Buttonwood Center for Investor Education

Ready, Fire, Aim

2014-05-17T09:47:00.003-07:00

Todays “Intelligent Investor” by Jason Zweig starts out by quoting a money manager who says that, “the market is kind of dangerous right now. I’m nervous. I think it’s a really nervous time right now.” Nervous about what? The markets going to crash and we all are going to end up living on the street. The basis for all of this nervousness is the fact that the markets are at an all-time high. How many times have we been an all-time high? And that has always been followed by another all-time high. Zweig then asks the question, “are stocks cheaper or expensive? He then goes on to point out that the market is currently at 15.3 times earnings and that normal level is 14.7 times earnings. Do the math!!! That means that the market is .04% overpriced. It went down 1% on Thursday, so if that’s the case maybe the markets are undervalued? His remedy for this pending disaster is to look to overseas markets. So sell your portfolio of blue chip stocks, which will pay you a dividend this year of 3%, pay a commission, pay capital gains taxes and move into a new investment that maybe might be better than the one you have. Some things you can know and some things you need to know. You figure it out.

Big Cap

2014-05-16T07:45:00.000-07:00

The term big cap stock refers to the market capitalization of a specific stock. A stocks market cap is calculated by multiplying the number of shares outstanding by the current market price. The market cap of a stock simply represents the value of the stock in the open market and normally has no direct connection to the value of the underlying company. The usual definition of the big cap stock is one whose market cap exceeds $10 billion. Companies with market cap in excess of $10 billion would include approximately the largest 300 in the S&P 500. When purchasing individual stocks I would prefer to keep in the top 50 of the S&P 500 which will get you companies with market caps in excess of $40 billion. Really large cap stocks are in the $300 to $500 billion range.

Overlooked Reward

2014-05-15T07:34:00.000-07:00

There are two elements of the financial return that owners of common stock experience; capital gains and dividends. Dividends tend to be the ugly stepchild of the Financial Services Industry because they don’t make any money off of them. Last year, if you owned a portfolio consisting of entirely Dow component stocks you would have received a dividend payment in the neighborhood of 3.2%, nothing like the 31% return on the S&P 500, but nothing to scoff at. Your dividend return can never be negative and 3.2% compound that out over the course of one or two decades is significant. That compound in is even more significant when the dividend returns are reinvested back into your portfolio.

Makes Sense, But Does It Work?

2014-05-14T13:01:00.003-07:00

I have a friend who has a very nice portfolio of 25, low P/E, big cap stocks, all of which are in the top 50 of the S&P 500. He told me that he had some Caterpillar stock that had been doing really well and some Ford stock that has done poorly. He asked me if it was a good idea to sell the Caterpillar stock, since it had done so well and put it into the Ford stock because it might turn around. First problem, it’s in a non-tax sheltered account, so he would have to pay capital gains on the sale of the Caterpillar stock, reducing his gains. Using the same logic, another way to look at it is Ford is doing poorly and Caterpillar is doing well, so why not sell the Ford and put it into Caterpillar. On the surface, both ways seem to make a modicum of sense, but they rely on the ability to predict where Caterpillar and Ford are going to go. I have seen dozens and dozens of studies that indicate that even the professionals’ stock analysts have a very poor track record at predicting the short run movement of a stock. So why should a novice get the involved in this activity? The biggest problem most investors have is a belief that the market is rational and predictable, whereas studies prove that in the short run the movement of the market is random. We also have a century of data on the market which shows that in the long term markets continue to rise as the economy grows. So, since his portfolio mirrors the Dow, just sit tight and watch it grow.

Beating the Pros

2014-05-13T13:17:00.002-07:00

I have spent the last four years preaching that financial professionals and professional money managers underperform the market because the market is efficient and they charge too much. Last Saturday I found a surprising ally in The Wall Street Journal. In their Weekend Investor section there is any article entitled “You’re Paying Too Much in Fees.” It states that “Investors face an array of often excessive charges. Here’s how to get the most from your money.” It then gives the following two examples; “Return after 30 years on $200,000 invested in a mutual fund with annual fees of 1.25%, in 2013 will average $1.4 million. Return after 30 years of $200,000 invested in a stock ETF with annual fees of .04%, $2.0 million.”

