Tag Archives: portfolio

Historical Rates Impact Common Stocks

Summary We think there is a recency bias surrounding interest rates. Historical rates are in the band between 3% and 6%. We believe rates will rise when there is a demand for credit, which can be a good thing for common stock owners. Time and coincidence often cloud our own perception. Consider interest rates. Baby Boomers and Generation Xers became adults (25 or older) between 1965 and 2005. During that period, these adults witnessed an aberration in the history of interest rates. They saw moments of monumental highs (20%) and levels consistently above historical norms. The chart below shows that long- and short-term interest rates in the United States have spent most of the last 400 years in a range between 3% and 6%. We contend that this deviation clouds the judgment and expectations of many of today’s investors. There are numerous implications for long-duration common stock owners arising from the examination of historical interest rates. Intrinsic Value Computations The father of value investing, Ben Graham, concluded through his years of research that 10-year corporate bonds averaged 4.4%. Therefore, in his revised intrinsic value equation, he used 4.4% as the numerator for adjusting intrinsic value based on interest rate fluctuations. This long-term interest rate chart supports the validity of his choice, and is right in the middle of the 3-6% historical range. One could argue that long-duration equity investors have been using discount rates in their intrinsic value calculations much higher than historical interest rates justify. This is likely due to the unusually high rates of the period between 1965 and 2005, a recency bias. Commitment of Capital to Bond Investments In 1980, the prime interest rate at the major banks was 20%. Long-term Treasuries peaked at 15% in early 1981. Inflation topped out in 1981 at 11%. Thirty-year fixed mortgages were issued as high as 17%. What people didn’t realize at the time was that they were living through a five-standard deviation event, according to history. Even if inflation had stayed at 11%, those interest rates offered investors very high inflation-adjusted returns. As the famous bond investor Bill Gross has argued, this laid the groundwork for more than 30 years of declining interest rates and a normalization back into the band between 3% and 6%. This has rewarded bond investors and got them addicted to an asset-allocation commitment based on lookback returns which are statistically unlikely. Interest rates are currently below the historical 3-6% range, and will likely rebound over the next 10 years into the historically normal band. We believe common stock buyers should include that likelihood in their stock selection methodology, whether in their intrinsic value calculations or in the effect that higher rates in the U.S. have on the U.S. dollar and overall economic growth in the country. We contend that the surprise in the U.S. will be how much stronger economic growth will be than what is expected. How else can rates go up, unless someone demands the capital via borrowing? Need for Solid Returns for Investors Owners of wealth in the form of liquid assets have an economic need in both low and high interest rate time periods. They need to earn a return above inflation to defend the purchasing power of their liquid asset pool. Ownership of long-duration common stocks has proven to be superior to that of other liquid assets over long time periods, except for the 10-year stretch from 1999 to 2008. As 10-year Treasuries fell to 1.6% in 2008 and stocks were liquidated in the financial crisis, two five-standard deviation events conspired to elevate bond investments in popularity and thrust bond portfolio managers into god-like status. We think a good rule of thumb is to avoid portfolio success stories created by five-standard deviation events. These only happen 2.5% of the time. Rather than being preoccupied with the consensus of investors, we believe building our portfolio around high-probability events is much more valuable to the long-term investor. Industries Benefited By Higher Rates in the 3-6% Range We have argued ad nauseam that common stock investors have two possibilities in front of them as it pertains to interest rates. If interest rates were to rise back into the 3-6% historically normal band, there must be forces which demand the money and industries which benefit from the forces that cause the rise in rates. If rates stay below the historical band, intrinsic value calculations using discount rates above the historical average will undervalue common stocks. Certain industries would welcome higher interest rates. Insurers must earn interest on collected premiums, banks would like to charge more for loans, and homebuilders would like to have so many customers for new homes that the resulting demand for money drives up interest rates. Consumer discretionary companies would love to see a level of prosperity which would drive retail sales and liberal advertising budgets. Drug and biotech companies would like everyone to be able to afford the fantastic new medicines they will introduce in the next 10 years. In summary, above-average returns don’t come along without taking risk. Investors have become very comfortable with today’s historically low interest rates, and fear continued poor economic growth rates. Equity portfolio managers use discount rates higher than today’s actual rates because of the abnormally high rates of the last 40 years. Lastly, the contrary long-duration common stock investor should be attracted to industries which benefit from the gravitation back into the historically normal returns from the bond market. The information contained in this missive represents SCM’s opinions, and should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results. Bill Smead, CIO and CEO, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past 12-month period is available upon request.

