UPDATE: The Gold Bear

by Matt Malick and Ben Atwater
 
On April 15, 2013, the same day as the Boston Marathon bombings, gold traded down 9.4%.  This was a significant technical (chart) breakdown.  But even before this drop, gold had already entered bear market territory. 
 
Three days earlier, on April 12, 2013, gold registered a loss of more than 20% from its high - the definition of a bear market.  It was a slow deterioration for the precious metal, as it took 599 days for gold to fall 20% from its peak.  According to Bespoke Investment Group, this is already longer than the average gold bear since 1975, which has been 483 days.  The average cumulative drop - peak to trough - has been 31.6%.
 
Bespoke further found that once gold crosses the bear line, the average number of days of additional decline is 309. 
 
Although gold is still down and out, it has, as of today, recovered the vast amount of its losses from April 15.  But, gold’s severe oversold level from April 15 was indeed historic. Since 1975, gold had never been more than 4.5 standard deviations below its 50-day moving average.  And in the eleven times it was nearly that oversold, more than 3.5 standard deviations, it had, on average, stayed depressed for the next six months. 
 
As you know, investors often view gold as a "safe haven" trade.  Therefore, if investors are selling gold, could this be a positive for stocks?  Again looking at the most oversold periods for gold from 1975, Bespoke found that over the next six months the Standard and Poor’s 500 stock index was up more than 70% of the time with an average gain of 7.08%.  Even very recently, since gold peaked in the summer of 2011 and then fell more than 20%, the S&P has climbed 40%. 


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UPDATE: 'Tis the Season for Volatility

by Matt Malick and Ben Atwater In 2010, 2011 and 2012 the spring has proven to be a tough time for stocks.  The old market adage “sell in May and go away” may seem like a no-brainer, but it is impossible to time the market over the short-term.  So with volatility creeping back into stocks, we think it continues to be advantageous to take a long-term perspective.  After all, the 16% drop in 2010, the 19.4% drop in 2011 and the 9.9% drop in 2012 were simply pauses in a powerful bull market that began in March of 2009. The two charts below are encouraging signs that equities may continue to have legs. The vast majority of investors are highly skeptical of the new highs in the Standard and Poor’s 500, but one must examine these highs in context.  Below you will see the 2000 high, the 2007 high and the recent 2013 high.  Presently, equities have much more earnings power than they did at the previous two peaks, while they trade at roughly the same price.  In other words, the market seems to be more fairly valued now.  Furthermore, we have some catching-up to do.  Between 2000 and 2013, S&P 500 earnings grew at an average annual rate of 5%, while the market was largely flat.  Over the long-term, earnings growth and market growth are highly correlated. Next you will see estimated future returns using a cyclically adjusted price-to-earnings ratio for the market.  In other words, the price-to-earnings ratio (a standard measure of how “expensive” stocks are) is adjusted for inflation and then averaged over the previous decade.  This is a conservative measure of valuation.  By this measure, stocks aren’t expensive, nor are they cheap.  Rather, they are in the 3rd quintile.  Using historical market data from 1926-2013, when stocks have been priced at this level, they have averaged a forward five-year return of 6% per year.  Although not robust, in today’s low interest rate environment, most investors would be pleased with this rate of return.   www.atwatermalick.com

Bombshell IMF Study: United States Is World’s Number One Fossil Fuel Subsidizer

Bombshell IMF Study: United States Is World’s Number One Fossil Fuel Subsidizer: Between directly lowered prices, tax breaks, and the failure to properly price carbon, the world subsidized fossil fuel use by over $1.9 trillion in 2011 — or eight percent of global government revenues — according to a study released this week by the International Monetary Fund. The biggest offender was by far the United States, [...]/p

UPDATE: The Future of Bonds

by Matt Malick and Ben Atwater

For the last thirty years, bond yields have fallen fairly consistently.  Consequently, bond prices have risen over this period of time.  It is often said that “what goes up must come down,” and this is probably the case with bond prices.  In an environment where the Federal Reserve has lowered short-term interest rates to zero and engaged in active bond buying (quantitative easing) to push down long-term rates, is the party over for bond holders?  Are we about to enter a new super-cycle of rising interest rates that will leave bond investors licking their wounds?

It is interesting to note how stocks and bonds performed during prior super-cycles of rising and falling interest rates.



From 1982, after interest rates peaked, through 2012, the Barclays Capital Aggregate Bond Index returned an average of 8.82% per year.  Stocks also did well during this period, with the S&P 500 returning 11.14% per year, but with far more drama, especially from 2000 until now.  Therefore, purely from a “sleep at night” perspective, owning bonds for the last thirty years served investors well, even though stocks actually did better.

According to Craig L. Israelsen, an associate professor at Brigham Young University, the federal discount rate (which the Federal Reserve sets) was 1.34% in 1948, similar to today. Over the next thirty-three years, this rate climbed somewhat steadily to 13.42% in 1981- reflective of a prolonged and dramatic increase in interest rates.  During this time, the Barclays Capital Aggregate Bond Index provided an average annual return of only 3.83%.  Meanwhile, the S&P 500 returned 11% annually during this period of rising rates.

In other words, stocks did well during a prolonged period of rising rates (1948 – 1981) and falling rates (1982 – 2012).  Bonds, however, delivered significantly lower returns when interest rates were on the rise.

Using a slightly different time period when interest rates increased dramatically, 1941 to 2009, Fidelity Investments calculated a 3.3% per year return for Treasury bonds.  However, after backing out an average annual inflation rate of 4.6% over the period, the real return for Treasury bonds was -1.3% per year.

This does not mean, however, that bonds should be irrelevant to investors.  The chart below shows that even in a rising rate environment (1941 to 1981), bonds lowered overall portfolio volatility (standard deviation).  A 100% stock portfolio from 1941 to 1981 returned 11% with a standard deviation of 14%.  Adding just 20% to bonds reduced overall return by about 9%, but volatility dropped by more than 20%.



Given the present depressed level of interest rates, we can infer three things from the last 70 years of history:  1) Bonds should experience below average returns and probably will not outpace inflation over the next several decades, 2) Bonds still have a place in the portfolios of risk-averse investors as a hedge against volatility and 3) Stocks will likely dramatically outperform bonds over the long-term.

Wealth Inequality - Most Americans Have No Clue

Although I've read about the Ariely and Norton study and talked about the results in my classes, I've only recently stumbled across the YouTube video that  takes the data from the study (and a couple other stats on wealth and income inequality) and cleverly attempts to explain the results from a graphical perspective.

For those unfamiliar with the research, a study by Dan Ariely (Duke) and Michael Norton (Harvard) in 2011 attempts to measure the difference between what average Americans believe is the level of wealth distribution in the US and what it actually is.  They also ask average Americans to reveal what they believe is the "ideal" wealth distribution for a country and compare that to what citizens estimated wealth distribution to be and the actual levels.  The results are fascinating.

http://www.youtube.com/watch?v=QPKKQnijnsM&feature=youtube_gdata_player

I've included, below, a link to their paper published in Perspectives on Psychological Science that includes a comparison of the results for democrats, republicans, men, women, wealthy, and poor.

Quote from their paper, "Most important from a policy perspective, we observed a surprising level of consensus: All demographic groups—even those not usually associated with wealth redistribution such as Republicans and the wealthy—desired a more equal distribution of wealth than the status quo."


http://www.people.hbs.edu/mnorton/norton%20ariely.pdf