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How Regulation Promotes Short-Termism

Every so often some prominent individual in the investment community reaches the erroneous conclusion that earnings guidance is the root of all evil. The latest to promote this idea is Larry Fink, CEO of BlackRock (NYSE: BLK ). BlackRock, which has $4.6 trillion in assets under management, claims to be the world’s largest investment firm. Fink has held the top post ever since he co-founded the company in 1988. He is rumored to be at the top of Hillary Clinton’s list of candidates for Treasury Secretary, should she win the presidential election. Fink might even be petitioning for the job. CNN Money recently pointed out that he is beginning to sound a lot like Clinton herself, even to the point of using the same terminology. Both of them are on the warpath against what they call “short-termism” in corporate America. Fink penned a letter on February 1 to the CEOs of major corporations and used that term in the very first sentence, calling it a powerful force that is afflicting corporate behavior. Frankly, I can’t argue with much of what he says. I agree with him that there is too much attention paid to how a company performs over the short term and not enough paid to how it does over the long term. I consider myself a long-term investor, and I much prefer to see the companies I invest in managed with a long-term perspective in mind. For example, management can easily boost earnings in any particular quarter simply by slashing capital expenditures or by cutting spending on research and development. Yet doing so comes at the cost of long-term growth. I take exception, however, to Fink’s call to CEOs urging them to put an end to quarterly earnings guidance. This is not a new position for me. Because I feel so strongly about this issue, I devoted an entire chapter to it in my 2008 book, “Even Buffett Isn’t Perfect.” I favor guidance for a number of reasons. First, it comes straight from the horse’s mouth. Guidance is provided by the very people who are running the company. These people know better than anyone how the company is likely to do. I want to hear from them in as specific terms as possible. I don’t take what they say at face value. But I do want to hear what they have to say – then it’s up to me to judge what to make of that information. Second, studies show that analysts’ earnings forecasts are not particularly reliable to begin with… and it turns out they are even less accurate when guidance is not provided. Third, although some investors believe that executives are more likely to take actions that will increase company value over the long term if they don’t have to deal with the pressure of living up to quarterly guidance, studies on the topic uncover no evidence that companies increase capital expenditures or investments in research and development after they eliminate guidance. Fourth, studies also show that there is a negative stock price reaction when companies announce that they will no longer provide guidance. Interestingly, although management usually says they are eliminating guidance because they believe it is in the best interest of investors, it turns out they usually eliminate guidance when the company is having financial difficulties. What’s even more interesting is that these very companies often change their minds and begin providing guidance again when business conditions improve. There is one critical issue I wish everybody would understand. While it’s true that there is too much focus on short-term results, this isn’t the result of guidance. The reason investors pay so much attention to quarterly earnings in the first place is that the SEC requires corporations to report their financial results every quarter. That’s right. Short-termism is a direct result of regulation. So if you really believe that short-termism is a problem, instead of urging CEOs to stop providing guidance, it would be more effective if you urged the SEC to end the quarterly reporting requirement. To be clear, Larry Fink is not in favor of that. Neither am I. Perhaps this is the greatest irony of all. Our country recently went through a financial crisis that was in part caused by a lack of transparency. In response, regulators implemented all kinds of new rules specifically designed to increase transparency. Eliminating guidance, however, does exactly the opposite. It reduces transparency. To say that we’d be better off with less guidance is the equivalent of saying that we’d be better off with less information. That’s simply nonsense. As I said earlier, research studies show that there is a statistically significant loss in share value when companies eliminate guidance. These studies also show that companies that eliminate guidance continue to underperform for as long as a year. So if you own shares in a company that has regularly provided guidance and then stops doing so, you might want to think about getting out of that investment. On the other hand, if you are invested in a company that has never provided guidance, you need not worry. Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ) and Alphabet (NASDAQ: GOOG ) (NASDAQ: GOOGL ) are two companies that have performed well over the long term. Neither one has ever provided guidance.

