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The Reformed Broker

An existing occupied home sits for sale next to new homes under construction this past April in Carlsbad, Calif. Brown argues that rising interest rates and their potential to slow down the housing recovery are the biggest threat to the financial markets right now. (Lenny Ignelzi/AP/File)

Higher interest rates are the biggest threat to the stock market

By Guest blogger / 09.10.13

I had a couple of quotes in the New York Post last week about what might represent the biggest threat to the stock market this month. I view Syria as a side show and I do not believe "valuations" are too high or represent a threat of their own volition. I also think the debt ceiling and budget deadlines, while they may offer up volatility-generating headlines, are probably more likely to provide the impetus for relief rallies than they are to derail the economic recovery.

These are all legitimate concerns, of course, but they pale in comparison to what I believe is the number one threat right now: Interest rates.

And by interest rates, I do not mean the absolute level, but the velocity of the increase, taking place at a speed the markets are currently unprepared for and businesses may not have planned for. The effect of higher rates on the housing market is already being felt in the New Home Sales number. We've seen a 20% drop-off in new home sales in June and July, and this does not bode well for existing home sales in the coming months or in Case-Shiller home prices next quarter.

The reason this is so important is that the housing recovery is the key underpinning of the economic recovery and the biggest tailwind for stocks and risk appetites in general. The wealth effect from stabilizing to rising home prices and the optics of a buoyant real estate sales environment have absolutely contributed to the rising PE multiples in equity markets. Should mortgage rates - which are already up 100 basis points since the spring - continue to rise, I believe that a lot of the essential confidence we've enjoyed could evaporate - and stock gains along with it. ( Continue… )

The headquarters of investment firm PIMCO in Newport Beach, Calif., last year. According to Brown, PIMCO's incorrect prediction that the stock market would fail to rally back after the recession is still costing investors who took it seriously. (Lori Shepler/Reuters/File)

When half-right market forecasts are disastrous

By Guest blogger / 09.09.13

PIMCO got it half-right with its New Normal forecast early in the post-crisis period - they nailed the economic environment we'd be in but completely missed one of the top ten stock market rallies of all time.

Barry Ritholtz has been writing about the Follies of Forecasting since before I was born, see this landmark 2005 piece on the subject at By the way, Barry's chutzpah to publish something like that in the pre-blog era - on a site rife with daily predictions - was quite extraordinary at the time.

In many other endeavors outside of investing, getting a forecast half-right isn't quite the end of the world (cloudy with a chance of showers doesn't upset anyone if the clouds arrive without any rain). In asset allocation, however, half-right can be a killer.

Here's John Rekenthaler at Morningstar:

"There was the New Normal argument, as advanced by PIMCO and Bill Gross. The main prediction of the New Normal was economic: The U.S. economy would not roar out of the 2008-09 recession, as is expected during recoveries, but would instead trudge along at only a modest pace. That analysis was spot-on and has earned PIMCO much-deserved credit. ( Continue… )

Jason Hardzewicz, a floor official and trader for Barclays, works at his post on the floor of the New York Stock Exchange. Brown writes that knowing your personality is key to becoming a good investor. (Bebeto Matthews/AP/File)

A good investor is a self-aware investor

By Guest blogger / 09.03.13

Edward Johnson, the legendary founder of Fidelity Investments, once said the following:

"The market is like a beautiful woman - endlessly complex, always changing, always mystifying. I have been absorbed and immersed since 1924 and I know this is no science. It is an art. Now, we have computers and all sorts of statistics, but the market is still the same and understanding the market is still no easier. It is personal intuition, sensing patterns of behaviour. There is always something unknown, undiscerned."

George Goodman, writing pseudonymously as "Adam Smith", begins the second chapter of his 1968 masterpiece The Money Game with that quote. This sets up his response:

"Personal intuition does not mean that you can translate last night's exotic dream into some brilliant choice in the market. Professional money managers often seem to make up their minds in a split second, but what pushes them over the line of decision is usually an incremental bit of information, which, added to all the slumbering pieces of information filed in their minds, suddenly makes the picture whole.

( Continue… )

The American flag and a sign for Wall St. are shown outside the New York Stock Exchange, in New York July 18. One investment author argues that investors relying on too much of the same information can be problematic if it leads to crowded trades. (Mark Lennihan/AP/File)

Is there enough diversity of thought on Wall Street?

By Guest blogger / 08.29.13

Michael Mauboussin's book about untangling the results we generate from skill and from pure luck lit up the investment biz upon its release last fall. Since then, his work has been widely referenced virtually everywhere people are seriously trying to understand results and randomness.

Quick shameless plug - Michael Mauboussin is a confirmed speaker at Barry's conference this October, we'll have more details in the days to come but you should save that date if interested...

Anyway, Shane at Farnam Street has a new interview with Mauboussin posted at his site, here's one exchange in particular I found interesting, about the diversity of thought among professional investors:

It seems that today, more than ever, people are going to Wall Street with very similar backgrounds. How do you see the impact of this?

