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Friday, September 28, 2012

Price Only Charts Don't Show the Full Picture

Tip of the hat to the great new Amazon money and investing blog. A post there(via motley fool) noted the importance of looking at total returns including dividends while almost all charts and news reports show price only.

The article presents this graph comparing price only with total return(dividends+ price change)
The article notes that in the "lost decade" for stocks from 2000 -2010 an actual investor in the S+P would have had a total return of 20%.

I ran charts for the period since Jan 2007 for growth of 100,000 in total return=+15.3%
But the price only chart below shows a negative return of close to 5% for that period

Thursday, September 27, 2012

That Dividend Trade is Getting Very Crowded

If there is one current conventional wisdom in the investing world it's investing in dividend or "dividend growth" stocks. It's not hard to figure out why: dividend yields above treasury yields, a need for cash flow and disappointing returns on the US overall equity market over recent years.

In fact strategies represented based on dividend weighting with reliable data (such as backtesting of formulas used in etfs like VIG and SDY) show some outperformance vs market cap weighted indices, as does performance of some large cap stocks that frequently show up on dividend screens. Furthermore this has been the case in recent years, even the utility index (XLU) was a star last year top performing sector for the first time in the last 50 years.

And many investors seem to be using the dividend flows as a substitute for bonds in their portfolios. Despite the cogent arguments against equating dividend stocks with bonds (like this one from Vanguard) the view persists. As I will point out in a future article they might be much better up expanding their horizons and constructing a portfolio of bond ETFs covering a mix of durations and credit risk to create their cashflows...and diversification.

Beyond those factors is another issue...the trade is getting very crowded. I found this chart in a recent research piece from Fidelity. They used it as an argument for investors to continue to buy dividend growth stocks because of growing demand. I view it as a sign of a crowded trade.

The picture is similar on the ETF side. Despite meager inflows into equity ETFs overall
Dividend ETFs remain popular as investors prefer funds that offer above-average yields and conservative strategies for exposure to the stock market.

A hot new dividend ETF from ishares HDV has amassed over $2 billion in assets in less than a year. A July Morningstar article noted the following...and there has been no sign the trend has slowed down since then.
Dividend-themed exchange-traded funds have been a popular choice among investors over the past year. The 42 dividend-themed ETFs that we follow raked in $16 billion in flows, nearly a third of every dollar going into equity ETFs, despite the fact that they make up just 5% by count of the 812 equity ETFs available. 

The above is a bit ironic since HDV uses a stock screen created by and licensed from Morningstart to pick its holdings.

What does that mean: a category that has been known for relatively low valuations (often considered "large value stocks) with low volatility has begun to carry valuations closer to that of "growth" stocks. Not surprisingly the very strong above market performance of last year has started to reverse itself, particularly during the market rally.

Here are returns for VTI (green,total stock market) and VUG (blue, large cap growth) vs  fast growing (in assets) Dividend ETF HDV (gold)year to date. Chart shows growth of $100,000.

  Ultimately dividends must come from either earnings growth or increasing the dividend payout. Based on the metrics below it seems that investors in some very popular dividend stocks are paying a very high price for those earnings. In fact those looking for dividends might well turn their sights outside the US...more on that in a future blog.

Here are some valuation measures of the top five holdings in HDV(courtesy of I'm not exactly how the current numbers can in some cases beabove the 5 year numbers. As a point of comparison the current p/e of the Vanguard large cap growth ETF has a p/e of 16, the S+P 500 14.
                      current p/e         5 yr p/e high      5yr avg p/e

ATT 51.5 48.4 20.5
Pfizer 18.4 19.3 13.4
JNJ 21.9 19.5 15.6
PG 18.9 17.9 15.2
Verizon 45.1 30.6 29.2

Tuesday, September 11, 2012

As I Was Saying...

Last week I noted the strong market rally on September 6 was likely due more to many portfolio managers returning from the beach vacation with performance anxiety more than any particular news item.

It seems I am not alone in my view. Raymond James analyst Jeffrey Saut wrote this in his September 10 commentary (after citing the same WSJ article I had noted):

In last week’s verbal strategy comments I suggested participants study the chart pattern of the S&P 500 (SPX/1437.92) and then think about what it would feel like if you were an underinvested portfolio manager (PM), or even worse a hedge fund that is massively short of stocks betting on a big decline. The concurrent performance anxiety would be legend because not only would you have performance risk, but also bonus risk and ultimately job risk. Accordingly, I have been opining that stocks were likely going break above the April highs (1420 – 1422) and then trade higher toward the 1450 – 1477 zone driven by what Dan Greenhaus said, “that pressure to try and play catch-up and not just merely play along but to gain some outperformance." Of course that performance pressure is magnified with end of the third quarter “report cards” due for PMs, followed by fiscal year-end, as many PMs close their books at the end of October.

