|
|
More Factoids June 04 May 04 May F-Too April 04 March 04 February 04 February F-Too January 04 January F-Too Financial Services Updates July 04 June 04 May 04 Feb 04 Jan 04 Dec 03 Nov 03 Oct 03 MLP Updates July 04 June 04 May 04 REIT Updates July 04 July Stats July Stats June 04 June Stats June Stats May 04 May Stats May Stats April 04 April Stats April Stats March 04 March Stats March Stats Feb 04 Feb Stats Feb Stats Jan 04 Jan Stats Jan Stats Fund Scandal June Update May Update April Update March Update March Update Feb Update Jan Update Dec Update Nov Update Oct Update Sept Update More Factoids Q4-03 Index Q3-03 Index Q2-03 Index Q1-03 Index Q4-02 Index Q3-02 Index Q2-02 Index Q1-02 Index Q4-01 Index Q3-01 Index Q2-01 Index Q1-01 Index Q4-00 Index Q3-00 Index Q1-00 Index Links by Topic Biz Links Business News Economic Reports Stock Exchanges Searches |
Jonathan Clements, WSJ 2-15-04
Where TIPS apply the adjustment to the bond's principal, corporate notes account for inflation in the monthly coupon. That difference ultimately means the corporate notes react more swiftly to interest-rate changes and generally provide more income over their lifetime. In addition, the TIPS investor is subject to a so-called phantom tax. Every time the Treasury adjusts the bond's principal higher, the IRS considers that taxable income. Thus, the investor owes taxes each year on the increased value, even though the money isn't received until the bond is sold or matures. The result is that corporate notes are front-loaded while TIPS are essentially back-loaded, as investors will receive most of the inflation adjustment when the bond matures. The different ways that TIPS and corporate inflation notes adjust for rising prices means that each is best suited for a different kind of investor. Because of their phantom taxes, TIPS are best purchased within tax-deferred accounts like an individual retirement account. That means they're more appropriate for savers who have no need for current income, but still want their nest egg to fight off inflation.
To be sure, the Value Line numbers haven't been very accurate in forecasting short-term market moves. But they have been quite reliable in predicting the longer term. They have proved particularly useful when the mood of investors reaches extremes of euphoria or despair. Value Line's median projection was last considered in this column on Sept. 30, 2001, less than three weeks after the terrorist attacks. At that writing, the indicator was at 105, its highest in more than a decade. At the time, many investors were unwilling to make any bets on the stock market, but those who relied on that high reading to invest in equities have been rewarded. The Standard & Poor's 500-stock index has produced a cumulative total return of 20% since Sept. 21, 2001, the day of the market's post-attack lows. Unfortunately for market bulls, however, the Value Line reading has now sunk to 50, a very low level. Over the last 36 years, in fact, the reading has been lower just 11percent of the time. The indicator has limits, of course. It's hardly foolproof. And because it focuses on median performance, it is not helpful in projecting how large-capitalization stocks will perform relative to small caps. If the large caps lead the market over the next four years, indexes that are dominated by the large caps - like the S&P 500 - will do better than the indicator suggests. Credit for realizing the indicator's market-timing power is shared by at least two people, who independently reported on its usefulness in the mid-1980's. The first is Daniel A. Seiver, an economics professor at Miami University in Ohio and the editor of the PAD System Report, an investment newsletter. The second is Peter L. Bernstein, the founding editor of The Journal of Portfolio Management and now the head of a consulting firm that bears his name. Professor Seiver is so confident about the indicator's market-timing powers that he bases his newsletter's market-timing advice on it. He considers any reading of 100 or more to be a buy signal, for example, while he uses a reading of 50 or below as an occasion to build a large cash position in his model portfolio. Based on the current reading of 50, Professor Seiver is recommending being only 50% invested in stocks. And he says he will not advocate reinvesting any of that cash in the stock market until Value Line's median projection rises back to at least 100. Professor Seiver says several factors help explain the indicator's usefulness. First, he says he finds that Value Line stock analysts tend to be "less susceptible to valuation manias" than most other analysts, because Value Line's are independent, immune from the pressures that can be found in research departments associated with investment banks and brokerage firms.A second factor, he said, is that few other firms besides Value Line even bother to focus on what will happen in three to five years, concentrating instead on just the next 12 months. Because so few other analysts are looking so far ahead, Value Line's researchers should find it relatively easy to spot profit opportunities. A third factor, Professor Seiver said, is the "law of large numbers," which holds that random errors become insignificant when focusing on many observations. He has no doubt that many Value Line projections of individual stocks' three-to-five year returns are wide of the mark. But because the median projection is the distillation of nearly 2,000 separate forecasts, he said, "the analysts' errors will tend to cancel each other out." And for now, the overall forecast suggests that investors should not be too optimistic about the stock market.
We live longer. Fewer of us die in childbirth. Entire diseases have virtually disappeared. We live in larger homes with appliances that didn't exist a century ago. More of us own our homes. We have more telephones. More cars. And going out to dinner is a given, not a special treat. Although most developed nations discourage immigration, we welcome it and benefit from it. We are more educated. Fewer people are poor, and most of those who are poor know it is a temporary condition. We give more and help more. For "more than a decade in the United States, charitable donations have been rising faster than the economy as a whole. In 2002, Americans gave away $241 billion – two-thirds as much as the entire defense budget," Mr. Easterbrook tells us. Aging is slower and better than it used to be: As an 84-year-old friend said to me recently, referring to his hip replacements, hearing aid and cataract surgery, "I'm not really 84 if you average in the age of all my new parts." "Researching this book and thinking about the alternatives," Mr. Easterbrook writes, "has caused me to begin whispering a regular prayer of thanks: Thank you that I and 500 million others are well-housed, well-supplied, overfed, free and not content; because we might be starving, wretched, locked under tyranny and equally not content." Amen.
