In Search of the Perfect Investment

Tuesday.
I slept in and got my times confused. This is yesterday’s column. Apologies. I’ll be back tomorrow. Idiot me.

I shorted Research in Motion (RIMM) a while back, but covered last week. My friends in Silicon Valley tell me that Research In Motion is now a “steal.” This once high-flier now sports a P/E ratio of under 3 and a seeming floor under the stock.

Apple rewards its shareholders. Maybe. Apple’s CEO Tim Cook and the company’s CFO Peter Oppenheimer will host a conference call at 9:00 a.m. ET to announce what the company is doing with its cash balance of nearly $100 billion.  Analysts expect the company to announce an annual dividend between 1 to 3 percent. Apple closed on Friday at $585.57. Some analysts believe it’s worth a lot more. New York Times story, click here.

Calpers is the biggest pension fund. It got itself into a bind by promising  too much money to its retirees. It did this by assuming it would always earn oodles of money on its portfolio. It now has lower expectations. The article by my friend Jim Shinn in the latest Institutional Investor concludes:

Arnott had a pair of killer slides on the ERP. These charts showed the four sources of equity returns over the past 30 years, with 2.8 percent coming from real growth of earnings, 2.7 percent from dividends, 3 percent from inflation and 3.2 percent from higher valuation of earnings. “Stocks have given us 11 percent in the last 30 years. So why shouldn’t we achieve much the same in the years ahead?” he asks rhetorically.

“Consider the world of 30 years ago. Stocks were yielding 5.5 percent; now they yield just over 2 percent. There goes 3 percent of our prospective return. Also, the drop from a 5.5 percent yield to 2 percent created outsize gains of 3 percent per year, due solely to rising valuation multiples and falling yields. The sensible assumption is that valuation multiples and yields in a decade will be about where they are today. There goes another 3 percent. Bottom line is that we think 5 to 6 percent is a reasonable expectation for stocks over the coming decade.”

The board took Arnott’s pitch with what seemed to me to be a slightly uncomfortable silence. I figured everybody in the room was intently aware that CalPERS had about $110 billion, or half of its portfolio, in listed stocks, whose official return was targeted at 7.75 percent.

I sympathized with the board’s dilemma. I’d been uncomfortably calculating the likely return on the stocks in my personal portfolio over the previous few months and had realized that I had to either write down the expected return or go make some more money. Every saver, personal or institutional, was in the same boat.

“Stocks are a wonderful tactical asset,” Arnott concludes. “They have no inherent advantage that makes them better, especially to those who think that the price doesn’t matter for the patient long-term investor. I don’t know how many decades of carnage will be needed to kill that urban legend.”

For the entire piece, click here.

Why Greg Smith Is ‘Dead Right’ About Goldman Sachs. From the Atlantic monthly. Click here.

These two New Yorker pieces are worth reading:

The Financial Page
Year of the Yo-Yo
by James Surowiecki January 16, 2012

In 2011, the S. & P. 500 finished the year where it started. (To be precise, it fell 0.003 per cent.) But it was anything but a placid year in the stock market. Instead, there was extraordinary tumult throughout 2011, with a series of sharp rallies and brutal selloffs, the biggest of which sent the market down seventeen per cent in a couple of weeks. Even on a daily basis, stocks were startlingly volatile: the Dow Jones Industrial Average moved more than a hundred points on forty per cent of trading days, and there were more than sixty days on which the S. & P. index moved about two per cent or more (which in 2005, for example, it didn’t do once). Ordinary investors, who have watched the value of their 401(k)s yo-yo seemingly at random, have been left feeling understandably dazed and confused as they head into the new year.

