Doubleline Data Fail, The Stock Market Has been up for 7 straight years...and More!

Recently Jeffrey Gundlach from Doubleline had a conference call and soon the below chart was being passed around Twitter (even I passed it around, before stopping to think about it for a second).

However, as people may recall, we had quite strong markets in both the 80s and 90s. Yet this chart shows that the streaks never got longer than 5 years in those decades. However, a quick check of the history books will remind everyone that the market was up 8 straight years from 1982-1989 and then was also up 9 straight years from 1991-1999. Below are the 2 separate streaks. You will also notice that there was only 1 down year of -3.06% in 1990 that actually stopped it from being 18 straight years.

So how did Doubleline mess this up? Well according to their chart their source data appears to be well known shiller data http://www.econ.yale.edu/~shiller/. The excel file is here. Odd they would use this for annual returns however, because that is not the purpose of the data...and you can't get calandar year returns from the data! (or any 1 year period for that matter) You will notice they say the streak in the 1980s was only 5 years. This is because they say the 1982 run ended in 1987....only 1987 was positive 5.81%. Why did they mess up? Well Shiller doesn't quote annual S&P returns. He only gives monthly S&P levels and they are NOT the starting or ending level for the month. They are the AVERAGE S&P level for the month. So the fact of the matter is you can't get calendar year returns from this data . Here is what it looks like 

The market closed at 242.12 on 12/31/86 and closed at 247.08 on 12/31/87. That's 2% up plus the dividends got you to 5.81% for 1987. None of those numbers match the Shiller data because his data is the AVERAGE close for everyday of the month.

So now everyone can stop repeating this inaccurate information. Thanks! (yes I did it too!)

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Additional Note: I have since come across an article where Roland Kaloyan of Societe Generale states in December "Since 1875, we have never seen the S&P rise for seven calendar years in a row, so an eighth year would seem highly unlikely,". Who was the originator of this myth?

How The Largest Actively Managed Mutual Funds From 15 years Ago Performed

You can't go long without reading an article about the death of active management. Somewhere in a discussion like that you will also hear that the larger a fund gets the more likely it is to under-perform. My purpose of this post is not to get into either of those issues but I thought it would be interesting to take a glimpse back in time to the largest funds of 1999 (15 years ago).

For this exercise I decided to screen for the largest actively managed funds 15 years ago (8/1999) which had the S&P 500 as their prospectus benchmark. The top 10 results looked like this

So how did they do? Were they too big to outperform?

Indeed, the largest fund did manage to under-perform. However, as a whole, these large funds did quite well. Over the last 15 years the largest 10 funds which were benchmarked to the S&P 500 managed to return an average of 5.47% compared to 4.47% for the S&P 500.

What's also interesting is that despite the fact that I compared them all to their prospectus benchmark of the S&P 500, a few of them tend to have a known growth tilt (Vanguard Primecap, Growth Fund of America, Fidelty Contrafund) but they all managed to significantly beat the S&P 500 despite the fact that growth significantly underperformed the S&P during this time (Russell 1000 Growth returned only 3.18% compared to 4.47% on the S&P 500).

Test Makers Fail Financial Literacy Test

So news was recently going around about a Financial Literacy Test made by the OECD. The Wall Street Journal provided 5 sample questions from the test and I must say that the OECD fails it's own question.

First of all I'm switching the "zeds" to $ for typing purposes. So Mrs Jones current loan balance is $7400, it has a 15% interest rate with monthly payments of $150. This means that the loan will take 78 payments (months) to payoff and TOTAL INTEREST paid over the life of the loan will be $4,178 (yes below it equals $4,180 due to rounding).

However, if she decides to take out a new larger loan of $10,000 at an interest rate of 13% while repaying at the same $150 rate then it will take 119 payments (months) to payoff and TOTAL INTEREST paid over the life of the loan will be $7,832. In other words she will be paying $3,654 MORE INTEREST.

Despite these facts OECD says the answer is as follows

Clearly A, as I showed earlier, is not correct. Therefore C is also wrong. While she is paying a lower interest RATE, she is clearly paying HIGHER INTEREST in total ($7,832 vs $4,178). B is in fact correct, she will have more money available but she will be paying interest on that money and unless she has an investment that is going to earn her more then the cost of funds (13%) she would be better off taking a smaller loan.

Why am I not surprised that the OECD would come up with this clearly incorrect answer regarding interest paid? Because they seem to encourage over-leveraged economies at every opportunity, so here they are teaching incorrect information, helping everyone become slaves to debt through bad information.

