Oil: Does Supply and Demand Matter?

Tuesday, August 14th, 2012

by William Smead, Smead Capital Management

If you are a long-time follower of our writing at Smead Capital Management (SCM), you are aware of our belief that a titanic shift is in process in the world economy. The fastest growing economy of the last ten years, China, is slowing down very quickly and the US is grudgingly growing during its deleveraging process. Since the US is four years ahead of most of the rest of the world in the cleansing/deleveraging process, we believe the US will ultimately lead the world out of the current growth funk.

We believe the long-term demand for oil will be greatly influenced by where the world gets its best future growth. As the chart below shows, the US has cut by 50% the amount of energy which is required to generate each dollar of Real Gross Domestic Product (GDP):

Source: Carpe Diem: 2011: Most Energy-Efficient Economy in History, April 2, 2012

From a personal standpoint, it is easy to see how dramatically US drivers are adapting to the $90 dollar price per barrel of oil and gas prices hovering in the $3.25-4.00 per gallon area. My wife and I bought a mid-sized sedan recently which advertised 23 mpg city and 33 mpg highway. After two months and 4000 miles of driving, I’ve confirmed that the highway mpg is consistently running around 35 mpg. A comfortable, mid-sized car which seats four full-sized adults and blends at 28 mpg means that we are going to use much less gas than we used to.

China, on the other hand, has been using a disproportionate part of the world’s commodities to produce about 10% of the world’s GDP. Professor Michael Pettis, from Peking University, computed that China used 40% of many of the world’s main commodity inputs in the year 2010. China’s use of oil rose 92% from 2000 to 2010 and coincided with a price increase of 242%. These facts are very typical of an emerging market nation whose economy becomes dependent on fixed asset investments for continued growth. If we are right and growth slows more than expected, China will demand significantly less oil than they have in the past five years and certainly their reduced demand is a huge factor at the margin.

If Europe was humming along in a favorable way, Japan was bristling with growth and Latin America didn’t have any problems, you might be able to make up lost US and China oil demand elsewhere. We haven’t even mentioned the damaging effect China’s slowdown will have on oil demand in the countries which have “suckled on China’s bounteous teat” like Australia, Singapore, Canada and Indonesia. Lastly, Brazil and Russia are hugely at the mercy of the price of oil for their prosperity. All in all, demand for oil sits in a very precarious position at best.

On the supply side of the equation, we have rarely seen so many holes poked in the ground and in the ocean looking for oil. From shale in North America to offshore drilling near Brazil, new supplies of oil are coming out of the woodwork. Iran, Syria and Egypt have done their best to keep a supply-fear premium in oil, but so much oil is being produced elsewhere in the world that it is diffusing the supply disruption threat.

Lately, Oil prices seem to trade in high correlation with the US stock market. When US stocks (as represented by the S&P 500 Index) bottomed in late May and early June of this year, oil hit the $77 per barrel mark. Those stock market worries seemed to have been about the possibility of a recession coming soon. To us at SCM, this infers that market participants believe that US economic growth, if it happens, will cause heavy additional use of oil and gasoline. Or it could mean that asset allocators and hedge fund managers are using oil as a trading vehicle to participate in market upswings. These thoughts raise some important questions.

First, where is the economic growth likely to come from in the US? Second, in what industries does the US have big competitive advantages over the rest of the world? At SCM, we believe that the backbone of US economic growth over the next ten years will come from our largest population group, the children of the baby boomers. There are 85 million boomer kids, slightly more than the 83 million baby boomers. They have been a little slower to get married, a little slower to have children and little slower to buy a house than previous generations. They are tech savvy and their attitudes associated with commodity usage have been formed in the last ten years. They are more likely to spend time online, shop online and socialize online. They are less likely to own two cars and less likely to have a landline phone when they do buy a house.

However, with hormones working like they always have and housing affordability the highest in my lifetime, we could see an explosion of household formation in the US over the next five years. Maybe, even “Jeff who lives at home” (recent popular movie) will buy a house. The boomer kids won’t have actors like Seth Rogen and Zach Galifinakis (playing unmarried slobs) as their favorite actors forever. Housing is starting to percolate in the US and you can almost feel the animal spirits start to build. We don’t believe there is any correlation between marriage, babies and buying a home with gasoline usage. Gasoline usage goes up when the kids get their own social life and that is a problem for ten years from now.

The other source of growth in the US is its dominant position in the connection between the virtual/technology world and the real economy. US Companies like Apple (AAPL), eBay (EBAY), Amazon (AMZN), Facebook (FB) and others are dominating the way technology is shaping how we live and spend money. These are US companies leading this phenomena and it is the fastest growing part of the world economy. It is not a sector of the economy which uses much oil and probably causes less oil usage per dollar of GDP produced.

We at SCM believe that supply and demand do matter when it comes to oil prices. We envision reduced demand from China and permanently lower demand in the US. Lower demand combined with spiking supply levels from all the new sources of oil spell lower prices to us. Historically, the US economy and US stock market are inversely correlated with oil prices. We’d like to think that is what comes about over the next three years. It could be the economic stimulus package we’ve been waiting for.

Best Wishes,

William Smead

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. It should not be assumed that investing in any securities we recommend will or will not be profitable. A list of all recommendations made by Smead Capital Management within the past twelve month period is available upon request.

Tags: Asset Investments, Brazil, Capital Management, Dollar Price, Emerging Market, Energy Efficient Economy, Fastest Growing Economy, Gross Domestic Product, Last Ten Years, Michael Pettis, Mpg City, oil, oil and gas prices, Peking University, Personal Standpoint, Price Per Barrel Of Oil, Professor Michael, Russia, Sized Adults, Sized Car, Smead, Time Follower, World Economy
Posted in Markets | Comments Off

Mythbusting: Emerging Market High Yield Bond Risk

Friday, August 3rd, 2012

by Del Stafford, iShares

Emerging market high yield bonds – about as risky as an asset class can get, right? After all, emerging markets are known for carrying a significant amount of risk, and high yield bonds are one of the more speculative sectors within fixed income. Put the two together, and aren’t you doubling down on risk? I thought the same myself before researching this very topic, but to my surprise I found that is not [always/necessarily] the case.

First, most investable emerging market high yield indices contain bonds that are issued in US dollars (USD), so with these indices there isn’t additional risk from owning other currencies. Also, emerging market high yield generally includes sovereign bonds (issued by a government) and quasi-sovereign bonds (issued by an agency backed by a government), while US high yield generally only includes corporate bonds.

Corporate bonds are typically viewed as riskier than government bonds, even when they have the same credit quality rating. In times of market volatility and stress, you can see that play out in what is commonly referred to as a “flight to quality”. For example, we saw this happen during the credit crisis of 2008 when the market largely sold out of corporate bonds and bought US Treasuries.

