Thursday, September 30, 2010

The Case for More Central Bank Action -

From yesterday's New York Times - an article by David Leonhardt (tip of the hat to Ezra Klein of the Washington Post).

Adam Posen is an American economist serving as an external voting member of the Bank of England’s monetary policy committee. He gave a very thoughtful speech arguing that more government action is needed, not less.

Here's an excerpt from an interview with Mr. Posen:

My basic argument is that the current macro policy discussion is mostly missing the point. Our situation (in the U.K., the U.S., and arguably in most of the major Western economies) is one where policy makers face a long uphill battle, in which monetary ease has an ongoing role to play, even if it may not deliver recovery on its own.

Insufficient monetary action risks turning sustained low growth and near deflation into a self-fulfilling prophecy. This happened in Japan in the 1990s, and in U.S. and Europe in the 1930s. I don’t think things will be “that bad” in the sense of an outright depression, but we face a real risk of long-term stagnation with some distracting upward blips and slowly eroding capacity

This is the point that I have posted on several times over the last few months (although Mr. Posen is certainly a more learned observer than I).

I think the correct policies that in a world drowning in excess capacity coupled with high debt should be focused on stimulus and job growth.

The low interest rates in today's bond market are not, in my opinion, reflecting a bond "bubble" but rather reflecting the capital market's collective wisdom that disinflation and deflation are the probable path unless changes are made.

One more note from the Times' article:

In terms of how to do more, there has been too much obsession with the scale of central bank balance sheets. It is backward logic to say that because central banks have bought more assets than ever before, we must have done a lot or our efforts must be fruitless. That is like saying, “that fire must be out because we’ve already pumped more water than for any previous fire we’ve fought before.”

The Case for More Central Bank Action -

Lecture Series at the MFA

A recommendation: My wife Christina (aka Mrs. Random Glenings) and I went to the Museum of Fine Arts last night to hear a talk with Matthew Weiner, creator of the hit television show "Mad Men".

It was a great talk, and reinforced our very high opinion of Mr. Weiner's work on the show.

The MFA is giving a number of talks in the coming months, and if you have the chance you should try to attend. A number of them are already sold out, but you might have some luck with some of the talks early next year (or you can follow the MFA on Twitter, where they periodically give away tickets).

Here's the link:

After preparing the original version of this post, I had the chance to speak to one of my savvy clients, who pointed out that perhaps not everyone is as familiar with the show as I might think.

So, in that spirit, I should note that the show is on every Sunday night at 10 pm on AMC. I tried to find a good promo on YouTube, but unfortunately some of the best scenes do not allow embedding. The best I could do was this promo from the BBC in England (warning: this is rated PG-13):

Wednesday, September 29, 2010

Obama as Comeback Kid Just Needs Weaker Dollar: Simon Johnson -

There was a big story in this morning's Wall Street Journal talking about the apparent strategy of currency depreciation that is being followed by many countries, including the U.S. Here's an excerpt:

Tensions are growing in the global currency markets as political rhetoric heats up and countries battle to protect their exporters, raising concerns about potentially damaging trade wars.

At least half a dozen countries are actively trying to push down the value of their currencies, the most high-profile of which is Japan, which is attempting to halt the rise of the yen after a 14% rise since May. In the U.S., Congress is considering a law that targets China for keeping its currency artificially low....

Simon Johnson, a professor at MIT and former IMF economist, is not surprised (BTW: I'm seeing Mr. Johnson next Monday at the Boston Security Analysts Society).

With U.S. domestic growth anemic, and no stimulus on the horizon, the only way to increase employment is to increase exports, which implies a weaker currency. Here's an excerpt from Johnson's piece on Bloomberg:

The main reason the U.S. isn’t bouncing back so fast is because of exports and the dollar. South Korea, Russia, and other emerging markets that go through severe crises usually undergo a sharp depreciation in the inflation-adjusted value of the currency, making them hypercompetitive, at least for a while. This makes it easier to replace imports with domestic goods and services and much more attractive to export.

In contrast, the global financial crisis actually strengthened the U.S. dollar as it was seen as a haven, although the dollar has fallen somewhat from its recent peak against major trading partners.

Interestingly, Johnson also argues that current government policies do not necessarily lead to inflation and higher interest rates:

The dollar is, therefore, likely to depreciate against all floating currencies. If this happens, the impact on U.S. interest rates will be minimal because the Fed will continue its easing. Inflation may rise slightly but high unemployment means the impact will be small, perhaps not even to the 2 percent annual rate that modern central banks quietly prefer.

The Obama administration is blamed for high unemployment -- the result of a financial mania that was emerged long before it came to power. It would be a nice irony if, also through no fault of the administration, jobs return faster than expected as we head into the 2012 presidential election.

Obama as Comeback Kid Just Needs Weaker Dollar: Simon Johnson -

I think that Johnson might be right over the next couple of years, but I worry about the longer term effect of competitive devaluations. The last time we saw countries fight trade battles using their currencies on a global scale was in the 1930's, when "beggar-thy-neighbor" policies were the norm, which of course ended badly.

Tuesday, September 28, 2010

Ten IRA Tasks To Do Before The Year Ends

This was a helpful that came from the FA Advisor by way of Dow Jones.

You can read the whole list yourself if you click the link below, but items 5 and 6 on the list that I thought were particularly useful:

5. Who's your beneficiary?

Here's some well-worn but can't-be-repeated-often-enough advice: Review your beneficiary designations. Make sure there is both a primary and a contingent beneficiary named on the beneficiary designation form.

"If there is no beneficiary named, the IRA proceeds will go to the estate and lose the tax advantage of the stretch," said Connor. "If there is no contingent beneficiary, and the primary beneficiary has died and no new primary beneficiary has been named, then the assets also go to the estate with the same negative result."

It's especially worth checking your beneficiary designations if you are divorced, recently or ever.

"Make sure your ex-spouse has been deleted as a beneficiary, unless you want them to remain as a beneficiary," said Connor. "The U.S. Supreme Court has recently ruled that the beneficiary named on the beneficiary designation form trumps divorce."

Connor also advised against naming a "living trust" as the beneficiary. "A living trust should not be the beneficiary because the living trust must qualify as a 'designated beneficiary' to receive favorable stretch and tax treatment," he said. "I find that most living trusts do not qualify, or lose their designated beneficiary status through later changes to the trust."

Make sure your custodian has a written copy of your beneficiary designations.

6. One last chance for Roth conversions

If you plan to do a Roth conversion in 2010, "the funds must leave the IRA by Dec. 31 to be reported and taxable as a 2010 distribution and conversion," DeVeny said. "The funds can then be rolled over to the Roth IRA up to 60 days after they are received by the account owner--up to March 1 if the distribution was received on Dec. 31."

