Analysts, Gurus &amp; Pundits

Top 558. Aug 11, 2005 6:59 PM

» Normxxx - Todd Market Forecast

Todd Market Forecast
http://www.toddmarketforecast.com

By Steve Todd | 11 August 2005

STOCK MARKET ANALYSIS:

Oil surged another 2% to still another record high, but the stock market, after an intraday sinking spell, managed to fight back. Some said the reason was that the retail sales figures, even though smaller than expected, were still strong and foreshadowed a solid third quarter GDP. Others said that a strong 10 year note auction suggested continued foreign participation in our capital markets.
These considerations may have been a factor, but we noted yesterday that our technical indicators were strongly oversold. For instance, the five day m.a. of the Composite Gauge was 14.4 yesterday. Also, the supply demand figure was .23. Any reading under .40 is oversold.
That said, there are some cross currents that concern us. For instance, since the top on August 2-3, the Nasdaq Composite has severely under performed the S&P 500. Sometimes, after a strong run, this kind of action presages a modest correction lasting a number of days. Stay tuned.
Late note! I received a call from the L.A. Times business section today asking for a market comment and it prompted me to summarize my feelings about the longer term. Essentially, there is one partial negative for the stock market and three main positives. The price of oil is the partial negative. We say partial because a number of companies such as drillers actually benefit from high oil prices. Also, be aware that the historical peak for oil is $94 per barrel in inflation adjusted terms. We are about 2/3 of the way there.
The positives are low interest rates, massive liquidity and earnings that have shown double digit growth for something like 13 quarters in a row and are anticipated to come in above 10% for the next two quarters at least. Finally, don't forget, no year ending in five has ever been down. The smallest gain was 1965 when the Dow gained only 11%.

NEWS AND FUNDAMENTALS:

Retail sales for July came in at +1.8% which was lower than the expected rise of 2.0%. However, June's figure was revised upward to 0.9% from 0.7%. This is suggesting that a strong GDP gain for the third quarter. Initial claims were 314k. The expectation was for a reading of 315k.
On the stock front, Alcoa was upgraded by UBS and gained 3%. Analog Devices was upgraded by Morgan Stanley and rose 3%. Pier 1 Imports was upgraded by Deutche Bank and also gained 3%. Elizabeth Arden had a smaller than expected loss and added 5%. News Corp. beat estimates and rose 3% and Tommy Hilfiger settled a dispute with the IRS and jumped 11%.
On the negative side, Four Seasons and Shoe Pavilion came up short on earnings and lost 7% and 2%. Jacuzzi Brands guided lower and lost 17% and finally, Tivo sank 6% after DirecTV stated plans to stop marketing it's video recorder.

BOTTOM LINE:

Our S&P and NASDAQ intermediate term systems are back on a buy signal as of the close on April 21, 2005. Mutual fund investors are 100% invested in a growth fund or S&P 500 Index fund of their choice.

SPY and QQQQ traders are back in cash. Remain there for now.

For new subscribers, the QQQQ and SPY are exchange traded funds or Spiders. The former mimics the Nasdaq 100 and the latter mimics the S&P 500. ---- Additionally, an m.i.t. order means "market if touched" It means that your order becomes a market order if the price is touched.

OTHER MARKETS

We are on a sell signal for bonds since July 21, 2005.

We are on a buy for the Euro and a sell for the dollar since August 3, 2005.

We are on a buy signal for gold as of August 3, 2005.

We remain long term positive on all major world markets, including those of the U.S., Britain, Canada, Germany, France and Japan.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 559. Aug 11, 2005 9:53 PM

» Normxxx - Bollinger: Speculation

Housing, or a History of Speculation

By John Bollinger | 12 August 2005

Speculation is an elemental force that feeds on liquidity, the greater the liquidity the greater the speculation. Speculation is usually thought of as coming in waves, but it is more useful to think of it as a quantity driven by liquidity. Let's examine the recent record in light of this idea. In the early 90s there was massive speculation in the bond market. The primary focus was on mortgages in their securitized form known as Fannies, Freddies, or Ginnies after the nicknames of the issuing agencies.

These were then combined into new pools called CMOs, Collateralized Mortgage Obligations, and sliced up in various ways to give a variety of investors bonds with the characteristics they desired. Such bonds are also known as derivatives, as they are derived from other securities, in this case from agency mortgage pools, which are also derivatives as they are derived from the individual mortgages.

A vast wave of speculation emerged driven by the fact that these bonds offered yield at a time when yield was getting ever harder to come by- interest rates had been falling for 12 years. (You might say that this was a classic case of reaching for yield, an often fatal practice.) In many cases the characteristics of the bonds such as their responsiveness to interest rate changes was simply ignored, as it was thought that rates would be stable or continue to fall. But these bonds were negatively convex, which meant that as rates rose the maturities lengthened, making them even more sensitive to increases in rates. This is the exact opposite of what a rational investor would want in a bond.

So, in early '94 when the Federal Reserve started raising interest rates, the prices of these bonds, which had been bid to astronomical heights, started collapsing. They fell slowly at first and then at an ever-quickening pace. In the final panic many bonds simply went without bids; they couldn't be sold at any price. The amount outstanding was massive and the damage was catastrophic. We lost Kidder Peabody, Orange County went bankrupt, many careers were ruined, and a great wailing and gnashing of teeth was heard across the land. So extensive was the damage that even the term derivative became 'streng verboten.'

I detail this debacle because the common wisdom is that such an event extinguishes speculation, but in this case the decline in the bond market was met with accommodation on the part of the fiscal and monetary authorities and the general level of liquidity remained healthy and even grew. Thus speculation did not cease; it merely moved on, searching for a new target, which turned out to be the ASEAN nations, the "Asian Tigers." This new wave of speculation began slowly at first and then accelerated into a full-blown bubble in 1997 and 1998. This time the palette was wider, a broad selection of countries from Singapore to Thailand and Indonesia were caught up and the speculation involved stocks, bonds, and currencies.

The overvaluations were extreme as always and the subsequent crash was devastating as usual. This time the big names subsumed in the destruction included Victor Niederhoffer's hedge fund in '97, Long Term Capital in '98, and several sovereign nations. Again, the bursting of the bubble was met with dynamic increases in liquidity and speculation, rather than being quelled simply moved on- this time into the US stock market where the stage was being set for the Internet bubble.

