New CFA Institute Link on Idea Flow Page – Rethinking Equity Risk Premiums

In 2001, a group of highly regarded academics and practitioners met to discuss the equity risk premium (ERP), which is one of the tools that many investment professionals use to project future returns and establish growth assumptions for investment portfolios (retirement and pension plans, foundations, endowments, family financial planning, etc.).

In 2011, a similar discussion took place with many of the same participants including Robert Schiller, Jeremy Siegel, Roger Ibbotson, Marty Leibowitz and Robert Arnott.

The result was a CFA Research Foundation publication, Rethinking the Equity Risk Premium.

It is rather long and has some technical sections, but consider at least a scan if you have time.  I hope you find it useful in giving you some insight into projections that the investment industry uses on your behalf.

As a summary teaser, the group reached more of a consensus in 2011 than in 2001 (yes, traditional bulls and bears somewhat came together).  They suggest that, going forward, returns will be lower than historical long-term returns.  SJM agrees with this view.

We hope we are wrong, but better to be conservative in planning and have better than expected outcomes than the opposite.

 

 

SJM Blog New Look and Feel

We are pleased to announce a new look for the SJM Blog.

Our new service should make it easier to receive Blogs that include graphics and useful links.

During our update, Blogs that we posted over the last few weeks were not automatically sent out.  Consider taking a look at Past Blog Posts to view our latest thoughts.

As always, we welcome your feedback.

Are Wall Street Earnings Estimates Good Barometers of the Future?

Individuals, institutional investors and the financial press often make much of earnings estimates from the big Wall Street firms.  Are these estimates good indicators of the future or can they be much ado about nothing?

A McKinsey study that was done over a decade ago on the accuracy of earnings estimates was updated in the Spring of 2010 (see Equity Analysts: Still Too Bullish or refer to the link on our Idea Flow page).

Why do we start our Blog today on a report that was done years ago based on some decade old premises?  Because, like the original report, the new data produced results that are surprising to many.

Before I get to the punch line, twice each year (Spring and Fall) I get the privilege of conducting a series of classes for a Harvard-sponsored investment club, Smart Woman Securities (SWS), that is primarily focused on educating young women about the basics of investment management.  SWS was founded approximately 9 years ago at Harvard and has grown with the support of individuals such as Warren Buffet to establish itself at many Ivy League campuses.  The subject of my first talk this semester was on thoughts to consider when formulating an investment plan and the basics of stocks, bonds and money market instruments.  This coming Thursday, I will speak to the group in more detail about the equity market and discuss some of the factors that I feel drive the overall market and individual security prices.  For the past few years, I have been showing the slide below, which was based on the original McKinsey study and data compiled from Thomson Reuters.

The combination of my preparation for this week’s class and an article in the Sunday NY Times by Paul Lim (more on this below), made me finally post this Blog, which I had drafted at the beginning of the year.

What the chart above highlights, and the McKinsey study has twice observed, is that Wall Street analysts can be herd animals and get somewhat anchored on a trend.  They tend to be late to revise earnings up, to be late to revise earnings down and to move in groups.  Beyond anchoring, I believe this is also due to pain avoidance.  It is painful to be right early on Wall Street.  If an analyst is out in front and seems to be wrong for a quarter or two, the pain in terms of job security and reduced bonus potential might be high.

For those of you who wish to dive deeper into the current numbers, consider a look at earnings estimates that were just put out by Ed Yardeni and Job Abbott.

Yardeni – Earnings, Revenues & Valuation S&P 500/400/600

With all of this, I am not suggesting that we should not follow useful information being published by top analysts.  I am just cautioning that we should not get overly anchored on estimates of the future.  Many factors beyond Wall Street estimates affect the market and the prices of individual securities.

This brings me to the article by Paul Lim in the NY Times Sunday Business section titled “Fundamentally”.  In Lim’s article, he mentions research done by Doug Ramsey, Chief Investment Officer of the Leuthold Group.  For those of you who do not know Leuthold, it is a well respected, independent institutional research firm that is known for thought leadership.

According to Lim, Ramsey’s research looked at stock market performance going back to 1938, and discovered that little correlation exists between earnings growth and stock price movements in any one year.  In the article, Lim mentions that Ramsey discovered that in the 16 best years for stocks, eight actually coincided with declines in corporate earnings.  And profits rose in 13 of the 16 worst years for stocks.

