The Permanent Portfolio, Investing, Finance and Random Thoughts.
Posts tagged stocks
Index Funds and IPOs
3A poster on the forum brought up a great question on whether index funds would be forced to buy the upcoming Facebook IPO. The worry is that the index funds will load up on the IPO and take a loss later as the IPO price comes back down to Earth.
No, this isn’t likely to happen.
IPOs are, for the uninitiated, one of the worst investments to buy. The company and investment bankers hold all the cards. They set the date for the offering, set the price, set the shares to be issued, grease the skids with brokers by allowing some early access (which they’ll dump after the price goes up), etc. Never buy IPOs no matter how tempting the media hype says they are.
So why won’t the index funds go out and load up on a big IPO like Facebook? Well, they have entry requirements for the most part. The S&P index formulation requires IPOs not only be listed for a certain period of time (6-12 months), but also have a certain number of profitable quarters before they would be added. These guys weren’t born yesterday!
From Standard and Poor’s Eligibility Requirements starting on Pg. 5
Specifically, these two points will keep most of the IPO hype at bay:
Financial Viability. Usually measured as four consecutive quarters of positive as- reported earnings. As-reported earnings are Generally Accepted Accounting Principles (GAAP) net income excluding discontinued operations and extraordinary items. For REITs, financial viability is based on both as-reported earnings and Funds From Operations (FFO). FFO is a measure commonly used in REIT analysis.
Another measure of financial viability is a company’s balance sheet leverage, which should be operationally justifiable in the context of both its industry peers and its business model.
Treatment of IPOs. Initial public offerings should be seasoned for 6 to 12 months before being considered for addition to an index.
The index funds are not going to load up on Facebook when they go public (or they shouldn’t!). This is actually another good reason to own index funds and not actively managed funds that do not have these screening rules before buying stocks. Index funds still remain the single best way to own exposure to the stock market.
Now, if you really want to own a new IPO company for your variable portfolio (for money you can afford to lose), then let it just simmer for about six months and then buy into it. By then the price normally will have settled (usually lower) and you’ll have a better chance of making a profit.
EDIT: The Finance Buff asked about other indices like Russell 3000 and Wilshire 5000. These indices are more lax than S&P and will reformulate and bring in IPOs sooner. However they still have a lag time and it is not likely they will be going out and immediately bring in Facebook IPO based on their formulation criteria which I list below:
Russell Index Formulation and Methodology
Russell lists out the specifics on how IPOs are added beginning on Pg. 8.
Wilshire has their methodology here. They will do monthly, but it doesn’t look like the Facebook IPO is going to be snapped up immediately either:
In the past when someone asked what Small Cap value fund to use of Russell 2000 vs. S&P 600 for instance I would steer them towards the S&P versions because of their more sane screening process to weed out IPOs. I think S&P’s handling of IPOs is a smarter way to do it vs. their competitors.
Trading Against Pros
0Doing some research recently I’ve found that almost 9 out of 10 of the trades on any given day on Wall Street are between professionals, not individuals. Think about that for a second. When you go to make a trade, 9 out of 10 times you are doing it against someone that does it for a living. And not just a living, but paid really big bucks to do it and has a tremendous amount of resources behind them. This includes mutual funds, pension funds, hedge funds, professional speculators, investment banks, etc.
But it gets even better. If 9 out of 10 trades are between professionals that means that most of the trades pros do are between each other. Now that’s interesting to consider. That means the average you see in the investing products on Wall Street represents the best that the pros on Wall Street can do in any single year.
Often I read about an investing strategy or trading method that claims to beat the broad market indices. That’s a pretty bold claim. I have to wonder if the sellers of these ideas are aware of the reality of trading on Wall Street. To think that you’re going to teach an individual investor to go up against a highly skilled pro and win. It’s kind of like telling an amateur golfer they are going to turn into Tiger Woods if they just buy the right golf club. It’s a fun thing to think about, but just not very realistic.
Even much vaunted hedge funds, the supposed masters of secret Wall Street strategies, often bomb. If they can’t do it, what chance does an individual have?