As the stock market formed a bottom in 1998 in the wake of the Federal Reserve bailout of Long Term Capital, it was becoming "obvious" to everyone that the Internet was "the future" and speculation in a short list of highly capitalized Internet names blossomed into a massive run-up that left the rest of the market behind and culminated in the first quarter of 2000. This time Wall Street firms consumed by greed fanned the flames mercilessly engendering to some of the greatest excesses ever.

The interesting part of this cycle were the raised ambitions on the part of the public. People quit their jobs to "trade for a living," and expectations were raised such that you were thought a dummy if you weren't making at the very least 20% per year. The bursting of the Internet bubble was also met with massive liquidity infusions and speculation dodged the bullet again, moving on first to the NASD Bulletin Board issues that traded for pennies or less per share before settling on real estate as the next big thing.

I know that it is wildly unpopular to call the real estate bubble a bubble, but it is, and we must be forthright. Real estate is simply the latest speculative vehicle. At some point this bubble will burst as other bubbles in the past have. The only question that remains is what the bursting of the bubble means for homeowners and speculators. The 'au courant' fashion is to say not much. However, we think that the leverage involved, sometimes 100% or more, suggests that many will be hurt, some substantially.

Ordinary homeowners with ordinary mortgage loads will likely be relatively unscathed as most are insensitive to changes in the value of their homes. Some homeowners, whom necessity compels to sell, will be hurt. Speculators and highly leveraged situations will likely be gored. We are at a loss to say what it will take to burst this bubble. However, burst it will and we are on the alert.

[Normxxx Here: And if we drown it with still more liquidity, where will the next bubble be? ]

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 560. Aug 12, 2005 8:16 AM

» lcha - Re: Bollinger: Speculation

In response to Bollinger: Speculation posted by Normxxx:

[Normxxx Here: And if we drown it with still more liquidity, where will the next bubble be? ]

Energy. In the early 80's energy stocks represented 30% of the S&P500. It could happen again and we have a long way to go to get there.

-- posted by lcha

Top 561. Aug 19, 2005 4:09 PM

» Normxxx - Pigs and Panics!

Investment Strategy: “Pigs and Panics!”

By Jeffrey Saut | 19 August 2005

“When prices of pork products begin to rise, farmers naturally begin to increase the breeding of pigs, hoping to profit from the rising market. Each farmer considers himself astute and novel in the concept, quite certain that prices will continue to rise. However, the same idea occurs to a large number of farmers simultaneously. It takes about one and one-half years for a pig to reach maturity, and the same one and one-half years for the market to become saturated with the flood of recently bred pigs. Inevitably, prices fall, farmers sadly take losses and reluctantly cut back production. Finally, as a result of the reduced breeding, shortages develop and the cycle begins anew.”

. . . Harry D. Schultz

Harry D. Schultz wrote a book at the top of the 1972 “pig peak” titled, “Panic and Crashes: How You Can Make Money from Them.” He points out that business, and pig-to-panic cycles, follow pretty much the same pattern. The typical cycle consists of seven phases: 1) shortages; 2) the development of a concept; 3) profitable production; 4) overproduction and oversupply leading to; 5) losses; 6) production cutbacks; 7) shortages and the start of a new cycle. This morning we are revisiting Mr. Schultz’s comments in light of last week’s surge in oil prices. Readers of these missives know we have been an “energy bull” for more than three years.

We remain a long-term bull on energy, particularly coal. That view is driven by our embedded belief that globalization will be a theme for years to come. To us, globalization means rising standards of living in less developed countries. And when you’re talking about countries with thousands of dollars of per capita income (Malaysia’s is US$4,530), rising standards of living mean more commodity consumption. So, we believe there will be a very strong secular trend in commodities for quite a few years to come. While all commodities will have temporary cyclical fluctuations, longer-term globalization should put the wind at the back of energy and commodities in general. Near-term, however, we think oil is ripe for a “cyclical fluctuation.”

As stated last week, “We think oil prices are searching for a short- to intermediate-term ‘pig peak’ provided someone isn’t about to blow up the mideast oil fields.” Consider this. The driving season is waning with vacation time ending and kids going back to school. The August/September timeframe has had a tendency to be a topping period for energy prices (the shoulder months). And with the Federal Reserve giving every indication that it is going to raise interest rates (a mistake in our opinion, given our finance-based economy), the economy should eventually slow, sating the need for increasing amounts of oil, at least on a short-term basis.

Further, we think crude oil is 17 days into one of these 17- to 25-session buying stampedes, so the timing is about right for some kind of price correction. That view is reinforced by the crude oil futures that are near their widest premium ever over their 200-day moving average, which has tended to lead to a correction. With many of the energy stocks three-to-four standard deviations overbought, any pullback in oil prices could cause an outsized decline in energy stocks. Therefore, we think it is only prudent portfolio management to rebalance some of your energy positions. That can be accomplished either by selling 20% to 30% of your most technically vulnerable energy stocks, or hedging the downside through the use of put options.

Speaking of stampedes, as noted early last week, we believe that gold is also into one of these 17- to 25-session buying stampedes. If correct, gold is at day 13 in the upside skein. Interestingly, gold broke out in the charts last week, bringing into view its old reaction high of roughly $456/ounce and if that level is surmounted our next price objective would be $470/ounce. With the barbarous metal currently changing hands at $446, such a rally would obviously have positive implications for the precious metals complex. To this point, our technical analyst Art Huprich penned a good report on gold last Thursday mentioning one of the gold funds we have used over the past three years, namely First Eagle Gold Fund (SGGDX/$16.39).

While we have clearly benefited from gold’s rally, we once again pose the question, “Is gold going up, or is the measuring-stick going down?” For example, gold has appreciated about 5.5% since the buying stampede began. The quid pro quo is that the U.S. dollar (i.e., the “measuring stick”) has declined by roughly the same amount (5.4%) from its recent peak. So indeed is gold going up, or is the measuring-stick going down?! The same question can be asked of the equity markets. To wit, since the “London Lows” the DJIA has rallied 5.4% using the intraday lows to intraday highs. Once again that is roughly the same amount the dollar has declined over that same period. We suggested six weeks ago that the bear market rally in the dollar was probably over, which is why we recommended eliminating all of the downside hedges on our “stuff stocks” (precious metals, base metals, timber, agriculture, etc.) that were instituted earlier this year in anticipation of a counter-trend rally in the dollar since a stronger dollar tends to be negative for stuff-stocks. Fortunately, we got that “call” generally correct, and precisely wrong, given the unrelenting strength in the coal stocks (we remain very bullish on coal longer term since it is the most cost effective way to generate electricity). Yet, there is another group we recommended hedging and/or re-balancing last week.

