Instant Gratification

Together with my family, I recently went to a restaurant that was located in a remote area.  When we got to the restaurant, we found that we didn’t have cell phone service.  Perhaps the restaurant had WiFi, but we didn’t ask.  

No Cell Service

Normally, during dinner at a restaurant, my family does what many other families do during dinner:  play with our cell phones.  Because we didn’t have cell service at this restaurant, we were forced to talk to one another.  This went well for a while until one of us was unsure of a fact.  We went to look up the fact – but we couldn’t.  No cell service!  Our discussion went unresolved as a result.  To be continued.  None of us were used to that.

Instant Gratification

We are all now so used to getting what we want the second we want it.  If we want to know something, we look it up right then and there.  This works better and better in information technology as internet speeds improve.  Patience is not a virtue when you have all of the world’s information available to you in the palm of your hand.  Our children have grown up used to this level of availability and they are largely impatient as a result.

Investing Takes Time

The problem is that this Instant Gratification culture doesn’t work in the investing world.  Investing is a long, hard slog with ups and downs along the way.  You pick a target for your net worth and hope and strive to hit that target 10 or 20 years from now by earning that 8% per year and compounding your gains.  Saving and investing and building your net worth is more like farming.  Your goals take time and nurture to materialize.  Patience is not just a virtue but is absolutely necessary to be a good investor and successfully to build your wealth.  If you join a hot start-up and become a millionaire early on when your company goes public, good for you, but that is the exception rather than the norm.  Now, with online trading access, you can monitor your portfolio constantly and in real time, but that is different than actually becoming wealthy overnight.  Even that can be counterproductive because buying and selling stocks based on daily news and daily trading fluctuations is likely not the best investing strategy.

IMO

There is nothing wrong with playing with your phone instead of talking with the rest of your dinner party.  There is nothing wrong with looking up something because you want to know it right then and there.  My point is that you shouldn’t translate the Instant Gratification mindset into your investing plans.  Successful investing takes time and patience as well as discipline.  It can still be an enjoyable adventure but it won’t happen overnight!

Aretha Franklin, R.I.P.

Everyone is paying tributes to Aretha Franklin, so I will take a part of her recording history and see if it might have a lesson for you.

Columbia Records

Aretha started in her professional career with Columbia Records in 1961.  She was a young, extremely talented singer with a background in gospel music.  She was not the only one at the time.  Although she did have some commercial success while at Columbia, the relationship was not a home run.  According to some reports, the head guy at Columbia did not really “get” Aretha and her gospel music talent.  Had Aretha stayed with Columbia, she likely would not have had the success that she ultimately had.

Atlantic Records

Aretha moved to Atlantic Records in 1967 and her career took off, despite personality issues between her family and Atlantic executives.  Unlike Columbia, Atlantic Records recognized Aretha’s talent and matched her with songs and styles that fit her talents.  Aretha’s biggest hits, such as “Respect”, “Natural Woman” and “Chain of Fools” were all from the Atlantic period.  Aretha clicked with the team at Atlantic, and the pair made it big.  

Later

Aretha’s producer at Atlantic Records, Jerry Wexler, departed to another company in 1976, and Aretha departed Atlantic in 1979.  Though a few hits followed during the 1980’s, Aretha didn’t have the same commercial success after she left Atlantic.  There are probably a number of reasons why, and other singers probably would be thrilled with the level of success that Aretha had post-Atlantic, but Aretha’s best years were behind her.  My point is that the team of Aretha and the executives at Atlantic Records brought Aretha the success she had and deserved.  

IMO

How many Arethas are there out there now or were there back in the day that had the talent but weren’t matched correctly with the professionals necessary to move their careers forward?  Do you think that relates to you and your activities?  Talent alone isn’t enough.  Talent has to be nurtured, guided, and put on the proper path to success.  If that is in the field of investing or financial planning, it is best if you team up with a like-minded professional who understands you and your goals and can set you on the proper path for you to meet your goals.  Don’t go it alone, and don’t try to make it work with people with whom you don’t mesh.  Demand excellence for yourself and demand that the people who are there to help you actually understand you and put your goals first.  Just like Atlantic Records did with Aretha.

Safe Houses

I enjoy reading spy novels, particularly those about the Cold War.  Through my local library, which is a wonderful facility, I am reading “Safe Houses” by Dan Fesperman, one of a number of authors who practice in the spy novel genre.  Though not great literature (most spy novels aren’t great literature), “Safe Houses” is a good read so far.