"For the last few decades Wall Street has attracted a lot of bright people. By and large, the folks I deal with on the Street are smart, thoughtful, and motivated. The key to robust markets and organizations is diversity of thought. And I don’t personally find such diversity greatly lacking. ( Continue… )

Fed Chairman Ben Bernanke's news conference is shown on a television screen on the floor of the New York Stock Exchange in June. According to a recent survey, a large proportion of Americans don't understand how rising interest rates, which could be on the way in the near future, will affect heir investment accounts. (Richard Drew/AP/File)

Survey: Americans don't understand interest rates' effect on investments

By Guest blogger / 08.22.13

Shocking but not shocking survey sponsored by Edward Jones asks Americans about the impact of interest rates on their investments and retirement portfolios:

The survey of 1,008 Americans conducted by ORC International, gauged how well they understood the impact potential rising interest rates would have on investment portfolios.

Age and Awareness

One-third of respondents between the ages of 18 and 34 replied they have “no idea” how interest rate changes will impact a portfolio. As respondents’ age increased, their level of awareness increased as well with the exception of the oldest age group. One-quarter of those 65 and older also indicated they had “no idea.”

Gender Breakdown

Men and women are evenly matched when it comes to respondents who, while understanding there will be some impact to portfolios, do not quite understand the specifics (40 percent and 39 percent, respectively). A division occurs among respondents who admit they “do not understand at all” what those impacts may be. While 29 percent of women admitted they do not understand the issue, just 19 percent of their male counterparts did. ( Continue… )

Bill Ackman, chief executive officer and portfolio manager of Pershing Square Capital Management, L.P., speaks at the Ira Sohn Investment Conference in New York, New York in May 2013. Ackman resigned from J.C. Penney's board after a public spat between him and the company's leadership could not be resolved. (Brendan McDermind/Reuters/File)

Betting on former J.C. Penney director Bill Ackman

By / 08.20.13

The piling on re: Bill Ackman - I would bet - has now reached its pinnacle. If he was a stock, and I a deep value investor, I'd be buying him in size here. Okay, maybe I'd be buying calls instead of common, but still - the beleaguered Ackman is probably a bargain here.

It's not that I agree with the way he's gone about meddling with JC Penney to the point of disaster or the presentation of his short presentation in Herbalife (in which his publicly-stated aim was to destroy a company and redistribute the profits to charity). It's just that I believe Ackman to be a very smart investor and, more than that, a determined businessman.

Removing himself from the board of JCP was the first sign that he is fully aware of his situation and the public perception. It may have set up his exit from the losing position or merely a diagonal way toward helping the stock price heal itself - the irony being that the most positive step he's taken as an activist in JC Penney's shares so far has been the removal of his own looming shadow.

If Ackman is now ready to play offense with his $12 billion Pershing Square fund, now that all of his enemies are out of the shadows and their positions illuminated, we should probably start to expect the unexpected.

In the meantime, two new reads this weekend to catch yourselves up:

Jenn Ablan and Matthew Goldstein on how it all started, just before Christmas:

How Ackman's Herbalife bet inflamed Wall Street passions (Reuters)

Also, The Economist weighed in, noting that "things change quickly" in the hedge fund world and Ackman has had the last laugh before, during the MBIA saga for example:

Hash of the Titan (The Economist)

A graduate cheers during the Berklee College of Music commencement in Boston, Mass. in May 2013. More adults in their twenties or early thirties are moving back in with their parents, but one bank says this may start to change. (Jessica Rinaldi/Reuters/File)

Has your kid moved back in with you? You're not alone.

By Contributor / 08.05.13

You probably know a kid or two in their twenties or early thirties still living at home with the folks. You might even be one. This has become way too common in the last five years.

According to Fortune, it's an epidemic: "The share of 18 to 34-year-olds living with their parents rose from about 27.6% before the Great Recession in 2007 to above 31%, where it remains today, according to an analysis by Trulia."

But there may be some good news on the way — according to Bank of America Merrill Lynch economists, a change in trend may be underway ...

We believe there is “pent-up” household formation of 2.5 million generated from the past few years of feeble growth. From 2007 through 2011, household formation averaged about 550,000 a year, a considerable slowdown from the average of 1.25 million over the prior 10 years. Household formation is a function of population growth and the percentage of the population to form households. Population growth has remained fairly stable, with an increase of 20-34 year olds, which is the primary age for household formation. We therefore believe that the decline during the recession was mostly due to economic conditions – weak labor market, foreclosures which forced doubling-up of households and delayed life events such as divorce and childrearing.

Comparing the first half of this year to last year shows we are on pace for annual growth of only 500,000 households. In order to match last year’s rate of 1 million, we would need to see a rapid acceleration in the second half of the year and/or revisions to the first half. Given the reliability of the real-time data, it is not unreasonable to assume both may occur. Even after smoothing the data to show the annual change of the 12 month moving average, there are notable swings in the time series. We pencil in a trajectory to derive household formation of one million, which looks reasonable to us given the historical trend.

