Category: Investing

I was chatting this morning with a friend who is a retired professional investor, having been previously involved in the management of $billions (not as the ultimate fund manager, but in a pretty senior role). A staunch Democrat and an active trader of his own portfolio (using exotic techniques such as “selling premium”, shorting a leveraged ETF while being long the unleveraged index, etc.), he was predicting doom and gloom for the U.S. economy due to Republican incompetence and stupidity. The stock market would continue to go down and we would suffer a depression. He cited the example of George W. Bush ladling out $700 billion to Wall Street in 2008 because “it was the right thing for the American People” and contrasted to Donald Trump, who wasn’t even trying to do anything right for Americans. I disputed that “Americans” was a meaningful term because the owner of an apartment building has different interests than the renter of an apartment. More substantially, I took the position that someone, maybe us, would blink first and mostly everything would return to the previous status quo. Therefore, I argued there was no need to do anything other than perhaps invest any available cash into the S&P 500.

The call in which my friend implicitly advised me to sell everything began at 10:12 am. What happened later in the day? NBC:

President Donald Trump said Wednesday he was pausing higher targeted tariffs for 90 days for most countries, a stunning reversal in his trade war that has sent markets reeling.

Trump wrote on social media just before 1:30 p.m. that he came to the decision because more than 75 trading partners didn’t retaliate and have reached out to the United States to “discuss” some of the issues he had raised.

(The S&P 500 was up 9.52 percent today.)

A Ukrainian immigrant friend has been (understandably) expressing rage at Donald Trump for wanting to shut down U.S. support of Ukraine’s military. He also recently texted us that he was enraged with Trump’s tariffs (that never actually happen? I can’t keep track) tanking the stock market. As an index investor who worships at the Church of the Efficient Market Hypothesis I don’t trade and, therefore, don’t check the market.

Not having previously checked, I proposed the following:

Compare to June 1, 2024 so that we filter out some of the noise (back in June the market thought that we’d have continuity with Genocide Joe)

I don’t think we can count the market’s optimistic run-up when it looked like Trump was going to win

Then I looked at a one-year chart:

The Google says that we’re up

adjusted for inflation, perhaps not

5643/5283 [the March 10 price divided by the June 3, 2024 price] compared to around June 1 that’s up 7%

actual inflation (not the government’s fake number) is 4%/year (3% in 9 months)? so we’re up about 4% real in 3/4s of a year, which means the market is on track to deliver a 5% real return (more like 6% if we accept the government 3% annual inflation stat)

that’s not too different from normal (7.5 percent real annual return over the past 20 years using the government’s understated inflation figures, so probably closer to 6 percent if we adjust for inflation by looking at the stuff that an investor might want to buy (houses in decent neighborhoods and upscale vacations, not DVD players at Walmart))

Happy New Year to everyone! Let’s consider a New Year’s resolution to look at our investments…

“Wave Goodbye To the Stock Market’s Historic Run, Goldman Sachs Says” (Investopedia):

Analysts at Goldman Sachs on Monday forecast the S&P 500’s average annual return over the last decade of 13% will shrink to just 3% in the next 10 years.

Goldman analysts forecast the S&P 500 will return an average of just 3% a year in the next decade, a far cry from the 13% average annual return of the last 10 years. That would rank in the bottom decile of comparable periods in the last century. It also puts the odds that stocks fail to outpace inflation at about 33%.

So why the pessimism? One of the primary causes for Goldman’s concern is the market’s extreme concentration, which by their measure is near its highest level in 100 years. Concentration of this magnitude, the analysts say, makes the performance of the S&P 500 overly reliant on the earnings growth of the index’s largest constituents.

The 10 largest stocks in the S&P 500 currently account for about 36% of the index, far higher than at any other time in the last 40 years. These stocks have swelled in size in large part because of their exceptional earnings growth over the last two years. The Magnificent Seven—Apple (AAPL), Nvidia (NVDA), Microsoft (MSFT), Alphabet (GOOG; GOOGL), Amazon (AMZN), Meta Platforms (META), and Tesla (TSLA)—more than doubled their earnings on a year-over-year basis in the first quarter of 2024.
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History shows, however, that it’s extremely difficult to sustain earnings growth at that clip. Just 11% of S&P 500 companies since 1980 have maintained double-digit sales growth for 10+ years, according to a Goldman analysis. A microscopic share (0.1%) has sustained 50%+ margins for a decade.

What’s the alternative if you don’t have a direct phone connection to God to tell you what individual stocks to buy?

However, growth is expected to pick up for the “Other 493,” which are forecast to post double-digit earnings growth over the next five quarters, significantly narrowing the gap between those companies and the Mag Seven.

The market’s extreme concentration and the difficulty of sustaining earnings growth are two key reasons Goldman expects the equal-weight S&P 500 index to outperform the more widely tracked capitalization-weight, or aggregate, version over the next decade.

Historically, the equal-weight index tends to outperform the aggregate index, but the last 10 years have been a different story. The aggregate index has outperformed the equal-weight by 3 percentage points a year since 2014.

Goldman expects the pendulum to swing back in favor of the equal-weight index, which their model suggests will outperform by 8 percentage points annually through 2034, its most dramatic outperformance since at least 1980. The size of the outperformance may seem extreme, the analysts note. “However, the equity market has also rarely been as concentrated as it is now.”

The current record outperformance for the equal-weight index is 7%, which it achieved in the decades ending in 1983 and 2010. These two 10-year stretches, Goldman points out, each began when the market was at peak concentration, as it may be today.

