McDONALD’S (MCD): YOURS TRULY MAY NOT BE LOVIN’ IT, BUT…

9/5/14

I bought some McDonald’s (MCD) stock today.

Loyal readers know that I am a fervent believer in the efficiency of markets and therefore in buying index funds, rebalancing with the religiousness of the Pope, and not making the slightest attempt to call the markets or individual stocks; see INDEX INVESTING:  “YOU (DON’T) GOTTA HAVE HEART…”, 8/21/14.  However, old habits die hard.  Consequently, I do trade a little bit of money, mainly to amuse myself and keep myself focused for my writing endeavors, which I also engage in primarily to amuse myself.

With that disclaimer behind us, why did I buy McDonald’s?   The stock has really been beaten up lately; it reached a year to date high of $103.53 on May 13.  It has since traded down 10.2% to the $92.99 at which I bought it.  The S&P in that time period is up 5.7%.  MCD pays a quarterly dividend of 81 cents, which works out to a dividend yield of 3.48%, more than 100 basis points over the ten year treasury. 

Why is MCD down?  Despite what the financial media and most of Wall Street would have you believe, no one knows.  But those who make a living opining on the unknowable tell us that MCD is down because the millennials don’t like McDonald’s  (Who does like McDonald’s…the food, not the stock?  But I digress.), the competition in the fast food business is too much for McDonald’s, and that the pressure for a higher minimum wage that is supposedly sweeping the country will be bad for MCD.  

As a believer in efficient markets, yours truly doesn’t  pretend to know why MCD is down, though I suppose I could guess as well as the people who are paid a lot of money to make such guesses.  What I do know from years of experience, though, is that when the stock of a great American company is down as much as MCD, it is time to consider buying.  When that same stock pays a healthy dividend and has made no indication that that dividend is in danger, it is time to take an even closer look.  When the reasons advanced for the stock’s having arrived at such a seemingly attractive valuation sound like they could only come from people who know little of life beyond the caverns, usually figurative, but often literal as well, of Wall Street, it’s time to put one’s money to work.

That is why I bought McDonald’s.   Was I early?  Will I prove prescient or foolish?  I don’t know.  But, as with football, having a little skin in the game makes watching more interesting.

BULLS, BEARS, AND BRAINS: THE RELENTLESS PURSUIT OF THE FOOL’S ERRAND OF CALLING THE MARKETS

8/29/14

The geopolitical situation has rarely been worse, short of all out war: 

• Russia is apparently conducting a not all that surreptitious invasion of Ukraine.
• ISIS is sweeping across Syria and Iraq, seizing territory and oil and conducting acts of brutality that are appalling even by Middle Eastern standards.
• A de facto military coup has taken place in Pakistan.
• Ebola continues to spread through western Africa and threatens to burst out of its present geographic constraints to threaten Congo, other African regions, and perhaps the entire world.
• The UK just put on a terror alert that borders on hysteria.
• The western Pacific continues to be a hotbed of sparring between regional and global powers, with the latest developments being an ongoing game of chicken between Chinese fighter planes and American surveillance planes spying on Chinese nuclear submarines.
• Cyber-attacks, on major financial institutions, power providers, retailers, and agencies of government seem to be a weekly, or daily, occurrence.
• The French government was reshuffled for the second time in months.
• It looks like David Cameron’s center-right coalition in the UK is encountering turbulence as euroskeptics start to jump ship.
• The usual nonsense and gimcrackery prevails in Washington, D.C.

Smart market observers are warning of complacency, not only about geopolitical turbulence but about everything; nothing seems to make the stock markets, or, lately, the bond markets, go down.

Equally smart observers point out that there have been many times when people thought the geopolitical situation has rarely been worse, but the world didn’t end and the markets weren’t fazed, largely because the markets seem to operate independently of geopolitics.  The markets have grown used to, and prospered despite, the obtuseness, or worse, of the politicians.  Further, these observers argue that the very fact that smart people are warning of complacency shows that not everybody is complacent.

