Perspective on Recent Market Events


It looks like the U.S. stock market will finally get something that happens, on average, about once a year: a 10+% percent drop—the definition of a market correction.  The last time this happened was a whopper—the Great Recession drop that caused U.S. stocks to drop more than 50%–so most people today probably think corrections are catastrophic.  They aren’t.  More typically, they last anywhere from 20 trading days (the 1997 correction, down 10.8%) to 104 days (the 2002-2003 correction, down 14.7%).  Corrections are unnerving, but they’re a healthy part of the economy—for a couple of reasons.

Reason #1: Because corrections happen so frequently and are so unnerving to the average investor, they “force” the stock market to be more generous than alternative investments.  People buy stocks at earnings multiples which are designed to generate average future returns considerably higher than, say, cash or municipal bonds—and investors require that “risk premium” (which is what economists call it) to get on that ride.  If you’re going to take more risk, you should expect at least the opportunity to get considerably more reward.

Reason #2: The stock market roller coaster is too unsettling for some investors, who sell when they experience a market lurch.  This gives long-term investors a valuable—and frequent—opportunity to buy stocks on sale.  That, in turn, lowers the average cost of the stocks in your portfolio, which can be a boost to your long-term returns.

The current market downturn relates directly to the first reason, where you can see that bonds and stocks are always competing with each other.  Monday’s 4.1% decline in the S&P 500 coincided with an equally-remarkable rise in the yields on U.S. Treasury bonds.  Treasuries with a 10-year maturity are now providing yields of 2.85%–hardly generous, but well above the record lows that investors were getting just 18 months ago.  People who believe they can get a decent, relatively risk-free return from bond investments are tempted to abandon the bumpy ride provided by stocks for a smoother course that involves clipping coupons.  Bond rates go up and the very delicate supply/demand balance shifts, at least temporarily, in their direction, and you have the recipe for a stock market correction.

This provides us all with the opportunity to do an interesting exercise.  It’s possible that the markets will drop further—perhaps even, as we saw during the Great Recession, much further.  Or, as is more often the case, they may rebound after giving us a correction that stops short of a 20% downturn.  The rebound could happen as early as tomorrow or some weeks or months from now as the correction plays out.

Once it’s over, no matter how long or hard the fall, you will hear people say that they predicted the extent of the drop.  So now is a good time to ask yourself: do I know what’s going to happen tomorrow?  Or next week?  Or next month?  Is this a good time to buy or sell?  Does anybody seem to have a handle on what’s going to happen in the future?

Record your prediction, and any predictions you happen to run across, and pull them out a month or two from now.

Chances are, you’re like the rest of us.  Whatever happens will come as a surprise, and then look blindingly obvious in hindsight.  All we know is what has happened in the past.  Today’s market drop is nothing more than a data point on a chart that doesn’t, alas, extend into the future.





When the Index Beats the Algorithms

You might wonder why there wasn’t more media coverage of one of the most interest bets ever made in the investment world.  We’re not talking about betting on a company; this bet was made between Berkshire Hathaway chairman Warren Buffet and a hedge fund called Protégé Partners, on whether a basket of hedge funds managed by algorithms and super investors would beat a simple S&P 500 index fund over a period of 10 years—which happened to include the Great Recession and one of the longest bull markets in history.  Each side put about $320,000 in 2007, with the proceeds—including all gains—going to charity.

The final score wasn’t even close.  The index fund gained 7.1%, compounded annually.  The basket of hedge funds returned a below-average return of 2.2%.

The original intent of the bet was to prove a point: that it is usually impossible to outthink the market, no matter how smart you are, no matter how cleverly you use derivatives, hedging and futures contracts.  Yes, Buffett has been outperforming the market for most of his career.  But he has unusual access to deals, and extraordinary patience—which can be more powerful than algorithms when it comes to beating the market.


Value of Diversification

It’s not always easy to grasp the value of diversification—why, in other words, it’s better to own many stocks inside a mutual fund than one or two stocks on their own.  But recent research conducted by Arizona State U. finance professor Hendrik Bessembinder offers some insight.

Bessembinder is not afraid of numbers.  He calculated every one month return of every U.S. common stock traded on the New York and American Stock exchanges, and the Nasdaq exchange, since 1926.  Even though nearly half of the 25,782 stocks that have been in existence over this time period lasted 7 or fewer years, this still accounted for 2,524,849 individual monthly returns from July 1926 through December 2015.

