Random Glenings

My Mom's Eulogy - January 17, 2015

2015-01-10T16:02:00.001-05:00

I am glad to have the opportunity to share the story of my mom with you.

She was a remarkable woman.

Mary Lou Cuthbert was born on May 13, 1930 to James and Margaret Cuthbert. She was the youngest of four children.

Most of her years growing up were on Savannah Street, in downtown Detroit between Six and Seven Mile roads. Her grandchildren Michael and Caroline would later think it was "cool" that Grammy had grown up so close to the trailer park on Eight Mile Road popularized by rap star Eminem in the hit movie of the same name.

But reality of her early years were more ones of struggle and lean times.

My mom's father worked in the Water Department for the City of Detroit. The job did not pay particularly well. In fact, at one point at the height of the Depression, my grandfather received his pay in script rather than cash, redeemable for food and other necessities only at the company store.

Both of her parents were strict Southern Baptists. This meant, among other things, that her family were sworn to avoid such vices as drinking, dancing and using alcohol (her husband Ted later "cured" her of these beliefs). Sundays were a day of rest - no one in the Cuthbert household was allowed to do anything other than think about religion.

When World War II came, her older brothers went into military service, becoming pilots along the way. After the war, they returned home and started a flying school where people could learn how to fly airplanes. My mother volunteered to help them in various administrative tasks. She was eventually rewarded by her brothers with a gift of a piano, which sat in our home for many years.

My mom attended Cass Tech High School, hoping to become an engineer. However, in those days only two professions were available to women: teaching and nursing. My mom said she didn't like the sight of blood, so the choice was fairly simple.

But this doesn't mean that she didn't take her major seriously. She threw herself into her studies with the same determination that would characterize her in so many other endeavors later in life.

Many years later, when we were celebrating her 65th birthday, I asked my mom whether she had any regrets in her life. She said had only one (a remarkable statement, when you come to think about it).

Before each semester at Wayne University, her father borrowed $75 to pay her tuition. Why, she asked, did her father do this? In those days, women were not expected to work outside the home. The best they could hope for would be to meet some nice young man, get married and raise a family -just as my mom's mother had, and her mother before that.

Why did James Cuthbert - the son of a poor Irish potato farmer - think that life would be different for Mary Lou?

My mom said that she wished she had kept the cancelled loan papers that her father had signed to remind her of how much he believed in her.

It was at her time at Wayne that she met her future husband.

My mom was involved in a musical revue at college. At one point in the show she was part of a chorus line. The line was coed, alternating with men and women.

Her sister and mother told her that there would be a cute guy next to her in the line. They thought he would be a great catch.

So when she came home the night after the performance, her sister and mom were eager to know whether she had managed to get to know the young man in question.

Yes! my mom replied. Ted Glen seems like a great guy and we're going out on a date.

Her sister and mother were appalled. They didn't want Mary Lou to go out with some kid from Hamtramic who had been born with the name of Gajewski. She was supposed to have met the other fellow next to her named Grant Beard.

Well, it was too late. Ted and Mary Lou were smitten, and eventually decided to get married.

Her father, however, would not allow the marriage until she earned her degree.

So, in 1952, my mom graduated from Wayne, and shortly thereafter became Mary Louise Glen.

The next few years were a whirlwind. My father took a job at the DuPont Company in Wilmington Delaware shortly after they were married against the wishes of both sets of parents. Moving from the Detroit area was hard, but it was not the first move they would make.

Stops in Bridgeton, New Jersey; St. Louis, Missouri; Toledo (for the first time); Waynesboro, Pennsylvania; and finally Toledo again followed over the course of the next 16 years. There were also two summers in Houston, Texas, when my father worked for NASA.

And, oh yes: there were three children. John, Paul and David were born in measured succession, every two years (my Mom was always big on planning!).

We were lucky kids. Our parents were role models in so many ways, and the love and attention we received laid a strong foundation for our futures.

Through it all, however, my mom never gave up on her dream to be a teacher.

At every stop along the way, she found ways to continue to teach. It was not always easy with three small children, but my mom always found a way.

Later, when she completed her PhD dissertation, she dedicated it to the three of us. She thanked us for understanding her desire to be "more than mom". Frankly, I can never remember feeling left out because of her career, such was my mom's determination to be both a mom and a teacher.

Her dissertation, by the way, was titled "The Educated, Working Wife and the Division of Labor in the Household".

(Wonder where she got the idea?)

The years went by. Eventually we settled in Toledo in 1968, which is where my parents spent the rest of their lives. They both were professors at the University of Toledo: my Dad in the Engineering School, and my mom at the Community and Technical College (nicknamed "ComTech") that at the time was part of UT.

My dad was the first to get tenure, in the late 1960's. Then, in 1972, it was supposed to be my mom's turn. She was listed as the number one candidate for tenure when the list went to the President's office for final approval. But she was denied.

Why? she asked. She had done everything to deserve tenure.

Well, the answer came, the President and his staff felt that they should give the available tenure slots to men. After all, my mom's husband already had tenure, so she didn't need it as much.

Wrong answer.

In one of the few times I saw my mom angry growing up, she told the University that she was going to sue. The threat was enough to get them to change their mind, and she received the much-deserved tenure.

But mostly their lives in Toledo were pleasant.They joined the Toledo Country Club and became a regular part of the Club's social activities - a long way from their lower middle class upbringing.

My mom's first brush with cancer came in 1976. But in typical Mary Lou fashion, she not only faced down the disease but also used it as a spur to complete her dissertation.

I remember her saying at the time that if she going to die, she wanted to have at least completed her doctorate. You see, she had delayed completion while raising children, and now with her youngest child off to college she thought she would have time to complete her work. Cancer would have to wait - it was not going to stop her. And so it didn't.

My dad died suddenly in 1984. My Mom became a widow at age 54, just when it looked like the two of them would enjoy many long and glorious years together.

But you can probably guess what happened. Despite her grief, she forced herself back into life. She volunteered at a number of different organizations, including several years at a woman's prison.
She attended numerous professional conferences, often giving papers or speaking on panel discussions. And all the while she maintained a full teaching load, including summer school.

Travel also became part of her life. My Dad was not one for travel vacations. As it turned out, however, my mom very much was.

She estimated that she took over three dozen cruises, mostly on her own. Her favorite stop in the
Caribbean was St. Thomas, with its beautiful vistas and plentiful shopping. She loved visiting Hawaii to see Paul and his family. My mom also came to Boston fairly frequently, although she grumbled that the weather was usually cold and rainy.

My mom lived a wonderfully full and interesting life. When setbacks occurred, she fought back, determined to not let events dictate the course of either her career or personal life.

Before I stop, I wanted to share a few things about my mom that you might not have known:

She was a good cook, but her specialty was breaded baked pork chops. She also made a pretty mean chili;
She played golf for many years, and was an active part of the 9 hole group at the Toledo Country Club. Unfortunately, her game was uninspiring;
She took an interest in Beatrice Potter - author of the Peter Rabbit books - after reading stories to her grandson Michael. She enjoyed Beatrice so much that she used to dress up as the author and give talks to school kids while dressed in authentic costume. The props you see here in this room were part of her performance;
She was passionate about reading, and teaching others to read. She taught a speed reading course in the 1960's. In the early 1970's she started a program at Com Tech aimed at inner city adults to help them learn to read. Even in retirement she was part of the "Ohio Reads" program, which helped third graders get started;
In her later years, she wanted to make sure that the World War II vets received the recognition of their service before it was too late. She paid for several vets fly to Washington so they could visit the World War II memorial;
She once smuggled $1,200 in cash to rural Kenya to help the women there build a well. She knew that if she sent a check it would be lost in the corruption of Kenyan government. If there are any federal agents in the room, I'm sorry, it's too late;
She traveled to Moscow shortly after the fall of the Berlin Wall as part of a Junior Achievement group. One meeting included Boris Yeltsin. She also reported that Moscow winters were colder than anything she had ever experienced;
She was as comfortable with the minority community in the inner city of Toledo as she was at the Toledo Country Club. Only a week before she became ill she volunteered at the polling place near Scott Park, as she had done so many other times. She was the lone white registered Republican not only among the volunteers but the voters as well;
She loved her grandchildren Michael, Caroline and Roni with a passion. Usually our Sunday morning conversations were mostly about their activities - I guess my mom felt that I was too late to help.