Contrary to what some might believe, you do not have until April 15, 2011, to do a 2010 conversion, DeVeny said.

Here is another reason why you might want to convert some or all of your IRA to a Roth IRA: according to Connor, the Roth IRA could fund a credit shelter or by-pass trust.

"A Roth IRA is usually not subject to the trust tax rate," he said. Also, review your power of attorney to make sure the agent has authority to recharacterize the Roth, if needed, Connor said.

Remember, too, that anyone can convert their traditional IRAs to a Roth IRA in 2010 regardless of income. What's more, you can pay the taxes over two years, instead of one.

Ten IRA Tasks To Do Before The Year Ends

Dealbook Column - The Value of a Donation of Facebook Shares to Newark -

I don't know about you, but when I saw the news report last week that Facebook founder Mark Zuckerberg was donating $100 million to the Newark Public School system I thought: Where does he get the money?

Facebook, of course, is still a private company but is probably worth billions - we'll have to see when the company actually goes public. I assume that Zuckerberg is paid a salary, but monetizing his part of Facebook is where the real money is.

Today's Dealbook Column in the New York Times discusses this question. Here's an excerpt:

{Mark} Zuckerberg away $100 million worth of Facebook shares to Startup: Education, a new foundation he has started and on whose board he will sit. The foundation, in turn, will sell the shares for cash in what’s known as the “secondary market,” a nebulous world where big-time investors buy into companies before they go public — through the back door.

It turns out that there is a robust market for Facebook shares, even though most people can’t buy them. The going price has been about $76 a share, The Financial Times reported last month, implying a market value of $33 billion. Dozens of employees have sold their shares in the secondary market.

I guess there is some controversy over whether Zuckerberg's gift is really worth $100 million, which seems pretty petty: Any way you slice it, and whatever Zuckerberg's true motivation is (the movie about Facebook comes out soon), it's a generous gesture.

Dealbook Column - The Value of a Donation of Facebook Shares to Newark -

Sunday, September 26, 2010

Op-Ed Contributor - Warren Buffett - Buy American. I Am. -

Don't let the title of this post fool you!

This editorial was actually written in October 2008, when the financial world was a very scary place (as opposed to now, when it just feels depressing).

The S&P 500 is up about +27% or so since this editorial by The Great One was published. I was reminded of it today when the New York Times had a retrospective section on past editorials.

As it turned out, Mr. Buffett's timing was a little early. The markets didn't start recovering until the spring of 2009, but Buffett has always maintained that he is not a market timer. A true investor can identify value, but no one can tell when the value will be realized.

Here's the quote that the Times reprinted today:

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.


A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors.

But here's the part of Buffett's piece that, in my opinion, is still very relevant to today:

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

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

To Buffett's point: if you had stayed in cash in October 2008 you would have earned about 1% for the past 2 years.

Op-Ed Contributor - Warren Buffett - Buy American. I Am. -

Gold is the final refuge against universal currency debasement - Telegraph

I am not an advocate of gold as an investment, as I have written several times on this blog.

However, it is certainly worth considering what the price of gold may be telling us. Today's Ambrose Evans-Pritchard column in the London Telegraph presents sober reading. Here's an excerpt:

It is no mystery why so many states around the world are trying to steal a march on others by debasement, or to stop debasers stealing a march on them. The three pillars of global demand at the height of the credit bubble in 2007 were – by deficits – the US ($793bn), Spain ($126bn), UK ($87bn). These have shrunk to $431bn, $75bn, and $33bn respectively as we sinners tighten our belts in the aftermath of debt bubbles.. The Brazils and Indias of the world are replacing some of this half trillion lost juice, but not all...

..So we have an early 1930s world where surplus states are hoarding money, instead of recycling it. A solution of sorts in the Great Depression was for each deficit country to devalue, breaking out of the trap (then enforced by the Gold Standard). This turned the deflation tables on the surplus powers – France and the US from 1929-1931 – forcing them to reflate as well (the US in 1933) or collapse (France in 1936). Contrary to myth, beggar-thy-neighbour policy was the global cure.

A variant of this may now occur. If China continues to hold down its currency, the country will import excess US liquidity, overheat, and lose wage competitiveness. This is the default cure if all else fails, and I believe it is well under way.

Basically Mr. Evans-Pritchard is contending that all countries (with the possible exception of Germany) are attempting to juice their domestic economies by allowing their currency to lose value against their trading partners.

If this is the case, the rise in the price of gold is more a reflection of concerns over the intentional debasement of currencies rather than a foreshadowing of inflation.

I hope he's wrong - because historically the end of game of a currency "race to the bottom" has never ended well - but Evans-Pritchard is a pretty savvy observer.

Gold is the final refuge against universal currency debasement - Telegraph

Friday, September 24, 2010

Ireland faces double dip, mulls restructuring of junior bank debt - Telegraph

I'm on the road today, visiting with clients, so my post will be relatively brief.

Ireland is in trouble. Faced with massive fiscal deficits, and a busted housing boom (sound familiar?), the government came up with an austere fiscal package of tax hikes and spending cuts. Former Fed chairman Paul Volcker, among others, praised the Irish government for taking the necessary steps to address their issues - or so it seemed.

Unfortunately, the economy is not taking its medicine well, as Ambrose Evans-Pritchaird's column in the London Times discusses:

The Irish economy contracted at a 1.2pc rate in the second quarter, making Ireland the first country since the Great Recession to face a double-dip downturn.

The setback is a blow for hopes that Ireland can slowly grow its way out of debt, and may renew concerns that fiscal austerity without other forms of relief risks tipping the economy into a self-reinforcing spiral.

Unlike the U.S., however, which has the world's reserve currency, and therefore is free to borrow whatever it needs, Ireland needs to tap the international capital markets, the cost of those borrowings is rising:

Spreads on Ireland's 10-year bonds have risen to 405 basis points. Gavan Nolan from Markit said credit default swaps measuring bond risks on Irish banks are nearing the levels of Icelandic banks shortly before they defaulted two years ago, reaching 955 for Anglo Irish (senior debt), 615 for Allied Irish and 530 for Bank of Ireland.

I don't know how this whole situation plays out, but I think that U.S. policymakers should take notice of what is happening across the Atlantic.

Ireland faces double dip, mulls restructuring of junior bank debt - Telegraph

Thursday, September 23, 2010

Devising Strategies While the Estate Tax Is in Limbo -

Here's one of the great things about social media: you get know experts that you have never met, and probably would not have ever heard of, if they had not been active in posting their articles and portions of their books on sites like Twitter.

