Record Low Stock Market Pessimism

One of the more striking features of the stock market is the decreasing pessimism among investors. After the dot-com bust in 2001, we sketched out an algorithm to analyze daily stock market data all the way back to 1928. This innovation records each day’s level of pain and pessimism. Our research shows that high levels of pessimism coincide with market declines and correlate with future good performance and low levels (like we’re experiencing today) eventually mean revert and are precursors to lower than average returns. The correlation isn’t perfect, but it’s good enough to give us some warning signs. And while the markets don’t follow a schedule, it is worth noting that we haven’t had one of the market’s “100 worst days” in over 890 days (which, if evenly distributed, we’d have every 210 days).  All this to say that the financial memory is very short; investors have all but forgotten what pain feels like.

The renowned Sir John M. Templeton, known for buying stocks at the point of maximum pessimism, said “Bull markets (long periods of above average returns) are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.”

Record Low Stock Market Pessimism

Record Low Stock Market Pessimism

Click Here to Download the JSCO Pessimism Index PDF

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Your Muni Fund Isn’t In Kansas Anymore…It’s in Puerto Rico

Puerto Rico van

Puerto Rico van (Photo credit: Wikipedia)

I bet there are plenty off people in New York who wish that 1 out of 4 of their winter days felt like Puerto Rico’s (which is 40 degree warmer in December!)

… but for those who can’t afford the plane ticket, some investors will have to settle for living vicariously through their bond fund. That’s right, for some New York Municipal Bond Fund holders (and many others), a large part of their funds are invested in the balmy (in more ways than one) US Territory.

Morningstar’s Eric Jacobson (@MstarEJacobson) writes in this month’s Morningstar Advisor about “Feeling the Heat From Puerto Rico”.

Because of Puerto Rico’s territory status, investors in their government bonds enjoy not only federal tax exemption, but also state exemption. That much tax-free income has been hard for some fund managers to resist. And this year, it has had huge implications for investors seeking “home state” tax-free returns.

In Jacobson’s list of Funds with the largest weighting in Puerto Rico, here are some notables:

  • Franklin Double Tax Free Income (FPRTX) tops the list with 61.29%
  • Oppenheimer Rochester VA Municipal Fund (ORVAX) @ 31.07
  • Oppenheimer Limited Term NY Municipal (LTNYX) @ 26.06%

And closest to home, the Oppenheimer North Carolina Municipal Fund (OPNCX) has 30.55% invested far south of South of the Border.

Holding to the rule of “yield is rarely free” these funds mentioned above that are heavily invested in Puerto Rico have experienced large losses year to date (though duration, state specific risks, and other factors influence returns also). And, as Jacobson notes, the scramble for the exits by investors to sell the funds, has caused some forced selling of individual bonds by the managers, continuing the cycle.

As we say often here, a big part of investing is about “knowing what you own, and why you own it”….and wearing sunscreen.

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Debt Ceilings Aren’t For Lovers: A Timeline of the Coming Debt Limit

This seems like a banner year for single economists, politicians, and journalists who want to blame their lack of Valentine’s Day dates on something. We’re headed right toward debt ceiling crisis and the Bipartisan Policy Center projects it will occur sometime between February 15-March 1 (including the extension due to “extraordinary measures”). Some highlights of their extensive analysis:

  • The Federal Government was able to use “extraordinary measures” in the Summer of 2011 to buy some time, roughly 2.5 months. They’ll be able to buy some more time, but due to seasonal cash flows, this looks like 1.5-2 months max.
  • There aren’t any “silver bullets” left like the much tweeted about Titanium $1T Coin (#mintthecoin), or simply ignoring the debt ceiling citing the 14th amendment.
  • We’re in truly uncharted territory. “There is no precedent; all other debt limit impasses have been resolved without reaching the X date”
  • The treasury has to make 100 million (100,000,000) MONTHLY payments. They could choose to pay some bills and not others, but the headache alone seems prohibitive.
  • Slides 25 and 26 show the “options” available if you were to pick programs to fund (should we pay tax refunds…or social security benefits). Relatively speaking, Solomon had it easy when he proposed to cut the baby in half.
  • Lastly, they have a day by day calendar for estimated revenues and expenses…it goes downhill quickly.This would make a great desktop calendar for someone who felt like they were too happy and needed to tone it down.