I'm reminded of the story in Scott Patterson's book The Quants . He writes about how in the middle of the financial crisis major hedge funds unwound their positions in quantitative strategies leading to large moves in stocks in the absence of any fundamental news. One of the quants looked up at the reporters on the CNBC screen scrambling to give reasons for the moves based on fundamental factors. The hedge fund manager just looked up shook his head at the cluelessness of the reporters...they had no idea what was going on ...they were looking in the wrong place.

Monday, September 10, 2012

IPOs and Shooting Stars...Not Healthy For Your Portfolio

Shooting Stars and Ipos

As an investment advisor there are two categories of stocks I most frequently get asked about. IPOs and shooting stars.
These categories share 2 things in common high visibility (everyone seems to be using their product), often it’s in the news and it seems like a “sure thing’  Potential investors also suffer from two well known characteristics now part of the textbook list of pitfalls of behavioral finance and in fact decision making in general. The brilliant and highly readable book on this subject is by Daniel Kahneman: Thinking Fast and Slow. Kahneman was the first and only winner of the Nobel prize in economics to come from Psychology and I think the first Nobel Prize winner in the field without a degree in economics (there have been other social scientists since). 
Kahneman’s work is important for learning about the sometimes irrational behavior of the markets when price differs from value. In other words markets can be irrational and cause bubbles and busts. But I think there is merit to the critique: no one has shown a systematic way to make money off behavioral finance.
But I think there is a way to avoid losing a lot of money through investing avoid IPOs and shooting stars. And avoid falling into the biases of paying attention to a selective sample of information which reinforces confirmation bias. You think the product is ubiquitous therefore it is a good investment and you know people that have made a lot of money IPOs picking hot stocks or buying the individual stock in question. In fact as a group IPOs and shooting stars are as a group the worst category of stocks.
IPOs (initial public offering).  This one may be more obvious due to the largest and most publicized IPO…facebook.  Nevertheless before the IPO many investors were salivating at the prospect (investment professionals(mutual and hedge fund managers) were included in the group. Relatively unusual this time was that some retail investors got access to the IPO …that in itself not a good omen.
Why were they interested in facebook ? Because they only remembered and/or remember about the big money made in some IPOs…and didn’t hear (especially at cocktail parties) of the larger percentage of duds.
What were they looking at something like Google (of course ignoring the jaw popping 50% drop.

But they failed to think about IPOs  such as Groupon

Therefore they looked at Facebook with optimism. As a wiseguy (not me of course) would say: how did that work out for you:

Shooting Stars: shooting stars are attractive for some of the same reasons: I see someone using all of the product, therefore it must be a successful company and a good stock. In addition since the stocks are already on the market.  The stocks also share:
They are usually small growth stocks (small companies with forecasted high growth) in general the worst category of stocks in the traditional market  cap (large/small) and growth/value division. Think of a quadrant dividing the market (small value large value large growth large value)
They trade at a very high (P/E) price earnings valuation (as well as other metrics) indicating high optimism of continued high growth.
Because stock prices have had tremendous gains they have heard from or read about some investors/traders making big money.
Often the stocks will become “short positions” for professional aggressive investors. Therefore if they were early and the numbers temporarily remained positive..they may wind up buying back the shares (short covering) and the stock will have a sharp move up.
The problem because the forecasted high growth is factored into the price  bad news about prospective growth falls and the stock price takes a big drop as the “shooting star” falls to earth.
Why is this: often the shooting star is related to a consumer (often fashion/fad) product that seems ubiquitous, is premium priced for it’s uniqueness. But it is usually a product that can easily be knocked of appear in a cheaper person in a mass market retail outlet (think Target). The number of people willing to pay the premium price drops as does the stock.
An example would be Deckers the importer of those UGG boots that seemed to be on the feet of every trendy young person. To put it bluntly when the popular shoes were available at Nordstrom  or the UGG stores at a premium price and the knockoffs at places like Target…there were only a limited number of people to buy the original. Despite the effort to broaden the brand the anticipate earnings…and stock price as dropped like a rock. 

Another would be Crocs

Two Shooting Stars That Earn a Yellow Light

Two stocks that fit the characteristics of shooting stars but have not(yet ?)  fallen to earth:

Lululemon: This is the seller of yoga pants and other hot products sold at their own stores at premium prices. Knockoffs that are priced at a far lower price are prominently displayed at Target and elsewhere. Is there a limit to the number that can be sold at the premium price. The market seemed to think so, although good news last week created a big (I think short covering) rally. The stock carries a P/E of 57.

Underarmour: the hot athletic wear premium priced product. It’s current p/e is an eye popping  128.

 As a point of comparison Nike trades at a P/E of 21 and sells products competing with both Lululemon and Underarmour

What is my answer to clients interested in buying IPOs and shooting stars: I make the points above and suggest if they want to buy them they open an account I don’t manage and purchase it there.

