

Too harsh - Johnson & Johnson stock price

Fund manager Eddy Elfenbein, over at Crossing Wall Street, has recently been on about the dividend yield/stock price of Johnson & Johnson (JNJ), which is currently yielding about 3.8% on a forward basis. Johnson & Johnson is routinely cited for winning various awards involving titles like "Most Admired Company ...", or "Best Managed ...".

While the JNJ stock price recently stumbled on a revised outlook for the year, investors should remember that this is a very robust and diversified business that has had a long history of growth. To be able to acquire such a nice dividend stream (and at only a ~40% earnings payout ratio), together with acquiring a nice robust business is an attractive prospect indeed.

Morningstar provides a description of the business as follows:
Johnson & Johnson holds a leadership role in diverse health-care segments,including medical devices, over-the-counter medicines, and several pharmaceutical markets. Contributing about 40% of total revenue, the pharmaceutical division boasts several industry-leading drugs, including rheumatoid arthritis drug Remicade. The medical device and diagnostics group brings in more than 35% of sales, with the company holding controlling positions in many areas, including DePuy's orthopedics and Ethicon Endo-Surgery's surgical devices. The consumer division largely rounds out the remaining business lines. The 2007 acquisition of Pfizer's PFE consumer business solidified Johnson & Johnson's position in this market.

They currently award it a five star rating (their highest, suggesting out-sized returns going forward), provide a fair value estimate of $80, low uncertainty rating, and indicate it is a wide moat business.

IndexArb currently calculates the average dividend yield of the S&P500 at 1.8% for all index companies, and 2.5% for just the dividend paying ones. Investors should ask themselves if JNJ is really worse than the average S&P500 company? (Not!)

Eddie is right: notwithstanding a minor bruise or two, what's not to like about this company, and especially the stock, at this price ($59; 3.8% dividend yield)?

Jay to Stock Market: "Man you are harshing me out!"

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!

JW The Confused Capitalist

Automatically generated links follow

Tuesday, July 20, 2010

Cranky Barry Ritholtz

Sure, Barry Ritholtz is cranky about the palaver of the unthinking about the Goldman Sachs case.

Oh, by the way, he's right.

The case did turn out to be a slam-dunk, otherwise the settlement would never have occurred so quickly, and for such a large amount.

The fact that the fine is a fraction of GS earnings is completely irrelevant as Barry points out.

The outflow of the case is now such that the initial beat-down on the stock from ~$180 to ~$130/share was perhaps due in part to the compelling case that Barry made. While I don't recall Barry mentioning any potential fine or settlement figures, now that those figures are known, and assuming that civil liability is held to under 10x that amount, suggests that the beat-down on the price was just about right.

Industrial strength caution: That assumes, of course, that the same unthinking commentators are right about that 10x being the maximum figure.

No matter what, if you thought about it for even 5 minutes, you'd realize that a case of "malfeasance-corporate-lite" isn't all that shocking today, nor was it really likely to damage Goldies franchise by much. After all, making money with an occasional touch of dodgy behaviour isn't like withdrawing from the "Bank of Fidelity" in marriage; money flows where money grows. And Goldie remains a powerful money tree.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content! JW The Confused Capitalist

Automatically generated links (might or might not be relevant):

Thursday, July 15, 2010

The New Normal - Low Returns

Many commentators have commented on the "New Normal", a paradigm in which returns from the two main assets classes, bonds and stocks, are poised for, perhaps years of low returns. Perhaps as low as 3-5% for a decade, in which the rich economies are nursed back to health, and before emerging economies begin to add lots of consumer demand. Add to that the sickly real estate market, and it's tough to see where decent future returns can be generated from.

This is true, particularly if your portfolio looks "normal" or average. Stuffed with a few mega cap stocks, or broad S&P 500 equity exposure, and a bit of bonds here and there, it's likely your returns will fit the New Normal profile.

To the extent that you move away from that normal profile, adding growing small cap companies at reasonable value, adding emerging economies companies of all sorts, leaning away from the popular sectors, and loading up on dividend growers, is the extent to which your portfolio won't be bedridden by the new normal.

You are only confined to the New Normal paradigm, if that's how you orient your portfolio. The easiest of all of these two components to begin swinging away from average are emerging market ETFs, and dividend-growing companies. The other suggestions take more effort and also entail more risk, but can help diversify your portfolio.

