Con-trar-y – adjective. 1) Opposite in nature or character. 2) Opposite in direction or position. 3) Being the opposite one of two: I will make the contrary choice. 4) Unfavorable or adverse. 5) Perverse; stubbornly opposed or willful.
When my boss called me “jaded” after I (once again!) disagreed with the opinion of a well-known and highly intelligent market forecaster, I decided that I need to set the record straight. Although I often take the opposite side in discussions (with just about anyone, it seems) about “big picture” issues such as the economy, currency markets, interest rates or the stock market, I do not do this just because I’m contrary. It’s actually more of a learning style, along the lines of the Socratic Method (“a form of inquiry and debate between individuals with opposing viewpoints based on asking questions and answering questions to stimulate rational thinking and to illuminate ideas.” – Nebraska Department of Education.)
By taking the other side I can actually test the solidity and rigor of an opinion. I may not actually disagree with the opinion, but if the opinion could affect my investment decision-making process, I need to be sure it can stand up to scrutiny and criticism. So, I am not a grumpy old man; I just act like one sometimes.
Con-trar-i-an – noun. A person who takes an opposing view, esp. one who rejects the majority opinion, as in economic matters.
Now we’re getting closer. This really sounds like me. So, why would I appear to be so anti-consensus when it comes to economic and stock market opinions (which really are forecasts)? In part, it is because in the perverse logic of the stock market, the consensus is often either wrong or already discounted in the prices of stocks. Much of the commentary and academic research out there supports the idea of contrarian investing. Some studies suggest that 80% of all investors consider themselves contrarian. Besides being mathematically impossible, I truly doubt that contrarian investing could ever be that popular. Why? Because it’s hard to do.
In many of life’s endeavors, being in the middle of the pack offers great rewards. Listening to popular music or watching popular TV shows can provide a person with a common link to others. The same can be said about going to restaurants, clubs, concerts and other places frequented by a lot of people. The entire fashion industry is based on the premise that a certain style of clothing is “in.” “Keeping up with the Jones” and “being a team player” are just two of many idioms which celebrate the idea of being a part of the crowd.
In equity investing, going against the grain can lead to above-market gains, but it is never easy to do. Imagine resisting the universal euphoria associated with the “paradigm shift” in the late 1990s. Imagine ignoring the huge housing boom of the last few years. Imagine selling oil stocks last summer when all the “experts” were forecasting oil prices to move as high as $250/barrel. Imagine wanting to buy stocks in early March of this year instead of selling them. With 20-20 hindsight, all of these moves may seem obvious now, but in the heat of each particular moment, they would have been very hard to do.
The ultimate downside to contrarian investing comes when the consensus view proves to be correct. This means that the contrarian investor was not only doing something that seemed illogical, misinformed and even a bit crazy, but it turns out to have been obviously the wrong thing to have done. It makes the contrarian look not only wrong, but stupid as well. It takes only a few of these experiences to test the mettle of a contrarian investor.
But in the final analysis, being a contrarian investor may not be a choice, but more of a personality type, or maybe like being left handed. Sure, the contrarian investor can develop and improve technical skills, but at the core, the contrarian needs to be solid and unwavering to the concept and the practice of going against the grain. It may be hard, but in my opinion, it is certainly worth it.
Friday, May 29, 2009
Tuesday, May 19, 2009
Of Subway Tokens and Stock Market Forecasts
I rode the New York City subway system for many years. Along with many of my fellow “straphangers,” I experienced the unique sights, sounds and smells (!) of Gotham’s underbelly. When I first moved to the City, we could buy subway tokens, metal slugs really, which we could use to enter the turnstiles. I remember as if it were yesterday how some enterprising young men figured out a way to retrieve tokens from the payment slot on the turnstile. One of these underground entrepreneurs would simply place his mouth on the token slot creating a near-perfect vacuum, suck really hard (I am not making this up!) and viola! – he would be the owner of a fresh (hardly), shiny (rarely) NYC subway token worth about $1.50 at the time. I suspect that these clever lads would do this multiple times and either sell these purloined pennies to hurried commuters or cash them in at the token booths.
Anyway, one of my mentors, after a long discourse about his views on this topic or another, would often end the discussion with “well, that (his opinion) and a token will get you on the subway.” It was his somewhat humorous, very self-deprecating way to highlight that sometimes an opinion about the capital markets is not worth very much. I have often wondered why anyone would think this way.
