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Risks And Avoidable Mistakes For 2015

Originally published on Jan. 4, 2015 Introduction For most dollar oriented investors 2014 was an “okay” year with a third year in a row of double digit gains for the S&P 500, but not for the bulk of institutional accounts. Consciously or not, many investors and managers were aware of the length of the present bull market having entered its 61st month. This has created twin dilemmas for the prudent management of responsible money. First dilemma – Large Cap over-ownership As regular readers of these posts recognize and true to my analytical history, I tend to view investments through the lens of mutual funds. When simplifying the fund performance data for 2014 by size of market capitalizations the following is revealed: Large Cap funds 11% Multi-cap funds (Unrestricted/ or “go anywhere” funds 9% Mid Cap funds 8% Small Cap funds 3% In a dynamic economy the rank order of operating earnings power generation would be in the opposite order, being led by Small Caps or possibly the successful “Go Anywhere” funds. Focusing on operational earnings, excluding foreign exchange benefits, I believe that the Large Caps were producing approximately 3 times the long-term growth of the Small Caps. The better market performance of the Large Caps, I believe, was a function of market structure changes. Some institutional investors being concerned with the duration of this bull market moved heavily into Large Cap stocks directly or more importantly through the use of ETFs invested in the S&P 500 and other indices. Because of perceived greater liquidity in Large Caps they were hiding out in what we used to call warehouses. With governments all over the world looking to Large Caps being “social progress” engines, I have some doubts as to the growth prospects for Large Cap companies. Second dilemma – Historical constraints As is often the case, apparent boundaries come with both hard data and locked-in thought processes. The data is the easy part. While as noted we are in the sixty-first month of the recovery, of the nine last market recoveries, four have been over 100 days in length with the longest being 181 days. Thus for a manager a possible career risk is exiting too soon which puts a premium on investing in liquid positions. Because so many others have made similar judgments as to the better liquidity in Large Caps, if there is a sudden drop in the market, I believe the excessive amount invested in Large Caps will find their exit liquidity either expensive or non-existent for those that are late. The biggest risk for investors and their managers are the biases that many of us labor with in making so-called rational decisions. The following are a list of these biases as listed by Essential Analytics. List of biases Outcome, herding, conviction (the curse of knowledge), recency, framing, band wagon effect, information, anchoring, optimism. I suggest that many of these biases find their way into reports; supporting in effect, the reasons we all have made decisions that haven’t worked out. The key for all of us is to understand our biases. Some biases we will be able to overcome. Others we will have to accept as immutable. This suggests that when putting together a portfolio of funds or managers, it would be wise to try to diversify the various biases of the hired portfolio managers as well as our own as the owners or fiduciaries of the capital being deployed. Overcoming biases I have a definite advantage in this task by personality. By nature I am both curious of what I don’t know and often a contrarian. As a contrarian again using the mutual fund microscope, the following may be useful thoughts: Looking to extremes one might wish to set up a pair trade of being long some of the components in the S&P Latin American energy index which declined -39% vs. the average Indian fund which was up 41% in 2014. In a similar fashion one might start to research funds in the following groups that declined in 2014: Energy Commodity funds -34% General Commodity funds -16% Global Natural Resources funds -15% Domestic Natural Resources funds -15% Dedicated Short-bias funds -15% I take some comfort in the contrarian thoughts contained in the headline to John Authers insightful Financial Times column: “The case for gently shifting money away from US.” I believe a well-reasoned portfolio should be looking for opportunities on a global basis both in terms of what companies do and where various securities are traded. Final thought Many year-end predictions are essentially extrapolations of existing market trends and this could be what will happen. However, I am searching for the beginnings of new trends that will produce +20% or -20% in a twelve month period. I would appreciate hearing your thoughts as to when and which direction (or both) you expect price movement. I firmly believe we will once again experience this kind of action.

Dividend Growth Equities Outperform During Increasing Interest Rate Periods

At the end of 2013 most if not all strategists expected interest rates to rise with the anticipated end of quantitative easing. However, the market proved the consensus point of view wrong. As the below chart shows, the high rate on the 10-year treasury occurred at the beginning of 2014 at just over a 3% yield. Throughout the year the interest rate trend was lower culminating in a spike lower to 1.87% in mid-October. The consensus view for interest rates in 2015 is the same as 2014, that is, rates will end the year higher. If this higher rate cycle is realized, investors realize the impact on bond prices is a negative one. For stocks though, a higher Fed rate cycle historically is not a negative for equities. As the below chart details, during periods of rising interest rates, dividend growth stocks have generated higher, and positive, returns with less volatility. Source: Blackrock (pdf) Investors should keep in mind dividend paying stocks historically dip lower an average of 9% during the first 3-4 months of the increasing rate cycle. Finally, in an early 2014 article in the Wall Street Journal, the author looked at average calendar year returns going back to 1963. The table included in the article(below) notes large company stocks generate near double digit returns during rising rate periods with small caps generating mid-teens returns. Source: Wall Street Journal If rates do rise in 2015, stocks may face an initial downward shock; however, over the entire rate cycle, stocks can be a positive contributor to one’s portfolio performance. Now that you’ve read this, are you Bullish or Bearish on ? Bullish Bearish Sentiment on ( ) Thanks for sharing your thoughts. Why are you ? Submit & View Results Skip to results » Share this article with a colleague

Should You Invest In Your Company’s Stock?