I first ran across the name of attorney Deborah Jacobs about a year ago, on Twitter. She had just published a book called Estate Planning Smarts, which is an excellent guide for anyone interested in the subject (interestingly, she published it herself, rather than using a conventional publisher). She also writes periodically for Forbes and the New York Times.

Again, I have never met Deborah, so my endorsement of her work is based solely on what I have seen and read.

In any event, she published a piece last week in the New York Times about what individuals should be thinking about doing while the debate over the estate tax continues. Her article contains a number of good suggestions, so I would encourage you to read the whole note, but there were a couple of suggestions that I thought were particularly interesting.

First, she discusses the possible use of life insurance:

During this period of uncertainty, buy a one- or two-year term policy to cover the tax bill if the exemption amount is only $1 million, said Ann B. Burns, a lawyer with Gray Plant Mooty in Minneapolis. The policy can be canceled if Congress eases your estate tax concerns.

Be sure that your beneficiaries, not you, own the policy, or the proceeds will count as part of your estate and could be subject to tax. As owners, your beneficiaries must pay the premiums, but you can give them the money to do that using annual gifts. If you already own a policy, sell it to the trust or to family members for its fair market value, said Ms. Burns.

The other idea which one of my clients is actually did last week involves lending money to a family member that might need some financial help:

If you lend money to family members — say, to buy a house or a car or to start a business — you create a win-win situation. You must charge a minimum rate of interest set each month by the Treasury, called the applicable federal rate, to avoid potential gift tax and income tax consequences. For September, the rate for loans lasting more than nine years and requiring monthly payments is an attractive 3.6 percent. That is less than family members would have to pay for a bank loan, assuming they could get one in today’s tight credit market, but more than you could earn from C.D.’s or money market accounts.

Here's the link to the whole piece:

Devising Strategies While the Estate Tax Is in Limbo -

Also, on Monday of this week, the Wall Street Journal had a good article on estate-tax planning. In this piece, the Journal asked several estate tax planning experts what they are currently advising their clients to do:

Both Ms. Jacobs and the Journal talk about gifting strategies as part of the estate tax planning process. Here's a excerpt from the Journal's article (which is actually quoting someone named Marv Hills):

Since clients expect that the estate tax is coming back in 2011, they are making plans now to implement taxable gifts this year. This way, they can pay gift tax at the 35% gift-tax rate applicable in 2010, in order to avoid paying estate tax later at a presumably higher rate in 2011 and after. Although it seems certain that an estate tax will exist beginning in 2011, it is impossible to know whether the rate will be 55% as currently scheduled, or a different rate if Congress changes the law before next year.

Even though the gift-tax rate is low in 2010, some clients are waiting to make the gifts very late in the year, between Dec. 26 and 31, because they are concerned about the risk of dying unexpectedly during 2010. These clients realize that if they make a taxable gift now but then die before Congress changes the laws, they will have paid gift tax at 35% when the assets could have passed through their estates in 2010 without being subject to estate tax....

Wednesday, September 22, 2010

Monetary policy: Fed next | The Economist

The Big News yesterday in the markets was the release of the Fed's policy statement.

As you have no doubt read in the papers, the Fed indicated that while it is not yet ready to act, it is closer to aggressively increasing its current monetary stimulus stance to try to spur economic growth.

To many, the question is not whether the Fed should act, but why is the Fed taking so long. Here's an excerpt from The Economist blog:

At this point, it seems silly to speculate about what's going on inside the FOMC. We've all looked into our crystal balls and wondered why the Fed hasn't yet acted, and there's little more to be said on this front. The bottom line is that the Fed could and should do more and most observers—including those drafting the Fed statements—seem to acknowledge this. It's a shame that we'll have to wait two more months, at least, to see something done at last.

I think the real reason that the Fed is hesitating is the current political mood in Washington. Any Fed chairman - and Bernanke is no exception - has to be sensitive to the political winds (recall his renomination was hardly a unanimous approval) and so caution seems to be the word of the day.

Monetary policy: Fed next | The Economist

And, to be fair, the markets don't seem to be able to make up their minds.

Gold and silver continue to rocket higher, which would seem to indicate a lack of confidence in paper money and a fear of inflation.

At the same time, U.S. Treasury bond yields moved sharply lower in the aftermath of the Fed statement. Two year Treasury notes now yield 0.43%- the lowest level in at least 40 years.

Someone buying a bond yielding less than 1/2 percent must be pretty confident that inflation isn't going to be a problem for at least a couple of years.

Municipal bond yields, by the way, have generally moved in the same direction as government bonds, with the exception of lower quality municipalities. This the one area of the credit markets that seems to be consistent in its fear of default.

And, finally, speaking of defaults, this morning's Wall Street Journal indicates the corporate bond default rates are now at lows not seen for at least a couple of years:

Corporate debt-default rates are expected to fall to the same levels that preceded the financial crisis of September 2008, marking a swift turnaround for the fate of the most troubled U.S. companies.

The U.S. default rate should fall below 3% by year's end, according to Moody's Investors Service, a stunning drop from the 14.6% peak of November 2009 and even below the default rate of 3.1% from August 2008.

This trend seems to be consistent with the jobless recovery that we seem to be experiencing: Corporate America is getting healthier, stocks are moving higher (the S&P 500 is now up over +11% in the third quarter), but unemployment rates remain depressingly high.

Tuesday, September 21, 2010

10 Reasons to be Bullish on Common Stocks

Years ago, at the end of 2001, Warren Buffett wrote an article on the outlook for the stock market in Fortune magazine.

The article was largely bullish on stocks, which turned out to be a great call. However, there was another part of the article that has stuck with me over the years.

Quoting Buffett:

Charles Darwin used to say that whenever he ran into something that contradicted a conclusion he cherished, he was obliged to write the new finding down within 30 minutes. Otherwise his mind would work to reject the discordant information, much as the body rejects transplants.

Man's natural inclination is to cling to his beliefs, particularly if they are reinforced by recent experience - a flaw in our makeup that bears on what happens during secular bull markets and extended periods of stagnation

And so last night, at 3 in the morning, I woke up with a start.

Perhaps, I thought, there were a number of reasons to be bullish on the stock market, despite the steady drumbeat of negative economic news and my own innate caution.

