Digesting Jobs Data....

It is widely known that employment figures are a lagging economic indicator.  But this does not stop everyone's fascination with these numbers.  Each week and month Wall Street eagerly awaits to see the initial unemployment claims, total unemployment, and nonfarm payrolls.

Today figures for September were reported better than expected.  Unemployment is still a dismal 9.1%, but September jobs added was higher than expected, as well as, July and August numbers were revised upwards.

The debate among analysts and commentators began quickly after the data was released.  Some believe the numbers are a much needed boost of confidence that could increase business spending, some believe the numbers are still not enough to keep us from falling into a double dip recession.  So what do the numbers really tell us?

Month to month trends in employment figures can sometimes be volatile even in strong markets.  And absolute values are not nearly as important and changes in value.  What we really want to know is what direction the economy is headed.  Yes; we all know absolute values are bad.  The thing we should be looking for is long term trends.  Are employment figures consistent with a recovering economy or with a double dip recession?

I think the following graph can provide a fairly good indication...

In the graph I have charted annual Nonfarm Job Gains/Losses and Annual Initial Unemployment Claims.  Intuitively we would think that job gains would increase and initial claims would decrease during a recovery.  This is exactly what we are seeing.  I made some pretty subjective assumptions for the last 3 months of 2011, but I think they are fair.  I kept initial claims at 400,000 a week.  The number has hovered around 400,000 for a while now and has trended towards getting under 400,000 so I think this is reasonable.  For Job Gains I calculated two assumptions.  The blue line assumes the last 3 months will add the same number of jobs as the last 3 months in 2010.  The red line assumes only 30,000 jobs will be added in each of the last 3 months.  I think both these assumptions are very conservative considering 2011 has added more jobs in 7 of the 9 months so far compared to 2010.

Understandably the numbers are not good enough yet.  This is evidenced by the unemployment rate staying at 9.1%.  The economy is not yet adding enough jobs or keeping enough jobs to move this figure down.  But what does the chart say about the direction of the economy?  Employment is a lagging indicator, so does the graph say we are currently in a slow recovery or in a double dip?  You know what I think, so I will let you decide.....

Quote for the Week

I recently received the CFA study materials for the Level III test this June.  While I am not looking forward to having no life again starting early next year, I did have a sense of "Christmas Morning" as I opened the package containing a stack of six books about a foot high.  Each with pristine and glossy cover pages which will soon be covered in blood and tears.  The excitement came not from the idea of starting the grueling process over again, but from the feeling of being "over the hump" (having 2 out of 3 tests complete)  And also because Level III is predominantly concerned with Portfolio Management, which I presume is the industry many CFA candidates ultimately wish to be in when they start the treacherous journey.

I could not help opening up a couple of the books to thumb through the subject material.  I landed on the section "Monitoring and Rebalancing:  Rebalancing the Portfolio." I then came across a paragraph I couldn't help but to admire.  It was like the CFA Institute had gone forward in time, read my blog ( because it will become wildly popular *sarcasm*), and then implanted my "Crowded Market" Idea into their study material.  

OR more likely I stole the idea which has been around for much longer than I have, and championed by people who are much smarter than I am who actually created these theories that are then put into a certification test that I then study and learn.

Either way, the paragraph went as follows:

"Successful active investors are not swayed by the crowd. The cultures of successful corporations and winning investors are profoundly different.  Corporations, which are cooperative enterprises, prize teamwork and reward triumph while dismissing failure.  The exceptional investor pursues an opposite course, staying far from the crowd and seeking opportunities in overlooked areas while avoiding excesses of the crowd.  Investing in areas that are not popular while refusing to join in trends sets the successful investor apart."

- CFA Institute.  CFA Program Curriculum.  Level III.  Volume 6 pg. 84

I could not have said it better myself, although I have tried.  It is this philosophy that drives the meaning behind the title of my blog.  Yes, it goes against our very nature.  As human beings were are highly emotional and following such strategy can be difficult at times, but being prepared and educated on why this strategy works can help many investors and clients make it through the difficult markets.

On a side note.  I do not know the Institute's meaning by "Active Investor" in this context.  I was just skimming through as I mentioned.  But I can't quote this paragraph without again emphasizing that "active investor" does not equate necessarily to "stock picker."  I believe this is the wrong conclusion in many cases.  There is a case of actively managing passive asset exposure.  Many times this "active" managing simply means systematically rebalancing.

Anyway.  I know this does not really count as a blog article, but I couldn't pass up sharing this quote.  And I am promising to myself I will not actually start studying until January, or maybe December, or maybe November.......

