I had two questions come in that I thought would be good to answer in a post.
The first came into my Street.com email account. I wrote an article that made a mention of the PowerShares Buy Write ETF (PBP) as being a low vol proxy for large cap US stocks and included this chart to illustrate the point.
The reader said in his email that YTD PBP was down 7.8% while SPY was down 8.75%. I can't vouch for his numbers but we can assume he is correct. Based on those numbers he said it is not clear to him that PBP offers any advantage WRT to the volatility. I'm not sure I would be so quick to dismiss 95 basis points in three weeks but I guess that did not resonate with him.
The above chart covers two years. As you can see, over the two years the lows are not as low and the highs are not as high--less volatile. However you can also see that that for short spells of time, like two-three weeks here and there, it offers no real difference.
During a brief bout of crazy market action, I think this month (the past week in particular) counts as crazy, it is very difficult to draw conclusions about too many things. Over a period of a few months there will be some difference and that difference either matters or it doesn't--that is for the individual to decide.
Another reader seems to disagree with the notion of that panicking out Tuesday at the open. You can click here to read the comment as I might be mis-reading him. He starts out with "i don't think it is necessarily panic or foolishness to severely limit one's exposure to the stock market in a highly uncertain time. "
He also makes a point that I would paraphrase as people should have respect whatever they had to do to get the money in the first place that I agree with completely. He is critical of "this generation" for its willingness to put capital at risk with no guarantee of getting it back--perhaps an homage to the Will Rogers quote about return of versus return on.
Well I think there are a couple of good things to point out. One part of this that I think he is missing is proper asset allocation. No matter your age if you are alive 15 years from now your expenses are going to be 50% higher than they are now.
Unless you have $10 million today and only need to spend $50,000 per year (or similar numbers) you need some growth. Only having cash and bonds won't give you the chance to keep up with inflation. If you are 75 and you make it to 90 but don't plan to make it to 90 you will have a problem.
I am not trying to minimize the the anxiety that stocks create, I know it is real but no matter what anyone's tolerances are our expenses are going to be 50% higher 15 years from now, that is just how the numbers work.
Another important aspect to this issue is how the stock market works. It has an up year almost 3/4 of the time. It averages about 10% per year which includes all of the booms and busts along the way. Anyone investing a lump some into equities on Friday October 16, 1987 has long since forgotten about that or they would look back and chuckle at the timing.
Remember a proper allocation has some portion of stocks, bonds and cash. If someone's target for stocks is 65% and they are close to that when equity calamity hits they should be able to weather it if the plan was constructed properly.
If you put all of your equity allocation into SPY and never make a trade you'll average 10% over reasonable periods of time. Now, to the extent that value can be added with some sort of well planned defensive strategy thought out ahead of time all the better and frankly a lot of ink is spilt (intentional mis-spelling) on this blog on trying to add value/smooth out periods of down a lot.
And with all due respect to the reader, if he is green-lighting selling stock into a sheer panic, that strikes me as the exact opposite of how to navigate markets. V shaped declines and their subsequent snap-backs happen more often than bear markets and it is during the V's where the biggest mistakes get made because they create the most emotion.
The rolling over from October to year end was the time to make changes (I feel my past blogs from that period give me the credibility to say that now). The start of this bear market, assuming that's what it is, was very typical. The current panic that seems to have subsided maybe a little atypical but recognize the beginning of the week for what it was; panic.
22 comments:
I would suggest looking at ETW a global buy/write closed end fund trading at a discount to NAV. There is info on etfconnect.com
You can see the NAV vs Market price and how NAV has been less volatile and you collect a 10%+ distribution, at least for now.
Eaton Vance Tax-Managed Global Buy-Write Opportunities Fund (ETW)
I know you will hate this, but how much is the S&P up since 2000? I suspect the answer to that question in 2009 or 2010 will not be good either. I agree 100% that people need to be invested, but there is time for very heavy cash allocations as well.
The panic this week was not the time to sell. If you finally figured out this is a bear market the time to sell is into this rally not when every one was panicking.
George castanza (sp) only succeeded when he started doing the opposite o what he thought. I am not saying the opposite is always correct but if you analyze the markets when your gut is in knots and telling you to sell you should probably be buying. Similarly when every one was giddy last year you should have figured out we were approaching a top. Bottom line is you can not trust your emotions.
Now comes the tough part IMO is this a 1 week, 1 month or 3 month rally? Because if you are going to lighten up on the rally this would be nice to know.
