Bob Carlson

October 22, 2014

Evaluating Investments

Filed under: Asset Allocation — Bob @ 12:20 pm

Nobel Prize-winning economist William Sharpe gave an interesting interview to AAII. He makes several points that all investors should note. Sharpe developed a statistic that’s now called the Sharpe ratio. He said he was looking for a number to consider if you only can look at one number to evaluate an investment. Now, he says that with all the computing power we have today, you should try to use only one number of piece of data to evaluate an investment. Another point: The Sharpe ratio and other data are historic. You should be more concerned about future return and risk, and historic data is an imperfect tool for evaluating that.

There’s a famous saying: If you torture a body of data long enough, it’ll confess to anything you want. People have looked for so many ways to beat the market using past data that of course they found ways that would have worked. But I would be much more comfortable if there were a story as to why, if everybody knew this history, it would still work. Most of these arguments don’t have such a story.

More Evidence the Correction is Mild

Filed under: Asset Allocation,Investing — Bob @ 8:17 am

The recent stock market decline drew a lot of headlines, but as I’ve said it hasn’t amounted to much in the long term. Here’s more evidence of that. When there’s a significant decline in stocks, value investors say that they are finding a lot of bargains and are happy for the decline. That’s not happy this time, as the story points out. Stocks still appear to be fairly valued to overvalued, and the decline so far hasn’t been enough to change that.

A global rout in stock markets has wiped $3.3 trillion from the value of equities worldwide this month through Oct. 16 and the Standard & Poor’s 500 Index has slumped 6.2 percent since reaching a peak for the year on Sept. 18. The plunge hasn’t been enough for Cinnamond and other money managers who hold unusually high levels of cash, such as Stephen Yacktman of Yacktman Asset Management LP and Wally Weitz of Weitz Investment Management Inc., who say bargains still aren’t easy to find.

“It’s not as if the world is all of a sudden dirt cheap,” Keith Trauner, co-manager of the $509 million GoodHaven Fund, said in a telephone interview from Miami. “It’s becoming more reasonable,” said Trauner, whose fund had 28 percent of its assets in cash as of May 31.

October 21, 2014

A Case for Optimism

Filed under: Retirement - General — Bob @ 5:20 pm

I know you’re bombarded constantly with negative forecasts and commentaries. That seems to be the predominant strain of the financial advice industry. It seems easier to build a negative case than any other. That’s why you should read Marc Andreesen’s interview in New York magazine. Andreesen says he’s always been optimistic, and that being optimistic almost always pays off.

On the other hand, if there’d been a few more skeptics in 1999, people might have kept their retirement money. Isn’t there a role for skepticism in the tech industry?

I don’t know what it buys you. Let me put it this way. If you could point to periods of time in the last hundred years when everything just stabilized and didn’t change, then maybe yes. But that never seems to actually happen. The skeptics are wrong all the time.

Gates and Others on Inequality

Filed under: Economy — Bob @ 5:20 pm

The French economist Thomas Piketty drew a lot of attention this year with the publication of his book, Capital in the 21st Century. I haven’t read it, but reviews indicate it is an attempt to build the case for using the government’s taxing power to reduce or eliminate income inequality in countries. One of the more interesting responses to the book is from Bill Gates on his blog. I also like this response to part of Gates’ essay.

To be clear, when I say that high levels of inequality are a problem, I don’t want to imply that the world is getting worse. In fact, thanks to the rise of the middle class in countries like China, Mexico, Colombia, Brazil, and Thailand, the world as a whole is actually becoming more egalitarian, and that positive global trend is likely to continue.

But extreme inequality should not be ignored—or worse, celebrated as a sign that we have a high-performing economy and healthy society. Yes, some level of inequality is built in to capitalism. As Piketty argues, it is inherent to the system. The question is, what level of inequality is acceptable? And when does inequality start doing more harm than good? That’s something we should have a public discussion about, and it’s great that Piketty helped advance that discussion in such a serious way.

However, Piketty’s book has some important flaws that I hope he and other economists will address in the coming years.

The Future of Oil

Filed under: Economy — Bob @ 12:20 pm

Some years ago I listened to an oil analyst say that there’s only way to understand the oil market. He said the Saudis control changes in prices and that they wanted a lot of volatility. They would tighten supplies when prices were low, pushing prices higher. When prices were high, the Saudis provided more oil to bring down the price. His thesis was that if hte price were volatile, new investment in either oil or in substitutes for it would be limited. People couldn’t plan multi-year billion dollar investments when they had no idea what the selling price would be.

That thesis seemed to hold true for a long time. That’s why this news is so interesting. Apparently the Saudis have been telling people that oil prices are going to stay low for a long time, and they are very comfortable with that. The Saudis have decided that things have changed, and that what works best for them in the long term is for oil prices to stay low for a while.

Saudi Arabia is quietly telling the oil market it would be comfortable with much lower oil prices for an extended period, a sharp shift in policy that may be aimed at slowing the expansion of rival producers including those in the U.S. shale patch.

