You Maniacs, You Blew It Up

David Van Knapp had a post at Seeking Alpha citing research that blows up the 4% rule, suggesting 2.8% might be the new 4%. The shift, if accurate, has to do with the current state of bond market yields and the threat possibility that yields may remain low for an extended period.

There is a massive psychological roadblock here IMO. The person who is able to accumulate $1 million very likely did so living a lifestyle far beyond the $28,000 that 2.8% would produce. You can plug in your own numbers into the equation to try to determine how much you need to save or how much of a reduction in lifestyle (financially) you might need to endure but to repeat something we've said many time before, if the 2.8% conclusion is right, which is that something's gotta give.

Although I don't think expressly stated by Van Knapp in this article, I believe his orientation would be to maintain a portfolio of dividend growth stocks and only withdraw the dividends, thus never touching the principal. For the right person this could work. A portfolio could be constructed that it does not take undue single stock risk, comprised of dividend growers that altogether yields three point something percent without having to load up on mortgage REITs and riskier MLPs.

There is at least one obstacle here as well. Often I talk about the idea that for most market participants the type of portfolio they have boils down to their interest in the task and their time available to spend on the task. It is not unusual to hear from retired people that they are busier in retirement than when they were working. If that is true then maintaining a portfolio of 20, 30, 40 or some other number of stocks (dividend or otherwise) would appear to be difficult from a time available standpoint. Obviously there is more than just the one obstacle.

One comment on the Van Knapp article listed several things that we have been talking about here for many years that I think are quite obvious. People need to save more money, they need to live below their means and they need to plan on having some sort of job past the age of traditional retirement age. I say some sort of job because many people don't want to stay at their same job or down want to maintain the same work week grind.

If a couple makes it to their mid or late 60s having paid off their mortgage, with no credit card debt and no more than one car payment then maintaining that same work week grind may not be necessary. If you love your job and it pays you $10k or $20k a month then sticking with it is a no brainer. Some sort of part time work that might be more enjoyable (like monetizing a hobby) can be economically effective though.

It is not implausible that all of the various monthly expenses for a couple with no debt or just one car payment could be $3000. If Social Security is there for them (for now it is) and they can make a combined $1000-$1500 per month doing something part time then the burden on the portfolio could be very light if anything at all. In this context the portfolio could be used for big one-off expenses and/or maybe one big trip per year.

At some point the part time income stream will probably end but a five-seven year run of little to no withdrawals would obviously be huge for increasing the odds of not running out of money. This sort of strategy relies heavily on behavior modification and I'm not sure how realistic this is across the board. For most it is probably unrealistic but there is some portion of market participants who can successfully modify their behavior if they need to.

Where a financial plan must have a certain rate of return to work, like a pension plan, it will be more difficult to succeed. If that is where you are now then hopefully you can recognize the need to make a couple of changes and then actually implement changes.
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Tuesday Twofer

My post disclosing our recent purchase of Medical Properties Trust (MPW) made its way to Seeking Alpha over the weekend. It prompted one reader to message me privately to note his opinion that the stock was better to sell (actually the time to sell according to him was December) because of insider sales. My reply;

There is always a bear case for every single stock in the market just as there is almost always a bull case. The decision to buy a stock comes down to weighing out both sides and then buying or not. Some percentage of decisions will be right and some wrong. This is no exception, it will be right or wrong simple is that. Insider sales are a good indicator except for when they are not if you take my meaning.   

The sentiment of my reply is likely very familiar to long time readers.

The other item is from a Jason Zweig article that ran over the weekend that looked at cognitive and behavioral issues related to investing including this;

People are revising their memory of the financial crisis, as if they were looking into a rearview mirror made of rose-colored glass. Financial planners report that clients are increasingly saying 2008 and 2009 were no big deal.

This is something we have touched on here as I think there has been a lot of this sentiment expressed in the comments here in the last four years. In 2008 there was genuine fear that the financial world was ending. The nature of extreme swings in prices is that they cause extreme swings in emotion and rational behavior. The article has several examples of this.

And of course this is guaranteed to repeat during the next crisis or bear market regardless of when it comes along. In the past I've talked about how at a time like now when stocks are are up people rationally say "of course bear markets occur" and they can tolerate the volatility but obviously that is much easier to say after four years of rising prices then in the middle of some sort of large decline "with no end in sight."

Before the crisis I used to say that it will be easier for some portion of market participants to endure large declines when they can think about them in advance, plan ahead (if they are ones to take portfolio action) and understand that large declines are a certainty, they are a normal part of the cycle. They are guaranteed to occur. The details are usually different but the market's response will not be unprecedented--in 2008 the details were different but the percentage decline at the low was not unprecedented.
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A Disturbing Parallel

The other day I mentioned my opinion on the extent to which the only ones that should have been bailed out were depositors into the banks, not the banks themselves or by extension bank shareholders or bank debt holders. There was a fair bit of pushback, all constructive I believe, just people drawing a different conclusion in noting a belief that things would have been much worse than they actually turned to be along with a couple of other threads.

There were also one or two comments that seemed to agree in some measure including over the weekend one from long time reader SEG. I have not changed my mind but of course we will never know what would have happened had a hard line been taken. There weren't comments stating a belief that what was done was a hard line so I think we can all agree that there was not much of a hard line taken.

Last week I also disclosed going to San Diego over the weekend for a fraternity function. It was the 50th anniversary of our chapter's founding. So a little more detail here. Our chapter lost its charter from the national fraternity a few months ago due to issues with partying and hazing in the last couple of years. Being long since graduated I have no idea what the specifics were beyond that.

The weekend function was still a big deal though and there were a couple of different big wigs there from the national fraternity and they each gave speeches. One on the main themes (the two speeches were obviously coordinated) was the extent to which the role that alumni are now playing in chapters which has changed dramatically, incomprehensibly really. The first speech was given by a guy probably in his mid 50's who described himself as a "chapter operations guy." The second speech talked about how they want alumni mentors for all of the officers of the chapter and alumni involvement in things like rush (recruitment of new members) along with a few others.

When I was in school (we had to walk five miles in the snow and gas cost a nickel, JOKE) the nature of it was that the younger guys learned some from the older guys and collectively we learned together, made mistakes together and then hopefully fixed the mistakes together. We were accountable and while there is clearly an element of luck in our not getting into trouble for partying too much (or whatever), the fact is we did not get taken down for partying and we were not given a chance to stop partying after getting in trouble and we did not then fail to effectively modify our behavior. The hazing thing is a different issue, there was no hazing when I was in the house as measured by any reasonable definition.