Summary Many employers offer stock option programs or 401k discounts on their own stock. While you want to stay diversified, contributing a little to your employer’s stock can be a good thing. Many people say investing in your own company is a grave mistake. Avoiding this option altogether, we believe is foolish. By Parke Shall The case against holding your own company’s stock in your 401k or IRA has been “common sense” in the financial world, thanks to commentators like Suze Orman who continually say it’s a terrible idea. Other financial pundits have also said the same thing. Recently, Jim Cramer from CNBC reiterated these comments, telling investors to avoid owning their own company in an article linked below on CNBC.com. Once again we’ve found a small instance where we fail to agree with stock guru Jim Cramer’s call on something. If you recall, we’ve had respectful disagreements with Mr. Cramer, namely over the Home Depot (NYSE: HD ) data breach, where he assured people it wasn’t likely to be a big deal before we knew exactly how bad the situation was. Later, it would be revealed that it was a bit bigger of a deal than Home Depot, or its shareholders, had anticipated. Mr. Cramer is no doubt very in tune with how the financial markets work, but we disagree with him here. This article in question goes on to talk about Cramer’s suggestion not to load the boat with stock of the company you work with. Of course, I know many people that have made exorbitant sums to retire with by doing just that – after all, who would tell someone in the 80s not to invest in their own company if they were working at places like Apple (NASDAQ: AAPL ), Google (NASDAQ: GOOG ), Microsoft (NASDAQ: MSFT ), or 3M (NYSE: MMM ). This recent article follows numerous articles like this one , which also claim owning your company’s stock in your 401k could be a “big mistake.” Let us also not forget that Mr. Cramer has made large sums himself, while investing in his own companies, like TheStreet (NASDAQ: TST ) and then selling their stock. Most of his money came from options, but it’s worth nothing. It’s also worth nothing that Mr. Cramer made a significant investment in TheStreet upon its launch. So, is this a case of “do as I say and not as I do?” Not really. We’re sure Mr. Cramer has the best intentions in trying to get his message across, but simply saying “don’t put all your eggs in one basket” would certainly be enough. We think there’s a good argument for investing a reasonably small amount in the company you work for. The PROs of investing in where you work: you can usually get stock at a discount (previous employers of ours have offered stock at the lowest point in the quarter at the end of each quarter, generally giving you immediate upside) keeps you engaged and working toward something makes work meaningful builds corporate culture allows you to share in your personal success and your team’s success helps you take interest in your company from an executive lens The CONs of investing in where you work: putting all of your eggs in one basket potentially blinding yourself and ignoring an objective analysis of a company and its financials The CNBC article goes on to say: What if you worked for a company like Enron and invested all of your retirement into their stock? Your retirement probably would have gone down the tubes along with the company. “You probably feel like you understand the company that you work for, and the excuse is that you’re investing in what you know. I’m telling you, that excuse doesn’t cut it,” Cramer added. Let’s face it, an Enron style company comes around once in every 10-20 years. The chances that your everyday job that you go to is the next Enron or Worlcom are very slim. That’s not to say there aren’t specific companies out there that we wouldn’t invest in right now, because there are. Having said that, there is some due diligence that you should be required to do before even investing in your own company’s stock. A 401(k) investment in a staple company like Johnson & Johnson (NYSE: JNJ ) would certainly be a different risk than investing in a speculative startup or a company with a high valuation. So, invest, yes; but do your research first. Some companies place restrictions on when you can buy and sell the stock you’ve earned from them. 401(k) plans usually have reallocation periods every other quarter or every quarter where you can rearrange your contribution percentages. As long as you’re actively managing your portfolio and paying attention to the publicly available information on your company as it’s made available in the market, it’s no different than going out an investing in other companies. After all, when you go out and load up on dividend stocks to make a portfolio, don’t you want the people at those companies to be owners of their own companies stock? I do. While we’re not saying you should go out and load 100% of your portfolio in your company’s business, we don’t think it should be something avoided altogether. Do your research; investing in your company and inadvertently, in yourself, can be a good thing. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.