The Worst Market Timer of All Time Outperformed You

There is a growing sentiment that the old investing strategy of "Buy and Hold" is dead. Now it is a little unfair for pundits to make such a sweeping statement. "Buy and Hold" is a term that should never have existed. It has been extensively used (and probably created) by the professional stock pickers of the day to justify their high management fees and "active trading" skills and is almost always used in the negative sense, such as: "Why would you want some one to use a "Buy and Hold" strategy when you can pay us large fees to churn your portfolio as much as possible?" (Ok, maybe no one has actually said that).

And if the commentators liken 2008 to the final nail in the coffin of the "Buy and Hold" strategy then someone needs to start reading active managers their last rights because, on average, not only did they lose as much as the market in 2008, you paid them more to do so!

But I digress. Getting back to the "Buy and Hold" strategy. This strategy is not to be confused with a long term exposure to equities or Modern Portfolio Theory (MPT) which it often is meant to refer to. The true practitioner of MPT will be re-balancing your portfolio when required and most likely BUYING equities during market downturns. This is far from the notion of "Buy and Holding" a portfolio into perpetuity.

However; The reoccurring theme in good investment management whether you are a stock picker or portfolio manager SHOULD be that no one can time or predict the market consistently, just ask investors who entrusted their money to PhD's and noble prize winners running Long Term Capital Management. The risk/return profile of equities is based on cash flows generated by the underlying companies; returned to you (the investor) through dividends or capital appreciation. Return is NOT based on timing the market. You should not buy and sell equities anymore than you would buy and sell your own company with the ebbs and flow of the economy.

Which brings me to this weeks graph and the title of the blog. What would you say if I asked you to guess the return to the worst market timer of all time over his/her life of investing in the S&P 500? -5%, 0%, 2%? The answer may surprise you.

The chart below was made based on S&P returns with reinvested dividends. I went back as many recessions as I thought was reasonable for the life of an investor which took me to 1973. That is 38 years of investing. A pretty typical time horizon for an investor, if anything a little short. I then based this hypothetical person's investments on the year the stock market first posted negative returns due to an economic recession. For example; the first $1 investment took place at the beginning of 1973, even though the recession did not formally start until the end of 1973. The reason being the market was down 15% in 1973 and was the first market reaction to the recession. This person made $5 worth of investments over his lifetime. All the in same manner i.e. the first negative year surrounding a recession. So how did they do through 2010?

They did pretty darn well considering.  9.68% time-weighted compound annual return.  This is right in line with the traditionally expected 10% return for equities. $5 has turned into $64.  And this is considering we have not fully recovered from the present recession.

So how did you (the market timer) compare to the worst market timer of all time?  Has your portfolio beaten almost 10% annual return?  Probably not without taking more risk i.e. international stock, small cap stock, etc.  It is highly unlikely that you did.  There is obviously not a direct comparison here as your investment horizon will not match up with this hypothetical person but the graph supports plentiful research that timing the market can not beat long term equity exposure.  The only timing you should do is ADDING to equities during recessions or market downturns as your portfolio needs to be re-balanced.  And remember, the return of the graph is ONE type of exposure to equities over a long time period.  A real life portfolio would include multiple different exposures to different asset classes with more or less risk and corresponding higher or lower returns.

What if you don't have 38 years?  Even if you portion the above investments into 10 year time frames after each $1 investment your annual return is: 12%, 17%, 18%, and 0% (remember still in a recession).

I will leave you with this: The return to the same investor above if he made $1 investments after the first negative S&P year going into a recession until he used up his $5 would have been 11.73%.  A seemingly small annual increase, but it equates to a ending dollar value of $164. 


So..... maybe you should start buying equities?

Lions, Tigers, and Bad Headlines, Oh My!

Today the ADP report announced that private industry non-farm payrolls added 91,000 jobs in August, lower than the expected 100,000.

So is this good or bad or neutral?  How is the every day investor to interpret these numbers?  The stock market is up as of 9:36 central time, but didn’t the jobs numbers fall short of expectations? Also out today: The Commerce Department says that factory orders climbed 2.4% in July, the largest increase since March.

Additionally, are there not other employment numbers coming out this week? Which are more accurate? Which data is most important?  We also have to consider: MBA Mortgage Application data, Challenger Gray & Christmas’s layoffs report, Chicago PMI, Consumer Spending, Consumer Sentiment, The Case-Shiller Index, Pending Home Sales, Initial Unemployment Claims, Continuing Unemployment Claims, Revised Productivity numbers, Construction Spending, GDP estimates, GDP revisions, the Philadelphia Fed manufacturing report, etc, etc.