The title got me thinking, are there any “Safe Houses” in the investment world?  A safe house in the spy world is usually a house controlled by a foreign country’s spy agency.  The US CIA had (and probably still has) safe houses in Germany and in eastern Europe where its spies can hang out between assignments, and where other people can watch out for them and therefore be safe.  If you watch “Homeland” on Showtime, you know what a Safe House is.  Maybe also the Ryan Reynolds/Denzel Washington film of the same name.

Gold

Is gold a safe house for investors?  Right now, no, it is not.  Gold has historically been a hedge against inflation and geopolitical turmoil.  What do we have now?  Inflation that is slightly higher now than it has been for the last several years (albeit still pretty low) and geopolitical turmoil, at least if you watch the mainstream media.  No major war, though.  We also have incessant TV ad spots touting gold. Yet, gold is hitting new 52-week lows.  Don’t believe William Devane and the TV ads.  Gold isn’t dead as an asset class, but it is not a safe house right now.  It may turn out to be a great investment if we do have a real war and much higher inflation, but I wouldn’t park money in gold right now if you are worried that the stock market is overbaked.

Real Estate

Residential real estate, in particular, is more of a safe house, especially in areas such as where I live in California where there are growth restrictions, both natural and unnatural.  Housing demand remains high, particularly affordable housing,  Affordability is key because so few households make enough money to qualify for the mortgage they need to buy the house they want.  Yet, there remains the liquidity issue:  It is more difficult to sell your property when you need to than it is to sell a stock or bond.  And, there remains the issue of interest rates, which will also price more people out of buying a house as rates move up, even as slowly as they are.  Yet, if you currently own or can purchase residential real estate at a relatively affordable price in a favorable location, chances are you will be safe in the long term.

US Treasuries

Unless you are a true believer in the impending apocalypse, US Treasuries are extremely safe, with a big If:  If you hold your treasuries until maturity, you will get back 100% of your principal plus your coupon interest.  If you sell your treasuries before they mature, you could lose some of your principal if interest rates have moved upward since you purchased the treasuries.  This is called Duration Risk.  If you like the almost-3% return on 10-Year US Treasuries and you absolutely need all of your money back, then you need to hold them all 10 years.  Of course, there are shorter terms – with all of the US debt, there is any maturity available that you want.  Now, with rates higher than they have been, US Treasuries are at least a somewhat appealing alternative that offers a safe return.

Cash

Cash is the safest of all, but it isn’t really an investment because you don’t get a return on cash.  When you have a brokerage account (including a retirement account) and you don’t invest all of the money in your account, the uninvested portion is usually “swept” into a money market account, which pays some return, albeit smaller than US Treasuries.  Most financial planners consider money market funds to be “cash”, and it is 100% safe if it is under $250,000 and therefore insured by SIPC.  When I want to stay completely “safe”, which is typically when I am seeing that we are not in a strong period for the stock market, I will opt for “cash” that is swept into a money market account rather than to buy US Treasuries because I know I won’t lose money when the stock market rights itself and I venture back into the fray.

IMO

These are just a few of the “safe houses” out there for investors.  Stocks by definition are not a safe house because their values are constantly changing in the stock market.  Safe means you will get 100% of your money back.  Don’t buy gold now if you want to stay safe, although you might want to if you want to speculate.  Consider residential property if you don’t need the liquidity, and definitely go with US Treasuries if you hold to maturity and cash if you want short-term safety.

Backward and Forward

As you may have guessed from the title, this posting is about the Price to Earnings Ratio (P/E).  P/E is one of the most common fundamental and quick ways to determine if a stock is relatively cheap or relatively expensive.  

Two Ratios

There are really two P/E ratios:  One that looks backward at previously-announced earnings, and one that looks forward at earnings projected by analysts.  If the company’s earnings are rising, the backward P/E will be a larger number than will the forward P/E.

WTF

Let’s take an example of a company I will call the WTF Company (because ABC is already taken by AmerisourceBergen).  WTF trades at $50/share and announced earnings of $0.625/share in the last quarter.  $0.625 times 4 is $2.50, and $2.50 times 20 is $50, so WTF is trading at 20 times earnings, or at a P/E of 20.  Always remember to take the latest quarterly earnings and multiply by 4 to get the annual earnings, unless it is a seasonal business such as retail and you are looking at the Christmas quarter, so you have to smooth out the earnings.  But I’m getting beyond my point.  My point is, let’s say WTF’s earnings are projected to grow by 10%.  This means next quarter they should earn $0.6875, which, times 4, is $2.75 per share annualized.  What does that mean for the P/E?  It means the forward P/E at $50/share is 18.18.  That doesn’t look as high as 20, and maybe you can feel comfortable buying a stock with a n 18 P/E where you wouldn’t feel comfortable at 20.  Remember, you buy a stock for the company’s future earnings, and while their past earnings can tell you something about how well the company is run and what you might expect for the future, you should be looking to the future more than the past.

