The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Tadas Viskanta is the founder and editor of the finance blog Abnormal Returns. Tadas has over twenty years of professional experience in the financial markets. He is also the author of the forthcoming book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere.

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There has never been a better time to be an individual investor.

Said another way one could argue that we are in the golden age of the individual investor.  That might seem like an odd thing to say coming off what some people call a ‘lost decade for stocks.’  However over that same time period the technological advancements that made Web 2.0, like Facebook, Twitter and LinkedIn, possible have also led to unprecedented opportunities for investors not previously seen.

We are for the moment leaving aside the state of the markets at the moment.  We could have written this same post a couple of months ago when the stock market was 20% lower.  We are also leaving aside the issue of whether the zero interest rate policy of the Federal Reserve represents a “war on savers” or is simply the byproduct of necessary policies.  The failure of MF Global and the systemtic risks it poses for all account holders are also outside the scope of this post.

This is not a novel theme for us.  Indeed one thing we note in our forthcoming book, Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere, is that investing has never been “cheaper or easier.”  Some of this has to do with the rise exchange traded funds.  In other respects it has to do with the blossoming of the options markets.  In large part, it has to do with technology.  In short, never before have investors had access to data, analysis, opinion and social tools that are commonplace today. Let’s take these points one by one.

1. Easier:  Investors today can with a brokerage account and a computer is now only a few mouse clicks away from a globally diversified portfolio of ETFs that in terms of expenses rivals what institutions paid a decade ago.  For all intents and purposes the expense ratio on the big ETFs is closer to 0.0% that 1.0%.  Many brokers now allow online trading of individual bonds and overseas securities.
2. Cheaper:  Brokerage commissions continue to get driven towards $0 over time.  In fact, many brokers today provide commission-free trading of a range of ETFs.  Options strategies that would have been cost-prohibitive a few years ago are now viable strategies today.  Do you remember when you used to have to pay extra for real-time quotes?  Today those are a commodity.
3. Richer:  The range of asset classes, sectors and strategies available via ETFs is truly dizzying.  It is even for interested parties hard to keep up.  Will most of these more exotic strategies fail?  Probably.  But sometimes a strategy, like low volatility investing, that is based in deep academic research, becomes available to investors.
4. More social:  Blogging and microbloggging (StockTwits & Twitter) has opened up the world of idea generation to the masses.  Anyone with a computer these days can put their ideas out there.  The blogosphere and Twittersphere is a meritocracy, albeit imperfect, where the smartest and most generous contributors rise to the top.  The social model is pushing into things like earnings estimates with Estimize and institutional-grade services like SumZero.  Many bloggers these days make fun of the raft of ‘free’ webinars that go on these days.  But if you think about it the software and Internet speeds were not there to make mass online seminars possible not all that long ago.
5. Smarter:  The raw material for investment analysis and trading is of course data.  Financial and price data is for the purposes of most individual investors is free these days.  Many firms are using data in interesting ways.  In the area of fundamental data some firms like Trefis and YCharts are making fundamental analysis easier.  A firm like AlphaClone allows you track the moves of (and invest) like the big hedge funds.  When it comes to portfolio level data firms like Wikinvest are aggregating account data making analysis easier for investors.

Most of the above discussion focuses on do-it-yourself investors.  However on the managed portfolio front things are changing for the better as well.

1. Brokers vs. RIAs:  The wirehouse brokerage model is going the way of the dodo bird.  Brokers and their clients now recognize in increasing numbers the conflicts inherent in that model.  Brokers are going independent as registered investment advisors in order to provide their clients with a conflict-free model.  That does not necessarily mean they are going to generate above-market returns, simply that these firms are no longer working at cross-purposes to their clients.
2. Online access to managers:  Not only is the fee-only model taking hold.  It is taking hold online in a big way.  If you can eliminate, to a degree, the human element inherent in portfolio management you can also reduce the end cost to the investor.  Some firms that are operating in this space include:  Wealthfront, Personal Capital, Covestor and Betterment.