THERE’S yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.
Basic stock market index funds generally aspire to nothing more than matching the returns of a market benchmark. So in a miserable year for stocks, index funds may not look very appealing. But it turns out that, after fees and taxes, it is the extremely rare actively managed fund or hedge fund that does better than a simple index fund.
That, at least, is the finding of a new study by Mark Kritzman, president and chief executive of Windham Capital Management of Boston. He presented his results in the Feb. 1 issue of Economics & Portfolio Strategy, a newsletter for institutional investors published by Peter L. Bernstein Inc.
The Index Fund Wins Again, Mark Hulbert February 21, 2009
http://www.nytimes.com/2009/02/22/your-money/stocks-and-bonds/22stra.html
I’ve been to financial firms on Wall St. in the past and had a chance to see some of their trading operations. These firms are trying everything possible to make a buck off each other. They are highly competitive and highly compensated if they manage to do it. Many use cutting edge hardware, algorithms and trading techniques trying to sniff out every last penny of advantage. There are actually magazines for the field (http://www.automatedtrader.net) discussing advanced applications in areas of High Frequency Trading and other esoteric topics.
These firms are looking for every possible edge to gain. And the harder they look, the more efficient the markets become. It is almost impossible to get an information edge, and therefore consistent excess profits, over anyone else at those levels. This is why, despite their best efforts, many funds cannot beat the market average once you subtract the costs from what they do.
You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have.
Sitting back and letting these people slice each other to pieces on trading is the best strategy. A Permanent Portfolio using a simple stock index fund let’s you do just that. You cannot compete against Wall Street with a home computer and technical analysis charts. The NSA would have a hard time competing against some of the computing power these firms have. This is why trading against the pros is a losing proposition on all fronts. Not only are you not likely to beat them, but they can’t even beat the simple market average themselves.
Conclusion?
Just own index funds where appropriate for your Permanent Portfolio. Don’t waste time and money trying to compete against those that aren’t even competitive against market averages.
Reminder: You can sign up for the announcement list for the upcoming Permanent Portfolio Book here.
The Misleading Stocks for the Long Run Chart
1 month ago
by craigr
in Permanent Portfolio
I see this chart posted from Jermy Siegel’s book Stocks for the Long Run from time to time to defend why owning lots of stocks is the way to go and why owning gold is some kind of chump move.
Well I think this chart is misleading for several reasons. Gold is useful in a diversified portfolio along with stocks and bonds. It should not be 100% of a portfolio just as stocks shouldn’t be nor bonds.
First let’s explain a few things about this gold line you see here. We must understand that for the first 130 or so years of the founding of the United States gold and the dollar were the same thing (aka. the Gold Standard). With that, let’s look at this chart with this gold standard in mind:
1) From 1802-1913 the value of the dollar was strongly linked to gold and there was slight deflation over this time. There was essentially no inflation except for the period around the Civil War when Lincoln printed a lot of money to pay for things. That’s the blip you see in the early 1860s. Gold went “up” simply because the dollar was going “down.”
2) In 1933 FDR broke the gold standard. He raised the price from $20.67 an ounce to $35 an ounce to deliberately try to cause inflation. This was done after prohibiting Americans from owning gold. That’s the rise in gold price you see in that year and also when the dollar started to rapidly decline in value. A gold convertible currency prior to that keeps paper currency honest because if people think the government is printing too much money they could turn in their paper dollars for gold specie and drain the Treasury. After 1933 that was no longer possible. This was a stupid idea that achieved nothing but allow the inflation genie out of the bottle and send the dollar on a downward trajectory from that day forward.
3) In 1971, after nearly four decades of artificially low gold prices due to government price controls, Nixon broke the last of the gold standard for foreign holders of dollars. Dollars could now be converted to gold by nobody. You see the gold price spike the first couple years as it adjusted for the prior price controls. After that, I believe it was simply responding to the very high inflation. The dollar also this year begins a very big decline. By the end of the 1970s the dollar bought about only 50% of what it did in the early 1970s. By today it’s lost something around 80% of its purchasing power.
