TAG | Financial markets
12
Why Burton G. Malkiel is More Right Than Wrong
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Why Burton G. Malkiel is More Right Than Wrong
by Alexander Green, Chief Investment Strategist
Monday, July 12, 2010: Issue #1299
At FreedomFest in Las Vegas last week, I debated Burton G. Malkiel, author of the investment classic A Random Walk Down Wall Street.
Malkiel is one of just a few men alive who has profoundly affected modern investment thinking. And his position is straightforward.
He believes that rational, self-interested investors take all public information and immediately incorporate it into the price of stocks. (This is where we get the term “efficient market.”)
He therefore concludes that market timing and security analysis is foolhardy… that it’s simply not possible to beat the market over the long term… and that you’d be well advised to give up that dream and just own a broad selection of index funds.
I actually agree with much of what Malkiel says. Much… but certainly not all.
Irrational Exuberance
For starters, you can count on investors to be self-interested. But rational? Not always. Just take a look at recent history…
- How rational were investors 10 years ago when they bid Internet and technology stocks to the skies, forgoing sales and earnings for financial metrics like “eyeballs” and “web hits?”
- How rational were investors five years ago when they put themselves deeply in hock to flip land, rental properties, vacation homes and condos because “real estate always goes up?”
- How rational were investors when they dumped stocks en masse 16 months ago – with the Dow at 6,500 – and plunked the proceeds into money market funds just as yields reached an all-time low?
It’s true that most investors behave rationally most of the time.
But it’s certainly not true that all (or even most) investors behave rationally all the time. And that creates opportunity.
Let’s take a look at another flaw in the “random walk” argument…
Get the Insider Advantage
Malkiel mentions that investors incorporate all “public information” into the price of stocks. But how about non-public information?
Most investors don’t have access to non-public information, that’s true. But that doesn’t mean no one has access to it.
Some of the best trades I’ve ever made have resulted from visiting a retailer and asking the manager how regional and national sales are going. Are they supposed to talk about these things? Absolutely not. But do they?
Sometimes they do. Gaining a bit of key information by talking to customers, suppliers, competitors and employees can give you an edge.
And how about company insiders? Officers and directors have access to all manner of material, non-public information. That gives them an enormous advantage over ordinary investors. And that’s also why Uncle Sam requires them to file a Form 4 with the SEC, divulging the details of their buys and sells.
If you watch what the insiders are doing, you won’t access the non-public information that they possess. But you’ll certainly know whether they think their companies’ shares are overvalued or undervalued. And that’s crucial information.
A 10-Year Market-Beating Performance
In short, Malkiel is right that it’s difficult to beat the market. But does that mean it’s futile to try?
Not only have men like Warren Buffett and Peter Lynch put the lie to that line of thinking, so has our own Oxford Club Trading Portfolio. The independent Hulbert Financial Digest confirms that we’ve beaten the market by a wide margin over the past decade.
But while Malkiel is wrong on some crucial points, he is absolutely right on several others. For example…
- He believes it’s a fool’s errand to try to time the market. I agree.
- He insists that an index fund will outperform the vast majority of actively managed funds over time. He’s right. They have and almost certainly will.
- He argues that index funds provide a big performance boost due to cost-efficiency and tax-efficiency. Right again – and this is far more important over the long haul than most investors realize.
In short, I agree with Malkiel far more than I disagree with him. His research – and similar work by John Bogle, William Bernstein and others – has had a profound impact on the development of my own investment philosophy. In fact, our Gone Fishin’ Portfolio is the very embodiment of much of what he espouses.
And Malkiel may be surprised to learn that this portfolio has beaten the S&P 500 – with far less risk than being fully invested in stocks – every year for over a decade.
I’d call that a non-random success.