So I got up and started writing. And much to my surprise, my notes were still legible in daylight:

1. Fed policy remains very accomodative. As this week's Economist notes, recessions are almost always the result of tight monetary policy. Most of the talk in Washington is about more Fed stimulus, not tightening;

2. With exception of the dismal unemployment rate, much of the recent economic data is actually not all that bad. True, GDP growth is has been low relative to other recoveries, but at least it is moving in the right direction;

3. The highly partisan bickering in Washington greatly reduces the chances of a major fiscal policy mistake. Yes, taxes will probably go higher, but it now seems more likely that they will simply revert back to the 2001 levels, prior to the Bush tax cuts;

4. Transportation stocks have continued to move higher, which is typically a bullish signal for the economy and the stock market;

5. Corporate cash levels remain very high, and we have seen a significant pickup in M&A activity. With top line growth muted, it is now almost an announced strategy for many companies to "buy growth" through acquistions;

6. The appetite for corporate bonds has remained strong, with no signs of worries. Even the junk bond market has been robust, and yield spread levels are back to 2007 (i.e. pre-crisis) levels;

7. Sentiment on stocks is ridiculously bearish. Domestic US stock mutual funds have seen large outflows in favor of either bonds or emerging markets. If most managers are bearish, can't most of the "bad news" be already priced into the market?;

8. September is historically the poorest month for stock market returns, yet we have actually had a pretty good up move so far. The fourth quarter, meanwhile, is historically the best;

9. Referring to point 8: volume has been low, and concentrated in just a few stocks, so a number of analysts say that the rally this month means little. On the other hand, historically good moves in stocks rarely begin with explosive volume, so perhaps the current market action is actually positive;

10. For anyone with a time horizon of longer than a few months, it is hard to get excited about investing in either bank CD's or short maturity bonds, with yields of 1% or less.

Yesterday's market action, I thought, was actually pretty encouraging, since both bond and stock prices moved higher together. There's a lot of cash on the sidelines that needs to be invested.

Finally, I would not that when Buffett wrote his article in 2001, we were just in the aftermath of 9/11, and virtually no one was bullish. Of course, his analysis was correct, and stocks moved sharply higher for the next few years.

Last week, Buffett dismissed talk of a "double-dip" recession and a stock market swoon. Just like 9 years ago, the media was fully of people dismissing his comments.

But it has rarely paid to bet against Buffett, and so perhaps we should talk about what might go right rather than all of the pitfalls that await.

Monday, September 20, 2010

What to Know About Home-Sale Tax Rules -

I didn't see this yesterday on the Wall Street Journal's blog but it came across Twitter today.

Thought it was a pretty useful summary of capital gains taxes on home sales (if you're lucky enough to still have a gain!). Here's a sample:

Here is how the basic rules work: In the late 1990s, then-President Bill Clinton signed legislation that officials said at the time would eliminate capital-gains taxes for most people who sell their primary home for a profit. That legislation generally allowed most sellers to exclude a gain of as much as $500,000 (if married and filing jointly) or as much as $250,000 (if single).

To qualify for the full exclusion, you typically must have owned the home -- and used it as your primary residence -- for at least two of the five years prior to the sale. For more details, see IRS Publication 523 ("Selling Your Home") on the Internal Revenue Service website (

What to Know About Home-Sale Tax Rules -

Wall Street’s Engines of Profit Are Slowing Down -

The front page of this morning's New York Times discusses how the slowdown in trading and general market activity is hitting Wall Street.

The interesting part of the piece, to me, is that fact that even the overall volume in the bond area is not at the levels of a year ago, despite very low interest rates:

Worldwide, the number of stock offerings is down 15 percent from this time last year, while bond issuance is off 25 percent, according to Capital IQ, a research firm. Based on these trends, Ms. Whitney predicts that annual revenue from Wall Street’s main businesses will drop 25 percent, to around $42 billion in 2010, from $56 billion last year.

While the numbers will not be known until after the third quarter ends and financial companies begin reporting earnings in October, the pace of trading this summer was slow even by normal summer standards. Trading in shares listed on the New York Stock Exchange was down by 11 percent in July from 2009 levels, and August volume was off nearly 30 percent.

“What’s happened in the third quarter is that after a very slow summer, people expected things to come back,” said Ms. Whitney. “But they haven’t, and the inactivity is really squeezing everyone.”

Now, I suspect most people are not too worried about Wall Street. However, it does raise a possible caution flag for stocks in the financial sector, which could impact the broader market indexes. Financial stocks represent 16% of the S&P 500 market capitalization, and an even larger part of the overall S&P profits, so this is a trend that bears watching.

Wall Street’s Engines of Profit Are Slowing Down -

Friday, September 17, 2010

A rare anniversary - The Boston Globe

Good column in this morning's Globe about Will Danoff, one of the best mutual fund portfolio managers of our generation.

You don't hear too much about Danoff, and you almost get the impression that he likes it that way. Still, the performance record that he has compiled in Fidelity's Contrafund has been truly impressive, especially when you consider that the fund is now $61 billion in size.

The best part of the column, in my opinion, in the article speaks to why he has been so successful, namely patience and humbleness:

Danoff believes the lessons he learned over 20 years are simple but powerful. Chief among them: acknowledge you will make mistakes, and learn from them.

He sounds like Peter Lynch when he talks about a strategy of searching for young companies with big potential and sticking with them for the long haul. “They don’t go up in a straight line,’’ Danoff says. “Just staying with them is one of the big lessons I’ve learned.’’

Sounds simple, but it's harder in practice, especially when you're under constant performance pressure. Fidelity pays well for top performers, but can be ruthless if results start lagging the competition.

So here's how Danoff's combination of patience, humbleness, and just plain hard work has paid off:

Contra has earned an average of 12.2 percent annually over a 20-year period that ended Aug. 31, better than the S&P 500’s average gain of 8.3 percent. Stretch that over two decades, and Danoff’s fund returned a total of 903 percent, compared to the index’s 393 percent.

Numbers like those aren’t unprecedented, but they’re rare as hen’s teeth. I asked the fund research firm Morningstar Inc. for a list of top-performing mutual funds over the past 20 years and then isolated those managed by a single person throughout. Only five funds, including Joel Tillinghast’s Fidelity Low-Priced Stock fund, performed better than Contra.

A rare anniversary - The Boston Globe

Thursday, September 16, 2010

Looking Ahead to the Spend-Down Years -

I saw this ad from Lincoln Financial last weekend, and thought it was pretty good.

Then I saw this article in this morning's New York Times and realized that Lincoln had some pretty solid behavioral finance work behind the piece.

First, here's the ad:

An article in this morning's Times indicated some research that had been done at Northwestern that indicated the following:

Researchers at the Kellogg School of Management at Northwestern University created images of college-age survey participants that showed how they might look as they aged. In tests, participants who saw the aged image of themselves saved twice as much for retirement as those who saw their current appearance.

So this commercial plays right into the retirement planning market.

The article ends with another observation, noting that older participants might react differently to images of how they might look in a few years. As one of the Northwestern professors said:

“If you take a 65-year-old and say here is an image of what you will look like at 90, that could be potentially very scary. It might have the opposite effect from what we want and make people want to spend now.”

