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.
Tuesday, April 28, 2009
Not About the Swine Flu!
Whew! You can really tell when a story hits the media at a time when nothing else important is going on. With words like “pandemic” and “crisis” being thrown around like cowboys at a rodeo, it’s hard not to panic a little bit. If there is any good news in all of this, it seems that this flu strain is responsive to treatment by existing medicine, which seems to be available in ample supply. We hope for the best for all involved.
What I really wanted to talk about today is the housing market. Remember that problem? Every once and a while, we will hear something about how many homeowners are “upside down” (have mortgages bigger than the value of their house), how many homeowners or behind on their payments or how many foreclosures there were last month, but generally the news flow about the housing market has been rather light lately. When swine flu, automaker bankruptcies and/or banking industries do not dominate the airwaves, we might reasonably expect the media to recycle the apparent bad news about the housing market.
Recall that the baseline problems which led to the current recession and bear market were housing related. Recall that many experts consider the bursting of the housing bubble a key factor in all the economy’s current struggles. Recall that the US government is trying to lower mortgage rates in an attempt to help homeowners keep their houses. Amid of all this, it’s easy to ask “When Will Housing Recover?”
Well, in the latest issue of the Financial Analysts Journal, two finance professors, Eli Beracha and Mark Hirschey, attempt to answer that very question. They point out that in the 25-year period from 1982 to 2007 the annual rate of house price appreciation in the U.S. was 1.65% per year, and that over this period nominal house price never fell. This makes the experience in 2008, where nominal prices fell, so unusual – something not seen since the Great Depression. Yet, they emphasize, that despite stunning declines in several states (California, Nevada, Arizona, Florida and Virginia), the housing market remains moderately strong (or at least not horribly weak) through most of the country. The real trouble exists in those markets which had been the strongest.
This may sound pretty obvious to many of us, but it was a bit of good news to me – that the real estate problem was not the wide-spread “pandemic” we might think it is, just listening to the nightly news. After many pages of data and commentary, the authors were able to offer this conclusion – “…if typical per capita income growth continues for only 1.49 years [note the academic penchant for precision without accuracy! – ed.] with flat housing prices and continued low interest rates… the nationwide housing ‘crisis’ will be on the road to recovery by the second quarter of 2010.” In other words, they can see the housing market recover by the middle of next year, IF incomes rise and housing prices stabilize. Perhaps those two assumptions are overly optimistic, but they are based on reasonably assumptions spelled out in detail in the essay. IF this were true, we could expect the stock market to begin discounting this good news sometime later this year.
I am sometimes accused of being too optimistic. Well, if this is a fault, then label me “guilty.” My optimism is not congenital; is has been acquired through many years of analyzing great companies and seeing how much motivated, creative and hard work goes on behind the scenes. The economy is not one thing. It is not a monolith controlled by some all-knowing entity. Rather, it is the amalgamation of millions of actions by millions of people all trying to make products, provide services and make some money along the way. The fact that this is the driver of our economy makes me optimistic. Better news about the housing market will make me even more so.
What I really wanted to talk about today is the housing market. Remember that problem? Every once and a while, we will hear something about how many homeowners are “upside down” (have mortgages bigger than the value of their house), how many homeowners or behind on their payments or how many foreclosures there were last month, but generally the news flow about the housing market has been rather light lately. When swine flu, automaker bankruptcies and/or banking industries do not dominate the airwaves, we might reasonably expect the media to recycle the apparent bad news about the housing market.
Recall that the baseline problems which led to the current recession and bear market were housing related. Recall that many experts consider the bursting of the housing bubble a key factor in all the economy’s current struggles. Recall that the US government is trying to lower mortgage rates in an attempt to help homeowners keep their houses. Amid of all this, it’s easy to ask “When Will Housing Recover?”
Well, in the latest issue of the Financial Analysts Journal, two finance professors, Eli Beracha and Mark Hirschey, attempt to answer that very question. They point out that in the 25-year period from 1982 to 2007 the annual rate of house price appreciation in the U.S. was 1.65% per year, and that over this period nominal house price never fell. This makes the experience in 2008, where nominal prices fell, so unusual – something not seen since the Great Depression. Yet, they emphasize, that despite stunning declines in several states (California, Nevada, Arizona, Florida and Virginia), the housing market remains moderately strong (or at least not horribly weak) through most of the country. The real trouble exists in those markets which had been the strongest.