These bright bulls point out that it is earnings that drive the markets, and earnings, for the most part, are just fine.  Equally bright bears point out that it is future earnings that drive markets, which are perhaps nature’s most efficient and effective discounting mechanism.  A still debt laden economy, weak consumer spending, tepid consumer confidence, and confusing, but largely bearish, economic news out of China don’t bode well for future earnings  These bears point out that the still lukewarm economy, combined with the aforementioned geopolitics, does not present a scenario in which we should be experiencing near record highs in the major stock averages.  Bulls scoff, arguing that record highs are just numbers.  With the S&P trading in the neighborhood of 16-17 times projected earnings, the markets are at best only mildly expensive.  Bears trot out measures like the CAPE ratio, which adjusts earnings for the business cycle and smooths them over the last ten years, is trading at 25, a level that has been reached only in 1929, 2000, and 2007.

The bears argue that, with the 10 year treasury at 2.33% and the 30 year at a calendar year low of 3.07%, bonds are ridiculously expensive and that it is these low rates that provide the helium that inflates our stock markets.   Bulls argue that with the German and Japanese 10 year government bonds at 0.87% and 0.49% respectively, treasuries don’t look rich at all; in fact, they might be cheap.   On the other side of the equation, some observant bulls are pointing out that with U.S. corporate spreads still very tight, treasuries might be cheap not only relative to foreign government bonds but also relative to credit sensitive U.S. paper.   So not only may treasuries be a better value than is commonly supposed but continuing low, and maybe falling, rates will further sustain the stock market.

So what is the point?  Do I delight in confusing my readers?  The latter is certainly not true.

One side of this argument will turn out to be right; the markets, both bond and stock, will either go up or go down.  (They could trade sidewise, in which case both sides will claim victory, but I digress.)   But given the strength of arguments on both sides, those who emerge correct will do so by nearly sheer luck.   Predicting markets is little more than a game of chance, a fool’s errand.  

The two most salient conclusions one can draw from the serendipitous nature of market prognostication are

·        We waste a lot of time and brainpower, in this country and throughout the world, trying to do the impossible—call the markets.  Very smart people are paid very handsomely to do things they can’t do (i.e., call the markets) because people understandably place a very high value on their hard-earned money and still believe that they can get a jump on the markets by listening to the smart guys.  What if those wonderful brains on Wall Street and in the City of London spent their time curing diseases, finding new forms of energy, or working out the logistical and infrastructure problems that look to be a profound source of economic difficulty in the future?  Not only would it be a better world, but everyone would make more money.  The two, by the way, are not at all mutually exclusive; quite the contrary.  But I digress…again.

·        The best course of action for the investor is not to chase the pied piper of market beating returns.  Instead, the investor should, as best as s/he can, determine how much risk s/he is willing to take and set up, alone or with the help of a genuine financial advisor, a balanced portfolio of index or index like products that conforms to that risk profile.  And then rebalance religiously.  See INDEX INVESTING:  COULD ITS SUCCESS BE ITS UNDOING?, 8/23/14 and INDEX INVESTING:  “YOU (DON’T)GOTTA HAVE HEART…”, 8/21/14

INDEX INVESTING: COULD ITS SUCCESS BE ITS UNDOING?

8/23/14

The index fund bandwagon is getting more crowded.   Yours truly has been an ardent advocate of such passive investing (a term I don’t like much, even in connection with index funds, but that is grist for another mill) for 20+ years.  Warren Buffett, one of the few active managers who has managed to beat the indices over long periods of time, appears to have gotten on the bandwagon more recently.  (See the already seminal INDEX INVESTING:  “YOU (DON’T) GOTTA HAVE HEART…”, 8/21/14)  Now the Wall Street Journal’s Jason Zweig (“The Decline and Fall of Fund Managers,” WSJ, page B1, 8/23-8/24/14) reports that Charles Ellis, the founder of Greenwich Associates and an icon in the fund management industry, says that the day of the stock picker has passed and that

“With rare exceptions, active management is no longer able to hold its keep.”

