Travel: Mexico City

I’ll be in Mexico City next week, drop me a line if you want to meetup!

Also on the schedule in the next two months are Arizona, Colorado, Las Vegas, and a whole bunch of Florida.

Are Stocks Overvalued?: CAPE vs. Dividends

People seem to have a lot of misgivings when it comes to CAPE.  I have no idea why as almost all valuation indicators usually line up on the same side when a stock or market is over/undervalued.

Here is another chart, this time looking at CAPE vs CAPD.  They are basically the same chart (with dividends showing even more overvaluation) and CAPE is 90th percentile and dividends 94th.  Neither are good places to hang out the next 3-10 years.  Next q, next y?  Who knows.

 

divs

 

Note that we published a paper on sorting countries by earnings.  What about dividend yield?  Same outperformance:

 

giry

 

Source: GIRY 2011, 2013giryyy

Gameplan for 2014?

We did a paper years ago that combined the Presidential Cycle and the January Effect.  It was also known as our least read paper.  Anyways, if you were to follow history, and I’m not sure that you should, conclusions would be that the investor should be a little more concerned in 2014 , or at least rotate into mid or large caps until near year end.  Then strap on for big runs in 2015/2016.

But that is just what happened in the past.  (data up to 2009, will update soon.)

Amazingly, since publication, had one just rotated each year into the size (small, mid, large) that historically did best that year you would have beaten the S&P500 by 15 percentage points since 2010. Who says history doesn’t rhyme? 

CLICK ON BOTH TO ENLARGE (note these are median returns, arith and geo average would be different but similar). French Fama dataset.

1920.

 

2014

 

 

What Would You Rather Own?

From this paper:

Emerging markets have > 30% world GDP, but only 12% of world market cap. A Shiller CAPE of about 15.  55% of global population.  

or

The US is about 25% of world GDP, but 45% of world market cap. And a Shiller CAPE of about 24. 5% of global population. 

Now, how much of your portfolio of stocks is in the US?  My guess for most is 50, 75, or 100%.

(also here is a related piece from Vanguard)

Emerging Equity Markets in a Globalizing World

Abstract:      

Given the dramatic globalization over the past twenty years, does it make sense to segregate global equities into “developed” and “emerging” market buckets? We argue that the answer is still yes. While correlations between developed and emerging markets have increased, the process of integration of these markets into world markets is incomplete. To some degree, this accounts for the disparity between emerging equity market capitalization in investable world equity market benchmarks versus emerging market economies in the world economy. Currently, emerging markets account for more than 30% of world GDP. However, they only account for 12.6% of world equity capitalization. Interestingly, this incomplete integration along with the relatively small equity market capitalization creates potentially attractive investment opportunities. Our research has important policy implications for institutional fund management.

 

The Dividend Challenge

bp352313
Beginning in the 1980′s Pepsi started running the Pepsi Challenge — television commercials featuring taste tests that would pit their soda versus Coca-Cola.  Tasters would take sips of each unmarked beverage, and were asked to declare which soda they preferred.  Invariably, Pepsi was the favorite choice.  Coke conducted its own trials and astonishingly found similar results.  The oft cited reason was that Pepsi’s formula was sweeter, and this led to the conclusion that Coke needed to change their formula and resulted in the disastrous roll out of the abomination called New Coke. 

 However, even though people blindly prefer Pepsi, people still buy Coke to the extent that it commands a much larger share of the soda marketplace than Pepsi (I’m more of a Diet Mt. Dew guy.)    In tests, researchers also found that foreknowledge of the brand led to the results changing – people’s responses changed and the majority preferred Coke when they knew the brand.

Why is this?  Are people totally irrational?  Or are there other factors at play – childhood memories of drinking a Coke with grandpa on the front porch swing, or perhaps the warm fuzzy feelings you have from watching the polar bear commercials and the Super Bowl.  Regardless, the simple conclusion is that there is more at work than simply taste, or even logic alone.  Brand means something, and this applies to other items such as wine, automobiles, and clothing.

Does the same branding imprints apply to investing and stocks?  Certainly – for the older investors think back to the old EF Hutton (“When EF Hutton talks, people listen”) or Smith Barney (They make money the old fashioned way, the earrrnnnned it)  commercials.  Or perhaps the great brands of Warren Buffett of Peter Lynch.  The Pepsi challenge can provide a metaphor for high yielding dividend funds as of late.  Investors love dividends, and rightfully so.   Companies that pay dividends have historically outperformed the broad market in the United States, and in other countries all the way back to 1900.  Since 2000, dividend-paying companies have trounced the overall markets, and sorting countries by dividends works as well.