In the New York Times this past weekend there was an article talking about the many changes we are seeing through the analysis of “big data.”  The applications of big data has taken hold faster in the world of personal finance, like BillGuard, than it has in investing.  However one can easily see how access to data on individual trading decisions could make for an interesting recommendation engine.  In the end, more algorithmic investment tools and services coming one way or another.  The fact is that a simple, well-designed algorithm can do a better job of managing in real-time a portfolio than the vast majority of investors or investment advisors.

In many ways the automation of much of what constitutes investing today will be a godsend for investors.  The majority of investors really don’t want to manage their own portfolios.  Not do they a hyper-personalize portfolio.  An algorithmic service that managed in a low-cost fashion portfolios it would allow those investors to focus on the things over which they have some control.  The stuff of truly personal finance like:  savings rate, lifestyle choices and retirement options.

Sometimes in the midst of volatile markets we can forget just how far things have come.  Just a few years ago who thought you could trade a leveraged on $VIX futures.  But today you can.  Who would have thought you could buy an ETF for the Egyptian market, but you can.  However this example points out the double-edged sword that is today’s markets.  Now we do have access to all manner of investment and trading vehicles.  However like any tool these vehicles need to be used responsibly.  The vast majority of investors should likely take a pass.

The reason is that despite the many technological advancements we have seen in investing our brains are still largely hardwired for an age of scarcity.  That is why so many of the behavioral biases we have accumulated over time work against us when it comes to investing.  That is why we consistently buy high and sell low, i.e. the behavior gap.  That is why we oftentimes only seek out (and recognize) that information that conforms to our long held beliefs, i.e. confirmation bias.  In the end the most difficult hurdle to investment success is not the market environment or the range of investment vehicles, it is us.

So despite the advances we have seen, most investors would be well-served in investing in a low cost, globally diversified portfolio which they systematically rebalance and occasionally revisit.  The upside is that this sort of investment process is, as we said, now cheaper and easier than before. In the end no one knows what the markets will do, but the vast majority of investors can do more by doing less.

The full application of technology to the investment world will simultaneously open up novel areas of investment for adventurous investors and simplify the mechanics of portfolio management for the average investor.  Investors have to choose which path they will follow.  They simply need to recognize that their own, somewhat flawed brains, are coming along for the ride.

*I know I have likely omitted some very cool startups in the investing and personal finance space.  This is not meant to be a comprehensive accounting of the field.  Feel free to include in comments any interesting firms in this space.

BR prefaces this: I am always wary about making comparisons between now and the Great Depression. The record keeping, when it existed, was much worse, and the government intervention was much greater Not too long ago, a study of NYC CRE during the 1930s looked at actual sale prices as recorded by the county clerk. Prices fell as much 65%.

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Great chart from the recently released Economic Report of the President.  We suspect the Great Depression housing bust didn’t have the government props to soften the blow as we do today,  which,  therefore, on a relative basis,  makes the current bust much worse.   The prior conditions to the current bust must have been much worse than those before the Great Depression.

The Council of Economic Advisers (CEA) do note,

…during the Great Depression, the only other instance of nationwide price declines since WWI, much of the comparably-sized decline in nominal home prices was offset by a concurrent drop in general price levels, so the decline in real housing values was only about one-quarter as large as the one we recently experienced.

Thus the current collapse in housing prices is a relative price shift whereas the housing bust of the Great Depression was more a symptom of general price deflation in the economy.

If not for the decisive action of Paulson, Bernanke, Geithner and Co.  we all may have become farmers living under the freeway.    Can’t prove counterfactuals,  but that is what we  believe.   So we give them an A+ for stabilization.   Structural adjustment and long-term reform is an entirely different story, however.

We heard Meredith Whitney say this morning that 95 percent of current mortgages are backed, effectively, by the taxpayer,

…95-plus percent of mortgages today are being backed by Fannie and Freddie.  Fannie and Freddie are effectively subsidizing unprofitable mortgages that the banks wouldn’t put on their balance sheet. That’s not sustainable and ultimately the taxpayer is paying the bill for it.  The banks used to price profitable loans and you know, they’re a myriad of loan products that they’re still not pricing for profits.

Basic microeconomics tells us that government repression of prices creates supply shortages.   Think back to the rent control supply and demand graphs in Econ 101, which we have modified in the chart below.

