political risk/Nixon impeachment

Last week a reader asked me to comment on these two issues.  Here goes:

political risk

When investors talk about political instability/risk, they typically think about stuff that happens in emerging economies, like a country:

–defaulting on its international borrowings (think: Cuba or Argentina)

–changing tax or other laws retroactively (think: India)

–arbitrarily seizing foreign-owned assets (lots of places)

–having judicial ruling that favor locals no matter what the facts/law say (again, lots of places)

–having rigged elections (lots…)

–having crony capitalism (think: Russia)

–overthrowing the sitting government by military coup (lots…)

In sum, no matter what we think about partisan politics in the US, the EU or Japan, these are by far the most politically stable places for investors on earth.  The US, in my view, is the most stable–although arguably this is in part because I think I understand the rules of the game.

Having said that, I think there is an important stock market issue now beginning to play out in Washington.

As I see it, Donald Trump, an outsider, was elected in part on his promises to “Drain the Swamp,” to reform corporate taxation and to dramatically increase government spending on infrastructure.  At the very least, this is why the S&P 500 has risen by 15% since the election.  So far, however, he has demonstrated poor judgment, a lack of focus and an inability to grasp the basics of how to do the job he now has.   Of course, Washington insiders of all stripes haven’t been particularly helpful.

From a stock market point of view, though, if what we’ve seen so far from Mr. Trump is all he has to offer, it will be very hard for world stock markets to move higher–and we could lose, say, half of the post-election gains as investors come to terms with this failing.  

As I’ve been pointing out for some months, the “Trump trade” ran out of steam around inauguration time.  This may mean, ironically, that Trump stocks will be relative outperformers in any feet-of-clay correction.
Nixon impeachment

I’m taking this question as really being “What can we learn about the stock market during Nixon’s impeachment that we might apply if Trump suffers the same fate.”

Two modern presidents have been impeached, Nixon and Clinton.  So the sample is very small.

In the Nixon case, his impeachment wasn’t the only stock price depressing game in town.  During the same time frame we had:

–the first oil shock, with prices tripling

–the UK economy collapsing, requiring the IMF to prop it up

–the gold-based fixed-rate international currency exchange system in place since the end of WWII falling apart

–the early Seventies speculative stock market bubble, roughly the equivalent of the Internet bubble of 1998-2000, popping.

So while there may have been stock market weakness around the impeachment, it would be hard to factor out the other stuff.

As to Clinton, who was actually tried by the Senate, in January 1999, and acquitted, the market scarcely noticed.  Of course, Internet mania was just getting a head of steam then.  And unlike Nixon, Clinton remained very popular at the time–particularly among women.  Go figure.

As to assessing Mr. Trump’s stock market impact, I think a lot depends on whether his possible demise would be read as the fate of a hero done in by an entrenched, self-interested political elite defending its privileges or of a real estate bungler brought to fame as a reality host and elected in a win-the-lottery series of fortunate accidents.  In other words, would a Trump demise mean the end of the government reform movement–increasing the likelihood of a Japan-like economic fate for the US.





buying an individual tech stock

This is just a brief overview:

–Buying any stock involves both a qualitative and a quantitative element.  That is:  What does the company do that makes this a good stock to own? and How do the numbers–the PE ratio, asset value, dividend yield and earnings growth–stack up?

–For value stocks, the numbers are more important; for growth stocks, the story is the key.  That’s because the primary element in success for value investors is how carefully they buy (because the ceiling for a given stock is relatively clearly defined).  For growth investors, it’s selling before/as the drivers of extra-fast earnings expansion run out of steam.

–Most tech stocks fall in the growth category.  My advocacy for Intel a few years ago was one of the rare occasions where a tech story is about under valued assets.

–In most cases, tech companies own key intellectual property–software, patents, industrial knowhow–that is in great demand, and which competitors don’t have and can’t seem to create substitutes for.  As long as that remains true, the company’s stock typically does well.  As I just mentioned, a crucial element in success with tech (or any other growth sector) is to exit before/as the growth story begins to unwind.  One yardstick is that this typically happens five years or so after the super-growth starts.  Yes, the best growth companies, like Apple or Microsoft or Amazon, have an ability reinvent themselves and thereby extend their period of strong earnings success.  But this isn’t the norm.

