Category Archives: Investing

Fat Tail Years

By Larry Luxenberg  

A fat tail in investing doesn’t describe an animal. It’s a statistic that indicates a rare but often important outcome. In investing it may mean the odds of a really good or really bad outcome.

Stock market investors are afraid of lots of things but they really should fear four things. One: The stock market has a terrible year. Two: After that terrible year, the stock market doesn’t recover for a long time. Third: The investor is out of the market when it goes up. Finally: they hit on one of the many ways to mess up their investments.

Looking at the last 95 years of stock market returns, the odds of number one and two are low — not zero — but low. In that time, the broad market has declined by more than 20 percent in only six years and by 10 to 20 percent an additional eight times. In 10 more years the returns have been slightly negative; disappointing years but not something to fear.

The rest of the time — 71 years/75 percent of the time — the broad stock market as measured by the CRSP database  has had positive returns and 58 percent of the years, those returns have been greater than 10 percent.

A 10 percent return is the long-term average for the last century and it’s a powerful return because at that rate portfolios double every seven years.

The overall message is that the odds of you messing up by overthinking the problem and doing something creative is one of the biggest risks. The odds of the stock market having a really terrible year and taking a long time to recover are low. And one risk you can control is the chance of the stock market having a good to great year and you not being involved. 

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Watching Paint Dry

By Larry Luxenberg  

Good investing should be even less interesting than watching paint dry. Paint dries in a matter of minutes or hours, perhaps a day or two at the most. While it’s happening, there is no perceptible change. After it’s done, if you touch the surface, you realize the paint is dry. None of that process is the least bit interesting and while it’s happening there is no sense of change. But at least it’s quick and in the end, it’s satisfying if whatever you’ve painted looks better or is more protected than when you started.

Good investing is similar except it’s much, much slower. While it’s happening, you also don’t get much sense of satisfaction that you are making progress. It also can be upsetting in the meantime with wild fluctuations in the stock market or other markets.

Many investors are seduced by the idea of a quick hit, a get rich overnight scheme or the excitement of rapid trading and immediate results. Occasionally that works just like someone always wins the lottery. But similar to the lottery, the odds of quick success as an investor are low and most participants go away disappointed.

While good, long-term investing is unexciting and unsatisfying along the way, the odds are good and the results can bring you ultimate pleasure.

On average for the last 100 years, large U.S. stocks like those in the Dow Jones Industrial Average, have returned 10 percent a year. There’s no guarantee that will continue but the principle of what follows is the same, even if the returns are lower.

Some years there are big losses in stocks and some years the gains are small. But over time that 10 percent has held for nearly a century. While 10 percent a year or .83 percent a month may not sound like much, over time it yields very exciting numbers. At 10 percent a year, stocks double every seven years and quadruple in 14 years. That means one dollar turns into four over 14 years.

Over fifty years, that same dollar turns to $117.39. This doesn’t take into account inflation, taxes and fees for investors, but any way you slice it, that is a powerful and big return. And it doesn’t require heroic trading, skill or luck. To achieve big returns, it does require history repeating, a little bit of knowledge and, most of all, monumental patience.

Most of what we do in life does not come with a guarantee. Intuitively, we act on probabilities. There’s no guarantee we’ll wake up in the morning, but the odds are good. With investing, if we have a diversified portfolio, keep our costs low, resist the temptation to do much trading or think that we are smart, the odds of success are good. If we crave more excitement or believe that we know more than other investors, the odds plummet.

Investors have to choose. They can have an interesting and exciting experience and likely failure or they can have a dull financial existence with a high probability of success. It’s unlikely you can have both.

For me, the more boring, the better. I’m looking for results, not excitement. I’ll pull my chair over and take a snooze while the paint is drying.

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The Price of Certainty

By Larry Luxenberg  

As children, we crave certainty and we never truly outgrow this wish. As adults we know that there is no certainty in the world but this is impossible for people to accept.

Investors fall into lots of traps because they fall under the spell of this desire for definite outcomes. In a world gripped by pandemic and economic convulsions this search for certainty is even more compelling.

When so many people are in the market for certainty, the price — paid or opportunity cost — goes up dramatically as well as steers people into the wrong products and magical solutions.

It is unfortunate that at these inflection points people can squander decades of prudence for impulsive actions that color their financial pictures for extended periods, often for the rest of their life.

It’s easy to rationalize panic but when we crawl out from under the bed, the damage has been done and it may be hard or impossible to undo that damage.

One of the most distinguished writers about the Holocaust, Primo Levi, after the war ruminated about his experiences including his time at Auschwitz, which he barely survived. He marveled that one seemingly small error, which led to his capture and deportation, had such grave consequences.

The lesson for us, in much less dire circumstances, is to tread carefully when danger lurks.

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On Gold

By Larry Luxenberg  

When I began my investment career forty years ago, the price of gold was $800 an ounce and the Dow Jones Industrial Average was at $800. Today gold is a little under $2,000 an ounce and the Dow is at 28,000. Stocks, by any measure, are the clear winner.