Stocks That Can Double, Can Give You Trouble

Summary Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Fourth, for the few that rise a lot, you can’t invest in them. I haven’t written about promoted penny stocks in a long time . Tonight, I am not writing about promoted stocks, only penny stocks as promoted by a newsletter writer . He profits from the newsletter. Ostensibly, he does not front-run his readers. Before we go on, let me run the promoted stocks scoreboard: Ticker Date of Article Price @ Article Price @ 12/1/15 Decline Annualized Dead? ( OTCPK:GTXO ) 5/27/2008 2.45 0.011 -99.6% -51.5% ( OTCPK:BONZ ) 10/22/2009 0.35 0.000 -99.9% -68.5% ( OTCPK:BONU ) 10/22/2009 0.89 0.000 -100.0% -100.0% ( OTC:UTOG ) 3/30/2011 1.55 0.000 -100.0% -100.0% Dead (OBJE) 4/29/2011 116.00 0.000 -100.0% -100.0% Dead ( OTCPK:LSTG ) 10/5/2011 1.12 0.004 -99.6% -74.2% ( OTC:AERN ) 10/5/2011 0.0770 0.0001 -99.9% -79.8% ( OTC:IRYS ) 3/15/2012 0.261 0.000 -100.0% -100.0% Dead ( OTCPK:RCGP ) 3/22/2012 1.47 0.180 -87.8% -43.4% ( OTCQB:STVF ) 3/28/2012 3.24 0.070 -97.8% -64.7% ( OTCPK:CRCL ) 5/1/2012 2.22 0.001 -99.9% -87.2% ( OTCPK:ORYN ) 5/30/2012 0.93 0.001 -99.9% -85.4% ( OTCQB:BRFH ) 5/30/2012 1.16 1.000 -13.8% -4.1% ( OTCPK:LUXR ) 6/12/2012 1.59 0.002 -99.9% -86.3% ( OTCQB:IMSC ) 7/9/2012 1.5 0.495 -67.0% -27.9% ( OTCPK:DIDG ) 7/18/2012 0.65 0.000 -100.0% -100.0% ( OTCQB:GRPH ) 11/30/2012 0.8715 0.013 -98.5% -75.4% ( OTCPK:IMNG ) 12/4/2012 0.76 0.012 -98.4% -75.0% ( OTCPK:ECAU ) 1/24/2013 1.42 0.000 -100.0% -94.9% ( OTCPK:DPHS ) 6/3/2013 0.59 0.005 -99.2% -85.5% ( OTC:POLR ) 6/10/2013 5.75 0.005 -99.9% -94.2% ( OTC:NORX ) 6/11/2013 0.91 0.000 -100.0% -97.5% ( OTCQB:ARTH ) 7/11/2013 1.24 0.245 -80.2% -49.3% ( OTCPK:NAMG ) 7/25/2013 0.85 0.000 -100.0% -100.0% ( OTCPK:MDDD ) 12/9/2013 0.79 0.003 -99.7% -94.5% ( OTCPK:TGRO ) 12/30/2013 1.2 0.012 -99.0% -90.9% ( OTCQB:VEND ) 2/4/2014 4.34 0.200 -95.4% -81.6% (HTPG) 3/18/2014 0.72 0.003 -99.6% -95.9% ( OTCQB:WSTI ) 6/27/2014 1.35 0.000 -100.0% -99.9% (APPG) 8/1/2014 1.52 0.000 -100.0% -99.8% (CDNL) 1/20/2015 0.35 0.035 -90.0% -93.1% 12/1/2015 Median -99.9% -87.2% If you want to lose money, it is hard to do it more consistently than this. No winners out of 31, and only one company looks legit at all – Barfresh ( OTCQB:BRFH ). But what of the newsletter writer? He seems to have a couple of stylized facts that are misapplied. Every day, around 45 stocks double or more in price. Some wealthy investors have bought stocks like these. Wall Street firms own these stocks but never recommend them to ordinary individuals The media censors price information about these stocks so you never hear about them Every day, around 45 stocks double or more in price. That may be true, but most of those that do double or more in price don’t do so for fundamental reasons; they are often manipulated. Second, the stocks that do double in price can’t be found in advance – i.e., picking the day that the price will explode. Third, the prices more often fall hard for these tiny stocks. Of the 30 stocks mentioned above that were not dead at the time of the last article, 10 fell more than 90% over the 10+ month period. 13 fell less than 90%, 1 broke even, and 7 rose in price. The median stock fell 61%. This was during a bull market. Now you might say, “Wait, these are promoted stocks, of course they fell.” Only the last one was being actively promoted, so that’s not the answer. My fourth point is for the few that rise a lot, you can’t invest in them. The stocks that double or more in a day tend to be the smallest of the stocks. Two of the 30 stocks listed in the scoreboard rose 900% and 7100% in the 10+ month period since my last article. How much could you have invested in those stocks? You could have bought both companies for a little more than $10,000 each. Anyone waving even a couple hundred bucks could make either stock fly. So, no, these stocks aren’t a road to riches. Now the ad has stories as to how much money people made at some point buying the penny stocks. The odds of stringing several of these successful purchases in succession, parlaying the money into bigger and bigger stocks that double is remote at best, and your odds of losing a lot of it is high. This idea is a less classy version of the idea promoted in the book 100 to 1 in the Stock Market . If it is difficult to find the 100-baggers 30 years in advance, it is more difficult to find a stock that is going to double or more tomorrow, much