I think you get the point.  As another example, just look at the economic indicators graphs supplied by the New York Fed:

http://www.newyorkfed.org/research/national_economy/nationalindicators.html.


That is 96 graphs!

On top of the raw data the media presents the information in multiple different ways: absolute values, changes month-to-month, changes year-to-year, changes week-to-week.  Primarily they report which ever way suits their agenda which is and always will be to sell newspapers.  Not help you sleep at night.

My Advice: STOP!! Stop reading headlines.  Stop freaking out.  Stop looking at your 401 (k) every 5 minutes.

If you do not have the time to investigate the underlying data and methodologies used to compile the data then do not get caught up in things you may or may not understand. (And trust me; it’s hard to even find a news article that actually has a link to the real report.)  If you did not understand annual weather patterns and decided to buy and sell your wardrobe every 3 months based on the current weather conditions you would make some very poor decisions and wind up with the same wardrobe every year, but for 4 times the cost!

With the amount of data being thrown at you everyday you can only be certain about one thing: being uncertain.  This leads to panic and fear and causes investors to make poor decisions.  Do not think that anyone is immune to this, including myself.  By our nature we are often emotional and irrational.  The best we can do is recognizing these impulses in ourselves and make a conscious effort not to act on them.

History and research, not fear and speculation, reveals that people who invested during uncertain economic times and down markets have ALWAYS come out better on the other side than those who sold during recessions and bought during booms.

I will leave you with this for today.  The graph below is the total private non-farm payrolls since the beginning of 2001.  Unemployment is everyone’s favorite economic indicator.  But the problem is:  IT IS A LAGGING ECONOMIC INDICATOR.  Businesses will not start hiring until the future of the economy is certain.  So if you are in need of a job this is a very important number; however; if you are an investor it is merely one piece of information.  Investing on jobs numbers will almost inevitably cause you to miss the market upswing and repeat the never ending wealth destroying cycle of “buy high and sell low.”

If you just had this one graph to judge the economy on which way would you say we are headed?  It appears we are headed in the right direction, although slower than we would all like.  We all see the future of the economy through a glass, darkly.  Do not bias your lens with too narrow a focus; the world economy is too large for that.  Put on the wide angle lens and give yourself some perspective.  Things are not great; no one argues that.  But do not confuse your investment decisions with the economic situation.  As is documented, and I will attempt to show in the next few blogs, investors who have the ability to tame their innate fear and invest in uncertain economic times reap a financial reward, as well as, peace of mind.  And that will never make the headlines…..

Fool's Gold

Is Gold a Good Bet in Inflationary Environments?


Situation: The global economy is talking about recession.  Unemployment is too high.  GDP growth is miserable and fear of rising inflation is widespread.  The price of gold is skyrocketing.  You are now thinking: Should I buy gold? It is a safe investment right?  A store of value in uncertain economic times.  A safe haven that will let me sleep easier at night.

I am describing the current economic crisis, am I not?  Actually, I am describing 1979-1980,  the couple years leading into a severe global recession (or double-dip recession depending how you see it). This is a recession that the economy would not fully recover from for 3 to 4 years.

The economy of the late 70's and early 80's is eerily similar to the previous 3 years in the US starting in late 2008, with the exception that interest rates remain at record lows and inflation has been tame.  Perhaps we can glean something from the familiar past as to the performance and safety of a gold investment in such an environment.

I will even give the gold bugs the leg up and say they were so on top of market trends in the late 70's that they put all their money into gold at near optimal timing.  For my analysis, I assumed someone invested in gold at the end of 1978 at $208/oz.  Just prior gold’s run up to its highest inflation adjusted price of all time, somewhere north of $2500/oz ($850/oz in nominal terms).

How did such a prescient investment work out?  

The results may surprise you.  The graph below compares that investment to the same investment in the S&P 500 assuming all dividends are reinvested.  It assumes the S&P ends 2011 down 5% from 2010 and that gold ends 2011 at $1800/oz.

So the answer to the question is: the gold investment performed very poorly on a relative basis.  The $1 invested in the S&P has grown to $31.92 at the end of 2011 while the investment in gold has grown to a mere $8.65.  The S&P returned 4.3% higher on an annualized basis.  The gold bugs from the 1980's are probably not feeling great about the "store of value" that gold provides nor do they care at all that gold is a "safe bet" because it is considered "currency."  Especially the ones that bought gold at its all time inflation adjusted high in 1980.  They still have not broken even.

So let me ask:  The year is 2011.  The global economy is talking about recession.  Unemployment is too high.  GDP growth is miserable and fear of rising inflation is widespread.  The price of gold is skyrocketing.

Are you going to buy gold?