Good investing,
Alexander Green
28
The Japanese Stock Market: How to Play “The Land of Rising Stocks”
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The Japanese Stock Market: How to Play “The Land of Rising Stocks”
by Alexander Green, Chief Investment Strategist
Monday, June 28, 2010: Issue #1290
The Wall Street Journal reported last week that, for the first time in three years, foreign investors are increasing their holdings in the Japanese stock market.
Data released by the Tokyo Stock Exchange shows that foreign ownership of Japanese shares rose to 26% for the year that ended in March, up from 23.5% a year earlier.
The Journal suggests that a recovery in Japanese corporate earnings is tempting foreign investors back to the country’s equity markets.
But I think there’s more going on here. Perhaps hedge fund managers and other savvy global investors have paged back through their old, dog-eared copies of Dr. Jeremy Siegel’s Stocks for the Long Run.
If so, they may have recognized something significant…
Crunching the Numbers on Japan
Siegel notes that it’s rare for stocks to go 10 years without giving a positive return. Yet we’ve experienced just such a rarity over the last decade.
For stocks to go 20 years without giving a positive return is almost unheard of. And 30 years? That’s rarer than Big Foot, Nessie and the Abominable Snowman combined.
Which brings me back to Japan…
- In 1989, the Nikkei 225 – Japan’s equivalent of the S&P 500 – hit a new all-time high near 40,000. Today, more than 20 years later, it languishes near 10,000 – almost 75% lower.
- In other words, the Nikkei 225 would have to rise 300% just to get back where it was in 1989.
And it wouldn’t surprise me if it did just that by the end of the decade. After all, it’s happened before.
In the 1970s, the U.S. market returned just 0.34% a year – a 3.4% total return for the decade. Yet the Japanese market compounded at 16%, generating a 10-year return of 344%.
What other asset class offers that kind of potential return over the next decade? (Gold bugs, keep your seats.)
Don’t Chase the Bullet Train… Get on Board Now
The groundwork has been laid.
Last August, after more than 50 years, Japan’s opposition party trounced the Liberal Democratic Party in a landslide election.
The new government has promised to shrink the country’s massive bureaucracy and cut wasteful public spending. It also intends to end more than 20 years of economic stagnation by cutting taxes and focusing on small and mid-sized businesses.
Of course, we’re all skeptical of politicians’ promises, but there is evidence that they mean business this time. Twenty years is a long time to leave your economy in a funk.
It’s resulted in Japanese stocks being among the cheapest and most unloved in the world. Virtually no one is enthusiastic about the Tokyo market.
However, great opportunities are born when dirt-cheap valuations marry investor apathy. Plus, Japanese investors are flush with cash. They’ve largely ignored domestic stocks after two decades of sub-par returns. And as that money begins to find its way out of mattresses and back into Japanese equities, the Tokyo market should lift off.
This is doubly true when institutional money managers return to Japan in a serious way. For years, global fund managers have outperformed the world benchmark by simply underweighting Japan. But let the Shinkansen take off without them and they will be forced to dash after it.
So how do you play this?
Two Ways to Ride the Japanese Stock Market
There are dozens of worthwhile Japanese ADRs trading on Nasdaq and the Big Board.
But you can gain exposure to the Japanese stock market through two ETFs…
- iShares MSCI Japan Index (NYSE: EWJ), which invests in large-cap Japanese stocks.
- Wisdom Tree Japan Small-Cap Dividend Fund (NYSE: DFJ), which captures the best of the Japanese small-cap sector.
Or you can spread your bets and own both.
Incidentally, if you remain skeptical about Japanese stocks digging their way out of this 21-year hole, consider again how unlikely it is that Japanese stocks will earn a negative 30-year return.
As Dr. Siegel writes in Stocks For the Long Run:
“In the 12 years from 1948 to 1960, German stocks rose by over 30% per year in real terms. Indeed, from 1939, when the Germans began the war in Poland, through 1960, the real return on German stocks matched those in the United States and exceeded those in the U.K. Despite the total devastation that the war visited on Germany, the long-run investor made out as well in defeated Germany as in victorious Britain or the United States. The data powerfully attest to the resilience of stocks in the face of seemingly destructive political, social, and economic change.”