A successful man in his 50s who says he is a chapter operations guy is something that makes no sense to me whatsoever. I should note though that most of these people are donating their time so the chapter operations guy's heart is in the right place.

By now you can see the parallel I'm drawing between the two. Markets and (what I know of) fraternities are stronger when participants are accountable for their actions and/or decisions. If you buy a stock or bond of a company that fails for whatever reason then you need to understand and own the consequence. Part of understanding an owning is learning by doing, learning by experience and by making both good and poor decisions.

In both examples above the extent to which people are given the opportunity to learn on their own without overly intrusive hand holding is diminishing and net net I think that is a negative.

The first picture was from the drive out to San Diego in either Ripley, CA or Palo Verde, CA and the second picture is sunrise on Sunday and the view is of downtown San Diego.
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The Big Picture for the Week of February 24, 2013

Over the course of a couple of hours on Thursday morning we bought Medical Properties Trust (MPW) for most large accounts and RRGR (the ETF our firm subadvises). We've had a little cash build up from the Heinz sale and from some dividends. The timing of the purchase was such that the market had a bad day Wednesday and so I decided that if it had a lower open on Thursday we would buy some stock and that is what happened.

Often when the market starts to pullback I have thought the pullback will be more than it ends up being so I made a conscious effort to realize that market seems to want to work higher and that maybe I should take advantage of an almost 2% pullback instead of waiting for 5% or the 10% a lot of people think is right around the corner. If we get that kind of pullback we still have dry powder.

As far as buying a REIT, I view MPW as having different demand characteristics than REITs that own shopping malls exclusively or office property exclusively. MPW operates hospitals, rehab facilities and urgent care facilities which plays into how the US' demographics have been evolving and could play a bigger role in how healthcare is delivered (urgent care), at least I think it will.

I think that the line of business it is in will make it less cyclical than other REITs but the company does a lot of transactions and so if the capital markets were to freeze up like in the fall of 2008 then  MPW should be expected to get hit hard. Note that the market going down a lot at some point is not the same thing as markets not functioning normally and I don't think another freezing up is in the cards.

The specific timing of the purchase turned out to be a little lucky in that our average price was below the closing price and then the name was up a little more on Friday. The reason to bring this up is that occasionally someone will be incredibly unlucky with a purchase. Someone, a lot someones actually, bought VeriFone (PAY) Wednesday near the close at $31.89. Unfortunately for those folks the stock opened on Thursday at $19.99 presumably for guiding earnings to $0.47-$0.50 when the consensus had been $0.73-$0.80.

Although not a black swan it is clear the market did not see this guidance coming. Any stock can get hit hard because of earnings related news but some are more likely to get hit hard in the face of bad news and some less likely. One surprising niche that seems to get hit hard due to earnings related news is medical testing. Check out the charts of Quest Diagnostics (DGX) and Lab Corp Holdings (LH) and you will see some very fast declines. In the case of DGX and LH this isn't terrible because it isn't uncommon and the stocks do make it back. The huge drop in PAY obviously will not be as easy to come back from (I don't follow the name so I have no opinion about it).

When you buy a stock you buy a stock you obviously think it is going to do well and if Yahoo Finance is current there were three analysts who liked PAY enough to rate it strong buy. Over the course of an entire investment lifetime it is reasonable to expect that at least once you will be incredibly unlucky with the timing of a purchase. It hasn't happened to me yet but at some point it will.
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Getting Rich Slowly

This weekend I am headed over to San Diego for a reunion for my chapter of the fraternity I was active with which is celebrating its 50th anniversary. It will be a good chance to see people who were very important many years ago and lie about how much money we make and how much we can still bench press.

On a more serious note I haven't seen too many of these guys since the 1980s (although have reconnected on Facebook and LinkedIn) so this is a milestone event of sorts. We all have these occasional milestones and they are logical times to take some kind of inventory of where we are and how we feel about where we are. Also relevant is whether we are on a path that gives us a chance of getting to where we want to go.

This has plenty of investment relevance in my opinion. I've mentioned quite a few times that when we figure out what is important to us that we then are more like to invest properly.

On a related note is this article at IndexUniverse that takes a very detailed look at how low volatility investing outperforms in the long term. This is along the lines of getting rich slowly which Barry Ritholtz mentioned just yesterday.

The way I view this is that once you get your life stuff together and can look at your big picture you can then really understand that what matters is your long term investment results. It simply doesn't matter whether you beat the market this quarter or this year because very quickly you won't remember your investment result from this quarter or this year. Without looking, how'd you do in the third quarter of 2011?

Obviously everyone comes at this differently, the above is how I come at it and obviously not everyone agrees with the above; no single approach can be right for all investors but you will make things much easier for yourself when you sort what is really important and how you should invest.
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Understanding the Bull Market

Nassim Taleb was on Bloomberg TV yesterday making an interesting point (his TV appearances have been less interesting in the last couple of years) that although made many time before in many places is still important.

The objective behind much of the Fed, Treasury and government policy has been to try to avoid the full consequence of recession and crisis but what has actually happened is that recession and crisis have gone on much longer than the otherwise would have. Saying "recession and crisis" is not the most accurate description but we have not had a proper recovery from the recession and crisis of 2008.

My view all along has been that if the US had done the difficult thing (let the banks fail, let equity and debt holders face whatever came and only protected depositors) we would have seen real and organic recovery by now. Although the US has far more moving parts, Iceland offers an example of a country that actually fared worse than the US that then did the difficult thing and started to show signs of real recovery in just a couple of years. The US is now four, five or even six years on (depending on when you start counting) and we have many data points that are still weighed down from the crisis.

Of course none of this has prevented the stock market from soaring. I saw somewhere that investors lost $16 trillion in the Great Recession but have now made $13.5 trillion back. To be crystal clear, regardless of anything else stocks have done very well in the last four years, there's no doubt about that.