One other thing I am a firm believer in is adding some exposure to food commodities, either directly through ETFs/ETN's, or indirectly through companies operating in the farming sectors. The longer term picture is a compelling investment theme, one which has been disguised by the general economic weakness and crisis over the past two and a half years. That won't last forever and, likely, not even for that much longer on a go forward basis.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JWThe Confused Capitalist

Wednesday, July 14, 2010

Do we ever learn. As seen through the "Big Fish" Movie

I was watching the movie "Big Fish" last night (released in 2003), directed by Tim Burton, with Jessica Lange (as Sandra Bloom) and Albert Finney (Ed Bloom) as the lead characters. At one point, the dialogue absolutely grabbed me in reference to the 2007-2009 credit crisis origins.

Scene: 1970s - Albert Finney has just robbed a bank as an unplanned accomplice of the poet Norther Winslow (played by Steve Buscemi). The vault however, which Finney inspected, was empty:


Buscemi: Yeah! There's gotta be close to $400 here! And that's just from the drawers. Let's see what you got from the vault.

(looks in the vault bag)

This is it? The whole vault?

Finney: I'm afraid so.

Buscemi: It's got your deposit slip on it.

Finney: Well, I just didn't want you leaving empty-handed.
There's something you should know. The reason they don't have money...
I told Norther about the vagaries of Texas oil money...

...and its effect on real-estate prices...

...and how lax enforcement of fiduciary process...

...had made savings and loans particularly vulnerable.

Hearing this news, Norther was left with one conclusion:

He should go to Wall Street. That's where all the money is.

I knew then that while my days as a criminal were over...

Thanks for the hand!

...Norther's were just beginning.

When Norther made his first million dollars...

...he sent me a check for $10,000.

I protested, but he said it was my fee as his career advisor.


Substitute "oil money", for "ridiculously low mortgage rates for an extended period of time" and you have a perfect apt description of the culmination of the sub-prime lending crisis.

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JWThe Confused Capitalist

Friday, July 09, 2010

What diversification is and isn't

(Note: During a crash - all movements become highly correlated)

A few recent readings about the crash of '08-'09 has led me to this post. Investors wishing to diversify away from all market volatility are foolish indeed (an impossible task); it can't be done at times of violent market movement. Investors panic en-masse in those times, so traditional measures of relative correlation totally dismember.

What diversification does, is during relatively normal times, involving single stock fluctuations of 30-40% per annum (eg normal variations), is produce more stable returns during those periods. Even during some periods of somewhat greater than average relative market strength or weakness, it the chance for those non-correlations to hold together, producing those more stabilized returns, that most investors prefer.

During times of market stress or extreme giddiness, only YOU can provide the non-correlation to market averages: keeping your head about you and increasing (decreasing) your market exposure during periods of violent downdrafts (irrational exuberance).

Note: If you're on a blog aggregator, you can visit The Confused Capitalist here (or here: for additional articles and exclusive content!JWThe Confused Capitalist

Friday, May 28, 2010

Market Decisions - Process

  1. Process

    This is #2 in the Market Tremors series.

    In the last posting, I stated that few retail investors ask and answer the right questions before portfolio construction, with the result that they panic during both bear and bull markets. This panic, whether due to significant market decline or portfolio lag, is the cause of most market underperformance. That is primarily because the investor panics and begins chasing the wrong asset class, at the wrong time.

    I suggest that all investors need to deal with these five questions, in order to have a good chance to outperform the market:

    1. Process;
    2. Rationale;
    3. Emotions;
    4. Holdings;
    5. Market Exposure

    Today, we are looking at Process, through the lens of my own recent portfolio reconstitution. Here’s how I define Process:

    What process and tools did I use to construct this portfolio?
    Have I given myself an edge in some way?

    Firstly, it’s rare that any long term market outperformance is possible without a decent process. If you’ve been outperforming the market without a specific process, then you better chalk it up to luck – and just like in the casino, it’s not likely to last. If you’ve luckily lurched from stock tip and suggestion and back to the same, better quit now and put your winnings in your pocket. Stop now, build and define your process.

    While I don’t suggest my process will fit everyone, it fits me. Here’s mine.

    First, I admit with my time constraints, I just don’t have the time to delve deep into the annual report of every corporation in the areas I have chosen. I used to do that when I bought just small and micro cap stocks, but have neither the time nor the desire to orient my portfolio that way anymore.

    Instead, I use quality “buy side” analysts who have my interests at heart (unlike the conflicted investment banks and their ADHD analysts). Therefore, I extensively use the Morningstar database to find stocks that might interest me.

    Using their database, I screen for stocks based on both “moat” (barriers to competition) and largest discount to fair market value.