The group in question was the semiconductors. If you listen to our fundamental analyst Brian Alexander on the distribution business, he will tell you that distributors like Arrow Electronics (ARW/$28.49) and Avnet (AVT/$23.75) have guided for flat revenues in their components business for 3Q05. As a big user of semiconductors that is very interesting since most of the semiconductor companies are guiding for high single-digit revenue growth. The inference is that the manufacturers are growing faster than the distributors. Yet, the distributors are much closer to the front-end of the food chain (read: end demand) than the manufacturers. Ladies and gentlemen, somebody is lying! We think it is the semis and anticipate they will ratchet back their revenue guidance for the third quarter.

As for the stock market, today is session 27 since the “London Lows.” Plainly, if you believe in our day-count sequence, the recent rally is long of tooth. While markets can do anything, buying stampedes typically wane in the 17- to 25-session timeframe. A few of them have extended for 27 to 30 sessions, but it is rare for one to go more than 30 sessions. The longest outlier we have chronicled in our notes is 38 sessions. Consequently, we tend to be odds “players” on a trading basis and currently we don’t like the odds. We also don’t like the DJIA’s break of the uptrend line from March 2003, as well as its inability to recapture said trendline. The same pattern can be seen in a number of the other index charts. Nor do we like the weakness in DRAM prices, Baltic Freight Rates, lumber, scrap steel, etc., all of which have been pretty good historically in telegraphing economic weakness. And, evidently we are not the only ones worried because we read a report from Pershing’s technical analyst last week that noted, “There is a strong probability that the final rally of the bull market has now ended, with the S&P 500 having reached 1,245, right in the middle of our previous 1,240 – 1,250 target and shy of our most recent 1,250 – 1,270 target. While the market may rally again in the coming days and weeks, it is now unlikely to rise much above the above levels within the context of this bull market.”

We leave you with this advice, “Bulls make money; Bears make money; but Pigs don't make any!” We continue to trade and invest accordingly.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 562. Aug 19, 2005 6:25 PM

» bob90245 - Re: Pigs and Panics!

In response to Pigs and Panics! posted by Normxxx:

The author may not have all the facts with respect to semiconductor mfgs regarding component distributors. There are many semis that sell high margin ICs directly to OEMs. Here, the order book is quite reliable. I will grant that the portion of commodity (low margin) semiconductors directed to distributors are prone to discounting of pricing and revenues when there is excess product in the channel.

-- posted by bob90245

Top 563. Aug 20, 2005 1:01 PM

» Normxxx - Re: Re: Pigs and Panics!

In response to Re: Pigs and Panics! posted by bob90245:

The author may not have all the facts with respect to semiconductor mfgs regarding component distributors.

<img Align="Left" hspace="10" vspace="5" src="http://www.businessweek.com/bw50/2003/ar...">Fred Hickey, editor of the influential High-Tech Strategist newsletter, toils far from Wall Street, in Nashua, N.H. That distance, plus an enviable Rolodex amassed over 20 years in techdom, enables the fiercely independent analyst to keep tabs on the industry without getting caught up in the hype. Toward the end of the boom, for instance, Hickey told anyone who would listen that the insanity wouldn't last. (The High-Tech Strategist costs $120 a year and is available at P.O. Box 3133, Nashua, N.H., 03061.)

So far, Fred has pretty much called the hi-tech bear— consistently noting that it is not so much a demand problem as the persistence of the manufacturers (such as Intel) to keep adding capacity, and thus continuing to run at considerably less than capacity (and less than full efficiency). In the meantime, Hickey advises readers to play the bear market rallies. In October 2003, for instance, he bought software makers Legato Systems (LGTO ) and Network Associates (NET ) and doubled his money when he sold them three months later. When the next rally gets going, Hickey says, investors could profit by buying shares in two cash-rich, debt-lean companies: Lawson Software (LWSN ) and 3Com (COMS ).

But Hickey believes the sector won't finally bottom out until the tech companies approach the p-e's of 16 reached in the 1990's bear market. To him, that means the Nasdaq could drop 50% more before the bears final retreat.

Right now, Fred reports he has already restocked on put options on Intel, betting the stock will fall as the result of 3Q results. The longtime bear argues that investors are making a fundamental mistake in assigning high price-earnings multiples to tech stocks such as Intel at a time when maturing technology companies are largely driven by macroeconomic factors. Besides corporate caution about technology, he notes that tax- and interest-rate cuts that artificially stimulated U.S. consumer demand in 2003 have been played out, and consumer demand in China may be slowing. "We are in a new ballgame," Mr. Hickey says."

Many computer-related companies this quarter reported better quarterly results than they did this time last year. Yet a spate of earnings warnings and other indicators suggest the technology recovery is further along than many investors had realized. Even without negative surprises— and bears see more on the way— there are few signs of a late-inning rally that would produce additional gains in tech stocks.

The uncertainty is particularly pronounced for companies exposed to the market for personal computers. ... Intel, the bellwether maker of electronic brains for PCs and other products, crystalizes the debate. The bullish case for the stock: Intel dominates a huge market, which should get bigger as corporations step up PC upgrades and as more consumers in China, India and Eastern Europe get hooked to the Internet. ... The bearish case focuses largely on that inventories of unsold microprocessors and other chips are building, competition is heating up, and margins are being squeezed. Intel has offered benign reasons for the lower margins, but whatever the reasons, concerns have taken Intel's stock down 10% since mid-July. Analysts fear that increased competition and price cutting (especially from AMD), will reducing Intel's closely watched profit margins. They fear a replay of some part of last year, when Intel dropped about 40% from its high in January to its low in September.

Investors may have been lulled into thinking that the second-quarter results at tech companies have been sunny because reports of shortfalls had been relatively rare. ... Nevertheless, three signs point to problems ahead for technology stocks. First, semiconductor shares, which often lead the action in tech stocks, have been showing some topping action lately. Second, spot prices of computer chips are forecasting further declines. And, third, many companies (including Intel) have prophesized no better than a "flat" third quarter.

This may simply be a replay of 2004, when things turned out OK in the end. But currently, profit margins are being hurt, and high inventories threaten hefty write-downs. The sales shortfalls at some technology companies should become most evident in the third quarter.

Personal computer sales in the United States are growing at rates in the single digits or low teens; PC and notebook sales are also slowing in Europe, and are actually declining in Japan and China.

In addition, the tax rebates, courtesy of the White House, are spent, mortgage refinancings have peaked (again?), and rising oil prices are pinching consumers. So it's no wonder that sales of tech gear have slowed.