Perhaps it is because there are so many opinions about the markets (oversupply can depress pricing). Perhaps it is because investors would really like someone to tell them what is going to happen and this creates big demand for forecasts and predictions. Again, creating the oversupply of viewpoints we see out there. Perhaps it is because the uncertainty inherent in the capital markets makes a correct opinion such a rare and wonderful thing that people feel richly rewarded for either making a prediction which proves to be correct or for following a successful prediction. Still, I suspect that at some very basic, honest level, most forecasters fully understand the large margin of error attached to their predictions.
So what’s the point of all of this? Despite all the commentary about uncertainty and the difficulty of making accurate predictions, I am still amazed at the sheer number of forecasts which cross my desk on a daily basis. In the newspaper, on TV, in research reports, mutual fund monthlies, webcasts, Internet sites and so forth – I am constantly bombarded by these “experts” and their “expert opinions.” For fun some times, I will try to match up two of these arguments (presented by intelligent, experienced commentators, of course) which are mutually exclusive and exactly opposite from each other. One of these must be wrong…
Many times, these forecasts consist of a series of events. For example, the US Treasury is providing a great deal of liquidity, and this will eventually lead to inflation, and this will depress the value the US dollar, therefore buy Chinese stocks. Regardless of the logic, flow and validity of such a forecast, because it requires so many events or trends to result from the previous ones, its fruition is much like calling a flip of a coin correctly six times in a row. It can happen, but its likelihood goes down with each additional forecast added to the mix. These serial forecasts rarely can accommodate exogenous shocks (Black Swans, if you will) that often determine the trajectory of the markets.
While I am somewhat entertained by all these capital market forecasts, I rarely rely on them for little more than gauging where the consensus is. My efforts are highly focused on measuring value and determining the context of these measurements. I understand that extreme levels in the things I can measure (sentiment, cash levels, volatility, valuation, etc.) can often signal an inflection point. Did I predict the market’s turn in March? No, I don’t make predictions. Am I surprised by the market’s rise since then? Not really, my measurements suggested some huge imbalances in a number of indicators at that time. Will the rally continue? I am not sure (I don’t make predictions). Am I still fully invested? Yes. I can still find a large number of stocks with very attractive valuations. I suspect my enthusiasm for the market will continue until these kinds of bargains become harder to find.
Anyway, one of my mentors, after a long discourse about his views on this topic or another, would often end the discussion with “well, that (his opinion) and a token will get you on the subway.” It was his somewhat humorous, very self-deprecating way to highlight that sometimes an opinion about the capital markets is not worth very much. I have often wondered why anyone would think this way.
Perhaps it is because there are so many opinions about the markets (oversupply can depress pricing). Perhaps it is because investors would really like someone to tell them what is going to happen and this creates big demand for forecasts and predictions. Again, creating the oversupply of viewpoints we see out there. Perhaps it is because the uncertainty inherent in the capital markets makes a correct opinion such a rare and wonderful thing that people feel richly rewarded for either making a prediction which proves to be correct or for following a successful prediction. Still, I suspect that at some very basic, honest level, most forecasters fully understand the large margin of error attached to their predictions.
So what’s the point of all of this? Despite all the commentary about uncertainty and the difficulty of making accurate predictions, I am still amazed at the sheer number of forecasts which cross my desk on a daily basis. In the newspaper, on TV, in research reports, mutual fund monthlies, webcasts, Internet sites and so forth – I am constantly bombarded by these “experts” and their “expert opinions.” For fun some times, I will try to match up two of these arguments (presented by intelligent, experienced commentators, of course) which are mutually exclusive and exactly opposite from each other. One of these must be wrong…
Many times, these forecasts consist of a series of events. For example, the US Treasury is providing a great deal of liquidity, and this will eventually lead to inflation, and this will depress the value the US dollar, therefore buy Chinese stocks. Regardless of the logic, flow and validity of such a forecast, because it requires so many events or trends to result from the previous ones, its fruition is much like calling a flip of a coin correctly six times in a row. It can happen, but its likelihood goes down with each additional forecast added to the mix. These serial forecasts rarely can accommodate exogenous shocks (Black Swans, if you will) that often determine the trajectory of the markets.
While I am somewhat entertained by all these capital market forecasts, I rarely rely on them for little more than gauging where the consensus is. My efforts are highly focused on measuring value and determining the context of these measurements. I understand that extreme levels in the things I can measure (sentiment, cash levels, volatility, valuation, etc.) can often signal an inflection point. Did I predict the market’s turn in March? No, I don’t make predictions. Am I surprised by the market’s rise since then? Not really, my measurements suggested some huge imbalances in a number of indicators at that time. Will the rally continue? I am not sure (I don’t make predictions). Am I still fully invested? Yes. I can still find a large number of stocks with very attractive valuations. I suspect my enthusiasm for the market will continue until these kinds of bargains become harder to find.
