Wednesday, November 27, 2013

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Tuesday, November 26, 2013

Bubble, Bubble - Where's the Real Bubble?

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

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

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

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

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

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

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

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

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

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

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

Monday, November 25, 2013

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

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

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

Here's the link:

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

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

As we all know, the Federal Reserve has been aggressively adding monetary stimulus to the economy.  This chart illustrates just how large the stimulus has been in the past few years:
Graph of M2 Money Stock

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

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

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

 Graph of Velocity of M2 Money Stock

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

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

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

Friday, November 22, 2013

OMG! Larry Summers Changed His Mind!

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

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

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

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

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

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

Earlier this month, however, Summers appears to have changed his mind, and now questions whether we could indeed learn something from the Japan experience. Quoting from his IMF speech:
“Even a great bubble wasn’t enough to produce any excess of aggregate demand…Even with artificial stimulus to demand, coming from all this financial imprudence, you wouldn’t see any excess.”

“The underlying problem may be there forever”

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

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

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

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

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

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

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

Thursday, November 21, 2013

Government for the People

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

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

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

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

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

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

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

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

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

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

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

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

Evans-Pritchard recites some of the dismal figures:

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

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

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

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

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

Wednesday, November 20, 2013

"Healthcare Care Inflation At Lowest Rate in 50 Years"

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

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


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

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

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

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

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

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

More fuel for the deflationary camp?

Tuesday, November 19, 2013

Ignoring the Pundits

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

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

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

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

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

Here's an excerpt from what he wrote:

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

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

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

Here's a recent example.

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

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

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

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

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

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

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

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

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

Monday, November 18, 2013

"Secular Stagnation"

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

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

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

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

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

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

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

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

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

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

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

There's lots to ponder from this short talk.

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

Friday, November 15, 2013

Deflation? Really?

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, November 14, 2013

Buying Tech Stocks

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Wednesday, November 13, 2013

What's The Next Move for Biotech Stocks?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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