The move to cash comes after investors have ridden Wall Street higher during the rally of the last two years. Interest rates are on the rise; inflation is a concern; earnings growth is expected to slow next year; and the valuation of everything from stocks and bonds to real estate and commodities has plateaued, for the moment at least, at generally rich levels. The risk is that cash-laden mutual funds will underperform in coming quarters. Cash remains the safest place to endure what many see as a dearth of investment opportunities and the possibility that stocks will go nowhere for a long while. Still, cash has little allure for many individual investors because of tepid yields. Certificates of deposit, money-market accounts and short-term Treasurys all currently yield roughly 2% or less. This trend isn't yet visible on a broad scale. Currently, of the $5.5 trillion in nonmoney-market mutual funds, 4.7% is in cash, a level that hasn't wavered much in recent years, according to the ICI. Of course, many mutual funds are mandated -- often by their management company -- to remain fully invested no matter what, skewing the trend. Yet it's clear managers running the gamut of stock and bond funds are increasingly moving to cash.
For professional investors, timing plays a role as well. With interest rates rising and the market snarled by uncertainty over everything from inflation, Iraq, the presidential election and concerns about equity valuations, a number of money managers are raising their cash stakes. The Investment Policy Committee of Standard & Poor's recommended last month that investors boost the cash portion of their portfolios to 30% and reduce stock exposure to 60%. The previous recommendation had been to keep 20% in cash and 70% in equities. "Slim pickings" among stocks led Robert L. Rodriguez, portfolio manager of the small-cap focused FPA Capital Fund, to accumulate a cash stake of almost 40%, up from about 23% at the start of the year. It's not so much that he thinks cash is a good place to be, it's just that he hasn't found much he'd like to buy. Forecasting a total equity return of about 5%t over the next five years, Rodriguez shuttered his fund to new investors this month. The last time Rodriguez closed his fund was in 1998, near the peak of the tech bubble. He said he's starting to recognize similar patterns now. "We're just going to sit tight until something happens," said Rodriguez, who has managed the fund since 1984. "I have great confidence that fear and anxiety will eventually return to the financial markets, and people will have wasted their capital, and we will have not." Rodriguez is one of a small but growing number of mutual fund managers maintaining hefty cash stakes. According to Morningstar, 162 domestic stock funds have cash positions of 20 percent or more; 88 hold at least 30 percent of their assets in cash. But if you are overly cautious, and hold too much in cash for too long, you'll never be able to outrun inflation. "People forget that inflation, over the long run, is the biggest threat to their portfolio, far more than volatility,"says Patricia Jennerjohn, head of Focused Finances in Oakland, Calif. "It's the slow rust at the bottom of your portfolio. You don't see it, but it eats up your money. It's insidious. So don't go too crazy with cash."
Both rats and people recognized that the green light flashed more, but they responded differently. Rats chose the green light every time. People tried to predict when the red light would flash. End result: Rats won 80% of the time; people won just 68% of the time. When it comes to investing, the propensity to perceive patterns where there are none can cause investors to chase hot market segments - but often after the sectors have started to cool. And it causes them to avoid markets that haven't done well lately, even though that's often the optimum time to invest, Ankrim said.
Investors should consider the caveats, though, before hanging on to their bond-fund shares in what promises to be a choppy market. If you're skittish about rate rises or need your bond-fund money soon, it makes sense to shift to shorter-duration funds that invest in bonds that mature more quickly and are less sensitive to rate changes. Financial pros say investors should choose bond funds with average maturities shorter than the number of years remaining before they will need the money. Also, if rising rates are accompanied by rising inflation, the added returns driven by higher yields are worth less each day due to rising prices and lost purchasing power.
2. You get excited when stock prices fall. 3. You're richer than your neighbors, and they haven't a clue. 4. You smirk when others boast about their stock-picking prowess. 5. You save part of every paycheck. 6. You've ensured your heirs won't inherit a nightmarish financial mess. 7. You remember your investment mistakes, and they still make you shudder. 8. Before you buy an investment, you think about when you will need to sell. 9. You aren't 100% sure about anything. 10. You never open your credit-card bills with trepidation. 11. You own bonds, even thought they will likely drag down your portfolio's performance. 12. You can bring yourself to sell losing investments. 13. You could easily afford to buy a new car, but you don't. 14. You check your portfolio every day, but trade only twice a year. 15. You don't trust anybody on Wall Street. 16. Whenever you hear about somebody with a huge house and a driveway full of new cars, you don't wonder how rich they are. Instead, you are in awe of the staggering sums they must have spent. 17. You never thought Beanie Babies were an investment. 18. You still haven't figured out how to beat the market. But you're a whiz at cutting investment costs and trimming your portfolio's tax bill. 19. You think CNBC is a font of useless insights, but you enjoy watching it anyway. 20. You are filled with horror when your neighbors describe their latest meeting with their broker. 21. You've given your executor a list of all your financial accounts. It fits on one page. 22. You view personal-finance columnists with suspicion. 23. You know enough about hedge funds to know you don't want one. 24. Your retirement dreams don't hinge on beating the market or earning double-digit annual returns. 25. Sure, you want the big house, early retirement, the fancy vacations and the kids to go to Harvard. But you long ago realized you couldn't have it all. 26. You don't own any investments you don't understand. 27. Yes, you worry about a market crash. But what really scares you is not having enough money in 30 years, when you retire. 28. You're appalled whenever you see somebody buying lottery tickets. 29. You realize remodeling the bathroom is a money loser. 30. You have all the insurance you need, and no more. 31. You can describe your investment strategy in 60 seconds. 32. You always make the maximum possible 401(k) contribution. 33. You would love to sell your house and buy a bigger one. But you get queasy thinking about the brokerage commission involved. 34. When the TV talking heads throw around technical jargon, you don't understand what they're saying. But you're pretty sure it's garbage. 35. Whenever a market sector rockets higher, you don't get greedy, you get scared. 36. You never do anything just to earn frequent-flier miles. 37. You have no idea which part of the market will perform best over the next year. But because you're well diversified, you're pretty confident some part of your portfolio will make money. 38. You earn more than your brother-in-law, but don't live nearly so lavishly. 39. You wince when you think about the time you carried a credit-card balance and ended up paying 17% in annual interest. 40. Every time you buy a stock, you wonder whether the seller knows something you don't. 41. Whenever people ask you for investment advice, they're almost always disappointed by your answers.