Thursday, May 14, 2009
The Car is Parked, But the Motor is Still Running
With the stock market currently standing some 30% above its March low (still a bear market rally, really?), my thoughts turn to those investors who sold their stocks anytime before then and still hold cash. Selling stocks because the market is going down is a classic investment “tactic” driven more by emotion than cogitation. Hey, I’ll admit that I’ve done it, and I suspect a lot of other people have done it too. To be fair, it’s not really our fault, at least according to Jason Zweig in his book, Your Money and Your Brain: How the New Science of Neuroecononics Can Help Make You Rich. It’s our brain’s fault!
His research suggests that when we start losing money in the market, the feral, animalistic and primitive portion of our grey matter grabs the steering wheel and starts driving with somewhat reckless abandon. This response is neurologically similar to what we feel when in real (not just financial) danger. It’s the classic “fight or flight” adrenaline rush. Often in those moments of stress, our ability to think clearly, carefully weigh options and calmly deliberate on possible outcomes goes out the window. We feel we must do something, and selling is the only thing that seems to make sense.
So now here we are, holding on to our cash and watching the market move up. How do we feel about that? On the one hand, maybe we find some comfort knowing that our asset values are no longer going down. On the other hand, perhaps we are wondering if we really missed the boat. This is when the rational part of our brain takes over and starts to make sense of what happened and what to do now. For investors who need their assets to grow in order to achieve long-term financial objectives, stocks and bonds must be an important part of the portfolio.
Ultimately, the decision to raise cash and sit on the sidelines is two decisions; the other one being when to get back into the market. Do you get back in now? Wait until it goes even higher? Or do you wait for a pull back? How much of a pull back is enough? Do you wait for the “other shoe” to drop and buy at a much lower level? What happens if the market never goes back to where you sold? Ah, such are the dilemmas faced by those who try to time the market. The rational part of the brain may understand at some level that timing the market is impossible, but all this good wisdom is forgotten when the feral brain takes over.
I am seeing a large amount of press lately about how “buy and hold” investment strategies no long work. Given the results of this strategy over the last 10 years, some of this press seems reasonable. However, the conclusion that active trading strategies are the only way to make money in the markets going forward seems misguided. Into this debate steps Stephen Mauzy and his excellent article “Trading Paces” (which can be found in the latest issue of CFA Institute Magazine). In this piece, he reminds us that successful traders are as rare as Kansas surfers. One great quote: “You may call one top or one bottom [in your trading] or you might call two. Getting it right requires many excellent decisions in buying and selling. But I don’t know anyone who is able to constantly produce exceptional after-tax results with trading strategies.”
He references another study in which investment professionals were asked to provide 30-day forecasts for 20 stocks and estimate the size of their own errors. It turns out that the professionals were able to make successful predictions only 40% of the time – less than what a simple coin toss could do. This is not to suggest that investment professionals do not provide valuable services, I truly believe that they do. But they may not be all that great at predicting near-term market or stock movements. And, if the professional is not adept at making short-term predictions, what chance does the non-professional really have?
You may be saying to yourself, “That’s all fine and dandy, but what do I do with my cash NOW?” Well, my advice now would be the same as in March, December, September or even last July – buy cheap stocks trading well below their intrinsic value. Over time, cheap stocks (if identified and measured properly) will usually move upward toward their fair value. Nothing is guaranteed, but the time-tested value investment approach, so well explained by Graham and Dodd and so well practiced by Warren Buffett, John Neff and a host of others, is still my favorite way to make money with stocks. There are many great values out there right now, and I am happy to buy and own them.
His research suggests that when we start losing money in the market, the feral, animalistic and primitive portion of our grey matter grabs the steering wheel and starts driving with somewhat reckless abandon. This response is neurologically similar to what we feel when in real (not just financial) danger. It’s the classic “fight or flight” adrenaline rush. Often in those moments of stress, our ability to think clearly, carefully weigh options and calmly deliberate on possible outcomes goes out the window. We feel we must do something, and selling is the only thing that seems to make sense.
So now here we are, holding on to our cash and watching the market move up. How do we feel about that? On the one hand, maybe we find some comfort knowing that our asset values are no longer going down. On the other hand, perhaps we are wondering if we really missed the boat. This is when the rational part of our brain takes over and starts to make sense of what happened and what to do now. For investors who need their assets to grow in order to achieve long-term financial objectives, stocks and bonds must be an important part of the portfolio.
