Bibliography … and books I want to read too

I can never just read one book at a time.  Especially since I’ve gotten my Kindle (which is fantastic, btw), I have 4 or 5 books going at a given time.  This is part of always remaining a student, in my eyes.  Reading websites and blogs is good, but you rarely get as much in depth stories or analysis that you can get in a book. 

Here is that I’m reading now that you might find interesting … I link to the actual book but these are all available on kindle too, which is what I recommend.

The Sellout: How Three Decades of Wall Street Greed and Government Mismanagement Destroyed the Global Financial System

Liar’s Poker

The Inheritance of Rome: Illuminating the Dark Ages, 400-1000 (Penguin History of Europe)

The Book of Basketball: The NBA According to The Sports Guy

And warming up in the bullpen I have the following …

ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism

Intermarket Analysis: Profiting from Global Market Relationships (Wiley Trading)

Prechter’s Perspective, 2004 Edition

How We Know What Isn’t So: The Fallibility of Human Reason in Everyday Life

These ought to keep me out of trouble for a while … just thought I would share

Asset Allocation – Quarterly Rebalancing

As I continue my journey into Asset Allocation enlightenment, I thought it would pay to see what would happen to my model portfolios if we changed the time frame between rebalancing. 

The Little Book that Saves Your Assets: What the Rich Do to Stay Wealthy in Up and Down Markets (Little Books. Big Profits)

I looked into annual rebalancing at first.  Basically at the start of each year, we would make sure the entire portfolio had the right percentage of each mutual fund.  We learned that doing this kept our asset allocations from deviating too far from where they would be if we never rebalanced.  In completing this exercise it occurred to me – a year sure is a long time. 

A great deal can happen in a year to misalign our portfolio with our risk appetite. 

What I did was add 3 more rebalancing episodes per year.  With a total of four – one for each quarter (I’m clever like that), I believe we can capture any gains and keep our allocations in their proper proportions. 

The results were even better than I had hoped – the Quarterly Rebalancing led to better portfolio performance over the long term.  You will see annual variances on this, but over the 9 year test period, the Quarterly Rebalanced portfolios outperformed the Annually Rebalanced portfolios.

See the results below:

Guess I should watch the highlighting when I’m snagging from excel … in any case …

These results are enough for me to say that EVERYONE’S PORTFOLIO SHOULD BE REBALANCED QUARTERLY.  This goes for 401k’s and IRA’s.  Roth or standard. 

Now then … I’m starting to get somewhere here.  There are a few more topics I need to jump into as part of this project:

• How do fees effect performance?
• What asset mix is right for you?
• Does it make sense to change asset mixes year to year?

Until next time … keep learning!

Can Stocks Keep Going Higher?

Stocks seem to have started their way back up – I think the Dow Jones just went positive for 2010.  The sell off of January seems to have worn off in February and we are getting close to making new highs. 

It looks like the long term chart is showing some price support.  I have used the Volume-by-Price indicator before and I see something interesting.  Any new high will likely see a lack of resistance up to the 1200 level or so. 

During the rally, different Vol/Price levels filled up with black – that is “up” volume.  These levels had not seen much up volume since we plunged thru them on down volume back in September and October of 2008.  See the price levels from 900-1050.  That could be a continuing trend.

The channel lines that I drew based on the most recent high and low are not perfectly aligned with the Volume/Price level.  But I think it is still give us an indication that there might not be much selling pressure until we get thru the next band – which would be about 1200 on the S&P 500. 

Vol/Price data aside, we are quickly approaching the level of the market before the major sell off from Fall 2008.  I think this could be a resistance level for the overall market.  Dan Fitzpatrick likes to call this the “I want my money back” trade.  Well if you remember that sell off, more people than ever were in tuned with the sell off, and therefore were more aware of their own investments.  Those who lost money might be inclined to distrust this market and might move their money out if they are close to making their “money back”. 

This is pure speculation on my part, and I am often wrong. 

However, there is a little ways to go before we get to the “money back” point.

Asset Allocation – Rebalancing Reduces Risk

When determining the mix of asset classes to include in our portfolio – be it an IRA, 401k or Ameritrade – we consider many factors.  As I see them, the basics of these are:

• Performance – what return we expect
• Risk Level – how much volatility we can stomach
• Time Horizon – how long are we going to invest

I put together four model portfolios considering the first two of those considerations.  I really have not dived into time horizon yet, but that will come.  I made the assumption of rebalancing the portfolios on an annual basis.  I thought that I would play with that to see how it would change my portfolios. 

The Little Book that Saves Your Assets: What the Rich Do to Stay Wealthy in Up and Down Markets (Little Books. Big Profits)

Last week I studied how my model portfolios would perform if I never rebalanced them.  I determined that the overall portfolio performance was not effected too much by not rebalancing – which surprised me.  I acknowledged at the time removing rebalancing would end up changing more than the performance – it would also throw your asset mix out of line with what you had originally set it up to be.  It would, in short, not be in line with your original risk tolerance level. 