The sovereign and quasi-sovereign exposure in emerging market high yield caused it to behave differently from other risk assets during 2007-2009. The below chart shows correlations of emerging market high yield (Barclays EM High Yield Index), US corporate high yield (Barclays US Corporate High Yield Index), emerging market equities (MSCI Emerging Markets Index) and developed international equities (MSCI EAFE Index) to US equities (S&P 500 Index) during this time period. You can see that developed international equities, emerging market equities, and US high yield increased in correlation but emerging market high yield decreased in correlation.

In addition, when you look at historical volatility in the below chart, emerging market high yield has experienced comparable levels of risk to US high yield over the past seven years.

Now, the intent here isn’t to say that emerging market high yield bonds are for everyone, but rather to challenge investor assumptions about the investment’s risk profile. Investors interested in emerging market high yield debt should still consider whether it suits their portfolio needs (Matt Tucker’s recent post may be helpful).

Source: Markov Processes International (MPI)

Del Stafford, CFA is the iShares Head of Product & Investment Consulting and a regular contributor to the iShares Blog. You can find more of his posts here.
Correlation is a statistical measure that captures the degree of the historical relationship between the returns of a pair of investments or indexes.

Correlation ranges between +1 and -1. A correlation of +1 indicates returns moved in tandem, -1 indicates returns moved in opposite directions, and 0 indicates no correlation.

Standard deviation is the statistical measure of the degree to which an individual value in a probability distribution tends to vary from the mean of the distribution. It is widely applied in modern portfolio theory, where the past performance of securities is used to determine the range of possible future performance, and a probability is attached to each performance.

Bonds and bond funds will decrease in value as interest rates rise. High yield securities may be more volatile, be subject to greater levels of credit or default risk, and may be less liquid and more difficult to sell at an advantageous time or price to value than higher-rated securities of similar maturity.

Copyright © iShares

Tags: asset class, Barclays, Corporate Bonds, Correlation, Correlations, Credit Crisis, Credit Quality, Emerging Market, Emerging Markets, Fixed Income, Government Bonds, High Yield Bond, High Yield Bonds, International Equities, Ishares, Market Volatility, Markets Index, Sovereign Bonds, Time Period, Treasuries
Posted in Markets | Comments Off

Rethinking Asset Allocation (PIMCO)

Wednesday, July 18th, 2012

by Curtis Mewbourne, PIMCO

• Asset classes are likely to be affected by the situation in Europe and, more broadly, by high debt levels in developed countries. The related political debate about austerity vs. growth is also critical.
• Fixed income investors should note whether countries control their own currencies and can monetize their debts. Those that can may be greater inflation risks. Those that cannot may be greater credit risks.
• These factors are contributing to market volatility and lower returns, which in turn are challenging investor expectations about asset classes.
• We encourage investors to broaden their opportunity sets, for example, looking more closely at emerging market government bonds. They also may consider assets such as real estate and commodities, which may partially replace traditional domestic equities.

Navigating the global landscape these days is tough. Macro risks range from uncertainty about the future of Europe to mixed messages about the U.S. economy – not to mention a host of concerns about indebtedness, policy and politics.

In the following interview, portfolio manager Curtis Mewbourne discusses how investors can approach asset allocation in such an environment and over the longer term.

Q: What are the most critical factors likely to affect asset classes over the next three to five years?
Mewbourne: Investors need to monitor the situation in Europe, whether they are directly invested there or not, because of the systemic implications of a potential shock to Europe’s banking system or sovereign debt. The eurozone has the second largest economy and the largest banking system in the world, and the slowdown that we are already seeing in emerging market growth is partially driven by slower demand for goods and services from Europe.

More broadly, asset classes are likely to be affected by high debt levels in Japan, the U.S. and other developed countries as well as the related political debate about the trade-off between austerity and growth. Unemployment levels remain elevated in many countries, partly as a result of austerity measures.

These factors are contributing to market volatility and lower returns, which in turn are challenging investor expectations about asset classes. For example, European equity markets in some cases are at the lowest levels in years, and, as a result, investors may be questioning the notion that European equities provide reasonable returns above inflation – a key point for pension-fund managers and other investors.

Similarly, the low policy interest rates that central banks are implementing around the globe contribute to government bonds in several countries trading at very low levels. These low yields create an asymmetric return profile: There is not much room for further price appreciation, while concerns about possible future inflation could lead to significant volatility and price declines. For fixed income investors, it is critical to understand whether bonds have credit risk, inflation risk or both. Countries with their own currencies have more flexibility to print money and monetize their debts, and hence typically have more inflation risk and less credit risk. Countries that do not have the ability to print their own currencies have the opposite. This largely explains the divergence between Europe and the U.S./U.K./Japan in terms of government bond yields and knock-on effects on risk premium valuations.

Put simply, nominal government bonds and traditional equity investments, at least in the case of Europe, have not performed in the way that investors have expected and likely may not perform according to textbook expectations going forward.

Q: Will we see more convergence – or divergence – in the behavior of asset classes?
Mewbourne: It depends on which asset classes we are talking about, but there are a few high level themes that are relevant to understanding how asset classes may behave. Very high global debt levels and unconventional monetary policies mean that balance sheets are more levered and the global economy is more vulnerable to policy changes. Under such conditions it is likely that certain macro factors, such as policy changes, will affect many asset classes in roughly the same way at the same time. Over the past few years, we have seen periods of heightened correlations between regional markets as well as between previously uncorrelated asset classes.

This is not set in stone. In some cases capital will move from one area to another, or fundamental economic differences will lead to divergence of asset classes. We have seen that recently in currency markets where there has been a large shift away from emerging market currencies and into the U.S. dollar.

Q: PIMCO has talked about the emergence of credit risk in the sovereign market. How will this affect portfolio construction?
Mewbourne: As I was saying before, fixed income is an asset class that has become quite different from textbook explanations. For example, five to seven years ago it was a reasonable decision for a European citizen saving for her child’s education to invest in government bonds, counting on a low probability of principal loss, little volatility and a modest return. Fast forward to today, and government bonds in many European countries have behaved quite differently than expected. The clearest example is the loss of principal on the restructuring of Greek bonds; but also prices of other European sovereign bonds suggest higher probabilities of potential losses. In all, the expected volatility, risk and returns on such bonds have changed, and therefore they likely play a different role in investors’ portfolios.

This shift is a challenge for certain institutional investors, such as insurance companies and some banks, whose business models or regulatory requirements require high-quality bonds with low probability of principal loss and low volatility.

Q: Staying with the topic of risk, what are some other risk factors investors should be managing, and how should they go about doing so?
Mewbourne: Investors need to think about the potential loss of principal on bonds of overly leveraged countries and companies. They also need to think about the loss of purchasing power from inflation as a result of central banks pursuing very low interest rates. When interest rates are lower than inflation, the resulting negative real yields eat away at investors’ purchasing power.

Given the issues that we have discussed, the time they need to spend thinking about and focusing on political risks has increased significantly, and they need to increase significantly their efforts in understanding and factoring such risks into their investment decisions.