This is one of the reason why we believe housing is so slow to recover.  Who in their right mind x/ the Govie would lend long-term money at a rate lower or close to the current inflation rate?   Rational lenders also take into account the massive monetization that is currently taking place globally and its impact on future inflation in calculating their expected real returns.

(click here if chart is not observable

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For each $1 paid in Federal taxes, how much does your state receive? (Political orientation approximated by the parties of states two Senators).

This is done on a per state basis, I’d like to see the data depicted on a per capita basis as well — both the paying and the receiving.

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Source:
Red Staters Use The Safety Net Too
BRIAN BEUTLER
TPM, FEBRUARY 22, 2012  
http://tpmdc.talkingpointsmemo.com/2012/02/the-map-that-proves-red-staters-use-the-safety-net-too.php

My back-from-the-beach reading:

• S&P 500 Cheapest to Bonds on Zero Fed Rates (Bloomberg) See also Wall Street Confounded as Volatility Extends Record Stretch (Bloomberg)
• Under Volcker, Old Dividing Line in Banks May Return (DealBook)
• ECB preparing to close liquidity floodgates (Reuters)
• Plan B for China’s Wealthy: Moving to the U.S., Europe (WSJ) See also China Mfr Data Show Risk of Deeper Slowdown on Exports  (Bloomberg)
• Gary Shilling: Why Renters Rule U.S. Housing Market  (Bloomberg)
• Living to 100? That Will Be $3.5M (Smart Money)
• The Northern and Western European Housing Bubble (The Bubble Bubble)
• How Much Would it Cost to build the Death Star? (Centives)
• How Waiters Read Your Table (WSJ)
• Lessig’s One Way Forward (BoingBoing)

What are you reading?

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Greece Tacks Left

Source: Spiegel.de

click for full graphic

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Read the rest of this entry »

Click to enlarge:

Source: Pension Partners LLC

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Although markets have already rallied strongly in 2012, the move is still early if current price ratio trends behave similarly to recent history.  The chart shows the price ratio of the SPDR S&P Dividend Index ETF (SDY) relative to the S&P 500 (SPY).  A rising price ratio means dividend-oriented stocks are outperforming (risk-off), while a downtrend suggests the opposite (risk-on).  Much like a pendulum that swings from fear to hope, investor sentiment goes through cycles in terms of what type of returns are preferred at any moment in time.

This is poetry.

“Congress, 535 commoditized temple monkeys pawing through the ruins of America in search of bribes. The bicameral whorehouse on Capitol Hill works like a vending machine. You put coins in the slot, select your law, and the desired legislation slides out.”
-Fred Reed, May 30, 2009

I added it to the QOTD in the sidebar, but I wanted to pull it out for emphasis . . .

This post was originally published at The Financial Philosopher, by Kent Thune.

“I do nothing but go about persuading you all, old and young alike, not to take thought for your persons or your properties, but and chiefly to care about the greatest improvement of the soul. I tell you that virtue is not given by money, but that from virtue comes money and every other good of man, public as well as private. This is my teaching, and if this is the doctrine which corrupts the youth, I am a mischievous person.” ~ Socrates

Every time I see news coverage of street protests in today’s Greece or of political leaders discussing Greek Austerity, I imagine, if Socrates were living today, if he would be there among the protestors and, if so, what he might say or do. Would he support the protestors? What might he say to the government leaders? Would he approve of Greek Austerity measures?

Luxury is Artificial Poverty

Socrates never recorded any of his thoughts or ideas on paper and all that is known about him comes from the writings of his contemporaries, such as Plato. However, it is clear from these writings that Socrates cared little about money and materiality and he certainly shared no affection with the ruling Aristocrats. Many accounts of Socrates describe him as something of a poor, unattractive hermit wandering the streets of Athens, teaching his philosophies to anyone who would listen. In a time when men labored for a living and spent much of their free time working for the affairs of the city aspiring to political power, Socrates did neither.