What I did not know, however, is how much it would change.  Without rebalancing, your portfolio can become an entirely new animal.  You would not recognize it over time – as short as a single year. 

The change is seen most dramatically in the class labeled “Other”.  This includes Real Estate, Precious Metals and Commodities.  These are each asset classes, but for this experiment we will treat them all as one.  They are more volatile – riskier – assets than either stocks or bonds.  My opinion is that there is a place for them in all of my asset mixes. 

Take a look at the “safe portfolio” – Allocation 3. 

Here we wanted half of the portfolio in Bonds.  Only 10% was to be allocated to the riskiest of asset groups.  Within a year, the allocation mix of the risky assets nearly doubled.  By mid decade the allocation to these classes nearly tripled!  It is not even close to the portfolio that we had wanted. 

Of course, looking at the performance of the portfolio, you might not be inclined to worry about it – I mean, you’re making money …

So what’s the problem? 

The problem is that if you are like me, you always want to know how your 401k is doing?  One of the things that you will see is your allocation and your future contributions.  If you don’t rebalance, you will be watching your desired asset mix change on a monthly, quarterly or yearly basis!

Of course, if you were checking your portfolio, you probably would not let your asset mix get too far out of line with your risk tolerance.  I suppose I am really not talking to you in this post.

I’m talk to the people who have not checked your portfolio in years.  You know who you are.  Of course, if you’re not checking your portfolio, you’re nog likely to have found my website.  But that’s ok. 

It is entirely likely that over time you may want to change your asset mix.  Your desire for more performance and tolerance for risk may be greater.  If that is the case, then the thing to do is develop a new asset mix.  The thing not to do is let your portfolio run wild and determine your portfolio for you. 

I will spend time on how and why and when to adjust your asset allocation.  I’ll just tell you now – don’t do it to chase performance in the Dow.  Please.

What did we learn today?  We learned that rebalancing is a great way to control your portfolio.  It keeps you from worrying about having too much invested in Real Estate or Gold.  If you think either is a “bubble”, then you’ll have a good idea how much you are exposed to them.

Rebalancing allows you to “set it and forget it” … ok, not really.  But it lets you sleep at night knowing that you’re no more exposed to risk than you were last year.

Now … having said that … all we have looked at thus far is annual rebalancing.  A year is a long time.  Much can happen and change in a year.  My next task will be to explore Quarterly Rebalancing. 

Excited?  Me too.

Mortgage Rates – artificially low right now?

I read a few articles yesterday regarding mortgage rates.  The firstwas on Calculated Risk, a site that I was recently turned onto.  It does a very thorough job discussing the real estate markets and mortgage rates.  The article yesterday mentioned included a graph of historical mortgage rates.  The result that the current yield on a 10 year Treasury – say 3.75% for talk’s sake – should be met with a 30 year fixed mortgage rate of 5.62%

The current 30 year fixed mortgage rate is much closer to 5.00% (exact numbers aren’t that important here).  The position taken by Calculated Risk was that this could be due to the Federal Reserve’s policy of purchasing Mortgage Backed Securities. 

That program is set to expire in the near future – at the end of March I believe.  When this ends, the theory was that we could see a jump in 30 year fixed mortgage rates of 35-50 basis points – or 0.35-0.50% to us lay people. 

I found this very interesting.  This assumes that the only mitigating factor keeping the rates artificially low is the purchasing of MBS by the Fed.  Of course, there are many factors that could be keeping the rates lower than would be expected by historical rates.  What those are I clearly have no idea (I’m just a student here).

The article ringed true to me because I associate the 30 year mortgage rate with both the 10 year yield and the MBS market.  Tracking the MBS market is something that I have not yet begun to learn, but you don’t have to be an expert to understand that the Fed purchase policy is impacting that market.  What will happen when this “backstop” is removed is a matter of much conjecture. 

Now then … I tweeted this article thinking I was all smart.  Then I read this on CNBC.com.  I don’t know Jeff Cox, anymore than I know the people behind Calculated Risk.  I just found the timing interesting. 

The premise of that article is that the market reaction to the news of a rise in the Federal Reserve’s Discount Rate was not as severe as some had thought.  The fear is that when the Fed stops buying the MBS’s, there will be a lack of buyers to step in.  The market reaction last week flies in the face of that.  There is less certainty that the MBS market will collapse. 

This could mean that the expected sharp rise in interest rates could be much less than expected.  30 year mortgage rates might not rise as much as feared.  There may still be time to refinance, which is all most of us are worried about. 

On top of that, back on the Calculated Risk site, they posted an addendum to their previous article.  They temper their statement of the sharp rise at the end of March.  They note that there will be private buyers out there for the Mortgage Backed Securities, it will just be a “matter of price”.  They quote an analyst who believes the rise in the rates will be less than some expect. 