Some OPEC members including Venezuela are clamoring for production cuts to push oil prices back up above $100 a barrel.

But Saudi officials have given a different message in meetings with investors and analysts: the kingdom, OPEC’s largest producer, will accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two, according to people who have been briefed on the recent conversations.

Past Performance is No Guarantee

Filed under: Economy,Emerging stock markets — Bob @ 8:20 am

Financial firms are required to include the phrase “Past performance is no guarantee of future results” in much of their literature. According to recent research, the same holds for economic data. A country’s recent growth rates tells us nothing about future growth. That’s the word from economist Larry Summers, who uses the point to argue that China’s growth in the future isn’t going to be any where near the 10% growth many have gotten used to expecting. He thinks it is likely to turn under 4%.

But when it comes to predicting China’s medium- and long-term growth, economists are chucking that wisdom out the window, argue former US Treasury secretary Larry Summers and Harvard University professor Lant Pritchett in a new National Bureau of Economic Research paper (registration required).

As a result, they say, even the more cautious economic forecasts for China are overestimating the country’s growth prospects. Summer and Pritchett’s calculations, using global historical trends, suggest China will grow an average of only 3.9% a year for the next two decades. And though it’s certainly possible China will defy historical trends, they argue that looming changes to its  authoritarian system increase the likelihood of an even sharper slowdown.

October 20, 2014

4 Market Lessons

Filed under: Asset Allocation — Bob @ 5:42 pm

Mohammed El-Erian gives four lessons to be learned from recent market turmoil.

Driven by risk-taking, which has repeatedly rewarded investors in recent years, prices in certain market segments have been taken to levels that have become decoupled from investment fundamentals. Lacking a sound footing, the markets become overly sensitive to unanticipated news, such as the Ebola epidemic or, with the exact opposite effect, to suggestions that the Fed could slow its exit from its third round of quantitative easing. The resulting fluctuations are then greatly amplified by patchy liquidity and crowded trades.

Behind the Scenes in Last Week’s Markets

Filed under: Investing — Bob @ 1:40 pm

This Bloomberg.com article gives a good, detailed look at what was happening in the markets the last couple of weeks. Not surprisingly, it was a case of investors that were very leveraged deciding that news events were turning against them and they needed to liquidate some positions.

Credit fund managers were shaken by the move in rates, as many hedge against swings in Treasury yields to capture the extra yield tied to company risk. Traders had a record amount of bearish wagers against U.S. government debt earlier this year as they prepared for the Fed to withdraw stimulus.

Investors unwound some of those short positions last week, adding further fuel to the rally in the debt.

The market hadn’t been tested until Oct. 15 “and we failed the test,” said Michael Cloherty, head of U.S. rates strategy at Royal Bank of Canada’s RBC Capital Markets unit in New York. “Liquidity is not what it used to be.”

Perspectives on the Decline

Filed under: Asset Allocation,Investing — Bob @ 8:21 am

In the next issue of Retirement Watch, which will be posted on the web in a few days, I make the case that the recent stock market decline likely is a correction, not the beginning of a new bear market. Since the market decline began a lot has been published on it. I thought it would be interesting to group together a few of the different views.

Here are a couple calm viewpoints on the decline, one here and one here. More pessimistic views are here and here.

The S&P 500 Index has lost as much as 9.8% from its intraday peak, the Nasdaq Composite index more than 10%, and the small-cap Russell 2000 more than 14%.

But far from feeling vindicated, I’m just as frightened as you are.

Corrections aren’t fake. They look like bear markets and act like bear markets. They scare you like bear markets do, but corrections end faster and stocks bounce back quicker.

October 17, 2014

Dangers of Large Mutual Funds

Filed under: Economy,Financial crisis,Investing — Bob @ 5:20 pm

Some of you might remember back to the stock market crash of October 1987, when major indices fell about 25% in one day. There was a lot of finger pointing at the time about the cause, but I remember a number of people saying that a major mutual fund company decided to unload a lot of stocks quickly. That crash of 1987 happened and reversed quickly, partly because stock markets are so big and liquid. But what about other markets, such as high-yield and distressed bonds.

New attention is being drawn to the fact that a few large mutual fund companies control major positions in some asset classes and even in the bonds of some companies. There are several potential concerns. One is that all this mutual fund buying gives a false picture of how liquid and efficient the market is. Another concern is that if these funds suffer large redemptions they’ll have to sell the bonds quickly and at whatever price they can. It could be like the fall of 2008 again. Read the linked article for more.

The chief risk officer of Goldman Sachs, Craig W. Broderick, warned at the I.M.F. meetings last week that the asset management firms that now hold the bulk of these bonds had not yet been tested in terms of how they would react to a market shock.

“Now there is plenty of liquidity,” Mr. Broderick said. “But when things are different, the alternative providers will not be there.”

The term of art for this scenario is a liquidity mismatch, with some going so far as to call it a systemic liquidity mismatch. If, for example, there is a sustained emerging-market crisis and a fund wants to liquidate these bonds to meet redemption demands, the manager will be required to provide cash immediately even though it may take several days to sell the securities in question.

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