What did Bessembinder find?  Among other things, only 4% of the listed stocks accounted for the entire lifetime dollar wealth creation of the U.S. stock market since 1926.  In other words, all the market returns came from only 86 top-performing stocks out of nearly 26,000.  If you owned some of those stocks, mixed with the vast majority of stocks whose companies underperformed or went out of business, you got decent returns.  If you decided you could pick your own handful of stocks, there is an almost overwhelming chance that you would have missed out on the small number of winners.


Population in Decline

You’ve probably read some alarming statistics about the world becoming overpopulated, unable to feed itself, and meanwhile using up all the fresh water and energy that is available.  If you found these reports disturbing, and believe that humans are multiplying like jackrabbits, then here’s some good news: it appears that the human birthrate is actually trending downward on a global scale.  Demographers employed by the United Nations have estimated that there will be 140.89 million births in 2018—61,000 fewer than in 2017, and reversing (albeit by a sliver) a longstanding increase in global population.  The demographers project that birthrates will continue to fall through 2050, after which the variables make it impossible to make an accurate prediction.

Next year, as always, Asia will produce more than half of the world’s babies, but for the first time the continent is in danger of losing its status as the top population increaser to sub-Saharan Africa.  In 1990, just 19% of babies were born in Africa; in 2018, 31% will be.  Meanwhile, India’s birthrate has collapsed; its people now reproduce right at the long-term population replacement rate of 2.1 births per woman.  Bangladesh, Mexico, Brazil and Iran have recently begun producing too few babies to maintain their current population, and this has been true for more than a decade of all European countries and America.

2017 Annual Investment Report


The bull market continued for another year, causing market indices to soar to new heights over and over again and—ominously—also pushing valuations further beyond the long-term averages.A breakdown shows that just about everything gained in 2017.  The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—rose 6.39% for the 4th quarter, finishing the year up 20.99%.  The comparable Russell 3000 index was up 21.13% for the year.

Looking at large cap stocks, the Wilshire U.S. Large Cap index gained 6.70% in the fourth quarter, providing a 21.84% return for the year.  The Russell 1000 large-cap index finished the year with a similar 21.69% gain, while the widely-quoted S&P 500 index of large company stocks gained 6.12% during the year’s final quarter and overall returned 19.42% gains in calendar 2017.

Meanwhile, the Russell Midcap Index finished the 2017 calendar year up 18.52%.

As measured by the Wilshire U.S. Small-Cap index, investors in smaller companies posted a 3.56% gain over the final three months of the year, to stand at a 13.45% return for 2017.  The comparable Russell 2000 Small-Cap Index gained 14.65% for the year, while the technology-heavy Nasdaq Composite Index rose 6.27% in the final three months of the year, to finish up 28.24%.

International stocks are also participating in the bull run.  The broad-based EAFE index of companies in developed foreign economies gained 3.90% in the recent quarter, and ended the year up 21.78% in dollar terms.  In aggregate, European stocks were up 22.13% in 2017, while EAFE’s Far East Index gained 23.37%.  Emerging market stocks of less developed countries, as represented by the EAFE EM index, rose 7.09% in dollar terms in the fourth quarter, giving these very small components of most investment portfolios a remarkable 34.35% gain for the year.

Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, posted a meager 1.70% gain during the year’s final quarter, yet finished the year up a respectable 4.18%.  The S&P GSCI index, which measures commodities returns, gained 9.90% in the 4th quarter, to finish the year up 5.77%.

In the bond markets, coupon rates on 10-year Treasury bonds have risen incrementally to 2.41%, while 30-year government bond yields have fallen slightly to 2.74%.  Five-year municipal bonds are yielding, on average, 1.70% a year, while 30-year munis are yielding 2.62% on average.

This was a year when investors ignored the dire headlines, North Korean missile threats, investigations of the Presidency, hurricane devastation and a rapidly-growing national deficit to produce one of the smoothest investment rides in the past century.  As you can see in the accompanying chart, which was compiled through the end of October, the VIX “fear” index has produced the lowest volatility since data has been collected starting in 1990.  In October, the S&P 500 index broke its all-time record of consecutive days without a 3% drawdown.  The biggest single-day drop in 2017 was just under 2%.