Q: Let’s talk about opportunities: Are there new or emerging opportunities that investors should be thinking about? And can you offer some insights into alternative ways for investors to capture these opportunities?
Mewbourne: Markets are still healing from the major financial dislocation of 2008 and 2009 and, in a sense, the recovery creates opportunities in many areas for investors to identify and take advantage of attractive risk-adjusted returns. This requires a very active focus, as those opportunities can be in sectors that have become more credit sensitive and require more resources to review.

For example, in the non-agency mortgage market in the U.S., investors need to understand the underlying loans, a process that can take considerable time and knowledge but also lead to some very good opportunities.

Another example is the U.S. municipal bond market. That asset class has become much more credit sensitive and requires much more credit focus, but investors can really benefit from rolling up their sleeves and doing their credit research.

Also, the heightened market volatility that we expect in the years ahead can lead to greater risks but also opportunities during periods in which investors look to exit the same strategies at the same time. Given the geopolitical landscape, we expect overshoots in currency and commodity markets to result in buying opportunities.

Q: Ultimately, what are the key things investors should be thinking about or doing in their portfolios, considering PIMCO’s secular outlook?
Mewbourne: As risk and return characteristics transform, our view is that investors need to transform the way they think about using asset classes. We encourage them to broaden to the greatest degree possible their opportunity sets, for example, looking at emerging market government bonds as a replacement for some more traditional developed market government bonds.

Developed market government bonds have become riskier in some respects, and emerging market bonds are becoming less risky, and in cases where they pay a higher rate than inflation, they may be less risky both in terms of credit risk and the risk of purchasing power erosion.

We also encourage investors to broaden the type of financial instruments they consider. While they need to appreciate the risks of different instruments, they may benefit from investments in areas such as real estate and commodities as part of overall portfolio construction, and those areas can replace some of the roles that traditional domestic equities have played in the past both in terms of expected returns and volatility.

Past performance is not a guarantee or a reliable indicator of future results. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Commodities contain heightened risk including market, political, regulatory, and natural conditions, and may not be suitable for all investors. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market.

This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Tags: Asset Allocation, Asset Classes, Austerity, Banking System, Critical Factors, Debt Levels, Domestic Equities, Emerging Market, Eurozone, Global Landscape, Government Bonds, Indebtedness, Inflation Risks, Investor Expectations, Market Volatility, Mixed Messages, Other Developed Countries, PIMCO, Political Debate, Portfolio Manager, Sovereign Debt
Posted in Markets | Comments Off

Global Shipping: Any Port in a Storm? (PIMCO)

Monday, May 21st, 2012

by Sai S. Devabhaktuni, and Gregory Kennedy, PIMCO

May 2012

• With the exception of LNG tankers, all three major shipping categories have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.
• Although banks have worked with ship owners through this down cycle, they have also pulled back from financing the industry.
• Given the current low point in the cycle, we believe downside risks are likely minimized in the shipping industry for new lenders and investors. Vessel values are depressed by rates that are sometimes below owners’ operating costs and by an oversupplied market that suppresses secondary market values.​

In spite of the current woes in the shipping industry, including a significant erosion of value and a glut of new vessels, we see the potential for a brighter future on the distant horizon – especially as the order book of new vessels begins to shrink and emerging market growth provides a much-needed driver of demand.

As a result, select opportunities to buy the debt of operators or to buy portfolios of vessels at prices below their intrinsic value are now available to informed investors – and could offer attractive long-term returns. Capitalizing on this anticipated rebound, however, requires patience, dedicated long-term capital and a strong understanding of industry fundamentals and maritime restructuring dynamics. These waters demand careful navigation.

A brief history of the voyage to today’s market
The global shipping industry is in the midst of its worst cycle since the 1980s. A recent Bloomberg article highlighted that “the combined market value of the world’s 80 biggest publicly traded shipping companies plunged by $101.7 billion in the four years to March 23, 2012.” What caused so much value destruction? The combination of an excess supply of new vessels that were financed at the peak of the market and a global recession from which there has been an uneven recovery has led to persistently low charter rates and plummeting ship values. In its wake is nearly $500 billion of debt, the overwhelming majority of which is held by European banks.

Over 90% of world trade activity depends on the shipping industry’s global fleet of 58,000 ships, according to Clarksons and J.P. Morgan. The fleet includes tankers, dry bulk ships, container ships, chemical tankers, liquefied natural gas (LNG) tankers and other cargo ships across what is a highly fragmented industry. As the global economy expanded and international trade increased after the end of the Cold War, world seaborne trade increased by nearly 50% from 1990 to 2000, from about four billion tonnes to six billion tonnes annually, which helped the shipping industry recover from the vessel oversupply it faced in the 1980s (see Figure 1).

The global shipping industry has long cycles and was historically driven by demand and GDP growth in developed economies. But by 2003, demand from emerging economies like China began accelerating, which pushed global seaborne trade to over eight billion tonnes by 2008. China’s demand for coal and iron increased nearly 20% per year from 2004 to 2011, and the country is now a net importer rather than exporter of coal. This insatiable emerging market demand, combined with increased prosperity due in part to the credit bubble in developed markets, led to a vessel shortage, driving shipping rates to new highs (see Figure 2).

The shipping industry responded to these historically high shipping rates by ordering what turned out to be an excessive number of vessels. From 2003 to 2008, over $800 billion of new ships were ordered, with half of the orders placed in 2007–2008, when vessel prices were at their peak, according to Clarksons. During these boom years, bank lending was widely available for new ships, as banks offered financing of up to 80% loan-to-value (LTV) for new vessels (versus 50% to 60% today), leaving little margin for error in vessel values. Most of those vessels were scheduled for delivery in the years immediately following the financial crisis of 2008–2009, compounding the oversupply issue.

Rough seas follow the expansion
As a result of the order book overhang resulting from overly optimistic expectations of demand (i.e., volume) growth, shipping rates have faced persistent headwinds from net new vessel deliveries at about twice the rate of shipping demand growth during the recovery of the past few years (see Figure 3). With the exception of the under-fleeted LNG tanker market, all three major shipping categories (bulkers, tankers, containers) have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress.

Because of new vessel deliveries over the past three to four years, the global fleet is fairly young, which means there are not as many older ships available that would typically make economic sense to scrap. And while delivery slippage of the order book and cancellations help to slow the supply of new vessels entering the market, there is an incentive for shipyards to maintain their order backlog.

Tags: Bloomberg, Distant Horizon, Downside Risks, Emerging Market, Excess Supply, Financial Distress, Fuel Costs, Global Recession, Global Shipping Industry, Gregory Kennedy, Intrinsic Value, Lng Tankers, Long Term Capital, Peak Of The Market, PIMCO, Port In A Storm, S Market, Secondary Market Values, Ship Owners, Shipping Companies, Supply Glut
Posted in Markets | Comments Off

Looking to China to Fire Up its Economy

Sunday, May 13th, 2012

Looking to China to Fire Up its Economy

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

Following on the heels of renewed concern over Europe’s debt situation, China released its monthly economic data. Fixed asset investment, industrial production and retail sales all rose in April, yet growth was not as strong as analysts anticipated. “Weak” is the word to describe China’s April figures, says CLSA’s Andy Rothman in his Sinology Report.