President Barack Obama speaks near the National Mall in Washington, D.C. on July 27, 2013. Obama has not successfully convinced Americans that his economic policies will create jobs, Brown says. (Jacquelyn Martin/AP)

Obama versus austerity: Who wins?

By Guest blogger / 07.29.13

The debt ceiling debate resumes headed into this November for some unknown reason that makes sense to very few educated people. In the meantime, Obama's going to make another push for infrastructure spending, R&D spending, and the other things he campaigned based on - the stuff Congress won't let him enact in real life.

He is unlikely to succeed in his efforts given political realities.

This weekend, the New York Times ran a wide-ranging interview with the President on this economic agenda. Here's what he had to say about the politics of austerity during a time of growth and job market challenges:

Without a shift in Washington to encourage growth over “damaging” austerity, he added, not only would the middle class shrink, but in turn, contentious issues like trade, climate change and immigration could become harder to address.

Striking a feisty note at times, he vowed not to be cowed by his Republican adversaries in Congress and said he was willing to stretch the limits of his powers to change the direction of the debate in Washington.

“I will seize any opportunity I can find to work with Congress to strengthen the middle class, improve their prospects, improve their security,” Mr. Obama said. But he added, “I’m not just going to sit back if the only message from some of these folks is no on everything, and sit around and twiddle my thumbs for the next 1,200 days.”

In my opinion, neither side has articulated why its economic policies will create jobs. Obama has failed to convince the American people that we've had a historic opportunity to borrow money - essentially for free - to rebuild 30- to 70-year infrastructure around the country. As President, this should have been a primary thrust of his in the first term. Instead, we really only heard about during his campaigns.

Too late?

A sign seen at Facebook headquarters in Menlo Park, Calif. Facebook reported quarterly earnings on Wednesday, July 24, 2013, and the company has raised its advertising reveue considerably since going public last year. (Ben Margot/AP/File)

Facebook is profitable, despite what you hear

By Guest blogger / 07.26.13

The narrative since the Facebook IPO has been that the company had done the bulk of its growth prior to coming public and the valuation had already reflected it.

Advertisers were not "getting" the platform or particularly excited by the prospect of branding as opposed to the more performance-driven click-and-buy-something they get from Google.

In addition, mobile was going to be a headache for the company because even if they "figured it out", a mobile click was not worth as much as a desktop one.

This morning the stock opened higher by 30% because they have largely been able to do the most important thing - demonstrate profit growth despite these "headwinds."

In my mind, the most important stats are these two (via CNET):

More than 1 million active advertisers. Facebook's bread and butter. The company said there's a lot of growth here, with local businesses leading the charge.

$1.81 billion in revenue. As expected, the biggest chunk of the revenue, $1.6 billion in fact, came from advertising. Advertising dollars increased by 61 percent from last year. About 41 percent of that $1.6 billion came from mobile advertising. The rest of the revenue, $214 million, came from payments and other fees. This figure mostly reflects money from game payments, which Facebook said are up by 7 percent.

That's a business, guys. ( Continue… )

Federal Reserve Board Chairman Ben Bernanke speaks at a conference of the National Bureau of Economic Research on July 10, 2013, in Cambridge, Mass. Bernanke's hints that the Fed will begin tapering in the fall has led investors to falsely believe that interest rates will soar and dividend stocks will underperform, Brown says. (Josh Reynolds/AP/File)

Beware the Fed taper? Not quite.

By Guest blogger / 07.22.13

The taper talk that began earlier this summer has led to many investors racing away from dividend-paying stocks under the false impression that:

a) less QE means much higher interest rates


b) dividend stocks would underperform thanks to competition from bonds which would now be paying higher yields

This line of thinking is precisely backwards - because nominal yield is not the same thing as total return.

Ned Davis (via BlackRock) has run the numbers - it turns out that high-paying dividend stocks outperform non-paying stocks in both neutral rate environments and in rising rates - the opposite of what many people currently believe ...

From BlackRock:

Dividend paying stocks in the S&P 500 returned 2.2% annualized during such times of tightening (increasing rates), while non-dividend stocks in the S&P gained 1.8%, according to Ned Davis Research. On the other end of the spectrum, during periods of easing (declining rates) by the Federal Reserve, dividend payersgained 10.2% annualized and non-dividend payers lost 1.3%. During times of neutral Fed policy is when dividend payers have performed best, returning 12.3% versus 6.2% for non-dividend stocks. There is no guarantee that stocks will continue to pay dividends.

While I don't believe the excessively rich valuations people had been paying for utilities and telecom stocks made sense, I also don't believe the wholesale dumping of dividend stocks every time Bernanke made a hawkish statement was warranted either.

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