Traders and professional money managers don’t seem to have any real clue about what’s going to happen, either. You might think that volatility would allow people with superior information and market sense to get ahead. But last year money managers did a very poor job of playing the market. According to estimates made by Goldman Sachs, as of the last week in December seventy-two per cent of core large-cap mutual funds had underperformed their market indexes. The average stock-market mutual fund was down almost three per cent for the year. And hedge-fund managers, who are supposed to thrive on volatility, did even worse, with hedge funds that focus on stocks falling more than seven per cent. Strikingly, some of the biggest flops came from superstars: Bruce Berkowitz, whom Morningstar named one of the money managers of the past decade, saw his flagship fund fall more than thirty per cent; the hedge-fund manager John Paulson, whose bet against mortgage-backed securities a few years ago has been called “the greatest trade ever,” saw one of his funds drop nearly fifty per cent.

To make matters worse, the raw numbers for 2011 probably understate how badly ordinary investors fared, because they don’t account for our tendency to chase performance. As myriad studies have shown, investors often put their money into funds that have enjoyed recent success and take it out of funds that have been struggling. This seems logical, but, since most of a money manager’s performance, particularly in the short term, is the result of luck rather than of skill, this means that people often end up in funds that are about to go cold and leave ones that are about to do better. One study that looked at investor returns between 1991 and 2004 found that trading in and out of funds cost investors in actively managed mutual funds 1.7 per cent annually, and a Phoenix Investment Partners study that looked at rolling returns between 1990 and 2000 found that buying high and selling low cost investors twenty per cent of their returns over the decade. Hedge-fund investors, though supposedly more sophisticated than your average Joe, pay a similar price for chasing performance. Investing in actively managed mutual funds or in hedge funds already reduces the chances of beating the market, since, according to Vanguard, over the past decade more than sixty per cent of actively managed mutual funds underperformed the S. & P., while hedge funds have trailed the market since 2003. But the search for the hot hand takes a bad situation and makes it worse.

The sensible solution would be for investors to put their money into low-cost index funds and just keep it there. But that’s hard to do when the market is extremely volatile. Most of us find it difficult enough in normal times to take a long-term approach. So when prices are rising and falling two per cent a day, and when it seems like getting in or out of the market could be worth ten per cent of our portfolio’s value, the temptation to try to time the market is hard to resist. (The way the financial media covers the stock market-with each rise and fall treated as a major event-only exacerbates this problem.) Unfortunately, the same psychological forces that make investors bad at rating money managers also make them bad at market timing: all else being equal, they’re prone to sell at the bottom and buy at the top. And, the bigger and more dramatic the swings in the market, the more likely we are to make the wrong decision.

In other words, while crazy volatility may be great for traders (who live for the chance to make two per cent a day), it’s lousy for the rest of us, and for the economy as a whole. It isn’t just that volatility costs ordinary investors money. It also makes them more likely to give up on the stock market entirely: over the past three years, investors have pulled almost two hundred and fifty billion dollars out of equity funds, even though stock prices have almost doubled since the lowest point of the crash. And, while some of that money has gone into exchange-traded funds, most of it has just left the market. This flight from stocks is probably not a good thing for people’s retirement accounts-after all, in a capitalist country owning some capital is usually a smart way to make money. But it may well be a good thing for investors’ psychological well-being. In effect, they’ve decided that, in a market as volatile as this one, the only way to win the game is simply not to play. 

The Financial Page
Great Expectations?
by James Surowiecki March 19, 2012

The story of America’s recovery from the recession has been one of dashed hopes. In early 2010, and again early last year, the economy looked as if it might be starting to grow under its own power, only to slow markedly in the months that followed. So what should we make of the current signs of rebound? The employment report for February, which came out last week, was solid, meaning that businesses have created more than two hundred thousand jobs a month for three months in a row. Economic data show that the economy, and real incomes, grew at a fine clip at the end of 2011. And unemployment, while still painfully high, has fallen a full two points from its peak. Bitter experience might suggest that we regard these numbers with a jaundiced eye. But there are at least a couple of reasons to think that, this time, we aren’t looking at a false spring.