    Second, I require all of the stocks I select to have a moat, and preferably a wide moat. I want that implicit margin of safety. I also require that all of the stocks I buy to have some margin of safety in terms of the pricing – the lower the stock price relative to their fair value estimate, the better. Also, I generally want to buy a four or five star rated equity, which, according to Morningstar’s data, have on average significantly outperformed the market over a relatively long period.

    I also check this rating with the S&P report (another buy side rating agency), to see if it’s roughly similar. Again, they report that their four and five star rated equities have significantly outperformed the market on average.

    Third, I also require that the equity be paying a dividend. I am looking for both an above average dividend yield, and recent history of dividend growth (or the possibility that is about to occur). Given the long-term outperformance of dividend-paying stocks, as further boosted by those providing dividend growth, I consider this one of the edges I use in the market.

    Fourth, when looking at the truncated financials, I look for above market average returns on equity and capital (assets), as both are long term drivers of stock price growth. I look for decent earnings per share growth. I also look at overall financial health of the company, accepting a “C” Morningstar rating at the lowest, but looking for better if possible. I also look at the PE ratio to see if that is a relative bargain.

    In terms of my ETF selection, I use a much more “gestalt” process – I usually pick specialty ETFs in areas I think there’ll be considerable growth into the future. Here, I use my general reading, and just plain thinking about the future, to orient towards those ETF buys. I also try to envision those ETF buys ten years out, because that’s my projected holding period in that instance. I look at the valuation ratios but, given I perceive these as the growth portion of my portfolio, are somewhat less concerning than in the stock selection (which I perceive as the value oriented portion of my portfolio). However, I also check relative value measures, like the PE ratio, to ensure I’m not buying the NASDAQ index circa 1999, with a PE of 100.

    Now, the final piece of the process is to print up all these materials I’ve compiled, together with any handwritten notes on the reports. I then do a very brief summary on the equities selection, such as dividend yield, Morningstar ratings and percentage of fair market value the equity is selling at, and a brief narrative overview, including PE ratios, value drivers, exposure to the US market, and/or other odds and sods. I do the same for my ETFs.

    Next we’ll look at “Rationale”, which will be published next.


The Confused Capitalist

(Reprise series from 2008)

Saturday, May 22, 2010

PIGS - Market Tremors

In my family of origin, reading something you thought interesting to a sibling, parent or child was a sign of love and affection, as well as a way to stay connected and to expand your world. Receiving one of those readings was taken similarly.

So, on a recent trip, I asked my wife to read to me, as I ground it out for the fifth hour on the freeway on our way there.

“Read what?”, she asked.

“The business pages, please.”, I replied.

But then I glanced down at the paper and saw the front page headline – “Markets Pounded – PIGS to blame”. Knowing my wife’s market nervousness, I told her to skip the reading. Instead of it being an enjoyable pastime for us both, I know she’d be pounding me with questions about our holdings, feeling sick if we lost anywhere near the average and dismal if it was more.

Which brings me to the point of this exercise: she reacted just like many people do. At a sign of market decline, they seriously question the market in general, and their holdings in particular.

Unfortunately, it is usually only at times of market extremes like these that people begin ask these questions, and it is usually in this order:

1. Market Exposure – Am I comfortable with the levels of equities I hold?

2. Holdings – What are my specific holdings – what is their orientation, what is their risk profile? How much am I counting on “the future” (potential growth of earnings etc.), rather than “the past” (historical earnings, etc.)?

3. Emotions – What is my emotional readiness to handle declines or lags in my portfolio, without changing strategies?

4. Rationale – What was my thought process for assembling this particular portfolio, and how well will this rationale hold up if market conditions are reversed?

5. Process – What process and tools did I use to construct this portfolio? Have I given myself an edge in some way?

In a bear market, the predictable answers to #1 and #2 are “I have too much equities – I need to lighten up”, and “I have too risky holdings, I need to sell”. In a bull market the answers are of course reversed. Typically, whether in a bull or bear market, few bother to get around to questions #3, #4, and #5.

If you want to outperform the market, aside from being willing to assemble a portfolio that looks unlike the market – and all the perceived and real risk that can entail - you need to spend considerable time on questions #3, #4 and #5.

In fact, I believe you need to reverse the order of asking these questions. That’s because they form the long-term framework for sticking with your ideas. And retail investors are notorious for dumping both their strategies and equities, just as market conditions begin to favor those very equities and strategies.

So, over the course of the next few postings, we’ll look more deeply at all these questions, in what I regard as the proper order (1. Process; 2. Rationale; 3. Emotions; 4. Holdings; 5. Market Exposure).

(Reprise series from 2008)