In many blog posts I have talked about the need to at least capture most of the effect. The market doubled in about three years from the 2009 low and that type of lift doesn't happen often. Not missing a huge move needs to be balanced out with understanding the world today. The market is up a lot but it is up without the normal fundamental strength that goes with economic recovery and expansion. The bull market is now long in the tooth at 47 months and there is quite a bit of positive sentiment. This could continue for many more months of course but it makes sense to especially alert for any subtle signs the the bull is ending. The first signs are always subtle.
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The Right Tools For The Job

For any newer readers who may not know, I have a second job as the Fire Chief for the all-volunteer department where I live. My entire involvement is a lot of fun. Part of the equation is trying to help the department evolve on all levels, big and small. I work closely with the other (professional) departments on ways we can make progress on a whole range of things-- we are just about the only all volunteer department near here.

One tool common to other departments is some sort of command vehicle. For many departments the amounts to a Battalion Chief in an SUV overseeing the incident (Incident Commander) and typically the SUV has tools and other supplies that might come in handy if something can't be found on the engines or an extra in case something on the engine breaks. 

After giving it some thought I think we are going to add a couple of enhancements to one of our older brush trucks (a Type 6 Engine) to make it a dual purpose Type 6 and Command Vehicle. We don't need to spend money modifying anything we will just need to add some equipment here and there so that it can still offer safety for me if I need to go size up a fire before anyone else can respond (it will still have 300 gallons of water and a pump) but also serve as an additional resource when we have a wild fire that is more than a tree struck by lightning. 

For example one thing to add would be my EMT bag. When we have a structure fire it is standard procedure to have an ambulance dispatched to the scene and standing by just in case. For whatever reason this is not standard procedure on a wildland incident. It would also make sense to have extra water and Gatorade and flagging (like non-sticky tape to mark where to turn while driving to the incident) if I'm the first one there and the route in is not obvious. There are a few other things that we could add and make it a pretty useful resource in addition to still being a functioning Type 6. 

So it is in our financial lives, the need to utilize available tools to map out a decent plan while still taking into account things that can reasonably go wrong (a sprained ankle at a wildfire is far from a black swan so having a SAM splint or two nearby makes sense). Financial tools can include an actual financial plan, investment products, various IRAs, the ability to do research on the internet and your own common sense. 

Plus there's always pictures of neat looking fire trucks to be found....enjoy the day off.

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Sunday Morning Coffee

The Barron's cover story was titled Next Stop Greece and offered a very grim assessment of where this country is headed in terms of the consequence for what for now looks like a straight path to $20 trillion in debt and the problems that go with our aging population. Gene Epstein lays out a case for a depression in the 2020s or 2030s and a 20% unemployment rate. Epstein has been the economics columnist for years and typically does not draw extremely pessimist conclusions like this.

The article relays a series of possible outcomes determined by the Congressional Budget Office (CBO) and then goes from there. I'm not going to recite the article but among other conclusions was the very obvious idea that taxes will have to go up for everyone, that means everyone. There will also have to be spending cuts that are painful to some segment of the population. One problem of course is that we lack the political will to do the difficult thing and this seems likely to remain an obstacle for a long time.

The article also includes a bit on "the risk that Uncle Sam would have to renege on promises made to people over 65" which of course is Social Security and Medicare. CBO stresses the need to get started fixing things immediately so that people would have time to "plan and adjust their behavior."

Concerns along these lines have been around for a long time and the threat seems to be getting more serious as we begin to understand the demographic problem embedded within and perhaps also because if something bad is going to happen we are obviously moving closer to that time.

That the issue is not new and that the conclusion of the article is that this won't really hit the fan for quite a few years then we all have years to be able to "plan and adjust our behavior" if you haven't done so already.

My perspective is that of people solving their own problem, or maybe more correctly, preventing their own problem. One very tangible solution that we've discussed countless times is living below your means. I write about this frequently because it comes easy for me. I've disclosed before that my parents made some poor choices in their 30s and 40s and I was able to understand the consequences of their choices when I was younger. If your expenses are low then it becomes much easier to endure any sort of financial shock like losing your job.

For many years I have been saying that I don't expect to get Social Security. I realize there are plenty of people who disagree with me on this but we continue to kick this can down the road and I can see some President and some session of Congress that will be painted into a desperate corner and will be forced to start whacking away at benefits and I believe this will come down the income scale much further than people think.

My own plan is to do all I can to have enough when I need it assuming no social security. You may disagree with me of course but if something bad is coming we have years to prepare (repeated from above for emphasis). I've said many times that where all of this is concerned, something's gotta give which means that something is going to have to give.

And on a lighter note, the picture, I was watching a rerun of The Sopranos and Furio said "I gonna go watch Bloomberg." I thought that was hysterical. Interestingly, reruns on HBO stand up over time but when it was on A&E I thought it was unwatchable because of the editing required.
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The Big Picture For The Week of February 17, 2013

Thursday morning it was announced that Berkshire Hathaway is teaming with 3G Capital from Brazil to buy Heinz (HNZ). Many of our client accounts own HNZ as does RRGR, the ETF we manage. I should say owned, as I sold the position within the first 40 minutes of Thursday's session.

The quick sale after the news is consistent with what I have done before with takeovers or rumored takeovers. Typically the first reaction will account for the vast majority of the total move. In round numbers, HNZ popped $12 on the news, sticking around for another $0.50 would risk holding on for the deal to unravel and have the stock go back down. That isn't how HNZ traded, that was just an example.

It was nice to get the boost we did from it but there is a downside. HNZ was generally a low vol high yield name. Relative to what we own this was a simpler holding to keep track of. We owned it for many years, sometimes it was a top performer and sometimes it lagged but it just chugged along as a good proxy for the staples sector (you can compare to XLP) but with a higher yield. It outperformed the S&P 500 for the last five and ten years but lagged for the last 15 years.

The downside is that now we have to think about how or if to replace Heinz. Heinz fits in well to the conversation we've been having for the last couple of weeks about demystifying stock picking with names that are familiar and relatively easy to follow compared to other kinds of stocks. Heinz has been around forever, isn't likely to go under and may or may not be a world beater but it is no surprise that it has been a decent proxy for the staples sector.

Maybe we could replace it with Clorox (CLX)? Note that this is a hypothetical scenario. I don't follow Clorox but it has been around forever, isn't likely to go under but not having ever followed it I don't know how it has done without looking (so it is a random choice).

