Monthly Archives: April 2012

Why Mutual Fund Managers May Not Act in Your Best Interest

Jeremy Grantham has produced yet another truly outstanding essay in GMO’s Quarterly Letter to Investors for April 2012.  Never reluctant to take on controversy, he focuses on the ways in which mutual fund managers have strong incentives to behave in ways that are often not in the best interests of investors in their funds.  In the academic world, these perverse incentives are referred to as “agency problems.” 

A mutual fund manager makes decisions on behalf of his or her fund’s investors.  In the parlance of economics, the manager acts as an agent working on behalf of the investors (the meaning here is similar to the use in the term real estate agent).  Continue reading

Financial Literacy is the Issue of the Month? Try Issue of the Century.

April is Financial Literacy Month.

All month long, I have been trying to think of how to write a post that can express the depth of my conviction that the lack of financial knowledge is at the core of some of the biggest problems that we, as individuals (and as a nation) are facing.

There are so many areas in which we can see the enormous problems created by a lack of financial literacy that, frankly,  I don’t even know where to start. In fact, the Wall Street Journal just ran an article about college graduates who have little hope of ever being financially secure given their enormous levels of student loan debt. (Even President Obama isn’t exempt: he admitted today that he paid off his student loans just 8 years ago.)

This is a big problem. Continue reading

Sell in May? 9 Trillion Reasons to Say “No”

Guest Post by Contributing Editor, David Kotok, Chairman and Chief Investment Officer, Cumberland Advisors.

The old adage “Sell in May and go away” was good guidance for stock markets last year.  The market peaked on April 29 and bottomed out on October 3.  For a detailed discussion of this period and the subsequent bull-market recovery, see our new book From Bear to Bull with ETFs.  The eBook (ten bucks) is now available on Amazon.com.  Paperback by month end and other channels of distribution like iBook and Nook are coming.  Please note that profits from this book will be donated to the Global Interdependence Center, www.interdependence.org.

History shows that ‘Sell in May and go away’ has applied when the Federal Reserve was in a tightening mode during the six-month span from May to November.  Continue reading

Chasing Yield: Is the Flow of Money into Munis and High Yield Bonds Rational?

There has been a steady flow of money into junk bonds and municipal bonds over the last several months.  In fact, we have had a string of eighteen weeks with increases in mutual funds assets that invest in high-yield bonds and munis.

There is also evidence of money flowing into ETFs that focus on preferred shares. The ETF Industry Association reports that two high-yield bond ETFs were included in their list of the ETFs with the highest inflows for the year-to-date (Note: readers can access data on ETF inflows and outflows here). 

 What I want to know is: Are these flows simply evidence of investors chasing yield? Continue reading

Sell in May?

Guest Post by Contributing Editor, Kip Robbins, CFA, Zacks.com. 

This week, I bumped into a friend who remembered my article based on seasonal investing in which I suggested to buy around Halloween and sell in May (see “Goblins, Ghouls and the Halloween Effect“).  He reminded me that May is soon approaching, and asked me whether I still felt that way.  After I published the article in the Fall, I purchased one of the stocks I’d recommended.  Its price is up a modest 1% since then, has a 3.6% dividend yield, and lately I’ve been reading a lot of positive prose about the stock, so I’m a little uncertain if it’s really time to sell. Continue reading

The Biggest Unknown in Financial Planning

In a recent blog post, I reviewed a new book on the future of the Equity Risk Premium (ERP).  For those who are not familiar with the ERP, it is the additional return that investors expect to receive for bearing the risk of owning company stock vs. owning a low-risk asset like government bonds.  As readers of the  book, Rethinking the Equity Risk Premium will discover, there is little agreement on how the ERP should be measured historically and even less consensus on how to estimate the future ERP.

We all know that there is no guarantee that stocks will deliver higher returns than bonds. In fact, at the depths of the last market crash (think back to early 2009) bonds had out-performed stocks over a trailing period of more than 40 years.  If markets are at all rational, it would make sense that Continue reading

Be Entertained by the Stories; Trust Only the Data

Guest Post by Contributing Editor, Robert P. Seawright, Chief Investment and Information Officer for Madison Avenue Securities. 