Dividends also have a great “story”.  You may have learned about them from your parents, or perhaps taking an investing course in college.  Historically, when you invest in dividend stocks you are adding a value tilt to your portfolio.  This is one of the reasons investing in dividend stocks works – they are value stocks.  One could go as far to say dividends have a great brand.  Much like Coke, thoughts of dividend stocks immediately conjures images of regular checks coming in the mail from profitable, established companies.   

 However, market valuations and stock and fund characteristics ebb and flow based on cycles as well as investor psychology.  And while it was nearly impossible to find someone wanting to invest in dividend stocks in the late 1990′s, almost everyone you talk to currently seems to love dividends as interest rates have fallen and investors search for yield. 

One useful exercise for investors is to examine their funds (mutual funds or ETFs).  In the spirit of the Pepsi Challenge, you should type their tickers into the Morningstar portfolio report here.   I try to stay away from mentioning tickers on the blog but you can find a list of dividend funds at ETFdb.com or certainly the Morningstar screener.  

Notice that these funds are more expensive across every valuation measure (this is a generalization but true for most of the funds I examined).  What most people want is solid returns and safety.  But looking at these stats do you feel safe?  Does it seem reasonable to be paying a higher valuation than the overall market for high yield? (Note: this may not be the case for high yield funds that have a quality and or valuation screen.)

In addition to overvaluation, one additional headwind for dividends is the potential interest rate environment.  O’Shaughnessy found sixteen periods of rising rates in the United States since 1927.  The average duration for each cycle was 25 months, where the 10 Year US bond rate change was 2.35 percentage points.  The market averaged an 11.1% return over these periods (though wide dispersion from 40.9% to -45.9%).  However, the high yielding dividend bucket underperformed the market by 2.6% compounded.   

So with potential headwinds of valuation and rising interest rates, why do investors still invest in dividend funds when they could be investing in something else?  There are a few possibilities.  For many investors they simply may not be aware of the characteristics of their funds, and they may simply assume a high yield strategy confers a value tilt.  Other investors probably prefer the high dividend funds for the same reasons they prefer Coke – they are familiar with dividends.  Perhaps they think back to getting burned by non-dividend stocks in the 2000 tech bubble – or maybe they recall talking to their parents around the kitchen table as a child.  Making the best investment choice requires a separation of logic and emotions.

Enjoy the old broker commercials below!

 

Online Backtester

Finally starting to see some innovation here.  Two great entrants, all they need is a little more front end design, and of course a little tactical special sauce and they will be killer!  

 

http://www.portfoliovisualizer.com

 

http://turnkeystats.com/

What Happens Next for Stocks?

Ned Davis ran a great study that I thought I would replicate with a different dataset. They wanted to know what stocks did in Nov/Dec after the market was up as much as it was YTD in 2013 (I used 20% though I think it was up around 23%).

Since 1900, Nov/Dec returns averaged 2.7% (not bad!).  72% of Nov/Dec periods were positive.  

Since 1900, in years where the market was up over 20% YTD, Nov/Dec returns averaged 5.4%.  87% of Nov/Dec periods were positive.  

(Returns are slightly better when using real returns.)

 

Is the Stock Market Expensive?

Readers know we have done a lot of work on stock market valuation measures.  One of my favorite, that is hard to find anywhere, is the P/E for the MEDIAN stock in the S&P500.   Often if you look at the broad market it is distorted by it being a market cap index.  Anyways, Ned Davis gave me permission to run this wonderful chart:

median

 

Copyright 2013 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.
See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/.

ETF Contest Winners (and non-Winners)

I had a lot of fun receiving ideas for my little ETF Contest.  We received over 200 submissions.  They included everything from the absurd, to impossible, to hilarious, to already filed, to actually a few pretty good ideas.  Below are the ideas that are non-winners and already filed funds.  I imagine some of the non-winners are already funds or are filed but I am not familiar with them.  It is good to see there is still a lot of innovation going on – including a robotics ETF that just launched recently.  

I included a brief description if the fund concept was not clear from the name…We withheld a few I consider to be reasonable enough to think a little more about.

