Tag Archives: income

The ETF Monkey Vanguard Core Portfolio: April 13, 2016 Rebalance

Back on February 11, 2016, I executed a series of transactions to rebalance The ETF Monkey Vanguard Core Portfolio . As explained in that article, the severe decline in both domestic and foreign stocks left these two asset classes significantly underweight, with bonds being overweight. Here, for convenience, is a “before and after” snapshot of that transaction. Click to enlarge As it turns out, the timing of that rebalancing could not have been better. In hindsight, it can be seen that February 11 represented, at least to this point, the low point for 2016. I don’t take particular credit for this. My efforts were simply an application of the principles found in this article . As I also noted in my previous article, I executed a fairly aggressive set of transactions. Mindful of the fact that I am deliberately incurring trading commissions on all transactions in this particular portfolio, to make the exercise as “real world” as possible, I commented that I need to make each transaction count. This being the case, I temporarily underweighted bonds in favor of adding to the other two severely depressed asset classes. Here is the equivalent Excel spreadsheet for today’s transaction. Have a look, and then I will offer some comments. Click to enlarge Likely, the first thing that jumped out at you is that both domestic and foreign stocks have staged fairly stunning comebacks since February 11. The Vanguard Total Stock Market ETF (NYSEARCA: VTI ) registered a gain of 14.69% during this period, while the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ) did even better, at 15.55%! On the flip side, this incredible performance, combined with my aggressive rebalancing transaction, left bonds substantially underweight, with their 13.37% weighting being a full 4.13% below my target weight of 17.50%, or a full 23.6% in relative terms (13.37 / 17.50). Given these developments, it appeared to me that this was a fitting point to take some of those profits, so to speak, and get the portfolio more closely aligned with my target weights. While it is not yet May, I will admit that the old adage “Sell in May and go away” contributed in some small way to the timing of this decision. I didn’t want to take a chance on being overweight domestic equities, only to have them experience a summer swoon! You may also notice that foreign stocks were about even with my target allocation as I reviewed the portfolio today. This is because I did not add as heavily to this asset class in the prior rebalance. Therefore, I decided to only affect the domestic stock and bond asset classes with this transaction, saving me one trading commission. Take one last peek at the “after” section of the spreadsheet, and you will notice that all 3 asset classes are now fairly closely aligned with their targets. I hope that this sets the portfolio up nicely for the summer. Disclosure: I am not a registered investment advisor or broker/dealer. Readers are cautioned that the material contained herein should be used solely for informational purposes, and are encouraged to consult with their financial and/or tax advisor respecting the applicability of this information to their personal circumstances. Investing involves risk, including the loss of principal. Readers are solely responsible for their own investment decisions.

Estimating Future Stock Returns

Click to enlarge Idea Credit: Philosophical Economics , but I estimated and designed the graphs There are many alternative models for attempting to estimate how undervalued or overvalued the stock market is. Among them are: Price/Book P/Retained Earnings Q-ratio (Market Capitalization of the entire market / replacement cost) Market Capitalization of the entire market / GDP Shiller’s CAPE10 (and all modified versions) Typically these explain 60-70% of the variation in stock returns. Today I can tell you there is a better model, which is not mine, I found it at the blog Philosophical Economics. The basic idea of the model is this: look at the proportion of US wealth held by private investors in stocks using the Fed’s Z.1 report. The higher the proportion, the lower future returns will be. There are two aspects of the intuition here, as I see it: the simple one is that when ordinary people are scared and have run from stocks, future returns tend to be higher (buy panic). When ordinary people are buying stocks with both hands, it is time to sell stocks to them, or even do IPOs to feed them catchy new overpriced stocks (sell greed). The second intuitive way to view it is that it is analogous to Modiglani and Miller’s capital structure theory, where assets return the same regardless of how they are financed with equity and debt. When equity is a small component as a percentage of market value, equities will return better than when it is a big component. What it Means Now Now, if you look at the graph at the top of my blog, which was estimated back in mid-March off of year-end data, you can notice a few things: The formula explains more than 90% of the variation in return over a ten-year period. Back in March of 2009, it estimated returns of 16%/year over the next ten years. Back in March of 1999, it estimated returns of -2%/year over the next ten years. At present, it forecasts returns of 6%/year, bouncing back from an estimate of around 4.7% one year ago. I have two more graphs to show on this. The first one below is showing the curve as I tried to fit it to the level of the S&P 500. You will note that it fits better at the end. The reason for that it is not a total return index and so the difference going backward in time are the accumulated dividends. That said, I can make the statement that the S&P 500 should be near 3000 at the end of 2025, give or take several hundred points. You might say, “Wait, the graph looks higher than that.” You’re right, but I had to take out the anticipated dividends. Click to enlarge The next graph shows the fit using a homemade total return index. Note the close fit. Click to enlarge Implications If total returns from stocks are only likely to be 6.1%/year (w/ dividends @ 2.2%) for the next 10 years, what does that do to: Pension funding / Retirement Variable annuities Convertible bonds Employee Stock Options Anything that relies on the returns from stocks? Defined benefit pension funds are expecting a lot higher returns out of stocks than 6%. Expect funding gaps to widen further unless contributions increase. Defined contributions face the same problem, at the time that the tail end of the Baby Boom needs returns. (Sorry, they *don’t* come when you need them.) Variable annuities and high-load mutual funds take a big bite out of scant future returns – people will be disappointed with the returns. With convertible bonds, many will not go “into the money.” They will remain bonds, and not stock substitutes. Many employee stock options and stock ownership plan will deliver meager value unless the company is hot stuff. The entire capital structure is consistent with low-ish corporate bond yields, and low-ish volatility. It’s a low-yielding environment for capital almost everywhere. This is partially due to the machinations of the world’s central banks, which have tried to stimulate the economy by lowering rates, rather than letting recessions clear away low-yielding projects that are unworthy of the capital that they employ. Reset Your Expectations and Save More If you want more at retirement, you will have to set more aside. You could take a chance, and wait to see if the market will sell off, but valuations today are near the 70th percentile. That’s high, but not nosebleed high. If this measure got to levels 3%/year returns, I would hedge my positions, but that would imply the S&P 500 at around 2500. As for now, I continue my ordinary investing posture. If you want, you can do the same. Disclosure: None