"Let's start with a thousand workers. Of the thousand, about 15% won't be eligible for one reason or another. That takes us down to 850 workers. "Of the 850, about 30% won't join. That eliminates 255 and takes the number of workers down to 595. Mr. Hamilton figures that about 95 of the 595 will be "highly compensated" – those earning $90,000 or more this year. He figures they will contribute the maximum allowed. "But 70% [of the 500 less highly compensated employees] will contribute too little, too late. That knocks out another 350, leaving 245 workers who have survived the second Monkey. "Then there's Monkey No. 3. How many workers achieve near-market results? Ninety percent won't. That takes 202 of 245, leaving 43. In other words, 43 workers in 1,000 succeed – but the rest have been obliterated by a sorry gang of Really Big Monkeys," Mr. Hamilton says. "Only 5% of the people can retire in dignity." "Now ask yourself a question. If only 5 percent of the people can retire in dignity, can the board of directors, the investment committee, the trustees, the accountants and all the providers claim they've honored their fiduciary duty? Mr. Hamilton puts the situation another way. He likens the fiduciary to a general: "If a general took an army of 1,000 into battle and returned with 50 survivors, leaving the rest as casualties on the field, what do you think would happen? The general would be court-martialed." What Mr. Hamilton sees coming is worker rage as millions of them realize the scope of the failure they are facing and the complacency of those responsible – the fiduciaries. He calls it "a perfect legal storm. It has not escaped the attention of the plaintiffs' bar that a RICO violation will trigger triple damages and only requires that two or more people be involved in a conspiracy to enrich themselves by diminishing the well-being of others," Mr. Hamilton noted. (RICO, passed in 1970, stands for Racketeer Influenced and Corrupt Organizations Act and was originally intended as anti-organized crime legislation.) "Remember," he said, "ERISA [the Employee Retirement Income Security Act of 1974] imposes a fiduciary duty that is greater than anything previously defined in Western civilization – a duty of faithfulness, loyalty and care." Average account balances by age among people who had 401(k) plans from year-end 1999 through year-end 2002. The increases for participants in their 20s and 30s reflect the greater impact of new contributions due to their lower balances.
In fact, what started as a regulatory smackdown of wayward brokerages may end up giving them a competitive edge, since they'll be giving customers research once reserved for big clients. Perhaps to blunt this advantage, rival firms not involved in the settlement have begun scrambling to add outside stock reports to their in-house research. For investors, more information is supposed to be better. But for brokers, the new landscape may be tricky to navigate. What do you tell your customer, for example, when your firm's analyst loves a stock but the outside analyst hates it? While the brokerage firm can meet its legal obligation by simply making sure the customer receives the outside research, many investors will turn to their brokers to make the call when one report says "buy" and the other says "sell." Skeptics point to another problem. Noting that investors won't be charged for the expanded research menu, they say free stock picks tend to be worth exactly what you pay for them. Some critics also fear that the outside research will be stale or watered-down compared with what the institutions are seeing. "The idea you're going to get high-quality boutique research out of this is pie in the sky," said Charles L. "Chuck" Hill, a consultant who tracks analyst recommendations. "If somebody's really good, they ain't going to stay in this arena very long. They'll work for the institutions, where the money is." The brokerages were ordered to set aside a total of $432.5 million to be spent on the independent research over the next five years. The firms' individual budgets range from $7.5 million to $75 million — again, spread over five years. BNY Jaywalk, a unit of venerable Bank of New York, has emerged as the most popular vendor, chosen as an independent research provider by four of the six brokerages that have announced their selections so far. BNY Jaywalk calls itself an "aggregator": It doesn't have analysts of its own but contracts with more than 100 independent research firms that together cover some 6,000 stocks, or practically every U.S.-listed stock. Jaywalk's original business plan was to sell research mainly to institutional investors, but when the settlement came about, the firm recognized it as an opportunity, John D. Meserve, Jaywalk's president, said in an interview last week. Several of the brokerages' independent consultants said they found Jaywalk's one-stop-shopping approach more convenient than signing contracts directly with multiple firms.
The S&P study looked at nine categories of equity mutual funds based on investment style, from small-cap value to large-cap growth. It split the categories into funds with lower-than-average and higher-than-average fees. In eight out of nine cases, the funds with lower-than-average fees outperformed, often returning as much as 20% more in a 10-year period, and in one category -- small-cap growth -- 37.5% more. Only the higher-cost midcap-blend category bucked the trend, outperforming the low-cost funds by about 13% after 10 years. That isn't to say that a focus on fees is a foolproof method for picking winning mutual funds. But investors who are aware of the annual costs stand a much better chance of improving their returns.S&P did a similar study last year, which reached the same conclusion. The study looked at expense ratios, which are annual fees that go toward the management of the fund, including the investment-advisory fee, administrative costs and marketing fees. Sales charges, or loads, paid to the broker who recommended the fund, weren't included. Low fees tend to be tied to funds that are "more efficient and less risky," said Russel Kinnel, director of fund research for Morningstar Inc., which also has conducted studies showing a strong correlation between fees and returns. More News on Fund Fees Tom Lauricella, WSJ 7-02-04 Between December and May, according to fund researcher Lipper Inc., 43 mutual-fund companies out of the 620 tracked by Lipper said they would lower fees on 206 funds, mainly linked to asset growth. Fees on just 49 funds -- mostly run by small companies -- were increased. It's the opposite of the year before, when fees were raised on 233 mutual funds and reduced on 147. Overall fund expenses charged to investors in stock and bond funds have risen over the past two decades, and in the case of stock funds, expenses have more than doubled. But a confluence of events is at work to lower fees. Since filing the first charges against mutual-fund companies for improper trading in the fall, New York Attorney General Eliot Spitzer insisted that fee reductions be part of any settlements reached with funds ensnared in the scandal. Meanwhile, more funds are passing on fee discounts to fund shareholders as funds grow. These discounts, known as breakpoints, are triggered as funds hit predetermined asset levels. Investors are gravitating toward funds whose fees are generally lower than the industry averages like Vanguard, Fidelity and American Funds, while higher-cost funds are struggling. Indirect regulatory pressure also may come into play. The Securities and Exchange Commission last month approved a rule requiring fund boards to disclose significantly more about how they determine whether a fund's fees are reasonable.