(Will send out the free Idea Farm winners an email this wknd…)

Entries in alphabetical order… ENJOY!

Already Exist or are Filed

  1. Activist ETF
  2. Automat-Robotics Companies ETF
  3. Business Development Companies ETF
  4. Cattle ETF
  5. Columbia ETF
  6. Covered Calls ETF
  7. Diamond ETF
  8. Emerging Market Corporate Debt ETF
  9. Equally Weighted Emerging Market ETF
  10. Foreign Shareholder Yield ETF
  11. Fracking ETF
  12. Global CAPE ETF
  13. Global Momentum ETF
  14. Natural Gas ETF
  15. PIGS ETF
  16. Risk Parity ETF
  17. S&P 490 (500 – top 10)
  18. Sovereign High Yield ETF
  19. Tail Risk ETF
  20. Uranium ETF
  21. Value and Momentum ETF
  22. Vice ETF

  

Non Winners

  1. 5x long or 5x short ETFs
  2. Adult Film & Toys ETF 
  3. Anti-Green energy ETF 
  4. Apple Supplier’s ETF
  5. Bad Corporate Management Short ETF- this would be filled with stocks where management have been poor stewards of shareholder capital. Poor acquisitions, waste money on exec perks, and poor all around decisions.
  6. Brand Index ETF
  7. Capital Efficiency Company ETF
  8. Commodity Spreads ETF/ETN – gold/silver, energy crack spread, feeder cattle/live cattle, bean crush, etc.
  9. East Africa ETF
  10. Geothermal stock ETF
  11. Global Engineering Company ETF
  12. Global Exchanges ETF – An ETF that tracks only Exchanges globally not brokers and banks. Not just CME, ICE or NYX, but also BME.MC, DB1.DE, BOLSAA.MX and so on. 
  13. Inverse 3X ETF Market – Shorts all the 3X ETFs.
  14. Iran ETF
  15. Lumber ETF
  16. Micro loan ETF
  17. Momentum ETF – rebalanced monthly.
  18. Non-durable Goods ETF – An ETF linked directly to companies involved in very short-term non-durable goods (perishable goods) like fruits, vegetables, meat and dairy products. These products have a very fast response to inflation, demographic trends and income. 
  19. Obamacare Failure ETF – An ETF that includes the 50 businesses that will benefit most by Obamacare failing to be implemented.
  20. Owner-operator ETF- This ETF would have companies where the execs have a large percent ownership in the company. 
  21. Palm Beach Real Estate ETF
  22. Political Return ETF – This ETF would be filled with the top holdings of our esteemed congressmen.
  23. Recession ETF- these stocks would do well in a recession, or at least outperform the market.
  24. Sharia Law compliant ETF
  25. Single Family homes REIT ETF
  26. Sovereign Wealth ETF
  27. Sports betting strategy ETF
  28. Sports Franchises ETF
  29. Tiki Time ETF – An ETF that includes at least 50 businesses engaged in the resurgence of tiki drinks. This includes Alcohol companies (especially Rum), agriculture (sugarcane/molasses), restaurants, art galleries, and any other businesses benefiting from the craze.  
  30. Too Big to Fail ETF- This ETF would be filled with companies which are too big to fail. 
  31. Unemployment Rate ETN

The Problem with Market Neutral (and an Answer)

I’m pretty sure this ideas below came from SocGen (who does a ton of great momentum work) but I’m on a plane watching the Red Sox game and for the life of me can’t recall where I saw this. 

One of the biggest challenges for a market neutral strategy is your shorts ripping when a market bottoms and all of the (expensive/low momentum) stocks rip straight up.  That is why most factor based long short portfolios rarely survive – they are long and short the wrong things at market bottoms.  

Below is french fama momentum data that shows high and low momentum stocks back to the 1920s.  Hi mo beats both the market and low mo.  One would think a market neutral portfolio would be really low risk, but in reality it has massive drawdowns in the 1920s and 2009.  

One way to rectify this situation is to simply short less the more the market goes down.  Kind of makes sense as you think about it and is probably just prudent risk management.  So the modified strategy below starts 100% market neutral, and depending on the drawdown bucket will reduce the shorts all the way to zero once the market has declined by 50% (in 20% steps for every 10% decline in stocks).

Pretty cool, huh?

Screen Shot 2013-10-30 at 9.26.47 PM

 

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