P.S. Now review the post I made last Saturday which documented that investors who used actively managed expensive mutual funds and try to time the market did even worse than the expensive mutual funds.

What Goes Up Must Come Down

2014-05-12T10:47:00.000-07:00

With the Dow Jones Industrial Average currently at an all-time high, it is not unusual to see and hear comments about some form of a market pullback. Markets don’t just keep continually going up and up in a straight line. Their charts look more like saw teeth that a rocket trajectory. Several observations are appropriate at this point. First of all, stock prices in general are not at bubble prices levels and there is no indication of any speculative activity. Prices are only slightly above what many consider to be appropriate and P/E levels have not moved upward with the indexes with is the result of continual profit growth in the blue chip sector. Secondly, there is no evidence of a major structural issue as we saw during the subprime crisis when financial institutions and individual investors were buying securitized mortgages whose underlying values were about to decline rapidly. The most likely and healthy scenario is a 5% to 10% pullback from current levels. For those of you with 401(k) investments, the best course of action is to continue to make the monthly contributions and add those to the funds you already own.

Underperformance Doubled

2014-05-10T09:41:00.001-07:00

It is well documented that actively managed stock mutual funds underperform the market. A new study documents that members of the general public who use actively managed mutual funds perform even worse than the funds themselves. Dalbar, a financial research firm in Boston, has studied individual investor and market returns for the last thirty years. Their research showed that for that period, the S&P 500 stock index had an 11.1% annualized return. During that same period, investors in actively managed stock mutual funds had an average annualized return of 3.7%. Thus, investors underperformed the market by a 7.4% over the thirty year period. The primary reason for this discrepancy is that investors jumped aboard hot performing funds after they turn hot and bailed out of them when times turned bad.

Big Brother Is Really Really Watching

2014-05-06T10:18:00.002-07:00

FINRA, the regulatory body of the brokerage business is proposing a new electronic data collection system that would transform how the regulators scrutinize brokers. The proposed system would collect, on a weekly basis, on all activity at the more than 4,100 national brokerage firms. It will be looking for evidence that a firm or broker was trying to take advantage of client. These no no’s would include such things as excess trading or commissions, switching one mutual fund to another or over charging on bond trades. While this proposed system would make it easier for the cops to catch the bad guys, it also has the potential for some unintended consequences. Take the example of a fee based account where the broker has discretion to manage the assets. The broker may see no reason to trade in the account, but the regulators are going to be looking for activity to justify the fee. Knowing this, the broker may make trades they way feel are not warranted, but does so to satisfy the regulators. Another example of activity not driven by sound investment principles.

Smarter Than Buffett???

2014-05-05T11:49:00.000-07:00

In his latest Letter to Shareholders of Berkshire Hathaway, Warren Buffett reveals that when he dies he has directed his financial advisors to take the money that goes to his wife and put 90% of it in Vanguard's S&P 500 index fund. As part of the coverage that accompanies the Berkshire Annual Meeting, the Omaha World Herald did a story on this and asked several local brokers for their opinion. Their response was “that’s okay for Buffett, but not for the average investor.” Their justification for their position is that the average individual needs more diversification, revealing they don’t understand what diversification really is. Ownership in this index fund exposes the owner to 500 of the largest companies in the United States. The probability that even a small handful of them would go broke is highly unlikely. One element of the index approach that most of them did understand was that for this investment philosophy to be successful the investor must buy and hold and not panic and sell when the market drops. One more thing they know about this approach, they can’t make any money doing it.

