Archive for the ‘Stock Market’ Category
Ever since Fama and French published their seminal paper “The Cross-Section of Expected Stock Returns” in 1992, the world (at least the academic world) has come to understand that over the long run, small cap stocks outperform large cap stocks and value stocks outperform growth stocks.
This quest to understand stock returns has not stopped. In 2013, Robert Novy-Marx published “The Other Side of Value: The Gross Profitability Premium” in the Journal of Financial Economics. In the course of this research, he discovered that profitability, measured by gross profits-to-assets, has roughly the same power as book-to-market in predicting the cross-section of average returns. Profitable firms generate significantly higher returns than unprofitable firms, despite having higher valuation ratios.
Almost concurrently, other researchers confirmed Novy-Marx’ discovery, notably Fama and French’s new paper “A Five Factor Asset Pricing Model” and Hou, Xue and Zhang’s “Digesting Anomalies: An Investment Approach.” Both papers were published in 2015.
Unlike the small cap premium and value premium, the profitability premium does not have a satisfactory risk-based explanation.
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After the Comey firing and the dropping of a few other shoes, there is enough talk about the similarity to Watergate that piques my interest to study the stock market’s reaction during the Watergate period.
The Watergate period started with the arrest of five burglars breaking into the DNC offices located in the Watergate Hotel on 6/17/1972 and ended with Nixon’s resignation on 8/8/1974. I split that time period into three different stages.
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The early stage: from 6/17/1972 to Nixon winning re-election on 11/11/1972.
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The middle stage: from 11/11/1972 to 10/20/1973 when Nixon fired Archibald Cox and abolished the office of the special prosecutor. Attorney General Richardson and Deputy Attorney General William D. Ruckelshaus resigned. The day’s events are commonly known as the Saturday Night Massacre.
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The final stage: from 10/20/1973 to 8/8/1974 when Nixon resigned.
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Stocks Decline 14% (June 1950 to July 1950) North Korean troops attack along the South Korean border. The U.N. Security Council condemns North Korea. The U.S. gets involved. - Stocks Decline 20.7%, (July 1957 to October 1957) The Suez Canal crisis manifests itself, the Soviets launch Sputnik and the U.S. slips into recession.
- Stocks Decline 26.4% (January 1962 to June 1962) Stocks plunge after a decade of solid economic growth and market boom, the first “bubble” environment since 1929.
- Stocks Decline 22.2% (February 1966 to October 1966) The Vietnam War and Great Society social programs push government spending up 45% in five years. Inflation takes off.
- Stocks Decline 36.1 % (November 1968 to May 1970) Inflation really starts to pick up, hitting 6.2% in 1969 up from an average of 1.6% over the previous eight years. Vietnam War escalates. Interest rates surge; 10-year Treasury rates rise from 4.7% to nearly 8%.
- Stocks Decline 48% (April 1973 to October 1974) Inflation breaks double-digits for the first time in three decades. There is the start of a deep recession; unemployment hits 9%.
- Stocks Decline 19.4% (September 1976 to March 1978) The economy stagnates. High inflation. Adjusted for inflation, corporate profits haven’t grown for eight years.
- Stocks Decline 17.1% (February 1980 to March 1980) Interest rates approach 20%, the Read the rest of this entry »
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Is A Market Crash Imminent?
Posted on: July 30, 2014
Yesterday I received an email from a doctor client of mine telling me how he had a conversation with some fellow doctors, and all of them are pulling their money out of stocks because they feel that with the market breaking new high after new high, a crash is imminent. He wanted my opinion.
First of all, while all of his doctor friends might feel a market crash is imminent and certain, there is simply no such thing as certainty in the stock market. All we can work with are odds. The following are the odds of market corrections:
| Magnitude of market decline | Frequency of occurrence (out of 64 years from 1950-2013) |
| >5% | Every year (94%) |
| >10% | Every two years (58%) |
| >20% | Every five years (20%) |
| >30% | Every ten years (10%) |
| >40% | Every fifty years (2%) |
My study also shows that the market breaking a new high does not substantially change the odds of returns. In other words, the odds of the market dropping over 20% in the next twelve months are still about one in five; the odds of the market dropping over 30% in the next twelve months are still about one in ten.