The Buyback Binge: Is It Good For Shareowners?

By Paul McCaffrey Share buybacks haven’t been getting the best press of late. They’ve been dismissed as ” self-cannibalization ,” “corporate cocaine,” a recipe for conflict of interest, and a form of stock price manipulation – not to mention shortsighted and counterproductive . Yet share buybacks are incredibly popular. Since 2009, S&P 500 companies have spent more than $2 trillion on repurchases. From 2005 through late 2015, IBM (NYSE: IBM ) spent $125 billion on them. In the first three quarters of 2015 alone, Apple (NASDAQ: AAPL ) bought back $30.2 billion worth. Indeed, much of the credit for the post-financial crisis bull market of the last seven years can be attributed to the ubiquity of share buybacks. At bottom, repurchases are a way of rewarding shareowners. By buying up shares, a company raises the value of those remaining with its stockholders, which in turn will tend to boost earnings per share (EPS). At the same time, buybacks are more tax efficient for shareowners, than, say, spending the capital on taxable dividends. Share buybacks, proponents maintain, are also a good use of excess cash when business circumstances make the timing for other outlays, whether acquisitions, new research, expansion, etc., less than ideal. Critics argue that whatever the upsides of buybacks, they tend to be short-lived, adding no real value over the long term. Every dollar spent on buybacks is one less that could otherwise be used on research and development, acquisitions, etc. Management surely could find a more productive use of capital. And sometimes the repurchases are financed by issuing debt. The timing can also be problematic. Repurchases may make sense if a stock is undervalued, but if a stock is priced higher than its intrinsic worth, any buyback is a net loss. Buybacks can create a degree of moral hazard for management as well, skeptics claim. Pay packages are often tied to EPS, so executives may be incentivized to implement buybacks and sacrifice the firm’s future viability for a short-term boost in EPS. Similarly, if compensation is in any way a function of share price, executives might be inclined to use share repurchases to meet their targets. Buybacks can likewise be employed to facilitate share options programs for management, effectively transferring value from shareowner to executives. To get a sense of how investment professionals view share buybacks, we polled readers of CFA Institute Financial NewsBrief . Specifically, we asked them whether share buybacks were good for shareowners. Are share buybacks a net positive or negative for shareowners? A majority (53%) of the 814 respondents said that, on the whole, share buybacks constituted a net benefit to shareowners. Another 24% declared that they were neither positive nor negative, while 21% felt they were detrimental. Of course, the poll question and the results have a number of enigmas embedded in them. The degree of variation encapsulated in the word “shareowner” necessarily complicates the matter. Each shareowner is unique, with different inclinations and incentives. Certainly, share buybacks might benefit the shareowners anxious to unload their stakes. But those with a longer time horizon might have a vastly different take on things. It also brings up the whole concept of shareholder value, and by extension, shareholder value maximization and whether that it or isn’t a dumb idea . And what about the larger implications of share buybacks? Ultimately, the poll focuses on only one kind of stakeholder. Whether repurchases are beneficial to a company’s long-term health, its employees, the markets, and the larger economy are entirely different issues, and well worth further exploration. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.