Mr. Hickey said the situation at some of the nation's biggest technology companies reminds him of late 2000, when demand from nascent Internet companies screeched to a halt. Although it became apparent in March 2000 that the Internet boom, created in part by a profligate Wall Street and a Oz-like telecommunication industry, was over, the impact of this steep decline in demand did not show up in major suppliers' results until much later that year and in early 2001.

[Normxxx Here: But he said that last year about this time. ]

"This industry is hopelessly optimistic," Mr. Hickey said. "They always overproduce."

None of this would matter if technology shares were cheap. But they are not. The price-to-earnings ratio on Dell is still an inflated 27x. Texas Instruments' is a bloated 60x.

On the other hand ...

Money- TheStreet.com: Debating Fred Hickey

By RealMoney Staff, | 7 July 2005

Tech talk is heating up on RealMoney once again. Cody Willard stirred an intriguing debate about the current rally in technology stocks among RealMoney columnists when he questioned the relevance of "one of the most high-profile and influential permabears, Fred Hickey." Barry Ritholtz challenged the "permabear" characterization of this newsletter author. James Altucher commented on his surprise at Hickey's 2003 bearishness and the renewed willingness of investors to take on risk in tech stocks. Rev Shark cast his lot with the camp that is critical of Hickey's bearishness on the tech sector. Cody Willard rejoined the discussion to bolster his case for considering Hickey a permabear. Norm Conley said that, as a subscriber to Hickey's newsletter, he was comfortable calling him a "cup half empty" guy, but that his homework was a worthwhile read. And Cody Willard wrapped up the discussion by making the reason for his critique of Hickey clear: the connection between Hickey's research and most of the bear tech camp.

Cody Willard

Earnings season has brought to light a whole lot of answers, the single biggest answer being: "How's business?" Business is good. Corporate America is killing it. Companies are cranking out the profits. The economy is strong and growing.

From UPS to Microsoft to Amgen to Pepsi, profits are hitting records. Likewise, sales are hitting records.

I start today's diary off with this simple snapshot to underscore a very important point: Nobody can anticipate when the economy and profits will sour. How long have we been hearing from the permabears that there's no more leverage in Corporate America's models? How long have we been hearing about how high inventory levels are going to undermine growth and margins? How long have we been told that the housing boom is a bubble and will be popped imminently?

I poked some fun at the permabear case the other day after the "Heard on the Street" column from the WSJ quoted one of the most high-profile and influential permabears, Fred Hickey, saying essentially, "Just wait for the second half— business at Intel will get really bad relative to expectations!" The permabears have long chastised CEOs at tech companies for saying "the second half will be strong" for years. Ironic, isn't it? (Heck, while we're talking permabear irony, can someone please explain to me why the author of a newsletter called the "High Tech Strategist" uses a fax machine as his distribution mechanism. And you want to sign up for the newsletter? Send a check in the mail, because you can't sign up on the Internet. I have a hard time giving credibility to someone who's supposed to be "high tech" but isn't— not to mention that he's been so wrong for so long.)

As for the second half and Intel ... heck, maybe Hickey's right. I certainly expect that the economy and tech earnings will turn south at some point. In fact, longtime readers know that since 2003 I've postulated that this current economic boom is likely to come undone around 2007 or 2008. Certainly, I could end up dead wrong, and the economy as well as Intel could end up in trouble later this year.

But we're not there right now. The economy is strong, and more importantly for investors, profits at Intel and SanDisk and Broadcom and Exxon and Wal-Mart and Urban Outfitters and Toll Brothers and oh-so-many other places are through the roof. It is what it is, man.

The fact that profits are strong and growing quickly means that valuations really aren't stretched in general. And that too is important, because it means we're not overpaying relative to the near-term earnings power of these companies. Investors aren't speculating on some pie-in-the-sky future when they buy Intel at 18 times trailing 12 months' earnings. Not that 18 times is screamingly cheap either, of course. It's just not speculative. It's realistic.

If and when profits start to erode and the current virtuous economic cycle turns vicious, we'll need to deal with that then. Perhaps the current environment is as good as it can get already. I just don't think it's wise to speculate that such is the case.

Barry Ritholtz

I would never call Fred Hickey a permabear, as Cody does.

Influential, definitely, but he is a very respected tech guy (out of New Hampshire!) who was suitably bullish through most of the 1990s. When things got goofy, he pulled his horns in 1999 and 2000.

Having spoken with Fred, I know he was bullish in October 2002, and made several trading calls, both bullish and bearish, since then. Most recently, he flipped bullish in April 2005, buying IBM (IBM:NYSE), Linear Technology (LLTC:Nasdaq), Cisco (CSCO:Nasdaq), Advanced Micro (AMD:NYSE), KLA-Tencor (KLAC:Nasdaq) and Motorola (MOT:NYSE). He also sold all of his semiconductor puts in April.

I know that longer term he believes there's still too much excess in the system, and that tech stocks have not worked their way down to true bear-market valuations. When a smart guy with a good track record is long-term cautious, it's worth paying attention to.

James Altucher

Hickey was surprisingly bearish through most of 2003 for similar reasons to why he is bearish now: inventory levels, global slowdowns, etc. Perhaps the stock he was most bullish on, 3Com (COMS:Nasdaq), has come down from the mid-$5s to the mid-$3s, while the world has been watching what was once $4 in net cash to about $2.50 in net cash.

Right now you have companies like Microsoft (MSFT:Nasdaq) and Intel (INTC:Nasdaq) trading at below-market P/Es, spinning off a ton of cash, and the S&P 500 as a group has more cash in the bank than ever. I hate looking at the large-cap stocks because I feel there is almost no edge when analyzing them alongside 10,000 mutual funds. Yet for the first time in several years, I find myself liking Microsoft, Intel, Cisco (CSCO:Nasdaq) and other tech large-caps, including many of the semi stocks.

I'm also involved in a lot of micro-cap stocks and, for the first time since last December, I'm seeing investors coming out of the woodwork and taking more risks in these plays. This isn't necessarily bullish, but it was five years of this type of speculation in the 1990s before the boom turned to bust.

Rev Shark

Fred Hickey has certainly been wrongfully bearish on technology stocks quite a bit over the years, but I'm not sure he is of the "Fleckenstein" school of "folks who can find something wrong with every market." However, the fact that he doesn't maintain a Web site for his newsletter nor embrace email makes me wonder about his overall mindset when it comes to evaluating "technology."