–Learning to be a stock investor is sort of like learning to play baseball.  There’s no substitute for actually playing the game.  The best way I know to learn about a stock is to buy a very small position and see what happens.  Don’t just sit idle, though.  Read everything on the company website, and the websites of competitors.  Read the last annual report and 10k.  Listen to (or read the transcripts of) the firm’s earnings conference calls.  Find and monitor (at least the headlines) financial newspapers and relevant blogs.  Try to form expectations about what future earnings might be and check this against what actually happens.  Then figure out where/how you went wrong and adjust.  Watch how the market reacts to news.  At first you may be terrible.  I certainly was.  But if you’re honest with yourself in your postmortems, you’ll probably make considerable progress quickly.

–Sooner or later–preferably sooner, learn to interpret a balance sheet and income statement.  A local community college course would probably be good, but you can get the basics of financial accounting (definitely don’t worry about double entry bookkeeping) from a book over a weekend.  Remember, here too there’s no substitute for the experience of trying to work out from a given company’s actuals what future income statements, balance sheets and flow-of-funds statements will look like.


investing in tech (ii)

other tech characteristics

–unlike areas like, say, fossil fuels, tech will likely continue to experience strong growth for a long period of time

–tech is also an area where the US has a comparative advantage, due to the presence of  strong tech-oriented universities, the large size of the existing tech community and the easy availability of capital to finance new tech ventures

a French scholar as tech banker

Early in my career, I had an acquaintance who had spent her life to that point studying for a PhD in French literature, intending to teach at a university somewhere.  She should have studied at least some economics in addition, because, like me, she finished here degree just as the Baby Boom finished college and universities stopped hiring new faculty.  I’d become an equity securities analyst; she’d become a banker to tech companies.  Initially, she was worried that her lack of a science background would be a severe negative.  She found, however–as I did–that electrical engineering was far less important than being able to figure out whether there was any demand for the stuff a given tech company made, at what price, and whether there was any competition.

I think this is still true today–meaning that most people can be successful tech investors, provided they’re willing to put in time and effort.  While a technical background (or access to a friend or relative who has one) is a plus, common sense and a little supply/demand economics is much more crucial.

active or passive/individual stock or fund

The simplest, and lowest risk, way for any of us to increase the tech component of our equity exposure is to replace an S&P 500 index fund/ETF with a tech sector index fund/ETF .

There are also subsector funds/ETFs that allow a narrower focus on, to name a few popular subsectors, internet or cypersecurity or semiconductor stocks.  There are even a few actively managed tech ETFs, although it’s not clear that these outperform passive vehicles.

The largest rewards, and the greatest risks, come with buying individual stocks.  My approach to holding an individual tech stock is pretty much the same as for holding any other type of individual stock.

More tomorrow.


investing in tech

A reader asked me to write about how I approach investing in tech stocks, an area I like and one which I think I’ve acquired some competence in over the years.

IT as a component of the S&P 500

Let’s start with the structure of the S&P 500, which, as of yesterday’s market close, looked like this:

Information Technology          22.5% of the index

Financials          14.1%

Healthcare          14.0%

Consumer discretionary          12.5%

Industrials          10.2%

Staples          9.3%

Energy          6.3%

Utilities          3.2%

Real estate          2.9%

Materials          2.9%

Telecom          2.3%.

Source:  Standard and Poors

Yes, the numbers add up to 100.2% but that’s just rounding and doesn’t affect analysis.


An obvious conclusion from this list is that when we buy an S&P index fund, almost a quarter of what we get is already tech.

A second observation is that 22.5% is a big number.  But if we look back to the end of 2009, when the current bull market was in its earliest stage, IT represented 19.8% of the index.  In other words, by far the largest determinant of IT sector performance in the bull market has been the upward movement of stocks in general.  (For what it’s worth, by far the largest losing sector has been Energy, which comprised 11.6% of the S&P 500 back then.)

