Earlier in the week Barry Ritholtz posted this chart from Bronson Capital Markets Research. It shows 139 years of nominal returns for equities (probably somewhat familiar to you) along with 139 years of real returns.The real return component is called the Reversion To The Extreme Supercycle Oscillator. The fist observation one might make is uh-oh. I imagine the big thing should be the consistency in where the market has reverted to in the bottom of the channel and the very long period of time that these cycles encompass.
While there is some variation in where past cycles bottom out the chart obviously implies several more years of stock market malaise. The fundamental condition of the US economy, balance sheet, housing market, underfunded liabilities, employment situation and so on certainly creates visibility for a poor result for several more years.
I have no idea whether the current "reversion" will last as long as is implied by the chart and it is reasonable to question the utility of extrapolating from 1920 but as a supporting nugget to the more important current events it provides perspective for how long cycles can potentially last and how big some of the counter-trend rallies have been.
You can do with this what you want but not surprisingly I view this as yet another argument for learning about foreign markets and investing in them selectively.
David Kotok had what I will call a peculiar moment Friday morning on CNBC. He always says that his firm only uses ETFs in client accounts. The segment was titled Consumer Headwinds (based on the graphic on the screen anyway) and along the way Kotok disclosed being overweight discretionary ETFs and that they use two funds; the iShares DJ US Consumer Services Fund (IYC) and the Vanguard Consumer Discretionary ETF (VCR). So far so good I suppose, overweighting discretionary is either right or its wrong--not sure why they use two funds but ok.
Then he said "Melissa (Lee) pointed out to me earlier that one of them (the ETFs) has been lagging because Walmart is a heavy weight and has been dragging it down." Melissa then explained the point a little more and asked the reasonable question of whether, based on Walmart, the ETF will be "dead money." Kotok went on to sort of defend the ETF as being a way in for people who not pick stocks which he reiterated that they do not.
IYC is the ETF with Walmart, it has 8% and if VCR has any Walmart it is not in the top ten (I am quite certain there is not WMT in VCR given that it is cap weighted but I did not look at all the holdings). As far as IYC lagging VCR because of Walmart it was not clear what the time frame was in the conversation but YTD IYC is trailing by about 2% and for the trailing 12 months the lag for IYC was about 25%.
What was peculiar to me was that Kotok seemed to not know that IYC was heavy in Walmart. I believe he is the CIO of the firm and depending on how big they are the situation could be such where he says overweight discretionary stocks and then portfolio managers come back after the fact and tell him that this is how they did it. This sort of scenario is very easy to imagine.
The important thing is the point made by Melissa. As obvious as it should be it is vital to understand what is under the hood of any investment product. If you think iShares DJ US Telecom is the best way to own the sector you should probably know a thing or two about AT&T which has a 16.43% weighting in the fund.
As a quick reiteration of an old point it is unclear to me why any investment professional (and do-it-yourselfer for that matter) would limit themselves to only one type of product. Favoring something is easy to argue for but as useful as ETFs are there are of course gaps in what is available.
With some ETF segments all the choices could be bad. I have to think that for a while there every financial sector ETF was a bad choice. During the worst of it I was pretty open about the type of banks I owned--there were places that offered relative outperformance which is important for people not wanting to completely zero out a sector (this is true of many advisors). I have to think that if I found these things they were not that difficult to find but whether that is true or not, the typical financial sector ETF did not cut it.
If you are familiar with Kotok and have read his stuff you know he is no lightweight so I am not sure why he of all people is ETF-only.
10 comments:
That's a great chart, Roger. Going by that chart the next few years should be a great time to accumulate for those of us 'youngsters' who are looking at long-term (30 year) horizons, unless I'm reading it wrong. And as long as we're fairly balanced, diversified and not leveraged, plus saving enough and not making knee-jerk decisions we might even be able to retire in comfort!
Shame I didn't see the chart last March but what-you-gonna-do?