Play your game, not the other guy's. In other words, the way to develop an edge over other investors is to focus on what you know. If what you know is limited, don't worry. Brown notes that Warren Buffett says the size of one's sphere of influence is less important than the level of competence within it. Every investor can develop such a sphere. Own pieces of individual businesses at attractive prices, not "cheap stocks." This concept -- first formulated by the late Benjamin Graham -- is by far the best way to think about investing in equities. Consider yourself a partner in a business, not an owner of a stock, Graham said. Or, as Brown puts it, "We see our portfolio as a collection of enterprises in which we own stakes, not a list of company stock symbols on a spreadsheet." From this simple idea flows the notion that the price of a company on a given day is not as important as most investors think. "Who cares if you pay $31 a share for a given stock instead of $30 -- if you think its fair value is twice the current market price?" writes Brown. "What's the difference if the stock is 'ahead of itself' at $40 if you believe it's on its way to its $75 fair value?" Brown says he obsesses a lot over a company's fundamentals, but "we spend less time on valuation" -- price-to-earnings ratios and the like. "We want to know how [a firm's] growth will be funded, and what will happen to any excess cash it generates. (By contrast, we don't spend much time worrying about how the current quarter is shaping up.)" A company that increases its earnings in a consistent and powerful way is a company whose stock will rise, no matter what. Concentrate your holdings. Brown argues that "at any given time it's impossible to have a true knowledge advantage -- the investor's indispensable edge -- in more than a couple [of] handfuls of companies. If you diversify away from those few, you're only diluting your results. What's the point of that?" But for most small investors, I would modify Brown's rule: Keep your portfolio diversified so that it looks like the economy as a whole and includes a variety of companies of different sizes and with both growth and value characteristics. But use your own expertise and that of concentrators like Brown himself to make choices in specific sectors and styles. Also, don't be shy about owning a lot of what you truly like, and beware of trying to keep track of too many stocks. Brown writes, "We have had as much as 25 percent of our partners' equity in one position. That will make for highly volatile near-term results. But if you're a long-term investor, who cares? It will also help assure sizable long-term outperformance." Evaluation of management is critical. My shorthand is, "Invest in people, not stocks." Brown says that if he doesn't know a company's senior management, he "won't own a meaningful position in the company." When he gets face to face with the top executives, he uses some tricks "to find out whether a management is the real deal." First, he visits the company on its own turf since a chief executive "is never as complacent and unguarded as when he's sitting behind his own desk." Second, he watches body language. "Fidgets can speak volumes." Finally, he listens to be sure that everyone on the team is on the same page. He asks the same questions over and over, with slight variations, of different people. A smart management team, Brown writes, "knows the business it's in, knows its company's strengths and weaknesses, and knows its numbers cold. The members of the team communicate with each other, clearly and regularly." The team "wants nothing better than to win, and knows how to."
The dollar amounts would be even larger for Russell 2000 index funds, according to a recent academic working paper by the finance professors Honghui Chen of the University of Central Florida, Gregory Noronha of Arizona State and Vijay Singal of Virginia Tech. They estimate that from the beginning of 1990 through 2002, those funds could have increased their annual returns by an average of 1.8 percent by acting immediately after announcements. It can be argued that by not acting immediately after index changes are announced, index funds are doing just what many of their clients want. That is because many investors judge index funds by how closely their performances match those of their benchmark indexes. Professor Blume and Mr. Edelen said that deviation from index fund benchmarks would climb markedly if the funds bought or sold stocks on any day other than when changes became effective. Index funds could address this matter by changing their benchmarks to indexes with reduced turnover (example: the M.S.C.I. benchmarks).
Here's the math. Abundant research and history show that a broad index fund is likely to do better than about 70 percent of its more expensive managed competitors. At this moment, for instance, the Vanguard Total Market fund has done better than 69 percent of the competition over the last five years, and that's its worst performance figure. The 10-year figure is better than 71 percent of its competitors; the three-year figure is better than 84 percent of its competitors. So your as-yet-unnamed-expert has about a 30 percent chance of better performance with the first selection. At the second selection, the chance drops to 9% (30 percent times 30 percent). By the third selection, the probability is down to 2.7%, and so on. Add a 1 percentage point annual fee, and your odds of winning with managed funds probability is zip, and that's assuming your fund selector doesn't charge an annual- percent-of-assets fee for his brilliance. If you think long term, index investing is the way to go. Exchange-traded funds, like traditional index mutual funds, can help us do it.
"Did anyone notice that yields have gone up, the Fed is tightening, but stocks are at a new cycle-high?" asks Jim Paulsen, chief investment officer at Wells Capital Management. The notion that higher stock prices should accompany rising interest rates isn't funky new-era thinking, but a return to the world of the 1950s, when inflation wasn't the overriding preoccupation of investors. Back then, Mr. Paulsen notes, rates and stocks also were "positively correlated," in other words, they tended to move in the same direction. From the mid-1960s to mid-1990s, inflation was the main preoccupation of the market. As inflation rose from 2% in 1966 to 14% in 1980, interest rates soared, stocks largely moved sideways and price-to-earnings ratios plunged. The reverse occurred from 1982 through the mid-1990s: As inflation and interest rates fell, a multiyear bull market began, half of which was the result of rising price-to-earnings multiples and the other half to rising earnings. Yet it is surprisingly hard to pin down exactly why inflation should hurt stocks. In fact, prior to the 1970s, Wall Street's conventional wisdom was that stocks were an inflation hedge; when the rate of inflation rose, so did the value of corporate assets such as buildings and machinery. The most popular explanation for inflation's toxic effect on stocks is that