Presentation here:
Debt Limit Analysis

(I found this link thanks to the always-great, ever-tweeting, sometimes-posting-pictures-of-cats-along-with-debt-ceiling-analysis Heidi Moore at The Guardian. Find her here: @moorehn)

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Get Stuff Done by Creating Your Own Personal “Fiscal Cliff”

On New Year’s Eve, while Congress was busy waiting until the last-minute to “resolve” the Fiscal Cliff crisis…I was busy doing the same at my kitchen table.

As it goes with Cobblers kids going shoeless, I have to admit that my wife (Millie) and I aren’t always consistent with maintaining a home budget. When we have had a budget and a set of financial goals, it has been a huge positive in our marriage and when we let the budget slide, we’re both frustrated and feel like we’re wasting money.

So three weeks ago, I was having a guys night with four good friends and told them I needed their help…all they had to do was agree to take my money. I vowed that if I didn’t get our home budget in order by January 1st, I’d pay each of them $50.

With $200 on the line, I worked on it for several nights after that (Christmas Eve included). I dusted off my account, massaged all our budget categories, made the choice to go back to using Mvelopes instead of Mint, and had everything set up a week before the deadline…but I wasn’t done.

I had told my friends that I not only needed to know all about our budget but Millie needed to be in on the plan, she needed to know what amounts she was “in charge” of, and be able to categorize transactions.

Unfortunately, I decided to wait until two hours before we were set to go out with friends on New Year’s Eve to have that little “budget summit” with her. But thanks to Millie’s graciousness and Netflix’s ability to babysit our kids, we got it done and averted the $200 fiscal cliff with smiles on our faces. And I think we did a pretty good job at it…well, at least Governor Christie didn’t have a press conference the next day telling us what disappointments we were.

Sometimes, knowing yourself is key to making smart choices. For me, a $200 penalty was plenty of motivation. What personal fiscal cliffs have you put in place? Which ones should you put in place.

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Because all we need is less time between an investment idea and a purchase



I disabled 1 Click buying from my Amazon account because I bought a couple things that I probably wouldn’t have if I’d had the 5 more seconds to consider if I really needed it.

This new App from eTrade (who…Spoiler Alert…makes money when you TRADE) lets you scan a product, pull up the maker’s stock quote, and then trade away. I’m no genius, but I bet that trading a soft drink maker on no more data than the can’s label is a bad idea.

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Warren Buffett: From The Way Back Time Machine


A friend of mine sent me this photocopy of an article written by Warren Buffett in 1984: The Superinvestors of Graham-and-Doddsville (thanks @CurtisChesney). In it, Buffett highlights some of the results and process of some of his like-minded contemporaries. Note: all of this written 6 years before this chart of BRK.A going bonkers versus the S&P here: 

It’s a great look into some investing themes that don’t change. He says, on page 11, speaking about value investing “it is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or it doesn’t take at all.” I think it is something to remember when confronted with paying 90 to 100…to 105 cents for a dollar bill.

And again on page 12, speaking about Stan Perlmeter: “But every time Perlmeter buys a stock it’s because he’s getting more for his money than he’s paying. that’s the only thing he’s thinking about. He’s not looking at quarterly earnings projections, he’s not looking at next year’s earnings, he’s not thinking about what day of the week it is, he doesn’t care what investment research from any place says, he’s not interested in price momentum, volume or anything. He’s simply asking: What is the business worth?”

And I can’t speak enough about Margin of Safety. The less margin, the greater the risk. Go read it.


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QE Explained on a Whiteboard by @paddyhirsch

QE Explained by Paddy Hirsch:

“The danger, of course, is that if the banks turn on the pump and start pouring cash into the shallow end of the pool, we could end up being the ones drowning in cash. Which is an analogy for a little problem called inflation.

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Opportunity Costs: From Fig-Leaf Underwear to Robert Frost

Over 250 years ago, Benjamin Franklin penned a four page pamphlet titled “Advice to a Young Tradesman from an Old One”. In it, Franklin dispensed wisdom that seems concurrently basic and indispensable. For example, Uncle Ben advised that if I owe someone money, I should make sure they hear my hammer banging early in the morning and late into the night, rather than hear my voice booming in the tavern at midday.