I want to leave you with one final anecdote. I doubt I will make it through without tearing up, but it illustrates so much of who she was.

Two weeks ago, my mom made the decision that further medical intervention was pointless, and she wanted to end her life with the same dignity and courage that she had exhibited in her 84 years on this planet.

I followed the ambulance that transported her to hospice, and was waiting when they opened the doors to take her inside.

I must have looked pretty sad. My mom saw me, shrugged her shoulders with a wry grin and waved at me. She wanted to let me know that she loved me, and was comfortable with her decision. Later, when I sat by her bed to try to offer comfort to her, instead she thought only of me, and told me to go have dinner - she would be fine.

At the time when she was facing death, her only thought was of her son. We all should experience such a love.

Godspeed Mom.

Mary Louise Glen

2015-01-10T08:09:00.001-05:00

My mom passed away earlier this week. She had been ill for some time.

As it turned out, I had read a book called Being Mortal written by Dr. Atul Gawande in early November. The book was terrific in helping me face the issues my family has been dealing with in the past few days. I thought I would write the Doctor an email, which is shown below.

Dear Dr. Gawande,

I am sure you get hundreds of emails like this, and so I doubt you will even see this.

Still, if you do, I wanted to let you know how much Being Mortal meant to me.

I read your book in early November. It is a terrific read on a difficult subject, and I told several friends and colleagues about it.

Then I got the call that I dreaded. My mother was admitted to the hospital with esophageal cancer on November 15. Even though she was 84 years old, she had been in generally good health for most of the past few decades. My grandmother had lived to 102, so the combination of good health and genetics seemed to bode well for many more years of life.

Unfortunately, that did not turn out to be the case. My mother’s health quickly deteriorated. Scheduled radiation and chemo therapies were delayed with the hope that she would get stronger.

Then her feeding tube became clogged, and she was readmitted to the hospital to try to insert a new one.

However, as you well know, this procedure on an older woman in failing health can be tricky. With the help of my brother (who is also a doctor), my mother’s medical team discussed the alternatives with my Mom. She told them that she did not want to go through any more medical treatments. After living a very full and productive live, she wanted to end her days with dignity.

While logically this was the right decision, it was difficult for me to accept. The stories from your book – particularly about your daughter’s piano teacher – helped me understand that often it is better for a person to end their lives doing what they love.

Your book helped me to not only understand what was going on, but also to realize that even our advanced medical skills cannot prevent death.

Last Friday, acting as her health care POA, I signed the papers to send her to hospice. My mom was still lucid enough to understand what was going on, and so we talked for a while longer. I followed her ambulance to hospice.

When they pulled her out of the van, I was standing there waiting. She smiled at me and waved. Even so close to death, my mom wanted to let me know that she loved me, and that she was comfortable with her decision.

My mom died three days ago. I miss her terribly, but I am proud of the way she faced the end.

I apologize for the length of this email, but I wanted let you know how much your work meant to me.

Thanks, Dave Glen

Good Bye for Now

2013-12-17T09:38:00.000-05:00

Me, Michael and Christina - October 2013

A number of years ago I ran across a quote in the newspaper from the novelist James Michener.

It impressed me so much that I cut it out and carried it in my wallet until it was tattered and worn:

Southern Florida is filled with people who are 65 years old who wanted to do something big in their lives but wanted to wait until it was safe. Now it is safe and they are 65 years old.

Yesterday I left my employer of 14 years for another opportunity at a money manager here in Boston. My first day is tomorrow.

Unfortunately my new company does not (yet) allow me to continue to blog, so I will be temporarily suspending Random Glenings. Hopefully I can convince them to change their policy soon.

In the meantime, I wish you only the very best of holiday seasons!

Tom Keene and "The Adult 401(k)"

2013-12-12T10:24:00.000-05:00

Regular reader Rich Sipley passed along this good piece from Bloomberg Editor-At-Large Tom Keene.

With stocks having rallied so strongly this year, and doubled over the past five years, the air is thick with predictions of a coming correction in the next few months.

Perhaps. Markets don't move in one direction, and the possibility of profit-taking in the near future seems reasonable (I would even suggest likely).

However, as Keene writes, market corrections are part of investing in stocks. For someone saving for retirement, or has a longer time horizon than just a few months, stocks should continue to play an important - if not the only part - of an investor's portfolio.

Here's what Keene wrote:

My Big Idea for 2014 is for me, and perhaps you, to grow up and understand that declines in equity markets happen. Ten percent south is a correction; a drawdown of 18% is a bear market and, that jewel of an index fund in my 401(k) collapsed 55%+ from the nirvana of 2007 to the we're-all-gonna-die of March 2009.

In short, I need to get smarter and less childish about my retirement finances. Next year is The Year of the Adult and adult begins with withstanding some measure of loss in the stock market.

http://www.linkedin.com/today/post/article/20131210122858-205519992-big-idea-for-2014-the-adult-401-k?trk=cha-feed-art-title-5813860289242095616

Keene's comments are backed up by the chart of the S&P 500 over the past three decades that I have posted above.

As you can see, the march of the S&P 500 from 163 in December 1983 to nearly 1800 in December 2013 has not always been a straight line. But for investors that simply held on, their accounts gained ten-fold, not including dividends.

The Year of the Adult 401(k) indeed.

What's Ahead for Small Cap Stocks?

2013-12-11T10:32:00.000-05:00

I had the chance to go hear Lori Calvasina, Small/Mid Cap US equity strategist at Credit Suisse yesterday.

Smaller stocks have been on a tear for the last few years, and have handily outpaced the performance of their larger cap brethren.

Through the end of November 2013, for example, the S&P Small Cap index is up +42% for the past 12 months compared to the S&P Mid Cap index +30% for the same period. Meanwhile, the S&P 500 is "only" up +27% over the past year.

Longer term, as the chart above shows, small and mid cap stocks have risen +60% more than larger cap stocks over the past 5 years.

The question I had for Lori:

Can this continue into next year?

First, some background. After their recent run, the valuation of small and mid caps stocks is very rich by historic standards. Here's an excerpt from an article posted on Yahoo Finance written by Michael Santoli (I added the emphasis):

The Leuthold Group, which has tracked stock-market mechanics and fundamentals since 1981, has lately characterized what we’re witnessing as perhaps “a final gasp in small-cap leadership.”

The firm calculates that, based on a variety of measures tied to underlying company profits and balance sheets, small stocks trade at roughly a 40% premium to the S&P 500 – essentially as pricey as they’ve been in the “modern era.” ...

Then there’s the Value Line Median Appreciation Potential gauge, which has served as a broad guide to equity-market opportunities since the 1960s. Value Line tracks some 1,700 stocks through mostly quantitative analysis of a company's past and projected earnings and its shares’ valuation, calculating for each one how they might perform over the next three to five years. The Median Appreciation Potential, updated weekly, is simply the median of the percentage gains expected for all stocks covered.

Because it keys off the median of such a large set of stocks, it tends to reflect smaller-stock prospects. It just fell to a 45-year low, meaning the projected upside over the next three to five years hasn't been this poor since 1968 – the peak of a huge small-cap cycle, which gave way to a nasty downturn as huge blue chips did well for a couple more years. Today’s level of the VLMAP score is a bit below those of April 1998 and July 2007, which were great times to lighten up on smaller stocks.

http://finance.yahoo.com/blogs/michael-santoli/small-stocks--leaders-for-years--now-face-growing-risks-135421017.html

Lori agreed that it would seem logical that the relative outperformance of smaller stocks is due for a correction.

She noted that larger caps could benefit from the apparent recovery in Europe and Asia, since a much larger percentage of larger company revenues tend to come overseas. Moreover, if the entire market "corrects" at some point in 2014, the fact that larger cap stocks are trading at a much lower valuation could provide more downside support.

However, Lori also thinks that the longer term case for smaller stocks remains intact. It's not really so much that she is "talking her book", since she was a large cap strategist for Citigroup for 7 years before joining Credit Suisse.