How long can this continue?  Who knows?  The S&P 500 is now trading at around 18 times forward earnings, which is above the historical average of 16—which, loosely translated, means you aren’t getting a bargain when you buy stocks today.  At the same time, we are experiencing low unemployment rates and solid profits for American companies.  The U.S. economy is growing at a 3% rate.  And the psychology of the markets doesn’t match what you traditionally see at market tops: people still seem to be suspicious about how long the market rally will last, unlike the normal buying frenzy that often presages the next sharp downturn.  (To see what a market frenzy looks like, are you hearing more about bitcoin than you have in the past?)

And indeed, not all stocks have prospered despite the rise in indices.  A company called Range Resources lost 54% in 2017 due to continuing low fuel prices, and firms you’ve heard of incurred significant drawdowns, including General Electric (-43%), Mattel (-43%), Advance Auto Parts (-42%) and the Apache oil and gas company (-34%).

Eventually, there will be a broader bear market which will see most stocks lose value.  It will be impossible to spot by forecasters, but will seem inevitable with the benefit of hindsight.  The important thing to remember is that few people have ever become extremely wealthy by timing the market and jumping out because they think they can predict the next downturn.  Many have gotten significantly wealthier by holding on whenever the raft hits the rapids.  We missed the rapids in 2017, but everybody knows they’re coming—someday, though perhaps not soon.  Let’s make sure we have a tight grip anyway.


Wilshire index data:

Russell index data:

S&P index data:–p-us-l–

Nasdaq index data:

International indices:

Commodities index data:

Treasury market rates:

Bond rates:








Gender Differences – in Retirement

You may have read that women are far more likely to face poverty in retirement than their male counterparts—but you may not realize just how big the disparity is. In fact, women are 80% more likely to fall into poverty toward the end of their lives, compared to men, according to a 2016 study by the National Institute on Retirement Security.

In an attempt to explain how this came about, the study’s researchers noted that women are more likely than men to engage in part-time unemployment due to starting a family and staying at home with the kids, and at the other end of their lives, they have much higher rates of caregiving for elderly parents. Men, on the other hand, can enjoy an uninterrupted work career, making them more likely to receive promotions and career opportunities.

Even if you take away this disadvantage, there’s another one. During their working years, women earn, on average, 80 cents for every dollar their male colleagues earn—for the same jobs.

But…. Isn’t this changing as we become a more gender-aware society? Apparently not. If you look at the accompanying chart, you’ll see that women were catching up to male pay scales from 1979 until about 1993, at which point the gains seemed to totally stall out. And women still make up 66% of all caregivers for elderly parents. Even when men provide assistance, the Family Caregivers Council estimates that women spend as much as 50% more time than the men do in caregiving activities.

And 2015 data adds that 48% of women above age 75 live alone, compared with less than a quarter (22%) of men at a comparable age. After caregiving for others, women are less likely to receive it for themselves.


Personal Robots?

The robotics revolution, so far confined to factories and the cute little device that roams your house sucking up dirt, is about to hit closer to home. In Japan, so-called “carerobos” are now helping workers look after the elderly in assisted living facilities. In one facility, a large-eyed humanoid named Pepper leads the residents in song, while a robotic baby harp seal named Part responds to touch and sound, turning to and nuzzling patients who stroke or talk to it. Aibo, a robo-dog originally intended for the retail market, is being repurposed as a pet for the elderly. Pepper also helps monitor the corridors at night, and even leads exercise classes. A survey found that using robots encouraged over a third of the residents to become more active and autonomous.

Will robots get even more personal? A survey of 12,000 people of mixed ages worldwide found that up to 27 percent of 18-34-year-olds would be comfortable swapping out a human romantic relationship for a romantic—and sexual—relationship with a robot. Men were three times more likely than women to form such relationships.


What NOT to Skimp On

Save and invest. Save and invest. Isn’t that all you hear when it comes to planning your financial life?

An online article by an individual who refers to himself as “the Financial Samurai” makes a more balanced case regarding how you deploy your money. Yes, you should be capable of deferring gratification and have a healthy savings rate during your accumulation years. But there are a few items that are well worth investing in: your comfort, well-being and certain aspects of your lifestyle. Some of these items might be considered luxuries by people who are perhaps overly frugal.

For instance? The Samurai says you should splurge on a really good mattress—recognizing, of course, that you can avoid markups and still buy quality. His argument: you spend almost a third of your life sleeping. Your waking hours will be more comfortable and productive if you are spending your mights on the most comfortable, supportive mattress you can afford.

