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According to Jay R. Ritter, a finance professor at the University of Florida who specializes in IPO research, it is better to study the percentage of a given month’s completed offerings in which the offer price was below the midpoint of the range that the company initially indicated when it registered its intended new issue with the SEC. Reliable data on this percentage are readily available for several decades. And, according to Professor Ritter, the same underlying factors that lead a large number of companies to withdraw or postpone their initial offerings will usually also cause other companies to go public at lower prices. Such factors include a depressed mood generally among investors and, in particular, among those traders most likely to purchase shares in an initial offering. In June of this year 58% of the domestic companies that completed their new issues came to market below the midpoints of the ranges they indicated when initially filing their new-issue registrations. For initial offerings completed so far this month, 86% came in below their midpoint. The average of comparable percentages for all months back to 1980, according to Professor Ritter, is 44%. (To help insure that his database reflects trends in the domestic equity market, Professor Ritter excludes from his calculations new issues for REITs and foreign companies’ American depositary receipts. To prevent relatively small offerings from skewing the results, he also excludes those for which the midpoint of the initially indicated price range was below $8 a share.) In a handful of occasions, this proportion was 100% — meaning that every I.P.O. came to market at a price below the midpoint of its anticipated price range, according to Professor Ritter. The last such occasion was February 2003, when the stock market was barely higher than where it stood at the October 2002 bear market low. Other such occasions include December 1987, in the wake of that year’s stock market crash, and October 1990, during the stock market’s break after Iraq’s invasion of Kuwait. After each of these three occasions, the stock market rose strongly. At the other extreme, months of widespread investor optimism have often been characterized by very few IPO’s coming to market at lower-than-intended prices. Just 2.8% of the new issues completed in December 1999 were priced below their intended ranges, for example, according to Professor Ritter. In March 2000 it was 3.9%. Those months came at or close to the stock market’s record high before the bursting of the Internet bubble and the beginning of the 2000-2 bear market. A statistical analysis of the monthly readings since 1980 shows that the relationship between lower-than-intended IPO prices and higher markets is significant at the 95% confidence level. Professor Ritter emphasizes that, although the correlation between new-issue pricing and the stock market’s subsequent return is statistically significant, there are a myriad of other factors that will undoubtedly influence stock prices over the next year.
When you are evaluating any investment, you must compare it to every other available investment, including ones you may already own. Instead, many investors collect stocks like baseball cards and the resulting portfolio bloat will likely not increase returns or reduce risk. So when you hear about the new hot stock in the next can't-miss sector, ask yourself two questions: (1) Do I understand the investment as well or better than one I already own? (2) Is the risk and reward profile of the investment superior to all other alternatives? If the answer is "no" to either questions, it is probably best to stay away. Rational Decisions Result in Returns "Rationality is not just something you do so that you can make more money, it is a binding principle. Rationality is a really good idea. You must avoid the nonsense that is conventional in one's own time. It requires developing systems of thought that improve your batting average over time." Munger is an evangelist for the virtues of rationality and his outstanding investment record is testimony to a lifetime of disciplined thought. To succeed as an investor, one has to make good decisions that are anchored in reality and free from emotional and cognitive distractions. One should search for companies with significant market potential, rising demand, an economic moat, and growth-oriented management for purchase in your portfolio. This is not merely a checklist, but a research process focused on helping you make the most-rational decision. If you make enough rational decisions, you will eventually have the returns to show for it. Beware of Envy It was a very few venture capital firms made most of the money in this area, "and they made it in just a few periods. Everyone else returned between mediocre and lousy. When returns happened, envy rippled through institutional money management. The amount invested in venture capital went up 10 times post-1999. That later money was lost very quickly. It will happen again." Munger and Buffett often say that envy is worst of the seven deadly sins because it is the only one that isn't fun to commit. When a group of people make money, others are compelled by an irresistible force to get a piece of the action, even though prices have risen so far above fair value as to guarantee disappointing returns and there are much better alternatives available. I am completely puzzled by this behavior, but I am also glad it exists. Learning, Modifying, or Destroying Ideas "We all are learning, modifying, or destroying ideas all the time. Rapid destruction of your ideas when the time is right is one of the most valuable qualities you can acquire. You must force yourself to consider arguments on the other side. If you can't state arguments against what you believe better than your detractors, you don't know enough." Carl Jacobi, a noted 19th-century mathematician, counseled his students to "invert, always invert" when they encountered a particularly vexing problem. I think this is a great way to approach investing. After you compile all the reasons you should buy a stock, invert the question and state the reasons why you should not buy the stock. By doing this, you ensure that your research process is more complete. Remember Your Mistakes "Chris Davis [of the Davis funds] has a temple of shame. He celebrates the things they did that lost them a lot of money. What is also needed