Ultimately, the decision to raise cash and sit on the sidelines is two decisions; the other one being when to get back into the market. Do you get back in now? Wait until it goes even higher? Or do you wait for a pull back? How much of a pull back is enough? Do you wait for the “other shoe” to drop and buy at a much lower level? What happens if the market never goes back to where you sold? Ah, such are the dilemmas faced by those who try to time the market. The rational part of the brain may understand at some level that timing the market is impossible, but all this good wisdom is forgotten when the feral brain takes over.
I am seeing a large amount of press lately about how “buy and hold” investment strategies no long work. Given the results of this strategy over the last 10 years, some of this press seems reasonable. However, the conclusion that active trading strategies are the only way to make money in the markets going forward seems misguided. Into this debate steps Stephen Mauzy and his excellent article “Trading Paces” (which can be found in the latest issue of CFA Institute Magazine). In this piece, he reminds us that successful traders are as rare as Kansas surfers. One great quote: “You may call one top or one bottom [in your trading] or you might call two. Getting it right requires many excellent decisions in buying and selling. But I don’t know anyone who is able to constantly produce exceptional after-tax results with trading strategies.”
He references another study in which investment professionals were asked to provide 30-day forecasts for 20 stocks and estimate the size of their own errors. It turns out that the professionals were able to make successful predictions only 40% of the time – less than what a simple coin toss could do. This is not to suggest that investment professionals do not provide valuable services, I truly believe that they do. But they may not be all that great at predicting near-term market or stock movements. And, if the professional is not adept at making short-term predictions, what chance does the non-professional really have?
You may be saying to yourself, “That’s all fine and dandy, but what do I do with my cash NOW?” Well, my advice now would be the same as in March, December, September or even last July – buy cheap stocks trading well below their intrinsic value. Over time, cheap stocks (if identified and measured properly) will usually move upward toward their fair value. Nothing is guaranteed, but the time-tested value investment approach, so well explained by Graham and Dodd and so well practiced by Warren Buffett, John Neff and a host of others, is still my favorite way to make money with stocks. There are many great values out there right now, and I am happy to buy and own them.
Tuesday, May 5, 2009
Mr. Obama’s Big Tax Plans
Yesterday at a mid-day press conference, President Obama unveiled several new tax initiatives aimed at “curbing offshore tax havens and corporate tax breaks.” According to White House estimates, these proposals, if they became law, would raise $210 billion in new tax revenue over the next ten years. I suspect that this number, as is true with many government estimates regarding taxes, is based on a ceteris paribus estimate that assumes rational entities will simply pay higher taxes rather than try to avoid them. And, just for perspective, one-tenth of these new tax revenues (the amount we might expect to see in any given year) represent only 0.6% of this year’s government budget. But hey, at least he’s trying, right?
While the media seems focused on the corporate side of these proposals, what I really want to talk about today is the impact on individuals. Whenever I hear the words “tax haven,” I immediately conjure images of Swiss bank accounts and shady characters in Armani suits. But recent actions by the IRS have convinced me that they are casting a very, very broad net in an attempt to increase tax revenues. Thousands or even tens of thousands of people may be at risk.
Specifically, they are targeting all foreign bank and brokerage accounts held by U.S. citizens and tax residents and even some non-citizens who work in the U.S. The following information comes to me via the international tax experts at The Wolf Group.
Income from foreign bank accounts is taxable and should be reported on a taxpayer’s personal return if that person is a US citizen or resident regardless of where they live. In addition, taxpayers are required to report their ownership interest in a foreign financial account every year to the U.S. Treasury (separate from their income tax return) regardless of whether the accounts generated income that was or was not reported on the income tax return. This report is called the Foreign Bank Account Report (FBAR).
This rule has been on the books for years, but according to The Wolf Group, the penalties associated with failure to file have been levied only 3 times in the last 35 years. This is about to change. The IRS is hiring more agents to discover and research these accounts. They have new and better ways of collecting information about these accounts, aided by new treaties between the U.S. and other nations. Foreign banks are now required to file 1099 forms with the IRS, showing interest income earned offshore. Conservative estimates put the deposits subject to new and intense IRS scrutiny in the hundreds of billions of dollars.
The law states that failure to file these reports on a timely basis carries civil penalties up to 50% of the maximum account value, and the penalty applies to each year the account is not timely reported. Criminal penalties may also be imposed. Each year! That means for an account of say $50,000 that a person held for 6 years without filing the FBAR could be liable for 50% x $50,000 x 6, or $150,000! This kind of draconian penalty is rare but not unprecedented. A person who only held an account open for a short period of time (on a business assignment or to purchase real estate, for example) may still be liable for FBAR filing.