This may sound pretty obvious to many of us, but it was a bit of good news to me – that the real estate problem was not the wide-spread “pandemic” we might think it is, just listening to the nightly news. After many pages of data and commentary, the authors were able to offer this conclusion – “…if typical per capita income growth continues for only 1.49 years [note the academic penchant for precision without accuracy! – ed.] with flat housing prices and continued low interest rates… the nationwide housing ‘crisis’ will be on the road to recovery by the second quarter of 2010.” In other words, they can see the housing market recover by the middle of next year, IF incomes rise and housing prices stabilize. Perhaps those two assumptions are overly optimistic, but they are based on reasonably assumptions spelled out in detail in the essay. IF this were true, we could expect the stock market to begin discounting this good news sometime later this year.
I am sometimes accused of being too optimistic. Well, if this is a fault, then label me “guilty.” My optimism is not congenital; is has been acquired through many years of analyzing great companies and seeing how much motivated, creative and hard work goes on behind the scenes. The economy is not one thing. It is not a monolith controlled by some all-knowing entity. Rather, it is the amalgamation of millions of actions by millions of people all trying to make products, provide services and make some money along the way. The fact that this is the driver of our economy makes me optimistic. Better news about the housing market will make me even more so.
Tuesday, April 21, 2009
The Susan Boyle Rally
By now I suspect that most of the world’s population which is connected to the Internet knows about Susan Boyle. She is the unassuming-looking, late-40s woman from Scotland who amazed the judges (and the world) in her audition for the television talent show “Britain’s Got Talent.” Within a week of being placed on YouTube, her rendition of “I Dreamed a Dream” has been seen and heard by over 12 million people. In an industry that so highly favors looks and image, it’s inspiring to many to see Susan Boyle receive so much praise and notice. As John Rash, an advertising columnist put it, “[her video] encapsulates the power of everyday people becoming overnight sensations.” Bravo, Susan, Bravo.
I think the stock market rally we’ve been experiencing since early March has much in common with Susan Boyle. At the beginning, there was much skepticism. Economic data was clearly drab and uninspiring. Most of the “experts” were not looking at the markets favorably. I suspect many of them expected the market to disappoint or even fall on its face.
Just as Susan’s clear and melodic tones stunned the judges, the market’s rise began to sway sentiment. As the rally progressed, grumpy skeptics, who before only saw gloom and doom, began to see “glimmers” of favorable economic activity. With the market now over 20% above the March low, many more investors are seriously discussing the market’s potential? Is this the big turn? Can it be sustained? Can this market become a “big star?”
We hope the best for Susan Boyle and her budding singing career. We can’t predict whether or not she’ll be a big success, but we hope she will be. Similarly, we hope the current rally will be sustainable and even become the next bull market, but we can’t really predict this. Yet, we are encouraged by the market’s tone and responsiveness to new information (bad or good).
In our view, the fundamentals that matter to the capital markets are always a mix of positives and negatives. The direction of the market is not so much determined by the difference between these two extremes, but rather by which part of the spectrum captures investors’ attention.
Here is a partial list of positive fundamental factors as we see them now:
• High Cash Levels. We see $9 trillion in money market accounts. These funds had been in stocks and bonds and now just sit there waiting for the “all clear” signal to get back in.
• Sentiment. High bearish sentiment (we saw historically high levels in early March) often accompanies the bottom of the market.
• Interest Rates. The Federal Reserve is determined to keep short rates low (which helps a large number of borrowers) and has also begun a tactic aimed at lowering longer-term rates, especially mortgage rates. This could stabilize the housing industry and via refinancing, put more cash into households.
• Lower Energy Prices. The dramatic decline in energy prices from last summer is another stimulus to the American household budget.
• Government Action. The new administration is determined to do as much as it possibly can to jump start the economy and return confidence to the system.
Despite the above, we continue to see significant negatives which may impact the establishment of a new bull market:
• Unemployment. As layoffs continue, many may worry about the impact this has on consumer sentiment, spending and saving. The fact that employment is a lagging indicator may not matter to the average citizen watching the nightly news.
• Earnings. First quarter results have just started to trickle out and despite good news from Wells Fargo, it’s hard to imagine that all companies will report better-than-expected earnings in a quarter where GDP is expected to fall 6%.
• “Expert” Opinions. The handful of economists and academics credited with “predicting” this recession are mostly staying with their pessimistic forecasts. Unless they are particularly nimble (and different from past prophets of doom), they will miss the upside of a new bull market. Yet, the combination of their new-found fame and continued gloomy opinions may sway investor sentiment and stifle the rally.
• Bailouts. Major U.S. industries (banks, real estate, insurance, banking, etc.) may yet require a great deal of government assistance and/or dramatic changes before the “all clear” signal can be sounded. Regardless of the skill of the decision makers involved, these industries’ status is highly uncertain and fraught with risk.