is a temple of shame squared for things you didn't do that would have made you rich. Forgetting your mistakes is a terrible error if you are trying to improve your cognition. Reality doesn't remind you. Why not celebrate stupidities in both categories?" I have kept track of my investing mistakes for some time now, and it is a painful, but illuminating, experience. Without doubt, I am a better investor for it. With a post-mortem catalog of your mistakes, you will be able to identify patterns in your decision-making process that produce unforced errors. Risk Has a Season "I know a man named John Arriaga. After he graduated from Stanford, he started to develop properties around Stanford. There was no better time to do it then when he did. Rents have gone up and up. Normal developers would borrow and borrow. What John did was gradually pay off his debt, so when the crash came and 3 million of his 15 million square feet of buildings went vacant, he didn't bat an eyebrow. The man deliberately took risk out of his life, and he was glad not to have leverage. There is a lot to be said that when the world is going crazy, to put yourself in a position where you take risk off the table. We might all consider imitating John." Related Link: Munger on The Advantages of Scale, Techological Change, and The Secret of Winning Betters
Many fund companies have begun to require managers to tie their personal fortunes to their funds. Franklin Templeton Investments and Janus Capital Group have started directing a portion of managers' bonuses or incentive pay to the purchase of shares in their funds. Previously, these awards were made mainly in cash or company stock. At Legg Mason's Royce & Associates funds, senior portfolio managers must accumulate an investment of at least $1 million in each fund they manage, and assistant managers must invest at least $500,000. Putnam Investments, have begun making managers' ownership information more readily available in a fund's prospectus or on their Web sites. Investors typically must look for these data in a fund's statement of additional information, which often must be requested from the company or retrieved at SEC database www.sec.gov/edgar.shtml. The moves to encourage manager ownership could benefit investors. Researchers at the Georgia Institute of Technology and London Business School found that funds with managers who owned some fund shares at the end of 2004 delivered an average return of 8.7% in the following year. This exceeded the 6.2% average return by funds without manager ownership for the same period. The study, which examined about 1,300 U.S. mutual funds, showed that manager ownership was highest in domestic stock funds and lowest in international bond funds. For every 0.01% increase in manager ownership, fund performance improved 0.03%, it found. The disclosed information is not perfect. Managers' holdings aren't listed in exact dollar amounts, but rather in ranges -- $1 to $10,000, for instance, or $100,001 to $500,000 -- giving an imprecise picture of how much is invested. Also, investments aren't disclosed as a percentage of a manager's net worth, so investors can't get a perfect understanding of his financial commitment to the fund. Even a $50,000 or $100,000 investment may be just a token commitment for many portfolio managers, advisers say. The median compensation for mutual-fund managers in 2005 was $390,000, according to a survey by Russell Reynolds Associates and the CFA Institute. Morningstar recently ranked fund families by the level of manager investment and found wide disparities. Janus topped the list with an average manager investment of nearly $1 million. Some of the firm's fund managers with more than $1 million invested include Jonathan Coleman, with Janus Enterprise fund, David Decker, who runs Janus Contrarian fund, and James Goff, of Janus Research fund, according to the latest company filings. Other fund families that earned high marks in the Morningstar survey were Royce & Associates, with an average manager investment of $877,000; Artisan Partners, with $712,000; and Capital Research & Management's American Funds, with $597,000. Managers at some of the largest fund companies, including Vanguard Group, Fidelity Investments and T. Rowe Price Group, aren't required to invest in their own funds, though many do so voluntarily, the companies say. In some cases, it's not appropriate for a manager to hold a substantial stake in his own fund, as when a relatively young person manages a conservative bond fund, says a T. Rowe Price spokesman. "We have fund managers allocate their investments based on their own personal investment needs and goals," a Vanguard spokeswoman says. Average manager investment at Fidelity and T. Rowe Price topped $400,000, according to the Morningstar survey, while Vanguard's average manager investment was just below that mark.
Which is better? Often, it depends on one's view of the company. To argue that Apple Computer shares are overpriced, point out that they sport a trailing P/E of 30. (The lower the ratio, the "cheaper" the stock.) To argue they're not so expensive, use the "forward" 12-month P/E of 25. Over the long haul, which P/E one uses may not matter, argues Pavel Vaynshtok, an analyst at ING Investment Management. Going back to 1985, he found that the performance of a stock portfolio made up of the 20% of the stocks in each sector of the Russell 3000 index with the lowest trailing P/Es came up dead even against a portfolio with the lowest forward P/Es. (The portfolios were rebalanced monthly.) Mr. Vaynshtok also found that in years when the market at large rose, the basket of stocks with low forward P/Es outperformed the basket of stocks with low trailing P/Es, on average by 1.2 percentage points. By contrast, in years the market fell, the trailing-P/E basket outperformed the forward-P/E by 2.5 percentage points. Mr. Vaynshtok thinks this may happen because analyst estimates become overly pessimistic in down markets, making forward P/Es less useful. Trailing-P/E stocks also tended to do better when the level of uncertainty in the market, as measured by the CBOE Market Volatility Index, was high. That may be because analysts have a harder time coming up with accurate earnings forecasts during periods of uncertainty. Looking forward, many investors fear that a slowing economy will hurt corporate earnings, and therefore stock prices. If the market gets really hairy, they'll want to look backward.