There is something though, that we have to keep in mind when predicting or anticipating the demise of active management.  While this consideration is probably more valuable as an intellectual exercise than as a practical investment tool, it is worth pondering. 

If Mr. Ellis is right and, as a consequence, active managers (and, probably more importantly, active analysts) lose their jobs in large numbers,  fewer people will be doing the research they think will enable them to beat the markets and thus the mechanisms for information getting “into” the markets (i.e., to be reflected in securities prices) will get rusty.  The market will thus become less informationally efficient and thus the markets will get easier to beat, weakening one of the major arguments for index investing.  That will induce more people to invest their money with active managers and start the circle turning again, making the market more efficient and harder to beat and thus increasing the allure of index funds.  This is one of those self-correcting mechanisms that is endemic to finance and economics.

As I tell my finance and investments students, the great irony of the efficient market theory is that it only has validity because not everyone believes it.   If everyone believed the efficient market theory in its strongest form, no one would bother to do the research necessary to make the market efficient.

We certainly don’t have to worry about the world going entirely to indexing and thus destroying the efficiency of the markets, which is the very underpinning of index investing.  There will always be a lot of (primarily young and inexperienced) people who are certain that they can beat the markets; yours truly used to be one of them.  And we probably don’t even have to worry about a precipitous deterioration in the markets’ efficiency because of a sharp falloff in active managers and active management; there will always be legions of people chasing the dream of consistently beating the market.  But it is worth considering, from an intellectual standpoint if nothing else, the consequences for index investing of its own success.

EXOTIC INVESTMENT PRODUCTS FOR THE “AVERAGE GUY”: WHAT’S THE POINT?

8/16/13

Today’s (i.e., Friday, 8/16/13’s, page C1) Wall Street Journal contained an article (“Mom-and-Pop Pitches Draw Flak,” by James Sterngold) discussing the concern of some in and around the investment industry about the increasing number of esoteric investment products being sold to small and medium sized investors.   These products, born largely of search for yield in the wake of what I like to call Ben Bernanke’s War on the Elderly and a desire to avoid the kinds of market downturns we saw in 2008, include long and short funds, private equity funds, funds that buy unregistered bond issues, and a range of investment products limited only by money managers’ imaginations and ability to sell.

Regular readers can probably guess my reaction to this proliferation of esoterica in the financial marketplace:   What’s the point? 

I have long contended that the best strategy for just about everyone to follow is to hold a balanced portfolio of stock index funds and bond index funds, with the proportions of each based on one’s long term risk tolerance rather than one’s perceptions of where the market is going, which are as likely to be wrong as they are to be right.   (See my 5/8/13 post,ANOTHER OF THOSE TRITE BUT TRUE INVESTING MAXIMS for only my latest, until now, expostulation on this point.) The only trades one should do in one’s portfolio are an annual rebalancing, which must be done with nearly religious fervor.  It would also help not to look at one’s investments with any degree of frequency; doing do can lead to panic or euphoria, both dangerous emotions in investing.    By holding index funds and religiously rebalancing, one will capture a portion of the stock market’s upside, avoid a portion of the market’s downside and, in almost all cases, beat the performance of more “sophisticated” products in any meaningful time frame.  (The size of the portion of the market’s upside and downside one will avoid depends, of course, on the proportions of one’s portfolio invested in stocks.)  If one really wants to simplify one’s investment life, one could hold a balanced index fund, which holds both a bond index and a stock index and does the rebalancing automatically, though generally in a slightly different manner than an annual rebalancing.

Why do I make this case for index funds with such fervor and certainty?

