Euro Economy = Bad; Euro Stocks = Good (maybe)

1. Europe’s economy is going back in the trash as GDP is flat with even all mighty Germany turning negative (see red bars indicating economic growth from the prior period):
   
2. This has been a persistent theme, since 2009 other developed economies – US, Japan, Britain – have grown faster while Europe has stagnated:
   
3. European stocks have reflected this economic weakness as US stocks (SPX on chart below) have returned much more than European stocks (FEZ on chart below) since the end of 2008 (note: the S&P 500* bottom early March 2009, though chart is intra-month making bottom appear to be February 2009):
   
4. However, this underperformance of European stocks has possibly presented an opportunity though as European stocks are now cheaper (note: cheap stocks in general should have more room to grow than more expensive stocks):
   
5. Further, the ECB has yet to institute quantitative easing (QE), but the rumors are swirling.  In the US, QE worked out nicely for US equity markets as each listed program in the chart below resulted in a subsequent move higher in the stock market:
   
6. Thus, if/when the ECB version of QE it could have a positive effect on European equity prices as it did on the US.  Plus the stocks are relatively cheap so there could be some more room to grow.

Caveat: the trend in the European stocks is weak so for the time being caution should be used.

Note:  On 09/04/14 the ECB cut interest rates and may or may not enact quantitative easing later in the day or in coming months.  European stock markets were higher.  This post was written before today’s news.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Why the QE Tapper Matters.

Stocks have gone up with the Fed’s balance sheet, so what happens when the latter is no longer the case?

There are a lot of things that don’t really matter to the markets much of the time.  A short list:

• Geopolitical – the world is always fighting somewhere
• Congress – do they ever get along?
• Data Points – trends > one piece of data
• Analyst Targets – no idea how any of these can be accurate

Not that any of those can’t ultimately change the markets, but I can’t think of a logical reason to sell because country X on the other side of the world might invade country Y on the side of the world.  How does that matter to the US again?

Anyway, I digress.  One thing I do think matters is the quantitative easing tapering (QE).  QE is when the Fed buys longer-term Treasuries to force down rates in attempt to increase lending and subsequently boost the economy.  Its actual impact on the economy can be argued, but from my point of view it has had a large impact on the stock market:

Shown another way:

So what is obvious from the charts is that the larger the Fed’s balance sheet, the higher the S&P 500*.  Further, when the balance sheet didn’t move we had almost a 20% move down in the stock market (red circle).

Anyway, the Fed is “tapering” their purchases.  What was once $80b a month is now around $25b.  They haven’t stopped buying and certainly aren’t selling, but they are cutting back.    So while day to day noise tend to be the headlines, the real focus should be on what happens when the Fed’s balance sheet stops getting bigger?

Please see the important disclosures that apply to this commentary HERE.  See important definition on the S&P 500 at the same link.  The above charts are for illustrative purposes only and does not attempt to predict actual results of any particular investment.  In regard to both charts, Source: S&P 500 - FRED and FED Treasury Holdings - FRED; calculations by CAL and idea via Market Anthropology

Avoid an Investment If…

Use research to come to an investment decision, avoid being a sheep

Maybe avoid is the wrong word.  More like don’t blindly follow.  I am talking about information friends, clients, family, etc. use as a justification why they (and you) should invest in ABC.  The following should give you pause, as they are fairly weak justifications:

1. Advice from a political pundits or their sponsors
2. Chain emails
3. A guy who got a past market call right
4. Anything said from a permabull or permabear
5. Golf course investing tips
6. Any inside information
7. A guy who has a TV show
8. Anything from an investment company
9. Returns that are much higher than the market
10. Anything you can’t really understand

And why:

1. They are pushing politics or their revenue stream, not investments
2. Usually crazy rumors with little basis in reality
3. Yes, could give the guy credibility OR every blind squirrel finds a nut
4. If they are always bullish or always bearish they have a predisposed view of the market
5. Typically people only talk about their winners
6. Aside from being illegal probably isn’t inside anyway
7. He or she is gunning for ratings, not necessarily investment advice
8. They are pushing a product (caveat: they could have some pretty good research)
9. All good things come to an end or it’s a total fabrication
10. More confusing = more costly AND/OR less idea of how it will perform

Of course, this list is not all encompassing.  Just what popped into my head.