Cody Willard

This Hickey discussion is important, simply because he really has become such an influential tech analyst. I'm actually shocked that Barry or anyone else would take exception to my calling Hickey a permabear. I have friends who ran hedge funds back in the 1990s and they tell me stories of buying millions of dollars of puts, based on Hickey's analysis, in the same companies that Hickey loves to trash these days -- in 1997. Namely, Intel (INTC:Nasdaq) and Micron (MU:NYSE).

In the 21st century, Hickey has been backed off his "day of reckoning is coming" stance for brief periods of time, and usually with pretty good timing. But to say he's not been a permabear in this century is inaccurate.

In particular, Barry's "When a smart guy with a good track record is long-term cautious, it's worth paying attention to" is misleading. Hickey's track record isn't good, and he's been long-term cautious for years upon years. It's already been long term and he's been wrong.

So much of the bearish case we all read and hear about stems from Hickey's faxed newsletter. Keep that in mind, when you hear the bear case repeated from all the pundits and traders you know.

Norm Conley

As a subscriber to Hickey's newsletter (and incidentally a fellow ND alum), I think his views are best described as being generally bearish. I would have to agree that he is clearly in the permabear camp, because his newsletters almost never have a positive tone on the market. He often writes wistfully about the bargain-basement prices he was able to buy tech stocks for in the early 1990s, but since the mid-1990s he has been fairly consistently negative on technology and on the U.S. markets. It is what it is: He is clearly a "cup half empty" guy.

That said, the guy really does his homework. His newsletters are jam-packed with all kinds of great stuff for investors involved in the technology sector. For a long-only guy like me, who is clearly biased to be a "cup half full" investor, I find Hickey's stuff very worthwhile to read. In my opinion, educated investors should always spend more time reading people who disagree with them than those who see the world the same way they do. I disagree with much of what Hickey writes, but I respect him a lot for his diligence, and I read every newsletter within minutes of it hitting my fax machine.

Also, in his most recent letter, Hickey was very (for him) bullish on certain technology stocks. He wrote that he had purchased call options on a variety of semiconductor issues in June, in anticipation of very strong 2Q earnings. His calls, best as I can tell, should have generally worked out quite well for him. Also, over the last six months or so he has been growing increasingly interested in LBO-type turnaround plays in the small-cap software and networking spaces. While most of those have not yet worked out well, the takeaway for me is that even a bearish guy like Hickey sees some value in the technology space. To the extent to which he presages interest from value-oriented investors in the tech space, that supports the thesis that tech could outperform through the back half of 2005.

Cody Willard

To be sure, I'm not saying I have all the answers. I make tons of mistakes and I'm often wrong right here in front of everyone, and I certainly don't try to hide from that fact.

My point is simply to point out that the permabear camp has been long wrong on tech's fundamentals (not to mention the trade deficit, consumer debt, housing, etc., etc.) and that Hickey's diligent research is the root of most of the bear tech camp.

It is what it is

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 564. Aug 30, 2005 7:03 PM

» Normxxx - CONSUMER-DEPENDENT ECONOMY

THE CONSUMER-DEPENDENT ECONOMY

By Gary Shilling | 30 August 2005

The role of American consumers in promoting economic growth in the U.S. and, indeed, in many export-driven foreign countries will be especially significant in coming quarters. The effects of the previous huge federal tax cuts and rebates are over. And the leap in federal spending for homeland security and military action in Afghanistan and Iraq is over, so federal spending's share of GDP has leveled.

At the same time, the stimulative effects of earlier Fed credit ease have been reversed. Housing remains strong but the bursting of that bubble may be near, I believe.

“The housing bubble apparently has convinced many that their house is a huge piggy bank that allows them to borrow more and save less— and thereby generates all that money that will be needed to sustain rapid consumer spending and overall economic growth.”

While the Fed's rate increases have had little effect on housing or other economic activity, three realities are clear. First, tighter credit is simply not stimulative to the economy and in fact is constrictive, one way or the other, sooner or later. Two, history says that the Fed will tighten until something happens, and that something almost always is a recession. Third, with Treasury bond yields falling, the Fed will probably need to invert the yield curve to get long rates where it wants them. That situation is very rough on banks and other financial institutions that rely on a positive spread between the long rates at which they lend and lower short-term borrowing rates. In the post-World War II era, the Fed has precipitated recessions without inverting the yield curve, but when it does invert, a recession is almost assured.

Elsewhere in the economy, capacity utilization here and even more so abroad remains so low and business caution so subdued that a capital spending boom big enough to lead the economy is unlikely. Indeed, the first quarter weakness in nonresidential fixed investment growth may suggest even less stimulus from this sector in future quarters than earlier.

U.S. consumer spending strength has been reflected in rising imports while sluggish exports follow from subdued economic activity in Europe and the zeal in Asia to export, not import. This negative and growing trade gap is, of course, a drag on the U.S. economy.

With consumer spending growth about 1/2% faster than after-tax income on average for over 20 years— and that's what the decline in the saving rate tells us— American imports grow 2.9% for every 1% rise in GDP. In contrast, this propensity to import is much lower in other major countries.

By process of elimination, then, it looks like the economic ball will need to be carried by consumers in the quarters ahead. Will they have the income to do the job? Personal Income grew 6.7% in the 12 months ending May 2005, or 4.3% after subtracting the 2.4% year-over-year rise in the Personal Consumption Expenditure deflator. That's a healthy clip, and is much greater than the first or second quarter annual rate rises in GDP. But is it sustainable?

The 7.2% year-over-year growth in total compensation and 7.0% rise in wages and salaries might suggest so, but these numbers hide some important details. The financial services industry did well last year, and bonuses and commissions were robust in the fourth quarter.

But, much of the bonuses and commissions go to high-income people who tend to be big savers. Meanwhile, lower-income people who depend on weekly paychecks have seen their real weekly pay continue to decline. Part of the reason for the weakness in real wages is that U.S. employment is shifting from high-paid areas like manufacturing to low-pay areas such as leisure and hospitality.

Furthermore, much of income growth for Americans comes from working more hours. A recent study found that in the 1970-2002 years, annual hours per capita rose 20%.

The net result has been a recent leap in the share of income going to the top 20% of Americans while the other four quintiles' shares keep slipping. Indeed, a recent survey found that the number of U.S. households with a net worth of $1 million or more, excluding their residence, jumped 21% last year.

Pressure on wages will probably continue. The explosion in profits in recent years is unlikely to continue as most of the low-hanging fruit of restructuring has been picked, and the rebound from the corporate trouble of the early 2000s is over for the vast majority of companies. Meanwhile, global competitive pressures remain intense. A move from the second quarter's 8.2% toward the long run 5% mean for profits' share of GDP seems likely, especially since in the long run, profits actually grow slower than the overall economy or corporate sales.