Instead, she argued that the sheer size of the large cap stocks makes it mathematically more difficult for them to outperform over an extended period of time absent a major change in valuation similar to the late 1990's period.

In short, while Lori would suggest moving up in market cap positions from a tactical strategy, she would continue to view smaller and mid cap stocks as the best place for longer term investors.

BlackRock Turns Cautious

2013-12-10T10:08:00.002-05:00

When the world's largest money manager turns cautious on the outlook for stocks, you probably should listen.

Featured on the cover of this week's Economist magazine, BlackRock manages $4.1 trillion, which makes the largest investor in the world. Although a good portion of its asset management business is in passively-managed index funds, BlackRock also houses a $1 trillion active management area.

Nearly three years ago, in the early part of 2011, BlackRock CEO Larry Fink hit the media circuit with the word that investors should be buying stocks. Here's an excerpt from a March 24, 2011, piece that appeared on the CNBC website:

BlackRock CEO Larry Fink isn't surprised by the recent climb in U.S. equities, as the asset class remains "very cheap," he told CNBC Thursday.

Speaking from the trading floor of BlackRock —which with more than $3 trillion in assets under management stands as the world's largest money manager—Fink said the U.S. equity market remains one of the "most under-invested" asset classes today.

"People have underinvested in U.S. equities for years—people have over-invested in fixed income," he said. The long-running rally in fixed-income, Fink added, has left equities "very cheap versus where credit spreads are."

http://www.cnbc.com/id/42254264/US_Equities_Are_Cheap_Under_Invested_Larry_Fink

This courageous call was, of course, absolutely correct: the S&P 500 has risen+45% in the past three years.

BlackRock just published its 2014 investment outlook. While it is not necessarily recommending that investors sell stocks, it does point out that the twin engines of stock market growth over the past few years - central bank liquidity and valuation expansion - are not likely to be as helpful in the coming year.

Here's an excerpt from financial columnist Ambrose Evans-Pritchard of the London Telegraph reported on BlackRock views:

BlackRock, the world’s biggest investor, has warned that central banks are poised to tighten monetary policy in the Anglo-Saxon countries and China, advising clients to be ready to pull out of global stock markets at any sign of serious trouble.

“2014 is the year to squeeze more juice out of risk assets. But investors should be ready to discard the fruit when it starts running dry,” said Ewen Cameron Watt, chief strategist for the BlackRock Investment Institute.

The group said in its 2014 Investment Outlook that investors have “jumped on the momentum train, effectively betting yesterday’s strategy will win again tomorrow”, but vanishing liquidity could leave them trapped if the mood changes. “Beware of traffic jams: easy to get into, hard to get out of,” it said.

http://www.telegraph.co.uk/finance/economics/10507003/Worlds-biggest-investor-BlackRock-says-US-rally-nearing-exhaustion.html

Here's a link to the full BlackRock Institute Report:

http://www.blackrock.com/corporate/en-us/literature/whitepaper/bii-2014-outlook-international.pdf

I am typically not a fan of "year ahead" forecasts - so many times they are wrong - but given BlackRock's track record and asset size it is certainly worth considering their views.

Employment Blues

2013-12-09T11:03:00.001-05:00

Last Friday's unemployment report was slightly better than most analysts had expected. The markets initially rallied sharply, but most indices ended the day essentially unchanged.

The official unemployment rate now stands at 7%, which is the lowest level in 5 years. Here's what the New York Times reported:

Employers have hired at least 200,000 workers in three of the last four months, including 203,000 in November. By contrast, as recently as July, when the economy seemed stuck in yet another summer swoon, only 89,000 new jobs were created...

The 7 percent unemployment rate last month — down from its most recent peak of 10 percent in October 2009 — is the best reading since President Obama took office, providing one bright spot for a White House beleaguered on many other fronts. The unemployment rate was 7.3 percent in December 2008, the month before Mr. Obama was inaugurated.

http://www.nytimes.com/2013/12/07/business/economy/us-economy-adds-203000-jobs-as-unemployment-falls-to-5-year-low.html?_r=0

However, relative to history, unemployment rates are unacceptably high.

I started After the Music Stopped: The Financial Crisis, the Response and the Work Ahead (New York: The Penguin Press, 24 Jan. 2013. ISBN 978-1594205309) last week.

Written by former Federal Reserve Vice Chairman Alan Blinder, the book has been cited as one of the best reviews of the 2007 - 2009 credit crisis.

So far, at least, I agree with the critics.

One of the points that Blinder makes early in his book is the tepid state of the current economic recovery. While the stock market has doubled from the March 2009, the economic recovery has been incredibly weak by historic standards.

Here's an excerpt from Blinder's book talking about unemployment (emphasis his):

During the quarter century from February 1984 through January 2009, Americans never witnessed an unemployment rate as high as 8 percent for even a single month. An entire generation entered the labor force and worked for decades without ever experiencing an unemployment rate as high as the lowest rate we had from February 2009 through August 2012....even unemployment rates above 7 percent were rare during this twenty-five year period.

So with Blinder's book in mind, I turned to the Federal Reserve of St. Louis to get more information on the current employment situation.

Unfortunately, I think I am seeing Blinder's point.

Look, for example, at the size of the total civilian workforce. Yes, it is up considerably from the lows five years ago, but still slightly lower than it was in 2007:

Labor participation rates are considerably lower as well. Even for workers with college degrees - normally considered the most "employable" - are considerably lower than a generation ago:

Not surprisingly, then, real income growth remains anemic:

The question that Wall Street economists are debating is when the Fed begins to "taper", i.e., reduce its presence in the credit markets.

Based on the current employment data, this date might be further away than many anticipate.

Peter Lynch on Investing

2013-12-06T09:43:00.000-05:00

Investment legend Peter Lynch appeared was interviewed by Charlie Rose earlier this week.

Peter Lynch, of course, produced one of the best investing records of our generation when he ran the Magellan Fund for Fidelity. From 1977 to 1990 Magellan produced an annual compound return of over +29% per annum.

Lynch retired in 1991 to focus more time on his family and philanthropic activities. However, he still remains one of the most astute and thoughtful investment voices in the business.

The interview runs almost 24 minutes, but it is well worth your time.

Lynch was always a proponent of "invest in what you know". As he discusses in the interview, if you truly understand the business any declines in prices are viewed as opportunities rather than cause for concern.

He dismisses any idea that successful investing in stocks can be gleaned from a careful reading of economic data - focusing on company fundamentals is the path for success.

Towards the end of the interview Rose asks Lynch for his views on the current market.

His answer was fairly simple: stock prices follow earnings, and earnings should continue to grow at +7% to 8% for the next few years. While he said he had no idea what the market would do in the next couple of years, investors with a longer time horizon would be well-served to simply stay invested.

A "Taper" In a Teapot?

2013-12-05T09:31:00.002-05:00

Stephen Antczak of Citigroup is out with an interesting research piece this morning on tapering.

Market participants have been worried for most of the year about what will happen when the Fed gradually starts withdrawing (i.e.,"tapering") its active in the credit markets.

In June of this year, for example, interest rates jumped higher, and the stock market moved lower, when Fed Chair Bernanke suggested that the Fed might start gradually reducing its bond buying program. Although Bernanke later claimed that his remarks were misinterpreted, many investors viewed the negative market reaction in June as a harbinger of things to come.

Antczak gives three reasons that Citi believe that fears over tapering are overblown:

Net Treasury issuance in 2014 is projected to be at its lowest level since 2008 as the federal deficit gradually declines. Meanwhile, $1.4 trillion in Treasury debt is set to mature next year, and it is likely that a large chunk of these funds will be plowed back into the government bond market;
The amount of attention to tapering has dramatically increased in recent months. Citi's research indicates that nearly 300 stories a day have been written on the market effect of tapering compared to almost none at the beginning of the year. With so much attention being paid to the issue, perhaps market prices already reflect the beginning of tapering;
Following on point 2, Citi looked back at prior periods when interest rates on Treasury debt moved sharply higher. They found that corporate bond yields did not move up nearly as much as Treasury yields, meaning that the net effect of a rise in government interest rates would not be felt as much by corporate bond investors even if rates rise when the Fed begins to taper.