I agree with most of what roger has to say except I do not see the next 5 to 10 years as being extremely rewarding in the markets as the household debt bubble will prevent the euphoria of the 80's and 90's. These are difficult years ahead of us just like since 2000. There will be a lot of movement, but I do not think we will go anywhere.
seg
Roger
A totally agree with your reader that avoiding stocks during uncertain and volatile periods makes perfect sense. Unfortunately for me, I never know when those periods are going to come until we're underway. Of course then it's too late to avoid the loss.
Last fall, I was far more bearish about the market than almost anyone else I knew. But even I would not have predicted SPX down 15-20% in just a few months. By the time it was obvious we were in a "volatile" period, the market was already down half of that. Decisions are obvious ex post, but have to be made ex ante.
And of course your reader probably didn't mean to avoid volatile up moves. So I assume what he really meant is to avoid crashes. But if you've really got good insight to an impending crash, far better to short the market than avoid it. That's how Soros made his fortune...
Michael
Seg, you are right about this decade. The round trip to nowhere also pertains to the 1970s and the 1930s and will happen in some future decade too.
However during this decade there have been forerign markets that have gone up as opposed to round trips to nowhere.
Michael, I have been bearish far more often than has been warranted. Fortunately I have not acted as bearishly as I felt in those past episodes. People have more bear markets than the actual market does, if you know what I mean.
I stick to the 200 DMA as catalyst and do not make big bearish bets.
Seg, I can't front run clients on this blog. Most of the time disclosing a trade after the fact does not matter much, the trade tuesday morning being the exception that prove the rule.
As far as what come next, for now this can be labeled as a feel good rally--maybe that will be wrong and a true bear is averted but I don;t think so.
Roger,
I do not expect you to front run your clients here. I am very thankful for the clarity of view you bring to this blog even when I disagree with you.
You are correct on foreign markets likely performing better over the long run even though I think the decoupling story is silly in the short run. There are not household debt bubbles in many foreign markets, but a bear market in the US will hurt most every where.
BTW, personally I think cash is ok from time to time, but everyone makes mistakes. Shorting and margin should not be used by almost everyone reading this blog IMO. It is risky enough heavily buying on tue and wed, but I could not resist the oversold condition with a panicking FED to boot.
seg
i am not a stock price de-coupling guy either but there are certain fundamentals that could decouple which might mean stocks tied to those themes might go down less or start to recover sooner.
Decoupled or not, foreign markets have their own set of problems.
I know you will hate this, but how much is the S&P up since 2000? I suspect the answer to that question in 2009 or 2010 will not be good either. I agree 100% that people need to be invested, but there is time for very heavy cash allocations as well.
How much is the REIT index up since 2000? From memory, I think they were trading at 10x FFO and 10% yields at the time. Of course, nobody was going to rent space anymore because of the Internet.
How much is the Russell 2000 value index up since 2000? It was around 10x earnings as well
How much is Berkshire Hathaway up since 2000? It traded down to 1.0x book value because Buffett was an old fogey who didn't understand technology and the new paradigm.
The S&P 500 was at 30x+ earnings in 2000. Not a big surprise it has been a round trip to nowhere.
FWIW, I'm holding about 15% cash right now, but there is always some good value to be had somewhere, although this market environment is tough as just about everything did well from 03 to recently.
Still, there are some very good values out there right now. Not sure what you mean by heavy, but I don't think 75 to 100% cash ever makes sense because the market might rally when least expected, and it also means you simply haven't turned over enough rocks looking for value.
Roger,
Interesting post. I'm just reading some of your stuff and notice a lot of similarities between my investment ideas and yours. Got a question for you that I've been contemplating lately. What do you think of using the ultrashort funds as a long term investment by shorting them. I'm I have been using them to hedge my portfolio for the past few months as a long position. Just sold my FXP in the mid 90’s after picking it up in the 60’s. Long term though these funds are designed to loose money though as I’m sure you well know. The fact that they are double short and use constant leverage will take these to nothing over the long term. I use conservative amounts of leverage at various times but when there is so much fear in the market these are tempting to short. What are your thoughts? Thanks.
Scott
scott i have heard about shorting the double short funds but the cost to carry is quite high because of the dividend the double short funds pay out to share holders.
to be clear it can go to zero. the purpose of the fund is twice the inverse on a daily basis. so depending on how the next 100% in the market comes will determine how low the double shorts go, further the daily buying and selling of futures to square positions also great reduces the likelihood of going to zero also.
I think a buy-write ETF is the way to go if you think there's market weakness ahead but don't want to try to time the drops. BXM's outperformance since June (-5% vs. -12%) is proof of that.
The only time BXM suffers is during strong rallies, and those often follow crashes.
Roger,
A very good blog. keep up the work.
An interesting thought crossed my mind. The fed has an egg on their face now that we know that the rogue trader in france was part of the reason the futures were pointing downward.