In this climate, business is likely to press labor costs harder, much as it did in 2002-2003 when hiring was curtailed and the resulting robust productivity growth flowed to corporate earnings. One reason employers are concerned about wages and employment levels is the rapid rises in medical, pension and other fringe costs.

Dividend income is benefiting from the pressure on companies in the post-Enron/Arthur Andersen world to pay more to shareholders. But big overall dividend jumps will be difficult even though the current dividend yield, 1.7%, is well below the previous 3% floor.

In the post-World War II era, the payout ratio, the percentage of after-tax profits paid as dividends, has only been at 60% or higher in recessions when earnings fall faster than dividends. Yet with the current 19.3 P/E on the S&P 500 index, a 3% dividend yield over time calls for almost a 60% payout ratio as the average.

It appears, then, that personal income growth in the quarters ahead will not be sufficient to provide the money consumers need to sustain rapid economic growth. But that won't necessarily deter them. They can fuel their spending the old fashioned way— by increasing borrowing and reducing saving. In pursuing these tried and true techniques, however, consumers do face some new challenges.

One is the recent, tighter bankruptcy law, which makes bankruptcy much less desirable. Now, filers with incomes above their state's median and with the ability to repay some debts must file under the more stringent Chapter 13 and must undergo credit counseling at their expense six months before filing. They also must repay in full auto loans within 30 months of filing and they can't file for Chapter 13 more than once every two years.

Another challenge for consumers is that not only debts but debt service, the monthly payment of interest and principal, continues to leap and, in relation to DPI (after-tax income), is much above the mid-1980s peak. Interest rates are much lower now, but the principal owed has exploded.

Back in the late 1990s, many argued that the saving rate as structured by the National Income and Product Accounts was irrelevant because it excluded capital gains, which were plentiful at the height of the dot com bubble.

Sure, many consumers considered those capital gains as saving. They felt wealthier and spent lavishly even if those gains weren't cashed in. That spending, of course, fueled the economic boom that accompanied the stock bonanza. Economists call this the "real wealth effect." But with the collapse in tech stocks, those capital gains disappeared and so did the criticism of the saving rate definition.

But with the recent leap in house prices, the idea that capital gains are saving is back. Some note that even though capital gains are not included in income as defined by the NIPA, the taxes on them are included in the income taxes that are subtracted from income to ultimately arrive at saving. So, they contend, even the NIPA definition understates saving.

This effect is really small, however. Even in 2000, a huge year for capital gains, removing capital gains taxes would have only increased the saving rate by 1.7 percentage points to 3.0%, still well below the 12% level of the early 1980s.

Regardless of how personal saving is defined, unless house prices leap forever, or the stock bubble revives, most Americans' assets are totally inadequate to support them in retirement. And, the almost nonexistent saving from current income means that those net assets are being augmented year by year at trivial rates. A recent study of Federal Reserve data found that the households headed by baby boomers had median financial assets of $50,700. With a 5% annual withdrawal rate, that would generate only $2,535 annual retirement income.

Another recent study found that personal savings will provide only 10% to 20% of retirement income, and when pensions and Social Security are included, the total retirement income will be just 59% of median current income for working Americans.

Apart from saving out of personal income, investment gains are unlikely to provide comfortable retirements for many. It’s a question of when, not if, the housing bubble collapses, in my view. Also, in the mild deflation I foresee, stock returns will average 4% to 5%, assuming 3% dividend yields, a far cry from the 20%-plus in the 1995-1999 era. After Treasury bonds rally with the advent of deflation, 3% yields will prevail.

Meanwhile, Social Security benefits will probably become less generous, given the impending financial strains on the system. And defined benefit pension funds are being frozen, terminated, converted to less generous cash balance plans, cut out for younger workers or turned over to the government’s Pension Benefit Guaranty Corp., leaving many employees to rely principally on 401(k)s that depend on investment results.

So, Americans will need to finance much more of their retirements the traditional way— by saving more of their disposable personal income, but this will be difficult. Only about 70% participate in their company 401(k) plans and thereby take advantage of company contributions, even though 64% of employers in 2004 said 401(k)s are their primary retirement plan. Lower paid employees are especially absent from participation, with 40% for those making less than $20,000 and 60% for those earnings $20,000 to $40,000, while 90% of employees earnings $100,000 or more participate.

Despite these financial strains, Americans have yet to run up their saving rate and run down their debt and debt service levels. Instead, the housing bubble apparently has convinced many that their house (or houses since increasing numbers own more than one) is a huge piggy bank that allows them to borrow more and save less— and thereby generates all the money that will be needed to sustain rapid consumer spending and overall economic growth in coming quarters.

So, if my analysis is correct, the key to consumer spending and overall economic growth is the housing bubble. When it breaks, so will the economy as construction nosedives and consumers shift to a massive saving spree and debt repayment, and a serious recession or worse unfolds. Miserly consumers also will slash imports, to the detriment of the many nations that rely on Americans to buy their excess goods and services. With the Chinese economy cooling and headed for recession, aided by the small revaluation in the yuan, a global recession will result. Furthermore, a serious break in U.S. house prices could destroy so much net worth and so disillusion Americans that the good deflation of excess supply I foresee will instead be the bad deflation of deficient demand.

When will the all-important housing bubble break? Ah, that’s the $64 trillion question. It looks like it’s in the blow-off stage that is typical of the end of a speculation. Still, speculations tend to last longer and go to greater extremes than imaginable. I’m watching closely for signs of a bursting in the housing bubble, and suggest you do too.

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx

Top 565. Sep 23, 2005 7:35 AM

» bob90245 - Interview with William Bernstein

Monkey Business
SmartMoney.com
By Lisa Scherzer
September 22, 2005

IT'S A COMMONLY USED explanation of probability and randomness: Take 1,000 chimpanzees, have them flip coins 10 times in a row, and some of them are bound to get heads all 10 times. We consider those chimps lucky.

Take the same idea and apply it to stock-picking. Only now, the primates in question are mutual-fund managers. With so many out there actively running portfolios, some are bound to pick winners. Most of us would call the ones that do talented, but not William Bernstein. The author and investment adviser puts the fortunate managers' performance on par with that of the coin-flipping simians.

Despite endless warnings from financial experts and the fine-print in prospectuses, Bernstein says, investors continue to make the costly mistake of presuming that a fund's past performance is indicative of future returns. It's not. That's why Bernstein, who runs Efficient Frontier, a boutique money-management firm in North Bend, Ore., with $140 million in assets, always favors index funds for long-term investments. While some managers will outperform the market over any given period, he concedes, very rarely do those same managers continue to do so indefinitely.