it pushes up interest rates, reducing the present, discounted value of a dollar of future profits. In 1979, Franco Modigliani, later to win the Nobel prize for economics, and Richard Cohn wrote a now-famous academic paper arguing that this explanation simply didn't add up. If prices across the economy were all rising one percentage point faster a year, then, so should profits (as long as profit margins are stable). In a basic model of stock valuation, higher interest rates and higher earnings growth exactly offset each other -- leaving P/E ratios unchanged. Nonetheless, in 1977, they observed, stocks were selling at just half their "rationally valued" level. They tested other explanations, such as whether inflation raised the tax burden on corporations and concluded that, too, was wrong. Their explanation: Investors were systematically fooling themselves. The view that high interest rates driven by high inflation hurt the relative attractiveness of stocks is an illusion. If so, the illusion persists, because as inflation fell from the early 1980s to the late 1990s, P/E ratios, with a lag, rose. In retrospect, the P/E ratio of almost 30 that stocks hit in 2000 was excessive. Yet here we are, having endured a recession, terrorist attacks and a wave of corporate-accounting scandals, and ratios still are around 20, compared to a long-term average of about 14. If it isn't an illusion, what explains why inflation hurts stocks? Perhaps when inflation rises one percentage point, interest rates rise more than one percentage point -- i.e. interest rates minus inflation, so-called real interest rates, rise. This could be true if lenders react to high inflation today by expecting even higher inflation tomorrow, and demand higher returns to protect themselves. Another explanation could be that high inflation generates a lot of wasteful corporate activity such as shuffling inventories and accounts receivable rather than making better or cheaper products. Fed Chairman Alan Greenspan long has argued that low inflation raised economic growth by forcing companies to find ways of boosting sales other than just raising prices year after year. Perhaps the most convincing explanation for the fear of inflation brings us back to the Fed. Most of the recessions of the past 50 years resulted from the Fed raising interest rates to combat inflation. The two deepest recessions occurred when the Fed was trying hardest to defeat inflation: in 1974-75 and 1981-82. High inflation also brings about other wrenching policy responses, such as President Nixon's imposition of wage and price controls in 1971, or President Carter's imposition of credit controls in 1980. Investors may sensibly conclude that high inflation makes the world a much more uncertain place, and they thus won't hold stocks until prices are really cheap. Some stock selloff in the early stages of a Fed tightening is understandable since no one knows if the Fed will, ultimately, achieve its soft landing. There are lots of reasons for caution this time around: a gaping budget deficit, an even bigger trade deficit, signs of a housing bubble and still-high stock valuations. On the positive side, productivity growth is as high as it was in the 1950s and 1960s. The chances look good the Fed will, once again, achieve its soft landing. If so, the stock market should be happy -- no matter how high interest rates go.
How was the fund industry able to produce such a remarkable turnaround? According to researchers who have extensively studied the phenomenon, funds did so by engaging in a trading tactic known as "marking the close" -- an illegal activity which the SEC defines as "attempting to influence the closing price of a stock by executing purchase or sale orders at or near the close of the market." Here's how it works. Imagine that you're a fund manager who owns a big chunk of a given stock. If, right before the close of the quarter, you place an order to purchase a lot more of this stock, you most likely will cause that stock's price to spike upwards. If you do that with lots of the stocks in your portfolio, you can propel your fund's performance ranking for the quarter from being just OK to being close to the top of the rankings. That in turn would make a huge difference in the amount of new assets you attract. So the incentive is clearly there to engage in "marking the close." What's the evidence that funds actually succumb to those incentives? Though it is circumstantial, the evidence is compelling. Consider what was unearthed by Mark Carhart, co-head of quantitative research at Goldman Sachs Asset Management; and three finance professors: David Musto and Adam Reed of Wharton and Ron Kaniel of the University of Texas at Austin. Their study was published in the April 2002 issue of the Journal of Finance. One of the more revealing discoveries was what happens at the end of the quarter to the trading volume of certain stocks -- the ones held by funds that, as of the next to last day of the quarter, were within shouting distance of finishing at or near the top of the quarterly rankings. These are the funds whose managers had the greatest incentive to mark the close. For each of these funds' stocks, the researchers compared trading volume on the last day of the quarter to average trading volume on all other days. They found that not only was volume above-average throughout the last day of each quarter, but also that this volume began to spike upwards starting around 3:30 p.m. Eastern, 30 minutes before the stock market's close - and then reaching a peak right at the close. How should you protect yourself from these funds' behavior? As I have mentioned before, the most important thing to do is avoid investing in mutual funds on the last day of the quarter. To be sure, many retirement plans are set up to invest on the last day of each month or quarter, so you may not have much choice. But if you can arrange to invest instead on the day before the end of the quarter, you may be able to increase your performance markedly. Carhart and the three finance professors found that this simple change in the past would have increased your returns by as much as 4 percent per year in the case of small-cap funds.
The bond market does some of the Fed's work for it but not all of it. In the post-Volcker period, bond yields rose over half of the total cyclical upward move before the Fed made the first hike. In the pre-Volcker period bond yields rose about a quarter of the total move before the first Fed action. History suggests that the Fed is embarking on a tightening cycle of somewhere between one and two years. It may remain mild and "measured" or it may intensify if the inflation fears become a reality. Either way, history suggests that bond yields will work their way higher before this cycle is over. For now, our best guess remains a target of 5.5% on the 10-year treasury note. That is without an overshooting. If the Fed gets more intense at tightening and substitutes a more aggressive anti-inflation policy for the present "measured" pace, we could see the 10-year yield above 6%.