Franklin’s most famous saying from the short work is “Time is Money”. He explained it as such:

“Remember that TIME is Money. He that can earn Ten Shillings a Day by his Labour, and goes abroad, or sits idle one half of that day, tho’ he spends but Sixpence during his Diversion or Idleness, ought not to reckon That the only Expence; he has really spent or rather thrown away Five Shillings besides.”

The concept our forefather was explaining is something every reasoning creature has encountered since the beginning of time. Economists have labeled it “Opportunity Cost” or plainly, the cost of a missed opportunity. It’s a dilemma that plagued Adam in the Garden (“Do I risk Eve being smarter than me or risk wearing fig-leaf underwear?”). Robert Frost faced it in the Woods (“Two roads diverge, do I risk the monotomy of taking the same one everyone else takes, or risk the unknown of the road less traveled?”) And even Charlie Brown gave it far too much consideration on the Football Field (“Do I risk Lucy taking the football away at the last second for the 100th time and falling flat on my back or risk not achieving my life’s dream to kick a field goal?”)

“Hey…should I refinance?”

It seems every week we’re hearing about mortgage rates dropping to new lows, and with every drop we get a number of calls from clients and friends about their prospects for refinancing. With a simple online calculator, one can surmise the payback period for the refinance. For example, staying in a house for 22 months at the new lower payment might “pay for” the closing costs associated with refinancing. The calculator seemingly indicates that all one has to do is determine if they’ll to be in the house long enough to recoup the costs and whip-bam-zoom: refinance!

You’ll see from the chart below (click to make bigger or see full size chart at the end) that, only part-jokingly, the decision to refinance isn’t as easy as it sounds. I have to think through how long we want to stay there, figure the payback period, consider the emotional toll a mortgage takes on us, and how close I am to retiring. Most importantly, I must take into account not just the absolute rate (and for round numbers’ sake, a 3.5% fixed rate is really more like 2.5% after the mortgage interest tax deduction), but also how that rate compares to my other investment opportunities.

Only So Much Room

We’ve written about it before, but investing is like managing a 100 room hotel. Investors have 100 1% slots (rooms) in a portfolio to “rent out” to different stocks, bonds, commodities, and cash. A rational investor makes his room assignments by measuring the potential gain of one investment over the missed Opportunity Cost of not being able to invest in another.

Typically, the Opportunity Cost we’re presented with in the market makes sense (if I were an economist, I’d say something like “Markets are mostly efficient”…but I’m not, so thankfully I don’t have to). Often, investing looks more like Robert Frost’s somewhat difficult two roads dilemma than Charlie Brown’s no-brainer to let Lucy hold the football. For example, investors can typically buy a Utility Company with very little growth prospects, but little fluctuation, for 10 times what the company earns in a year. Or investors can buy a Tech Company whose earnings could grow rapidly, but fluctuate, for 20 times earnings (twice as much). Either one could be an appropriate choice, but neither goes against years of market data, current fundamentals, or at least common sense.

Ben Bernanke’s Bait…and Switch?

But the Opportunity Cost between Cash, Bonds, and Stocks is another matter. In the last three years, the Fed has lowered interest rates (and kept them artifically low) in an effort to increase investors’ wealth and stimulate the economy. GMO’s Ben Inker puts it well:

“Today, the Fed has engineered a situation in which the really unattractive asset classes [read: the ones with low to negative real returns] are the ones we have always thought of as low risk: government bonds and cash. And unlike the internet and housing bubbles, this time it isn’t a quasi-inadvertent side effect of Fed policies, but a basic aim of them. The Fed has repeatedly said that a central part of the goal of low rates and quantitative easing is the creation of a wealth effect by pushing up the price of risky assets. By keeping rates very low and taking government bonds out of circulation, the Fed is trying to entice investors into buying risky assets. The question we are grappling with today is whether we should take the bait.”

Investors are being asked to analyze the Opportunity Cost of holding Risk Assets (Stocks) against the prospects of holding Cash (which is susceptable to inflation) and/or Bonds (which are negatively sensitive to rising interest rates.) As PIMCO’s Bill Gross puts it, we must make a choice about which “cleanest dirty shirt” to put on. Gross’ comment pertained specifically to US versus Foreign Bonds, but we think it goes for other asset classes as well. The European Debt crisis isn’t near resolved, the US will likely have a rerun of last summer’s debt ceiling debate after an unsure election. As we wrote last quarter, profit margins and interest rates are still far outside their normal ranges. It’s like someone forgot to do the laundry.

