Finance and Stuff

Thoughts on finance and other stuff by Johan Lindén

Category: Investing (Page 1 of 2)

S&P 500 Makes a New Multi-Year High

Some people cannot believe it — The S&P 500 and the NASDAQ 100 has made a new four-year high under what seems the be a financial Armageddon if one was to listen to the financial press. Readers here should not be surprised though. Let’s see what the last follow-up said and what to expect next.

From the last follow-up in the 23rd of April:

What can we expect next?

Most statistical signals are indicating that the market will be higher in the coming months. The risk-averse person should be out of the market while the speculative person should be buying on short-term oversold conditions and selling on overbought conditions.

What we should look for before expecting a longer change of the trend is that sentiment gets increasingly bullish while hitting new highs or that it gets stubbornly bullish while making the next correction down.

The market had a fair share of zig-zag movement and to buy the oversold conditions and sell on the overbought conditions would have been highly lucrative. So let’s make a new probability forecast:

What can we expect next?

We still have a few long and intermediate term indications of a higher market. We also just received some indications of some warning signs. According to the Hulbert Financial Digest, newsletters that are focused on the NASDAQ Composite index are now recommending a 60% net long position. It may not sound that extremely bullish but that’s in the top 11% of readings since 2000, and is up from a recommended net long of 18% just two weeks ago. Fundamentals can be regarded as either bearish (Q-ratio, P/E10) or bullish (P/E in a none recession environment) and that is why we don’t look at them to take decisions. At the moment we only go long on oversold conditions and sell on overbought conditions until a longer term scenario is set out by the market’s price action.

Good luck and please feel free to post questions or comments in the comment field of this post.

Speculative Stocks

Most first-time investors and gamblers seem to focus on high beta stocks or markets, such as oil prospecting companies or the Russian stock market. In the article in the link below there is an explanation why there may be a negative downside to this besides just higher volatility.

[…] People who bet on horse races bet on the long-shot horses more than would be justified by the actual odds of winning (and conversely bet less than they should on the favorite horses). The story generally goes like this: Horse-racing bettors have difficulty evaluating small differences in outcome probabilities, for example the difference between a 1-in-50 odds horse and a 1-in-100 odds horse. That’s a 2% probability of winning versus a 1% probability of winning. This results in a large proportion of bettors placing too high of a bet on the longer odds because the potential winnings appear larger in that case.

The logic behind this behavior is most likely applicable to other markets of uncertainty such as the stock market.

http://isharesblog.com/blog/2012/06/05/a-lesson-in-minimum-volatility-gleaned-at-the-horse-races/

Do You Understand Financial Markets?

Many think that they can easily understand human behavior and financial markets by reading financial press and use common sense. But when an outcome is based on complex factors such as human behavior, than outcomes can be counter-intuitive.

For instance, how would you like to bet on the Euro compared to the US Dollar? Most people would find that to be a really bad idea. However, we have had two years of horrendous news from Europe, and the Euro still gained (sic!) from $1,23 to $1,25 during this period. Who would have thought?

Another example of how complex human behavior is, or perhaps very simple and narrow-minded in some way, can be found in this graph from the betting firm Intrade. Below you can see the very close correlation between the S&P500 and how likely it is that Obama gets reelected. So it seems that reforms, tax-breaks, and competing candidates seems to matter very little compared to how the stock market performs.

obama sp500 stock market reelected

Lesson to be learned, don’t think common sense as applicable to the financial markets, and with common sense I mean readily available information. The greatest brains in the world are setting the prices and they are not easily fooled. You rather have to think three steps ahead rather than one or two steps ahead.

Cash Better than Stocks?

monkey picking stock marketIn my search to provide you with more evidence that stock investments are bad placement for most investors/traders, I found an article about the e-book “Monkey With a Pin.” It’s free so go ahead and read it.

According to the book there is a 6% annual cost for the average stock investor trying to make money. Compare that to the long-term gains in the average stock market which is around 5 percent.

From the article about the book on the Sci-Fi blog:

Comley starts with the fairly undisputed fact that 85% of fund managers fail to beat the market each year.

Most stockmarket growth in the last century was generated not by capital returns – which were more or less flat, adjusted for inflation – but from reinvesting dividends.

Looking at the average investor’s return, which is biased by our overoptimistic need to buy high and sell low, Comley’s estimate comes in at between minus one or two percent.  That is, investor “skill” generally reduces returns by one or two percent. […] Roughly fund investors appear to lose 2.2% a year, stock investors about 1.3% per year.  Those costs add up as well: they depend critically on your investment size, and the bid-offer spreads, but the Dalbar figure is roughly 3.8%.

The book also tried to give some answers to way people are so willing to keep investing in the stock market.