Many Government Bonds Yielding Less Than United States

I can't listen to a talking head, bond manager, strategist or seemingly anyone without hearing about how "Rates can only go higher from here". When in reality THEY CAN go lower! In fact, when you look around the world, on a relative basis, THEY SHOULD!

Look at that list and tell me the United States should pay more on their debt then all those countries. France is borrowing at 1.77% people, FRANCE! You have Japan borrowing at a rate 76% lower than the US with more than twice the debt. Now all this doesn't mean the united states SHOULD trade lower, but it's either that or others SHOULD trade higher because on a relative basis, much is out-of-whack. And those calling for much higher rates in the U.S should realize that basket cases like Italy and Spain are trading at 3.1%!

Interestingly enough, despite the relative attractiveness of US rates you have nearly EVERY "unconstrained" bond fund avoiding US duration risk at all costs, meanwhile loading up on risky credit. How often is the herd correct?

A Look At Sloppy Nonsensical Mutual Fund / ETF Analysis

I read a lot of stuff online so I should be used to sloppy-stupid nonsensical things written online. However, this one titled "Why ETFs Are Better than Mutual Funds, in Two Charts" hits it on every base of stupidity. Now usually ETF Database is a decent source of some good information but clearly the editors were asleep at the wheel on this one. Let the article speak for itself.

It starts off fine enough

"Though some may disagree, exchange-traded funds have certainly proved their worth over the years. With more than 1,500 products to choose from, more and more investors have turned to the ETF wrapper, embracing the vehicles’ low-costs, efficiency, and many other advantages."

All is good there. And so she continues

"Some investors and industry professionals, however, have not yet come to embrace these products, preferring mutual funds instead. For those who need some convincing, we’ll try to show you why ETFs are better than mutual funds, in two charts."

Great, let's see it.

"For this exercise, we take a look at the popular Emerging Markets ETF (VWO, A), comparing it to the GS Emerging Markets Equity Fund (GEMCX). First, a comparison of expenses:"

Whoa Whoa, wait a second, WHAT? First of all what made her decide to use Goldman Sachs Emerging Markets Fund? Furthermore, why would she use a C share? The fund also comes in other share classes including IR share class which comes in at 1.48% (we will also overlook the small fact that net expense ratios for those funds are 0.15% and 2.47% not what she has listed). The only people who might be using a C share are people working with an adviser and the advisers fee is being included into the expense ratio (but that is a discussion for another day). This is nowhere NEAR an apples to apples comparison showing why ETFs are better than Mutual Funds.

She goes on to point out the performance gap that this inevitably leads to 

And she concludes:

The Bottom Line

This is just one of many examples of how ETFs are often better than mutual funds. Not only are exchange-traded funds usually cheaper, but they are often more efficient than mutual funds. If we’ve managed to convince you, use our free Mutual Fund to ETF Converter Tool to find an alternative to your current mutual fund.

Sorry, you have not managed to convince me and hopefully you didn't convince anybody with your ridiculous comparison. I hope your "converter tool" has a little more logic then is displayed here. So what is a PROPER comparison of the ETF VWO if you are trying to see the difference between mutual fund and ETF structures? Well the very simple and logical comparison would be Vanguard's Emerging Markets ETF (VWO) to Vanguard's Emerging Market Index Mutual Fund (VEMAX).

Only problem is that when you show a REAL comparison, your point is pretty much lost . As you can see, looking at the complete common period between the two funds, there return is essentially identical.

Not only does a proper comparison make her performance point invalid, her point about cost is as well, as both carry an expense ratio of 0.15%. But just for giggles lets throw in Vanguard's Active version of emerging markets which is a little more expensive with an expense ratio of 0.94%. Unfortunately, their active emerging markets strategy hasn't been around as long (A little shy of 3 years) but as you can see it has managed to handily outperform. You may also notice that over this timeframe the index MUTUAL FUND slightly outperformed the supposedly superior ETF.

Are Index Investors Unknowingly Increasing Interest Rate Risk?

Here in an interestingly look at the Barclay's US Aggregate Bond Index from Lord Abbett  The below Chart shows how the duration of the Index has changed over the last ten years.

As you can see, up until late 2010 the duration of the Aggregate Bond Index tended to hover around 4.5 years. That has increased to approximately 5.5 years today. I think it is important that "passive" index investors be aware that they are currently making an "active" decision to increase their interest rate risk.