As a result, we continue to tilt our portfolios to more conservative allocations across the board. We’ve said it before, but we do this by holding more Cash than typical and staying on the High Quality side of equities with a strong leaning to dividend paying stocks. At times, this can be uncomfortable, because typically this will cause us to lag behind a benchmark when the market is on the upswin
g. But as Warren Buffet said, “Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.”

To Peanuts viewers, kicking the football always seemed like a decision Charlie Brown shouldn’t even consider. But Lucy’s assurances, the fear of missing out, and Charlie’s own behavioral biases (if cartoons can have such) made him think it was an Opportunity he couldn’t miss. And as strange as it sounds, the history of financial markets is made up of Charlie Brown type decisions. Without perspective and a good handle on history, it’s hard not to believe “Lucy” even though sitting out would save plenty of headaches.

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The 5 Sources of Moat (video by @StockInvestPaul)

In the video below, Morningstar’s Paul Larson describes what an economic moat is, where is comes from, and why it matters in investing.

As a side note, we think a  growing or stable moat is more important than the actual size of economic moat. A company with a shrinking moat is, by definition, experiencing a departure from past returns on invested capital (ROIC), returns on assets (ROA), and returns on equity (ROE). When those metrics decline, so go earnings, so go valuation, so goes price…not necessarily in that order.

Certainly worth the 8 minute video or you can read the transcript: The 5 Sources of Moat

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Unprecedented Fiscal Cliff – CFA NC Annual Meeting Recap

Last night, Jonathan and I went to the Chartered Financial Analyst (CFA) NC Annual Meeting at the Grandover Resort in Greensboro. Our speaker was Andy Laperriere, CFA from ISI speaking giving us an “Economic Policy Outlook”. And as dry as that might sound, it was possibly the most informative and helpful talk we could have booked.

Andy’s firm applies science, statistics, and reason to politics, economics, and financial markets. Highlights:

  • His second bullet point contained the phrase “unprecedented fiscal cliff”…good job on not burying the lede.
  • Congress – he seemed pretty certain we’ll see a Republican majority. Democrats have to pick up 25 seats…doesn’t happen very often in the circumstances we’re in.
  • Presidential race. It’s nearly 50/50 for him, but his boss made him choose so he leans Romney if election is today, partly due to two stats:
    • An incumbent has never garnered more popular vote that 2 points above his approval rating. Obama is currently at ~48%
    • An incumbent’s vote share has typically be tied closely with the trailing 12 months’ change in real disposable personal income. Meaning: when people are richer than 12 months ago, the incumbent president has a better chance of winning. Of the last 15 incumbents, Obama is sitting on the lowest change in real disposable income over the last 12 months than any president except Carter (who failed to get reelected in 1980). If Obama stuck to the trend, the model would suggest he only gets ~45% of the vote. He noted that he doesn’t believe in single variable models (this data point doesn’t mean Obama can’t win, it’ll just mean if he does, it will be an outlier).
  • He thinks we’ll get a deal in terms of tax breaks because we’ll have to raise the debt ceiling and if we have to raise the debt ceiling (again) we’ll have to have a deal. Sort of the argument “if something can’t continue, it won’t”
  • Laperriere sees this happening in 2013. Sees winners as equities, the dollar, treasuries, and the losers being health care stocks. His other outcomes are less pretty.
  • If all tax cuts expire and health care taxes hit, he sees a $1700 tax increase to the family making $40-50k. That’s a big dent and not politically easy to swallow.
  • Someone asked about his thoughts on the Wisconsin election. Said he thought Walker was near assured a win and the media would make it out to be a bigger story that it really was. He didn’t think it would be a big deal unless he only won by 1% (moral victory for democrats) or if he won by 15% (boost to republicans). Interestingly we see the results today that he won by 7%…and the media makes a big deal out of it. Two-for-Two.

My takeaway is that he expects a deal to be made but not after some significant uncertainty. Don’t let the next debt ceiling, rating downgrade rumors, political musical chairs get translated into doom. At least in his opinion.  

Note: if I get the slides, I’ll update with some of the charts. They really drove it home.

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