While data were lower than expected, they weren’t disastrous, says Andy. According to CEBM Group, slower growth was the government’s intention. China wants the ability to manage a “stable decline” to “promote medium-to-long-term structural reforms” as well as avoid a hard landing, says CEBM.

Because they weren’t devastating results for the country, more fine-tuning, rather than a major stimulus plan, is likely to come from this emerging market if growth continues to stall. “The government should move forward to introduce accommodative policies stabilizing economic growth,” says CEBM.

Easing policy for China is only a matter of willingness. Unlike the developed countries of the West that have overworked their printing presses and are now strapped with a tremendous burden of debt, China is in good shape. According to BCA Research, the country’s overall gross debt is only 42 percent of GDP, significantly lower than all of the G-7 countries which have the most debt of the countries listed below. Of the E-7 countries, only Indonesia and Russia have less government debt compared to GDP.

To offset the country’s liabilities, BCA says China also has “a massive net asset position,” including owning interests in publicly listed firms, large companies and the country’s land mass. According to BCA, if you look at only state-owned enterprises, the net assets are nearly “as large as the total public (local and central combined) debt.” By these stats alone, it appears the emerging country does not have a solvency issue.

However, rather than serious stimulus, CLSA anticipates that China will make a move to ensure its two primary goals are met, which include new loan growth as well as M2-money supply growth of about 14 percent.  Andy says, to accomplish these goals, the government will likely boost its spending on infrastructure and low-income housing, ease restrictions on new home purchases by first-time buyers, and offer more credit to the private sector.

Hear Andy Rothman discuss a hard or soft landing China now

We believe government policy is a precursor to change, and when China feels the need to fire up its fiscal or monetary firepower, we believe the flow of money will send Chinese stocks—along with commodities—higher.

CEBM notes an interesting correlation between the A-Share market and economic growth, which points to a possible improvement. The research firm compares today’s economy with what we saw in late 2008. While the data is not as ominous and the government has grown comfortable with slower growth today, there is still a resemblance to the situation in 2008, where the market rebound led improved economic growth by four months. CEBM believes it may be seeing the same signs of bottoming of the market today, and if the 2008 trend holds, economic growth should now be in the bottoming process.

Fine-Tuning Your Portfolio to Potentially Benefit
As economic data is released over the next few months, China will be keeping a close eye to determine when to open the spigots. Before this happens, we believe investors should position their portfolios to potentially benefit. Here are two ways:

1. Invest in emerging markets companies and commodity equities. Emerging markets continue to offer the most potential for growth, and as you see below, over the past five years, as the Shanghai Composite Index rose, the S&P Global Natural Resources Index soon followed.

2. Get “paid to wait” with dividends. This week, investors fled any asset that was perceived as risky, including stocks of any country and commodities, including gold, in favor of “safe” government Treasuries. The 10-year note on U.S. Treasuries fell to 1.85 percent, which is lower than the dividend yield on numerous stocks. Currently, the annualized dividend rates on the S&P Global Natural Resources, MSCI Emerging Markets and the S&P 500 indices are nearly 2.9 percent, 2.8 percent, and 2.1 percent, respectively, all higher than a 10-year investment. Along with steady income provided by dividends, these stocks offer potential appreciation on your capital.

On May 14, I’ll be presenting at the Hard Assets Conference in New York, sharing more investing insights about China, commodities and how to apply Super S-Curves in a portfolio. I’ll be in good company, as Pam Aden, Adrian Day, Ian McAvity, Jay Taylor and Gregory Weldon will be presenting as well. I hope to share some of their thoughts as well as my takeaways in the coming weeks.

Tags: Asset Investment, Asset Position, Chief Investment Officer, Clsa, Debt Situation, Developed Countries, Economic Data, Emerging Market, Frank Holmes, Good Shape, Government Debt, Gross Debt, Land Mass, Net Assets, Printing Presses, Retail Sales, Rothman, State Owned Enterprises, Stimulus Plan, U S Global Investors
Posted in Markets | Comments Off

BRIC Country PMI, New Business, Employment, Exports, Mfg Import Purchases

Friday, April 20th, 2012

by Richard Shaw, QVM Group

HSBC Emerging Markets PMI Index rises to 53.4 from 52.4 for 2012 Q1

Stephen King, HSBC’s Chief Economist, said:

“The latest HSBC EMI underlines the relative immunity of emerging nations to the economic permafrost of the developed world. Emerging nations still have many years of economic “catch-up” ahead of them, suggesting that their growth rates – driven by continuous urbanisation alongside productivity gains linked to improved access to global capital – should remain significantly higher than in the west. They also have considerably more policy ammunition to deploy, including rate and reserve ratio cuts and, if necessary, fiscal stimulus.

Despite two successive quarters of strength, EMI remains at a relatively low level, thanks largely to further deterioration in Chinese export orders but also domestic demand as a result of attempts to tame inflationary pressures through quantitative tightening. Emerging market inflation has generally eased outside India, despite the return of higher oil prices, and policymakers are returning their focus to promoting growth over limiting inflation.

Emerging nations still have to balance the risks of too little growth against the threat – if not yet the reality – of commodities-driven inflation. But the outlook remains encouraging with China, India, Brazil and Mexico all set to be top ten global economies by 2050.”

click images to enlarge

source: HSBC Emerging Markets Index 2012 Q1

Tags: Business Employment, Chief Economist, Chinese Export, Emerging Market, Emerging Markets, Export Orders, Fiscal Stimulus, Global Capital, Global Economies, Inflationary Pressures, Level Thanks, Markets Index, Oil Prices, Permafrost, Productivity Gains, Qvm, Relative Immunity, Reserve Ratio, Richard Shaw, Urbanisation
Posted in Markets | Comments Off

The Impact of High Oil Prices on Emerging Markets

Tuesday, April 10th, 2012

Tags: Added Source, Africa Region, Balance Of Payments, Carlen, Central And Eastern Europe, Commodity Prices, Countries In Central America, Emerging Market, Export Demand, Fiscal Adjustment, Gasoline Prices, Global Growth, Gulf States, Import Prices, Market Volatility, Oil Import, Rising Oil Prices, South American Countries, South Russia, Trade Act
Posted in Markets | Comments Off

3 Trends to Watch for Global Investors

Thursday, April 5th, 2012

Bloomberg announced over the weekend that China’s manufacturing grew at the fastest pace in a year. We follow the government’s Purchasing Managers’ Index (PMI) closely, as we believe it is a better indicator of China’s domestic demand than the HSBC PMI. Whereas HSBC PMI surveys 400 small and mid-sized companies, which are typically export-oriented, the government’s PMI surveys 820 mostly large, state-owned enterprises across 20 industries.
Though manufacturing activity exceeded analysts’ estimates, some China bears focused on the fact that the March 2012 number is lower than the average during the third month from 2005 through 2011. What’s important for investors to consider is that the trend is your friend: It is the fourth month in a row where the PMI landed above the three-month PMI, and shows the economy is on the right path.