I do not feel that this work should be taken to suggest that earnings are not important to stock market performance.  I think they are an important factor.  As does the McKinsey paper, the research by Ramsey just highlights that we should not be as focused as I think we often are on current earnings or earnings estimates as predictors of future performance.

Versus trying to track or watch earnings estimates, or predict year to year market movements, try to be focused on sticking to the long-term factors important to achieving your plan.

As I speak to the SWS group this week, I will remind them of my strong feelings about investing to meet personal objectives versus making it a competition against others or the market.  Investing should be about doing what is proper over the long term for you, not about watching the market day to day, or estimate to estimate.

So, when you turn on the financial press in the morning or get the latest research from your favorite firm, try to take it with a grain of salt.  What will the future bring?  I certainly do not know.  What I do feel is that we all need to try to avoid the day to day market swings and the emotion from future estimates of the market.  If we can, and it is not easy, I am confident that we will be better investors and fiduciaries of our plans.

 

Behavioral Finance Affecting the “C” Suite?

Are we all affected by emotions well presented in Behavioral Finance?  You bet.

Profits have been solid, interest rates low, and many say bargains are abundant in certain industries, yet many companies aren’t investing at levels that some say are appropriate.  Uncertainty about the economy, markets, and economic policy is affecting us all, but decision bias in the “C” suite may be playing a bigger role than we might have thought.

A recent McKinsey study of over 1,500 senior executives found that respondents who reported observing the fewest decision biases were more likely to have made significant investments since the global financial crisis.  In addition, this same group’s number of perceived biases correlated with the performance of investments.  The fewer reported biases, the better the reported performance.

The study also found that biases could be constraining overall investment, even when in the minds of the executives the investments could have helped.

Many investment firms have pieces out on behavioral finance and how it affects the stock market and investors.  I thought it would be good to remind all that emotions affect everyone.

Now back to the news…

Greece passed a key vote to continue to kick the can down the road some more (have they just taken too much hemlock for their pain?).  The full story on this has not been written yet but the markets reacted as they should have, positively.

With all of the back and forth, and literally blood on the streets, are some investors frozen and being too conservative in terms of not investing according to their long-term plans?

I could write much more on decision bias, loss avoidance, anchoring and other common behavioral finance terms.  We are all human and affected by our emotions.

This is why I think it is important put down in writing a long-term plan that will achieve your goals and revisit it often to make sure it is on track.

Try to get anchored on a well thought-out plan versus getting caught up in the day to day.  It has been my experience that if you write down an objective before you invest, it is easier to stick to the plan versus letting emotion, or the competition of the market, take over.

Wishing us all good fortitude to stick to our plans.

 

 

Bill Gross Update – “Life and Death Proposition”

Mr. Gross is out again with one of his sure to be well read and quoted letters.  The title alone will probably make a few headlines.

This time he must have written his piece looking out over the Pacific from his office (yes, Newport Beach, CA is a nice place for a headquarters), as he gets a little existential, starting with quotes from Virginia Woolf (see below).

His thoughts and those of his colleagues at PIMCO do get a lot of press and can sometimes move markets.  They are always worth a read.

Enjoy!

  • ​Recent central bank behavior, including that of the U.S. Fed, provides assurances that short and intermediate yields will not change, and therefore bond prices are not likely threatened on the downside.
  • Most short to intermediate Treasury yields are dangerously close to the zero-bound which imply limited potential room, if any, for price appreciation.
  • We can’t put $100 trillion of credit in a system-wide mattress, but we can move in that direction by delevering and refusing to extend maturities and duration.

​Where do we go when we die?
We go back to where we came from
And where was that?
I don’t know, I can’t remember
             Virginia Woolf, “The Hours”

 

Economic Update – Good Headline News But Not Off To The Races

I hope everyone had a wonderful weekend!

Last week ended with some good headline news from the U.S. Bureau of Economic Analysis.  The economy grew at a seasonally adjusted annualized rate of 2.8% after growing 1.8% in Q3 and 1.3% in Q2.  Some news reports were rightly positive, and the probability of a double dip is low.

Unfortunately, however, the data showed a sharp slowdown in real final sales, a significant weakening in government spending and a deceleration in business fixed investment.  The data left U.S annual growth in 2011 at 1.7%.  By Q2 2011, real GDP had reached its prerecession peak, marking a painfully slow recovery that has been insufficient to bring any improvement to the labor market.

