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Three American Professors Awarded Nobel In Economics; Fama Of DFA Is Recognized
Monday, October 14, 2013 10:28

Tags: advisor industry people | asset allocation | portfolio management

Three American professors — Eugene F. Fama, Lars Peter Hansen and Robert J. Shiller — were awarded the Nobel Memorial Prize in Economic Science on Monday for competing theories about the movements of asset prices.

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The three men, who worked independently, were described as having collectively illuminated the financial markets by showing that stock and bond prices moved unpredictably in the short term but with greater predictability over longer periods. The prize committee said these findings showed that markets were moved by a mix of rational calculus and human behavior.
The New York Times points out that the decision to honor Mr. Fama and Mr. Shiller as contributors to a shared understanding of financial markets, however, papered over differences in their work that have been enormously consequential in recent years. Mr. Fama was honored for his work in the 1960s showing that market prices are accurate reflections of available information. Mr. Shiller was honored for circumscribing that theory in the 1980s by showing that prices deviate from rationality.

 

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U.S. Stock Performance Remains Red Hot In The 3rd Quarter, Moving Into A 5th Year Of Rising Returns
Tuesday, October 08, 2013 09:45

Tags: asset allocation | growth investing | sector investing | stocks | value investing

U.S. stocks earned 6% in the third quarter and were up a stellar 21% in the first nine months of 2013. That performance caps off a 145% run-up in the S&P 500 over the past 4½ years, in the face of serious headwinds. Here’s what’s been working, and not working, in 2013.

 

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In the first nine months of 2013, growth stocks, especially smaller growth stocks, have led the way with a 35% return, despite anemic economic growth, rising debt and global social unrest. Large-cap core companies earned 13% and large value earned 17%. Other than these extremes, style returns clustered around 23%, a pretty good place to be. On the sector front, consumer discretionary and health care companies have been hot with returns above 30%, while materials and utilities have not.

 

 


In foreign markets, Japan has outperformed the United States with a 27% return, and Europe has matched the United States’ 21% return. The rest of the world lagged, with Latin America losing 4% and Emerging Markets flat.

 

 

 

The most interesting details lie in the cross-sections of styles with sectors, especially if we are interested in exploiting momentum effects. Looking forward to the fourth quarter, I am forecasting winners in large-value consumer discretionary, mid-cap value health care and small-cap value industrials, and laggards in small-cap growth materials, small-cap core utilities & telephone, and large-cap core technology.

 

To see more details, including my results in forecasting winners and losers for the third quarter, check out the full version of my third-quarter market commentary. The full version also includes a survey and forecast for foreign stocks, special commentary on target date funds and hedge funds, and a link to an amusing new video that exposes the charade of hedge fund due diligence performed via peer groups and indexes.


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Stocks Stay Strong Despite Government Shutdown
Thursday, October 03, 2013 14:55

The Wall Street Journal  didn’t run the very postive headline to this post, but it could have.

 

Instead, WSJ went with, "Washington’s Grim Face-Off.”

 
Nonetheless, the stock market's reaction to the government shutdown is a bit suprising. 
 
Politicians and pundits have been throwing around all kinds of scary stuff labout how the shutdown will “crash the economy,”  “throw people out of work,” and “cause a debt default.”

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You’d need to suffering from amnesia to think this shutdown is an aberration in American politics.

 

And, while unsettling, the history of Washington’s playing chicken with the budget and debt ceiling is that partial government shutdowns have not, in reality, created material economic or market dislocations as both sides factions like to suggest as a scare tactic. The market knows this.

 
The market’s reaction to previous shutdowns was summarized earlier this week in Investor’s Business Daily:
“If the government shutters its doors, it wouldn’t be the first time. A research report from U.S. Trust noted 17 such instances since 1976. Shutdowns have been as short as one day to as long as three weeks. Nine of those times, the S&P 500 was flat to up 2.5% over the period of the shutdown.”
Looking past the "crisis" in Washington, some of the most important of the latest economic data have, in fact, strengthened and are key to the strength of stocks.
  • Leading economic indicators both in the U.S. and abroad have picked up.
  • Key US purchasing managers indexes remain very strong.
  • Unemployment claims have broken to the downside and ADP’s September employment figure continued the slow but steady new jobs trend.
  • Household net worth back to trend and hitting new highs. The Fed just released new household balance sheet data.