The story in Japan was similar. By the end of 1945, stock prices stood at about approximately one-third of their level just prior to the Empire’s surrender. Over the next 40 years, the Japanese market returned more than 20 times its American counterpart.
If 200 years of world stock market history is any guide, the current decade should be another barnburner for Japan.
Good investing,
Alexander Green
6
Why the Euro Has Further to Tumble
0 Comments | Posted by Alexander Green in Alexander Green
Why the Euro Has Further to Tumble
by Alexander Green, Chief Investment Strategist
Thursday, May 6, 2010: Issue #1254
Being a contrarian is a lonely business.
If you’re a regular reader, you’ll know that ordinarily, I am market neutral on stocks, bonds, currencies and commodities.
The truth is that markets are reasonably efficient. So most years, I don’t stick my neck out and make any market calls on any asset class.
That’s because the vast majority of the time, most assets are neither grossly undervalued, nor wildly overvalued. Rational, self-interested investors keep prices close to true value.
But I am not an efficient market theorist. Investors are always self-interested, yes. But they are not always rational. And I most certainly do not believe that all publicly traded securities are efficiently priced all the time.
That would be lunacy…
Anomalies develop (and opportunities alongside them). Sometimes, these anomalies develop into outright bubbles. When that happens, you will always see eye-popping valuations paired with extreme sentiment. (In other words, sky-high prices and unbridled optimism or rock-bottom prices with extreme pessimism.)
What surprises me is how few investors recognize a bubble, even when it’s right under their nose and they have many thousands of dollars at risk…
Bubble Watch
For example…
- When I warned about the dangers of Internet stocks over a decade ago – I actually quit my Wall Street firm to take possession of my soaring pension shares – most respondents told me I was clearly ill-equipped to recognize the nature of opportunities in “the New Era.”
- Readers similarly scoffed at my warnings about the housing market five years ago. “Real estate always goes up,” they reminded me.
- At $150 a barrel, I wrote a column calling oil “The Mother of All Bubbles.” Demand was already waning and supply was rising as oil hit a new all-time high on various “peak oil” theories. It then quickly lost nearly two-thirds of its value.
- Five months ago – again, right here in Investment U – I predicted that the much-maligned dollar would soar against the euro. And yet again, my readers insisted that I was grossly mistaken and that a weaker dollar was “the ultimate no-brainer.”
Except it wasn’t…
Europe’s Monetary Policy Mish-Mash
Today, the euro hit a 14-month low against the dollar ($1.2689) on increasing recognition that Greece’s fiscal problems are bigger than expected, more expensive than expected and potentially contagious.
Trust me, this is far from over. The 16-member states in the Eurozone are about to start bickering like an old couple that has locked the keys in the car.
Understandably, weaker states don’t like having their economic policies dictated from Frankfurt. And stronger states don’t like spending billions to bail out their profligate brethren from years of fiscal mismanagement.
“Preposterous” Expectations for the Euro Against the Dollar
When the euro was born on January 1, 1999, skeptics rightly worried that the then-11-member states were too divergent to share a single currency and monetary policy.
These fears were well-founded. And the euro promptly plunged on world currency markets to well under $0.90. Today, we know that problems among member states aren’t just possible… not just probable… but right here, stinking to high heaven on our doorstep.
Yet the euro is still trading around $1.27.
Expect it to hit $1.10 by the end of this year – and trade at parity with the dollar sometime next year.
Sounds preposterous? Yes, so I’ve heard.
Good investing,
Alexander Green
Editor’s Note: Find out how The Oxford Club’s “market neutral” investment approach, combined with a keen eye for lucrative contrarian recommendations, led the Hulbert Financial Digest to rank the group’s Communiqué in the top five investment newsletters over the past 10 years.
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