Looking Ahead to the Spend-Down Years -

Wednesday, September 15, 2010

Overview: Risk aversion lifts gold, yen, and US Treasurys

Global stock markets have been rallying this month.

At the same time, gold prices continue to hit record highs, and Treasury yields have sharply declined. These would indicate that there still is a large segment of the investing public that is deeply concerned about worldwide economic trends.

Then there is the yen, which hit 15 year highs versus the dollar yesterday. Although the strength of the yen has not received much press attention here in the United States, it is of deep concern to Japanese businesses, which are depending on export business.

And so this morning the Japanese government intervened in the currency markets for the first time in six years. The Nikkei turned in a strong performance as a result, rallying more than 2%.

It remains to be seen how much effect on a longer term basis the intervention will have. Most governments have stopped trying to intervene in the currency markets, after wasting considerable resources in the 1990's to try to influence currency levels with little or no effect.

I must confess that I have been puzzled as the yen continued to move higher versus the dollar throughout the year. I have been reading a number of reports on the currency markets, and as best as I can tell here is why the yen has been so strong:

  1. With global interest rates so low, the "yen carry" trade (borrowing in yen at low rates to invest elsewhere) has largely disappeared;
  2. Japanese exports have been much stronger than imports, thus creating a larger demand for yen;
  3. China is diversifying away from only US investments to investments in Japan, mostly Japanese government bonds (JGB's).
This last point is important from at least a couple of respects. First, it demonstrates the larger role that China is playing in Asian markets. And, second, although so far China has been a largely passive investor in JGB's, there is always the possibility that it might start playing a bigger role in Japan, especially since China is now the largest trading partner of Japan.

Oh, by the way: guess who was selling dollars in favor of the yen this morning (i.e. directly counter to the trade the Japanese were implementing)?

That's right: the Chinese.

It is clear that with their increased economic strength that the Chinese are becoming more assertive in the global markets. Not only are they directly intervening against the Japanese currency effort, they have also quietly ignored the strong desire on the part of the US for the dollar to weaken versus the renminbi. Here's the way the FT put it today:

Japan’s intervention is likely to heighten tension around the already charged issue of China’s persistence in holding down the renminbi, which is set to be one of the most contentious issues at the forthcoming meeting of the G20 group of countries in Seoul.

The US is disappointed that China has allowed the currency to rise by less than 1 per cent against the dollar after its decision to unpeg the renminbi in June. This week, the US Congress will hold hearings to investigate options for penalising Chinese imports or having the currency intervention declared illegal by the World Trade Organisation.

Tetsufumi Yamakawa, head of research at Barclays Capital in Tokyo, said Japan’s intervention “at least, would give a good excuse to China for not moving by claiming that the Japanese authorities are manipulating their currency [as well].”

Stay tuned. / FT's rolling global market overview - Overview: Risk aversion lifts gold and yen

Tuesday, September 14, 2010

112 Stocks Now Account For Half The Day's Trading Volume

Following up on my post this AM:

Here's another reason the stock market has been tough for fundamental investors.

Based on trading data from August, only a handful of stocks are actively trading, and these are probably dominated by high frequency traders (HFT) using programmed trading algorithms. Meanwhile, the rest of the market mostly just followed the overall trends through the use of index funds and exchange-traded funds (ETFs).

Here's a quote from the article (courtesy of the blog Zero Hedge):

The latest Abel/Noser analysis has been released and according to the data analytics firm just 112 stocks now account for half of the day's volume, the top 20 stocks account for 26% of all domestic volumes, and the first 1,029 stocks are responsible for 90% of all volume, meaning the remaining 17,349 account for just 10% of all dollar traded. These are also the stocks where HFT will never tread, so if anyone wishes to avoid the HFT marauders, just stay away from the top names.

The blog goes on to conclude from this trend:

As ever more of the volume is concentrated among fewer and fewer stocks, it is certain that one day, when a top 10 name crashes, will crash the the entire market, which continues to trade near record-high implied correlations.

I don't know if I agree with this pessimistic conclusion, but the figures are certainly unsettling.

112 Stocks Now Account For Half The Day's Trading Volume

Why some gloomy investors are bullish on stocks - Yahoo! Finance

I found this link to an article on Yahoo! Finance from Eddy Elfenbein, a fellow blogger.

Eddy posted a short note on Twitter yesterday noting the following:

Today was day 82nd day in a row that the S&P 500 closed between 1020 and 1130, but we're getting close to the upper bound.

Put another way, stocks have essentially gone nowhere for the last three months.

In addition to being mired in a trading range, stock movements over the last few months have all tended to move in lockstep. Correlations are above 0.80 for most sectors with the S&P, meaning that fundamental and sector analysis has not added much value.

Little wonder, then, that frustration has lead to apathy, with overall stock market volumes declining and many investors staying on the sidelines.

And yet, it could very well be that boredom is creating opportunity, as the article from Yahoo! indicates. Here's an excerpt:

If you believe a few respected money managers, there's opportunity aplenty in stocks now. If you find that surprising, wait until you hear where they think the bargains lurk: big blue chips that almost always fetch premium prices.

Legendary bear Jeremy Grantham of GMO LLC in Boston says the U.S. faces "seven lean years" of meager growth, but he has been pounding the table about blue chip bargains with big dividends. Steven Romick of FPA Crescent predicts rising taxes and an economic malaise but is singing the praises about "bigger is better" stocks now, too.

"If you're worried about a feeble economy you want to own companies with strong balance sheets," says T2 Partner's Whitney Tilson, who is loading up on big, multinational companies though he doubts the market will rise much for a while. "The beauty today is those companies are on sale."

The bull case for stocks, in my opinion, remains the lack of interesting investment alternatives. Money market rates remain low, and bond yields are also meager, especially for maturities under 5 years. For investors with a longer term time horizon, it seems reasonable that dividend-paying blue chip stocks should be at least part of your portfolio.

Why some gloomy investors are bullish on stocks - Yahoo! Finance

Monday, September 13, 2010

Looking For Yield? This Is The Definitive Presentation For You | zero hedge

Random Glenings prides itself on being democratic.

I try to listen to other points of view, even if my initial temptation is to dismiss an analyst or commentator's viewpoint immediately.

So I have been stuck on this post that came from Zero Hedge last week.

As I written numerous times over the last few months, I believe that we in a disinflationary, if not deflationary, period for the next several years. I don't believe we will see serious price deflation, however, although I am increasingly concerned that government policies are not helping.

(This morning's Washington Post, for example, carried an editorial observing that for all of the bashing of Keynesian economics by Republican candidates, Keynes remains the foundation for many of the ideas espoused by those same candidates. Here's the link:

In any event, I have been an advocate of stocks paying attractive dividends for many of my clients. A number of stocks in several sectors of the market - consumer staples, utilities, and industrials - offer yields that are higher than bonds issued by the same corporation, and also offer the potential for longer term capital growth.