People do not want to put their capital in money market accounts since they are almost certain to give a negative yield when adjusted for inflation. However, as the article says:

Losing small amounts of money to inflation is far, far better than losing large amounts investing in overhyped stocks. The odds are against the investor, but loss aversion dictates that people will often prefer to take the gamble of a possible large loss, but a possible large gain, over a certain loss.

That is called the loss aversion bias, which is well documented in psychology.

Another fact is that people’s memories are anchored to the huge stock market gains of the 90’s and they still live on the hope to re-live that time once again.

Source: The Sci-Fi Blog

Most People Should Rely on Passive Investment

The intelligence of the average stockholder is probably above the population average. Still they cannot bet the index. That is to say they cannot even beat random guessing, a coin flip, or similar, as the chart below shows.

Active vs passive investment decision-making

Buffett Doesn’t Like Gold

Warren Buffett, the world’s most famous and richest investor, wrote the following in his annual letter to his stockholder:

“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?”

Steve Beck’s has some interesting points in his answer to this in an article at Marketwatch.com.

“To explore this question, simply exchange gold for cash in this comparison. Would it be wise to own a huge $9.6 trillion pile of cash over $9.6 trillion in diversified corporate value? The answer is the same, no. The wise investor would select the diversification and compounding of corporate productivity every time. What can cash do for you other than sit there, produce nothing and deflate at an historic rate of approximately 3% a year.

Should you then draw a conclusion that cash does not belong in your portfolio? Obviously not. Even Buffett himself would acknowledge that cash, stocks and bonds are fundamental building blocks of a portfolio. Cash is useful on several levels including liquidity, security, fixed value, and simplicity, to name a few. Therefore, although you may not want your entire portfolio to consist of one asset class, you may in fact want some of that asset class represented in a globally diversified account.”

Read the whole story here: http://www.marketwatch.com/story/buffett-rebuffs-gold-but-inflation-says-buy-2012-02-29

Related articles:
Gold Weekly Buy Signal
Gold Sentiment Among Market Analysts
Platinum and Silver vs. Gold
Should I Buy gold?

Stocks vs. Long and Short-term Bonds

The relative performance of long and short-term bonds vs. the S&P500 index for the last 5 years.

As one can see, even short-term bonds, the safest theoretically assets one can buy, have outperformed the S&P500 stock index.

bond comparison stock index s&p500

NASDAQ 2% Below Ten Year High

Just an interesting note: NASDAQ 100 is only 2% below its ten-year high now. How many years ago was it that we reached the 10 year high last time? Actually it was this summer. I guess that, intuitively, this is not what most people would guess.

nasdaq qqq 10 year high

Mortgage Rate Spread

falling house prices mortgage loansThe spread on interest rates between mortgage loans and central banks’ loans to other banks are increasing. While banks pay less for long-term loans, the private households who want a loan to buy a house need to pay a higher premium each day.

This implicitly means that house-buyers have to pay an increased risk premium to their bank and that real-estate investment are getting worse each day, not taking future depreciation of house value into account.

I do not see that this phenomenon is widely recognized and that more pressure on real estate is to come.

Q-Ratio

q-ratio q-valueThe Q-ratio is one of the methods to estimate the fair value of the stock market. It is defined as the total price of the stock market divided by the replacement cost of all its companies.

To put it more simply, the Q-ratio shows how much do we have to pay to buy the stock market compared to how much it would cost to build it up from scratch.

The Q-ratio is a fairly simple concept, but timely to calculate; fortunately, the US Federal Reserve provides the data on a quarterly basis.

To compare how much the companies cost with how much it would cost to rebuild them seems like a clever and objective way to measure the fair value the stock market. And looking back at “Q:s” history it has been of great value for investors using it.

The basic logic behind the Q-ratio is that if the “Q” is above 1.0, then the market is valuing the present stocks more than it costs to reproduce them; making them overvalued. If it is below 1.0, then it cost less to invest in stocks than it cost to reproduce them, thus making it more profitable to invest in the stock market than creating new companies.

On contrast to the P/E-ratio, the Q-ratio, is independent from the interest yield for comparison analysis. This makes the “Q” an easy and objective way to measure markets.

One of the drawbacks with the Q-ratio is that you have to trust the FED releasing the correct data, unless you wanna calculate the replacement cost of every stock by yourself.

Most people would intuitively think that the value of Q would be around 1 or a bit above in long-run. But its long-term value is close to 0,7. This is probably due to the fact that most firms assets are generally booked too high.

It is a shame that most amateurs in the market does not prefer to use the Q-ratio instead of P/E-ratios or dividend yields, both of which need to be compared to interest rates and other measures to be understood in their context.

Today the Q-ratio is a bit above 1 making the stock market overvalued by 40-50%.

I hope you enjoyed this article! Feel free to leave a comment.

 

Chart below shown for a historical view and is not recently updated

q-ratio historical chart

Chart from: http://mla.homeunix.com/q-ratio/

Page 1 of 2

WordPress & Content by Johan Lindén