A recession-warning gauge devised by Federal Reserve economist Jonathan Wright -- based on yields on the three-month Treasury bill and 10-year Treasury note and the Fed's current target for short-term rates -- calculates the odds of recession in the next year are now at 36%, up from 14% six months ago. Merrill Lynch economist David Rosenberg put them even higher, at 40%, noting that a slowing economy could pose problems for business and consumer borrowers and deepen the slowdown. And Ian Shepherdson, chief U.S. economist at High Frequency Economics, sees a 50% chance of recession. "Hopefully, the Fed will recognize that risk and not be crazy enough to raise rates again next month," he said. Of course, recessions are notoriously hard to predict, and early-warning gauges can be misleading. "You have to monitor movements among so many indicators," said Victor Zarnowitz, a longtime business-cycle watcher now at the Conference Board, a business-research organization in New York. "It's complex to find a consensus in economic activity." The U.S. has shaken off a surprising number of shocks in the past few years. "We have found that the U.S. economy has been surprisingly resilient, surprisingly able to manage the increase in prices that we have already seen," Energy Secretary Sam Bodman said at a Friday news conference with Canadian government officials. "I am hopeful that it will continue to do so." Lakshman Achuthan of the Economic Cycle Research Institute in New York, which tries to predict the turns in the economy, expects just that. "In terms of recession risk, we don't see that yet," he said. "Our leading indicators of growth, while they're down, are not in recessionary territory." Welcome signs of life in the Japanese and European economies and continued vigor in China, moreover, suggest they might help sustain world economic growth as the U.S. slows.
If your mutual fund closes to new investors, should you cash out? Because the reasons for doing so vary, a fund's closing alone shouldn't be a reason to sell your shares. "I think it's a mistake to see a fund closing as a sell signal," says Dan McNeela, associate director of fund analysis at investment research firm Morningstar, though he adds: "When your fund closes, it calls for some investigation to figure out why." If a fund is about to merge with another portfolio, shareholders should make sure they know what fund they are getting in exchange for their current one. The new fund may have a different manager, higher expenses or may even belong to a different fund classification - all situations where investors may want to reconsider their position in the fund. Conversely, funds often close to new investors as a means of protecting existing ones. A typical scenario: A successful fund attracts more cash than its manager can find places to invest. As more money keeps coming in, the manager might be forced to expand the fund's portfolio and risk diluting returns, so the fund closes to new investors. In many cases, though, a fund waits too long before closing. "Too many funds say, 'We're not having a problem executing a strategy with this larger asset base, and we're not going to close our fund' -- and it's only when they start experiencing trouble that they make a decision to close," Mr. McNeela says. "And by that time, it may be too late to protect the investors who've been in the fund all along." Aggravating the problem is the fact that asset bloat is often caused by "hot money" poured in by investors chasing returns. "In those cases, closing a fund is a warning sign that investors may be too optimistic about the future prospects of what has worked over the past few years," Mr. McNeela says.
American Funds recently cut fees 10%, to as low as 0.56% for some of its portfolios of U.S. stocks, compared with an average charge of 1.4% for such funds, according to Morningstar. Other fund companies, including Vanguard, Fidelity and T. Rowe Price, are also slashing fees, helping to bring mutual fund expense charges down 4.2% in 2005, according to the Investment Company Institute. Much of the credit goes to New York Atty. Gen. Eliot Spitzer and his crackdown on improper mutual fund trading practices that hurt returns and raised costs for average investors. As a result of settlements made since Spitzer's probe began in 2003, 11 fund companies have reduced fees and saved investors nearly $1 billion, said Russ Kinnel, Morningstar's director of fund research. The SEC also helped the low-fee cause by requiring mutual fund boards to better explain fees and charges in prospectuses, Kinnel said, making it harder to hide the costs in the fine print. Finally, the lackluster U.S. market also contributed, because fees eat up an increasingly noticeable portion of investment returns in a market that's making little progress — or losing ground, as almost all major categories of stock funds did in the second quarter. "When you think about one fund charging 1.5% and another charging 0.5% for the same service, particularly in this low-return environment, you realize that's a huge percentage of your return," Kinnel added. That point has not been lost on investors, who are pouring money into the funds with the lowest fees and turning cost cutting into a competitive edge. "It is the market at work," said Mike McNamee, a spokesman for the Investment Company Institute. "Competition is on fees, and investors are flocking to the lowest-cost funds." Mutual fund fees may seem small, but on large investments held for long stretches, they add up. The difference of just one tenth of a percentage point — roughly 10 cents for every $100 invested — saves an investor with $100,000 about $100 a year. But if that individual leaves his money invested over 30 years and earns an average of 10% on his money, the savings mushrooms to $58,152. "The difference compounds over time and magnifies," Kinnel said. There are three types of fees associated with mutual funds: [1] Loads, which are sales charges levied by some, but not all, funds. Loads assessed at the time of purchase are called front-end loads, and those charged when selling are called back-end loads. [2] Annual management fees, which cover the cost of managing the fund and choosing investments. These are charged by all funds. [3] 12(b)1 fees, which are levied by some funds to cover sales and marketing costs. The relative ease of checking fund costs on the Internet may be another reason more investors are switching to lower-cost funds. Roughly 70% of new money pouring into mutual funds is earmarked for those that charge fees below the average for their peer group, according to the Investment Company Institute. That's a significant change in attitude, said Francis Kinniry, who runs the investment counseling and research operation at Vanguard. Back in the 1990s, when annual returns of 18% were typical, many investors saw fees as barely significant. "Instead of getting 18% on stocks, you were getting 16.5% after fees and no one was complaining," Kinniry said. Although most companies are slashing fees, there are differences in degree and approach. Vanguard and Fidelity, two of the biggest fund companies, are among those giving discounts for investors who are willing to maintain relatively high balances. Vanguard, for example, announced last year that it would automatically shift investors with $100,000 in assets into so-called Admiral shares, which are available in about half of the company's 135 funds. The only difference between Admiral shares and others is that Admiral shares are cheaper. The Vanguard 500 Index fund — the company's largest, with $105 billion in assets — charges 0.18% to the average investor, but just 0.09% to those who qualify for the Admiral class. Late last month, Vanguard made Admiral shares available in its emerging markets fund, which normally charges 0.41% annually. Admiral investors get the fund for 0.3% — about one-sixth the cost of the average emerging markets fund. Fidelity countered by creating Advantage Class shares for its domestic index funds, undercutting Vanguard on fees. Advantage Class shares, available to those with $100,000 in assets, charge just seven-hundredths of a point. Fidelity has been gradually eliminating loads over the last three years for all its fund investors, a company spokesman said. In mid-2004, it cut management fees on some of its most popular index funds to 0.1%. T. Rowe Price, another massive fund company, has cut expenses on a handful of funds, regardless of an investor's balance. In October, T. Rowe Price cut the expense ratio on its Capital Opportunity fund to 0.95% from 1.15%. Its Global stock fund trimmed expenses to 1% from 1.2%. In May, T. Rowe Price shaved 0.05 of a point off the management fees for two Treasury bond funds too, said spokesman Steve Norwitz.