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Investors Good At Hurting Themselves: Investor Returns vs Investment Returns
Posted on: March 18, 2014
Like to hurt yourself?
In 2009, Morningstar did a study comparing mutual fund returns vs investor returns. Here is what they got:
| Fund Category | Fund Return | Investor Return | Investor Lag |
| Large-Cap Blend | -1.4% | -5.7% | -4.3% |
| Large-Cap Growth | -1.7% | -7.7% | -6.0% |
| Large-Cap Value | -1.8% | -2.2% | -0.4% |
| Mid-Cap Blend | 0.4% | -3.0% | -3.4% |
| Small-Cap Blend | -0.5% | -6.9% | -6.4% |
| Europe/Pacific | 3.1% | 0.5% | -2.6% |
| Emerging Markets | 15.6% | 3.8% | -11.8% |
| Financials | -10.5% | -28.6% | -17.9% |
| Health Care | -1.3% | -3.1% | -1.8% |
| Communications | 1.9% | -3.7% | -5.7% |
| Energy | 8.6% | 4.0% | -4.6% |
| REITs | -2.5% | -11.8% | -9.3% |
| Technology | -2.6% | -8.3% | -5.7% |
| Utilities | 5.5% | 2.1% | -3.4% |
| Total and Simple Averages | 1.0% | -3.5% | -4.5% |
Source: Morningstar
We can make a few observations about these data:
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January Indicator: 2014 Could Be a Year of Opportunity for Wealth Accumulator
Posted on: February 6, 2014
Last year after the market was up about 5% in January, I wrote a newsletter to introduce my clients to the so-called “January Indicator”:
According to research done by Cooper and McConnell, what the market does in January has a strong predictive power for what the market will do for the rest of the year.
Using data since 1940, they found that if the market is up in January, it will rise an additional 14.8% for the rest of the year; if the market is down in January, it will rise only 2.92% for the rest of the year. This gives rise to a spread of almost 12%, a highly statistically significant number.
According to Sam Stovall, chief equity strategist at S&P Capital IQ, the S&P 500 since 1945 has risen 56% of the time following a down January. That is lower than the 84% frequency of February-through-December gains following a higher market in January.
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2013 has been a stellar year for stocks. As of today, the S&P 500 is up more than 25%. There are about ten trading days left and barring unforeseen circumstance, the index will end the year in the 20+% range.
A few of my clients are concerned; with the market doing so well this year, what does that bode for 2014? Well, I don’t have a crystal ball, so all I can do is to look at historical data to make an imperfect reference.
To answer the question, I asked my intern Nahae Kim to do a study of the relationship of immediately subsequent year returns. Specifically, can one year return predict the next year?
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You Sold My Apple? What a Shame!
Posted on: December 4, 2013
That was a message I got from a new client of mine. I must admit, it really bites. Yes, I sold his Apple stock. And yes, since then the price has gone up 15%. So of course, I can understand he’s upset and beginning to question whether I know what I am doing.
Having studied improvisational comedy, I’m aware that regardless of how I feel, it is wise to always validate others’ feelings. So I replied, “Yes, I should have asked you before I sold it.”
Afterward, I sent him some data to mull over.
Nasdaq just crawled its way back to 4000 a few days ago, and this time Apple is the biggest and hottest stock in the Nasdaq 100.
Last time when Nasdaq passed 4000, the top ten tech stocks (try saying that ten times fast) were, Microsoft, Cisco, Intel, Qualcom, Oracle, JDSU, Nextel, Sun Micro, Veritas and MCI Worldcom.
Since the last time Nasdaq passed 4000, Microsoft has gone down 34%, Cisco 59%, Intel 53%, Qualcomm, the only up stock in the group, has gone up 25%, Oracal has gone down 67%, JDSU 98% and the remaining four are no longer in business; they were either merged out of existence or end ignominiously.
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New York Stock Exchange
Recently, I got a call from a physician client of mine who asked a fantastic question. The Shiller PE of the S&P 500 index is at 24 now, much higher than the historical mean of 16 – is the market headed for a fall?
What is the Shiller PE?
