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

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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

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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