Adding the net stock-issue numbers for the years 1982 through 2002 shows that during the period companies retired $178 billion more stock than they issued. This means that little of the money that flowed into pension plans, mutual funds, and direct stock purchases during the bull market went to companies as a whole. Of course, capital was moved around, but $178 billion went out of stocks. In spite of the retirements, the total market value of stocks increased from $1.38 trillion to $11.74 trillion. Market action produced this gain -- a compound annual-growth rate of 9.7% over the 21 years. There was a clear pattern of changing ownership, with one group of stockholders being net buyers and another group being net sellers. The net buyers were mutual funds, life insurance companies, foreign investors, state and local pension plans, and others, in that order. The buyers were largely retirement-related. They started out with $249 billion worth of stocks, bought $3.51 trillion worth, and ended up with $5.82 trillion worth. Their growth due to market action was just under 6% per year. The net sellers were households, company pension plans, and bank trusts and estates. They started out with $1.13 trillion worth of stock, sold $3.69 trillion and ended up with $5.92 trillion worth. Their growth due to market action was 13.7% per year. Households, the largest selling group, started out with $780 billion worth of stock, sold $2.98 trillion, and ended up with $4.19 trillion worth. Their growth was 15.1% per year. How was this possible? There are at least two sources of clues, and both point to corporate insiders. The annual Forbes articles on the world's and America's richest people are the first source. Bill Gates headed the list in March 2003 with a fortune of $46 billion, based largely on his Microsoft stock. He is reported to have sold about 2 billion shares (adjusted for splits) and still owns 1.2 billion. When Microsoft had its IPO, he retained 45% of the shares, and he still has enough to continue selling 20 million shares a quarter for 15 years. His cost was probably less than a million bucks, $0.001 per share, so virtually all of his receipts and the value of the shares he still owns are profit. Gates is the extreme example, but he and the other 243 Americans identified in Forbes had total fortunes, based largely on stocks, of $700 billion, or a sixth of all the stocks held by American households at the end of 2002. In addition, there are the corporate insiders, including employees who received stock directly from companies as grants or through options. The second source is the weekly table of Insider Transactions published in each issue of Barron's. The tables show the huge amount of money that insiders take out of stocks in relation to the amount they put in. For example, the 2-23-04 table showed the largest reported sale was 32 times greater than the largest purchase. Taken together, the Fed data, the Forbes lists and Barron's tables show that the households of corporate insiders must have been the primary sellers of the stocks that were bought by mutual funds and other retirement-related portfolios. The extreme gains that households received as a group may well have been driven by the insiders' low acquisition costs. The hard conclusion must be that retirement-related portfolios absorb the large blocks of stocks that corporate insiders acquire directly from companies at low cost. Insiders who have the lowest costs get the largest profits. When later buyers acquire insiders' stocks on secondary markets, most of the profits the stocks will ever produce have already been made. As a group, retirement savers who buy on secondary markets will always earn less than the insiders. It is getting harder to make money by buying stocks on secondary markets with the passage of time. Insurance companies illustrate this. Among the net buyers, they came to the game late, bought most of their stocks during the go-go years of the 1990s, and managed to lose money during the full twenty-one year period. There has been a symbiosis of retirement plans and insiders since 1981. The plans needed stocks and insiders wanted their money. Anyone who looks ahead can see that when boomers' retirement plans need cash to pay retirement incomes, they will have to sell stocks, and most of the domestic buyers will have to be the relatively smaller number of younger workers. But few understand that when the plans need to switch from buying to selling in order to pay benefits, the symbiosis will end. The plans will switch from supporting insiders to competing with them for the purchasing power of younger workers. A prolonged bear market is likely, and many of the insiders will be able to make money at prices that will destroy the retirement plans.
Dalbar's astonishing findings have been repeated again and again in books, articles and Wall Street research. Brokers and financial planners gleefully publicize the study's results. After all, if investors can be persuaded of their own incompetence, they are more likely to hire an investment adviser. But are fund investors really so clueless? I have long had my doubts. To its credit, Dalbar helped me out, taking the time to spell out precisely how it calculates each month's return for fund investors. The bottom line: There is a bias in the study's methodology. With the formula that Dalbar uses, stock-fund investors don't earn the full monthly return on any money that they invest during that month. As a result, investors appear to lag far behind the S&P 500 when the market rises and investors are simultaneously shoveling money into stock funds. This, of course, is what happened for much of the 19-year period studied. When I spoke to Dalbar President Louis Harvey, he agreed that the methodology has a bias. After our conversation, he directed his staff to create a new benchmark, which assumes that investors poured money into stock funds in equal monthly amounts during the past two decades. The result? Instead of the 9.6-percentage-point annual gap between investors' paltry gain and the S&P 500, it seems investors' underperformance is considerably smaller. Using its new benchmark, Dalbar now figures that investors' ill-timed purchases and sales may have cost them only 3.4 points a year over the 19-year stretch. But our mystery story isn't over. The next twist: It seems investors' poor market timing may not be entirely their fault. Which brings me to another set of numbers, this time from the University of Michigan's Lu Zheng and the University of California at Berkeley's Terrance Odean. Like Dalbar, the two professors looked at how stock-fund investors fared over the 19 years through 2002. But they took a more direct approach, considering both the size and the performance of each fund. The professors started by weighting each fund's monthly results by the fund's assets at the beginning of the month, so that big funds like Fidelity Magellan and Vanguard 500 Index carried more weight. These dollar-weighted monthly results were then strung together, generating an annual stock-fund return of 9.9% for the 19 years, versus 12.2% for the S&P 500. This lackluster performance is no great surprise, and it certainly doesn't mean investors are inept at picking funds. The fact is, stock funds -- burdened by annual fund expenses and trading costs -- have a long and sorry history of lagging the S&P 500. Instead, the big surprise came when our two professors calculated a second set of returns. This time, they didn't just give more weight to bigger funds when calculating each month's result. They also gave more weight to those months in which investors had more money invested. For instance, because investors had far more at stake in 2002 than in 1984, the results earned in 2002 were given greater weight. Suddenly, as with Dalbar's original study, investors' performance appears to be downright dreadful. Over the 19 years, stock-fund investors earned a mere 5.1% a year. That's far below the 9.9% you get when you give equal weight to each month, which indicates fund shareholders were most heavily invested during some of the