Every decade or so, gold and other commodities have a flurry of activity and a brief price run. Traders periodically jump in and we hear people spouting theories about how paper money has no backing and only physical things have value.

Admittedly, stocks are an abstract concept and every once in a while we need a reminder of what they are. Stocks are a fractional ownership in a company. If you buy a mutual fund you have a fractional ownership of a fund that has a fractional ownership in these companies. If you own an S&P 500 index fund you have a stake in 500 of the biggest and best companies in the history of man.

What do you have with gold? You have a shiny object that has tantalized man for thousands of years and held value since prehistoric times. Should investors avoid gold? Not necessarily. If one loves shiny objects, by all means indulge. But as a repository for your life savings? Not for me and I would suggest not for most others.

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A Pig in A Poke

By Larry Luxenberg  

Every so often, complacency sets in on Wall Street. You never know how long afterwards bad stuff will start to happen but it’s a time to be vigilant.

For me, one of the warning signs is when people start to cut big blank checks. A few weeks ago billionaire investor Bill Ackman attempted to raise $3 billion dollars to buy something. Instead, investors threw money at him and he raised $4 billion.

Ackman gave investors vague clues about what he’d do with the money but only in time will they actually find out where the money will indeed go. He would like to buy a company or two and he’ll let you know when he does.

The actual investment vehicle is titled the Pershing Square Tontine Holdings. It’s a blank check company or more properly a SPAC, a Special Purpose Acquisitions Company.

Ackman has compiled an enviable investment record and there are checks built into the SPAC structure. Still, these vehicles normally appear during bull markets and disappear in bad times when investors are more reluctant to part with their money and fund speculative vehicles.

Sometimes it can be years before there is a reckoning. Sometimes, it’s only parts of the market that suffer. Still, every time there is a global pandemic and deep recession and yet investors are eager to buy a pig in a poke, I get nervous as a cat.

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Market Timing

By Larry Luxenberg  

The phrase “market timing” is of paramount importance to investment professionals but is difficult for most people to grasp. No matter how many times the subject is broached, most people cannot internalize the idea.

The concept comes down to this: if the stock market from time to time is going to go crazy and plunge, why don’t I just sell stocks before that and buy them back when it is safe? Why suffer those losses and that pain, when it can be avoided?

If that were possible, I would certainly sign up. But all of the evidence and my own experience of 45 years of closely following the stock market support the conclusion that only in retrospect is it possible to predict market downturns. Sometimes an investor takes action before a crash or a bull market and the media trumpets their success. But then the investor makes a second call and a third and the inevitable failure erases that guru from the scene.

A recent example was the hedge fund investor John Paulson, whose shorting of mortgage backed securities before the 2007-9 collapse was the subject of the book “The Greatest Trade Ever.” Paulson then proceeded to give much of that money back quickly with a series of disastrous trades.

The examples are endless and the academic evidence is even greater. Few investors even come close to equaling stock market returns over an extended period of time and only a handful have surpassed the market over a period long enough to be at all meaningful.

One reason that it’s impossible to time the market is that the stock market tends to move ahead of the news. Normal logic does not apply and the people who are most logical and analytical — scientists, engineers, mathematicians — have the most difficulty with this.

Over time, average market returns are powerful — in the U.S. for the last century on average the broad U.S. stock market has nearly doubled every seven years. Trying to do better leads most people to do much worse. If you take the bad with the good, you’ll get plenty of good.

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Out Like a Lion

By Larry Luxenberg  

March is typically an odd month, the transition from the harshness of winter to the promise of spring. This year it’s been the reverse in the worst way in modern memory.

The month began in New York as a normal time with mild weather, the stock market near record levels and unemployment at a half century low.

March ended in a totally unprecedented way with two-thirds of the country confined to their homes, an explosion of illness and death across the U.S., the biggest jump in unemployment on record by a factor of five and $8 trillion of stock market value wiped out.

Congress had just approved a record bailout of everyone, adding $2 trillion of debt to plug massive holes in an economy at a self-imposed standstill. Coronavirus cases had gone from a handful to more than 100,000, making the U.S. suddenly the world leader.

Muddled mixed messages proliferated and fear was rampant. While glimmers of hope popped up here and there like the regular appearance of forsythia, cherry blossoms and daffodils, the gathering storm overshadowed everything as the world braced for the mysterious plaque to strike and dissipate.

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Survival Mode

By Larry Luxenberg  

With the economy in free fall, for most businesses it’s a sudden shift to survival mode.

Most businesses spend most of their time trying hard to grow, to innovate, to take on new markets and better serve old ones. Few people with a choice go into business just to survive. But that’s where we find ourselves today.

You can’t grow if you don’t survive. Businesses that worked hard for decades to flourish, now find themselves facing excruciating choices. Capabilities and staff that were nurtured for many years, long established relationships, beautiful facilities — all are now on the chopping block.

President Eisenhower, the wartime U.S. commander of the European theater said that in war everything and everyone is expendable. With an imploding economy, that same attitude and urgency must be applied to businesses.