As it turns out for most of the past five years it has been better than a decent proxy for XLP --it looks like it outpeformed HNZ coming off the 2009 low but HNZ has done a little better recently. CLX also outperformed the SPX for the last five years. For ten years it lagged a little behind XLP but was better than SPX and for 15 years it has actually outperformed meaningfully. I looked up the performance after writing that first paragraph mentioning CLX, I want to stress I picked it randomly as a name I don't follow. It currently yield 3.2% which is not high for a staples stock but it looks like it has a pretty good track record for  growing its dividend.

Going forward I have no idea whether it will continue to outperform or whether it will lag but it is very likely to be a decent proxy for staples.

Hopefully it is obvious that this idea of simplicity does not apply to the majority of stocks or even the majority of sectors. Like in tech for example, I think a lot of people would say they know Cisco but it has not been a good proxy for tech. In the last five years CSCO is down 9% while the iShares Tech ETF (IYW) is up 38%. For ten years CSCO is up 53% versus 134% for IYW. Dell which is probably just familiar if not more so is actually down 42% for ten years. IYW is a client holding.

In past posts I've talked about it being reasonable for some investors who are willing and able to spend some time on their portfolio to own a few stocks along with their funds and I think the above is consistent with that idea.
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Avoiding A Risky Stock Is Just As Important As Picking A Good One

CenturyLink (CTL) cratered 22% yesterday after reporting weak earnings, weak revenue, a poor outlook and a cut in its dividend. A few years ago CTL bought the much larger Qwest Communications. The company has a huge debt load and for a long time popped up regularly on stocks screens and articles about dividends for its high yield which before the price drop and the coming dividend cut was about 7% compared to 5% for AT&T (T) and 4.6% for Verizon (VZ) which some clients own.

It is typical for telecom companies to carry a lot of debt but CTL has a lot of debt relative to its peers. During the day I got an email from a PR firm for the AdvisorShares Ranger Equity Bear Fund (BEAR) noting that the fund is short CTL because "We knew the company's dividend was at risk. The company did a capital lease that overstated its free cash flow. There's no way they could cover the dividend," among other reasons.

I don't follow the stock so I'll take their word for it. A point I have been making here for years is the extent to which dividend yields can be a signal of how much risk shareholders are taking and CTL is one kind of example with this.

Another more striking example is Alaska Communications (ALSK). This first popped up on my radar a few years ago after getting a favorable mention in Barron's. It had something like an 8 or 9% yield. The dividend was very steady for quite a few years without much growth then it was cut dramatically before being eliminated. The stock price was somewhat volatile trading from $8 to $16, back down again and then up to around $11 a couple of years ago and now it is under $2.

It is probably a leap to say the CTL is headed the way of ALSK but it is not a leap to have realized that CTL paid a much higher dividend and had a lot more debt than its peers and so wouldn't have taken a lot of time to decide to leave it alone.

It is important to understand the relative nature of this stuff. A 5% yield isn't crazy for a telecom company but maybe it is for something like a gold miner unless the miner is structured as an MLP (don't know if there are any gold miners that are MLPs).

The picture is of a tree tent (who knew?) and has nothing to do with the post.
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Sing Dollar ETF is Here

A short post, yesterday was my wife's birthday and we went out to dinner and I usually write at night.

Guggenheim launched a Singapore dollar ETF with the symbol FXSG. Guggenheim bought Rydex at some point and of course Rydex launched the first currency ETFs. Many years ago I asked a Rydex exec, his name might have been Steve Sachs, about launching this fund and he said there were obstacles to Singapore but apparently they worked them out.

Singapore is generally a very stable currency and is a benchmark of sorts in Asia or maybe better thought of as a relative safe haven. The chart shows the pretty slow and steady decline of the US dollar compared to the Sing dollar except for the worst of the financial crisis. The hit to SGD during the crisis though was nothing like the drop in the iShares Singapore ETF (EWS), which is equity exposure--EWS was down 60% at its worst. 

Over the years we've done a couple of things with currency ETFs although it has been a few years since we last used one. I imagine we'll use currencies at some point again but I'm not sure when.

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Not All Stock Picking is Wildly Complex

I wanted to continue on with a concept I brought up recently about stock picking despite the ruckus it raised. In trying to demystify stock picking a little I said that there are some stocks that can serve as reasonable proxies for decades. They may not "beat" the market but they can be great holds and don't require a degree in forensic accounting to understand and follow.

In the post from a couple of weeks ago I mentioned several stocks (that we do not own) that fit the bill. Another one to mention in this context that we also do not own in Chevron (CVX). The company has been around forever although the name has changed a few times over the years and there has been M&A activity along the way. 

Since the debut of the Energy Sector SPDR (XLE) in 1998 CVX has lagged XLE noticeably but going year by year there have been many times that CVX has outperformed. CVX has been a decent proxy but not a world beater and the company is nowhere near as complicated as something like a mortgage REIT or insurance company. Going forward it is very likely to continue being a decent proxy (it also has some yield) even if it doesn't beat XLE for the next ten or 15 years. 

This compares to a stock with much different attributes that was extremely popular a few years ago but has since fallen on hard times and was taken down pretty aggressively at Seeking Alpha; Nordic American Tanker (NAT). NAT used to pay out a very large dividend (quite often it was actually a return of capital) and the CEO was on stock market television very frequently although I never understood why. 

I've written about NAT twice on the blog that I could find. One time I included it on a listy post about combining higher risk and lower risk names to build a sector allocation and I mentioned it again with a much more skeptical tone noting among other things my suspicion about the CEO's performance on stock market television. In that second post I said the space was valid but that the CEO made me uncomfortable relative to ever buying NAT which we never did. Based on how many stocks in the shipping group have been crushed without every coming back maybe the space isn't valid. NAT is down 75% from its 2008 high. 

The last time I mentioned shipping stocks a reader pointed out Navios Maritime Partners (NMM) as being an exception. I don't know if it is an exception but it has done better than many other shippers. 

It probably would have been easy to have been sucked into this stock a few years or at least infatuated with it because of how often the CEO was given a platform to speak and how articulate he is. As someone not having a forensic accounting degree however it would not have taken long to realize that the company is far more complicated than something like Chevron for several reasons including the many secondary offerings. The very high yield back then would have also been a clue for risk even if not complexity.

This is not a post about being anyone having to be a great stock picker. I would contend that picking a name like Chevron, even if it does fantastically well, is more about picking what you know and what is a little easier to understand and avoiding something like NAT is about avoiding the complex. Investors who keep it simple and have an adequate savings rate are giving themselves a very good shot to have enough money when they need it.