First, it is difficult for anyone to beat “the market” over any meaningful investment horizon.  The definition of “the market” varies with the asset class in which one is investing, but virtually every market is represented by an index and there is an index fund for just about every index.   These percentages vary as rolling ten year periods change, but the latest I saw is that only 13% of active large cap stock managers beat the S&P 500 index over the prior ten year period.

Second, while there are managers who outperform their indices, there are few (See the last paragraph.) who do so after the fees that actively managed funds charge.  For example, the aforementioned Journal article talks about a retired physician in Florida who bought the Mainstay Marketfield Fund, which takes long and short positions on stocks depending on who knows what criteria.   This fund charges management fees of 1.50%, or 150 basis points.  The Vanguard S&P 500 Index charges 10 basis points on its Admiral Shares.  The spread between index and active fees is not usually this large, but the spread is always considerable and acts as a kind of ankle weight on the performance of actively managed funds.

Third, while there are managers who outperform their indices even after fees, there are not many of them and the chances of your finding the manager who will do so over the next five, ten, or more years are miniscule.  Remember, past performance is not necessarily a good indicator of future performance, so simply picking the best performers for the last ten years doesn’t work.   Things change.  This is called “manager risk.”  One supposes one could find a broker and/or investment advisor who is skilled at finding really great managed funds, but one would have a hard time finding such an advisor who is clairvoyant.  And brokers who can find such great managers will doubtless charge more fees, further reducing the chances of your outperforming “the market,” as defined by an index fund.

Fifth, these exotic new products will not necessarily perform as advertised.  The same physician cited in the Journal article reports that he is not dismayed by the underperformance year to date of his Mainstay Marketfield Fund of the S&P 500 by about 900 basis points because

“I was happy to sacrifice optimal performance on the upside for the defensive characteristics.”

There may be something to this; the Mainstay Marketfield was down only 13% in 2008 while the S&P was down 37%.  But then again there may not be anything to the doctor’s argument; we simply don’t know how the Fund will do in a similar downturn in the future.  And even if Mainstay does that well on relative basis, not every such exotic fund will. 

We do know how a well run index fund will perform; it will do as its index does, less fees.  And we also know that we can adopt defensive characteristics by not putting all our money into a stock index, by balancing out the risks of stocks by holding a bond index.  We further know that we will force ourselves to buy low and sell high with a portion of our portfolios if we religiously rebalance.   And we can achieve all this while not paying an active manager 14 times more than we pay an index “manager.”

A necessary word…

Some have mistaken my enthusiasm for index funds as a rejection of the work of financial advisors.   This is certainly not my intention.   We who have invested, or do invest, for a living and know what we are doing tend to underestimate the difficulty for the average person of techniques such as rebalancing.  We also tend not to be intimidated by talk of markets and the use of jargon by the investment community.  In short, we think it is as easy for the proverbial “average guy” to invest as it is for us to invest.  While this can be the case with just a little bit of effort and a mastery of some pretty elementary arithmetic, it is usually not the case that the “average guy” finds this stuff as easy as I and my colleagues do.   And sometimes people simply need a trusted hand to hold, figuratively of course.  If you are an “average guy,” at least as far as money and investing go and/or you’d feel better working with an expert, by all means work with a financial advisor.   It would be best, though, to work with a financial advisor who is open to index and index fund like products.   More importantly, be careful; while there are some good advisors out there, there are plenty of charlatans in the money business.   And one can usually detect such a mountebank by his or her promises of to deliver “above market returns,” “more yield with the same or less risk,” or “consistent market beating performance.” 

Trust and honesty are far more important characteristics for a financial advisor than are purported investment skill and knowledge.

Even I work with a financial advisor on a portion of my portfolio and have been doing so for about the last 25 years.  It’s good to have someone with experience both similar to and different from mine with whom to discuss things.   He is smart and honest and does his best to keep the costs down.   I trust him and like him and he more than tolerates my enthusiasm for index and index like products.