Justified is the key word.  Any of the above may ultimately have the right call on the market or an investment; however, I would bet using any of the above as the ONLY reason to invest in something will often end in disappointment. 

Point being, do your own research to formulate your own thesis or find some research with an actual thesis before making a decision either way and if you see fit use one of the items from the list above to compliment that thesis. 

Please see the important disclosures that apply to this commentary HERE. 

Reducing the Risks from Your Brain

“Knowledge alone isn’t enough. Even though we know it’s a bad idea to buy high and sell low, spend more than we earn, or invest in only one stock, we still repeat these mistakes… So ignoring what we’ve learned in the past makes it difficult to benefit from that knowledge. And pretending that there’s no consequence in the future for the decisions we make today creates a similar conflict.”

 The above sums up what I found to be a quick, insightful article in the New York Times.  It touches on the most overlooked issue in personal finance – the psychological barriers to making sound financial decisions. 

We take great pride in trying to educate our clients, often using the phrase “a great client is an educated one.”   However, as the article indicates information alone may have limitations when rubber meets the road as the client may convince him or herself otherwise using the “this time is different” or “we can make up for it down the road” or anything really as a reason.

The article mentions “by recognizing the impact our [psychological issues] may have, we stand a greater chance of turning that knowledge into good behavior”, but does little mention ideas to help with the recognition.  We understand that human nature won’t change and thus those issues will never go away.  Thus, we have taken steps to minimize their impact and proactively prevent them:

• Build a financial roadmap so clients have a clear understanding of how a financial decision will affect their long-term goals and objectives and balance sheet/cash flow trends.
• On top of client education, we take time to answer all client questions thoroughly so they will understand our plan to alleviate their concern.
• Transparency in our process helps understand the how and why of our recommendations.
• Reducing risk as market movements indicate a higher probability or large loss in the future in order to keep them from selling at the bottom.
• Meeting clients in the middle.  For example, putting a % of what they were going to invest in a private investment instead of the original amount

Of course, these methods are not perfect and we constantly evolve to find new and better ways to mitigate the psychological risks.  Still, the above are good first steps to recognizing the deficiencies we have and taking steps to avoid the pitfalls the deficiencies can bring.  

Please see the important disclosures that apply to this commentary HERE. 

Time for Active to Shine?

Picking active managers isn't easy, but for those who are disciplined and know what they are looking for this could be the right time to go active.

For at least a decade now passive management (managers who attempt to mimic an index) has been all the rage.  Originally passive management advocates were only on posters in Tiger Beat, but now they are on the cover of Vanity Fair.  More and more we get research, white papers, even client calls extolling the virtue of passive management over their active counterparts (managers who attempt to beat an index).  The trend continues to move more and more toward passive managers.  Will this ever change?

No, at least not forever, and I am a big advocate of passive management.  The reason was highlighted to me in the article.*  Thesis: the trend will continue to move as millennials, who are skeptical of active management, migrate to passive managers and the older active managers, who make up the bulk of active management, retire leaving new managers with little track record.

But the reason the trend will eventually reverse is the same reason why the money ultimately started flowing that way – returns:

1. Active management became popular in the 80s as ways to get diversified* market exposure and good rates of return
2. As it gained in more popularity, more managers entered the field = lower % of managers beating their respective index as quality erodes. 
3. Many of these managers raised their fees given the increased demand, lessening their chance to beat the benchmark
4. So here comes passive managers, cheaper and better performing than active managers
5. Repeat steps 2 and 3 AND lower quality active managers leave the field as dollars move to passive AND if everyone is buying an index stocks will naturally become over and undervalued, creating a nice situation for active managers AND creates a self-reinforcing problem - during a market selloff who is buying if everyone is passive?  This is where we are at.
6. The small pool of high quality active managers who were probably in cash before the sell-off and may now be well positioned to outperform over the full market cycle
7. Start over again

The debate of for academics, but why does this trend matter to retail investors?  Opportunity.  With everyone moving towards passive management, quality active managers should be better situated to beat an index over a full market cycle.  Picking active managers isn’t easy, but for those who are disciplined and know what they are looking for this could be the right time to go active.

Please see the important disclosures that apply to this commentary HERE.  See important definition on diversification at the same link.