Below are three additional constructive trends we see in China.

1. China Returns Poised to Revert to the Mean

Over the past few years, Chinese stocks have lagged compared to their emerging market peers. However, the Periodic Table of Emerging Markets perfectly illustrates how last year’s loser can be this year’s winner. Historically, every emerging country has experienced wide price fluctuations from year to year. Over time, though, each country tends to revert to the mean.

In the visual below, we highlighted China’s performance pattern over the past 10 years. Chinese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astounding 163 percent; in 2007, it was the top emerging market again, returning nearly 60 percent.
Since then, the country has fallen to the bottom half of the chart. If you apply the principle of mean reversion, history appears to favor China landing in the top half during this Year of the Dragon.

See the original Periodic Table of Emerging Markets here.

2. Liquidity Cycle Could Benefit Stocks

Yet China leaders won’t leave its success to pure luck. If the Dragon doesn’t breathe fire into markets, it may be a shot of liquidity injected by policy easing that could drive stock prices higher. Macroeconomic theory states that when a country’s money supply exceeds economic growth, the excess liquidity tends to drive up asset prices, including stocks.

BCA Research documented this trend in China over the past eight years. The research firm compared the difference between the change in money supply growth and nominal GDP growth and Chinese stock prices. In both instances when the change in excess liquidity fell to a low, so did stocks. Conversely, the rise of money supply growth compared to GDP growth “coincided with major rallies” for China’s stock market, according to BCA.

Today, it appears that the change in excess liquidity is just beginning to bounce off another low, as are stocks, indicating another potential inflection point.

3. Incentive to Maintain Growth

BCA hedges China’s possible stock advancement in the short-term if signs of economic improvement continue because they “reduce the odds of aggressive policy easing.” A few weeks ago, I discussed how investors seemed to overlook China’s focused macro policy strategy, with its actions deliberate and purposeful. This year, the government has extra incentive to sustain meaningful growth as it transitions to a new leadership by the end of the year. As President Hu Jintao and Premier Wen Jiabao depart, Xi Jinping and Li Keqiang are expected to take over.

Looking at historical GDP growth per year since 1978, Deutsche Bank finds there’s precedence for this idea. During the fifth year of the leadership transition cycle, “high or stable” GDP growth was maintained, with the exception being the Asian Financial Crisis in 1997.

These trends will be covered in my upcoming webcast on China with CLSA’s Andy Rothman. Join us as we discuss what investors should expect from China in terms of long-term GDP growth, fixed asset investment, exports and the housing market.

When I was in Singapore at the Asia Mining Congress last week, I was fortunate to be among a group of sharp and intelligent experts across the financial and mining industries. A China bull presenting an excellent case for the country was Jing Ulrich, JP Morgan’s managing director and chairman of China equities and commodities group. She’s the Oprah Winfrey of the investment world, as for the past three years, Forbes Magazine has ranked her among the 50 Most Powerful Women in Business.

Ulrich expressed similar views toward China and its political will in a recent “Hands-On China Report” following her attendance at the China Development Forum in Beijing. She said that the government ministers emphasized their commitment to rebalancing the economy toward consumption. While “fundamentals are currently sound, the nation must modify its ‘imbalanced, uncoordinated and unsustainable’ course of development,” says Ulrich. What investors should remember is that the government had the financial resources to effect this change and considered it important to maintain sustainable growth.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The Hang Seng China Enterprises Index is a capitalization-weighted index comprised of state-owned Chinese companies (H-Shares) listed on the Hong Kong Stock Exchange and included in HSMLCI index (Hang Seng Mainland Composite Index).

Tags: China, Chinese Stocks, Commodities, Commodity, Dragon, Economy, Emerging Market, Emerging Markets, Estimates, Global Investors, Gold, History China, India, liquidity, Loser, Mining, Pace, Periodic Table, Pmi, Price Fluctuations, Principle, Purchasing Managers Index, State Owned Enterprises, Surveys, Year Of The Dragon
Posted in Brazil, Markets | Comments Off

Does China Hold the Winning Ticket?

Sunday, April 1st, 2012

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

The odds of winning tonight’s Mega Millions jackpot are 1 in 175,711,536. This remote chance hasn’t stopped people from lining up to buy a ticket, as the “what-if-I-win” idea seems so thrilling.

Some bears may think the odds of China being the winner among emerging markets in 2012 are also remote. Over the past few years, Chinese stocks have lagged compared to its emerging market peers. However, the Periodic Table of Emerging Marketsperfectly illustrates: last year’s loser can be this year’s winner. Historically, every emerging country has experienced wide price fluctuations from year to year. Over time, though, each country tends to revert to the mean.

In the visual below, we highlighted China’s performance pattern over the past 10 years. Chinese stocks landed in the top half four out of 10 years—2002, 2003, 2006 and 2007. In 2003, China climbed an astounding 163 percent; in 2007, it was the top emerging market again, returning nearly 60 percent.

Since then, the country has fallen to the bottom half of the chart. If you apply the principle of mean reversion, history appears to favor China landing on top during this Year of the Dragon.

See the original Periodic Table of Emerging Markets here.

Unlike the lottery system, China won’t leave its success to pure luck. If the Dragon doesn’t breathe fire into markets, it may be a shot of liquidity injected by policy easing that could drive stock prices higher. Macroeconomic theory states that when a country’s money supply exceeds economic growth, the excess liquidity tends to drive up asset prices, including stocks.

BCA Research documented this trend in China over the past eight years. The research firm compared the difference between the change in money supply growth and nominal GDP growth and Chinese stock prices. In both instances when the change in excess liquidity fell to a low, so did stocks. Conversely, the rise of money supply growth compared to GDP growth “coincided with major rallies” for China’s stock market, according to BCA.

Today, it appears that the change in excess liquidity is just beginning to bounce off another low, as are stocks, indicating another potential inflection point.

BCA hedges China’s possible stock advancement in the short-term if signs of economic improvement continue because they “reduce the odds of aggressive policy easing.” A few weeks ago, I discussed how investors seemed to overlook China’s focused macro policy strategy, with its actions deliberate and purposeful. This year, the government has extra incentive to sustain meaningful growth as it transitions to a new leadership by the end of the year. As President Hu Jintao and Premier Wen Jiabao depart, Xi Jinping and Li Keqiang are expected to take over.

Looking at historical GDP growth per year since 1978, Deutsche Bank finds there’s precedence for this idea. During the fifth year of the leadership transition cycle, “high or stable” GDP growth was maintained, with the exception being the Asian Financial Crisis in 1997.

When I was in Singapore at the Asia Mining Congress this week, I was fortunate to be among a group of sharp and intelligent experts across the financial and mining industries. One China bull presenting an excellent case for the country was Jing Ulrich, JP Morgan’s managing director and chairman of China equities and commodities group. She’s the Oprah Winfrey of the investment world, as for the past three years, Forbes Magazine has ranked her among the 50 Most Powerful Women in Business.