Looking forward, we learned that an advance estimate of Q4 2011 GDP came in under 3%, which was below the projections of some economists.  Consumption looks to be a little soft (personal spending has dipped) and a slow down in key services was noteworthy.  Trade also turned down (is a strong dollar good or bad?), government spending was a drag, and equipment investment slowed.

Why all of this detailed data on a Monday Blog?

The stock market has gotten off to a wonderful start to 2012 (gave a little back last week and this morning).  We are encouraged by positive signs that the worst is probably behind us, but we continue to caution that we are not out of the woods yet.  Wall Street analysts are likely to remain positive, but keep in mind that they are often late to revise earnings estimates on the way up and importantly are also late to revise down (more on this in a later post – see McKinsey study in the Idea Flow page for a preview).

In summary, we remain constructive of some risk assets but we are cautious on economic growth in the first half of 2012.  The Fed has has made it clear that they will be very accommodative.  Risks, however, from many external financial factors (Europe is still day to day), slower global growth, and domestic fiscal drag continue to merit attention.

I know we sound like a broken record, but please consider keeping a little powder dry, remain broadly diversified, and invest for your goals (investing should not be a competition).

Idea Flow Page Updates – New Links to McKinsey Research and Manager Commentary

Keeping up on our theme of bringing clients the best thinking in the market on a wide variety of subjects, we have added a link to McKinsey’s Quarterly Research on the Idea Flow page.  It is completely free and easy to access.  If you want their full reports you will need to register with them, but those also are free and we have not received any unwanted e-mails as a result of registration.  I think you will find the current links particularly interesting.

How the Role of Equities May Shrink 

Equity Analysts – Still Too Bullish

Next, we have posted Mauldin’s latest.  Yes, the title gives you a good idea of how cheery he is.

The End of Europe?

In addition, one of our top managers, Fiduciary Management Inc. (FMI) has put out their Q4 letter.  It is always worth a look.

FMI Q42011 Large Cap Letter

Please check our Idea Flow section for more links to some of the research and commentary we find useful.

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Europe’s Downgrade – Our Thoughts – Comments from El-Erian

We were expecting it, but the market still reacted and it’s front page news.

How is it that France and some other Euro countries had a higher credit rating than the U.S., especially considering all of the issues in Europe?

The answer to this question finally came.  The downgrade that, in our minds, should have come a while ago happened.

What will it bring for the future?

It is too early to tell, but the rating agency S&P is now more formally suggesting that the path forward is more uncertain.

If the Euro area crisis shows signs of a resolution, we could see risk assets (equities, etc.) jump quite dramatically.  If we do not, however (other news of a potential breakdown in talks between Greece and its creditors is not a good sign), we could be in a period of “Sub-Normal” for some time.

What to do?

We suggest revisiting your allocations to make sure you are positioned for multiple outcomes.  Have funds that will benefit from surprises to the upside and others that will protect on the downside.  In our minds, it is not a time to be a hero.  Remain well diverisifed and make sure you are investing for your goals, not the goals of others (investing should not be a competition).

For a well written, more formal commentary on the downgrades, consider taking a look at a Blog on CNBC from Mohamed El-Erian of PIMCO.  While he ends on what could be considered a bearish note to which we do not wholly subscribe, we feel it is important to understand views from professionals and firms that can influence the market.

Mohamed El-Erian – CNBC Blog

Please check our Idea Flow section for more links to some of the research and commentary we find useful.

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New Idea Flow – John Mauldin – 2012 Update

If you have not heard of or read John Mauldin’s pieces, consider signing up for his free newsletter, Thoughts From The Frontline.  His publications are sure to be thought provoking.  We do not always agree with, but do enjoy, his ideas.

2012: Year of Choices

Please check our Idea Flow section for more links to some of the research and commentary we find useful.

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New Idea Flow Addition – Blackrock

This time of year, most investment firms update outlooks for 2012.  We are sure to have a few more Blogs about 2012 prognostications on the way soon.

Yesterday we added Blackrock’s 2012 Investment Outlook to the Idea Flow page.

It is a well done piece that has comments from all of their top strategy professionals.  Consider taking a look.  The title alone says a lot.

Year of Living Divergently – Blackrock 2012 Investment Outlook

Please check our Idea Flow section for more links to some of the research and commentary we find useful.

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