In today’s Greece, I believe Socrates would still find himself in the unique position of standing in a corner completely his own–neither with the protestors, nor with the government. While he might sympathize for the struggle of the Greek people against the governing leaders, he would remind the people that money is the corrupting force at the root of all of their troubles and that they would find contentment to let go of their material desires and to end their reliance on government to cure their ills.

Socrates to Greece: Die But Don’t Forget to Pay ‘Debt’

The featured quote at the beginning of this post comes from Plato’s account of the trial of Socrates, where Socrates was accused of “corrupting the youth of Athens” and was given the choice to either denounce his philosophies or die by drinking the poison hemlock. Socrates chose death.

His last words were reportedly spoken to Crito, where Socrates said, “We owe a rooster to Asclepius. Please, don’t forget to pay the debt.” Asclepius was the Greek god for curing illness. Therefore these words are interpreted to mean that death is a cure and a means to freedom.

I would never expect a political body to take the path of a wise philosopher, but Socrates would likely say today that Greece must metaphorically die–to split from the European Union–to be cured of its ills… And, yes, don’t forget to pay your debt to Asclepius…

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Follow Kent Thune on Twitter or subscribe to his blog at The Financial Philosopher.

There was a 21.2% decline in listing inventory from December 2010 to December 2011.

Relying on typical housing market scenarios and reasonable logic, a decline in listing inventory nearly always meant a tightening market was developing – fewer houses coming on line matched against steady demand meant housing prices were more likely to stabilize or rise.

Declining inventory is the variable in the housing equation that usually makes conditions improve. During the mid-decade housing boom, falling inventory was caused by the insatiable demand by buyers – product could not get out to the market fastest enough. Listing inventory was simply “worked off” by (artificially) inflated demand. Listing discounts approached zero, days on market fell to record lows and prices rose rapidly.

Old scenario: Declining Listing Inventory = declining housing prices ease their decline, prices stabilize or prices rise.

However over the last year, listing inventory fell sharply in many markets yet sales were generally anemic or showing nominal increases. In the NAR numbers, non-seasonally adjusted sales were up 1.4% year over year (using NSA since inventory is also NSA) yet inventory was down 21.2%. Inventory was clearly not declining because sales were overpowering the amount of listing inventory that was available.

Then why is inventory declining?

The answer to this question was not considered in the recent prediction of a market bottom.

New scenario: Declining Listing Inventory = fall in seller confidence and the sharp decline in distressed inventory entering the market.

From NAR…

Total housing inventory at the end of December dropped 9.2 percent to 2.38 million existing homes available for sale, which represents a 6.2-month supply2 at the current sales pace, down from a 7.2-month supply in November.

“The inventory supply suggests many markets will see prices stabilize or grow moderately in the near future,” Yun said. – National Association of Realtors

We are seeing unusual declines in many markets I keep tabs on such as:

• Baltimore, MD Down 21.6% YOY
• Washington, DC Metro Down 35.8% YOY
• Las Vegas Down 12.9% YOY
• Broward County, FL Down 35% YOY
• Miami-Dade Down 40% YOY
• ReMax National down 25.7% YOY
• Phoenix (Realtor.com) down 48% YOY
• Boise City, Idaho (Realtor.com) down 41% YOY

Admittedly I am cherry picking some of the cities that are posting huge declines in inventory. However the problem I find in all of these markets, is that sales are only increasing a few percentage points. Not nearly enough to explain the rapid decline.

The drops are being touted as a good sign that housing is getting back on its feet. I’m not so sure.

I think the sharp drop in many US housing markets (and this has been happening for much of 2011) has to do with three key reasons:

• A large swath of foreclosure volume was artificially delayed.
• Seller confidence has waned after the pounding it took last fall.
• Low interest rates extended by the Fed for the next two years have removed any sense of urgency.

Declining foreclosure volume is one of the key reason inventory levels are dropping. The 1/3 decline in foreclosure volume in 2011 has resulted in a sharp drop in foreclosure inventory resulting in a sharp drop in total inventory. Distressed sales have been running at about 30% of total sales nationally for a few years but fell to about 20% in 2011. With a 2 million more homes expected to go into foreclosure over the next 2 years, a year long internal review of procedure after the 2010 “robo-signing” scandal and the 50 State AG settlement with the largest services/banks, distressed inventory is expected to rise sharply over the next several years.