Ulrich expressed similar views toward China and its political will in a recent “Hands-On China Report” following her attendance at the China Development Forum in Beijing. She said that the government ministers emphasized their commitment to rebalancing the economy toward consumption. While “fundamentals are currently sound, the nation must modify its ‘imbalanced, uncoordinated and unsustainable’ course of development,” says Ulrich. Importantly, the government had the financial resources to effect this change and considered it important to maintain sustainable growth, writes Ulrich.

The ups and downs of this road toward a consumption-led economy are topics I’ll cover in next week’s webcast on China. I will be joined by CLSA’s Andy Rothman. Together, we’ll discuss what investors should expect from China in terms of long-term GDP growth, fixed asset investment, exports and the housing market. Be sure to sign up now.

Copyright © U.S. Global Investors

Tags: Asset Prices, Chief Investment Officer, China, Chinese Stock, Chinese Stocks, Commodities, Commodity, Emerging Market, Emerging Markets, Excess Liquidity, Frank Holmes, Gold, India, Lottery System, Macroeconomic Theory, Mega Millions, Mining, Money Supply Growth, Nominal Gdp Growth, Periodic Table, Price Fluctuations, Ris, Stock Prices, Theory States, U S Global Investors, Year Of The Dragon
Posted in Brazil, Markets | Comments Off

Charles Ellis and Peter Bernstein: On Risk and Winning the Loser’s Game

Thursday, March 29th, 2012

Here is the full transcript:

CONSUELO MACK: This week on WealthTrack- how you can win in what one of our guests calls a losers’ game- the stock market- and how can you protect yourself from financial peril? These two wise men of Wall Street have skillfully navigated many financial storms. We revisit the late, great Peter Bernstein, a renowned expert on risk, and Charles Ellis on timeless investment strategies, next on WealthTrack.

Hello and welcome to this edition of WealthTrack. I’m Consuelo Mack. Sometimes, to understand the present, you have to revisit the past. That is what we are doing this week. We are re-broadcasting a WealthTrack classic, interviews we did with two of Wall Street’s wisest men: one sadly no longer with us, the other very much alive and contributing.

The year was 2006, two years before the financial crisis hit full force. But storm clouds were gathering for those experienced and attuned enough to notice. One of those was Peter Bernstein, universally considered to be the authority on risk. He was an economist, money manager, seminal financial thinker, historian and author of many books, including the bestseller, Against the Gods: The Remarkable Story of Risk . His twice monthly analysis of the economy and the capital markets, Economics and Portfolio Strategy, was read by investors around the world. Even back in 2006, Bernstein expected relatively low returns from the financial markets in the years ahead. I asked him how we should invest?

PETER BERNSTEIN: As you know, I believe passionately in diversification, so you have a little bit of everything. The United States is kind of a very well worked over as an investment opportunity. So I think one goes abroad. Not only are securities abroad, both bonds and stocks, valued more cheaply than in the U.S. They’re no bargains, but more cheaply in the U.S. But in the emerging market world, in the developing world, exciting things are happening. Countries that were once in the doghouse are on a roll now, largely because they’re selling to us in such huge amounts. But even in Europe, which has been kind of laggard, things are stirring, governments are changing. Nobody notices this, but productivity growth in Europe is as good or better than in the United States. They’re giving it away in the social safety net rather than in growing their businesses. But this is beginning to change. And I think if something happens there, there’s huge opportunities. We see Japan finally coming up out of the doldrums.

So I think the opportunities are outside the U.S. Somebody once said to me, you’re not diversified if you’re comfortable with everything that you own. And we’re always comfortable with what we know. We buy, we live in New York, we buy Con Edison. If we live in California, we buy the California utility. But that means going outside the U.S. is very important. And it’s a big part of the world now. It’s not a little peripheral thing. It’s a major part of the world.

CONSUELO MACK: Now, let me ask you about that, Peter, because I know one of the things that you have advised clients, and you and I have talked about before as well, is the importance of being well diversified, and having a little bit of everything.  And as kind of the least risky way to go, and also the best way again, to get the kind of returns that we expect more, that we want from our investments. But, so how should we diversify, though? Because the average U.S. investor has probably, you know, 60, 70, 80% in stocks. We’ve been fed this mantra that stocks provide long term growth, that’s where we should be. You disagree with that. About U.S. stocks at this point. But how do we diversify then? What should we be investing? I mean do so asset allocation for us.

PETER BERNSTEIN: I mean I guess, today I would have no more than half my assets in the U.S. if I was starting fresh.

CONSUELO MACK: In U.S. stocks.

PETER BERNSTEIN: Well, the U.S. stocks, maybe even U.S. stocks and bonds. One can do this quite easily. There are exchange traded funds- all kinds of, almost anything that you want. And exchange traded funds that will offer a whole big piece. For instance you can buy all the stocks in the world outside the U.S., and similarly, you can buy bonds outside the United States. And there’s one for gold.  If you do, just go to iShares on the Internet. They have a very easy, easy site to work with, and to look. So I do not think that individuals say, I wonder what French stock I should buy, or what German stock. I wouldn’t dare do that myself. So it should be done in funds. And these are the best ways to do it. It’s worth looking at.

CONSUELO MACK: And talk a little bit about one of the things, again, one of your major themes has been in investing is that dividends matter.

PETER BERNSTEIN: Yes.

CONSUELO MACK: So dividends have mattered historically.

PETER BERNSTEIN: Yes.

CONSUELO MACK: I think the returns, the stock returns from reinvested dividends is, I don’t know, 50%.

PETER BERNSTEIN: Yes, that’s right. That’s right.

CONSUELO MACK: But in this day and age, with stock payouts low, and dividend yields low, do they matter as much, and will they matter as much in the future?

PETER BERNSTEIN: Yes. I think they matter, first, because it is cash in your pocket. And at a time when, who knows what earnings are, there’s been so much hanky panky all the way. Now they’re going to start expensing options, so that it gets a little more complicated. This, at least, you know what it is. And you can make more of a judgment about a stock, the growth rate dividends. But dividends at this point, I think, have two positive features that deserve attention. One is the tax rate is the same as on capital gains, 15%. Not a big number. I mean it’s 85% is yours.

CONSUELO MACK: Right.

PETER BERNSTEIN: And the other is that because the payouts are so low, and because of the tax thing and so forth now, there is pressure for companies to increase their payouts. I think dividends are going to increase faster than earnings. So if you’re in something where you think the earnings growth is there, and the dividends, that it is important. It is an important consideration. Even Microsoft is paying a dividend.

CONSUELO MACK: Yes, they are. They paid a big one as a matter of fact. Let me ask you about that point. Because a lot of analysts, or strategists that one talks to, will tell you that the companies that keep earnings, and don’t pay them out in dividends, you know, they can grow faster, and you know, they’ll give you better growth over the long term. You have found through your research absolutely the opposite.