To be clear, CVX is simply an example, we have no plans to buy the name. One other point to make is that I pay attention to all sorts of stocks including complicated names like NAT (even though we never bought), it is one of the things that makes the job so fun. 

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Luck and Position Management Revisited

In the last couple of weeks or so I've had posts about understanding the role luck plays in portfolio management and the importance of managing position sizes in the portfolio. Both of these ideas converged yesterday when client and RRGR holding Novo Nordisk (NVO) took a swift kick in the stock price after the FDA said ni to Tresiba.

In terms of revisiting luck, a couple of weeks ago we rebalanced our position down in the stock. This was not across the board but was a case by case rebalance and not every client sold. Clients at 3% didn't reduce down to 2% for example but some for some clients it was prudent to sell down some shares based on how large the position grew for them.

From the market's perspective I would say there was no chance that Tresiba wouldn't be approved. This turned out to be incorrect of course. I will say that this does seem like an odd development. Odd or not, that we sold any stock before the drop certainly was lucky to some extent, a lot or a little I don't know but certainly luck was involved. However, it was also bad luck that we didn't sell more at that time.

This gets us to revisiting the need to manage position sizes which we talked about recently (linked above) with the one advisor who apparently didn't manage his clients' Apple (AAPL) at all. If you buy a stock and hold it long term then there are three possible outcomes. It will either grow somewhat inline with the portfolio (so probably won't need to be rebalanced), will do noticeably better than the portfolio (which might then require action) or will do noticeably worse then the portfolio (which might require a different action).

Some people have objective trigger points for this sort of thing but I don't. The way I view it, actively managing a portfolio means keeping tabs on the news and the price action of each holding. Objective trigger points are not right for me but may be right for you. It doesn't necessarily matter how you go about this as long as something is done in this regard.

It is not possible to be precisely correct with every rebalancing trade but that isn't really the point, the point is managing risk.

One curious aspect of this episode is that NVO dropped down to where it was just five weeks ago.
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Permanent Portfolio By A Different Name

Jason Zweig had an article over the weekend that although didn't say so, offered a variation on the Harry Browne permanent portfolio. Browne advocated for 25% each into stocks (via a broad, domestic index fund), long term bonds, gold and cash with the idea being that this mix would always have at least one thing doing well no matter what came along in the world. The results have generally been quite good looking back but obviously the past 30 years as been a heyday for long term bonds.

Zweig found an advisor who uses four different buckets than Browne; expansion where you would have stocks, real estate and commodities, recession where you would have bonds, in the inflation bucket you would have TIPS and commodities again and in the deflation bucket you would have stocks and conventional bonds.

Note that the suggestions in the preceding paragraph are from the article not from me. The comments on the article are worth reading. The article points out that allocations like this are not about striking it rich but more about preserving the nest egg and growing it slowly. Any mention of nest egg merits this photo of Albert Brooks and Julie Hagerty from Lost In America.

I tend to believe that the best path is a simple stock bonds cash allocation but it is still worthwhile to explore these types of ideas all the same. They can be a useful influence on a simple portfolio and maybe one these alternatives will turn out to be the Holy Grail.

The starting point of the article was that the blending together of historically lowly correlated assets works great until a crisis comes along like in 2008 when correlations went way up and almost everything went down a lot at the same time.

Conceptually these buckets are interesting and I would add a fifth that I think is consistent with preserving the nest egg and growing it slowly; an emergency cash bucket for however you define emergency. This could include X number of month's expenses, an amount equal to the biggest one-off emergency you've ever had or something else but an amount sufficient to make you comfortable.

The contents of each bucket as outlined in the article seemed a little thin because of the overlap in buckets. It may also not be especially forward looking either especially for the inflation bucket. I am a huge believer in TIPS exposure, buckets or otherwise, and TIPS have done well generally but for the last few years headline inflation has been nonexistent but it has been pretty high for several real world expenses like health insurance. In the future, if inflation looks the same as it has for the last few years and rates are moving up then TIPS might not be very effective.

As far as commodities working well as inflation protection everyone probably understands the argument and I generally believe in it to a point but there is some measure of reliance on the next inflationary period being like the one in the mid to late 1970s. It probably will be similar but what if it is not?

There needs to be a little more detail to simply putting equities in both the expansion and the deflation buckets. Anyone actually doing this strategy would probably want deeper cyclical stocks and other generally more volatile segments in the expansion bucket. In the deflation bucket you would probably want more defensive exposure and a distinction needs to be made between a deflationary environment which we kind of had a few years ago and a true deflationary debt spiral which a lot of people were worried about a few years ago but never actually materialized (yet?). In a true deflationary spiral you probably don't want equities.

It is not practical construct a portfolio today that can protect against unknown crises tomorrow because we don't know what tomorrow's crises will look like. Maybe there will be some event where we should own a lot of foreign currencies or something else not included in the article. One assumption in the article seems to be that you need to construct your protection now and don't bother trying to analyze what comes down the road later. For someone who is actively engaged in markets it  makes sense to understand how the next crisis starts to unfold (there was plenty of warning ahead of the Great Recession which I wrote about in 2006 and 2007) and reallocate accordingly.
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Sunday Morning Coffee

A fun post that is not stock market related. We had a snowy Saturday here in Walker and after Fire Department business and some college hoops there were all kinds of Jason Bourne movies on. We've had some fun here over the years pondering the content of Jason Bourne's go bag which was in a safety deposit box at the Gemeinschaft Bank in Zurich and also maybe a couple other things that might come in handy that were not already in there for him.

The two pictures give some sense of what he's got in there to start with including a lot of cash (the equivalent of $5 million per the above link), six passports, a Sig Sauer, a thumb drive, a wrist watch, a couple of things that look like tools, contact lenses, a credit card and a few other items.

From the tool standpoint he could probably use a Leatherman, a pocket knife (if his Leatherman doesn't have a blade), a small role of duct tape (these come in handy during wildfires so maybe for Bourne too), a small LED flashlight and a GPS device.

For more personal items, Excedrin or Motrin (he has a problem with headaches), Bandaids, Neosporin and a couple of Cliff Shots if he's hungry.

He might want a couple of clothing items too. Bandannas always come in handy, a hat of some kind if it is cold or to disguise himself somewhat (although he doesn't seem to do that very often) and for when it is cold there are hiking shirts that are very lightweight but very warm.