But there may be a reason these stocks look cheap, and may in fact turn out to be "value traps".

Zero Hedge cited a piece from Morgan Stanley which listed numerous reasons why investors should be wary of dividend payers. Here's the five reasons that Morgan Stanley feels that dividend yields are rising relative to corporate bond yields:
  1. Possibility of a structural de-rating of stocks, i.e. investors may require higher expected returns from stocks;
  2. An outlook for weak long-term earnings growth and reduced possibility of P/E expansion, meaning that dividend yields are a more dominant part of total returns;
  3. Higher equity risk premium. We estimate the equity risk premium is ~5.2% versus an average of ~3.5% since 1990, meaning a higher dividend is required;
  4. Investors doubt that companies can reinvest earnings to create value, so higher dividends make more sense;
  5. Rising dividend yields can be interpreted in two ways: either risk premiums have permanently risen and dividend yields need to rise; or, long term earnings growth has shifted down, implying expectations of low GDP growth and even weaker earnings growth, which means that dividend yields need to rise to attract investors.
So, here's how Zero Hedge interprets dividends:

Surging dividend yields is not an indication that dividend stocks are cheap; on the contrary! It indicates an increasing loss of confidence in equity as an asset class.

Again, I am not sure I totally agree with this analysis.

I would note, for example, that corporations collectively have about $1.8 trillion in cash on their balance sheets, so they are hardly turning into ATMs for investors.

In addition, most companies I listen to either in person or on conference calls continue to indicate that they prefer stock buybacks to dividends as a way to return cash to shareholders. Moreover, companies cite that near-certain prospect of higher dividend tax rates in 2011 to bolster their belief that buying back stock remains a better way of increasing after-tax returns to shareholders.

But still: Arguing with the market tends to be an expensive, usually money-losing, proposition. If dividend yields are rising relative to corporate bond yields, it is a trend that bears further study.

Looking For Yield? This Is The Definitive Presentation For You | zero hedge

Friday, September 10, 2010

11 Companies in 2 Days: Thoughts on the Consumer

As I have mentioned in a couple of previous posts, I had the chance to attend the Barclays "Back-to-School" conference here in Boston earlier this week.

The meetings featured some of the biggest consumer products names making formal presentations followed by Q&A on their strategies and outlook. The best part, to me, is the opportunity to meet managements in smaller settings, after their presentations, where you get the chance to ask questions and hear their thoughts in an unscripted basis.

I thought I would share some of my general observations, since I think they are both interesting as well as pretty indicative of the current economic environment.

Here's the companies I had a chance to hear: Pepsi; Church & Dwight; Avon; Colgate; Campbell's; McCormack; Boston Beer Company; Kimberly Clark; Estee Lauder; Newell Rubbermaid; and Smucker's. Unfortunately I did not get the chance to see a few other companies that I would have liked (e.g. General Mills; Procter & Gamble; Coca-Cola) but I had a couple of scheduling conflicts.

Most companies reported that sales in North America were sluggish, as was activity in Eastern Europe. Surprisingly, several executives indicated that Western Europe was showing signs of improvement. Everyone was bullish on Asia, although several indicated that their profits in China were still pretty skimpy.

Top-line revenue growth is still slow, but margins for most companies were showing definite improvement. While this is happy news for stock investors, it was not so great for the employment picture in the United States, since most of the margin and profit improvements were being achieved through a combination of using the internet as well as moving production to low-wage countries (e.g. Avon is essentially closing all of its US manufacturing in favor of sites in
countries like China and Poland).

Social media initiatives were also mentioned several times. For consumer products companies, sites like Twitter and Facebook are ideal places to reach out to consumers with new ideas of how to use their products. Estee Lauder, for example, posts beauty and fashion tips on Twitter, while Campbell's and McCormack will post new recipes on their Facebook pages.

Several companies are actively involved in M&A activity. While they obviously could not comment on their current negotiations, it was mentioned that there seems to be more activity in the last couple of months. Some of this could be related to possible changes in the capital gains tax rate in 2011, but I think a lot of the activity is related to the growth pressure that managements are feeling. If the economy is going to remain sluggish, one of the best ways to grow would be to acquire another company.

Specific company thoughts:

  • I don't understand why Pepsi is changing the names of some of its most recognized products (e.g. Gatorade is now "G"). The company seems to be dominated by corporate finance people rather than consumer marketing specialists;
  • Church & Dwight seemed to have the most shareholder focus, which is something I always like to hear. Still, they strongly hinted they have the capacity to make a major acquisition, and I always worry that they can harm shareholder value;
  • Chuck Cramb from Avon is a changed man. A little more than a year ago he was brought in from Gillette to try to rev up the company, and he seemed to have all the answers last year. This year he seemed much more focused on cost cutting and "green initiatives", which indicated to me that they are struggling;
  • I love Colgate. They have a terrific track record of innovation and long-range planning that continues to pay off for shareholders. True, their second quarter results were slightly short of Wall Street expectations, but the subsequent stock price decline represented an opportunity, in my opinion;
  • Campbell's and McCormack have always been thought of as relatively boring companies, and their presentations reinforced these perceptions;
  • Boston Beer Company has a smaller market cap than I typically invest in, but the company has been a real winner over the last few years. Founder Jim Koch gave his presentation while drinking their signature beer Sam Adams, and he was fun to hear;
  • Kimberly Clark is too tied to wood pulp prices to offer much operating leverage to investors. Still, it seemed committed to its high dividend (currently 4.7%);
  • Estee Lauder has improved tremendously since they got rid of Bill Lauder, son of the founding Lauders. The stock has had a good run but they have great opportunity in China and India - I need to look at this one more;
  • I don't understand Newell Rubbermaid's strategy;
  • Smucker's is one of my favorite companies. They "get" consumer marketing in supermarkets, and have a great company culture. The Smucker family remains very involved in the company, and they take evident pride in their products.

Thursday, September 9, 2010

Low Interest Rates Help Companies at the Expense of Savers -

I would have posted this article from the New York Times earlier today but I was at a client meeting. Turns out I should have brought the article with me.

At my meeting, the topic of discussion was exactly along the lines of this article: namely, how can the client earn a higher rate of interest without taking too much principal risk.