4) Gold is not volatile. It’s a piece of metal. It is only volatile against the currencies it is priced in which are the real culprits. Price spikes in gold are more of a reflection in the value of the dollar than anything. Gold is a form of money and people buy it when they think the dollar is going to have problems keeping its value.
Now back to the chart in general. This chart is misleading for several reasons:
1) The data going back to 1802 is suspect to me. Nobody could have invested that way if they wanted to even if the data is accurate (which is another debate). This chart is what stock bugs use to justify why you only need to own stocks. It’s as bad as when a gold bug shows you a chart of gold vs. the dollar and insists you only need to own gold. No, you need to own a variety of assets like the Permanent Portfolio. Concentrating your bets in any one asset is a bad idea.
2) Nobody lives for 200 years. An investor’s timeline is like 30-40 years before they need the money. Stocks have had extended periods of bad performance in the past and this makes total returns very time dependent on the individual level.
3) Gold doesn’t have interest and dividends. This is a statement of the obvious. But it has much different risks than stocks and bonds and that means it is still useful in a portfolio. The same economic factors that are horrible for stocks and bonds can be quite good for gold and vice versa. That simply means you own gold as part of a diversified portfolio and not 100%.
4) This chart also shows that over 200 years gold has had a remarkably good record of stability in terms of preserving purchasing power. This is quite remarkable when you consider the history of the US, the wars, the booms, the busts, etc. that have happened. How many companies from 1802 are still around today?
5) Gold in a diversified portfolio can increase returns, decrease volatility, decrease risk, and provide protection under serious currency problems. All good things in my book.
This chart doesn’t make the case that gold shouldn’t be owned to me. It basically makes the case that owning a lot of different assets with different risk profiles is a really good idea. Stocks can be very powerful when the economy favors them, but when it doesn’t they can languish with big losses or zero real returns for protracted periods. A portfolio with stocks, bonds, cash and gold however can weather just about anything the economy is throwing at it. Diversification is your friend.
Growth, Aggressive, Value and Other Stock Plays for the Permanent Portfolio
10 months ago
by craigr
in Permanent Portfolio
Over on the forum there were some questions about my latest podcast where I discuss Harry Browne’s use of “aggressive” stocks in earlier versions of the Permanent Portfolio. This is a great topic and it was good question that I think I want to talk about here.
To review, in the last podcast I answer a reader’s questions about why Harry Browne probably switched to using a broad based S&P 500 index for the stock allocation vs. his earlier advice. We have to speculate on his reasons, but my own thoughts were basically confirmed by his former business partner John Chandler that picking “aggressive” stocks is very hard to do in the market.
It is no secret that I am a Total Stock Market index guy and is what I said over and over again to use for the portfolio (or the S&P 500 if that’s what you have access to). But people sometimes want to try to squeeze some more performance out of the portfolio and value investing is usually the first place to look. Now Harry Browne did talk about “aggressive” stocks, but this is a really nebulous term. Same with “growth” stocks. They are nebulous because they require a manager often to make these calls. What is one person’s “growth” stock is another’s “Sell it because it’s gone too high” stock. If the manager makes a good call then you make money above the market returns. If not, well you know the rest…
Counter-intuitively the best place for volatility is not growth usually, but value stock funds. This is because value funds often are filled with companies that have been the most beaten down in price. So, the idea goes, that they are more likely to benefit from a good recovery because they have the furthest to go back up to hit the mean Price to Earnings and Price to Book ratios. Whereas growth stocks have been getting all the attention and the stock prices have been driven very high already. This is usually not a good idea to invest in companies that everyone wants to buy right now.