A couple of miscellaneous items he might need would be leather gloves and a smart burner-phone of some sort (taking a picture and emailing from his anonymous Gmail account might come in handy).

Lastly he will need a waterproof bag to put this stuff in. He ends up in the water quite a bit and he'd probably appreciate having everything still being dry.

Another bad ass spy from a different movie.
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The Big Picture for the Week of February 10, 2013

Mark Hulbert posted an article that was skeptical of what is being referred to as the great rotation. The great rotation is the supposed shift from fixed income to equities because many boomers are believed to be underweight equities. So if/when this happens it would lead to much higher equity prices.

Hulbert says ni to this idea. As he puts it "all stocks and bonds currently are owned by someone. There is — by definition — no under- or overownership." This is an oversimplification in my opinion and distorts quite a few real world factors.

All stocks are owned by someone but someone can include inventories of professional market participants whose job it is to provide liquidity not actual investors. Further, if two investors currently own no equities and decide on the same day to go back in and coincidentally decide to buy the same stocks and funds then depending on the circumstance they may be in competition for the current inside offer.

If our two investors want to buy 1000 shares Transatlantic Zeppelin (one of the stocks in Montgomery Burns' portfolio) then there is buying demand for 2000 shares. If the current offer is $25.41 and is good for 1000 shares only, then one of our two investors will get that 1000 shares offered at $25.41 and the second investors will either need to pay a higher price or wait until another seller is willing to sell at $25.41 and of course no one may be willing to sell at that level ever again (the risk of using a limit order instead of a market order, of course market orders have risks too).                                            

If a lot of cash comes into equities, great rotation or not, then demand will likely exceed supply and prices will go up (not a prediction, just basic economics). Such an increase could persist for an extended period or not but the argument that the great rotation can't matter because every share is already owned is simply incomplete.

The better question is whether this will matter. If the great rotation does occur it will simply be a positive catalyst for equities but will not ensure equities go higher. At any given time there are a series of positives and negatives for stocks. You may conclude the great rotation is meaningful and then you will either be right or wrong just like anything else.

As far as my take on this I tend to believe that demographically driven flows of capital can move markets for an extended time however I don't think that is what is in store for stocks, that is to say I don't think there will be a great rotation resulting in a 1990s like rally stemming from investors rotating out of fixed income in the manner Hulbert is referring to.

The Great Depression drove some segment of the stock-buying public away forever and I believe that has also been the case with the Great Recession too (more precisely the 2000s). I believe some portion of the investing public fled stocks, was willing to go into bonds and if they get punished in the bond market then the next stop for them is the mattress (metaphorically speaking).

That is not to say that stocks can't go up just that any rotation won't be so great.

FYI Barron's is free this weekend.
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Position Management

The other day on CNBC Simon Hobbs and Melissa Lee were interviewing a portfolio manager who is a semi-regular on the network about his position in Apple (AAPL). The way I heard it, he started buying the stock for clients in 2003 and continued buying for new clients as they came aboard subsequent to that first purchase.

He said at no point has he sold any shares and so Simon and Melissa tried to pin him down on this point. During this cross examination the PM said some clients had their position grow to more than 10% but again no shares were sold and Simon and Melissa pretty much attacked him and most of what I heard from him were a couple of salesy comebacks like how can you lose money when you're up and he also seemed to be saying he does not think anything is wrong with the company. Simon actually accused him of not managing the position.

We'll get to the position management in a moment but I can imagine that this guy may not have been prepared for such a grilling. Maybe he brought that on himself just by what he said or maybe he submitted notes to them beforehand and the anchors planned to pursue this but either way I can believe he wasn't expecting such a rough segment.

It is also perfectly reasonable that this guy doesn't think anything is wrong with the company. He might be right, yes it is down a lot and I have drawn a different conclusion but he might turn out to be right. He could also be wrong. Being wrong about a company is not the worst thing, every manager gets some number of calls incorrect.

However it is not ok if he really did not manage the position as Simon alleged. What he described he had done sounded to me like not managing the position and obviously this was the point the anchors were making and he didn't really defend the inaction very well but not being clients or employees of the firm we can't know precisely what happened.

Any clients of his who had more than 10% in AAPL as he said up at $700 have endured a meaningful drag on their portfolios but I was wondering about that 10% figure he tossed out. According to Morningstar $10,000 put into AAPL ten years ago would have been worth $943,000 when the stock was at $700.

Let's say the firm has a $500,000 minimum, which is quite common and to keep the math simple we'll assume 100% equities, and ten years ago they allocated 1% to AAPL and never sold a share then at the September high the stock would have been worth $471,500. During this time period the S&P 500 TR was up about 95% so the $495,000 not put into AAPL ten years ago (assuming a market equaling return) would have grown to $965,000 so in this example AAPL would have been almost 34% of the portfolio.

Even if only 0.50% went into AAPL and the rest of the portfolio went up 150% it still works out that AAPL would have been 19% of the portfolio.

Obviously I've made several assumptions in trying to crunch these numbers but I can't figure how they could have bought ten years ago, not sold any stock and have the position only be around 10% of the portfolio at the peak.

The portfolio manager might not think his clients have lost anything because they are still up from where they bought in but I wonder how many of his clients who know, see it the same way as him.
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Add One More To The List...

...of unbudgetable one-off expenses.

Our stove died (my wife says it is called a range) and we had to get a new one. The old one came with the house (we just moved in November) and apparently was on its last legs. Things like appliances don't break very often (hopefully) but when they go they have got to be replaced right away.

It can be easy to carried away with how much gets spent on a new (in this case) stove range and as you can see below we went all in, all in.

That is a Molteni range and if I am reading the Spend Like a King blog correctly it costs $106,000 and is not what we bought. Home Depot was having a sale (what a coincidence!) and we got one for just under $1000. Had we needed to go cheaper we probably could have gotten one for $400 (on sale) and obviously based on the Molteni the upper end is infinity--we have propane and those cost a little more than electric, I believe.

We have had discussions here in the past about how to try to budget for the unbudgetable. This sort of expense, the one off, often falls through the cracks of the financial planning process but of course there will always be things like appliance replacement, new tires, unexpected vet bills (god forbid the dog swallows something for the dog's sake and the wallet's sake), something with the roof, even new toothbrush heads (electric toothbrush reference).