The more I study this issue, the more I am inclined to agree with Citi. Perhaps the initial reaction to a Fed tapering announcement might be negative, but the Fed will probably not move until the economy shows solid signs of improvement.

In other words, if the Fed is beginning to leave the credit markets, corporate America is probably chugging along with enough steam to generate earnings growth that will support current market levels.

For your reference, I last wrote about tapering at the end of October 2013. I referenced an interview with Nobel laureate Eugene Fama who also believed that tapering will essentially be a non-issue. Here is an excerpt from my Random Glenings piece dated October 30, 2013, with the link below:

Nobel Prize winner Eugene Fama was interviewed by CNBC's Rick Santelli earlier this week.
In his usual hysterical fashion, Santelli was trying to get Fama to say that interest rates were set to soar once the Fed ends its "Quantitative Easing" (QE) program.
Problem was, Fama doesn't believe it.
As you will see from the interview, Fama notes that he has been doing research on the possible effects on the credit markets once the Fed starts reducing its holdings of longer term Treasurys.
Fama doesn't believe the markets will be as roiled as Wall Street believes once the Fed stops buying.
He points out that the purchases of Treasurys have been financed by the Fed's borrowing activities in the short term market. Thus, the $4 trillion in Treasurys that it holds have been financed by $4 trillion in borrowing. Reducing one side of the ledger also reduces the other side, so the net effect should be relatively neutral.

http://randomglenings.blogspot.com/2013/10/eugene-fama-on-fed-tapering-its-net.html

Waiting for Godot: Timing the Next Market Correction

2013-12-04T15:32:00.000-05:00

I've been having numerous conversations with clients about the stock market this week.

Most people are aware that stock markets will "correct" over time. This is not a particularly bold prediction. J.P. Morgan's Paul Quinsee pointed out to clients recently that this year is unusual is the lack of a serious market decline at any point during this year.

Here's a chart he prepared which showed that although markets typically experience some turbulence, returns have been mostly positive for the past three decades:

source: http://www.businessinsider.com/stock-market-intra-year-decline-chart-2013-12

Longer term, however, is the question of whether the market is seriously overvalued after its recent run.

As I have been writing in numerous posts over the past couple of months, most investors are uneasy with the disconnect between a sputtering economy and a roaring stock market. While it is only anecdotal evidence, there is very little sign of "irrational exuberance", at least as far as I can tell.

Bears will point to the very high multiples accorded to recent internet company valuations. However, for the overall market, it is hard to make a case that most stocks are overvalued.

Stocks on an absolute basis relative to history are probably no better than reasonably valued. Here for example is one historic chart courtesy of analyst Doug Short:

Source: http://www.advisorperspectives.com/dshort/updates/PE-Ratios-and-Market-Valuation.php

I continue to believe that the clues to the next serious market problem will be found in the bond market.

Most of the serious bear markets over the past few decades have had their origins in the credit markets. When credit becomes tight - either through central bank activity or just general market fears - business activity grinds to a halt, and brings down earnings.

We are far from a tight credit markets today. Corporate borrowers continue to find a ready group of buyers for new bond issues, almost regardless of credit quality. Municipal bonds too are in strong demand, particularly for shorter maturity paper.

I fully expect that we will see a market correction in the coming months, but only because stocks have been on such a roaring uptrend in 2013.

The Great Expansion

2013-12-03T11:43:00.002-05:00

source: Federal Reserve Bank of St. Louis

In my memory, 1974 was not a particularly happy year.

President Nixon resigned in August 1974 in the aftermath of the Watergate scandal. He left behind a country that was about to see its decades-long military effort in Vietnam collapse. Inflationary pressures were continuing to build, pushing prices ever higher. The mood of the country was sour.

Yet an article published over last weekend contended that 1974 was actually a year that U.S. workers should celebrate.

Harold Myerson wrote a long article for American Prospect that pointed out that 1974 marked the end of a long-term trend that had started after World War II which had seen a steady rise in middle class wages and living standards.

The upper income class had not benefited to the same degree as the middle class, which meant that the wage differential between the higher paid and lower paid workers had narrowed considerably:

Since 1947, Americans at all points on the economic spectrum had become a little better off with each passing year. The economy’s rising tide, as President John F. Kennedy had famously said, was lifting all boats. Productivity had risen by 97 percent in the preceding quarter-century, and median wages had risen by 95 percent. As economist John Kenneth Galbraith noted in The Affluent Society, this newly middle-class nation had become more egalitarian. ...Economists have dubbed the period the “Great Compression.”

However, as Myerson writes, 1974 marked the end of the improvement in real wage gains for most Americans. For the next 40 years, wage and wealth gaps would widen enormously:

Then, it all stopped. In 1974, wages fell by 2.1 percent and median household income shrunk by $1,500. To be sure, it was a year of mild recession, but the nation had experienced five previous downturns during its 25-year run of prosperity without seeing wages come down.

What no one grasped at the time was that this wasn’t a one-year anomaly, that 1974 would mark a fundamental breakpoint in American economic history. In the years since, the tide has continued to rise, but a growing number of boats have been chained to the bottom. Productivity has increased by 80 percent, but median compensation (that’s wages plus benefits) has risen by just 11 percent during that time. The middle-income jobs of the nation’s postwar boom years have disproportionately vanished. Low-wage jobs have disproportionately burgeoned. Employment has become less secure. Benefits have been cut. The dictionary definition of “layoff” has changed, from denoting a temporary severance from one’s job to denoting a permanent severance.

http://prospect.org/article/40-year-slump#.UpnnWfSn9h4.twitter

In other words, the "Great Compression" of the post-war period has turned into the "Great Expansion". Wage and wealth gains have been largely concentrated in the upper income category, while most workers have not participated.

In a fairly heartless fashion, the stock market has apparently taken note of the lack of wage growth and moved steadily higher. Investors are cheered by the fact that while top line growth has been meager, margins have remained at record highs, allowing for profits to continue growing.

Here's what Bloomberg reported this morning:

The weakest employment recovery in seven decades is proving a boon to equity markets.

Five years into a rally that has restored $14 trillion to share prices, U.S. payrolls remain 1.5 million below the level in 2008, according to data compiled by Bloomberg. Resistance to hiring from ConocoPhillips to Walt Disney Co. (DIS) will help push Standard & Poor’s 500 Index profit margins above 10 percent next year, the highest ever, data show. Below-average employment was cited last month by Federal Reserve chairman nominee Janet Yellen as the biggest obstacle to raising interest rates.

While American workers struggle, investors are benefiting as expense reductions and record low borrowing costs drive profits and underpin a 167 percent advance in the S&P 500 over the past 57 months. To bulls...{this means that} equities will keep rallying as long as the Fed remains more concerned about employment than inflation.

http://www.bloomberg.com/news/2013-12-02/bull-market-shows-no-sign-of-death-with-yellen-support.html

Jeff Bezos on CBS's 60 Minutes - 12/1/13

2013-12-02T13:56:00.001-05:00

Why Amazon Has Been So Successful

2013-12-02T13:50:00.001-05:00

I just finished reading The Everything Store: Jeff Bezos and the Age of Amazon.

Written by Bloomberg technology reporter Brad Stone, the book is a terrific read.

While some have disputed some of Stone's facts (most notably, Jeff Bezos's Mackenzie has written a very negative review which is posted on Amazon), the overall story is an incredible one. Little wonder that the Financial Times named it "Business Book of the Year for 2013".

The focus of the book is on Jeff Bezos and his relentless drive to have his company succeed in becoming the largest internet retailer in the world. While Bezos is portrayed as a demanding boss, he is also given well-deserved credit for being a true visionary in seeing the opportunities in internet retailing.

Bezos is compared to a chess player who plays a number of different games at the same time. He is constantly thinking of the next step necessary to keep ahead of the competition and add more sales to his multi-billion dollar company.

I was reminded of this last night, when the CBS news program 60 Minutes carried a feature story on Amazon which featured an interview with Bezos.