According to a recent report from the Investment Company Institute, the total cost of investing in stock funds fell in 2005 for the third consecutive year. Stock-fund investors in 2005 on average paid 1.13% in fees and expenses, and they're increasingly shopping for low-cost funds. Some 30% of the $136 billion of the net new investments in stock funds last year went to funds with an expense ratio of less than 0.5%, according to ICI, the fund industry's largest trade group. Shareholders in lower-cost funds keep more of their profits, and over time, the compounded cost savings can be dramatic, numerous studies have shown. Phillips said the rise of low-fee index funds and exchange-traded funds is giving investors low-cost alternatives to active portfolios. Fund boards are also paying more attention to fees after the transgressions unearthed in 2003 left the industry with a black eye. "Fund boards aren't behaving like lap dogs anymore," Mr. Phillips said. "Boards are asking managers to justify fees." Meanwhile, some fund companies are closing or merging away their more costly funds. However, there are concerns about fees in the hedge-fund industry, where investors can pay as much as 2% of assets to the manager as well as 20% of profits. Although fund companies are suffering a brain drain as more managers jump ship for the more lucrative world of hedge funds, Mr. Phillips noted "your IQ doesn't go up 20 points just because you say you're a hedge-fund manager." Morningstar applauded regulators for requiring that portfolio managers disclose how much money they have invested in their own funds, a move that has allowed investors to see if their manager is paddling in the same boat. Although it's still early, the analysts said initial evidence suggests managers who eat their own cooking tend to outperform those who don't.
A vast number of people think that investing for the long term in a diversified portfolio of mutual funds is the smart thing to do. In my opinion, this ranks among the worst possible investments. The problem with funds is fees. The longer you invest in a mutual fund, the more you pay in fees. I've pointed out before that when I buy a piece of real estate or a stock, I pay the sales commission once, but when I purchase a mutual fund, I pay a sales commission for as long as I own the fund. That's why the return on investment is much lower on mutual funds - and why gains get lower the longer you own them. The reason most financial planners recommend you invest for the long term is simply because the longer you hold on to the fund, the more money they make. Just how much does a fund company make from investors who hang in there for the long term? John Bogle, the founder of the very successful Vanguard Group, shed some light on that. He was asked by an interviewer with the TV program "Frontline," "What percentage of my net growth is going to fees in a 401(k) plan?" Bogle replied, "Well it's awesome. Let me give you a little longer-term example. An individual who's 20-years old today [is] starting to accumulate for retirement.... That person has about 45 years to go before retirement -- 20 to 65 -- and then, if you believe the actuarial tables, another 20 years to go before death mercifully brings his or her life to a close. So that's 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8%, that $1,000 will grow...to around $140,000." He continued: "Now the financial system - the mutual-fund system in this case - will take about 2.5 percentage points out of that return, so you'll have a net return of 5.5%, and your $1,000 will grow to approximately $30,000 to you the investor." "Think about that. That means the financial system put up zero percent of the capital and took zero percent of the risk and got almost 80% of the return. And you, the investor in this long time period, an investment lifetime, put up 100% of the capital, took 100% of the risk, and got only a little bit over 20% of the return. That's a financial system that's failing investors because of those costs of financial advice and brokerage, some hidden, some out in plain sight, that investors face today. So the system has to be fixed," said Bogle. In other words, the longer you invest, the more the investment house makes. That's why the financial institutions recommend you invest for the long term.