It would seem unlikely that whatever your frequency is with these things it would decline once you retire. One way to try to understand the magnitude for your situation might be to fire up the Quicken and start counting for the last couple of years. This may not end up projecting forward too well but but at the very least it might put the issue into better context for anyone who doesn't know how much they have spent on these types of things.

Oh and the harvest gold stove above was not our original stove.
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Follow Up to Yesterday's Cluster of a Post

The point of yesterday's post was misconstrued by many so must have been poorly conveyed by me. For the do-it-yourselfer;

1) Focus on the real goal which for most is having enough money when you need it, not necessarily beating any index. Having enough when you need it comes from a combination of savings and growth.

2) Someone who wants to use individual stocks but not make a full time job out of it could probably pick ten household megacap domestic names, combine that with an adequate savings rate for the next 20 years and have a decent shot of having enough money when they need it.

3) If over the next 20 years the S&P 500 goes up 400% then in my opinion picking ten stocks from the current top 40 in that index and spreading it out sector wise might give a result of up 300% or maybe up 500% (or any other number) but get the investor pretty close to having enough for retirement provided they also have an adequate savings rate. They will not be up 1000% in an up 400% 20 year period nor will they be up 50% in an up 400% 20 year period.

4) More specifically, of the ten it is likely that one company would go bust, at least one would be a huge home run and the rest would be a little ahead or a little behind the market but again, provide a reasonable chance of having enough even if the ten did not beat any index.

The reader question that prompted the post said winning with stocks was very difficult to which I replied that it depends on how you define winning. A reasonable definition of winning is having enough when you need it and that was what yesterday's post tried to explore.

I should also again point out this is not a recommendation for a strategy. It is an attempt to demystify the use of individual stocks.
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Charlie Sheen Portfolio (winning)

A reader left the following comment on yesterday's post that I thought was worth exploring further;

Winning at stock picking over the long haul is very, very difficult business, but not impossible.

The first thing is, what does winning mean? As a long running theme here, one way to define winning is that the investor has enough money when he needs it, like at retirement. One way to get there of course is to save a lot and be in the ballpark performance-wise. With this in mind I wanted to spell out how to win in this context without being some sort stock picking genius. Below is a stock portfolio that someone who regularly read Smart Money and Money magazines regularly might have assembled in early 1993 (so 20 years ago).

Financials Fannie Mae and Bank of America
Healthcare Merck
Tech Microsoft and Intel
Industrials General Electric
Energy Exxon
Telecom Southwestern Bell
Staples Procter & Gamble
Discretionary McDonalds

These were all very popular stocks 20 years ago and the 1990s was a heyday for the equity market.  A couple of notes on the list include that I believe BAC's chart would actually be Nationsbank as when they merged it was the BAC name that survived but not the shares. AT&T is actually Southwestern Bell because the original T is no more. Picking a mainstream financial stock going back so far is difficult because similar to BAC JPM has a lot of Bank One, Chemical and if I am remembering correctly I think Chemical bought Manufacturer's Hanover. Maybe Wells Fargo would have been a better choice.

Putting $10,000 equally into each of the ten names until early 1999 would have worked out as follows;

Fannie Mae $42,089
Bank of America $30,051
Merck $33,843
Microsoft $161,845
Intel $107,089
GE $55,853
Exxon $28,760
AT&T $38,058
Procter $40,877
McDonalds $33,792

This would total $572,257 versus $332,519 putting the entire original $100,000 into Vanguard S&P 500 (VFINX). Having made no trades, by the summer of 2002 the values would be as follows;


Fannie Mae $45,831
Bank of America $34,029
Merck $30,279
Microsoft $88,746
Intel $57,496
GE $54,077
Exxon $32,586
AT&T $21,134
Procter $42,919
McDonalds $21,634


The total in summer 2002 would have dropped to $428,731 and the all-VFINX option would have been at $247,508. At the 2009 lows this is what it would have looked like;



Fannie Mae $280
Bank of America $5219
Merck $17,525
Microsoft $8787
Intel $9810
GE $15,720
Exxon $65,923
AT&T $22.837
Procter $48,743
McDonalds $53,346

The total at the March 2009 low would have been $248,190 versus the all VFINX option at $207,650. Finally, having held on to all ten through Friday;



Fannie Mae $219 lag
Bank of America $17,741 lag
Merck $36,574 lag
Microsoft $128,179
Intel $123,133
GE $56,425
Exxon $103,722
AT&T $47,014 lag
Procter $87,528
McDonalds $109,351

Today the portfolio would be worth $709,886 versus $513,903 for all-VFINX.

Of the ten stocks, four lagged but the long term total result obviously outpeformed. Keep in mind also that some of the names still greatly outperformed even after having done nothing for the last ten or more years. I did not change the list during this number crunching so I did not know what the outcome would be but being right a little more often than being wrong would have delivered a very good result despite some periods of extreme lagging for the ten. 

The point I intended to make was about rebalancing. I am a big believer in selling partial positions for any holdings that go up much faster than the market. While I would be clear that 10% in ten stocks is not how I would ever construct a portfolio we can stick with the example. At the 1999 check point MSFT had grown to 28% of the portfolio and INTC 18%. In targeting 10% weightings here I don't know if at 18% I would have rebalanced INTC down (never started with 10% in one stock before) but I do think I've laid the groundwork to say with credibility that MSFT would never get to 28% after having started at 10%.

If money had come out of MSFT and gone into Fannie Mae then interestingly enough the rebalancing argument weakens if we stick with the same ten stock universe.

Due to Super Bowl time constraints I will move this along to a conclusion. If you were to pick the same nine stocks for the next 20 years, omitting Fannie Mae, I imagine some would beat the market, some would lag and maybe one of the nine would be effectively out of business. The result might be ahead of the market or maybe not but combined with an adequate savings rate I bet the investor holding the group would at least be in decent shape. 

Please notice that I don't have any ownership disclosures to make, that means I don't own any of these stocks personally or professionally and right here right now there is no visibility to buy any of those names (unless they are in an ETF we own). I got the above data from Morningstar so I believe it does include dividends. 

Picking ten domestic megacaps to buy will probably never be the best result but it can still be a very effective result and is not insanely difficult. If that is one starting point then from there are unlimited different directions to go. A very simple way to go might be ten more domestic megacaps (total of 20) for a little  better diversification. A more complicated type of direction to go would be riskier companies like single-drug biotechs, stocks that capture a fad like Wheelies or tech stocks with products targeting a narrow application. 