IMO

The next time you have a conversation with someone about stocks and they mention the P/E ratio, ask them if they are talking about backward or forward P/E.  Chances are if they think stocks are priced too high and that we are about to have a downfall, they are talking about backward P/E.  However, if they are looking for reasons to buy stocks, chances are they are talking about forward P/E.  When you hear or read the term “P/E”, the default meaning is backward P/E.  However, investors tend to look forward.  In an era such as this when corporate profits are rising significantly, there is going to be a disconnect wherein adherents of P/E and metrics such as the Schiller CAPE Ratio (another expression of backward P/E) will be sounding the warning sirens.  If the forward P/E is more in line and you believe there is a good chance companies will meet or exceed their profit projections, then you don’t need to take cover when the sirens sound.

Relative Strength Index

Relative Strength Index (RSI) is a commonly-used technical indicator. RSI is a momentum oscillator that measures the speed and change of price movements.  RSI is presented as a number between 0 and 100.  A high number within that range indicates that a stock has been performing well, and a low number indicates the opposite.  A number between 30 and 70 is considered normal by the “experts”.  A number below 30 is thought to mean that the stock is oversold, while a number above 70 may mean the stock is overbought and therefore may be ripe for a correction.  Maybe.  I will get into that below.    Here is a link from Stockcharts.com/school that gets into RSI more deeply, including how to calculate the RSI.  RSI’s calculation includes a running lookback period of 14 days, meaning that data from more than 14 trading days ago is no longer relevant.  

Free

When you go to the free stock charting website Stockcharts.com and type in a ticker symbol, in addition to a daily chart of the stock for the past several months, you will also get a chart of the stock’s RSI, typically shown above the actual stock chart.

AAPL

Just to use one example, this of the now $1 Trillion Apple, Inc., the RSI of AAPL (as of this writing) is 73.79.  By the book, this means AAPL may be overbought since it is over 70.  However, let’s look at this more closely.  AAPL last week announced strong earnings, which caused the stock to bread that $1 Trillion barrier.  Kind of like Chuck Yeager and Mach I, or Roger Bannister and the 4 Minute Mile.  Do you think AAPL is ripe for a correction?  I don’t believe it is, but it certainly might.

S&P 500

The RSI is also helpful as applied to indexes, such as the S&P 500 Index.  Below is a chart of the SPY, which is the ETF proxy to the S&P 500 Index.  Its RSI currently is 66.36, which is high but still below the 70 “barrier”.  This implies that the S&P 500, while high, is not overbought and therefore may have room to run upward still. 

In My Opinion (IMO)

The purpose of this posting is to inform, not to advocate.  The Relative Strength Indicator is out there as a piece of information to take into account when looking at your holdings to determine whether to buy, hold, or sell.  I do not recommend that you make trading decisions solely based on the RSI, such as, “The RSI is below 30!  Great Buying Opportunity!  I must buy!”  Don’t do that!  Just be aware of the RSI and what it implies and you will be a more educated investor.  With a later posting I will discuss the other information on this chart, such as the MACD, which is the stock’s moving average.

A Closer Look

In my previous posting titled “Why I Use Indicators”, I cited a Wall Street Journal article, which in turn cited data from the Philosophical Economics blog and Ned Davis Research which showed that the percentage of household wealth invested in the stock market is currently high at over 56%.  This is bearish for future stock performance.  

Taking A Closer Look

After I wrote that piece, I read a piece by noted economist Dr. Edward Yardeni that supposed that one reason why interest rates remain as low as they are (albeit moving upward) is that investors still own a lot of bonds because they are afraid that “this is going to end badly”, likely because it has in fact ended badly many times in the past.

Thus, the Philosophical Economics data suggest investors don’t own enough bonds, but the Yardeni blog suggests that investors still are awash in bonds.  These two pieces didn’t foot with one another.

The End Is Not Near

So, I went back and looked at the Ned Davis Research (NDR) data that underpins that WSJ article.  NDR’s data shows that the ratio of stocks to bonds as a percentage of household wealth has gone from about 1:1 in 2009 to over 3:1 currently.  During this time period, the S&P 500 Index has risen from about 756 to its current level of about 2,840, which is an increase of about 276%.  That tells me that most of the increase in the percentage of household wealth invested in stocks has been due merely to the increase in the valuations of stocks, and not because investors have been pulling money out of stocks and into bonds.  To me, this is not as alarming as if investors were switching from bonds into stocks.  Investors are merely riding the wave, not stoking the wave.  Maybe the end isn’t near after all.