Evolutionary Markets

2014-04-30T11:24:00.001-07:00

Over the weekend, I had a chance to visit with a friend of mine who had just retired after 30 years as a mutual fund portfolio manager. He had retired a bit earlier than the normal 65 and told me the reason for his early departure was because it had grown increasingly difficult to beat the market. The fund he managed was a plane vanilla fund that focused primarily on large cap stocks and was neither value nor growth oriented. He bemoaned the fact that when we work together back in the eighties and nineties it was fairly easy to find undervalued small to medium cap stocks that outperformed the market. But, in today’s environment, inexpensive stocks were almost impossible to find. What was a bit puzzling to me was that he had experienced a change in the way that the market operated, but didn’t seem to have any interest in either determining what had changed and probably more importantly, didn’t seem to think that the problem might be his methodology. Why am I telling you this? To me this is confirmation from a Wall Street type that over time the stock market evolves in the way that it operates. This evolution is seen in changes in who holds the assets and the methodology used to make investment decisions.

Market Timing 101

2014-04-28T11:53:00.003-07:00

I am seeing and hearing commentary about the market increasing in volatility and that we are headed for some kind of a pullback. That is a possibility, it is always a possibility. The $64,000 question is what should you do about it? I heard one commentator yesterday saying that it’s time to take a little money off the table. How much money is a little money? One third of your portfolio? One half of your portfolio or ninety percent of your portfolio? That means you may not lose money on the dollars you withdraw, but what about the money you “lose” on the money that is left in your portfolio? (Technically, you don’t lose money until you sell, but that story will have to wait until later). Let me walk you through the sell scenario because I have been down this path so many times before. You have made the decision to sell part of your portfolio because the market is going to correct. How do you decide when to sell? Coin toss? Sell immediately? Let’s play the game and pretend that you are smarter than 99.9% of all the people on the planet. You knew the day that the market was going to start going down and sold in response. What happens if you are wrong and it goes up? Time passes and the market goes down a bunch. When do you get back in? The usual a response I get is when it stops going down and starts to go up. When it goes up, you say it’s going to come back down again and we need to wait until a move up is real. Then all of a sudden the market is higher than when you got out. Now you have two choices; pay more than it than you sold it for and lose money or number two, never invest in the market again.

Rebalancing???

2014-04-25T10:02:00.002-07:00

I was recently asked by an individual, “How and when should you rebalance a buy and hold portfolio of individual stocks.” My first response was “Why. “To which the individual replied, “Well, because some of the positions have gotten much bigger than the others." Right off the bat, rebalancing on a calendar basis makes absolutely no sense. Secondly, the conventional wisdom is that you sell the ones that have been going up because they might not continue to go up and you buy the ones in been going down because there probably going to turn around and start going up. What about buying because they are going up and selling because they are going down? To me neither one seems to make much sense. Over the years I have seen dozens and dozens of buy and hold individual stock portfolios and strangely enough they seem to perform an awful lot like the market even though they are never rebalanced.

Mom And Pop Rush In

2014-04-24T07:12:00.002-07:00

This morning, the Wall Street Journal reported that during the first quarter of 2014 discount brokers reported a large increase in the trading activity of their clients. TD Ameritrade and Charles Schwab Corp., the two largest discount brokers, reported that their average daily volume increased 20% plus to roughly 700,000 shares a day. While a 20% plus increase in activity may sound like a big deal, when you put it in the context of the overall market that’s not even a sneeze. Normal daily volume on the 13 U.S. exchanges runs between 2 and 3 billion shares, so 700,000 shares is not about to propel the raging bull market. This is one further illustration that the individual investor trading their own account has no influence over the direction the market. Institutions rule and the only time mom and pop have any influence over the market is when they move in and out of mutual funds.