worst-performing months. Investors, it seems, are indeed atrocious market timers. But that conclusion "isn't fair," says Prof. Zheng, who argues the results are heavily influenced by the time period studied. To prove this, the two professors looked at the 16 years through year-end 1999. If we use the professors' first calculation method, where we dollar-weight fund returns within each month but we don't dollar-weight over time, stock-fund investors earned 15.4% a year during this 16-year period, versus 18.1% for the S&P 500. But if we use the second method, where we give greater weight to those months in which fund shareholders had more invested, performance jumps to 17.1% a year. In other words, fund shareholders -- instead of looking like clods -- appear to be fairly savvy. But in reality, the results have nothing to do with investor brilliance or the lack thereof. Prof. Zheng notes that, over the past two decades, companies replaced traditional company pension plans with 401(k) plans and many investors dumped individual stocks in favor of mutual funds. Those two developments have caused stock-fund assets to grow far faster than the market, skewing the results. Investors had heaps of money in stock funds ahead of the late 1990s rally, which made them look smart, but also heaps invested ahead of the current decade's brutal bear market, which made them look dumb. A mystery story? Maybe it's the dog that didn't bark. Monthly Employment Stats
Also, employers added 35,000 fewer jobs than previously thought in April and May. The civilian labor force expanded 305,000 to 147.3 million in June as previously discouraged workers became job seekers. The unemployment rate, as a result, held steady at 5.6%. The June payroll gain "looks bad but there are no grounds for thinking it marks a reversal of the improving trend in the labor market," wrote Ian Shepherdson, an economist at High Frequency Economics, in a note to clients. "The softness partly reflects seasonals … partly an inexplicably small estimate for job creation … and partly the impact of higher oil prices." The manufacturing industry in June cut 11,000 jobs, its first cut since January. The government cut 5,0000 more jobs, after cutting 27,000 jobs last month. The service-producing industry added 122,000 jobs. That included a 39,000 increase in professional and business-services jobs, which include temporary-help jobs. Payrolls in the construction industry were unchanged. The job numbers coincided with a minuscule increase in average hourly earnings, which rose two cents to $15.65 in June. Wage gains moderated in annual terms in June: the increase last month was 2%, down from 2.2% in the year through May. The average workweek declined for the first time since April, falling 12 minutes to 33.6 hours In a separate report, factory orders fell by 0.3% in May, after a 1.1% decline in April, the Commerce Department said. The report suggests that growth in the manufacturing sector is moderating, but still came in better than Wall Street's expectations of a 0.5% decline in orders. Comments on the Jobs Report Caroline Baum, Bloomberg 7-02-04 Today's employment report for June, the first decline in manufacturing payrolls since January, and a dive in the workweek back to the all-time low, is certain to provide more fodder for those who think the expansion's best days are behind us. How do these folks think the business cycle works? After years of stimulative monetary and fiscal policy, the economy just runs out of steam, now that job and income growth are picking up? `U.S. economic cycles do not spontaneously implode,' says Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York. `They have to be pushed, hard, before they come to an end.' Prior Employment Updates: May 2004, April 2004, March 2004
The Labor Department also reported that the average weekly earnings of production and nonsupervisory workers, adjusted for inflation, in June decreased 0.8% from May. Average hourly earnings for such workers edged up 0.1%, but that was more than offset by a decline of 0.6% in average weekly hours and the rise in CPI. Compared with a year earlier, inflation-adjusted earnings for these workers were down 1.4%. Despite the weak wage data, the University of Michigan's preliminary reading of consumer sentiment for July rose to 96 from 95.6 in June and 90.2 in May. Just the Facts The Importance of Rebalancing Jonathan Clements, WSJ 7-28 You can garner a sizable performance bonus by rebalancing among a collection of stock-market sectors that generate fairly similar long-run returns. For proof, consider some numbers from T. Rowe Price. I asked the folks there to calculate the return on a portfolio with 50% U.S. stocks, 25% foreign shares and 25% REITs. If you had invested $10,000 in that portfolio 30 years ago and never rebalanced, you would have accumulated $347,000 by year-end 2003. But if you had rebalanced back to your 50-25-25 mix once a year, you would have amassed $390,000. And here's the impressive part: To pocket that extra $43,000, you didn't once have to guess the market's direction. The Importance of Plastic Jathon Sapsford, WSJ 7-22 For the first time, Americans used cards -- credit, debit and others -- to buy retail goods and services more often than they used cash or check in 2003. Last year, cash was used in 32% of retail transactions, down from 39% in 1999. Credit-card usage has remained stable, accounting for about 21% of purchases during that time. Meanwhile debit cards, which take money out of checking accounts immediately after each purchase, shot up to 31% of purchases last year, from 21% in 1999. Average amount a household spent on cards in 2003 was $15,066. Big Funds vs Smaller Funds Lawrence Strauss, Barrons 7-12 Large Mutual funds do operate at some disadvantage. Their portfolio's bulk can make it harder to get in and out of positions without roiling the market. And, even with volume discounts, trading costs can be hefty when huge blocks of stock are being bought or sold. But a September 2003 report by Lipper Senior Research Analyst Andrew Clark concludes "there is no consistently, statistically significant return differences between large and small funds over a variety of holding periods from 1991 to 2001." Investing to Beat Inflation James Stewart, SmartMoney 7-06 I think prudent investors should at least be prepared for the possibility that, after a remarkably long period of little or no inflation, we are entering a new period. So how should we prepare? I recently reviewed a study by Cambridge Associates examining how various asset classes performed in a high-inflation environment. During the period 1973 to 1981, the last (and one of the worst) high-inflation periods, the best-performing asset class was oil and natural gas (with annualized returns of 31% and 29% respectively). Next was timber, at 22%; real estate, 14%; commodities (other than oil and gas), 13%; government bonds, 6%; and the S&P 500, 5%. Health Care Costs Justin Lahart, WSJ 7-06 According to the National Health Statistics group of the Centers for Medicare & Medicaid Services, U.S. health expenditures now come to about 15% of gross domestic product. Japan spends about half as much on health-care as a percentage of GDP, yet has a higher life expectancy at birth and a lower infant mortality rate. U.S. companies willingly point out that they have been bearing the brunt of the rise in health-care costs, which is why so many of them have been passing along a larger share of the expense to employees. Firms with a strong union presence are less able to do this. General Motors says it spends $5 billion a year on medical expenses, or around $1,400 per vehicle.In contrast, Japan, like most industrial countries, has national health insurance. Many companies still provide health-care benefits for workers, but government-sponsored health insurance helps bring down costs significantly. Quality Stocks Won in Q2 Paul Lim, NY Times 7-04 While speculative segments of the stock market did well in the first quarter, continuing a trend from 2003, investors began to embrace higher-quality assets, including blue-chip stocks and