Interestingly a company/stock that doesn’t fit the characteristics of a shooting star is Apple. Apple does have a unique premium priced product but they are difficult (and given recent court rulings perhaps even more difficult) to copy.
Apple of course is the world’s largest company, it’s large cash position makes bankruptcy virtually impossible.  And interestingly relative to earnings it doesn’t seem expensive. the p/e is 16.  A new iphone is to be unveiled this week and a smaller cheaper Ipad is in the works. Is the stock worth buying on price dips  ? I’ll leave you to judge.

Friday, September 7, 2012

That Stock Market Rally of September 6....Don't Believe the Explanations in The Media

As the business news and today’s press will report it…today’s 2% rise in the S+P 500 and  rise in European stocks  (based on ETF VGK) of3% was attributable to actions (or pledges of  )
·         Further action to  support the European  bond market
·         A stronger than expected employment report from  private payroll  firm ADP (which doesn’t   always match the government figures which this month are released on Friday).

I have another explanation: the calendar and money managers trying to catch up.

The calendar: We are in the first week after Labor Day. The summer was a quiet one in the markets giving money managers a chance to get away…as described in a recent WSJ article. The deadly low volume and volatility  of the last  weeks in August indicate a lack of managers taking on new positions.
Paradoxically large moves are not uncommon in the summer—whether they are panic selloff or “melt ups in rallies
Some may attribute this to breaking news. Having worked on trading desks I can suggest another reason.
The reason: trading desks are lightly manned with junior staff in the summer. That staff is either instructed to cut back positions if the market moves against the portfolio in sharp moves, but not to undertake new strategies….or  the senior portfolio manager watching the markets intermittently from  his iphone on the East Hampton  beach calls up the junior staff and tells them to liquidate some positions pending a  portfolio review after Labor Day.
Well, the summer house is closed down, the trip to the mountains  or lake cabin with poor cellphone reception and no wifi is over and everyone is back to work.
And what are many mangers looking: at a missed summer rally in the stock market

In fact  I would not at all be surprised if much of the summer rally was fuelled by hedge managers short the market…anxiously calling their junior traders and instructing them to cover those short positions.
Stocks jumped nearly 10% over the summer, defying the expectations of many hedge- and mutual-fund managers who had bet on a decline. They saw a multitude of headwinds from Europe's woes to the slowing U.S. economy and sluggish corporate earnings.
Now, those defensive fund managers are facing what's known in Wall Street lingo as the "pain trade": having to buy stocks just to avoid being left in the dust.
Here’s the picture and it’s not pretty. Jeremy Grantham recently wrote a great paper on career risk in money management.  Underperformance gets punished with fickle investors chasing performance and fleeing from underperforming managers….this may be particularly the case with the increasing preference for index instruments among individual investors. Many will give up on active mangers and index…others will move funds to a hot manager
 Whether it’s a hedge fund manager or mutual fund manager their compensation is tied to assets under management and assets under management tied to performance. With a little less than 4months in 2012, those mangers are forced to catch up and buy stocks.
This whole pattern leads to short term fund management, the managers are not totally to blame….the investors respond to short term performance and movetheir money accordingly.
Academics callthis concern of managers of exceeding a benchmark “information risk”. The risk of underperforming the index is greater…the more the manager strays from the index….even if he thinks the move may make sense.  Of course this is ironic beause investors think they are paying active manager to find investing opportunism….Short termism and concern about the information ratio leave some opportunities unexplored. There seems evidence of potential for outperformance…on a risk /return basis but often not on an outright basis….more of that in a future article.
Other cyclical dates to watch:
The period towards the end of the quarter when managers will window dress, increase  their stock allocation particularly in top performing stocks
The period right after the end of the quarter when individual  investors review their 401ks and inevitably chase hot asset classes. With the heavy move of investors away from stocks and into bonds in the last couple years…they may rethink that positioning. With the S+P 500 total return over 13%for the year and the aggregate bond index +3.5%....I wouldn’t  be surprised by some asset shifting(missing much of the move) from individuals around the end of September/beginning of October.

A major survey of individual investors AAII shows a great deal of caution despite the stock markets strong 2012 performance....A look at those September 30 401k statements may lead to moving some more money into stocks....chasing performance.


Bullish sentiment among investors was down during the week ended this Wednesday, according to the most recent weekly online survey of members of the American Association of Individual Investors.
Bullish sentiment fell to 33.06% from 34.72%, while bearish sentiment rose to 33.06% from 32.64% during the previous week.
The percentage of investors who described themselves as neutral on the stock market rose to 33.88% from 32.64%, according to the poll. 

I wrote this blog entry (honest) before I saw this from Barry Ritholtz on his Informed Consent blog

Stock oriented hedge funds are charging 2% + 20% of the profits for their YTD returns of under 3%. Mutual funds that focus on large cap stocks are up YTD less than 7%. Oh, and those of you who index are up YTD 13%.
If you want an explanation as to what is driving stock prices, that is as good as any . . .