To the original reader comment, this makes "winning" complicated. A basic, simple portfolio with an adequate savings rate can get it done without "beating the market" and by "it" I mean having enough when you need it.

One last tie in to past blog themes. I've mentioned before that it would be great to be so correct with how a portfolio is put together that it never needs to be changed or rebalanced but of course this is not practical. The above ten stocks were chosen with just two criteria. One is that they were megacap household names 20 years ago and that I could chart them for the entire 20 years. So that was as random as you want to believe (I think its was a reasonably random group). 

If you can accept that this would not have been impossible to create 20 years ago and you really can define winning as having enough when you need it (not everyone can) then beating the market takes a back seat and the task does indeed become easier and simpler for someone wishing to be their own portfolio manager. 

This was a long post so I had to take a pretty healthy dose of deer antler spray to get through.

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Sunday Morning Coffee

We executed a rebalancing type of trade during the week that I forgot to mention. We selectively reduced our exposure to Novo Nordisk (NVO). This was not an across the board trade. The process was to go through each account one by one to see the position's weighting and then consider the client's circumstance.

We first bought the stock three years ago (almost to the day) at about $70 per share and it closed Friday at about $190. To clarify the client circumstance comment a little bit, we've had new clients come on board since we first bought the stock, if a client needed to take cash out of the account this was often a name we took from because it had grown much faster than the overall portfolio and there are also differences in volatility tolerances that can come into play in a situation like this. Hence the need to go one by one and sell what I thought was right given, again, the client's circumstance.

I disclosed the original purchase in a post in February 2010 titled Portfolio Tweak. I swapped out of Stryker (SYK) into NVO. So essentially this was a swap out of replacement parts into diabetes. As it turned out this was not a small tweak, it turned into a significant difference.

There are a couple of items worth mentioning with this story. The first one is understanding skill versus luck. Reasonably there was some skill here on both sides of the swap but there clearly was also luck selling something that is up 21% in three years for something that went up 180%. It is important to understand the role luck can play. It is not bad to admit to being lucky with something whereas I do believe bad things will happen (portfolio-wise) when the luck factor is ignored.

The other point comes from a couple of comments from that post three years ago. There were a couple of negative comments left about the stock. Often when I disclose a trade and the post makes its way to Seeking Alpha there will be more negative comments.

It is important to remember that there is always a bear case for any stock or fund you own. One way to think about choosing a stock or fund is that you are weighing out the bull and bear cases and making a decision. If you make a series of decisions like this over some period of time then obviously not every decision will be correct. Once you can accept that you will not be correct 100% of the time then it becomes much easier to be on the lookout for one that does turn out to be wrong and take appropriate action. We had a very recent example with Apple (AAPL) where it became clear we were wrong so we sold it.
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The Big Picture For The Week of February 3, 2013

A couple of different articles that I think can relate into the same topic.

First is an article at the WSJ titled Americans Rip Up Retirement Plans. This really is about people working longer or planning to work longer mostly because of generally poor investment results and to a lesser extent due to life expectancy going up.

This is something I've been writing about for many years as the need has seemed obvious for many years. Although I don't think I have used this word before, the idea of working longer or monetizing  a hobby or any other (hopefully) outside the box idea we've discussed, is adaptability. Part of the equation is the ability to adapt--something's gotta give.

Maybe you have enough to retire the way you want to at 65 but then two years later some sort of financial one-off comes along that costs 10% of your nest egg. And maybe this occurs after the market just went down 15% and the 10% cost is not versus your nest egg but instead versus your highwater mark from before the 15% decline.

So it is with this in mind, even if not specifically articulated, that I write so frequently about living below your means, finding alternative forms of income and avoiding a plan that must have Social Security to have a shot at working; all of these things make it easier to adapt to the unforeseen. There is no guarantee of adaptability only a better chance for it if needed.

The other article looked to build upon work done many years ago by Viktor Frankl by discerning between being happy in life and finding a purpose to your life. As you can imagine there are areas of overlap but there are some differences too, so says the article. One stat that stuck out was that four out of ten Americans "have not discovered a satisfying life purpose."

The article associated the word taker with being happy and giver with having purpose and steered its conclusion toward it being better to be a giver with purpose. While the article did acknowledge overlap between the two I think they overlap more than the article concluded or at least they can depending on a person's interests and outlook.

Zooming out some the quote from our friend Bill here in Walker is relevant; you can figure it out now or you can figure it out later but if you can figure it now you'll be much better off.

While I don't know how the four out of ten number cited above could have a large enough sample size, this is part of figuring it out. Of course financial-plan success can be had without adaptability and self-awareness but you won't know until you need it.
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Design Your Own ETF

State Street is reasonably speaking making a big deal for the the S&P 500 SPDR's (SPY) 20th anniversary including a contest to "design" your own ETF. Contest might be the wrong word because I didn't find anything about winning. Maybe they are just harvesting their database for ideas or as it said maybe this really is just a fun thing.

Over the years we've had quite a few ideas for new funds. A very long time ago (relative to the blog) we talked about a fishery ETF and a farmland ETF and funny enough those actually came to market but didn't last too long unfortunately. Another idea was a toll road ETF and Global X has an open filing for a toll road/airport/seaport ETF but based on how long ago they filed for this one it doesn't seem like it will come out.

Other ideas that have not come to fruition included cement companies, countries like Kazakhstan and one for the publicly traded stock exchanges. Below is the writeup I submitted for an ETF covering the exchanges. I don't have high expectations but I do believe it would be a worthwhile fund.

The idea is an narrow based ETF that owns publicly traded stock exchanges around the world. There are enough foreign and domestic exchanges to populate a fund. It would make sense for this to be a modified market cap construction so no holding gets to 20% or some other huge number as might be the case if ICE goes through buying NYX. 

There are a couple of capital markets ETFs already but they are broader than just owning the exchanges, they also own banks and mutual fund companies.

This fund would capture development of capital markets in countries where stock market investing is new, it would offer some yield (the exchanges in New Zealand and Australia have high yields) and offer some stability with more mature US exchanges which also offer some yield. This would be financial sector exposure without worrying about another shoe dropping with the banks.

The picture is Google's tribute to Jackie Robinson's 94th birthday yesterday.

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