Unfortunately, there are no simple answers. Corporate bond yields have declined dramatically along Treasury rates, and corporate borrowers are enjoying some of their lowest borrowing rates in decades. However, the article notes that corporations are simply holding onto the funds they raise in the bond market:

As demand for such bonds has soared, it has prompted corporations like PepsiCo and Wal-Mart to issue more bonds at bargain-basement rates of interest. Such companies sold $563.4 billion to United States investors last year, a record, and have sold $238.8 billion more so far in 2010, according to Dealogic, a financial data provider. Yet, economists complain that apart from a few notable corporate acquisitions that were financed largely with pent-up cash, many businesses are sitting on their money rather than spending it. For now, that would seem to undermine the purpose of low interest rates, which is to get companies and consumers spending again.

Nonfinancial corporations were holding about $1.8 trillion in liquid assets in the first quarter of this year, according to the Federal Reserve, a level that has been steadily rising and compares with $1.5 trillion at the start of 2009.

Besides a sense of caution, I also believe that corporations are holding off on their capital spending plans in anticipate of more favorable tax treatment in 2011, as President Obama recently proposed.

Of course, there is another part of the capital markets that offer good yields, but most are not interested: namely, dividend-paying stocks. As a previous post noted, the relative yield advantage of stocks versus bonds is also at a multi-year high, but investors are still fleeing the U.S. stock market in favor of other areas.

Finally, I should note that this article had already received more than 270 comments on the New York Times website as of 2 pm today. Regardless of the merits of the current Fed policy, low interest rates are essentially pitting savers versus borrowers, and no one seems too happy.

Low Interest Rates Help Companies at the Expense of Savers -

2010 Wesleyan University Men's Tennis Preview

You might have been watching the US Open last night (Federer whupped up on Soderling with an unbelievable display of serving) but the really important matches (to me, at least) start this Saturday, when the Wesleyan Cardinals start their 2010-11 season at Nichols College.

Keep your eye on the #6 singles player: Michael Glen. He's a gritty determined player who was named to the NESCAC all-sportsmanship team last year. Only a sophomore, we're looking for another strong season from Mr. Glen.

Here's coach Ken Alrutz with his take on his team:

Tuesday, September 7, 2010

Social networking is here to stay - Investment News

As I mentioned in an earlier post, I have been attending a conference here in Boston sponsored by Barclays. The meeting - titled "Back-to-School" - is very useful to me, since I get to see a lot of great consumer products companies.

I will publish more tomorrow about what I heard, but I wanted to mention one recurring theme at the conference. Namely, the strong push that virtually every company is making in social media.

Now, I realize that this might just be the latest business fad (remember zero-based budgeting?) but I don't think so. These companies seem to be getting real financial results from using Facebook and Twitter, so I suspect that this trend might continue longer than some expect.

For example, I still get push back from managers my age and older about the usefulness of social networking.

There is the tendency to simply dismiss sites like Facebook, LinkedIn, etc. as mere fads that will soon disappear. I don't agree (and I suspect you don't either, or you wouldn't be reading this blog!).

For example, most of the time that any one of us thinks about buying something (e.g., a new car) or engaging a service (e.g. house painter), one of the first things we do is check out the alternatives on the internet.

Most businesses consider their websites as part of their business, just as important as a telephone number or email address. Still, many do not spend enough time on it:

Your website is still your most important communication tool. A website serves as the portal to your company, its services, people and mission. It's the place where people verify who you are and, when done right, it legitimizes your business. It's also a great place to have an extended conversation or connection with your clients and prospects.

Yet many financial websites were built five to 10 years ago and look dreadful, offering nothing more than bland boilerplate content. Some are informative, but most use a home page that bombards the user with way too much information.

Your website should offer minimum choices on each page with links for more information so the user may navigate with ease and seek out the information that is most relevant. This is called “progressive disclosure.” This is not about hiding information or avoiding transparency; it's about offering choices and building a website that invites the user in on his or her terms.

At the conference I'm attending right now, virtually every company is discussing how they are using the internet to reduce costs and increase productivity. It seems that the web is not an interesting option; it has become an essential part of driving shareholder returns.

Social networking is here to stay - Investment News

Dividends Beating Bond Yields by Most in 15 Years (Update1) -

I'm going to be attending a Consumer Products conference here in Boston for the next couple of days, so my blog postings will probably be brief.

(The conference features a number of the leading consumer companies like Procter & Gamble; Smuckers; and Avon. Sponsored by Barclays Capital for the last few years, I've always come away from the meetings with lots of information, not to mention some investable ideas, so I'm looking forward to the gathering.)

With sentiment on stocks continuing to be poor, especially when it comes to to U.S. stocks, I thought this article from Bloomberg was interesting.

Here's an excerpt:

More U.S. stocks are paying dividends that exceed bond yields than any time in at least 15 years as profits rise at the fastest pace in two decades....

... The last time the number of S&P 500 companies paying dividends above the corporate bond rate approached the current level was in March 2003, data compiled by Bloomberg show. That was just after the start of a bull market in which the equity index more than doubled over five years.

I still think that the economy probably needs at least a second stimulus package, but it seems very unlikely to happen. However, stocks could have a nice upward move simply on the lack of investing alternatives.

Dividends Beating Bond Yields by Most in 15 Years (Update1) -

Sunday, September 5, 2010

Fundamentally - Have Investors Been Unfair to Domestic Stock Funds? -

I've posted a few times about how investors are fleeing domestic stock funds for just about any other asset classes, even overseas equity funds that historically have had a very high correlation with the U.S. market.

Here's an excerpt from Paul Lim's column this AM in the New York Times:

So far this year, on a net basis, more than $11 billion has actually gone into funds that focus on shares of companies based in the emerging markets, according to the Investment Company Institute. And an additional $17 billion has been invested in other foreign equity funds, including those that specialize in the developed markets of Western Europe and Japan.

In fact, upon closer examination, one major type of equity fund has been bleeding most of the assets: domestic stock portfolios.

According to the latest figures from the institute, funds that invest primarily in stocks based in the United States have had net outflows of nearly $30 billion this year, after losing nearly $40 billion in 2009.

I suspect this is really more of a "the grass is always greener" syndrome than any detailed analysis on the part of investors. That is, we're all familiar with the large fiscal and economic problems that we face here in the United States but are considerably less knowledgeable about overseas markets. Thus, we believe that the "grass" must be greener somewhere else other than at home.

But, with the U.S. still representing about 1/2 of the world's GDP, is does is make sense that foreign markets are really going to be a good refuge.

Not so far:

After all, a big reason for concern about the global economy is a slowdown in Europe, prompted by its debt crisis earlier this year. So far this year, the Morgan Stanley Capital International EAFE index (for Europe, Australasia and the Far East) is down by nearly than 7 percent, while the Standard & Poor’s 500-stock index of blue-chip domestic shares is off by less than 1 percent.

These choices may have less to do with investors’ appetite for European stocks and more with entrenched anxieties about the markets in the United States.