What will now happen if the fomc meeting next week decides to NOT lower the rates or not lower it enough. Do we get the bloodbath that should have happened last week. Fun fun :)
blood bath next week? i don't know.
a blood bath waiting out there around some corner due to Fed mis-management seems more likely.
Rog, you have been a calming influence these past several months and your careful modest responses to reader comments have been instructive. Your view is eclectic but I would suggest that there will be a new economic paradigm in our future which involves the unraveling
of our laizzez faire cheap energy model with its massive deficits, unfunded liabilities, unregulated credit markets,dollar distruction, resource depletion and global climate change. How many outliers and black swans can one investor take? Trying to navigate this future using tools derived from a different time just may not work well going forward. Seg's negative comment on the S&P performance over the past decade is provocative. Now consider the abysmal performance does not even take into account that the poor dollar return is negatively augmented by the dollar's plunging real value during that period! Picking which mix of asset classes going forward that will yield the greatest return may be a doomed strategy. At this juncture, preservation of capital and safety should be our shibboleth.
a strategy that focuses on protection? i'm on board.
the focus of the post was that taking protectionist steps the day of a big panic, like Tuesday or Wed of this week, is a bad idea.
I believe the focus of the writing the last few months is consistent with that.
all of these interviews on CNBC about what to do now...now when its too late...instead of always having something in mind palnned out ahead of time as I have preached about. I did not reduce at the top but am not feeling the full brunt and readers have had a front row seat before and during.
contrast that with reacting during the event.
Although I am about 60/40 equities/fixed, it is hard to know the right mix at any time with this volatility.
I have a friend who is an upper level guy at Merrill and I asked him what he was buying now and he said
Treasuries. He sees a whole lot more downside in
both domestic and foreign equities. There is apparently a whole lotta shakin goin on in the financial houses. As they go so goes the market.
Interesting how DBA held up today.
Happy weekend to all,
Scoot
dba. and moo too. hmmm.
Roger,
While it may appear the height of insensitivity during these drastically downward days, could you comment at some point (or direct me to a past blog if you have already done so) on money management (as in trader income)?
I have been overly bearish the whole of 2007 (losing large chunks of hard earned coin), and luckily continued as such into 2008, and the double shorts have done their job. Now, at what seems like at least an inflection point, if not something of a bottom, I'm recognizing that taking money off the table is not as easy as it sounds.
Do you follow a regular rebalancing schedule? (Weekly? Monthly?) Do you withdraw to a consumption account some predetermined amount in excess of a targeted amount? The street is littered with anecdotes of those that saw their paper profits blow away, but I'd like to hear an experienced hand describe a method for avoiding the same.
Thanks, and keep up the sanity.
Rick
Rick,
I probably have written about some of this stuff before.
Rebalancing schedule? No. When I think changes need to be made I make them, period.
Your question about a consumption account does not apply to what I do. As I read that part of your question that is more about trading for a living. Clients who take an income usually take an amount that does not require account upheaval. Things like drawdown don't apply to a diversified portfolio of stocks and bonds, at least it hasn't applied yet.
I have blogged recently about selling stuff when it spiked up and when it was puking down. The issue here is at the nexus of art versus science.
I am not a sell on weakness or a sell on strength guy, neither can always be right or always wrong.
today i place a limit order to sell a portion of one widely held name that is up a lot but is well off its high. If the economy is slowing the sector it is in will probably be effected (it has been already) so shaving some seems right, the stock is not forever broken but...
I disclosed selling SBUX months ago. I realized that I had something wrong so i sold. I disclosed selling some MON recently because it went up more than I expected--two divergent sales.
Roger, what is your prediction for the S&P for the next 3 months, 6 months and 12/31/08?
Thanks.
"No matter your age if you are alive 15 years from now your expenses are going to be 50% higher than they are now."
I would strongly disagree with such an extrapolation of the current inflation level so far.
Besides the availability of an accurate prediction of the future CPI growth in the USA
given in my blog http://inflationusa.blogspot.com/2007/08/inflation-and-unemploymet-in-usa-beyond.html
and working paper
"Inflation as a function of labor force change rate: cointegration test for the USA," MPRA Paper
http://ideas.repec.org/p/pra/mprapa/2734.html
one can always refer to the case of Japan. To say that the USA is protected is a very dangerous overestimation.
Great blog longtime reader and first post. Reflation may or may not occur this time. The fiscal insanity is going to stop at somepoint in the near future and anticipate a deflationary depression.The housing issue as well as the credit issues make this one for the records. I do believe they will relfate this plane one more time but we are running out of bullets.History is on the side of eventual deflation.
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