less a bunch of them in succession. You may as well go to Vegas and bet it all on Double Zero on the roulette wheel four times in a row. The odds are about that bad, as trying to get rich buying penny stocks. The ad also lists three stock that at some point fit his paradigm – MeetMe (NASDAQ: MEET ), PlasmaTech Biopharmaceuticals, Inc. (PTBI), which is now called Abeona Therapeutics Inc. (NASDAQ: ABEO ), and Organovo (NYSEMKT: ONVO ). All of these are money-losing companies (MeetMe may be breaking into profitability now) that have survived by selling shares to raise cash. The stocks have generally been poor. Have they had volatile days where the price doubled? At some point, probably, but who could have picked the date in advance, and found liquidity to do a quick in-and-out trade? The author lists five future situations as a “come on” to get people to subscribe. I find them dubious. As for wealthy investors, he mentions two: Icahn pulling of a short squeeze on Voltari (difficult to generalize from), and Soros with PlasmaTech Biopharmaceuticals, Inc. It should be noted that Soros has a big portfolio with many stocks, and that position was far less than 1% of his assets. In general, the wealthy do not buy penny stocks. As for brokers and the media not mentioning penny stocks, that is being responsible. The brokers could get in hot water for recommending or buying penny stocks even under a weak suitability standard. The media also does not want to be blamed for inciting destructive speculation. Retail investors lose enough money through uninformed trading, why encourage them to do it where fundamentals are typically quite poor. I’ve written two other pieces on less liquid stocks to try to explain the market better: On Penny Stocks and Good Over-the-Counter “Pink” Stocks . It’s not as if there isn’t value in some of the stocks that “fly under the radar.” That said, you have to be extra careful. Near the end of the ad, the writer describes how he is being extra careful also. Many of his rules make a lot of sense. That said, following those rules will get you boring companies that won’t double or more in a day. And that’s not a bad thing. Most significant money is made slowly – it doesn’t come in a year, much less in a day. That said, I recommend against the newsletter because of the way that it tries to attract people. The rhetoric is over the top, and appeals to those who sense conspiracies keeping them from riches, so join my club where I hand out my secret knowledge so you can benefit. In summary, as a first approximation, don’t invest in penny stocks. The odds are against you. Fools rush in where angels fear to tread. Don’t let greed get the better of you – after all, what is being illustrated is an illusion that retail investors can’t generally achieve. Disclosure: None

Creating A Quality Growth Portfolio For Millennials

Summary I searched through all ETFs and found five for building a quality growth portfolio given the current environment. The five ETFs I found cover: U.S. Mega-Cap growth, biotechnology, International Growth, High Yield Bonds and Cash. The portfolio is weighted 70% stocks, 20% bonds, 10% cash. In this article, I will be creating a simple growth oriented portfolio for millennial investors. The goal of the portfolio is to hold five ETFs to gain exposure to high quality growth stocks as well as targeting specific high growth areas. U.S Equity: Vanguard Mega Cap Growth ETF (NYSEARCA: MGK ) I chose MGK because it only holds the largest market-cap growth stocks. I wanted to be more conservative with my main growth selection because the second part of my U.S. equity allocation consists of a high growth/high risk segment of the market, therefore for balance, I chose MGK. When looking for large-cap growth ETFs, I narrowed my search down to MGK and the iShares Russell Top 200 Growth ETF (NYSEARCA: IWY ). I chose MGK over IWY because of the lower cost and exposure to health care. MGK charges 0.11% and IWY charges 0.20%, which is not a huge difference, however when taken in combination with the data table below MGK stood out as the superior choice. My second ETF selection is a health care ETF, therefore, I did not want a lot of exposure to health care from my main selection. I looked at the health care allocations of IWY and MGK and found that MGK has a lower allocation to health care. Health Care Allocation MGK 14.00% IWY 17.95% [Table Data from IWY & MGK websites] Targeted Sector Growth Equity: ALPS Medical Breakthroughs ETF (NYSEARCA: SBIO ) I chose SBIO because of its exposure to small & mid cap high growth biotechnology companies. SBIO only holds companies with a market cap between $200 million and $5 billion. Most importantly, SBIO only holds those stocks with a sustainable cash burn rate and companies with at least one product in phase 2 or phase 3 of development. This distinguishes SBIO from other biotech ETF offerings because it is targeting companies that have moved passed the initial stage of development and have the cash available to be able to fund continued clinical trials. It is widely know that many biotechs with promising drugs build hype when they are in phase 2 or phase 3 because of the potential to go from zero or very little revenues to a significant amount. A complete picture of the selection process can be seen in the image below. (click to enlarge) [Chart from SBIO Fund page ] International Equity: iShares MSCI EAFE Growth ETF (NYSEARCA: EFG ) I chose EFG because it holds mainly large cap companies in developed markets excluding the United States and then selects those companies whose earnings are expected to grow at an above-average rate relative to the market. The following chart shows that growth oriented stocks in the EAFE have significantly outperformed the broad iShares MSCI EAFE ETF (NYSEARCA: EFA ) and value oriented stocks of the iShares MSCI EAFE Value ETF (NYSEARCA: EFV ). (click to enlarge) [Chart from Google Finance] Short-Term High-Yield Corporate Bonds: First Trust Tactical High Yield ETF (NASDAQ: HYLS ) I chose HYLS because of its high-yield and superior performance during the most recent run up in interest rates. I believe all investors; even millennials should have an allocation to fixed income even though it is not growth oriented. With the potential for rising rates aggressive bond ETFs will most likely suffer, which is why when I searched through all the high-yield ETFs available, HYLS stood out among its competitors. HYLS stood out because of its structure, 6%+ dividend yield and its performance. HYLS is actively managed and uses a fundamental process to select long positions and has the ability to short treasury bonds or corporate bonds. According to the HYLS fact sheet: The team uses a combination of a rigorous fundamental credit selection process with relative value analysis and believes that an evolving investment environment offers varying degrees of investment risk opportunities in the high-yield, senior loan, derivative and fixed-income instrument markets. The second reason I chose HYLS was because it performed very well during the most recent rising rate period from February 2nd 2015 until June 10th 2015. As you can see HYLS [Yellow Line] outperformed both major broad high yield bond ETFs including the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays Capital High Yield Bond ETF (NYSEARCA: JNK ). In addition, HYLS also outperformed short-duration high yield bond funds including the iShares 0-5 Year High Yield Corporate Bond ETF (NYSEARCA: SHYG ), the SPDR Barclays Capital Short Term High Yield Bond ETF (NYSEARCA: SJNK ) and the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ). (click to enlarge) [Chart from Google Finance] Cash: PIMCO Enhanced Short Maturity Strategy ETF (NYSEARCA: MINT ) My final selection was MINT because I believe all portfolios either should have cash for safety or available to use for strategic purchases of quality growth stocks/ETFs. Millennials have a long-term horizon and if there is an opportunity to pick up a quality growth ETF or stock that is trading unjustly lower, having the cash available to do so is desirable. Portfolio Overview I have provided an example of what the portfolio would look like. As you can see, I allocated 30% to each main equity selection and 10% to SBIO, which made the total equity allocation to be 70%. Allocation MGK 30% SBIO 10% EFG 30% HYLS 20% MINT 10% Portfolio Composition Stocks 70% Bonds 20% “Cash” 10% Closing Thoughts The portfolio I created has exposure to quality growth companies in the U.S. and internationally. With the added allocation to target biotechnology, the portfolios growth should be enhanced by this high growth area of the market. In addition, by moving out on the credit risk spectrum for fixed income, the portfolio would generate some income, which instead of being reinvested into more HYLS, could be used to purchase more growth stocks/ETFs. Disclaimer : See here .