The major news story from the piece was the announcement that Amazon is considering using small drones to deliver packages to customers. In the interview Bezos argues that the day when a small package arrives at your door could happen as soon as 2015.

http://www.cbsnews.com/test

Cyberspace instantly went crazy. The idea of small aircraft whirring around the neighborhood with five pound packages to be delivered seems too implausible to be believed. Moreover, as Bezos himself acknowledges in the interview, the FAA has to date not been all that keen on allowing unmonitored aircraft into the air.

However, it could also be that Bezos knows this all too well. Perhaps he was using the 60 Minutes appearance to promote Amazon for free at the beginning of the holiday shopping season. In addition, by highlighting such a futuristic vision, he could very well have been trying to change the image of Amazon from a huge on-line retailer to a cool technology company.

The blog Business Insider (partly, by the way, by one Jeff Bezos) seems to agree with my assessment that perhaps Bezos - in typical fashion - was thinking far ahead of delivery drones:

The fact is, there is a very good chance that, last night, Amazon "announced" a service that will never exist in reality.

Why did Amazon do that?

The answer is free advertising. Even better: free advertising the night before the biggest e-commerce shopping day of the year, Cyber Monday.

How much was that free advertising worth?

"60 Minutes" gave more than 15 minutes to its Amazon story. A 30-second spot during the 7 p.m. show usually costs just over $100,000.

If you figure Amazon got 30 30-second commercials' worth of time, you can estimate that it got about $3 million worth of "earned" media.

But $3 million is probably a very low estimate. That's just the cost Amazon would have had to pay to reach "60 Minutes'" 13 million viewers. Thanks to all the coverage Amazon Prime Air has gotten in other outlets, many more millions of people are talking about the company today.

In short, you don't get to be Jeff Bezos without being pretty smart.

Age as an Asset: The Older You Get, the Better the Investor You Become

2013-11-27T09:32:00.001-05:00

In October 2008, a 78 year-old investor working for a reinsurance company out of Omaha, Nebraska, wrote an editorial for the New York Times urging investors to ignore the frightening news of the day and move assets into stocks:

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

http://www.nytimes.com/2008/10/17/opinion/17buffett.html?_r=0

The author of the piece, of course was Warren Buffett.

Although his market call was early - stocks would not actually bottom until March 2009 - investors who had heeded his advice would today seen the value of their portfolios double, as the chart above shows.

Investing is one of the few areas where age can be an asset. If you have followed the markets for a long period of time, you realize that while fluctuations in the market are inevitable, the longer term trend for stocks in the U.S. has been higher for nearly all of our country's history.

I have been working in the investment field for nearly 32 years. When I started in the business in January 1982 the Dow Jones Industrial average had just regained the 1,000 market. Today it stands at 16,000.

To be sure, there have been numerous "hiccups" along the way. But the longer term trend for stocks was higher, as it surely will be for the next 32 years.

Investing in stocks for the long run was also the mantra for a man named Alfred Feld. Feld started at Goldman Sachs in 1933, but eventually made his way to the investment management area where he worked for 80 years.

Feld died earlier this week, and today's Wall Street Journal carried his obituary. According to the Journal, Feld preferred blue chip stocks for his clients. He was also prescient to have avoided the technology bubble of late 1990's.

Away from the markets, Feld apparently was a fitness devotee as well as an investor. He felt that his work at the gym contributed to his long tenure as a trusted advisor:

In a 2003 interview with the Journal, when Mr. Feld was 88, he still worked four days a week and worked out regularly with a personal trainer in the Goldman gym. He said one of his main concerns was outliving his 40 or so clients.

“I see a lot of out-of-shape people here, and they would have a real hard time keeping up with him,” his trainer said at the time. “The first time I worked out with Al, he complained I didn’t do a good enough job working him because he wasn’t sore the next day.”

http://blogs.wsj.com/moneybeat/2013/11/26/alfred-feld-who-worked-at-goldman-80-years-dies-at-98/?KEYWORDS=alfred+feld

Bubble, Bubble - Where's the Real Bubble?

2013-11-26T09:21:00.003-05:00

Writing for the blog Seeking Alpha, contributor Wade Slome compiled an excellent montage of recent press headlines on the steady climb of the stock markets.

It has been a common theme in recent weeks that stocks are in a "bubble". The argument is made that much of the recent market rise is due to investors irrationally ignoring a tepid economic environment and troubled political environment. These pundits argue that the day of reckoning is close at hand, and stocks are set for a nasty tumble.

Problem is, it is hard to find much evidence of investor euphoria.

Here's a compilation of recent headlines that Slome put together for his post:

http://seekingalpha.com/article/1860231-confusing-fear-bubbles-with-stock-bubbles

Here's the lead paragraph from Slome's article:

With the Dow Jones Industrial Average approaching and now breaking the 16,000 level, there has been a lot of discussion about whether the stock market is an inflating bubble about to burst due to excessive price appreciation? The reality is a fear bubble exists…not a valuation bubble...

Volatility in stocks will always exist, but standard ups-and-downs don't equate to a bubble. The fact of the matter is if you are reading about bubble headlines in prominent newspapers and magazines, or listening to bubble talk on the TV or radio, then those particular bubbles likely do not exist. Or as strategist and investor Jim Stack has stated, "Bubbles, for the most part, are invisible to those trapped inside the bubble."

Bubbles occur when market prices diverge wildly from economic reality, and investor fears are nonexistent.

It seems more likely that much of the gains from 2009 reflect a market recovering from a vastly oversold condition.

Yes, market averages are higher than in 2007, but corporate America and the overall economy are also much larger.

Markets never move in one direction, so a correction of -10% or so would not be totally surprising. However, for the longer term investor, it would seem that this would represent an opportunity rather than a cause for panic.

Two Charts to Explain Why The Market Keeps Moving Higher in Spite of a Weak Economy

2013-11-25T09:57:00.002-05:00

The Federal Reserve Bank of St. Louis has a website that is an excellent source of data and graphs.

Nicknamed "FRED" (for "Federal Reserve Economic Data"), the site provides "154,000 economic data time series from 59 national, international, public, and private sources" which is more than enough to satisfy even the most wonkish analyst.

Here's the link:

http://research.stlouisfed.org/

FRED was recently updated, so I spent a little time this weekend on the site looking at some of the charts.

Here were two that caught my eye. In my opinion, they provide most of the explanation for the apparent disconnect between anemic economic growth and the relentless rise of the stock market.

As we all know, the Federal Reserve has been aggressively adding monetary stimulus to the economy. This chart illustrates just how large the stimulus has been in the past few years:

If you look carefully, you can see the Fed has added almost $4 trillion to monetary stock since 2009. This is roughly the same amount that the entire M2 money supply had reached in the year 2000.

Unfortunately for the economy, most of this monetary stimulus has been squirreled away.

The velocity of money - which measures how the rate at which a unit of currency is used to purchase goods and services within a given time period - is at all-time lows:

In times gone by, money added to the economy would have spent on consumption and investment, which would eventually lead to stronger economic growth and more employment.

However, these are unusual times. Instead of leading to an uptick in the economy, the Fed's increase in money supply is being simply added to the bond and stock markets.

Yields remain low, stock prices move higher, but the real goal of the Fed's activities (economic growth) is not being achieved.

OMG! Larry Summers Changed His Mind!

2013-11-22T12:59:00.001-05:00

When the facts change, so do my opinions. What do you do, sir? -John Maynard Keynes

A number of blogs and media sources are noting that the "secular stagnation" economic views aired by former Treasury Secretary Larry Summers are different than the opinions he held just a few years ago.

Fairly typical is a lengthy post from an economic blog called "This is Ashok" that the Financial Times featured in a link posted on an email this morning.

The blog goes back to 2011 when Summer was apparently much less concerned than other prominent economists about the future growth potential of the United States.

At that time Summers dismissed any notion that the U.S. was facing any sort of stagnant economy that carried the serious threat of deflation similar to what Japan has experienced over the past two decades. Quoting from remarks in November 2011:

It will take time. There are steps that need to be taken but we are a society that works. We are a society whose principle problems — we all up here agree — can be addressed by a change in the printing of money and the creation of infrastructure. That is not the kind of fundamental problem Japan has.

http://ashokarao.com/2013/11/21/the-evolution-of-larry-summers/

Earlier this month, however, Summers appears to have changed his mind, and now questions whether we could indeed learn something from the Japan experience. Quoting from his IMF speech:

“Even a great bubble wasn’t enough to produce any excess of aggregate demand…Even with artificial stimulus to demand, coming from all this financial imprudence, you wouldn’t see any excess.”