Now the “good” news. In late March, the IRS announced a partial amnesty to encourage voluntary compliance with FBAR rules. Under the initiative, qualified taxpayers who voluntarily file delinquent FBAR reports will only(!) be penalized for one year (the year with the highest aggregate value of foreign accounts among the six prior years) at a rate of 20% (5% in very limited circumstances) of that highest aggregate value. Additionally, the IRS will not seek fraud penalties or criminal charges for tax evasion. Taxes and other civil penalties will apply to any unreported income from the accounts.
So, 20% of the assets or as much as 100%? Sounds like a tough choice, but such are the choices sometimes when dealing with the IRS.
For anyone thinking that this might just be tough talk from IRS, consider the following quotes from IRS Commissioner Doug Shulman:
“We are instructing our agents to fully develop these cases, pursuing both civil and criminal avenues, and consider all available penalties including the maximum penalty for the willful failure to file the FBAR report and the fraud penalty.”
“For taxpayers who continue to hide their head in the sand, the situation will only become more dire.”
I am not a tax expert, but if I knew someone who had foreign bank accounts, I would be sure to let that person know about this new IRS initiative and encourage him or her to consult an international tax expert right away. The amnesty program will end September 23, 2009.
While the media seems focused on the corporate side of these proposals, what I really want to talk about today is the impact on individuals. Whenever I hear the words “tax haven,” I immediately conjure images of Swiss bank accounts and shady characters in Armani suits. But recent actions by the IRS have convinced me that they are casting a very, very broad net in an attempt to increase tax revenues. Thousands or even tens of thousands of people may be at risk.
Specifically, they are targeting all foreign bank and brokerage accounts held by U.S. citizens and tax residents and even some non-citizens who work in the U.S. The following information comes to me via the international tax experts at The Wolf Group.
Income from foreign bank accounts is taxable and should be reported on a taxpayer’s personal return if that person is a US citizen or resident regardless of where they live. In addition, taxpayers are required to report their ownership interest in a foreign financial account every year to the U.S. Treasury (separate from their income tax return) regardless of whether the accounts generated income that was or was not reported on the income tax return. This report is called the Foreign Bank Account Report (FBAR).
This rule has been on the books for years, but according to The Wolf Group, the penalties associated with failure to file have been levied only 3 times in the last 35 years. This is about to change. The IRS is hiring more agents to discover and research these accounts. They have new and better ways of collecting information about these accounts, aided by new treaties between the U.S. and other nations. Foreign banks are now required to file 1099 forms with the IRS, showing interest income earned offshore. Conservative estimates put the deposits subject to new and intense IRS scrutiny in the hundreds of billions of dollars.
The law states that failure to file these reports on a timely basis carries civil penalties up to 50% of the maximum account value, and the penalty applies to each year the account is not timely reported. Criminal penalties may also be imposed. Each year! That means for an account of say $50,000 that a person held for 6 years without filing the FBAR could be liable for 50% x $50,000 x 6, or $150,000! This kind of draconian penalty is rare but not unprecedented. A person who only held an account open for a short period of time (on a business assignment or to purchase real estate, for example) may still be liable for FBAR filing.
Now the “good” news. In late March, the IRS announced a partial amnesty to encourage voluntary compliance with FBAR rules. Under the initiative, qualified taxpayers who voluntarily file delinquent FBAR reports will only(!) be penalized for one year (the year with the highest aggregate value of foreign accounts among the six prior years) at a rate of 20% (5% in very limited circumstances) of that highest aggregate value. Additionally, the IRS will not seek fraud penalties or criminal charges for tax evasion. Taxes and other civil penalties will apply to any unreported income from the accounts.
So, 20% of the assets or as much as 100%? Sounds like a tough choice, but such are the choices sometimes when dealing with the IRS.
For anyone thinking that this might just be tough talk from IRS, consider the following quotes from IRS Commissioner Doug Shulman:
“We are instructing our agents to fully develop these cases, pursuing both civil and criminal avenues, and consider all available penalties including the maximum penalty for the willful failure to file the FBAR report and the fraud penalty.”
“For taxpayers who continue to hide their head in the sand, the situation will only become more dire.”
I am not a tax expert, but if I knew someone who had foreign bank accounts, I would be sure to let that person know about this new IRS initiative and encourage him or her to consult an international tax expert right away. The amnesty program will end September 23, 2009.
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