Reducing mutual-fund expenses can, and should, be done. Kiyosaki goes hopelessly wrong when he takes avoiding mutual-fund expenses to an absurd conclusion. "While index funds have the potential of generating greater returns via lower fees, I would still prefer to be an active investor. Most index funds think a 10% to 25% return is a good rate. Active investors can regularly beat those gains, especially if they stay away from traditional investments such as savings, stocks, bonds, and index and mutual funds." That, readers, is just plain wrong. Here's why. First, if you eliminate "traditional investments such as savings, stocks, bonds, and index and mutual funds," you are eliminating virtually all of the tradable, liquid capital in the entire world. While you and I may want to make some private investments that aren't liquid and tradable, the vast majority of our investments should be just that, liquid and tradable. Second, the case against active management is extensive. Mutual-fund portfolio managers are active investors, and about 70% of them consistently fail to beat their chosen index. Pension-fund managers are active investors, and about 70 percent of them consistently fail to beat their chosen index — in spite of having lower expenses than retail mutual funds. Hedge funds, the fastest growing and most actively managed money on the planet, also regularly fail to beat the major indices — and the published figures don't adjust for massive survivor bias because so many hedge funds with bad records simply disappear. If all those managers, who presumably have training, brains and talent, usually fail to beat a passive index, why should you and I think that we can regularly get returns of more than 10% to 25% a year simply because we become "active" investors in our spare time at home? The bottom line: All of us need to be active savers. We should limit our activity as investors to the aggressive pursuit of the lowest-cost index investments.
At the Vanguard Group, which created its first such fund in 1985, the amount of money managed by its quantitative group has quintupled in the last three years, to $20 billion at the end of 2005 from $4 billion in 2002. While no organization keeps track of flows into quantitative funds, they are probably still a very small part of the $9.5 trillion mutual fund industry. Many quant managers, however, say the funds' recent performance has received a lot of attention. Quant funds can come in different flavors. Those like the Vanguard Strategic Equity fund, which is closed to new investors and was up 5.9% this year through June, let the computer model make practically all the decisions, from which stocks to buy and sell to when to trade them. Other funds, like the Quant Foreign Value fund, up 11.1%, use quantitative analysis as a screen to narrow down a basket of stocks. The final investment decisions then made by humans. Quantitative techniques emerged in the early 1970's and gave birth to the index fund in 1971, when Wells Fargo introduced a mutual fund that tracked 1,500 stocks on the NYSE. As computer-processing power grew and more physicists and mathematicians left academia for Wall Street, money managers offered more robust services, and institutional investors began to embrace quantitative management for the advantages it offered. The most obvious advantage is that quantitative models can examine a much larger universe of stocks than human analysts. Schwab Equity Rating, for example, analyzes about 3,000 stocks and assigns grades of A through F, based on four metrics: fundamentals, valuation, momentum and risk. The expense ratios are also generally smaller than those of comparable actively managed funds. And because the models have rankings of stocks, many employ short-term as well as long-term strategies. But perhaps the most important attribute of quant funds is their superior risk control. Most models keep sector and equity picks within the benchmark attributes they are built around. This process reduces the risk that may otherwise be introduced by active managers who decide to make a bet on a particular sector or stock. And that leads to what may be the most attractive aspect of a quantitative fund. "With quant funds there is no emotion in the investment process," said Jeff Mortimer, head of equity portfolio management at Charles Schwab. In other words, the investor is not exposed to the whim of an active fund manager who travels to a company's offices and whose investment decision may be partially based on his very complex, but unquantifiable, human experience while there. A study published last year in The Financial Review found that enhanced index funds that use quantitative techniques outperformed their benchmarks, on average, from 1981 to 2000. Still, it has taken longer for individual investors to embrace fully the idea of a "black box" running their investments. It didn't help when, in 1998, Long-Term Capital Management, a hedge fund that bet on the predictions of its quantitative algorithm, suffered a spectacular implosion when its models failed to predict the Russian government would default on its debt. And that leads to the biggest criticism of quantitative models: their reliance on historical data and their inability to assimilate new information quickly. "It's not something that can be run on autopilot, despite the use of computer models," said Greg Carlson, an analyst at Morningstar. "You have to have a research team that's going to continue to look for new factors to add to the models because oftentimes the efficacy of a particular factor is either not recognized by the models or gets arbitraged away over time." Mr. Mortimer of Charles Schwab said human managers at the company halted purchases of Merck in 2004 during the Vioxx controversy even though their models were calling for purchases of the stock. Merck's shares declined roughly 25% from the beginning of the problems through the second quarter this year. There is another possible drawback of quantitative funds: because of the high volume of buy and sell signals generated by the models, the funds have higher-than-average turnover ratios and are therefore not as tax-efficient as index funds. This same factor also leads fund companies to limit the size of the funds. Even though quant funds have performed well in recent years, Joel Dickson, head of Vanguard's active quantitative equity group, said investors should be careful about jumping into such funds now. "I'm a little concerned that investors may be chasing performance," Mr. Dickson said. The most recent three years have been very good for many quant funds, he said, but he cautioned that their fundamental strategy may become less effective: as their stocks become more accurately priced, it becomes harder for quant managers to beat their benchmarks. One of the best-performing funds so far in 2006 is the Bridgeway Ultra-Small Company fund, which uses five quantitative models to fill out its holdings with an assortment of growth, value and momentum stocks. The fund, now closed to new investment, gained 18% this year through June. Still, it's rare to see a quantitative fund at the top of the performance charts, since many funds of this type aim only to outperform a benchmark. But that has not deterred investors. Trying to capitalize on the new interest, mutual fund companies have introduced new quant funds in recent months. Charles Schwab now offers 20 quant funds, 9 under the company's name, while the rest are managed by Laudus Rosenberg Funds. Vanguard started the Strategic Small-Cap Equity fund in April, bringing the number of its quantitative offerings to seven. In May, American Century Investments started three quantitative funds. How Fund Categories Fared WSJ 7-05-2006