• The Other Shoe. In the back of everyone’s mind seems to lurk the fear that something else, unexpected and dire, is just around the corner, and could bring us right back to the pain and losses seen last year. This fear is particularly worrisome because it’s impossible to prove the absence of something. To the extent that this fear inhibits action, it could dampen the recovery.
Over the last few weeks, the market has clearly been focused on the ““glimmers of hope” and not the “worst economy in 50 years.” Will this continue? Hard to say. I think the time to be defensive is long past. In my view, cash is the most expensive and “risky” asset, especially for those investors with longer time horizons and important financial goals yet unmet. Time will tell.
I think the stock market rally we’ve been experiencing since early March has much in common with Susan Boyle. At the beginning, there was much skepticism. Economic data was clearly drab and uninspiring. Most of the “experts” were not looking at the markets favorably. I suspect many of them expected the market to disappoint or even fall on its face.
Just as Susan’s clear and melodic tones stunned the judges, the market’s rise began to sway sentiment. As the rally progressed, grumpy skeptics, who before only saw gloom and doom, began to see “glimmers” of favorable economic activity. With the market now over 20% above the March low, many more investors are seriously discussing the market’s potential? Is this the big turn? Can it be sustained? Can this market become a “big star?”
We hope the best for Susan Boyle and her budding singing career. We can’t predict whether or not she’ll be a big success, but we hope she will be. Similarly, we hope the current rally will be sustainable and even become the next bull market, but we can’t really predict this. Yet, we are encouraged by the market’s tone and responsiveness to new information (bad or good).
In our view, the fundamentals that matter to the capital markets are always a mix of positives and negatives. The direction of the market is not so much determined by the difference between these two extremes, but rather by which part of the spectrum captures investors’ attention.
Here is a partial list of positive fundamental factors as we see them now:
• High Cash Levels. We see $9 trillion in money market accounts. These funds had been in stocks and bonds and now just sit there waiting for the “all clear” signal to get back in.
• Sentiment. High bearish sentiment (we saw historically high levels in early March) often accompanies the bottom of the market.
• Interest Rates. The Federal Reserve is determined to keep short rates low (which helps a large number of borrowers) and has also begun a tactic aimed at lowering longer-term rates, especially mortgage rates. This could stabilize the housing industry and via refinancing, put more cash into households.
• Lower Energy Prices. The dramatic decline in energy prices from last summer is another stimulus to the American household budget.
• Government Action. The new administration is determined to do as much as it possibly can to jump start the economy and return confidence to the system.
Despite the above, we continue to see significant negatives which may impact the establishment of a new bull market:
• Unemployment. As layoffs continue, many may worry about the impact this has on consumer sentiment, spending and saving. The fact that employment is a lagging indicator may not matter to the average citizen watching the nightly news.
• Earnings. First quarter results have just started to trickle out and despite good news from Wells Fargo, it’s hard to imagine that all companies will report better-than-expected earnings in a quarter where GDP is expected to fall 6%.
• “Expert” Opinions. The handful of economists and academics credited with “predicting” this recession are mostly staying with their pessimistic forecasts. Unless they are particularly nimble (and different from past prophets of doom), they will miss the upside of a new bull market. Yet, the combination of their new-found fame and continued gloomy opinions may sway investor sentiment and stifle the rally.
• Bailouts. Major U.S. industries (banks, real estate, insurance, banking, etc.) may yet require a great deal of government assistance and/or dramatic changes before the “all clear” signal can be sounded. Regardless of the skill of the decision makers involved, these industries’ status is highly uncertain and fraught with risk.
• The Other Shoe. In the back of everyone’s mind seems to lurk the fear that something else, unexpected and dire, is just around the corner, and could bring us right back to the pain and losses seen last year. This fear is particularly worrisome because it’s impossible to prove the absence of something. To the extent that this fear inhibits action, it could dampen the recovery.
Over the last few weeks, the market has clearly been focused on the ““glimmers of hope” and not the “worst economy in 50 years.” Will this continue? Hard to say. I think the time to be defensive is long past. In my view, cash is the most expensive and “risky” asset, especially for those investors with longer time horizons and important financial goals yet unmet. Time will tell.
Monday, April 13, 2009
Happy Birthday Mr. Jefferson
Thomas Jefferson was born on this day 266 years ago. The power of his words still reverberate throughout the nation.
"We, too, shall encounter follies; but if great, they will be short, if long, they will be light; and the vigor of our country will get the better of them." --Thomas Jefferson to Thomas Digges, 1806
"We, too, shall encounter follies; but if great, they will be short, if long, they will be light; and the vigor of our country will get the better of them." --Thomas Jefferson to Thomas Digges, 1806
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