Inflation and Valuations, Foreign Investors, Lead into Gold, The Many Faces of the Housing Market

Several market commentators have been highlighting that low inflation has historically corresponded with high valuations, thus implying current valuations are justified by low inflation. John Hussman, in a recent article, takes this notion to task.

Just because high valuations have corresponded with low inflation in the historical record does not mean it’s a great idea to invest now. You should be focusing on future returns, not data on current conditions. In fact, as Hussman shows, low inflation and high valuations tend to indicate weak future returns. Perhaps we should all drive by looking out the windshield instead of at the rear view mirror.

Most investment commentators are paid to get gullible people to buy stock now…Now!…NOW!!! Don’t be confused into becoming a lemming by such blather.

John Mauldin’s latest weekly letter had some delightful information, too.

First, Mauldin highlights the influence Sovereign Wealth Funds may have on markets going forward. Specifically, China’s recent $3 billion investment in BlackRock may be an indication of things to come. Can you say falling US dollar?

Next, Mauldin does a great job describing how the financial engineers of Wall Street are turning lead into gold. Specifically, he shows how such rocket scientists can turn non-investment-grade subprime loans into 95.8% investment grade securities. Do you think they’ll stay investment grade if the underlying assumptions prove to be based on a too short historical record?

Finally, Mauldin raises some questions about recent positive housing data and how such information may impact the US economy. Are housing statistics really good indicators of what is happening in the housing market? Did new home sales jump based on fundamental demand, or because new home prices are lower than existing home prices? If the economy’s growth over the last 6 years has been due to mortgage equity withdrawals, what will happen if home prices decline? And, how would this be impacted if unemployment were about to rise as forecast by Paul McCulley at PIMCO?

Just some good commentary to consider…

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The Effort Effect

I read a great article recently about psychologist Carol Dweck.

She pioneered research that shows people perform to their potential not because of inherent talent, but because of their attitude toward talent. The key, she found, was whether people think of ability as something inherent, or something that can be developed. Those who saw talent as something developed were able to reach their potential.

Perhaps, more importantly, she found that people can learn to adopt the belief that talent must be developed, and make dramatic strides in performance.

This concept applies universally–whether you’re a teacher, coach, parent, or simply trying to manage your own performance. If you want to excel at something, then focus on effort, enjoy challenges, focus on growth, and let the results take care of themselves.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Will China Tank?

The Chinese stock market has been on a tear over the last 2 1/2 years. My question is: how long will it last?

The Chinese economy has been growing at over 10% for many years, so the fundamentals seem strong. But, has any market gone straight up without temporary setbacks along the way? Not that I know of.

Chinese investors have been piling into the market any way they can. Some are even borrowing against their homes to participate in the frenzy. Does that type of mania end well?

In addition, China is not fully a market economy, and it’s still run by a communist party which doesn’t fully recognize human rights, much less voting rights. And those government folks are trying like crazy to slow down the stock market now. Do you think they’ll just give up and join the party? Not likely.

Timing the market seems like a fools errand to me, but markets in that type of frenzy seldom end well. I’m neither long nor short Chinese stocks, but after the 10% drop in the Chinese stock market last February, I can’t help but wonder how the Chinese stock market may impact other world markets. I don’t know when, but at some point, we’ll find out.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Academic research on investing isn’t all bad

A great article by James Montier at Dresdner Kleinwort (“Modern Portfolio Practice: A view from the Ivory Tower”) provided some remarkable evidence of what makes for successful investing. The truly amazing thing is that his evidence came from academia, a field that generally insists that no one can beat the market except by luck.

What are the secrets revealed by extensive academic research? Be a stock picker, run a focus fund, do something different, know when to sell, keeps funds small, keep turnover/trading costs low, stick with your principles, and have some skin in the game. Now, I’ll expand on each of these.

Be a stock picker means focus on picking good investments instead of trying to mirror the market over the short term. Most money managers try to hug the market to avoid short term under-performance, but this lack of conviction leads them to always under-perform over the long run. The best investors focus on picking good investments, not on the mirroring the market or indexes.

Run a focus fund means concentrate on your best investing ideas instead of diversifying over too many investments. Too much diversification is a bad thing if you are trying to out-perform the market. Most investors don’t have the conviction or long term time frame to do this.