"Forty to 50 years of data show that it's all due to luck," he says. "The studies show that if you take successful money managers that have done well in the past [and] track them, you see they don't outperform the market."

Bernstein points out that funds that tracks various indexes, whether bonds, domestic equities or foreign stocks, also have the advantages of lower fees and greater tax efficiency. That's generally not the case with actively managed portfolios that involve more turnover of holdings. SmartMoney.com asked Bernstein to elaborate on his belief in indexing and disbelief in some managers' investing skill.

SmartMoney.com: First off, you're a neurologist. How did you get into money management?

William Bernstein: I'm a retired neurologist. The only thing I do with that is teach on a volunteer basis.... The way I got over from neurology to finance is that 15 to 20 years ago, I found myself with money to invest, and I was looking to invest for retirement. I approached it the way scientists approach it, by looking at scientific literature. You look at what the best evidence and best data are. But I found that when physicians invest, they don't do that. They read the New York Times and USA Today. They don't read the Journal of Finance or Financial Analysts Journal. They don't even read the primary textbooks or stuff by Burton Malkiel and [Vanguard founder John] Bogle.... They read the popular press.

I surveyed the primary finance literature by Sharpe, Fama, French and people like that. I realized how important passive investing was, and how important keeping expenses down was, and how important asset allocation was. I started putting together my own asset allocations, and I realized that I had something valuable to small investors. I put together finance literature on my own. I figured out asset allocation on my own. I wrote it up in 1995, which was my first book [titled "The Intelligent Asset Allocator" and published in 1998].

SM: Why do you think it's so impossible to beat the market?

WB: I'm basically someone who's a top-down person. Markets are efficient enough that if you decide you want a certain asset allocation, you decide to invest passively, it's difficult to beat that performance at the market level. Indexes will beat three-quarters of active managers. If you look at a global portfolio, if you actively manage each of 10 asset classes, chances are you'll lose. To win in one asset class, you can be lucky and beat the index. But if you're an investor, you need to beat the benchmark in at least seven or eight of the asset classes if you're investing in 10 to 15 asset classes. The chances of doing that are close to zero.

SM: But people — be it mutual-fund managers, hedge-fund managers or ordinary investors — find ways to make abnormal returns in the stock market.

WB: Sure, I can show you data on hedge funds and mutual funds that mutual-fund managers have beaten the market. So say there is proof you can beat the market. But that's like saying you didn't wear your seat belt and you didn't have an accident, so you don't need a seat belt. So much of life is due to chance. Mutual-fund managers and hedge-fund managers behave like outperformance isn't due to chance. If it's due to luck, it won't repeat. If it's due to skill, it will repeat. Forty to 50 years of data show that it's all due to luck. The studies show that if you take successful money managers that have done well in the past [and] track them, you see they don't outperform the market.

One of the studies looked in given five-year periods at what were the best mutual funds, and tracked how they did going forward. In each and every case they underperformed the Wilshire 5000 Index. In a couple of examples they did better than the average mutual fund, and in a couple of examples they did worse than the average mutual fund. So they did average. But the average mutual fund is terrible. You're also paying transactional expenses, the hidden costs of doing transactions. The average mutual fund gets the market return minus their expenses. You're much better off getting market return. As John Bogle says, it's simple arithmetic. You keep expenses down by investing passively.

SM: Are you against all forms of active investing? Even exchange-traded funds?

WB: I'm not totally against active investing. I think if you diversify properly, it's OK to invest actively... There's nothing wrong with ETFs; they're basically index funds. I have no problem with ETFs. The average Vanguard plain-vanilla index fund is probably slightly better than the average ETF. If I had to grade these, the average Vanguard index fund is an A. The average ETF is an A-. The average mutual fund is a C. And a managed brokerage account is an F.

I liken an ETF to a chain saw. It can be very powerful if used correctly and appropriately. It will slice your arm right off if you use it improperly. Which means: If you're speculating, buying at 2 p.m. one day and selling the next week, if you try to follow trends, you're going to get your wealth amputated.

SM: What's an appropriate asset allocation?

WB: I agree with Bogle that bond allocation should be appropriate for your age. If you're 50 years old, you should have 50-50 in bonds and stocks.... The next question would be what do you invest in bonds and stocks? Bonds should be corporate Treasurys, somewhere between one- and five-year duration. The Vanguard Short-Term Bond Index fund (VBISX) is a superb fund. It doesn't get any more cheap or efficient than that.

With stocks, I say domestic with a value tilt. You should have some small stocks in there, like one of Vanguard's small index funds. And for large stocks, an S&P 500 index fund. And then as far as foreign funds go, Vanguard has a total foreign stock fund, and a Pacific and European fund if you want to break it down. One thing about Vanguard is that it doesn't have a good foreign value fund. That's the one case I'd recommend an ETF. Barclays has an ETF that's the value half of the EAFE index. You want to have value exposure.

In my two books I've recommended asset allocations. It's important to know one size doesn't fit all. A taxable portfolio is different from someone investing in IRAs. A good example is [real-estate investment trusts]. The income on REITs is all taxable, so not very tax efficient. Value stocks tend not to be as tax efficient. All of the recommendations I've made I believe still stand with one exception: instead of using Vanguard International Value fund (VTRIX), use the Barclays ETF [iShares MSCI EAFE Value Index fund (EFV)].

SM: The name of your company, Efficient Frontier, refers to optimal portfolios plotted along a curve that have the highest expected return possible for the given amount of risk. How does this financial concept relate to your recommendations?

WB: The Efficient Frontier name of my company is almost a sardonic title. Efficient Frontier refers to that portfolio which produces the highest return for a certain degree of risk; portfolios that have the lowest degree of risk for a given return... It sounds wonderful, but you can't get there from here. In order to get to the efficient frontier you have to know the future expected return of an investment, and you can't know that. So I might as well have named the site the holy grail of investing. It's like heaven; it's a nice place, but you can't get there...

If I had to have one investment motto, it would be you can't violate the law of gravity for very long. There are no bad asset classes. If you see an asset class that's been doing awfully, more than likely it's underpriced and will do well. If one asset class is doing really well in the last 10 to 15 years, chances are it's probably going to go down. That's what happened to the S&P 500 index in the 1990s. Everyone said American large-cap stocks were going to take over the world, and that was the only place you should invest your money. I was puzzled by this. It was the exact opposite of what we heard for the past 70 years...