One good sign is that Americans are buying new cars again. That’s a major shift: annual new-car sales fell from a pre-recession peak of seventeen million to just 10.4 million in 2009, a thirty-year low. And, though the economy began to recover, auto sales didn’t. Credit was hard to come by, and even people with jobs were wary of making big purchases. So people bought used cars, or just repaired the vehicles they had. It’s no coincidence that the stock prices of auto-parts stores, like AutoZone, have risen in recent years. But the result of this is that the age of the average American car has kept going up, too; last year, the average car on the road was eleven years old-an all-time high. This means that there is a lot of pent-up demand for new cars, and there are signs that potential demand is starting to translate into active demand. New-car sales began to rebound over the winter, and last month they jumped sharply, up almost sixteen per cent from the previous year. Even if that figure was an outlier, at the current sales rate factories will soon be running at ninety per cent of capacity, which suggests that more demand will lead to more jobs. Indeed, in the past year automakers, and auto-parts makers, have added forty-five thousand workers. And, while Detroit is much smaller than it once was, the auto industry remains a huge business-many “foreign” cars sold in the U.S. are actually made here-so its return to health will have ripple effects across the economy.

There’s an even more important source of pent-up demand, though: all the young adult Americans who have spent the past few years living with their parents. Perhaps the most striking feature of this economic downturn is the way it changed the rate of household formation. Between 1947 (when the government first started collecting data on the subject) and 2007, the number of households in the U.S. rose every year, closely tracking population growth. This recession dramatically broke the trend. In 2008, 2010, and 2011, the number of households dropped, even as the population continued to grow. As Gary Painter, an economist at U.S.C., has argued, the decline in household formation was largely a response to the slow economy and soaring unemployment among the young.

The dwindling number of new households, which the economist Scott Sumner has called a “demographic depression,” isn’t just a result of the weak recovery; it has also been a major cause. We rely on new households to help drive economic activity, in part through the construction of new homes. But, this time around, construction, which normally leads the way out of recession, has been a drag on the economy. While overbuilding during the housing bubble bears some of the blame, so, too, does the lack of new households: when people are doubling up, there’s little demand for owning or renting. This hurts not only the construction industry but all the businesses that make the products that you put in new homes. Spending on durable goods-washing machines and the like-has been very weak over the past few years.

That’s the bad news. The good news is that when this trend reverses there will be a spike in demand, both for housing, especially rentals, and for all the stuff that you put in a house. Some pessimistic observers argue that this reversal will never happen, and that the U.S. will become more like European countries-Italy, say-where living at home until one is older is more common. But it’s easy, during a crisis, to mistake a cyclical change for a permanent one, and surveys show no evidence that young Americans are more interested in living with their parents now. Painter’s study of past recessions shows that, in the past forty years, household formation has slowed notably during downturns but has rebounded as the unemployment rate fell. It seems much more likely that the same will happen this time around than that American aspirations and social norms changed overnight in 2007.

Of course, there’s still a lot that can get in the way of recovery. High oil prices or rising rents could lead the Federal Reserve to overreact and tighten monetary policy prematurely. Europe’s troubles could spill over into the U.S. Political concerns could produce cuts in government spending. And the housing bust put the economy in such a big hole that we have a long way to go before the job market is healthy again. But if the recession was a vicious cycle-in which shrinking demand led to layoffs and wage freezes, which led to shrinking demand-we may finally be seeing the signs of a virtuous one. 

Japan sends a thank you for help after their tsunami. Beautiful video. You’ll cry.  Click here.

Joseph Kony video goes viral with over 80 million views. Kony is head of he Lord’s Resistance Army, a Ugandan guerilla goup, which has committed unspeakable atrocities. To gain over 83 million views in under a month is remarkable, a record. Which brings me to:

+ The most popular search engine on the Internet is, obviously, Google.

+ The second most popular search engine? … It’s YouTube, owned by Google.

+ If you put a video on YouTube highlighting your product’s features and link to it on your web site, you will get a higher ranking in Google searches.

+ You will also get more sales of your product or service, because customers are increasingly attuned to watching videos, not reading text.

You can watch the 29-minute Kony video here.

Three great latest New Yorker cartoons:

Harry Newton who admits to being more relaxed on “vacation” in California. Something about the weather, the regular exercise (2 hours tennis a day) and the absence of New York City’s insanity. A benefit: If you sleep well, you start having nice dreams.