Emerging Markets Price-to-Book Ratio & Forward Returns

Here is an interesting look from J.P Morgan regarding the Price-to-Book ratio on Emerging Markets.

They then look at how those various Price-to-Book ratios relate to forward 1-year returns....In short, it looks good.

Although I don't like that the 1-year forward returns only use 1999 to today. Why not use the same data as the first graph back to 1993? Also, I don't tend to think any valuation metric is a reliable short-term (1 year) timing indicator. However, Rob Arnott has also been pointing out that longer-term forward returns (10 years) are also looking pretty tempting using a Shiller PE ratio. All I know is, anything looks good 'relative' to the US right now.

Foolish Fed Forecaster Rankings

The Wall Street Journal recently published a piece Ranking Fed Forecasters (you can read their methodology following that link). Let's see if you notice anything "convenient" about the sample period.

Does this "analysis" smell of sampling period bias to anyone else? June 2009 - Dec 2012? Who really cares about someones accuracy during exactly HALF a market cycle? If you were analyzing investment managers using this same type of sampling period bias you would be many times more likely to find managers that would under-perform going forward not outperform. I think the "analysis" here runs the same risk.

Unfortunately, this is being used by the WSJ to support the case for Janet Yellen. And gullible audiences everywhere are likely taking it hook, line and sinker.

What would it look like if they went back further? I'm not sure, but I do know that Janet Yellen was just as foolish as most everyone else currently at the Fed as demonstrated in this article from Feb 21, 2007 

"Janet Yellen, president of the Federal Reserve Bank of San Francisco, is sleeping better than she was a year ago, thanks to signs of stabilization in the housing market."

 "Last year, when it looked like the housing downturn could turn into a bust that risked tipping the broader economy into recession, Yellen said she found it more difficult to sleep."

 "But Yellen said she has noted recent signs of stabilization in the housing market and slim evidence that housing's slowdown has spilled into other parts of the economy."

Yes, in 2006 she had some worries about housing but apparently those went away after housing prices fell a whopping 1.5% before "stabilizing" in early 2007.

And how about the next year? What did she think then? This is from Reuters Feb 8, 2008

"San Francisco Federal Reserve Bank President Janet Yellen said on Thursday that the United States faces several quarters of "anemic" economic growth but will probably not fall into an outright recession."

Yes, that is in February 2008......2 months after the recession already started. And according to the WSJ that is the best forecaster of all Fed members. We have so much to look forward to........

Valuations of Emerging Markets vs US Stocks

As the US Stock market continues to sing it's own tone, I thought this look at valuations of US Stocks vs Emerging Market stocks was interesting. This is from a conference call presentation from Rob Arnott at PIMCO (all slides here)

Really hard to be tempted by US stocks at these levels, especially with both emerging & even developed international as alternatives considering valuations. Below is another chart from the slides, showing the shorter & longer term returns from various Shiller PEs. Clearly it's a longer-term gauge historically.

Is This Bull Market Fundamentally Driven? (A Look at PE Expansion)

This post over at The Big Picture Blog which had a listing of Bull markets of 20% or more without a 20% correction got me thinking about Bull Market fundamentals. Some people talk about this bull market being driven by the Fed and not fundamentals (me included). I can easily point at a Shiller PE of 23 to highlight overvaluation but I wanted to look at it another way, so I focused on PE expansion.

Fundamentally driven bull markets should rely more on cyclically adjusted earnings growth and less on investors willingness to pay ever increasing multiples on those earnings. To look into this I decided to focus only on bull markets of 100% or more. I looked at the Starting and Ending Shiller PE using Robert Shiller's online data and updated it with daily pricing data for the important dates (as he only has monthly prices). Then I divided the Bull Market gains by the amount of PE expansion to see how much gains investors were receiving per unit of PE expansion. The results are below, sorted by most fundamentally driven to least fundamentally driven. The results are quite interesting.

Take a look at the 1974-1980 Bull Market compared to today....The magnitude of the advance is similar between the two but the 1974-1980 advance only relied on a PE expansion of 2.2 vs 11.1 today. You will also notice that those that relied least on PE expansion tended to experience smaller subsequent bear markets. The top 5 averaged a bear market loss of 30.4% vs the bottom 4 which averaged a 48.5% loss. If history is any guide people should expect that the next bear market will be deeper then average because this bull market is lacking a fundamental underpinning.

UPDATED: 3/19/2013 - Corrected chart to reflect the proper starting PE of 8.8 for the bull market starting 6/13/1949. However, this did not change the overall ranking of any of the bull markets.