With a brutal recession on the near horizon, thousands of businesses will not survive. Those that hunker down and go into self-preservation mode quickly have a good chance to not only survive but to thrive after many of their competitors depart the scene.

Austrian economist Joseph Schumpeter called this the “creative destruction” of capitalism. After every painful recession, there is a flowering of innovation. It’s easy to see the destruction. Much harder to spot the bright new industries and new ways of doing business that are coming along.

After the 90-91 recession that shook America to its core, the Netscape browser appeared in 1995, ushering in the Internet and a towering wave of innovation.

Out of the current difficult period, good things will develop but only to those who survive and are sufficiently nimble to spot the emerging opportunities.

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It’s Ok to Panic… But Don’t Do Anything

By Larry Luxenberg  

On Monday, the markets panicked, resulting in the Dow Jones having its biggest point drop in history and one of its biggest losses in percentage terms. Bond yields just about vanished while oil prices dropped by one-third. More than one commentator said that if you think you know what’s going on, you’re not paying attention.

The elephant in the room is the rapidly spreading Coronaivurs, COVD 19. How widespread and how deadly it becomes are still huge unknowns. What we know for sure is it is hugely disruptive to the global economy and it is inducing fear way out of proportion to what has happened already. It may become a huge and deadly global pandemic and if it does the hype is justified.

So what is an investor to do? If you have the wherewithal to wait it out, you stand a high probability of winning. Long term investors usually (but not always) win. Ebola, Swine Flu and MERS vanished while the markets left them in their wake. Certainly COVD 19 could be orders of magnitude worse. Even so, it’s likely that vaccines and treatments will emerge over the next year or two and eventually the disease will get under control.

We don’t know the human or economic toll and it could be substantial. But if an investor has a well thought out financial plan, he should stick to it. The odds are in his favor.

Emotions destroy more investors than diseases. I know many investors who panicked in 2009 and that momentary lapse has adversely affected the rest of their life. People who think the stock market is dangerous tend to make it a self-fulfilling prophecy to their detriment.

In the meantime, do what I did on an otherwise beautiful day. Take a walk and wait until the wave of panic goes away and leave your portfolio untouched to recover on its own. Nature has great restorative powers, especially for portfolios.

 

 

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Nearly Everything I Know About Elections and Markets is Wrong

By Larry Luxenberg  

Many people have strong views about the impacts of presidential elections on the stock market and nearly all of these views are wrong. Like much else about the stock market, normal logic and common sense frequently do not apply.

An analysis of elections over the last century and presidential terms over the last half century century shows surprising results. The analysis, by Dimensional Fund Advisors, showed that presidential election years — widely held to be strong market years — instead are merely average years for the stock market.

Of the 23 elections in the last century, the average market return is 9.5 percent, close to the long-term average for all years of 10 percent. Most of those years have indeed been positive with only four negative ones — 1932 (-8.2 percent); 1940 (-9.8 percent); 2000 (-9.1 percent) and 2008 (-37 percent). The financial crisis of 2008 skewed the numbers  but for investors counting on a good return in election years, that’s not much comfort.

Those negative years had more to do with external events — the intensification of the Great Depression, the onset of World War II; the beginning of the tech bust and recession of 2000 and the Financial Crisis of 2008 — and little to do with elections.

Equally surprising has been the performance of the stock market during presidential terms and  by party. During the last half century there have been nine presidents of which six have been Republicans and three Democrats.

Most investors — regardless of their personal preferences — believe that Republicans are better for the stock market. The numbers don’t bear that out. Over the last 50 years, Republican terms have resulted in a below average 8.93 percent annualized return while Democrats have produced a 14.9 percent annualized return.

During that time, only two presidents have had negative returns, both Republicans. Richard Nixon, during his 5 years in office, had a negative 2.9 percent return which George Bush had a negative 4.4 percent return for his eight years, which included parts of two recessions.

Of course, to be fair, the best record was also a Republican president, Gerald Ford, whose three years featured a 20.2 percent return, far and away the best record. He benefited from the bounce back from the steep 1973-74 bear market which was triggered by the Arab Oil Embargo and spike in oil prices and high inflation.

Second best was Bill Clinton at 17.6 percent. His two terms included the tech led bull market of the 1990s. Number three was Ronald Regan, who started off with a steep double recession but ended with “Morning in America” and the start of the great bull market of the 1980s and an overall return of 15.9 percent. Back Obama was close behind with 15.4 percent for his two terms.

The remaining three terms are also surprising. George H.W. Bush had a return of 13.9 percent and that wasn’t good enough to return him to office, partly because a recession marred the period before his reelection campaign. Just behind was Jimmy Carter at 11.7 percent who president of a period of economic “malaise” but a continuation of the Ford bull market.

Equally surprising is the return of Donald Trump at 10.9 percent (before the recent market decline). This return is a little above average but still 7th of the 9 presidents of the modern era.

In general we give presidents too much credit or blame for the stock market performance during their term. The real lessons are that it’s impossible to predict stock market performance, the long-term returns have been great and many things about the stock market don’t conform to our notions of logic and common sense.

 

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