World Beta Blog

Yardeni does a great chartbook.  Below are two charts from his Sep publication…

I enjoyed hearing one of the top three ETF issuers mention all the ETFs that needed to be launched have been launched.  So, with that theme, I’m having a little contest inspired by Horizons ETFs in Canada.

It’s simple:  email in your top ETF ideas for new funds you think should be launched.  Feel free to get as creative as possible.  

Top 3 ideas get a free year subscription to The Idea Farm.

I’ll post some of my favorites to the blog at the end of the month…

I was giving a talk the other week in Chicago and one audience member asked me what was my biggest concern in the markets.  I responded that it was high yield stocks in the US.  I am finishing up a longer piece that should be out next week, but below is a simple exercise for those that want a sneak peek.

1.  Goto Morningstar and input a ticker for a high yield stock ETF or fund, let’s say VIG since it’s the biggest:

http://etfdb.com/type/investment-style/dividend-etfs/

http://portfolios.morningstar.com/fund/summary?t=VIG

2.  Scroll down and take a look at the valuation metrics.

3.  Compare to the overall market.

4.  Be surprised.

Due to flows, this is a good example of an asset class getting distorted and investors buying into something and getting something quite different than what they expected.  This asset class, which historically trades at a 20-40% valuation discount to the overall market is now at record PREMIUMS.  Dividends have worked historically because they have had a value tilt.  What happens when they don’t?  Buyer beware.

I wanted to illustrate a point I was trying to make to a friend about asset allocation.  Most people approach it with the “more is better” mentality, when in reality you can achieve a a nice, simple base case portfolio with only a handful of assets.  However, most people just don’t feel diversified with only a few funds for whatever psychological reason that may be.

Below is a nice well diversified portfolio.  It is a bit equity heavy, but it holds:

10% US large cap stocks

10% US small cap stocks

10% foreign developed stocks

10% foreign emerging stocks

10% US 10 Year bonds

10% Corp bonds

10% Commodities

10% Gold

20% Real Estate

I wanted to design a truly awesome hedge for this portfolio.  Kind of the “perfect asset class” or a hedge fund’s dream.  It would have the same return as US stocks, but a totally negative correlation.  You can see a chart of the asset below since 1900.  

So, what happens when you allocate a whopping 10% to this amazing hedge?  It should really juice your portfolio’s value right?

As you can see, the effect on total returns is almost imperceptible.  It does however reduce the vol and drawdown noticeably.  My points are twofold:  

1)  when you allocate to a new asset don’t bother unless you are going to allocate AT LEAST 5-10%.  Otherwise it does nothing.

2)  If you are looking for return enhancing, a non correlated asset isn’t really going to help.  You need to add something with higher CAGR.   

Now, what happens if you add the ultimate equity alpha fund?  In this case lets find a alpha substitute for the S&P that adds 300 bps per year.  Even though you replace the S&P with a better fund, it only adds 30 bps of total performance.  

I used the word “normal” above on purpose, as there is really nothing normal about stock returns.  They tend to be more extreme than people realize, obeying the distribution of power laws rather than any sort of bell curve world.  (We have a fun paper on the topic, Where the Black Swans Hide and the Ten Best Days Myth).

We’ve had a monster year in stock (even though we think they are expensive) thus far here in the US, so it is worthwhile to review where this year (if it ended today) would stand in history.  Interestingly enough, about a third of all years have HIGHER returns…  I’m guessing that would surprise most readers.  The median is around 13%, the average 11%, and the geometric average about 9%. (Damn those volatility gremlins!)

Below is a chart with a distribution of all the stock returns since 1900.  Now what would really surprise people…a 30-40% up year…

This is a good piece on secular bull/bear markets from Ed Easterling  on Barry’s blog.

I had never thought of visualizing the CAPE this way, although our chart on Japan last week was a similar metric…

I went back and picked the biggest bubble in 17 developed countries.  Three charts are below.  

1 – Peak CAPE value vs. length in time before CAPE went below 17.  ie basically how long did it take for the market to get back to “fair value”

2 – Same chart without Japan

Median bubble CAPE was 45, and median time to recover was 3.5 years…Note that the 2000 bubble in the US “recovered”  already in the 2008 dump (hit a low of 13 in March 2009).  By this metric the secular bear is over, but we are still expensive.

I”m doing a webinar with Zack Miller tomorrow – it’s different than most talks I do – this one is focused on the publishing world rather than the investment side (mostly).

So if you have any self publishing questions, or perhaps how to work with a traditional publisher, come listen in…

Register here.

In honor of the good professor winning the Nobel prize today, I thought I would show a quick chart we have never published.  It is from our global CAPE paper, and simulates our tests, but this time with various CAPE measurement periods of 1-10 years.  Note that most analysts use 1 year PE ratios, and also note which metric is the worst (1 year).  It seems the best range is near where old Ben Graham preferred, 5-10 years.

Smoothing value indicators has the added benefit of reducing turnover…

Chart is CAGR from 1980-2012:

I’m adding another allocation from some of my favorite writers at the Butler Philbrick shop.  They did a post here with an allocation below.  

Results following at the end:

(click to enlarge)

I know a lot of my readers don’t use Twitter, so every week I’ll post a few tidbits that you may have missed.

This week starts with a fun podcast with Stansberry Radio (iTunes here):