Reform Needed

2014-04-23T13:15:00.003-07:00

Recently, I was approached by a lady I know, who shall remain anonymous. She asked me if I would mind looking over here 401(k) and giving her some direction with the investment selection. She works for any large institution and I am guessing that she is a little bit past middle age. I looked at her statement, which had a modest sum of money in 12 different mutual funds. She asked me if I recognize any of them; I did not. Her employer, like many others relies on a very large mutual fund company to provide advice on the investment function of their plan. So, she was given an 800 number and told to contact the fund company. The fund company sent her a list of 200 funds to choose from. I told her to contact the mutual fund representative and see what they said. The response from the fund company was “Pick a couple of US funds, a bond fund and a foreign fund”. This poorly lady had no clue as to what to do next. What troubles me is that I’m pretty sure this story is reputed thousands of times every day.

Hedging Their Bets

2014-04-22T07:57:00.002-07:00

During the first quarter of 2014, investors continued to pour money into hedge funds resulting in an industry wide record of assets under management. Assets under management for the industry now stands at $2.7 trillion, which is almost double the amount the industry experienced in 2008. I think this shows the power of persuasion that the industry has over high net worth individuals. In 2013, the average hedge fund returned 9% while the S&P 500 gained 32 %, dividends included. Last year the average hedge fund charged a 1.54% management fee and 18.27% performance fee. The average index mutual fund charged 0.0 6% for the same period.

Scary Stuff

2014-04-21T12:33:00.000-07:00

The macho guys on Wall Street can’t stand plan vanilla and are always seeking new ideas to push off on the investing public. It has been reported that Blackrock Inc., T. Rowe Price and Fidelity Investments have been taking stakes in high profile startup companies, many of them in Silicon Valley. These are the kind of investments that either pay off big or go broke. Last year these three were involved in 16 private funding deals, up from nine such deals in 2012. So far this year, these three have closed 13 deals, putting the year on track to be the biggest ever. Nothing prevents mutual funds from buying pieces of startups, although the SEC limits them to having less than 15% of their portfolios in illiquid securities. The rules do not require immediate disclosure and the fact that these startups are privately held means that information about their fiscal condition is not available to the public.

Bubble vs. Pricey

2014-04-19T07:26:00.003-07:00

We’re starting to see stories that current Bull Market is long in the tooth and about to burst. It is important to make a distinction between being pricey and being in a bubble. When stocks are pricey it means that future returns are generally lower. A bubble means that stocks no longer have any connection to the real asset prices and the bursting of the bubble can result in price declines of over 50%. Is the stock market currently in bubble? Probably not? While the S&P 500 did gain 32% last year, the S&P 500’s Shiller PE is 25, which is higher than normal, but a long way from its dot com peak.

Until Proven Guilty

2014-04-18T07:08:00.003-07:00

Virtu Financial Inc. describes themselves as an electronic market making firm. They are in the middle of an Initial Public Offering, but announced yesterday that they are suspending their efforts indefinitely due to the controversy surrounding Michael Lewis “Flash Boys.” The Atty. General of the State of New York has subpoenaed a number of flash trading firms for information on their trading activities and he describes the strategies of some of these firms as “Insider Trading 2.0. I think it is way too early to pronounce a verdict on an operation that is not fully vetted. The rap on high frequency traders is that they have knowledge of market orders before the public does. How does that differ from the way the NYSE specialists operate?

Important Economic News

2014-04-17T08:35:00.003-07:00

The Wall Street Journal reported this morning that lending is on the rise at the sixth largest money center banks in the country. Earnings reports show an 8.3% increase in commercial lending for the first quarter over the same period a year earlier. Lending by the big banks has been a drag on economic growth and an indicator of pessimism by the banks and the corporate community. The increasing level of lending could be a change in attitude by both the banks and corporations and it is important because it could lead to increased spending on workers and equipment. The article also hinted it could also be an indication that corporations may be anticipating that interest rates may start to climb from their current rock bottom levels.

Bogle On Mutual Fund Performance

2014-04-16T10:49:00.003-07:00

Jack Bogle has written a journal article documenting his research on the impact that fees have on mutual funds performances. According to the article, fees and all of the costs associated with active trading reduce the investment returns of the average mutual fund by 2.66 basis points. Comparing this with a low-cost index fund, Mr. Bogle estimates that an investor using a passive investment approach would end up with 20% more income at retirement age. He also has some interesting data on the impact of investors attempting to time the market. During the last 15 years the average large stock fund earned 4.5%. The average investor, trying to be in the right place at the right time, had an average annual return of 2.59%.

