Monthly Archives: May 2012

The Facebook IPO: Why Gambling with Your Portfolio Rarely Pays Off

In the academic finance world, it’s fairly common to find comparisons of investors to gamblers and certain types of stocks have been referred to as ‘lottery tickets.’ I’ve found that this comparison is actually quite important. There is an odd paradox between the assumption that investors are rational when it comes to investing, yet still spend an awful lot of money playing the lottery.  When we speak of “lottery ticket” investments, we are talking about investments that have a small probability of a big “win” and a large probability of a modest “loss.” And this is precisely the situation with lotteries.

The reality is that people spend considerable sums of money on lottery tickets, a money gamble that has a negative expected value. This same appeal (big, low-probability win, modest high-probability loss) also seems to motivate some investors. Continue reading

What’s Driving the Price of Oil?

Gas prices are not keeping Americans at home this Memorial Day weekend. AAA projects that 34.8 million Americans will travel 50 miles or more this holiday weekend.

Here at the Portfolioist, we thought the start of Memorial Day weekend would be a good time to re-examine what drives the price of oil. This article was first published by Geoff Considine on May 4th.

From all of us at the Portfolioist, have a happy and safe Memorial Day.

There’s lot’s of talk right now about the price of oil and, particularly, gasoline, and it looks as though the price of a gallon of gas will be a significant political topic for the election this year.  President Obama recently proposed new rules for limiting the influence of speculators on the oil market.  Politifact, a media group that fact checks the truthfulness of political statements recently ran a piece on public statements about oil prices.  Their conclusion is that much of what is being claimed with regard to the causes of high oil and gas prices is, at best, based on half truths. Continue reading

What You Need to Know Before You Invest in an IPO

In light of all the discussion surrounding Facebook’s IPO, we thought we’d repost one of our most popular articles that explores the characteristic performance of IPOs.  This article was previously published in June of 2011, but the narrative feels very timely today.

It shouldn’t surprise you that investors have had a long history of enthusiasm for IPO stocks. But has this enthusiasm ever paid off over the long-term?

To answer this question, you first must do the research.

Do Your Due Diligence

There is a substantial body of research that examines how and why IPO stocks perform the way they do and there are two major themes that emerge Continue reading

Are We Hard-Wired To Make Bad Financial Choices?

Proper financial planning that provides for our financial needs in retirement is perhaps the prototypical example of willful blindness. We all know that most people have not saved enough to provide for a sustainable long-term income in retirement. The core issue here is that we (as a society and as individuals) are making consistently bad financial decisions that affect our futures, beginning with how we pay for Continue reading

Does “Low Risk” Outperform?

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

A new paper by Robert Haugen, president of research house Haugen Custom Financial Systems, and Nardin Baker, chief strategist, Global Alpha, Guggenheim Partners Asset Management, claims that low risk (really low volatility) stocks consistently delivered market-beating returns in all of the 21 developed countries they studied between 1990 and 2011 (video here). Their research showed the same was true of 12 emerging markets they looked at over a shorter period since 2001. In essence, their idea is that low volatility stocks are boring and underappreciated but outperform because Continue reading

The Most Common Mistake Investors Make

Each year, the research firm DALBAR publishes their Quantitative Analysis of Investor Behavior.  Every year, the results show that individual investors are their own worst enemies. 

And this year is no exception. 

The QAIB examines the real returns earned by investors in equity mutual funds, bond mutual funds, and asset allocation mutual funds.  Over the past twenty years, the average investor in an equity mutual fund has under-performed the S&P 500 Index by an annualized Continue reading

The Hidden Risk in Target Date Funds

Lately, Target Date Funds (TDFs) have been the subject of intense scrutiny and criticism, because investors have realized (in many cases, after the fact) that these types of funds can be very volatile. In the aftermath of the 2008 collapse of the financial markets, TDFs for investors near retirement (funds with a projected retirement data of 2010, a.k.a “2010 TDFs”) got considerable media attention because some of these funds suffered dramatic losses.

Clearly, investors nearing retirement didn’t understand the levels of risk they were taking by investing in 2010 TDFs.  It has also been widely noted that the percentage of assets invested in equities in 2010 TDFs varied dramatically among funds, which in turn meant Continue reading

What’s Driving the Price of Oil?