Still, there have been spectacular winners, both individual stocks and subsectors, in IT.  So taking the time and effort to study IT stocks can pay big dividends.

placing IT in a business cycle context

Let’s group stocks by the sensitivity of their profits to the ups and downs of the business cycle, starting with the most aggressive (meaning most sensitive) and ending with the most defensive.  This is my list:

most aggressive




Industrials  (this would be #3, except US industrials make mostly consumer            products)

less aggressive 

Consumer discretionary

Real Estate (this would be #4, except that a lot of the publicly traded vehicles are income-                            oriented REITs)





more defensive



I’m sure that the lists others would come up with would rank the sectors differently.  Try it yourself and see.

What I make of my list is that IT will likely outperform anything lower on the list during an economic upturn and underperform during a downturn.

Two reasons:

–most consumer IT purchases, like a new smartphone or a new PC/tablet, are discretionary and can easily be postponed when times are tough, and

–for many modern corporations, capital spending means software.  And, in my experience, no matter how they say they maintain steady investment in their business, companies rarely outspend their cash flow.  When bad times lessen cash flow, companies–despite their promises–cut capex (i.e., software) spending.  Consumers, on the other hand, are much less draconian in their cutbacks, at least in the US.


Tomorrow, secular trends.




the stock market cycle–where are we now?

As I wrote yesterday, stock market price-earnings multiples tend to contract in bad times and expand during good.  This is not only due to well-understood macroeconomic causes–the effect of higher/lower interest rates and falling/rising corporate profits–but also from psychological/emotional motivations rooted in fear and greed.

(An aside:  Charles McKay’s Extraordinary Popular Delusions and the Madness of Crowds (1841) and Charles Kindleberger’s Manias, Panics and Crashes (1978) are only two of the many books chronicling the power of fear and greed in financial markets.  In fact, the efficient markets theory taught in business schools, which denies fear and greed have any effect on the price of financial instruments, was formulated while one of the bigger stock market bubbles in US history, the “Nifty Fifty” years, and a subsequent vicious crash in 1973-74, were taking place outside the ivory tower.)

Where are we now?

My take:

2008-09  PEs contract severely and remain compressed until 2013

2013  PEs rebound, but only to remove this compression and restore a more typical relationship between the interest yield on bonds and the earnings yield (1/PE) on stocks.

today  The situation is a little more nuanced.  The bond/stock relationship in general remains much the way it has been for the past several years, with stocks looking, if anything, somewhat undervalued vs. bonds.  But it’s also now very clear that, unlike the situation since 2008, that interest rates are on an upward path, implying downward pressure on bond prices.

In past plain-vanilla situations like this, stocks have moved sideways while bonds declined, buoyed by an early business cycle surge in corporate profits.

Since last November’s presidential election, stocks have risen by 10%+.  This is unusual, in my view, because we’re not at the dawn of a new business cycle.  It comes from anticipation that the Trump administration will introduce profit-boosting fiscal stimulus and reforms.  The “Trump trade” has disappeared since the inauguration, however.  Our new chief executive has displayed all the reality show craziness of The Apprentice, but little of the business acumen claimed for the character Mr. Trump portrayed in the show–and which he asserts he exhibited in in his long (although bankruptcy-ridden) career in the family real estate business.

Interestingly, the stock market hasn’t weakened so far in response to this development.  Instead, two things have happened.  Overall market PE multiples have expanded.  Interest has also shifted away from business cycle sensitive stocks toward secular growth stocks and early stage “concept” firms like Tesla, where PEs have expanded significantly.  TSLA is up by 76% since the election and 57% so far this year–despite the administration’s efforts to promote fossil fuels.  So greed still rules fear.  But animal spirits are no longer focused on beneficiaries of action from Washington.  They’re more amorphous–and speculative, as I see it.