The consensus forecast of the 56 economists is that growth in real GDP will ease to an annualized 2.9% in the second half of 2006. That compares with an annualized 5.6% in Q1 and an expected 2.8% in Q2, which would bring first-half growth to about 4.2%. By the first half of next year, growth would cool further to 2.7%, the slowest rate since mid-2003. The forecasters expect nonfarm businesses to add an average of about 140,000 jobs in each of the next 12 months. That rate would not be enough to keep the unemployment rate from rising to 4.8% by next May from 4.6% in May 2006. Asked what they thought was most likely to happen with consumer prices, three-quarters of the forecasters said they thought inflation would surge before ebbing as the economy cools. They expect year-on-year inflation to be 3.1% in November, and to average 2.5% over the next 10 years. The combination of slowing growth and rising inflation has made economists less certain of their benign predictions. On average, they said they were 63% confident in their forecasts for GDP growth, down from 68% a year ago. Together, they put the odds of a recession in the next year at one in five, double the probability of a year ago. The overarching concern: With energy prices high, consumers heavily in debt and the housing market overextended, the U.S. economy could prove susceptible to an unexpected shock. "We're at a point where there are strains, so we're more vulnerable should a shock occur," says Lou Crandall, chief economist at Wrightson ICAP. Forecasters offered a litany of potential threats, from a widespread outbreak of avian flu to a geopolitically motivated energy crisis. But the most prevalent concern was that the Fed, zealous to beat inflation under a new chairman working to earn inflation-fighting credentials, will take interest rates too high and tip the economy into recession. In the survey, 12 of the 56 participants named a monetary-policy mistake as the greatest risk looming over the economy in the next 12 months. Worries about the Fed have risen along with interest rates: In the Journal's last two surveys, forecasters underestimated how high the central bank would take its short-term interest-rate target. "Rates have gone up more than I expected, so I'm more concerned that they're going to overshoot," says Maury Harris, chief U.S. economist at UBS. Forecasters see about a 50% chance that the Fed's target rate will hit 5.50% by the end of the year; at 6.25%, they put the chances of a recession at better than even. Still, for the most part, economists voiced a generally high opinion of Mr. Bernanke's ability to find the right balance. They gave the new Fed chairman a grade of "B-plus" for his interest-rate decisions so far, and 31 of the 56 polled said they expect the Fed to whip inflation with only a limited impact on growth. Just 14 said they think it will go too far and damage the economy. Some noted that even if the Fed chooses to stifle economic growth, it won't necessarily be in error. Resurgent inflation could force the central bank's hand -- a possibility that eight forecasters saw as the greatest risk to the economy. Several of those envisioning this scenario noted that the unprecedented rise in housing prices over the past decade and a half has only just begun to seep into consumer prices, in the form of higher rents. High home prices, together with higher interest rates, have made homeownership unaffordable for many, increasing demand for rental properties. "The Fed under [former Chairman Alan] Greenspan ignored the rising price of houses, which clearly was the result of very easy monetary policy," says Paul Kasriel, chief economist at Northern Trust. "Now it's paying for it." Two forces that many economists believe have kept inflation in check - globalization and booming productivity - could now be ebbing or even pushing the other way. Chinese companies whose inexpensive exports have helped hold down consumer-goods prices in the U.S. are now helping put upward pressure on capital-goods prices as they expand their production facilities. And as U.S. companies become less able to squeeze more out of their existing workers, some are starting to hire more workers, a trend that could ultimately push up wages. Under Mr. Greenspan, the forces of globalization and productivity "allowed us to have lower unemployment and lower inflation and higher growth all at the same time," says Allen Sinai, chief global economist at consultancy Decision Economics. "Chairman Bernanke unfortunately does not have that luxury." In other survey findings: [1]Forecasters remain stock investors. Almost half, 27, had more than half their investments in the stock market, down just a bit from 29 in December. The majority expect the Dow Jones Industrial Average to end the year between 11000 and 12000, though about a third think it could be below 11000. The industrials ended at 11228.02 Monday. [2] Corporate-profit growth is expected to slow. The consensus calls for profits to rise 14.5% in 2006, then slow to growth of 4.4% in 2007. They rose 16.4% in 2005. [3] Forecasters expect the dollar to weaken slightly. They see it buying 107 yen, and a euro costing $1.29, in June 2007. As of Monday, a dollar bought 114.65 yen and a euro cost $1.2807. [4] Oil prices are expected to ease to about $61 a barrel by mid-2007. As of Friday, oil was $73.93 a barrel on the New York Mercantile Exchange. [5] Forecasters expect GDP in Q3 to be 3.0%, the CPI by November 2006 to be 3.1%, the Jobless Rate by November 2006 to be 4.7%, and the10 Treasury on December 29th to be at 5.24%. Monthly Employment Stats
Health care employment continued to trend up in June, with a gain of 19,000. Over the past 12 months, the industry added 278,000 jobs. In June, employment rose in hospitals, doctors’ offices, and nursing and residential care facilities. Employment in professional and business services also continued to grow in June (+25,000). Job gains in the industry have averaged 27,000 per month so far in 2006, compared with 41,000 per month in 2005. Temporary help services employment edged down slightly over the month and has decreased by 36,000 since December. Retail trade employment was essentially unchanged in June following large declines in April and May. Retail employment is down by 86,000 since March. General merchandise stores lost 14,000 jobs over the month; this industry has accounted for most of the recent decline in retail trade employment. In the goods-producing sector, manufacturing employment edged up in June (+15,000), following a small decline in May. Mining employment grew by 6,000 in June. The industry has added 114,000 jobs since its most recent low in April 2003, largely reflecting gains in support activities for oil and gas. In June, construction employment was essentially unchanged for the fourth consecutive month. Average hourly earnings of production or nonsupervisory workers on private nonfarm payrolls rose by 8 cents in June to $16.70, seasonally adjusted. This followed increases of 10 cents in April and 1 cent in May.Average weekly earnings increased by 0.8% in June to $566.13. Over the year, average hourly earnings increased by 3.9% [the fastest annual growth pace since June 2001] and average weekly earnings increased by 4.5%.
