Help Wanted. No Smokers Need Apply

Help Wanted. No Smokers Need Apply: A Marketplace Podcast

Commentary on student debt crisis

Commentary on student debt crisis by Ben Cohen of Ben and Jerry's
http://www.cnn.com/2013/08/28/opinion/cohen-sallie-mae/

UPDATE: The New Emerging Market

by Matt Malick and Ben Atwater

From January of 2002 through September of 2007, emerging market equities experienced incredibly robust growth.  (“Emerging markets” is a label given to a group of immature, but fast-growing economies, most notably Brazil, Russia, India and China.)  During this almost six-year period, the MSCI Emerging Markets Index expanded by nearly 280%, which dwarfed the 33% return of the Standard & Poor’s 500.

As a result, financial advisors began to discover and then increasingly escalate their exposure to emerging markets.  In the minds of most investment strategists and market commentators, emerging markets were quite clearly the future and the trend would endure.



We all know what happened in 2008 - every stock market in the world swooned.  And then, they began to recover.

Over the past two years, though, emerging markets have faltered.  In defiance of conventional wisdom, since August 1, 2011, emerging markets have declined by more than 17% while the S&P 500 has surged almost 25% - a 42% performance differential.



Money flows have flip-flopped in favor of the U.S. for two primary reasons: (1) a quest for high-quality dividends in a low interest rate environment and (2) the perceived safety of the United States relative to the rest of the world.  Even within the S&P 500, we have seen stronger returns in recent years from companies that pay dividends and generate the bulk of their sales within the United States.

Since starting our business in 2008, we have been bullish on U.S. equities and our client portfolios, while globally diversified, have been positioned to take advantage of this expectation.  We anticipate that American equities will continue to lead in the near-term.  Cycles like these tend to reverse themselves only when they reach extremes in sentiment and valuation.  And at this point in the current bull market, many are still highly skeptical of equities, while the S&P 500 appears fairly valued, albeit not cheap.

The Road Taken

by Matt Malick and Ben Atwater

“Two roads diverged in a wood, and I – I took the one less traveled by, And that has made all the difference.”  -From The Road Not Taken, Robert Frost, 1916

In the spring of 2011, inflation expectations were high with commodity prices soaring and gold spiking.  At that time, Federal Reserve Chairman Ben Bernanke described these inflationary forces as transient.  Not too many people believed him.

A large number of diversified investment managers that implement a tactical asset allocation strategy increased their exposure to commodities - an inflation hedge - around this very time.

The 2011 drift to “alternative investments,” mainly commodity-centric ones, has been a regrettable asset allocation decision for many managers.  The Goldman Sachs Commodity Index has plummeted nearly 20% from its April 4, 2011 near-term high; while the price of gold has collapsed by more than 25% since its August 29, 2011 peak.

As a matter of fact, the overall trend among professional investors to avoid traditional U.S. stocks for the last several years has been disastrous.  Not only have managers emphasized commodities as an alternative investment, but they have also stressed “less volatile” vehicles because of an innate fear of markets.  Lo and behold, the experts largely abandoned the most conventional investment vehicle at the wrong time.

Through the end of May, the Standard and Poor’s 500, an index of essentially the largest U.S. companies, has gained an average annual return of 16.87% over the last three years.  Compare this to the aforementioned Goldman Sachs Commodity Index (energy, agricultural, metals, etc.), which returned just 4.79% annually over the same period.

Furthermore, the Hedge Fund Research International Fund Weighted Composite Index, a measure that includes about 2,200 constituent hedge funds of all varieties, returned 5.03% per year over these three years.  This is astonishing only in that a passive group of seemingly pedestrian stocks dramatically outperformed countless MIT PhDs and Harvard MBAs running hedge funds.

At the root of the mistake of underinvesting in the most traditional of asset classes (U.S. stocks) lay both sophisticated and simple reasoning.

Most basically, many investment managers looked at which asset classes performed the best in the five years prior to the financial crisis and assumed this outperformance would continue indefinitely, leading them to hedge funds, emerging markets, international bonds and commodities.  This analysis lacked the intellectual firepower of the most sophisticated asset managers, but the conclusions were the same.

The complex reasons for a forecast of below average U.S. stock performance stemmed from five major themes, all interrelated, that have yet to manifest themselves.  In our view, most major asset management organizations held these opinions and, as such, these views were the consensus forecast.

First, an expectation of inflation, and the repositioning of portfolios to reflect this anticipation, is the leading spoiler of investment performance for broadly diversified wealth advisors who implement a tactical asset allocation strategy.  After much fretting over central bank money printing – Bloomberg calculates that there have been 511 easing actions by central banks since June 2007 – inflation has yet to materialize.

Subdued inflation has allowed the United States Federal Reserve to keep short-term interest rates at 0%, while also purchasing $85 billion a month in long-term Treasury bonds and mortgage paper to suppress rates.  The ten-year Treasury bond pays 2.161%, while a thirty-year mortgage fetches 3.53% - extraordinarily low rates.  Therefore, the second prediction, which is part and parcel with the first, was that the Fed would not be able to maintain its amazingly accommodative policies this long, but they most certainly have.

Because most thought inflation would occur by now and because they then surmised the Fed would need to raise rates (stocks are less attractive as bonds pay more interest), experts have been broadly bearish on stocks.  The third mistake then, rather than allocating more dollars to stocks, managers have instead pushed more and more money into alternative investments, which have lagged core U.S. stocks significantly.

Ordinarily such low interest rates and a highly accommodative Federal Reserve would typically result in a weak dollar, the fourth common prognostication.  But, thus far, the dollar has strengthened - and markedly so over the last six months.  As a result, foreign stocks and commodities (because you can buy more of them with fewer dollars) have been laggards.

And finally, the fifth misstep was the assumption that slow U.S. economic growth would result in lackluster stock market returns.  Although seemingly logical, in reality there is little correlation between gross domestic product (GDP) growth and stock market returns.  With the United States consistently delivering below-trend economic growth over the last three years, the U.S. stock market has produced above average returns - much of which the Federal Reserve has made possible with its aggressive actions.  This takes us back to the first mistake . . .

UPDATE: The Gold Bear

by Matt Malick and Ben Atwater
 
On April 15, 2013, the same day as the Boston Marathon bombings, gold traded down 9.4%.  This was a significant technical (chart) breakdown.  But even before this drop, gold had already entered bear market territory. 
 
Three days earlier, on April 12, 2013, gold registered a loss of more than 20% from its high - the definition of a bear market.  It was a slow deterioration for the precious metal, as it took 599 days for gold to fall 20% from its peak.  According to Bespoke Investment Group, this is already longer than the average gold bear since 1975, which has been 483 days.  The average cumulative drop - peak to trough - has been 31.6%.
 
Bespoke further found that once gold crosses the bear line, the average number of days of additional decline is 309. 
 
Although gold is still down and out, it has, as of today, recovered the vast amount of its losses from April 15.  But, gold’s severe oversold level from April 15 was indeed historic. Since 1975, gold had never been more than 4.5 standard deviations below its 50-day moving average.  And in the eleven times it was nearly that oversold, more than 3.5 standard deviations, it had, on average, stayed depressed for the next six months. 
 
As you know, investors often view gold as a "safe haven" trade.  Therefore, if investors are selling gold, could this be a positive for stocks?  Again looking at the most oversold periods for gold from 1975, Bespoke found that over the next six months the Standard and Poor’s 500 stock index was up more than 70% of the time with an average gain of 7.08%.  Even very recently, since gold peaked in the summer of 2011 and then fell more than 20%, the S&P has climbed 40%. 


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