One overarching concept that I think is useful is how much noise there is in finance. You could take the dumbest, most inept, incompetent money manager, and without a great deal of luck he can beat the market over 10 years. If you're a terrible money manager you can beat the market. On other hand, you can be the best money manager, have the best information, the best discipline, and with a little bit of bad luck you can underperform the market for 10 or 15 years. When you see someone beat the market, it's probably because of dumb luck.

-- posted by bob90245

Top 566. Sep 23, 2005 9:29 AM

» Normxxx - The Big Lie

Efficient Frontier: The Big Lie

By William J. Bernstein | Originally written in 2002

As Joseph Goebbels knew when he drafted the Nazi campaign blaming the Jews for Germany’s failure to rise out of the ashes of the Great War, if you tell a lie often enough, it eventually becomes accepted as the truth.

Year after year, investment pundits repeat a fundamental falsehood about indexing that has somehow acquired the ring of truth— that indexing works for large-cap stocks, but not for foreign or small-cap stocks. The origins of this monstrosity are lost to time, but Charles Schwab deserves a major portion of the credit for popularizing this notion in its "core-and-explore" strategy, where one indexes more of a portfolio’s large-cap segment than its small and foreign.

I had hoped that core-and-explore’s manifest failure over the past three years would put this old chestnut to rest, but sadly, it hasn’t. In the Mutual Funds supplement to the May 6, 2002 Wall Street Journal, former Fidelity chief Robert Pozen, now firmly ensconced at Harvard, opined: "Active managers beat the relevant indexes on a regular basis for things like international funds, small-cap funds, etc."

Well, I really didn’t expect a balanced view of indexing from a Fido bigwig, but I had hoped that Harvard profs were a bit more data-driven. I’ve written about this one until my fingers ache, but no one seems to listen. So, Professor Pozen, this one’s for you.

Small Cap

Let’s start by dividing small cap into value, growth, and blend categories. The oldest small-cap-value index fund is the DFA U.S. Small Cap Value, which ranks 7th out of 58 funds at five years. It incepted in 1993, but it’s not much of a stretch to extend its record backwards by tacking on the performance of the Fama-French small value index, which it tracks closely. (Actually, almost all DFA funds beat their underlying indexes, so this is a more-than-fair approximation.) At 10 years, this fund would rank first of 14 funds, and at 15 years, first of nine funds.

For small blend, it all depends on which index you use. The Vanguard Small-Cap Index fund ranks only 26th of 36 funds at 10 years, and the underlying Russell 2000 Index would have ranked 12th of 16 funds at 15 years. But DFA U.S. Micro Cap ranks 6th of 36 at 10 years and 7th of 17 at 15 years, and DFA U.S. Small Cap, exactly in the middle of the pack at 10 and 15 years. It turns out that there’s a problem with the Russell 2000 Index— it is rebalanced every June 30. Since it is defined as the 1001st through 3000th stocks ranked by market cap, and since it is the most widely used small-cap index, savvy traders can easily predict which stocks will be added and dropped from the index, bidding these stocks up or down before June 30, adversely impacting the indexers who must buy or sell these stocks after June 30, lest they incur increased tracking error.

The DFA funds do not suffer from these disadvantages. Neither does the S&P 600, as it is committee-chosen and thus impossible to predict which stocks will be added and dropped; were it a fund, it would rank 60th of 160 funds at five years, and 13th of 36 at 10 years. In any case, the mediocre performance of small-blend indexing is largely an illusion— adjust for survivorship bias, and even the Vanguard Small-Cap Index fund beats the average actively managed fund by a significant margin.

Finally, small growth, as we’ve noted before, is a real problem for indexers. The Fama-French small growth index would have ranked 34th out of 53 funds at 10 years and 22nd out of 25 funds at 15 years. We’ve been down this road before— momentum effects are strongest in the small growth arena. An index fund that kicks out its strongest performers, which a small growth and to a lesser extent a small blend fund does, suffers accordingly. So, yes, don’t buy a small-cap-growth index fund. But the larger point is simply not to buy small growth funds at all— this is a miserable asset class, with long-term historical returns lower than all other market segments.

Finally, REITs. Surely, this a specialized, inefficient area where savvy analysts should be able to pick out underpriced securities. Well, no. DFA Real Estate Securities ranks 13th of 60 at five years; the Vanguard REIT Index offering, 28th. Again, add in survivorship bias, and the Vanguard fund too outperforms by a handy margin.

[Normxxx Here: I am missing something here; what does Bill Bernstein mean by "survivorship bias" in a REIT fund? Anyone? ]

Foreign

At first blush, indexing foreign stocks also appears to be a loser: the MSCI-EAFE, were it a fund, would have ranked 45th of 77 foreign entries at 10 years, and nearly dead last at 15 years.

The problem, of course, can be explained in one word— Japan. Indexing the foreign market in 1989-1990 would have resulted in a portfolio consisting of nearly two-thirds Japanese equity, something that even the most ardent indexer would not likely do, and which killed the EAFE index for over a decade and a half.

[Normxxx Here: And, which is an another excellent argument for equal-weighted— as opposed to cap weighted— indexes. ]

So, let’s break things down by region. At 10 years, the Vanguard European Index fund ranked 7th out of 19; at 15 years, the index it’s based on would have ranked first of seven. Pacific Rim? There’s no fund with a 15-year track record, but the MSCI Pacific-ex-Japan Index would rank second of four at 10 years and 20th of 46 at five years.

Emerging Markets? Now, if you buy the argument that active management adds the most value in inefficient markets, it should do so in this arena. The best index data are for the DFA Emerging Markets and Emerging Markets Value funds. At five years, they rank 30th and 5th of 106 funds, and at 10 years, adding on their strategies before their 1994 incepts, they would rank second and first of seven funds. (The Vanguard Emerging Markets fund ranks 46th of 106 at five years; since they don’t precisely track the MSCI Emerging Markets Index, it’s difficult to judge just how well they would have done at ten years.)

Lastly, I can’t help myself from adding in a value twist: At five years, DFA International Value ranked 122nd of 423 diversified foreign funds, even with its heavy Japanese market weighting. Adding on its strategy before the 1994 incept, it would rank 15th of 79 at ten years, and 4th of 29 at 15 years.

No one really expects the truth from anyone at Fidelity. But, Mr. Pozen, you’re in the big leagues now. People expect that when a Harvard professor opens his mouth he’s at least had an ever-so-brief look at the data. Better luck next time.

______________

The contents of this letter/report does not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.

-- posted by Normxxx