Please join me for our October 8 webinar for a complete tour of the latest economic and market data, addressing these data point as well as the following:

  • Earnings, P/E multiples and stock prices. Can stocks go higher this year? Next year? And, Wall Street’s latest forecasts.
  • Are record profit margins sustainable?  Analysts are expecting higher-still margins in 2014 from 2013’s record high levels.
  • Fed’s QE taper. What does it mean for the economy and stocks?
  • The Fed is printing money. What does this mean and why does inflation keep dropping instead of surging?
  • The fiscal crisis. CBO just released a new set of federal income and spending

 

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Higher Interest Rates Benefit Your Clients
Wednesday, October 02, 2013 19:49

Advisor, educate thyself! Don't foolishly believe that rising rates are bad for long-term investment goals.

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Private client advisers are at a crossroad. Interest rates have risen steadily and though they moderated some recently, are likely (though not certain) to rise again for awhile -- at least until the Fed has unwound its Treasury bond positions (quantitative hardening?).   
 
Educate your clients to know that although their bonds' prices are falling, this is irrelevant unless they sell the bonds (or bond fund shares) and invest in something else like cash, shorter duration bonds, or anything other than bonds similar or longer in duration to what they have been invested in. Understand that we are talking about long-term portfolios, not money a client needs to spend or have available in the next four to five years. (This time horizon should influence the average duration of your portfolio of bonds). 
 
For your clients' long-term money, you, and they, should be hoping for rates to increase. Yes, in spite of the drop in their bond prices in the short run, they will benefit greatly from increasing yields as rates rise. 
 
I won't cite all the research available on the realities of how individual clients benefit from rising rates and are harmed by falling rates in the long run -- you can do that on your own. What's important here is the basic premise that clients with long-term portfolios should be happy to suffer the shorter term paper losses of falling bond prices, in return for higher yields over the long run. 
 
Unlike a stock, which might not come back for many years, if at all, a bond has a set maturity date at which time it is paid in full. (I'm assuming here we are focusing on investment-grade bonds with very low default risk). 
 
So every year, the "loss" resulting from the interest rise is lessened, until at maturity it is zero. Even if you paid a premium, you still get the original yield you purchased at that time. So nothing is lost here either. And, yes, this concept holds true even for a bond fund! 
 
Though the fund itself does not have a set maturity date, the bonds in it do. And every day the bond gets closer to maturity, the loss is lessened. If a bond is sold before maturity and another bond purchased, remember that the bond purchased is cheaper, too. 
 
Like a homeowner who has to move in a down market -- yes, your house has gone down in value, but so has the home you are buying! What have you lost? Nothing, unless you are downsizing! 
 
Always better to buy up in a down market and down in an up market. Every homeowner knows that; bigger houses go down more than smaller houses! 
 
Bonds work the same way, only "buying up" means increasing the bond's duration, buying down means decreasing it. So instead of going shorter term when rates have risen, just the opposite may be more rational. 
 
Simple enough concept but it is up to you to get clients to understand it. Performance numbers may go down, but the client has lost nothing unless they panic and sell. 
 
Again, this is true even for a bond fund owner. Liquidations made to pay off frightened shareholders effects only the liquidating shareholder's return. The losses generated by the required bond sales will actually be useful for sheltering future gains. 
 
As long as you stay put, you will get the yield you paid for plus the higher rates as interest payments and other cashflows are reinvested.  Clients should be focused on yields first and only, and ignore total return when it comes to bonds.  A focus on total  bond return may be harmful to your client's long term portfolio's health.
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Answers To Questions From Advisors About The Economy And Investment Outlook
Monday, September 16, 2013 10:21

 

At last week's economic and investment update, advisors asked me a number of questions that we did not have time to answer. Here below are answers to those questions. 

 

If you're a member of A4A ($60 annually), you can replay the session and receive CFP and IMCA education

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Please touch on the labor participation rate.
Here it is, and you can see how it’s been in steady decline since the onset of recession. Its decline in part reflects peoples’ discouragement in being able to find a job. Its decline, in part, accounts for the decline in the unemployment rate even while the rate of new job formation has been sluggish.
 

 

And here is a picture that includes the Congressional Budget Office’s most recent 10-year forecast (through 2023) for the ratio of federal debt outstanding to GDP. The point is that the $7 trillion doesn’t get repaid. But it doesn’t have to. It can (and will) simply remain outstanding and, in fact, be added to with each passing year. The U.S. government can support steadily increasing levels of outstanding debt so long as the total stock of debt’s trend rate of growth does not exceed the trend rate of GDP growth – the engine with which we service the outstanding debt. Not repaying the $7 trillion you refer to has resulted in the new, higher level of debt to GDP in the 70% range which, as I say, is sustainable indefinitely. But, this leaves the U.S. with less flexibility should another crisis come along for which we need to borrow extraordinary amounts.
 