How would it work to put together an equal-weight portfolio? Just find a zero-commission broker and buy $1000 of each of 500 stocks (total value: enough to buy a meal at Five Guys a few years from now). It would require a lot more trading for rebalance, though, than the market-weight S&P 500 because the market-weight index adjusts automatically when one component stock rises or falls. The trading could lead to tax inefficiency that would wipe out the theoretical superiority of equal weight.

One could also let someone else do the trading, and somehow this Invesco ETF (RSP) seems to have figured out how to eliminate what you’d expect to be capital gains from all of the trading.

Past medium-term performance doesn’t seem to be great for equal weight:

Perhaps from letting the Mag 7 stocks run wild, the straight S&P (light/bright blue bar) seems to have outperformed, but if we go back 21 years to the fund’s inception (2003), the equal weight index has done a little better than the S&P 500 index (on the third hand, the ETF’s relatively high expense ratio of 0.2% will wipe out quite a bit of that small superiority).

Do we feel confident enough in the market power and dominance of the biggest companies in the S&P 500 that we think they can keep growing?

What about other indices? The NASDAQ-100 is now partly Bitcoin because they brought in MicroStrategy, a Bitcoin account selling at a bit premium to the value of the underlying Bitcoins (WSJ). And there is a lot of overlap by market cap with the S&P 500 (e.g., Apple, NVIDIA, Microsoft, Amazon, Alphabet). Maybe a simpler way to avoid the concentration risk in the S&P 500 would be to buy a midcap or smallcap fund.

And how about a little humility/honesty as an early New Year’s resolution? “He Lost 35% Ignoring 2024’s Biggest Trades: ‘I Am Not Good at What I Am Doing’” (WSJ):

In early December, Richard Toh, the chief executive and investment officer for the Singapore-based hedge-fund firm Kenrich Partners, sent a four-page letter to investors.

“I have come to the realization that I am not good at what I am doing but I guess some of you may have sensed that already,” he wrote. “I am sorry I have let you down.”

“I pretty much missed all the major themes in the last two years,” Toh wrote. “I was hopelessly out of sync with the market, buying when I should be selling and selling when I should be buying. We got whipsawed several times this year even as we got some facts correct.”

“I learned from that episode that sometimes the best investments are precisely the ones you cannot explain and probably made no sense. It also told me I am getting too old,” he wrote.

(There are so many people to whom I could legitimately write “I am not good at what I am doing” that I don’t know where to start…)

Separately, soon we will need to say goodbye here in Jupiter to our mayor’s personal Christmas light display (no keffiyeh as part of the crèche, as the Pope had):

Happy New Year’s Eve, everyone!

Some folks are using Zoom stock as an example of the pain that some Americans would suffer if the Democrats’ plan to tax unrealized capital gains were implemented. They posit a prescient investor who paid $100 for the stock just as coronapanic was unfolding, then got taxed based on the $337/share price at the end of 2020, and just held onto the stock for the ride back down below $100 (remember that the loss in real dollars is even more severe; adjusted for purchasing power, the $100 paid in 2020 had a purchasing power of closer to $200 today, e.g., for a house):

Today’s topic is not the wisdom of forcing successful Americans to pay their fair share, but on how the Zoom price today can be lower than the Zoom price before coronapanic. Zoom was worth $92 per share in August 2019, for example, before SARS-CoV-2 had infected even a single human, with or without a cloth mask to protect him/her/zir/theirself.

Given that Zoom was a curiosity in 2019 and is something that hundreds of millions of people today still use regularly, how can the company be worth less?

Let’s also consider the purportedly efficient market and the purported wisdom of crowds of investors. Zoom had potential, so it was worth a lot in 2019. What would have been an impossible dream for Zoom investors? How about governors all around the U.S. making it illegal for people to meet in person (except at liquor and marijuana stores in California, Massachusetts, etc.)? U.S. state and local governments did more for Zoom than investors could ever have hoped for and yet the company still hasn’t lived up to the expectations of 2019.

How did the investors of 2019 get it so wrong?

“When Wall Street Rolls Out the Red Carpet for You, Who Pays?” (Wall Street Journal, March 8):

Edward McQuarrie, an emeritus business professor at Santa Clara University who studies long-run asset returns, recently analyzed how mutual-fund investors have fared since the 1920s. His goal was to measure their returns not in theory, but in real life.

He found that a $10,000 investment in 1926 in the index that became the S&P 500 would have grown to just under $198,000, 30 years later, with all dividends reinvested. But you couldn’t have invested directly in that index; it was only a hypothetical measure, without commissions or other costs.

In the real world, where mutual funds charged sales loads of up to 8.5% plus annual expenses, a $10,000 investment in 1926 would have grown to less than $99,000 over three decades. In the real world, costs ate up half the wealth you could have achieved in theory.

Over the next 30-year period, through 1986, fund investors captured only 71% of the cumulative wealth that the S&P 500 hypothetically generated.

(None of these results account for the toll of taxes and inflation.)

That last sentence is brutal. Unless you live in a tax-free environment, e.g., as an EU citizen resident in Italy, It might be better to follow Hunter Biden’s example and enjoy whatever money falls to hand rather than trying to invest!

How about the alternative investments that savvy college endowments buy into?

A recent study found that, on average, for every dollar of return they generated from 1995 through 2016, hedge funds harvested 64 cents in management and performance fees. Lately, at some leading hedge funds, expenses have even risen—to as much as 5% to 7% annually.

Of course, this analysis is presented by the same newspaper that reported on the high effectiveness of lockdowns, mask orders, and school closures as means of preventing COVID-19…