Personally, I don’t think we’re at or near a speculative peak.  Of course, as a growth stock investor, and given my own temperament, I’m not going to be the first to know.  It does seem to me, however, that the sideways movement we’ve seen in the S&P since March tells us we are at limits of where the market can go without concrete economic positives, whether they be surprising strength from abroad or the hoped-for end to dysfunction in Washington.


discounting and the stock market cycle

stock market influences


To a substantial degree, stock prices are driven by the earnings performance of the companies whose securities are publicly traded.  But profit levels and potential profit gains aren’t the only factor.  Stock prices are also influenced by investor perceptions of the risk of owning stocks, by alternating emotions of fear and greed, that is, that are best expressed quantitatively in the relationship between the interest yield on government bonds and the earnings yield (1/PE) on stocks.

discounting:  fear vs. greed

Stock prices typically anticipate or “discount” future earnings.  But how far investors are willing to look forward is also a business cycle function of the alternating emotions of fear and greed.

Putting this relationship in its simplest form:

–at market bottoms investors are typically unwilling to discount in current prices any future good news.  As confidence builds, investors are progressively willing to factor in more and more of the expected future.

–in what I would call a normal market, toward the middle of each calendar year investors begin to discount expectations for earnings in the following year.

–at speculative tops, investors are routinely driving stock prices higher by discounting earnings from two or three years hence.  This, even though there’s no evidence that even professional analysts have much of a clue about how earnings will play out that far in the future.

(extreme) examples

Look back to the dark days of 2008-09.  During the financial crisis, S&P 500 earnings fell by 28% from their 2007 level.  The S&P 500 index, however, plunged by a tiny bit less than 50% from its July 2007 high to its March 2009 low.

In 2013, on the other hand, we can see the reverse phenomenon.   S&P 500 earnings rose by 5% that year.  The index itself soared by 30%, however.  What happened?   Stock market investors–after a four-year (!!) period of extreme caution and an almost exclusive focus on bonds–began to factor the possibility of future earnings gains into stock prices once again.  This was, I think, the market finally returning to normal–something that begins to happens within twelve months of the bottom in a garden-variety recession.

Where are we now in the fear/greed cycle?

More tomorrow.

professional investment advice (ii)

Yesterday, I wrote about the problems a Wall Street Journal reporter had in discovering how much she paid in fees to the professionals she hired to invest her money.  The task, which we’d think should be a piece of cake, turned out to be very difficult.  Although the reporter didn’t identify the firm in question, the corporate philosophy seems to be the usual one for active managers of emphasizing service rather than fees.  This decision, which is hard to fault in itself, has been transmuted into two courses of action–bury fee information as deeply as possible, and keep the fees (1.4% of assets per year, in this case) very high, in the hope no one notices.

Oddly enough, this strategy has been relatively effective for decades.

It seems to me, though, that being aware of what one is paying for professional investment advice is only part of the assessment process.  A second important criterion is what the gains in investment performance are that come from having an investment adviser.  The relevant metric is how effective the adviser’s asset allocation and portfolio management efforts are in keeping the client at least even with the appropriate benchmark after subtracting fees.  

Andrea Fuller’s case would work out like this:

Let’s say her “moderate” asset allocation ends up being 60% stocks, 40% bonds.  If we take the returns of the S&P 500 and of some broad bond index as proxies, a rough benchmark return for her over a given period is easy to calculate.

In my view, a reasonable expectation would be that one’s portfolio should (at least) keep pace with the index after fees.  I say “reasonable” although knowing less than a quarter of active managers are able to consistently exceed my standard and over half consistently fall short.

In an ideal world, an active manager who is consistently unable to perform in line with the appropriate benchmark after fees has an easy fix–at least a partial one.  Lower fees to the point where the portfolio is at least close to the index.  Her firm’s high fee level and the teeth pulling needed to figure out what they are suggest this is the last thing on its mind.

Given that this is the case, the operative question for Andrea, and for anyone else, is how much the service the firm may be providing–like determining asset allocation or the availability of a knowledgeable account executive to answer questions or handholding during crises–is worth in terms of losses to an index fund strategy that one could easily implement on one’s own.

It also seems to me that if annual returns consistently fall more than 1% below a benchmark after fees it’s worth the time to shop around for a different investment management firm.