Quick Facts, Stats & Opinions When the Fed Cuts Rates Chet Currier, Bloomberg 7-04 Hark back to Jan. 3, 2001, when the Fed last cut its federal funds rate. Stocks were almost two years from reaching the bottom of a bear market. In the six months after that first rate reduction the S&P500 declined 7.8%, and the Nasdaq lost 18%. That broke a pattern of consistent gains that followed the previous six transitions from rate increases to rate cuts. By my back-of-the-envelope calculations, in the six-month periods following all seven turning points from increases to decreases dating back to 1984, the S&P500 has averaged a gain of better than 10% and the Nasdaq more than 13%. Be especially wary of statements declaring that certain types of stocks - big or small, growth or value - are likely to perform the best when the next Fed easing starts. Yes, a check of recent history shows that the Nasdaq outdid the S&P 500, which is dominated by bigger stocks, more often than not in the six-month stretches after Fed turning points. But no, the pattern didn't hold every time. The S&P 500 outshone the Nasdaq twice in a row, after turning points in 1989 and 1995. Some market recoveries, it seems, draw their energy from revived enthusiasm for smaller growth stocks; others feature a more cautious nibbling at big-name blue chips. Time to take the HDTV plunge? Victor Godinez, Dallas Morning News 7-04 In the fourth quarter of 2004, the average 42-inch high-definition plasma TV cost $4,446, according to another research outlet, Austin-based DisplaySearch. By the fourth quarter of 2005, that average price had dropped to $2,611, a 41.3 percent decline. From the end of 2005 to the end of 2006, the average price of a 42-inch high-definition plasma display is expected to dip 22.9 percent, to $2,014. In dollar terms, a plasma TV shopper at the end of 2004 would have saved $1,835 by waiting one more year. A prospective buyer at the end of 2005 nets $597 by waiting 12 months. Seventeen percent of Americans now own an HD set, Forrester Research says. From 1833 through 2004, U.S. stocks averaged a 11% annual gain in pre-election years and a 6.8% advance in election years, according to the "Stock Trader's Almanac," published by Yale Hirsch and Jeffrey Hirsch. Those returns towered over average gains of 1.6% a year in post-election years and 3.7% in midterm years. (Chet Currier, Bloomberg 7-30) The fastest and most powerful way to change your retirement is to work on your expenses, not your investments. Every dollar of spending you avoid [in retirement] eliminates sales taxes and income taxes. Follow this trail. An item priced at $1 will cost $1.075 with a typical sales tax. To net $1.075 after a 15% federal income tax, you need to earn $1.26 on your investments. At a safe withdrawal rate of 4%, that means you need $31.61 in investments to support every $1 of retirement spending. If you happen to trigger the taxation of Social Security benefits or live in a state with an income tax, the investment multiple you will need can be much higher. A retiree who triggers the worst possible rates will need to earn $2 on his investments to generate $1.075 of after-tax income to buy something that costs $1. Every dollar he doesn't spend will eliminate the need for $50 in investments. (Scott Burns, Dallas Morning News 7-23) Useful piano shopping information is available on the Web from piano makers, retailers, technicians and enthusiasts. The site www.bluebookofpianos.com compiles new and used piano prices; pianoeducation.org/pnobuyng.html has general information about piano types and a buying guide. There is also the National Piano Foundation, at pianonet.com, and the Piano Technicians Guild resource page, at ptg.org/resources-pianoOwners.php. (Michael Fitzferald, NY Times 7-23) About 25% of all Americans over age 65 have yet to pay off their home loans, up from 11% in 1983, according to a Boston College analysis of Federal Reserve Board data. Among those aged 55 to 64, half owed money on their homes in 2004, up from 37% in 1989. Many older homeowners see their homes - rather than savings accounts - as piggy banks that can be tapped through home equity loans or refinancings. A new AARP national survey found that among workers 55 and older with mortgages, about half doubted that they could pay them off before they retired. (Jonathan Peterson, LA Times 7-22) Year to date, Target has lost 14%, while Wal-Mart is down 8.1%. A number of analysts expressed divergent views on Target's stock in commentary today. Brian Sozzi at Wall Street Strategies said the shares are trading at "depressed valuations." But AG Edwards downgraded it to "hold" from "aggressive" due to concerns about inventories and the slowing housing market. Perhaps real estate has something to do with Target's weakness when compared with Wal-Mart: If housing is slowing, and those with higher incomes were benefiting from the wealth effect of increasing home equity, then consumer spending in that demographic could indeed get hit hard. (David Gaffen, WSJ 7-18) James Picerno muses on the Capital Spectator on the nature of optimism and the market's ability to discount bad news, but he believes the recent increase in tension around the world may be harder to rebound from in the markets. "As one looks out over the escalating warfare in the Middle East, it's hard to see an endgame in the near future that leaves investor sentiment on the mend," he writes. "'Tis easier to tear down confidence than it is to build it up . . . yes, there