stock funds, in the second. Large-cap stocks held their own in the last quarter, but higher-quality large caps appeared to perform even better. Standard & Poor's categorizes stocks in the S&P500 index based on the quality of the underlying companies' earnings and dividends and applies letter grades to them, from D to A+. In the second quarter, the C's fell 1.2%, while those rated A-, A or A+ rose 1.1%; in the first quarter, both groups rose, but the C's were far ahead. There was another sign that speculation might be over: diversified emerging-markets funds fell by 9.1% over the last three months. That helped drag down the performance of international stock funds in general; they lost 2.4%, on average. Quick Facts, Stats & Opinions Going back to 1945, whenever a Democrat was in office, the Standard & Poor's 500 gained an average 10.7% per year, versus only 7.6% during Republican administrations.But incumbents definitely held an edge during the same period. During the same time frame, whenever they have been re-elected, the markets rose an average 7.5% in the subsequent year. When a sitting president has lost, the market has declined an average 4.7% the following year. When it comes to investing, it's a mistake to be too preoccupied with politics. In a study released last month, researchers with CFA Institute and Northern Illinois University found very little evidence linking market performance with who's in the White House. Their findings show stock and bond returns have a far more significant relationship with the Federal Reserve's monetary policy. (Meg Richards, AP 7-25) I believe we are in a long-term period when stocks will be re-valued. We'll gradually see today's high price-to-earnings ratios decline to lower levels. . . . A steep stock decline isn't needed to accomplish this. Rising earnings and stagnant stock prices, such as we've already seen in 2004, would do the job. (Bob Carlson's Retirement Watch via The Washington Post 7-25) The Stock Trader's Almanac looked at the 12 decades since 1881-1890 and found that the Dow rose in each and every year ending in a five (a record matched by no other digit; in second place were years ending in "8," which produced increases 10 times). More remarkable, the average gain in years ending in "5" was a stunning 31 percent (again, years ending in "8" were second, at a distant 19 percent; no other digit produced gains averaging better than 9 percent). The final bit of numerology is that the year ending in "5" was the best year of the entire decade in six of the 12 such periods since 1881 and ranked second in three of the decades. (James Glassman, The Washington Post 7-25) So far this year the S&P 500 has literally gone nowhere. It's down about two percent from the end of last year, with this year's closing high only around 7 percent greater than its closing low. To put this in perspective, there was a 40 percent spread last year between the market's closing high and its closing low. Indeed, there have only been four occasions in the past 25 years when equities have traded in such a tight range. Past periods of calm have usually ended with an explosion of prices both up and down. So what's behind the present pause? Uncertainty over the economy, the elections and the geopolitical (read terrorism) situation.(Dr. Irwin Kellner, CBS MarketWatch 7-20) Two of the main factors supporting spending over the past year, tax cuts and increases in [stock] wealth, have sharply benefited upper income households relative to others. Two other long term trends - technological change and increasing global competition - also aid the upper income and hurt the lower. Technology rewards skilled workers, and competition has generally punished the unskilled, who are susceptible to the movement of work overseas. The rise in the value of the family home has also helped American families, but it has done so disproportionately. Housing values have appreciated fastest in the most affluent regions during the past three years, according to research by Fiserv CSW. Meanwhile, the U.S. has seen a big increase in the sheer number of affluent families. In 2002, nearly 16 million U.S. households had annual incomes of more than $100,000, up from a little more than five million 20 years ago, in inflation-adjusted terms. (Hilsenrath & Freeman, WSJ 7-20) Some brokers contend that mutual fund B shares are a better bet because the client's entire investment immediately goes to work in the markets, rather than getting whittled down by front-end commissions.But this argument doesn't hold water. Edward O'Neal, a finance professor at Wake Forest University, has done a heap of work analyzing B shares. "What I've found is that the advantage of having all your money go to work for you right away does not recoup the value lost because of the higher expenses over time," he says. (Jonathan Clements, WSJ 7-14) Pfizer unveiled a plan to deeply discount its drugs for people without health insurance, a move that may blunt rising political criticism and reduce consumer demand for drugs from Canada. Under the initiative, uninsured families earning less than $45,000 annually or individuals earning less than $30,000 would be eligible for discounts averaging 37% off the retail price on Pfizer drugs. (Scott Hensley, WSJ 7-08) About 35 percent of homebuyers are choosing adjustable-rate home mortgages. (Sara Clarke, Baltimore Sun 7-4) So long as investors see the Fed as being ahead of any potential rise in inflation, we expect modest contractions in P/Es to be offset by earnings growth. Still, high U.S. equity valuations mean gains are unlikely to be above the mid-single digits over the next year, and our overweight of equities is due primarily to our bearish outlook on bonds. (The View, Citigroup Private Bank Research via The Washington Post 7-04) Investors added only $35 billion to mutual funds in the past quarter, down from an inflow of $89 billion in the first three months of 2004, estimates AMG Data Services. That's the smallest contribution since the first quarter of 2003, when investors actually pulled $5.9 billion out of mutual funds. (Anitha Reddy, The Washington Post 7-04) The performance of companies receiving the worst ratings by Wall Street's crack research analysts has topped the performance of highly rated stocks in each of the past four years, according to Zacks Investment Research. Through May of this year, the 1,000 lowest-rated stocks were up 2.1%, while the 1,000 stocks with the highest ratings were up just 1.3% (Gregory Zuckerman, WSJ 7-04) The S&P 500 index is up 1.2% since Dec. 31st. But the average U.S. stock fund was up 3.9% in the the same time period, according to preliminary data from Lipper..(Tom Petruno, LA Times 7-04) Analysts currently are forecasting earnings gains of 21% for the companies in S&P 500. Based on recent experience, Kennard Perkins, research analyst at Thomson First Call, thinks analysts are underestimating, and that gains could hit 26% -- just short of the recent peak of 28% in Q4-03. If profit gains are more than 20%, it would be the fourth quarter in a row -- a streak of gains that has occurred only five times in the past 50 years. The last such streak occurred in 1998-1999, and before that it hadn't happened in 20 years. Analysts forecast about 14% Q3 earnings growth and 16% for Q4. They expect a miserly 7% in the first quarter of next year. (E.S. Browning, WSJ 7-01) Through May, investors had put almost $33 billion into American Funds' equity portfolios, roughly 29% of the total inflows experienced by all equity funds. By comparison, Vanguard received 21% of the inflows, while Fidelity took in 12%. (Gretchen Morgenson, NY Times 6-29). Lipper data released this week show uninspiring performance this quarter across much of the fund universe. Large-cap growth funds gained 0.65%, while small-cap value funds gained 0.23%, Lipper reported. Multi-cap growth funds were down 0.15%, and small-cap core funds lost 0.57%. Target maturity bond funds were down 5.6%. TIPS funds lost 3.5%. (Arden Dale, WSJ 6-29) Home Page Previous Factoid Top Sites
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||