Another example? Your glasses or contact lenses. Vision may be your most important sense, so it is worth buying glasses with the thinnest lenses with anti-reflection and a scratch-proof coating. If you wear contacts, splurge on daily wear that contain the latest breathable technology.

If you’re serious about athletic performance, then the Samurai thinks that buying top-of-the-line sports equipment makes sense. If you have a baby, the best baby care products are worth the extra expenditure. If you’re in the habit of watching movies at the theater, then you might consider buying a high definition TV and surround sound system, which makes watching movies at home more enjoyable—and economical. He also recommends that you take care of yourself with massages, physical therapy and coaching—arguing that physical and mental health are priceless.

Finally, since most Americans receive very little vacation time from work, the Samurai recommends that you make the most of those days or weeks, by selecting the best adventure and the best amenities possible. The point: live a great life while you’re saving and investing.

Inflation Impact

We all know that inflation gradually erodes the value of our dollars, and you’re probably aware that this is one of the main reasons for investing in the stock market. If you hide your money safely under your mattress, it becomes incrementally less valuable each year depending on the inflation rate. To keep pace, you have to find ways to make it grow at least as fast as the value of a dollar is falling.

But you may not have heard about inflation as an argument against putting too much of your retirement money in a fixed annuity, which pays you a fixed amount for the rest of your life. That safe, comfortable income stream may work perfectly for you today, but will it be enough to live on 20 or 30 years in the future?

If you’re curious how much damage inflation can do to you over longer time periods, look at a free online calculator available here: You can input your current age and the income you’re receiving, and the site will calculate what your future income would need to be at some point in the future, just to maintain your current lifestyle.

Let’s say you’re 65 today, receiving $100,000 a year from an annuity. How much of your future lifestyle will that annuity pay you when you’re 90?

Assuming an inflation rate of 3% a year, you would need $209,378 in that year you turn 90 to afford the same things you do today. So your other investments would have to contribute more, in that year, than what the annuity was paying you. Put another way, the annuity would be paying less than half of what you need to maintain your current expenses into the later years of your retirement. If inflation were to average 4%, the future income needed to match today’s $100,000 rises to $266,584.

This is not an argument that annuities are to be avoided in all cases; a guaranteed lifetime income may have its place in some financial plans. But a few inputs into this calculator can go a long way toward making the case that investments that grow over time are vitally necessary to afford a comfortable future retirement. The safety of a guaranteed fixed income is a false promise, because it doesn’t protect you against the near-certain, incremental danger of yearly inflation.



Bank of Japan ETF Ownership

We’ve all heard about as much as we can take about the U.S. Fed’s multi-part QE program, and similar stimulus programs instituted by the European Central Bank. What they mostly have in common is the purchase of government and certain mortgage-backed bonds on the world markets, which has the effect of holding down bond rates and, therefore, borrowing rates.

But surely the strangest form of government intervention is taking place in Japan, where the Bank of Japan has embarked on an aggressive program of buying, not just Japanese government bonds, but also stocks. Having a buyer the size of Godzilla stomping into the equities market is bound to add to the demand side of the market, which will tend to raise stock prices—and, indeed, the Japanese Topix Index—the broadest measure of Japanese stocks—has risen from 1500 in May to 1813 recently. The year-to-date return is a robust 19.78%.

But the question is: how long can the Bank of Japan keep adding to its stock portfolio? A recent report shows that the Bank of Japan now owns 75% of the shares of Japanese ETFs (see chart), and some predict that it will own 80% by year-end.

The Bank of Japan’s aggressive buying up of Japanese government bonds has led to one of the more interesting anomalies in the global financial scene: bonds are now routinely issued at negative interest rates, meaning the Bank of Japan and other buyers are guaranteed to lose money when they buy the bonds. In the stock market, the situation may not yet be quite as disruptive, since Japanese ETFs are not as dominant as they are in the U.S.; the Bank of Japan holdings currently amount to just over 5% of Japan’s Topix index stock market capitalization. But nobody knows what will happen when (and it is not “if” but “when”) the central bank has to start selling off its positions. The bull market that Japanese investors have enjoyed this year may not be sustainable on the metric merits, and could turn around fast if Godzilla decides to stomp in the opposite direction.