Weak seller confidence is causing property not to be released into the market unless the need to sell is not optional. The 2011 home seller and buyer was bashed with the debt ceiling debate, the S&P downgrade of US debt, 400 point daily swings in the financial markets, the European debt crisis, the AG/Service settlement drama and the political stalemate on housing policy in Washington. What do people do when faced with the unknown? They sit and wait. Buyers had a lot more incentive to act with falling mortgage rates to record levels but mortgage underwriting grew tighter over the year as well.

The extension of the low interest rate policy by the Fed through the end of 2014 has obliterated any sense of urgency by sellers. I am getting a lot of feedback from real estate professionals about this as well as seeing it within my own appraisal practice. There is a lot going on the world right now and the action by the Fed suggested that they weren’t particularly encouraged by the economy. To many this may seem as an incentive for sellers to get going and sell. But many of those sellers have to buy.

The drop in inventory as a phenomenon may or may not pass quickly but one thing is clear – weird changes in market behavior happen for a reason – I don’t see declining inventory as a particular sign of strength in the housing market.

I met Joe Fahmy a few years ago at Lindzenpalooza. He has a great way of communicating his trading skills to a novice to intermediate traders based on his 16 years of trading. Fahmy has guided his hedge fund to outperformance over the past 13 quarters. As previously mentioned, I wanted to present something less technical and chart focused;

This is our second attempt at bite size, easy to understand, bullet points for traders. The first post is here.

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1) Loss cutting:  Trading has this amazing historical footnote: If you study the great traders throughout history, they all share the same statement as their number one rule: CUT YOUR LOSSES! Capital preservation “keeps you in the game.” It is especially important once you understand the math: a 25% drawdown requires a 33% gain to get to break even; Down 33% means you need to rally 50% to get back to square one; As we saw in 2008-08, a -50% loss requires a +100% gain to get back to even. In sports “Defense Wins Championships.” The same goes for stock trading. Most traders need to focus more on defense.

Even Warren Buffett understand the traders credo: “The first rule of investing is don’t lose money. The second rule is don’t forget Rule No. 1.

2) Confidence: There is nothing worse than seeing a great opportunity but not having the courage to “pull the trigger” and execute the trade. Freezing up due to fear does NOT happen to great traders. These thoughts don’t even enter their mind because they are confident in their plan. They know wht they will do if the trade goes their way, and perhaps more importantly, they know what to do if it goes against them. Confidence cannot be taught. It comes from making decisions, taking action, and learning from experience.

3) No ego:  Successful traders may have big personalities, but they separate their ego from their trading. They might have serious conviction behind their positions, but when the market proves them wrong, they don’t argue with it. They simply move on and accept it.

Two things I never argue with: the stock market and women. Both of them are smarter than me, and both are always right! (BR: Spoken like a married man)

4) Consistency: The best at anything are the best because they are consistent. Michael Jordan isn’t considered the best basketball player ever because he scored 30 points ONCE in a game. It’s because he averaged 30 points per game over his ENTIRE career.

Traders should not obsess with their day-to-day profit & loss. Rather, they should shoot for consistent positive months, quarters, and years with minimal draw downs. You do not want to be the “boom and bust” trader who does well in a strong market but gives it back during market corrections. These guys are a dime a dozen and typically get blown out of the market at key pivot points (Last cycle, I knew a few who became mortgage brokers — how is that for timing?)

5) Students of the market: Successful traders NEVER get complacent. They are always eager to learn, constantly looking to improve their skills.

One way to improve is through post analysis of your trades. It is important to look at your numbers and make sure your losses are smaller than your gains.

For technical traders, studying your entry points and looking at charts that worked (and didn’t work) is part of the constant learning experience of becoming a confident and consistently profitable trader.

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Fahmy holds seminars for active traders who want to improve their returns.   Readers of the Big Picture who are interested will get a $500 discount on the full day event. Go to TradingBigWinners.com and enter the promotional code: “bigpicture500” for the New York (3/3) seminars. I will be discussing trader psychology and cognitive errors at this seminar.