There’s lot’s of talk right now about the price of oil and, particularly, gasoline.  Oil is trading at more than $104 per barrel and the national average price of gasoline at the pump is $3.80.  It looks as though the price of a gallon of gas will be a significant political topic for the election this year.  Newt Gingrich, in his efforts to secure the Republican nomination for president, promised to bring the price of a gallon of gas down to $2.50.  President Obama recently proposed new rules for limiting the influence of speculators on the oil market.  Politifact, a media group that fact checks the truthfulness of political statements recently ran a piece on public statements about oil prices.  Their conclusion is that Continue reading

Stocks and Shocks: What to Do?

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

How do we avoid walking into a “left hook” in the markets? That was the discussion this week during a client review.

“Can’t you see them coming and avoid them?” he asked. Well maybe some folks can, but the issue of investing with possible shocks as an outcome is a very difficult one.

“Do you position for the worst outcome?” If yes, you would never invest in anything.

“Is there a middle road?” We think so and that is why we use a combination of ETFs and bonds and recommend diversifying risk among several asset classes.

Below this introduction is a partial list of upcoming potential shocks. As readers will note, we can see the potential shock relatively clearly. Scott MacDonald of MC Asset Management calls them “dangerous seas ahead.” His maritime metaphors sequence the Titanic and Lusitania. Lehman-AIG and the meltdown were the Titanic. “This leaves us to wonder if the U.S. economy is not like the Lusitania, operating in a high risk environment, but felt to be safe from prowling German U-boats in the North Atlantic.” ponders Scott.

Of course, we cannot know the result of a potential risk before it happens. We cannot know the outcome and the policy shift. Therefore, the anticipatory period preceding the risk and the aftermath (if as and when the risk is realized) are not symmetrical. In other words, you are investing in asymmetry. Knowing this in advance allows for an asset-allocation rebalancing as the circumstances and probabilities change. In other words: reassess, reassess, reassess risks and rebalance, rebalance, rebalance.

Some of the discussion in our new book addresses these types of asymmetries. See Amazon.com, From Bear to Bull with ETFs or visit Cumberland’s website. In the book, we actually show the comparison with the ten sectors of the S&P 500 index and the relative performance of each sector in the bear and in the subsequent bull market.

Now let’s get to some potential shocks and comment about them:

  • Possible Shock Number 1: The Fed will cease “Operation Twist” on June 30. They confirmed the policy shift as recently as this last meeting and Bernanke’s statement. What will a twist cessation bring to bond yields? Will it change home mortgage interest rates? Delay a housing market recovery? Alter the steepness of the yield curve? Or the flatness of the yield curve? What happens to bond credit spreads? Pricing of repo collateral? Maybe the whole thing will pass as a non-event. Nobody knows.
  • Possible Shock Number 2:The so-called “fiscal cliff” is approaching at year-end. Strategas’ Dan Clifton and Jason Trennert have hammered this theme. Their summary identifies three elements:“… roughly one-third of the entire tax code expiring at the end of the year, the spending sequester beginning on January 2, a debt ceiling increase needed in the six weeks after the election and before the end of the year.”How much will markets anticipate these outcomes? How deep is fiscal drag? Is there a fiscal drag? Is Ricardian equivalence dead? How large is the policy shift danger to our country from the Congress? From this President? From next year’s President (re-elected or new)? All of these tax-spend-borrow outcomes are probable in the present-day realm of American politics. That puts our American destiny in the hands of a class of people who are very unpopular and despised by the majority of American citizens. Our politicians have become the scurrilous, scatological scoundrels that we elect and send to Washington. (We include both political parties in this opprobrium). Jack Bittner asks if we should limit all pols to a single term.
  • Possible Shock Number 3: The Bank of Japan has leaped to the top of the G4 central banks when it comes to balance-sheet expansion. BOJ announced an increase in the rate of asset purchases and an extension of the duration of the Japanese sovereign debt it will buy. Initial market reaction was that this plan is “not enough.” BOJ is trying to get Japan’s inflation rate UP! They have not succeeded in the past. Is this time different? What will be the impact on the foreign exchange markets? Will the yen weaken? If so, which currency will strengthen? We have written in the past that FX market adjustments are quite distorted when the G4 central banks are all maintaining their policy interest rates near zero.
  • Possible Shock Number 4:The FDIC limit on non-interest-bearing demand deposit insurance is scheduled to revert back to the pre-crisis level at the end of this year. We quote from the FDIC website:“From December 31, 2010 through December 31, 2012, at all FDIC-insured institutions, deposits held in non-interest-bearing transaction accounts will be fully insured regardless of the amount in the account. For more information, see the FDIC’s comprehensive guide, Your Insured Deposits.”What will be the impact in the money-market end of the yield curve? Will there be an extension of the termination date if markets begin to tighten? What will happen to repo rates? Repo collateral pricing? How closely is the Fed watching this development, since the Fed has been providing the market with more repo collateral (T-bills) through its Operation Twist? Is there a relationship, or will there be one? Can the banking system withstand larger withdrawals of zero-interest deposits if corporate agents deem deposits to be insecure without FDIC insurance coverage? (Note that the FDIC just closed five more banks this week. In the case of the Bank of Eastern Shore, Cambridge, Maryland, the FDIC has not found a buyer or merger partner, and the uninsured depositors are at risk of loss. Readers who are still worried about the safety of their bank deposits may check the FDIC website for the current rules).
  • Possible Shock Number 5: Watch the price and futures prices of Brent crude. Many are sanguine about oil and energy pricing and the gasoline price. We are not. Libyan production is not coming back in a hurry (hat tip to Barclays for superb research on the risk of Libyan civil war). Geopolitical risk is high in the Persian Gulf (Iran) and in Nigeria (see the developing news story of turmoil in this important oil-producing country). Worldwide demand for oil inexorably rises. U.S. energy policy still fails to accelerate our move to energy independence. Despite Energy Secretary Salazar’s protestations, the fact is that the Obama Administration has a failed energy policy and continues to pursue it. We do not drill, we do not encourage the use of natural gas in an accelerated and proactive way, and we do stymie new production and exploration. We do have pipelines running in the wrong directions, and we do have distorted domestic oil pricing because of excess inventories in Cushing, Oklahoma. At Cumberland, we remain attentive to this sector even as the market has become sanguine about it. We continue to hold our oil-energy-exploration and oil-service positions. The range of forecasts of the oil price is a mile wide. We have seen a low of $40 a barrel within two years and a high of $175. We lean to the higher price, not the lower one.

Reassess and Rebalance

I will stop now with the list of possible shocks and leave it to the reader’s imagination to complete this compendium with thoughts about Europe or China slowing or future inflation risk. Here is how we see the portfolio management decision. Remember this is today. It could change tomorrow, next week, next month or next year. The operative structure is reassess, reassess, reassess, rebalance, rebalance, rebalance.

Cumberland continues its fully invested approach using ETFs. We have been in that mode since the bear-market bottom of October 3. We think the bull market that started on October 3 is only half over as to price change and only one-third to one-fourth over as to time. Of course, any shock could derail this forecast. Our bond portfolios are slowly repositioning to a hedged or defensive mode. We have time. The process of moving from the present very low interest rates will require years and be volatile but gradual. Interest rates cannot go below zero. To get them above zero and into a more normal relationship, the G4 central banks must neutralize over four trillion dollars equivalent of excess reserves. Collectively they are still enlarging this position and are a long way from extraction from it.

Two items are recommended:

  • Read “Death of a Theory,” by St. Louis Fed president James Bullard, in the March-April/2012 monthly bulletin of that bank.
  • For analysis of last year’s bear market and the ensuing bull market, readers may wish to consult our new book, From Bear to Bull with ETFs. We thank readers for their responses so far. For the first time in our life, we have had a three-week-running best-selling book. All links to book distribution will be constantly updated on Cumberland’s website.

(Disclosure: The views and opinions expressed here are those of the author(s) and do not necessarily reflect the views of the Portfolioist. Cumberland Advisors is unaffiliated with FOLIOfn Investments.)

About David R. Kotok:

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. Mr. Kotok’s articles and financial commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent guest on financial television including Bloomberg Television, CNBC and Fox. He also contributes to radio networks such as NPR and media organizations like Bloomberg Radio, among others.

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