“The underlying problem may be there forever”

“We may well need in the years ahead to think about how to manage an economy where the zero nominal interest rate is a chronic and systemic inhibitor of economic activity, holding our economies back below their potential.”

http://ftalphaville.ft.com/2013/11/18/1696762/summers-on-bubbles-and-secular-stagnation-forever/

Now, I am not trying to defend Larry Summers, or anyone else for that matter.

But I would point out that this seems to be a natural tendency in the financial press.

If you express one particular view at a given point in time, you are held to that position regardless if circumstances have changed.

This was a problem that Keynes faced when he was an economist working for the British government during World War II and immediately thereafter.

Several officials had expressed frustration with Keynes for apparently wavering in his belief as to the next policy step that should be implemented. Keynes's response to such criticism is captured in the quote above.

And I would rather have someone like a Summers evolve their views based on the evidence rather than simply holding onto to an opinion expressed years ago.

Government for the People

2013-11-21T13:25:00.000-05:00


President Abraham Lincoln gave his famous Gettysburg Address on November 19, 1863, here at Soldiers' National Cemetery in Gettysburg, Pennsylvania Photo by Flickr Creative Commons user Digitonin (via PBS)

http://www.pbs.org/newshour/rundown/2013/11/seven-score-and-ten-years-ago-the-gettysburg-address-entered-history.html

One hundred and fifty years ago, Abraham Lincoln gave the Gettysburg Address, arguably one of the greatest speeches ever made.

I have been watching and reading the story behind the Address in recent days. Lincoln's 270 word speech remains as fascinating to me as it was when I first learned and recited it from memory as a class assignment in grade school.

One of the aspects of the Address that really hadn't occurred to me until recently, however, was the fact that in 1863 democracy was still in the experimental stages.

Monarchies ruled most of Europe and Asia in the middle part of the 19th century. These leaders were hopeful that the American experiment would fail, and that the outcome of the American Civil War would be a bitter lesson to those that would allow "the people" to have a say in how their country was run.

Lincoln obliquely references this sentiment at the end of his memorable speech (my emphasis added):

That the nation shall, under God, have a new birth of freedom, and that the government of the people, by the people and for the people, shall not perish from the earth.

It seems odd to think about democracy as an experiment a century and a half later, but some in Europe are beginning to question whether governments are truly working on behalf of all of its citizenry.

source: London Telegraph

Ambrose Evans-Pritchard penned a column yesterday titled "There is Talk of Revolution in the Air" for the London Telegraph.

He discusses the fact that in many parts of the world, most notably France and Italy, as well as China and Russia, there is open discussion about the need for revolution, or at least dramatic changes in the way countries are being managed.

The problem is largely economic: since the 2008 credit crisis, nearly all of the gains in the industrialized countries have gone to the very few at the top of the income strata.

So while the stock market hits record highs, and real estate prices for high end properties reach staggering heights, real income levels have barely moved for more than a decade for most workers.

Evans-Pritchard recites some of the dismal figures:

Even as stocks soar, world trade is becalmed, and the West is still stuck in a contained depression.

Manufacturing output is still down 3pc from its pre-Lehman peak in the US, 6pc in Germany and the UK, 7pc in Japan and France, and 12pc in Italy. Compare that to the 60pc surge in US factory output over the same time lapse in the 1990s. It is another world.

The US workforce shrank by 755,000 in October. The labour participation rate for men dropped to 69.2pc, the lowest since data began in 1948. Discouraged workers are dropping off the rolls.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/10464141/There-is-talk-of-revolution-in-the-air.html

The speech that former Treasury Secretary Larry Summers gave earlier this month coined the phrase "secular stagnation". For a 16 minute talk given at an obscure IMF conference, it is striking the amount of discussion and reflection that his remarks have generated.

Like Lincoln so greatly put it, democracy remains an experiment in progress.

"Healthcare Care Inflation At Lowest Rate in 50 Years"

2013-11-20T17:04:00.001-05:00

Ezra Klein of the Washington Post is out this afternoon with a short note about the unexpected slowdown in the rate of growth in healthcare spending.

Klein writes that this chart published by the Council of Economic Advisers (CEA) illustrates the good news on health care costs:

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/11/20/this-chart-is-amazing-news-for-our-health-cost-problem/?wpisrc=nl_wnkpm

I went to the CEA site and they offered up another chart that illustrated the dramatic changes going on in health care spending:

2013/11/20/new-report-council-economic-advisers-recent-slowdown-health-care-cost-growth-and-rol

Now, to be sure, the CEA is part of the White House, so it is probably not the most unbiased source.

But on the other hand, it is hard to argue with the data.

Here's an excerpt from what Jason Furman of the CEA wrote in his note accompanying the charts:

..Health care price inflation is at its lowest rate in 50 years: Measured using personal consumption expenditure price indices, inflation for health care goods and services is currently running at just 1 percent on a year-over-year basis, the lowest level since January 1962. (Health care inflation measured using the medical CPI is lower than at any time since September 1972.)

..The slowdown in health care cost growth is not due solely to the Great Recession; something has changed: The fact that the health cost slowdown has persisted so long even as the economy is recovering, the fact that it is reflected in health care prices – not just utilization or coverage, and the fact that it has also shown up in Medicare – which is more insulated from economic trends, all imply that the current slowdown is the result of more than just the recession and its aftermath. Rather, the slowdown appears to reflect “structural” changes in the United States health care system, a conclusion consistent with a substantial body of recent research.

http://www.whitehouse.gov/blog/2013/11/20/new-report-council-economic-advisers-recent-slowdown-health-care-cost-growth-and-rol

More fuel for the deflationary camp?

Ignoring the Pundits

2013-11-19T10:05:00.001-05:00

Financial blogger Barry Ritholtz wrote a good column for the Washington Post that appeared last weekend.

Ritholtz noted that too often investors are buried in media commentary on the markets and the economy.

The constant news flow makes it difficult for investors to make calm, rational decisions based on longer term trends and outlooks.

Worse yet, Ritholtz notes that too often the media plays up commentary from "wise men" that usually foretell dire gloom and ruin scenarios.

Problem is, Ritholtz writes, there is no accountability to these pundits. Prophecies of ruin make headlines, but usually they are wildly wrong - but no one seems to remember.

Here's an excerpt from what he wrote:

One thing I detest most about the financial press is the lack of accountability. All sorts of nonsense is said without penalty. On TV, guests are rarely called out for terrible calls or stock picks. Columnists can say anything without worry of anyone remembering their really dumb statements.

I use a simple calendar trick to hold talking heads accountable. Whenever someone makes some wild claim or rolls out yet another set of predictions, I diary them. Any calendar or even your Outlook will work, but I especially like to use a simple app called FollowUpThen.com.

As an example, have a look at this letter published exactly three years ago, signed by a long list of economic wise men and politically connected policy wonks. It warns of “currency debasement and inflation.” My esteem for these folks’ economic judgment is now significantly diminished; each of the list’s signatories now get assessed as incompetent forecasters.

http://www.washingtonpost.com/business/use-the-news-how-to-get-the-most-out-of-financial-media/2013/11/15/30f8b014-4c9a-11e3-ac54-aa84301ced81_story.html

Here's a recent example.

Jeremy Grantham of the investment firm GMO is widely respected in the industry, and correctly so. His work on developing sound investment strategies has been used by a variety of institutions in setting investment policy. His most notable call was in the latter part of the 1990's, when he identified the wildly overvalued stock market as being vulnerable to a fall.