PETER BERNSTEIN: That’s correct. That the lower the payout, and the bigger the reinvestment, the lower the future earnings growth. There’s nothing like having management a little starved for money. Because then they will only choose the best investments. Best things to do, if they’ve got lots of it. If they’re plowing back most of their earnings, oh, boy, that’s like, in a … I forgot the metaphor. But they can just pick anything. So they will be making less than optimal investments, because they have so much money. That’s how it works. Managements like to have money. They like to be expansive. They like to add the power. And there’s more discipline when there isn’t as much. This is a lot about the whole buyout business of the 1980s was about- corporations accumulating too much cash, and not using it properly. The companies that have to go into debt in order to expand will be much more careful about what they do. Much more selective in what they invest in. That’s very important.

CONSUELO MACK: A couple of more questions. You wrote a book about the history of risk. What you know, when you and I have talked, you were actually, it strikes me that you’re an optimist.

PETER BERNSTEIN: Yeah, I really…

CONSUELO MACK: And why, given the risks that all of us toss and turn about every night, why are you essentially an optimist?

PETER BERNSTEIN: I’m an optimist about the U.S. But I’m an optimist because problems do get solved. Maybe not one day you wake up, and everything is back in order. But it takes an awful lot to crush a system as vital, in many ways as flexible, as the U.S. economy. We went through, in 2000, when the bubble burst. I mean the bottom really dropped out of NASDAQ, and a big drop in the U.S. market, too. And word about bankruptcies, and people were saying that the derivatives were going to pull the whole… nothing bad happened, really. I mean, Enron, all of the scandals, those companies disappeared. We kept right on going. Now this Revco, an enormous, really terrible failure, though it’s a ripple. So there’s a lot of resilience. There’s a lot of youth in this country; a lot of new people coming in, who want to be part of it. Sure I’m an optimist.

CONSUELO MACK: So, one last question. And what is the … for individual investors, for successful, long term investing, what should our philosophy be? I mean what should our mantra be? What should our approach be, to really take advantage of the vitality that you see in the capital markets?

PETER BERNSTEIN: Well, the vitality, I mean vitality you get in the equity markets.  I mean there’s no question about it. You must be there. All the scare stories about what might happen and so forth, you should still have some money in the equity markets. This is essential. As I say, I think big things outside the U.S. also. I am- since I don’t like stock picking, and I’m not very good at it- a big believer in funds, rather than in trying to do it yourself. And although- this occurred to me the other day- the mutual fund industry has been criticized, because their returns aren’t good enough, and so on. How much worse, the people who were in mutual funds, may be disappointed with what happened. But if they’d managed that money themselves, I know they would have done worse. So this may not be divine and perfect. But it’s better than doing it yourself. It’s worth the cost.

CONSUELO MACK: Peter Bernstein, thank you so much for your time and your just, brilliance. Thanks for sharing it with us.

PETER BERNSTEIN: Thank you.

CONSUELO MACK: Our second wise man of Wall Street is Charles Ellis. Charley is the founder and former managing partner of the international consulting firm, Greenwich Associates, from which he advised the world’s leading financial firms on strategy for decades. He’s found time to author 15 books, including Winning the Loser’s Game, Fifth Edition: Timeless Strategies for Successful Investing. And he’s also taught at Harvard and Yale’s business schools. He has chaired Yale’s investment committee, which oversees one of the best performing endowments of all time. I talked to Charley about why he thinks Wall Street is a loser’s game for most individuals.

CHARLES ELLIS: Active investing is the Loser’s Game, and the reason I call it Loser’s Game is the outcome is determined not by the winner but by the loser. And I like to use the analogy of tennis. The way some people play tennis. The winners with 120-mile-an-hour serves and brilliant shots at net and terrific placement, they win points. Game I play, we lose points. And who will come out ahead is determined by the person who loses the most points makes the other person the winner. And if you’re in a Loser’s Game, it’s important to know the right ways to play that game.

Give you another illustration. Teenage driving is a Loser’s Game. The kids all think if they’re really good with their steering, if they really take off when the light changes, if they’re clever about finding ways to bob and weave in and around traffic, that’s great. But as the father of a teenage driver, or the mother of a teenage driver, what do you really care about? Only one thing. No serious accidents. No serious accidents, your kid is a great driver. And if it’s my kid that’s driving your daughter, and my kid has no accidents, you’re very glad to have your daughter in my car. Same thing with investing. Active investing is, the outcome is driven by the behavior of the person that winds up, while they’re trying to get it right, trying to win, trying to get ahead, they wind up doing themselves more harm than good, and the net result is they lose relative to the market.

CONSUELO MACK: Why is that? What is it that individual investors do in trying to manage their portfolios that puts them in the Loser’s category? And you know, who are the winners, number one? And define what you mean by winning in the market.

CHARLES ELLIS: Well, to me, winning in the market is truly getting the results you really, really want, that are right for you over the long, long, long term. And I think of investing much more like marriages and most people who are active investors are doing more dating. And I have nothing against dating. But great relationships will be developed only by having a marital commitment and working together to have something of real importance take place. And I think anybody’s been married understands. This is a real difference, and none of us who are married want to go back to dating. Same way of investing. If you will think carefully about what are your real, long-term objectives and find a way to articulate those objectives, you can then find investments that match with what you’re trying to accomplish. And you’ll be relatively happy all the time and over the long term you’ll be very happy.

CONSUELO MACK: So, when I think about objectives, you’re talking about more than just, “I want to make money in the market.” You’re talking about really establishing an investment philosophy and discipline is key and then going out and seeking out the investments that will fulfill those goals.

CHARLES ELLIS: True.

CONSUELO MACK: Is that right?

CHARLES ELLIS: Yes. Most of us, most of us, our first objective is to not lose.

CONSUELO MACK: Actually…

CHARLES ELLIS: What Mark Twain used to call return of the money and then return on the money is the secondary thing.

CONSUELO MACK: So, that should be our first objective, is not to lose, as opposed to win?

CHARLES ELLIS: Yes.

CONSUELO MACK: Which is the way most people go about it. All right.

CHARLES ELLIS: Because we’re human beings, we do a whole bunch of stuff that there’s now in the field of economics being described as behavioral economics, we do crazy things that are not in our best interests. But that’s who we are. So might as well accept that that’s who we are and find a way to live with who we are. Those of us who get nervous when prices are coming down ought to study. You know, when prices are coming down, they’re less costly. You can buy more value for less money. This is actually, although you’re uncomfortable, it’s good news, and those of us who get excited about, “Look, my stock is going up, it’s really going up.” Well, yes, that’s right. But, Charlie, in the long run, if it’s gone way up, what’s the destiny? The destiny is, it’s going to come back to its average, long-term value to price relationship. It probably will come down. So it’s not necessarily good news for you that the stock has gone way up in price if you’re a long-term investor, and I’m only interested in being a long-term investor.

CONSUELO MACK: So, for long-term investors, you are a big proponent of index funds versus actively managed funds.

CHARLES ELLIS: I am.