This is a stock market metric invented by Yale Professor Robert Shiller. Basically, it is the average of the PE ratios of ten consecutive years. Because of that, Shiller PE is also called PE10.
Professor Shiller found it to be a reasonably good measure of valuation of the whole market: the higher the Shiller PE, the more expensive the market.
Back to my client’s question, I told him right away that I don’t know the answer. I don’t make investment decision based on opinion. I have to research historical data. After I hung up the phone, I asked my assistant to study the relationship between the Shiller PE and forward one-year and forward three-year returns.
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New York Stock Exchange
The S&P 500 closed the first quarter at a record high. Should that worry investors? The short answer is, No.
When the market was 30% below the high three years ago, I did some research. I categorized all market conditions into:
1. Breaking a new high.
2. Less than 10% below historical high.
3. Between 10% and 20% below historical high.
4. Between 20% and 30% below historical high.
5. Between 30% and 40% below historical high.
6. More than 40% below historical high.
Then I calculated the one year forward returns of the six conditions.
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January Barometer Effect: What Will the Stock Market Do for the Rest of 2013?
Posted on: February 7, 2013
New York Stock Exchange
With the market up about 5% in January, a prospective client of mine called to let me know he is not going to invest in stocks at this time – in fact, he is going to pull all of his money out of the market.
This may not be the best course of action for him.
According to research done by Cooper and McConnell, what the market does in January has a strong predictive power for what the market will do for the rest of the year.
Using data since 1940, they found that if the market is up in January, it will rise an additional 14.8% for the rest of the year; if the market is down in January, it will rise only 2.92% for the rest of the year. This gives rise to a spread of almost 12%, a highly statistically significant number.
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Is value investing still valid?
Posted on: August 10, 2012
New York Stock Exchange
Value investing as an investment discipline was pioneered by Ben Graham and is practiced by Warren Buffett. It has a long history of data collection and many rigorous studies done in the most prestigious research universities.
The idea of value investing is that undervalued stocks will ultimately outperform overvalued stocks in aggregate.
There are four simple measures one can use to determine if a stock is relatively undervalued or overvalued….
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I am not a big fan of IPO shares. Research has shown that IPO shares usually underperform seasoned shares by about 2% a year. Business owners tend to time their IPOs at the optimal time for them, not for the future shareholders.
With Facebook (FB), there are so many people chasing so few shares that the IPO will create a “Winner’s Curse” effect – whoever wins the shares will end up overpaying for them.
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On July 8, Morgan Stanley downgraded Google. Their reasons?
Given Google’s aggressive hiring plans, rising compensation costs and heavy advertising spending on Chrome and other products, the company’s EBITDA margins will decline this year and next year.
Morgan Stanley said Google is on pace to add 7,000 new staffers this year, well above the previous estimate of 4,000 new hires.
Investors, presumably including many of Morgan Stanley’s own wealth management clients, promptly sold off GOOG, causing its stock to tumble 3% that day.
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If the recent headlines make you feel like the international financial order is heading toward a cliff, I would not blame you. Apparently, the Europeans have managed to spread their sovereign debt crisis from Greece to Italy, a far more significant country for the world economy. Here in the US, politicians are engaged in high-stakes political brinksmanship regarding raising the debt ceiling, without which the US will go into default for the first time in its history.
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LinkedIn IPO
[Repost from my contribution to Morningstar Advisor] LinkedIn LNKD rallied more than 100% in its first day of trading. The market is buzzing about its spectacular performance. Even I, a known advocate of passive investment among my friends and clients, got calls asking if it’s a good time to invest in this stock. It’s not, emphatically. Here are three reasons:
Insider Advantage
LinkedIn has been in business since 2003. Who decided that it should go public now, as opposed to March 2009? Surprise! It’s the management of the company, acting in the interest of its shareholders. In LinkedIn’s case, it’s Reid Hoffman, who is both CEO and a major shareholder. Did Reid do that so that you could buy his shares at an undervalued price? I bet not. And for that matter, he was willing to sell shares at a pricing range of $32 to $35. The pricing range was only raised to $42 to $45 after popular demand from investment bankers.
The Investment Scientist 