Can you address TIPS before leaving please?
Here is the yield on the 10-year TIPS. Note how the yield has recovered from almost -1% to the current almost 1%. -1% on the TIPS coincided with the record low 1.5% 10-year Treasury yield last year during investors’ frantic scramble for yield combined with the Fed’s QE program. At today’s  1%, you’re still not being adequately compensated, in my opinion, for making a 10-year loan to the government. Historically, as you can see, something in the range of a 2% real return on a 10-year loan to the government has made more sense. My hunch is TIPS yields will, in fact, work their way back to the historic 2% range.
 

 

 

What about the approximate $7 trillion that have been added into the economy from deficit spending?  How and when does that get repaid?

Here’s the $7 trillion added to the total stock of outstanding federal debt (since 2008) that you refer to.

 

 

 

And here is a picture that includes the Congressional Budget Office’s most recent 10-year forecast (through 2023) for the ratio of federal debt outstanding to GDP. The point is that the $7 trillion doesn’t get repaid. But it doesn’t have to. It can (and will) simply remain outstanding and, in fact, be added to with each passing year. The U.S. government can support steadily increasing levels of outstanding debt so long as the total stock of debt’s trend rate of growth does not exceed the trend rate of GDP growth – the engine with which we service the outstanding debt. Not repaying the $7 trillion you refer to has resulted in the new, higher level of debt to GDP in the 70% range which, as I say, is sustainable indefinitely. But, this leaves the U.S. with less flexibility should another crisis come along for which we need to borrow extraordinary amounts.
 
 
 
 
The Budget Office just announced that the expected debt level to reach $23 trillion within 10 years - how can we continue to fund the government and handle the increasing cost of the debt without any negative consequences to the private sector economy? 
As you will can see in the preceding chart (which extends out the 10 years that you refer to), even as the debt level hits $23 trillion, the economy is forecast to expand at a similar growth rate, leaving the key debt-to-GDP level approximately constant at ~70%. This means that the economy’s annual debt-service burden as a percent of the GDP would remain unchanged, which implies no greater negative consequences to the private sector economy 10 years from now than are imposed on it today. Obviously, all of this supposes that these relatively benign CBO forecasts will in fact come to pass. That may be a stretch without some substantive modifications to the big entitlement programs, Social Security, Medicare/Medicaid and now the ACA.
 
 
You also commented on auto sales yet Ford announced yesterday that they have over capacity in Europe and are shutting down 2 plants.  Please comment on these issues.  You paint such a rosy picture and there doesn't appear to be any problems on the horizon. Household debt has been reduced because of loan forgiveness.  We are at all-time highs of consumer debt.  Is what we're hearing inaccurate?
Regarding Ford’s shutting down two plants in Europe it is yet another symptom of Europe’s basic problem: outside of Germany, they’ve long had overcapacity in virtually every industry because their labor laws have precluded companies from doing the necessary restructuring as we have been able to do here in the U.S. – to our great benefit. Downsizing, layoffs, restructuring are all extremely painful but necessary for the long-term health of any competitive, constantly changing economy. Fortunately, as I pointed out, Europe’s macroeconomic picture is improving after two dismal years.
 
Re U.S. consumer debt, the stock of consumer debt has come down from its all-time high as you can see in this chart. That has occurred, yes, partially as a result of foreclosures, but principally from Americans using their rising aggregate income to spend less and pay down some of that debt.

 

 

 

In fact, the result of rising income combined with declining debt is today’s record-low Financial Obligation Ratio, next chart. This measure is the acid test of consumers’ ability to make discretionary expenditures – and it suggests that American consumers’ ability to cover the monthly “nut” and then some has rarely been better. It’s a Federal Reserve statistic and the numbers don’t lie.

 


 

 
With continued upward GDP growth in the US + the Eurozone + China  and with interest rates rising materially over the last couple of months - why have commodities in general been so weak?
I think what you refer to is linked to what I was saying about the Gold story. That is, the “Fed is printing money” that is ultimately going to cause rampant global inflation and currency debasement – that whole hypothesis – has been debunked. (Refer to what I was saying about the key difference between the Monetary Base and M2 Money Supply) Global inflation trends just keep heading flat to lower. There is zero wage push inflation – the key to inflation – anywhere in the world. The other part of the story is China’s attempt to move away from export-led, commodities-usage-heavy expansion, toward internal consumer demand-growth driven expansion. So, China’s voracious appetite for many commodities has slackened. It’s put Brazil and Australia, in particular, into very low growth mode as ore orders have fallen way off.

 

 

 

 

 
 
 
 

 

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