may be a light at the end of the tunnel, but for the moment the aura from the Middle East is casting shadows of a particular hue on sentiment." (David Gaffen, WSJ 7-18) Merrill Lynch's monthly global fund manager survey reported that a net 60% of managers believe the global economy is going to weaken in the next 12 months, the worst ever recorded, and a marked decline in sentiment from three months ago, when just 5% predicted this. Also, a net 44% expect corporate profits to deteriorate over the coming year -- the worst reading since early 2001, Merrill notes. (David Gaffen, WSJ 7-18) In June, the nation's retailers employed 54,000 fewer people than they did a year earlier, a 0.4% drop. Goldman Sachs economist Jan Hatzius points out that since 1945, every time the year-on-year change in retail employment has gone negative, it's coincided with a recession. This time might be different. So far, it isn't showing up in national retail-sales data. In May, sales were up a pretty healthy 7.6% from a year earlier. If you take out the topsy-turvy auto sector, they were up 9.1%. (Justin Lahart, WSJ 7-14) More than 480 companies boosted their shareholder dividends last quarter, according to the latest data from Standard & Poor's. The research firm said that is a 5% gain over the number of companies raising dividends in the same period last year and a 25% gain over the number that did so in 2004's second quarter. Only four companies cut their dividends last quarter. Despite the steady dividend increases, there is ample room for more. After reporting several quarters of record profits and profit margins, companies in the S&P 500 are sitting on more cash than nearly ever before. Cash now adds up to more than 7% of the S&P 500 companies' stock-market value. At the same time the index's yield is still under 2%, well below historical averages. (Ian McDonald, WSJ 7-06) Increased speculation that the Fed will raise rates more than most think comes as little surprise to John Mauldin of Millennium Wave Advisors. "[T]he clear historical pattern for the Fed is to raise rates higher and longer than anyone then thinks," wrote the analyst in a June 30 note. "And it looks like this time is no exception." Mr. Mauldin expects to see a continued creep higher by inflation data in July and that second-quarter gross domestic product, first estimated on July 28, rose 3%, "giving the Fed clear space to rate rates once again in August." (Scott Patterson, WSJ 7-05) The historical picture for July is mixed, according to the Stock Trader's Almanac. Generally, it is the best month in the third quarter - except on the Nasdaq - but it only ranks seventh-best among all months of the year on the S&P500 index. Between 1950 and 2004, July's average return was 0.8% on the S&P500 and 1% on the Dow, which ranks it seventh- and fifth-best, respectively, for those indexes. August and September, meanwhile, are 10th and 12th-best for both of those indexes. Recent history has been less kind: in the last 22 years, the S&P500 has risen nine times and fallen 13 times, with an average gain of 0.4%, ninth-best. For the Nasdaq, however, July marks the beginning of what has traditionally been a lousy four months: since Jan. 1971, the index has fallen 0.4% on average, with only September a worse month for the index. In cases when midterm elections loom, the Nasdaq has been awful, losing 3.4% on average, with six negative Julys and two positive ones. (David Gaffen, WSJ 7-03) Hedge Fund / Private Equity News Briefs Fund raising by U.S.-based private equity firms is on track to break another record in 2006. According to Private Equity Analyst, firms raised $96.4 billion in the first half of the year, a 43% increase from a year ago. PEA found that nearly all the money came from buyouts, with 48 LBO firms raising $63.8 billion, or 67% of the total. But that figure tells only part of the story: Humongous p.e. funds, including The Blackstone Group, Kohlberg Kravis Roberts and Texas Pacific Group with their double-digit billion dollar funds, along with Bain Capital and Thomas H. Lee Partners, account for nearly $37 billion of that total – and 40% of all the p.e. fund raising. (Stuart Wise, Hedge Fund Daily 7-14) The Financial Times reports that hedgies are concerned about the growing level of correlation between the industry and the market, noting data from Merrill Lynch that indicate hedge funds are about 95% correlated to the Standard & Poor’s 500, compared with just 32% in 2000. (Stuart Wise, Hedge Fund Daily 7-11) The public’s appetite for private equity has encouraged p.e. firms to go where few firms have boldly gone before them: raising their carry charges. And investors seem more than willing to pay them. According to Financial News, Boston-based Berkshire Partners has followed the example of Rhode Island-based Providence Equity Partners and pushed its charge to 25%, beyond the 20% industry standard. Bain Capital goes even further, and charges 30% to carry. “This is a smart bunch of people, with an outstanding record,” a source told FN about Berkshire. “The returns from the previous funds have been so good that investor demand is bound to be there.” Indeed, Berkshire has raised around $3 billion for its latest fund, no surprise, considering its track record of returns of around 30%. When the object is to make money, charging more money for the privilege is no object. (Stuart Wise, Hedge Fund Daily 7-11) Home Page Previous Factoid Top Sites
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