If Iran launches a nuclear attack there may be little choice but to counter with a nuclear attack.
1. Israel has nuclear weapons an is unlikely to act restrained or listen to anyone if tens of thousands of their citizens are killed.
2. Smart bombs and penetrating weapons are great in allowing the US not to use nuclear weapons in many cases. But, it takes months to deploy enough smart bombs to attack Iran. If you have to stop Iran tomorrow or in a week because you believe an attack on Rome, London, or Tel Aviv your only choice is nuclear weapons.
Lets hope Irans nuclear program is stopped before anyone has to make these decisions, because once they get nuclear weapons there may be few options to prevent the use of nuclear weapons.
The chart is nice perspective, but you can not use it to determine if this bull will end next week, next year or the year after that.
The chart tells us periods of run ups are followed by periods of decline. I think we should already know that, but reiterating points is necessary. I do not see this bull ending anytime soon even though I know it will end some day.
Yes there may be good buying opportunities in the future, but that is no reason not to be invested in the current bull market.
SEG
ETFs are based on indexes – indexes that are constructed and maintained by index providers.
The US Consumer Services Index (IYC) is maintained by Dow Jones and iShares licenses the index from them. IYC has inception date of 6/12/2000, so its been around a long time – certainly long enough during a huge ETF boom to collect assets. Yet as of Friday, IYC had assets of just $160 million. I personally already knew that Dow Jones is not considered the standard in institutional asset management -- but the assets in this fund demonstrate this even not knowing anything about the indexing world. Both S&P and MSCI are well-regarded and hence, they are both kicking IYCs butt up and down the block in asset gathering.
For what its worth, Wal-Mart is considered part of the Consumer Staples sector by both S&P and MSCI – and hence is a large component in XLP and VDC. Dow Jones classifies Wal-Mart as a ‘Consumer Service’ – to me, this is strange that DJ can’t even get this right – but alas, a good ETF analyst should spend at least some time understanding the construction methodologies of the index providers.
This chart shows very little variation between S&P and MSCI’s classifications --- that battle is just a war between the distribution power of State Street (SPDR) vs Vanguard.
http://www.etfreplay.com/etfimages/vcr_xly_vdc_xlp.png
blew the link, should end in .png
http://www.etfreplay.com/etfimages/03132010.png
The fact that there are several badly constructed ETFs out there does not fix or counteract the fact that accountants and mangers are fudging the books at many companies. This does not mean people should buy stocks, but it does mean people still need to investigate the ETFs they buy.
I think the chart is an illustration of the reversion to the mean principle. The fact that the value of the stock market is not a smooth line shows that value has two components; intrinsic (earnings growth rate + dividends) and speculative (expanding or contracting P/E ratios). This is the sort of stuff Ben Graham wrote about years ago. Avoid the speculative and concentrate on intrinsic.
The question becomes how useful is the chart? Well, IMO it is useful because it shows that valuations matter. It is not useful in that it cannot tell you on what particular date the market reaches a cycle maximum or minimum.
Where Graham's writings are really helpful when faced with trying to make sense of a chart like this, one has to evaluate it in the context of margin of safety. Engineers employ this principle all the time in structure design, portfolio managers IMO should do the same. Use the relative value of the speculative component as a way to hedge the margin of safety.
Roger,
Knowing of your firefighting background, I thought you'd be interested in this blogpost I ran across - "extended periods of drought, followed by high winds" = "extended periods of debt, followed by low interest rates".
The link is so long, I'm not sure the copy works, but you can find it on "ZeroHedge.com" if you look for posts by "Mikla".
regards,
JC Morris
Ogden, UT
(USFS)
http://www.zerohedge.com/article/long-periods-drought-%E2%80%A6-followed-high-winds
thank you for this John, I had not seen the article.
here is a more refined study from 2002: http://tinyurl.com/ykodnr7
Jeff from Milan, Italy
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