Fundamentally - Have Investors Been Unfair to Domestic Stock Funds? -

Friday, September 3, 2010


I like Twitter but, honestly, I don't find it the most user-friendly.

Turns out that I'm not alone - here's a post on the service from Henry Blodget at the blog Clusterstock.

Twitter allows me to follow a large number of bloggers and traditional media sources fairly easily. This morning, for example, I was able to quickly get reactions on today's unemployment figures, which is helpful in doing my investment management work.

On the other hand, there does seem to be a number of tweets that go out that I really don't see the point. For example, I still don't get is a lot of the hashmarks (#) with numerous initials that stand for categories that Twitter pros get but lots of others don't.

I think that Twitter's potential is huge but they have to figure out a way to become more accessible to a larger market.

Op-Ed Columnist - The Real Story -

This morning's unemployment report was initially greeted with enthusiasm by the stock market, although in thin pre-holiday trading.

I think the market was surprised by the massive upward revisions in employment for June and July, since it is hard to get too excited about a 9.6% unemployment rate. Bonds predictably are getting hit, with yields on the Treasury 10-year "soaring" to 2.71%.

There are rumors all over the internet discussing the possibility that the White House will propose some sort of job stimulus package, perhaps in the form of a payroll tax "holiday". Whatever the proposal, if any, I doubt it will be very significant given the political climate in Washington.

Part of the problem is that there continues to be the steadfast belief that government spending and fiscal deficits are always bad, and will inevitably lead to inflation. While I would agree that this can sometimes be true, I think it is less likely in today's deflationary economy.

Which leads me to Paul Krugman's editorial in this morning's New York Times.

Professor Krugman notes the hysteria that accompanied the first stimulus package:

Those who said the stimulus was too big predicted sharply rising rates. When rates rose in early 2009, The Wall Street Journal published an editorial titled “The Bond Vigilantes: The disciplinarians of U.S. policy makers return.” The editorial declared that it was all about fear of deficits, and concluded, “When in doubt, bet on the markets.”...

...When in doubt, bet on the markets. The 10-year bond rate was over 3.7 percent when The Journal published that editorial; it’s under 2.7 percent now.

What about inflation? Amid the inflation hysteria of early 2009, the inadequate-stimulus critics pointed out that inflation always falls during sustained periods of high unemployment, and that this time should be no different. Sure enough, key measures of inflation have fallen from more than 2 percent before the economic crisis to 1 percent or less now, and Japanese-style deflation is looking like a real possibility.

Krugman has been steadfast in his belief that another massive stimulus package is needed, and that worries about inflation and debt are not nearly as important as the need to get the economy going again. My bet would be there will be no change in fiscal policy until after the November elections, but then most of the Bush tax cuts will be allowed to expire.

Op-Ed Columnist - The Real Story -

Thursday, September 2, 2010

Why Record Stock Correlations Are An Adverse Feedback Loop To Market Participation

Today's link comes from the blog Zero Hedge, and quotes extensively from work done by Nicholas Colas of Bank of New York.

One of the frustrating parts of today's investing environment (besides low interest rates, uncertain future tax policies, etc.) has been the high correlation between assets. For example, as this post notes:

U.S. equity correlations among the 10 industrial sectors of the S&P 500 remain near historical highs, as 7 out of the 10 sector ETFs show correlations with the S&P 500 in excess of 90%. Only Healthcare, Utilities and Consumer Staples are lower, and they're stuck in the 80% range.

Put another way, for managers looking to add value to portfolios through either stock or sector selection, 2010 has not been a good year. Little wonder that a Merrill Lynch report that landed in my email inbox this morning indicated that only 16% of the active stock managers they follow have outperformed the Russell 1000 index YTD.

(Commercial time: the equity portfolios that I manage have essentially tracked my benchmark, which is the S&P 500. A small victory).

And then there's the argument about diversification between asset classes.

The whole point of a diversified portfolio is that asset classes should move in different directions. However, since the beginning of the year, interest rates and stock prices have moved in the same direction. As I have written several times, this follows the Japanese experience over the last 20 years during their deflationary battle.

This means that owning bonds has been satisfying for investors this year in terms of absolute returns (since interest rates have moved lower, pushing bond prices higher) but bonds have not helped to balance principal valuations in portfolios.

Even overseas, the correlations between emerging market and developed market equities has been remarkably high.

What are the investment implications? Mr. Colas continues:

{This is} not a healthy market. The mathematical benefits of diversification require assets that exhibit low-to-no correlation amongst themselves. When everything moves in synch, asset allocators have to pull in their horns. Wonder why investors are shunning risk and buying bonds? Part of the reason is clearly that the historically proven benefits of diversification just are not working as well as they once did.

Some of my fellow portfolios managers argue that this will not continue, and that we will soon return to a period of significant differences in returns among asset classes.

I hope so too, but as one of my earlier posts on the dominance of program and high frequency trading in the stock market indicates, it is not clear to me now how all of this changes.

Why Record Stock Correlations Are An Adverse Feedback Loop To Market Participation

Wednesday, September 1, 2010

Scientist at Work - Dr. Donald A. Redelmeier - Debunking Myths of the Medical World -

The stock market is roaring ahead this AM on the basis of some ISM data that showed that manufacturing in August was expanding at a more rapid clip than expectations.

So naturally a number of bearish commentators are dismissing the figures as meaningless.

I don't know about other professions but this seems to happen a lot in my business. Once someone declares they are either bullish or bearish they have a hard time accepting data that might indicate a contrary opinion.

I remember reading an story about John Maynard Keynes, the great British economist who was also a very successful investor. He was in a meeting one time, and gave some advice that was different than he had given previously. When someone at the meeting pointed this out, Keynes was reported to have said:

"When the facts change, so do my opinions. What do you do, sir?"

This article from the New York Times describes Dr. Donald Redelmeier, an innovative thinker along the lines of the book Freakonomics (a fun read, by the way). Dr. Redelmeier is apparently not afraid to change his opinion if circumstances warrant:

Another Redelmeier philosophical pearl is “Do not get trapped into prior thoughts. It’s perfectly O.K. to change your mind as you learn more.”

In patient care, he said, he frequently does just that. “I think I know the diagnosis and start the treatment, then follow up and realize I was wrong,” he said. “I intercept a lot of my own errors at a relatively early stage.”

This, not surprisingly, became the basis of some classic Redelmeier research around raising physicians’ awareness of their own thinking — cognitive shortcuts that might lead to a diagnostic error.

Some of Dr. Redelmeier's research is whimsical (e.g. finding that Academy Awards winners live longer than those that are runners-up) but some of his other research on cell phones and driving have actually resulted in changes in the law.

Scientist at Work - Dr. Donald A. Redelmeier - Debunking Myths of the Medical World -