Colombia’s Economic Struggles Are Reflected In The Global X MSCI Colombia ETF

Summary The macro-economic struggles of Colombia are reminiscent of those within other countries in the Latin American region. China’s economic issues and commodity price declines have exacerbated the economic problems within Colombia and the rest of the Latin American region. Colombia’s economic struggles have affected the performance of the Global X MSCI Colombia ETF. Only 5 of the top 25 holdings in the fund have a positive YTD return. In order to fully understand the issues within the Colombian economy, it is important to review the economic struggle within the Latin American region. It is no secret that the Latin American region has had a very poor economic run in 2015. The economy in Venezuela is dealing with high inflation that could be seen in quite a few statistics such as the inflation rate , core inflation rate, consumer price index and food inflation. The economic struggle in Brazil can be seen in the following chart with regards to their GDP in their last several quarters. This economic statistic has resulted in a brutal performance for the iShares MSCI Brazil Capped ETF (NYSEARCA: EWZ ) in 2015. The fund has a -38.8% YTD return. (Source: Bloomberg ) The Latin American region has been in a downward trend for the last several years in terms of GDP. This can be seen in the next chart below: (click to enlarge) (Source: CNN Money) This chart is as of July 2015. Now it is projected that the Latin American region is expected to contract 0.2% for the year, according to FocusEconomics. Major catalysts to the economic struggle in the Latin American region include the current economic struggle in China and the decline in commodity prices. China has strategically resorted to domestic consumption in order to spark economic growth. This is not good news for a region that heavily consumes Chinese exports. It is no secret that the Chinese stock market index has practically fallen off a cliff since June 2015 . In addition, China has shown signs of slow growth with its recent import totals. China’s imports dropped 8.7% year over year to $143.13 million in November. In October, China’s imports dropped 18.8% year over year. This marks the 13th straight month of year-over-year decline for Chinese imports . Chinese exports declined 6.8% year over year in November. This was the fifth straight month of year-over-year decline for Chinese exports. The Chinese debt to GDP ratio reached a record high for the month of June . The depreciation of the Chinese yuan against the U.S dollar has weakened commodity demand in Latin America and devalued Latin American currencies. This can be seen in the chart below. Notice that the Colombian peso was affected the most. (click to enlarge) The decline in commodity prices is quite evident and can be seen in the following charts involving crude oil, heating oil, silver and gold. (click to enlarge) (click to enlarge) (click to enlarge) (click to enlarge) Unfortunately, Colombia is right in the middle of the economic struggle in the Latin American region. The Colombian stock market has declined by over 31% YTD . Colombia has experienced a rise in inflation within the past few years. However, the increase in inflation has only accelerated within the past year. The following is the 1- and 5-year charts of the Colombia inflation rate as well as the country’s consumer price index. (click to enlarge) (click to enlarge) (click to enlarge) Thus, the central bank of Colombia has had to raise the interest rate for four consecutive meetings in order to curb the impact of increasing inflation. The interest rate is currently 5.75%. (click to enlarge) Thus, it is not surprising that Colombia has one of the worst performing country ETFs in the market in the Global X MSCI Colombia ETF (NYSEARCA: GXG ). The fund has a YTD return of -41.0%. Out of the top 25 holdings within the Global X MSCI Colombia ETF, only 5 holdings have generated a positive YTD return. These holdings have a combined portfolio weight of only 14.42%. It is not surprising that all of the fund’s price multiples fall short of their Morningstar benchmark totals. Value and Growth Measures Stock Portfolio Benchmark Price/Prospective Earnings 11.90 15.11 Price/Book 0.69 1.54 Price/Sales 0.69 1.04 Price/Cash Flow 1.93 5.42 Given the volatility of Colombian equities, it is no surprise that this ETF would have a greater standard deviation than its benchmark. Unfortunately, the fund is rampant with negative returns and ratios as seen in the fund’s 3- and 5-year volatility measures . 3-year Trailing Standard Deviation Return Sharpe Ratio Sortino Ratio GXG 26.78 -27.45 -1.05 -1.23 MSCI ACWI Ex USA NR USD 12.38 3.31 0.32 0.51 5-year Trailing Standard Deviation Return Sharpe Ratio Sortino Ratio GXG 23.81 -16.57 -0.64 -0.79 MSCI ACWI Ex USA NR USD 15.33 2.99 0.26 0.38 Bottom Line Given Colombia’s economic vulnerability at the moment, I think it would be best served to steer clear of this ETF due to its significant exposure to Colombian equities.