All of us who work in the financial markets have seen narratives like it thousands of times and said something like it ourselves almost as often.  From Alan Abelson in the current Barron’s:

THE STOCK MARKET TOOK A wicked hit in last week’s early sessions on revived fears that the negotiations might fall through to keep Greece among the living, or at least still a member, however green around the gills, of the European Union. Instead, holders of its bonds and other creditors blinked and Greece seemingly managed to survive sufficiently to warrant another bailout despite its incredible shrinking GDP. Markets the globe over, including our own, natch, breathed a huge sigh of relief.

“While the reprieve afforded by the announcement of the latest last-minute resolution enabled equities to regain a good chunk of the ground lost, the rally was notably lacking in the kind of combustible conviction that generates big trading volume. For one thing, Greece, shmeece, Europe is enmeshed in a recession, hopefully a modest one, but who knows?

That’s a compelling narrative, but is it actually true?  Continue reading

Housing Prices and the Economy: Is There Any Good News?

New data shows that housing prices are not improving.

Nationally, prices have now dropped 34.4% from their peak in 2006.  Prices are now the lowest they have been since the end of 2002, according to the Case/Shiller index.  Robert Shiller, co-creator of the index and long-term researcher on housing prices, warns that risks remain and that we may be seeing a broad shift in consumers’ beliefs with regard to the desirability and risks of owning a house.  In fact, Shiller speculates that it may take decades for suburban single-family housing prices to recover.

A chart of the 20-city composite of U.S. house prices tells the story (below):

(Case/Shiller 20-City U.S. Home Price Index, Seasonally Adjusted. Source: Standard and Poors.)

Nationally, home prices more than doubled from 2000-2006.  From mid-2006 to mid-2009, prices dropped as dramatically as they rose during the boom.  We experienced a slight bounce from mid-2009 to mid-2010, but prices started to decline again in 2010 and are now at their lowest point in a decade.

Implications of Weak Housing Values

Beyond the obvious impacts on homeowners’ net worth, what are the implications of weak housing values for the economy?

First, for many Americans, their houses represent most of their net worth.  What’s more, less wealthy households tend to have a higher percentage of their net worth in home equity.  A continued decline in house prices tends to increase wealth inequality, as well as reducing household net worth as a whole.  Given that fewer and fewer Americans have traditional employer-sponsored pension plans, reductions in household net worth translate directly into fewer financial resources available to fund retirement and other long-term liabilities.

Second, we have the wealth effect.  People tend to feel wealthier when the paper value of their assets is higher, and they tend to spend more.  This may be an especially powerful driver of consumption when homeowners can easily use home equity loans to fund purchases of consumer goods.  A number of studies have found that wealth in the form of home equity is a larger driver of consumer spending than other forms of wealth.

Third, we have the manifestation of de-leveraging among individual investors.  People who lose their homes to foreclosure are not likely to purchase new homes.  In addition, baby boomers who are saddled with mortgages they cannot really afford are likely to sell their homes to get out from under the risks that such leverage (e.g. mortgaged) creates.  Gary Shilling recently outlined this scenario.  With a smaller pool of ready buyers, this de-leveraging across the residential real estate market is a deflationary force.

Is There Any Good News?

Yes, some. Buying a house is looking more and more attractive relative to renting.  With low interest rates and lower prices, the cost of purchasing a house is lower than it has been over most of the last ten years.  Ken Johnson, a professor who studies real estate, and the buy-vs.-rent problem in particular, concludes that buying looks like a better bet than renting.  On the other hand, it is hardly surprising that potential home buyers, and especially first-time buyers, will be very wary of borrowing large sums of money to purchase an asset that may be hard to sell (liquidity risk) and that has the potential to drop as much as we have seen housing prices fall in recent years.

On the other hand, the implications of the most recent Case/Shiller numbers are not very positive.  The best that can be said is that housing prices have shifted from a dramatic free fall to a slower downward drift.  It is hard to tell whether this persistent declined in housing prices is a symptom or a cause of an ongoing economic malaise.  For wealthier Americans, the massive upswing in the stock market has offset declines in housing values.  For less-well-off Americans, the continued erosion of net worth suggests it will be a very slow recovery in terms of personal wealth and in terms of a sustained recovery in consumer spending, which has historically depended on the “wealth effect.”

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