So it was with some interest that I read in Grantham's most recent newsletter that he believes the stock market is currently 75% overvalued:

"the U.S. stock market is trading at levels that do not seem capable of supporting the type of returns that investors have gotten used to receiving from equities. Our additional work does nothing but confirm our prior beliefs about the current attractiveness – or rather lack of attractiveness – of the U.S. stock market.... On the old model, fair value for the S&P 500 was about 1020 and the expected return for the next seven years was -2.0% after inflation. On the new model, fair value for the S&P 500 is about 1100 and the expected return is -1.3% per year for the next seven years after inflation. Combining the current P/E of over 19 for the S&P 500 and a return on sales about 42% over the historical average, we would get an estimate that the S&P 500 is approximately 75% overvalued."

http://www.gmo.com/websitecontent/GMO_QtlyLetter_ALL_3Q2013.pdf

Now, it could be right that Grantham is right, despite the fact that numerous other indicators would suggest that current market valuations are roughly in-line with historic averages.

On the other hand, if he is wrong, few will remember. Moreover, I doubt that GMO - which manages billions for institutional investors - has truly left the stock market.

Here, for example, is an New York Times columnist Jeff Sommers quoting Matt Paschke of the investment firm Leuthold Weeden Capital Management:

“There are two schools of thought on stock valuation,” {Paschke} said. “One says you should only buy stocks when they’re cheap. The other says I need to put my money somewhere, so where should I put it? If you look at it that way, stocks are the only game in town, and that thought will probably make us and some other market participants stick around a little longer than we might like because there’s nowhere else to go.”

http://dealbook.nytimes.com/2013/11/18/new-market-benchmarks-show-a-lack-of-options/?ref=business

In my opinion, the longer the current rally continues, the higher the likelihood that we will see a "correction" at some point, and stock prices will move lower for a while, at least.

However, with interest rates likely to remain low for the foreseeable future, I would agree with strategist Paschke: stocks remain the only game in town.

"Secular Stagnation"

2013-11-18T14:15:00.001-05:00

http://ftalphaville.ft.com/2013/11/18/1696762/summers-on-bubbles-and-secular-stagnation-forever/?ftcamp=crm/email/20131118/nbe/AlphavilleNewYork/product

The economics world is abuzz about a speech that former Treasury Secretary Larry Summers gave at an IMF Research Conference on November 8.

While I don't typically recommend talks by economists, this one might be worth a view.

Summers points out that real GDP growth has been essentially stagnant for the past few years, and unemployment remains unacceptably high, despite massive monetary stimulus attempts by the Federal Reserve.

Could it be, Summers asked, that the U.S. is mired in a period of "secular stagnation"?

Moreover, while he acknowledges that the Fed's actions staved off economic disaster in 2008, what tools would be available if another crisis were to arise?

Here's Paul Krugman writing in this morning's New York Times:

Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.

He then made a related point: Before the crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressure.

Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles.

I’d weigh in with some further evidence. Look at household debt relative to income. That ratio was roughly stable from 1960 to 1985, but rose rapidly and inexorably from 1985 to 2007, when crisis struck. Yet even with households going ever deeper into debt, the economy’s performance over the period as a whole was mediocre at best, and demand showed no sign of running ahead of supply. Looking forward, we obviously can’t go back to the days of ever-rising debt. Yet that means weaker consumer demand — and without that demand, how are we supposed to return to full employment?

http://www.nytimes.com/2013/11/18/opinion/krugman-a-permanent-slump.html?ref=opinion&_r=0

In other words, what if there are secular causes behind our current period of economic stagnation that government policies can do very little to address?

There's lots to ponder from this short talk.

For investors, however, one possible conclusion might be that the widely-held assumption that interest rates and inflation are inevitably around the corner might not be as obvious as most assume.

Deflation? Really?

2013-11-15T10:30:00.002-05:00

source: InflationData.com

For most of my career - actually, for most of my life, come to think of it - one of the largest economic concerns in the U.S. has been inflation.

However, as the chart above indicates, the inflation I experienced in the 1970's and 1980's was actually more unusual than the norm. If you assume that the inflation in the 1940's was largely the result of World War II price pressures, it could really be argued that inflation for most of the 20th century really was not a big issue.

Now policymakers seem to be more worried about deflation than inflation.

The European Central Bank cut interest rates last week (over the objections of the Germans) citing deflationary pressures. Fed Chairman Bernanke has signaled that he too is worried about the threat of deflation, as did Janet Yellen in her testimony yesterday.

The implications of a sustained period of low or declining prices are too numerous for a short post, but sufficient to say that there is enough reason to consider a deflationary scenario.

Here's an excerpt from a Reuters piece earlier this week:

Deflation alone is not seen as an outright negative for equities, which can still rise if there is moderate growth.

But in such an environment, financial stocks tend to underperform because deflation increases a borrower's real debt burden, contributing to higher non-performing loans and lower net interest margins for banks as the gap between short- and long-term interest rates narrows.

"If we get a deflation psychology beginning to break out in Europe you have to reconsider the relationship between a 'risk' asset and 'non-risk' asset," said Bill O'Neill, chief UK investment strategist at UBS Wealth Management.

"Markets will be focusing on assets that provide nominal guaranteed returns such as government bonds. You would want to be aware of risks in equities, in particular in financials."

http://www.reuters.com/article/2013/11/13/us-investment-deflation-analysis-idUSBRE9AC06720131113

Deflation also would increase the credit risk of corporate bonds, since the cost of repaying debts would be rising in real terms.

Still, I think the jury is still out as to whether prices really are entering a sustained period of flat or negative trends.

Buying Tech Stocks

2013-11-14T09:47:00.001-05:00

I wrote last week about the difficulties of developing a winning investment strategy in technology stocks. More examples can be found in recent news reports.

The pace of change in tech is, of course, astonishing. Here for example is an excerpt from an article in this morning's New York Times about the incredible processing power that Amazon.com is now offering on a subscription basis through something they call "Amazon Web Services" (I added the emphasis):

...On Tuesday, a company appearing at the Amazon conference said it had run in 18 hours a project on Amazon’s cloud of computer servers that would have taken 264 years on a single server.

The project, related to finding better materials for solar panels, cost $33,000, compared with an estimated $68 million to build and run a similar computer just a few years ago. Akin more to conventional supercomputing than {IBM's} Watson’s question-and-answer cognitive computing, the project was the first of several announced at the Amazon conference.

“It’s now $90 an hour to rent 10,000 computers,” the equivalent of a giant machine that would cost $4.4 million, said Jason Stowe, the chief executive of Cycle Computing, the company that did the Amazon supercomputing exercise, and whose clients include The Hartford, Novartis, and Johnson & Johnson. “Soon smart people will be renting a conference room to do some supercomputing.”

http://www.nytimes.com/2013/11/14/technology/ibm-to-announce-more-powerful-watson-via-the-internet.html?ref=business

Little wonder, then, that the most valuable companies in the technology area that have little or no profitability, murky revenue outlooks, yet are offering users capabilities that few thought available just a few years ago (e.g. Twitter).

Still, it is almost mind-boggling to see the young entrepreneurs who started the instant message service Snapchat turn down $3 billion from Facebook.

While Snapchat is hugely popular among millenniums, the company has no revenue or profits. Moreover, it is not clear how they will be able to monetize its current popularity:

What business makes no money, has yet to pass its third anniversary and just turned down an offer worth billions of dollars? Snapchat, a social media service run by a pair of 20-somethings who until last month worked out of a beachfront bungalow in Venice, Calif...

The service, started in 2011 by Evan Spiegel, 23, and Bobby Murphy, 25, two former Stanford fraternity brothers, lets users send photo and video messages that disappear after they are viewed. Snapchat quickly gained a reputation as an easy way to send sexually suggestive photos, but it also picked up steam as a fun and easy way to trade photo messages.

The company has in recent months become one of the most sought-after businesses in the tech industry, getting attention from top Silicon Valley companies and venture capital firms, as well as international technology companies.

http://www.nytimes.com/2013/11/14/technology/rejecting-billions-snapchat-expects-a-better-offer.html?hp&_r=0

Interestingly, Fortune magazine's technology columnist Dan Primack thinks that Snapchat was right to turn down a multi-billion dollar payday:

Facebook's original offer was said to be for between $1 billion and $2 billion, but today the WSJ is reporting that Zuckerberg later raised the stakes to $3 billion. And was still rebuffed!

At first blush, it seems ridiculous. A pre-revenue company founded less than three years ago turns down a deal that would value it at 3X what either Instagram or Tumblr got...