6 Weekly Sentiment Charts – Is The Blood Still Running Deep Enough?

Summary Two months ago, my sentiment charts were screaming BUY. I added to many positions. About a month ago, some of my sentiment indicators reached lows not seen in a year or longer. The time to buy stocks is when there is “blood in the streets” when others are fearful and selling. Sentiment has recovered quickly. After making his fortune buying during the panic that after Napoleon’s Battle of Waterloo, 18th century British nobleman and member of the Rothschild banking family, Baron Nathan Rothschild, is often credited for telling his clients that “The time to buy is when there’s blood in the streets.” (See ” When There’s Blood In The Streets “) I’ve explained in past articles such as ” SPY 8% Off Record High While WLI Rises To 6-Week High ” why I like SPY as an investment for the long-term. I use fundamentals to pick individual stocks and SPY for my portfolio, but I seldom buy as they are making new 52-week highs. I try to buy when they are on sale and when the blood is running in the streets. Every week I review my sentiment charts of the weekly data. In this article, I compare the sentiment levels from various surveys in my table to get an idea of overall investor sentiment. (click to enlarge) Note: “Blood Level” of 1 means the data is in the lower 20% of the graph while a reading of 5 is for the data in the upper 20% of graph. To get better prices, I start with my list of “Explore Portfolio” stock picks then wait for market pullbacks and extreme negative sentiment levels to buy if they haven’t quite reached the “low ball” prices I set ahead of time to buy during market panics and other periods of market inefficiency. Said another way, I like to take profits as markets make new highs then buy back shares when my sentiment charts loudly shout at once “Buy” as most investors are afraid and selling. Two months ago when the S&P500 made its low for the year, most of my sentiment indicators were at screaming buy levels not seen since the 21% bear market correction in 2011. While recovering, most of the sentiment indicators I track are still improving and have yet to reach extreme levels. Some, like the ten day moving average of the put to call ratio shown below have fallen enough to suggest we are again due for a market pullback, so I’ve taken profits in my stocks to have funds to buy any major pullbacks. If you have other favorite sentiment indicators you want tracked in my table, then let me know in the comments and I will consider adding them to future articles. What follows are the charts and brief explanations for the measures of sentiment I follow, in no particular order of importance. Chart 1: Put-to-Call Ratio – 10 day moving average chart courtesy of Stockcharts.com (click to enlarge) Chart 2: AAII American Association of Individual Investors Sentiment Survey Numbers posted weekly here on Seeking Alpha From AAII Sentiment Indicator , “The sentiment survey, taken once a week on the AAII website, measures the percentage of individual investors who take the survey who are bullish, neutral and bearish.” (click to enlarge) Chart 3: II: Investor’s Intelligence Survey From Investors’ Intelligence Sentiment Indicator : The “Investors Intelligence Survey” or IIS questions stock-market newsletter writers once a week to see if they were bullish or bearish on the stock markets in the near-term. Newsletter writers have a large following as a group and are thus considered “market experts.” Investor’s Intelligence web site (click to enlarge) Chart 4: Ticker Sense Blogger Sentiment vs. S&P500 From Ticker Sense Blogger Sentiment Poll : “The Ticker Sense Blogger Sentiment Poll is a survey of the web’s most prominent investment bloggers, asking “What is your outlook on the S&P 500 for the next 30 days?” Conducted on a weekly basis, the poll is sent to participants each Thursday, and the results are released on Ticker Sense each Monday. The goal of this poll is to gain a consensus view on the market from the top investment bloggers — a community that continues to grow as a valued source of investment insight. © Copyright 2015 Ticker Sense Blogger Sentiment Poll.” (click to enlarge) Chart 5: NAAIM Exposure Index From NAAIM Exposure Index – National Association of Active Investment Managers, “The NAAIM Exposure Index represents the average exposure to US Equity markets reported by our members.” Screenshot source Chart 6: CNN Money Fear & Greed Index The CNN Money Fear & Greed Index is derived from seven indicators explained here Screenshot source Notes I trade SPY around a core position in my newsletter’s ” Explore Portfolio ” and with my personal account. With dividends reinvested, my explore portfolio holds 137.202 shares of SPY with a “break-even” price of $99.33. I also have the index fund version of SPY in both my newsletter’s “core” portfolios. SPY is the exchange traded fund for the S&P 500 Index. VTI is Vanguard’s “Total Stock Market” exchange traded fund. If you want to invest in a single fund, that is my first choice over SPY. I recommend SPY and several others in my core portfolios for more opportunities to rebalance. VOO is Vanguard’s new exchange traded fund that tracks the S&P 500 Index. It is a lower cost alternative to SPY. I own and write about SPY, as I have many years of data for it, but VOO could do slightly better than SPY over time because it has a lower expense ratio. Disclosure : I am long SPY and own the traditional index fund versions of VTI and VOO bought long ago in various taxable and tax deferred accounts. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.