Do something different means think and act independently. If you’re focusing on what everyone else is doing and paying too much attention to short term results, you will get the same below average results as others. As Sir John Templeton put it succintly, “It is impossible to produce superior performance unless you do something different from the majority.”

Know when to sell means most investors focus too much on buying and not enough on selling. The investors with the best records follow rules for buying and selling and then adhere to that discipline religiously!

Keep funds small highlights the fact that the best money managers manage smaller amounts of money. As Warren Buffett puts it, “Size is the enemy of performance.” The marketing organizations that focus more on getting new clients than getting good returns are not a good deal.

Keep turnover/trading costs low seems simple enough. The average mutual fund manager buys and sells his whole portfolio every year (100% turnover) generating high trading costs and tax issues for taxable accounts. The best money managers trade infrequently to keep costs down and performance up.

Stick with your principles means don’t change your discipline just because it isn’t working right now. Most money managers and investors chase performance. That leads them to sell recent under-performers and buy recent out-performers right when the under-performers start to out-perform and the out-performers begin to under-perform. Sitting tight, even in a strategy that isn’t doing well in the short run, works better than changing discipline every time it’s not “working.”

Have some skin in the game means that managers with their own money at stake get better performance. Always ask a money manager where his money is. If he doesn’t have his own money in the same place he’s recommending you put your money, walk away quickly!

These rules may seem like common sense to you, but you can rest well and follow it more freely now that the rocket scientists in academia have blessed sound advice with their research.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Protectionism and inflation

Stephen Roach brings up concerns similar to the ones I expressed on April 2nd about how protectionism could cause serious economic consequences. In particular, he focuses on the likelihood that it could cause stagflation. Read his article here.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Dow 13,333

Amazingly enough, the market just keeps hitting new highs.

Despite headwinds from a slowing economy, higher gas prices, and a rocky housing market, most companies beat analysts estimates for the quarter.

The world economy is thriving with good (for them) growth rates in Europe and very high growth in China and India.

U.S. companies benefited this quarter, too, partially because they sell many goods and services to other countries and partially because the declining dollar provided an additional tailwind to results.

Another benefit, which the analysts seemed to have missed, came from companies buying back their own stock. If a company’s earnings increase by 5% and it buys back 5% of its stock, it suddenly has 10.5% growth in earnings per share. No real magic there.

I’m not foolish enough to try to forecast the short term direction of the market, but I do have some questions about how these dynamics will affect markets in the future.

If the Chinese economy slows, as the government there is trying to make happen, how will that impact the world economy? How much further can the dollar decline before it leads to increases in U.S. interest rates? How could U.S. companies be impacted by a slower world economy and higher U.S. interest rates? How much longer can companies buy back their shares instead of investing in new projects, capital expenditures or wages and salaries?

I don’t claim to know the answer to any of these questions, nor do I believe that answers to these questions are necessary to successfully invest over the long term. But, I do think it is important to assess the substance behind the recent good news and ask myself whether such tailwinds are likely to continue going forward.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Growth vs. Value; “and another thing…”

Another thing that bugs me about the growth versus value distinction is the bad advice that a lot of so-called investment advisers and financial planners give out.

First off, around 85% of financial planners and investment advisers are commissioned-based salespeople. Asking them for advice is like asking a Ford salesman whether you should buy a Ford. You’re not going to get objective advice.

I have no problem with salespeople making a living, but I do have a problem if they don’t disclose how they’re compensated. Here’s a tip: ask any “advisor” how they are compensated and you’ll get a clear picture of whose interests they are serving.

Another problem I have with the advice given out by so-called investment advisers and financial planners is the line that “you need both growth and value investments.” The rationale goes like this: you need to diversify so you will do well regardless of whether growth or value investing is working.

My problem with this “advice” is that mixing most growth and value investments together gives you market returns. And, market returns should not cost you a 5% upfront load plus an annual active management fee of around 1% a year plus an investment advisor fee of 1% a year. Instead, you should just buy an index fund that charges 0.2% a year for market returns.

Want to know why they recommend both growth and value investments instead of an index fund? Because the index fund doesn’t pay a big fat commission for selling their product, and the growth and value mutual funds probably do.

Accepting such advice will help the salesperson make their quota, but it won’t help you reach your goals. Either buy market returns at lowest cost, or find an active manager who can beat the market after all fees.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.