...Snapchat and its investors seem to believe that this company is the next generation of social networking -- not an add-on to the dominant incumbent. Snapchat is about immediate/disposable communication, not permanent record-keeping...

In other words, Snapchat is providing its users exactly what existing services like Facebook and Twitter and Tumble are not. Not surprisingly, some people close to the company say that Snapchat's depth of engagement is off the charts. Sure the core technology itself is fairly simple. So is Twitter's (TWTR) -- a company that also wasn't monetizing 2.5 years into its existence.

http://finance.fortune.cnn.com/2013/11/13/snapchat-crazy-facebook/?iid=SF_F_River

Meanwhile, back in "old" tcch, companies like IBM, Oracle and Microsoft are trading at multi-decade lows. Here's JP Morgan strategist Thomas Lee as quoted on CNBC:

{Lee} sees opportunities in low PE, mega-cap tech names like Microsoft, IBM, Cisco Systems, Oracle, EMC, even Hewlett-Packard—saying more than half the group are "under 12 [times earnings]."

"It reminds of the pharma trade a few years ago. People looked at these low multiples, these cliffs, and thought it wasn't worth buying. And then they were great stocks," he said.

http://www.cnbc.com/id/101190119

In other words, the current winners in the tech space seem to be inversely correlated with profitability.

What's The Next Move for Biotech Stocks?

2013-11-13T11:00:00.001-05:00

Investing in biotech stocks is not for the faint of heart.

Not only is the science challenging, but often the best performing stocks make no sense on commonly-used valuation metrics. Instead, huge price swings occur on the basis of "news flow" of the progress of new innovative drugs and therapies.

As the chart above shows, biotech stocks have been huge winners this year. Companies like Gilead Sciences and Celgene have nearly doubled in the wake of investor enthusiasm for not only their new drug innovations but also the large potential increase in patient usage.

In addition, biotech stocks are probably the only true growth area left in the health care space. If your mandate is to invest in growth stocks, biotech is essentially the only way to go.

I went to hear biotech analysts Joel Sendek and Steve Willey from the brokerage firm Stifel Nicolaus yesterday.

Joel and Steve think that there are more gains to come from the biotech space, but future returns will vary widely, as would be expected.

Since most of their stocks do not yet make any money - which is fairly typical in the biotech world - their views are largely based on their opinion of which companies have drugs and procedures in their pipelines that seem promising.

Among their favorites are the large cap stocks that have already had great runs: Gilead, Celegene and Biogen Idec. The only large cap biotech stock they don't like is Amgen, which in their view does not have nearly the pipelines as their other large cap brethren.

However, Joel and Steve are true biotech analysts, which means their real passion is finding the next "home run" stock.

They noted the most portfolio managers take a generalist approach to the biotech space. These managers have either a minimal exposure to biotech or focus their attention on the largest stocks. This means that the real opportunities are to be found in the stocks in the small and mid-cap space which are not as widely followed.

Still, most of the smaller cap stocks are true "dream" stocks. Their future price movements are largely predicated on binary events: if their drugs work, the stocks will soar; if not, potential total loss.

For example, one dream stock they currently touting is called Newlink Genetics Corporation (ticker: NLNK). Newlink is focusing on novel immunotherapeutic products that could potentially lead to major improvments in cancer therapy. In trials so far their products have shown great promise, but the final results will not be published until 2015.

Newlink is still losing money, and even if some of their therapies are approved the company will not be profitable until at least 2016.

If they are successful, the stock could go up five times or more before its valuation makes any sense. And if it fails, well, the stock probably goes to zero.

For me, this is too risky, but I am intrigued by some of their large cap ideas.

Boring is Best?

2013-11-12T11:37:00.000-05:00

James Stewart had a good column in Saturday's New York Times on the superior investment returns that small college endowments have been able to achieve relative to their larger brethren.

Over the past couple of decades, colleges have moved away from investing in publicly-traded stocks and bonds in favor of alternative assets.

The idea was that investing in private equity and hedge fund vehicles run by sophisticated managers would be able to provide superior returns with less volatility than traditional investment strategies.

This concept was first pioneered by Yale's David Swensen. Swensen's research suggested that investing in non-traditional asset classes provided superior long term results for patient investors. In addition, a portfolio of alternative asset investments was less volatile than investments in publicly traded stocks and bonds.

The strong investment results that Yale's endowment produced for much of the last decade was proof that Swensen was onto something, and many other colleges and universities followed suit.

However, as more funds copied Yale's approach, returns have been gradually reduced.

Here's an excerpt from a piece I wrote on Random Glenings on March 25, 2013:

The Yale Model became the focus of much attention on account of its performance during the tech bubble. From July 2000 through June 2003, while the S&P 500 fell 33 percent, Yale’s endowment actually gained 20 percent. Yale’s portfolio continued to perform well until 2008 (returns of 19.4 percent in fiscal 2004, 22.3 percent in fiscal 2005, 22.9 percent in fiscal 2006, 28.0 percent in fiscal 2007 and 4.5 percent in fiscal 2008 – through June 30, 2008).

http://rpseawright.wordpress.com/2013/03/22/is-the-yale-model-past-it/
As the article notes, the tremendous success of Swensen's approach inspired a wide variety of endowments to mimic his approach. Indeed, working with Swensen at Yale became almost a rite of passage for any chief investment officer at prestigious institutions like MIT.
More recently, returns from the Swensen approach have not proved to be as strong as in prior periods. Indeed, the article notes that a simple 60/40 stock/bond allocation has outperformed many endowment funds that followed the Yale model:
A simple 60/40 portfolio invested 60 percent in an S&P 500 index fund and 40 percent in a fund tracking the Barclays Aggregate bond index would have gained 12.6 percent annually over the last three years and 2.8 percent over the last five years, as compared with 10.2 percent and 1.1 percent, respectively, for the average endowment. Yale did somewhat better than the average endowment with three-year returns averaging 11.83 percent and five-year returns averaging 3.08 percent.
What's going on here?
The authors suggest that perhaps too many institutions are investing in the same asset classes, which is dragging down overall returns. In addition, as they parse through the numbers:
The bottom line here is that Yale’s success has been driven largely by private equity – mostly venture capital – returns. Outside of private equity, the research suggests that Yale appeared to underperform appropriate risk-adjusted benchmarks.

http://randomglenings.blogspot.com/search/label/Investment%20Strategy?updated-max=2013-03-28T09:19:00-04:00&max-results=20&start=51&by-date=false

Stewart's column on Saturday echoed the report that I first published last spring.

Namely, that the combination of high fees, and too many funds flocking to alternatives, has pushed returns much lower than expectations.

Here's an excerpt (I added the emphasis):

...The data released this week shows that small (less than $100 million) and midsize ($100 million to $1 billion) endowments — which typically have smaller allocations to alternative investments — have surged ahead of the largest endowments over the most recent three- and five-year periods.

Endowments with assets under $25 million reported the highest average three-year return, at 11 percent, while those with assets between $25 million and $50 million reported the highest average five-year return, at 5.5 percent, according to the business officers association.

The largest endowments led over 10 years and longer, and Yale still holds the 10-year crown with annualized returns of 11 percent. But that’s only because the strong performance of alternative assets in earlier years supercharged its results. It’s no secret that since the financial crisis, many alternative assets have been a drag on performance.

Hedge funds — whose owners typically charge 2 percent of assets under management and 20 percent of any gains and, in some cases, even higher — have performed dismally over the last three and five years, with annualized returns of just 3.88 percent over three years and 5.03 percent over five, according to the HFRI composite index of hedge funds. By comparison, the Standard & Poor’s 500-stock index has had annualized gains of 15.2 percent over three years and 15.34 over five.

nytimes.com/2013/11/09/business/fast-growing-endowments-without-the-ivy.html?_r=0

Now, to be sure, I think part of the problem is a matter of size.

An endowment that is less than $25 million in size really doesn't have the access to the top alternative asset managers that an institution like Yale does. Their recent investment success may more fortuitous than sagacious.

On the other hand, the lesson for most of us may be that simplicity when it comes to investment strategies may be the best course.