The World Has Changed

Another insight is that the world has changed a lot and stock ownership has become much more widespread as technology has advanced and the cost to trade stock has plummeted over the years.  Consequently, I don’t know how relevant data from the 1950’s and through the 1970’s are in this analysis.  NDR weighs its pre-1980 data as much as more current data and I think that is not the correct way to look at the investing world.

IMO

I reiterate from my previous post that the better way to look at indicators is to glean what investors, in general, are saying about the future of corporate earnings and the resultant stock performance.  I believe we are still in a bull market and that we should continue to own stocks, depending on your personal situation.  By the way, the Philosophical Economics blog is excellent but it is dense reading.  They post very long blogs but only a few times per year.  If you are up at night, you should try reading one of their pieces if you want to fall back to sleep.  Its author purposefully remains anonymous, but they are very good.  Yardeni uses a different method, more like mine – he posts shorter blogs several times per month.  Read them both for good education.

Why I Use Indicators

A recent Wall Street Journal article examined 8 stock market indicators that are out there and in common usage.  The point of the article is that all 8 currently conclude that the S&P 500 Index is overvalued by between about 5% and 20%.  The indicator that the author (Mark Hulbert of Hulbert Financial Digest) says is the single best (the percentage of household equity currently allocated to stocks) predicts that the S&P 500 is overvalued by about 15%.  Here is a link to the article:

https://www.wsj.com/articles/the-8-best-predictors-of-the-long-term-market-1533521521?mod=hp_jr_pos1

Next 10 Years

Here is a summary of the indicators mentioned in this article as being the most statistically significant:

  • % of household equity allocated to stocks, from Philosophical Economics blog (higher is bearish, lower is bullish)
  • Q Ratio, which is market value divided by replacement cost of assets
  • Price to Sales Ratio of stocks
  • The ratio of Total Value of Equities to GDP, which is Warren Buffet’s favorite indicator
  • CAPE Ratio developed by Nobel Laureate Robert Schiller, which is a version of the P/E Ratio
  • Dividend Yield of the S&P 500 – lower is bearish, higher is bullish
  • Traditional P/E Ratio
  • Price to Book Ratio

Hulbert, the author of the article, is testing the predictive power of each of these indicators with respect to the expected returns of the S&P 500 over the ensuing 10 years.  Hulbert back tested each of these indicators to see how they would have predicted 10 year the S&P 500 performance using data back to 1951.  This is one way to use indicators, but it is not the only way, and it is not the way that I use indicators.

Why I Use Indicators

I use general institutional buying and selling, accumulation and distribution, as indicators to tell me the general direction of the market at a point in time.  I am not trying to predict what the stock market’s performance might be during the next 10 years.  Though I would not label my indicators as “short-term”, I would say that they are more “at the moment”, and indicative of market momentum at that time.  When my indicators tell me that institutions are in an accumulation phase, then I will allocate more of my assets to stocks.  When institutions are selling, I will sell stocks and allocate more to bonds or cash.  As it has been for much of the time since the 2008 Financial Crisis, currently my indicators tell me we are still in an accumulation phase and that we should still over-allocate toward stocks.  I am confident that if we do find ourselves in a correction phase, that my indicators will provide me enough warning to bail out before the worst of the carnage.  This is because I have personally backtested my indicators and that they showed red flags in time to live to fight another day.

IMO

The P/E and CAPE ratios have gotten a lot of press lately because they are historically high.  I say that this is because the markets are forward-looking whereas the ratios are backward-looking.  Investors see that corporate profits are up and will likely continue to rise for a variety of reasons.  Stock prices represent the expectation of future earnings rather than the past.  Because the outlook for corporate profits is so rosy, these ratios are historically high.  Q Ratio may be obsolete because we have transformed into a service and high-tech economy and the replacement cost of assets isn’t as viable a concept as it was when we were a manufacturing and hard-asset economy.  The point is that there are holes in a number of these indicators.  Even so, if the average over-valuation is in the 10%-range, and the stock market suffered a 10% correction, would that be so bad?  And do you believe that the market would eventually recover that 10% correction?  I believe so, and that is why I will continue to rely on my own indicators rather than those described by Hulbert in this WSJ article.