Better Intellectually Than Empirically

2014-04-15T14:06:00.001-07:00

I’ve had conversations with dozens of people who ask me about a model their broker suggested to them that puts together mutual funds from different industrial sectors in the name of diversification. The implication is that by diversifying into different sectors you reduce risk. Intellectually it makes sense that when one sector suffers, others may fair better. It also is an opportunity for the broker to differentiate himself from his competitors and earn a few extra fees. From an intellectual perspective, I accept the argument, but recently I ran across data that indicates that since 2009, the 10 industrial sectors of the S&P 500 have averaged an 88% correlation to the index. This means that the sectors and the index move together 88% of the time and thus the costly diversification effort has little impact on portfolio volatility.

Seeing More Light

2014-04-14T12:26:00.002-07:00

I have run across to data points that are beginning to make sense of the notion that a selloff in tech stocks could lead to a 250 point decline in the S&P 500. The Wall Street Journal reported today that the class A shares of Google have declined 12% since the 1^st of March and that that movement accounts for 8.9% of the movement of the NASDAQ index. This make sense when you remember that the NASDAQ and the S&P 500 are cap weighted indexes and three of the biggest stocks in the NASDAQ are Google, Apple and Microsoft. Flip over to the S&P page and you will find that they are in the top 15. Because of their size they have influence which exceeds their number. Also remember that the is close to a $trillion in S&P 500 index funds so when the funds start to decline and nervous 401(k) owners liquidate, that further contributes to the decline in the index.

Shedding Some Light

2014-04-12T08:06:00.003-07:00

Jason Zweig’s column, along with a couple of others in todays’ edition of the Wall Street Journal shed a bit of light on what’s been going on the with the market this week. We do know that there was significant selling in some high flying tech stocks, but that does not explain the drop in the Dow and the S&P 500. One of the WSJ articles indicated that hedge funds were liquidating, not just tech stocks, but any stock they viewed as being risky. We know that the flash traders place orders for a small number of shares orders to discover whose buying or selling and at what price. Initially the small orders are filled which moves the market price and then when additional shares are sold the new lower price gets locked in and becomes the base price for the next round of selling. And remember that flash trading algorithms are pinging all stocks not just the techs.

Smoke And Mirrors

2014-04-11T08:20:00.003-07:00

Yesterday, the Dow Jones Industrial Average fell 266 points. An article in today’s Wall Street Journal attributes the drop to investors who dumped biotech and internet stocks because of the perception that they are currently overvalued. All but one of the thirty Dow stocks fell and none of them can be described as bio tech or internet related. Nothing changed concern thirty of the country’s largest corporations and yet they suffered the same fate as a handful of small cap stocks. This makes no sense to me now and never has. The only way to adequately describe what happened would have to include the role flash traded played in the e activity. Volume was normal and so it was not a rush to the exits by mad sellers. Computer algorithms are design to trade stocks in bundles of 100, so everybody in the bundle is treated the same.

Nothing New

2014-04-10T07:10:00.003-07:00

Since the signing of the Buttonwood Agreement in 1792, traders have sought ways to gain information on market activity before others did and then use that information to make a profit. In the early 1900s, traders paid to have ticket tape machines installed in their offices to find out about trades that were being placed before that information was available to the public. Starting in the 1970s, traders paid to have open phone lines between the floors of the New York Exchange and the Chicago Exchange again to get information about trading activity before others. When the New York Stock Exchange was a privately held company, traders paid millions of dollars for a seat on the exchange so they could be at the place where the trades occurred, again to have an advantage over those who operated off site. If my understanding of history is correct nobody thought ill of these practices, so why the fuss over high-frequency traders who are doing the same thing?