In fact, if you look at the three IShares Russell 3000 index funds (blend, value and growth) you see that the value funds tend to have slightly more Beta and more volatility as shown in standard deviation. Beta is the measure of a funds volatility over that of the general stock market. The higher the number above 1.0 the more the fund moves in relation to the stock index. Standard deviation is a measure of how much the returns can swing up and down. The higher the standard deviation, the more volatile the fund tends to be on price swings (both in good years and bad years).
http://finance.yahoo.com/q/rk?s=IWV+Risk
http://finance.yahoo.com/q/rk?s=IWW+Risk
http://finance.yahoo.com/q/rk?s=IWZ+Risk
iShares Russell 3000 Blend Beta: 1.03
iShares Russell 3000 Value Beta: 1.07
iShares Russell 3000 Growth Beta: 1.00
And std. deviation
iShares Russell 3000 Blend std. deviation: 18.41
iShares Russell 3000 Value std. deviation: 19.16
iShares Russell 3000 Growth std. deviation: 18.36
Even in small cap you see a slight edge to the Value:
http://finance.yahoo.com/q/rk?s=IJR+Risk
http://finance.yahoo.com/q/rk?s=IJS+Risk
http://finance.yahoo.com/q/rk?s=IJT+Risk
iShares S&P 600 Small Cap Blend Beta: 1.16
iShares S&P 600 Small Cap Value Beta: 1.20
iShares S&P 600 Small Cap Growth Beta: 1.13
iShares S&P 600 Small Cap Blend std. deviation: 22.33
iShares S&P 600 Small Cap Value std. deviation: 23.07
iShares S&P 600 Small Cap Growth std. deviation: 21.85
So in the above you can see a slight edge to the value funds for Beta and Std. Deviation which means they tend to be more volatile than the market in general. But again look at the differences in these funds. It’s negligible. Now these funds have been around less than 10 years, but you get the idea that it’s not a slam dunk as many may believe. When you wrap in the turnover costs, taxes and generally higher expenses involved with the value funds the differences become very blurry in terms of real world performance.
Now we could argue that a tilt to small value is best. And some people do this. But I prefer to optimize for my taxes and a market efficient portfolio so it’s not something I do. BUT if you really want to do it, then just use a good index fund and don’t tinker too much afterwards. Realize that you may have market tracking error and be prepared to wait it out if you are lagging the market every now and then. Most people won’t be able to do this. IMO. I think most are better served by using a broad based Total Stock Market index fund because they will have less regrets.
Lastly, Beta is a backwards looking measure. It tells you what the fund did, not what the fund will do going forward. So building a portfolio on things like Beta (or Alpha) alone is not a good idea. One year Beta could be great, but then a bad streak hits and it can go against you quickly.
The above is why I advocate the Total Stock Market style funds and not to try to get tricky trying to beat the market. When you own the Total Stock Market you hold large and small value and growth stocks together so you benefit no matter what is doing the best. The idea of picking more volatile stocks sounds great in theory, but in practice it’s almost impossible to do consistently.
Hope that explains my position a little better.
Hindenburg Omen Goes Up In Flames
Flashback to August 2010 in the Wall Street Journal:
Yes Folks, Hindenburg Omen Tripped Again
The Hindenburg Omen reared its ugly head late last week, signaling more doom and gloom as stocks plod along amid the dog days of summer.
The Omen, a technical indicator which uses a plethora of data to foreshadow a stock-market crash, was tripped again on Friday, marking the second time since Aug. 12 it has occurred. (It also came close on Thursday, but one of its criteria fell short.)
The latest trigger has prompted the Omen’s creator, Jim Miekka, to exit the market. “I’m taking it seriously and I’m fully out of the market now,” Miekka, a blind mathematician, said in a telephone interview from his home in Surry, Maine. “I would’ve probably stayed in until the beginning of September,” depending on how the indicators varied. “That was my basic plan, until the Hindenburg came along.
…
“With what we have now, I think it’s possible we could get a 20% decline going into the fall,” Miekka said. “But I would expect some type of selloff and be buying at a lower price.” (emphasis added)
Since August 2010 when the Hindenburg Omen was spotted in the market, what has happened?
The Vanguard Total Stock Market index is up almost 30%:
Lessons?
1) Technical analysis is bunk.
2) Don’t time the markets.
3) Hold all your Permanent Portfolio assets all the time no matter what you read in the news.