CONSUELO MACK: Why? Why index funds; why not just go with the market?

CHARLES ELLIS: The data shows over and over and over again that most all active managed funds underperform the index, a sensible index. Now, if you’re a small-cap value manager, active, the right index to compare against is a small-cap value index. Not high-growth, high-priced index. You have to choose your index. But if you choose the right and fair index, 75 to 80% of the active managers over every ten year period underperform, plus- and this is worth keeping in mind- you have higher taxes because the turnover is pretty rapid, and so, you’re getting short-term taxes as well as more frequent long-term taxes. Index funds don’t do much. So they don’t have much taxes, and the combination of low fees, low taxes, and low errors, index funds keep coming up with a better result.

CONSUELO MACK: There are tons of index funds being created as we speak. The exchange-traded funds, which are index funds that trade like stocks, you know, I feel like there’s one being created every day practically. How do you pick the best index fund, number one, and what kind of diversification should you have in your index fund portfolio? Again, thinking as a long-term investor?

CHARLES ELLIS: Well, you’re asking several different questions at the same time. So, I’ll try to–

CONSUELO MACK: Yes. I am. Sorry.

CHARLES ELLIS: –pick it up. Now, first thing in index funds, you want to be with a highly-reputable index fund manager who has specialized in this field, has become proficient at it, because if you’re really good at doing index fund management in your trading activities, you’ll be a little bit less costly than anybody else. Secondly…

CONSUELO MACK: So, names- Vanguard, for instance.

CHARLES ELLIS: Vanguard, with whom I’m associated because I’m a director. I became a director because I so admire the work that they do. It’s not the other way around. But they do a great job. Second would be that the fees are low. It’s really upsetting to me, again, I’m back to Vanguard, they’ve got a low-fee strategy towards life, and their concept of value-delivered service to investors. Low fee of ten basis points. You get to some index funds .Exactly same index fund. Now, ten basis point but 100 basis points. And you’ll never get that money back. And you’re not getting anything for it. You’re just paying up for nothing.

CONSUELO MACK: So, don’t pay them basically and those costs can really add up over time?

CHARLES ELLIS: Over the long, long period, they do add up.

CONSUELO MACK: So, second part of that question: Asset allocation. Very important, right, for long-term investment results?

CHARLES ELLIS: Yes. If you think about your children or grandchildren or the people that you love and care about the most, and you said, “Okay, I could give them the ability to pick stocks really well or I could give them the ability to pick managers really well, or I could give them the ability to know which kinds of stocks to be investing in or whether to go international or go emerging markets or go large cap or go small cap, or I could help them get the asset mix right.” So, okay, those are five different decisions. I could get only one of them. They’re going to get, like, the others will get average experience. Which one would you choose? Absolutely- asset mix. If you get the asset mix right, you’d have to make a major mistake to get anything negative to get a bad result in the whole. Get the asset mix right, most everything else can take care of itself. Get the asset mix wrong. You don’t have a chance.

CONSUELO MACK: How do you get the asset mix right?

CHARLES ELLIS First, understand who you are and understand what the money’s purpose is in your life. If you’re a very wealthy person, you’re probably investing for philanthropic institutions that you’re going to give money to or your grandchildren and their children and their children’s children. Think about it that way, you’ll probably be entirely involved in equity investing. If, on the other hand, you have a modest amount of savings- maybe it’s in your 401k plan, maybe it’s in your own investment account- and it’s probably enough to make it through your life with financial security, then you should be more protective. If, as a human being, you just do like stability, you don’t like the ups and downs of the market, accept who you are and behave accordingly.

CONSUELO MACK: Final question. Actively managed funds, which, you know, many investors follow slavishly. How do you handle the actively managed funds? Do you invest in them at all? Under what circumstances? What percentage of your portfolio should you put with an active portfolio manager?

CHARLES ELLIS: The last question about what percentage. That’s a matter of personal judgment. The fundamental proposition that I would put to you is if you’re going to choose an active manager, choose someone that you’ll stay with for at least 20 years. If you’re going to stay with a manager for 20 years, you’re not going to choose because of their recent performance, you won’t choose because of the stocks they own now.  Those will all be replaced. You won’t choose because of the individual fund manager. He or she will be replaced. You will choose character or culture or the value set of the organization. And as you know, and just slip in, I think there’s one such organization. They manage the American Funds. It’s called the Capital Group Companies. And I wrote a book about it because I wanted to understand: why were they so able over every long time period to outperform and compete so successfully? And I believe they understand how to manage professionals in such an effective way that they will achieve very substantial results. So, if you wanted to tease me a little bit, my wife owns the American Funds. And I own the Vanguard Index Funds. And we get along fine.

CONSUELO MACK: And the reason the American Funds- and Capital is the name of the book- that they do manage so successfully, why is it?  What is it about them that’s enabled them for 75 years to do so well?

CHARLES ELLIS They start with a very strong conviction. Their purpose, and they recruit for it, and they train for it, and they believe it in deeply; they drink the Kool-Aid, as they say. Their purpose is to serve the individual investor- full stop. It is not to make money for the people who are working there, to make money for the owners. That is not their objective. Their objective is to serve the investor, and, as a result, they do some very interesting things. For an example, when money market funds first came out, they would not introduce one. Why not? Because they were afraid that money market funds came out in the early mid ‘70s, and that was the worst time to move out of stocks and into cash. And they didn’t want to make it easy for people to make that mistake. So, they wouldn’t offer them. Then, as a result, their investors stayed more in equities and get the ride in the best bull market the world has ever seen.

CONSUELO MACK: Charles Ellis, it is a treat and an honor to have you here. Thank you so much.

CHARLES ELLIS Thanks.

CONSUELO MACK: At the conclusion of every WealthTrack, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: put the power of dividends to work in your portfolio. Over the last eight decades, dividends have accounted for more than 40% of the total return of the stock market. How do you invest in dividend paying stocks? Obviously you can buy companies that have a history of paying and increasing dividends year after year. Standard & Poor’s publishes a list of what they call their Dividend Aristocrats- stocks with a 25-year history of increasing dividends. If you prefer mutual funds, you can buy an equity income fund or an ETF, such as the Morningstar recommended Vanguard Dividend Appreciation ETF- the symbol is VIG. The key to getting maximum returns from any of these investments is by reinvesting the dividends, thereby unleashing the power of compounding over time.

That concludes this edition of WealthTrack. Next week, we’ll be discussing how to maximize your benefits from social security with retirement income guru, Mary Beth Franklin. It turns out that timing is everything. Thanks for watching and make the week ahead a profitable and a productive one.

Tags: Capital Markets, Classic Interviews, Consuelo Mack, Developing World, Diversification, Emerging Market, Financial Peril, Financial Storms, Full Transcript, Gold, Investment Opportunity, Investment Strategies, Losers Game, Money Manager, Peter Bernstein, Portfolio Strategy, Remarkable Story, Renowned Expert, Storm Clouds, Wealthtrack, Wise Men
Posted in Brazil, Markets | Comments Off