 

 

IT Spending

This is a great article published recently by columnist Christopher Mims in the Wall Street Journal.  Mims explains that recent research shows that the reasons why some companies make it while others don’t have to do with how much money companies spend on proprietary information technology systems and processes.  The reason the FAANG stocks have become such a disproportionate percentage of the market cap of the stock market is that the FAANG stocks account for a disproportionate amount of the proprietary IT spending.  Moreover, the gulf between these huge FAANG companies and smaller competitors will likely grow, not shrink.

Key Quote

Here is the key quote from Mims’ article, in my opinion:  “IT spending that goes into hiring developers and creating software owned and used exclusively by a firm is the key competitive advantage. It’s different from our standard understanding of R&D in that this software is used solely by the company, and isn’t part of products developed for its customers.”

Right Way/Wrong Way

Mims goes on to show that there is a right way and a wrong way for companies to spend on IT.  He uses the example of Wal-Mart and Sears, back a few decades ago.  Sears spent heavily on IT at the time but it spent it on outside consultants.  Wal-Mart built their own systems internally and developed their own proprietary scanning and inventory system.  Guess who won?  It appears that companies that develop their own software and systems and keep them for their own uses are the companies that win.

How to Tell

It is difficult to look at a company’s financial statement and tell how much they are spending on proprietary IT systems and how they are spending that money.  There may be narrative in the Annual Report or in press releases about IT spending and how it is being spent, which is helpful.  However, figuring out IT spending is more a qualitative rather than a quantitative skill.  I believe you have to read, ask, and read between the lines to figure out if a company knows what it is doing when it outlays money for IT.  It is helpful if you understand IT and have a working knowledge of what works and what doesn’t work.

IMO

This Mims article made me alter my opinion about why established companies grow bigger and why it is difficult for smaller companies to grow.  Although I still believe that regulatory hurdles are one issue why it is difficult for smaller companies to grow, I now understand that the scale and amount of money it takes to establish and maintain proprietary systems and processes means it is difficult for smaller companies to allocate sufficient resources in that direction.  Only the largest, most well-capitalized companies have enough money to pay for the brainpower they need to develop systems that set those companies apart.  Small and mid-cap companies face an uphill battle in order to compete with larger competitors who have a head start and more resources to spend on their own proprietary systems.

 

Earphones In

When you see people walking on the sidewalk with their earphones in their ears, seemingly oblivious to the world around them, what are your thoughts?  To me, I see someone whose thoughts are elsewhere and who is not “in the moment”.  Whether they are listening to music or a podcast or having a phone conversation, their attention is not with what is right in front of them, but instead with what is filtering into their ears.  They may believe they are multitasking and accomplishing more given the limited hours in a day, but they are also missing out on the beauty that is around them.  They are also a physical danger to those around them because their movements are less predictable:  Perhaps they will take their next step forward, but perhaps also they may veer left or right, unaware that their veer could put their bodies in jeopardy of a collision with others.

Avail Yourself

Ideas, including investment ideas or plans, can come to you at any time.  You just have to avail yourself to those opportunities, and the best way to do so is always to be aware of where you are and what is in front of you.  Be in the moment.  An example:  my idea for this blog topic came to me while I was on a morning bike ride.  I was on a bike path and there was a pedestrian in front of me with earphones in.  As a cyclist, your concern in that instant is perhaps the pedestrian doesn’t hear me coming and will inadvertently veer in my path and cause me to crash.  It has happened before – not to me, fortunately.  While some people do, I purposely do not wear headphones while cycling because I want to hear anything coming from behind.  I also want to avail myself to random thoughts that might spark an idea for me.  Now, maybe this pedestrian was engrossed in an audiobook with a great story.  What he may have thought he was gaining by listening to the audiobook he was losing by not paying attention to the world around him.

Yogi

One of the late Yogi Berra’s attributed quotes was “You can observe a lot just by watching.”  Famed investor Peter Lynch, who ran the Fidelity Magellan mutual fund for many years and who went on to author many books, used Yogi’s maxim to find new investment ideas.  Lynch would go to the shopping mall to find which stores were crowded and then perhaps invest with them.  In his book, “One Up on Wall Street”, Lynch discusses how you should “invest in what you know about” and that you should acquire “local knowledge”.  The only way to acquire “local knowledge” is if you observe things and truly understand them without having earphones in your ears.

IMO

There is nothing wrong with listening to your earphones.  You can certainly learn a lot by listening to a good audiobook or to an informative podcast.  My point is that you should do one thing at a time.  Listen to that book or podcast while you are sitting at home or on an airplane, for instance.  Don’t listen while walking on a crowded sidewalk and thereby make yourself a danger to others.  Be open to the phenomena around you.  You never know when you might come up with your next great investment idea.  The human brain works in strange ways – let it do its work!