So we will have to wait and see.  We know that there will be a change in the Mortgage Backed Securities market when the Federal Reserve’s purchase program ends.  We know that this market effects the mortgage market.  The table is set for some sort of shock to mortgage prices.  Whether this happens or not is something that the market will tell us in due time. 

Until then, make sure anyone who tweets “REFI NOW” is placed on “ignore” … even if that person is me … sigh … someday I’ll learn.

Portfolio Performance – To Rebalance or Not To Rebalance

Last week I posted the results of my first four different Asset Allocations.  I learned a few things about putting a portfolio together.  The biggest lesson I learned was this:

• USE AN ASSET MIX – any mix.  This will protect you from any Lost Decades

There are other important lessons out there, but that is the big one.  Even is you just pick two funds – 60% stocks and 40% bonds, you will do much better than in a single asset class.

The Little Book that Saves Your Assets: What the Rich Do to Stay Wealthy in Up and Down Markets (Little Books. Big Profits)

Having said that, I hope you do not simply pick one stock fund and one bond fund.  There are so many nice funds to choose from. 

I learned that a more risky portfolio performed better in generally ‘bullish’ stock market conditions.  Similarly, the bond-heavy safe portfolio lost less money in bearish conditions.  Really?  You need to come to studentofmarkets for that kind of insight?  If that’s all I learned, then I am no student.

I decided to look into the rebalancing of the portfolios to see how that would effect the portfolio performance.  Spoiler Alert – it didn’t change the performance as much as I expected. 

Rebalancing is necessary to keep a certain mix of asset classes – or in this case mutual funds.  If you want to be 30% in bonds, 60% in stocks and 10% in other classes, over time these percentages will drift.  Rebalancing your portfolio will sell some of the funds that grew beyond their allocation and buy some of the funds that shrunk in their percentage of your portfolio. 

Translation:  You will be selling high and buying low.  Generally.

In particularly bad market conditions (2008, I’m talking about you), all of the funds in my allocation lost money.  In this case you would sell the funds that lost the least and buy the ones that lost the most.  Still, you are selling the outperformers and buying the underperformers. 

Over time, some believe that performance evens out and seeks its long term average.  Rebalancing your portfolio goes hand in hand with this theory.  Outperformers will not always outperform and underperformers will not always underperform.  Therefore, it makes sense to trim back the high fliers and buy more of the beaten down asset classes.

So let’s take a look at a summary table of the four different allocations – the top set has been rebalanced annually and the bottom group was never rebalanced.  The bottom would be akin to starting a job, selecting a mix of funds in your 401k, and then never looking at it again for 9 years.  We would never do that though, would we?

Here we go …

For the most part, the allocations that performed the best when rebalanced performed the best without the rebalancing.  Only portfolio #2, which included fewer funds, performed appreciably worse over the whole time period with no rebalancing of the portfolio.  Each of the others is within a single percentage point. 

How is that possible?  If rebalancing is buying low, and selling high, then why would the fund performance be the basically the same if we DON’T do this?

I have to admit this surprised me.  I decided to look further into this.  Let’s look at the same table, only highlighted differently.  This time we will look at which version of each portfolio performed in a given year. 

Here it is …

With a couple of outliers, the non-rebalanced portfolios performed better before the stock market topped in 2007, and the rebalanced portfolios outperformed thereafter – in the bear market.

Hmmmm

This tells me that when the “sun is shining”, it is easy to outperform.  It is when market conditions get tricky that rebalancing becomes essential.

There is another aspect to this that I have not touched on and that is risk tolerance.  Each asset class comes with a certain degree of risk.  I won’t get into specifics but stocks are relatively high risk.  Commodities and real estate will be a bit higher.  Bonds will be less risky than stocks for the most part (corporate bonds can be risky).  Cash is even less risky, but I have not even added that into the portfolio yet. 

I will have to examine what happens to the un-rebalanced portfolios as far as the asset mix.  How far does the lack of rebalancing effect the desired asset allocation? 

At its most basic level, your asset allocation should reflect your own personal level of risk tolerance.  It should allow you to sleep at night. 

That will be the next step in this process.

studentofmarkets is now on twitter

It took me long enough, right?

Well I have a twitter account now. So now when I get a thought during the day, I can post it there.

That assumes that I get a thought during the day.

You can click on the right sidebar to follow me. If you want. And if you don’t want, that’s ok too.

Thanks!

Dow Jones Industrials compared to Price of Gold

Precious Metals Investing For Dummies

Back in December of 2008, I wrote about the Dow Jones Industrial Average price relative to the price of Gold.  It was one of my first forays into the world of  intermarket analysis.  I updated it about a year ago.    Just the other day I wrote about the S&P 500 compared to the US Dollar index.  I believe there is much to be learned by studying the interactions between different markets.  It is one of the reasons I consider myself a student of all markets – not just the stock market. 

The different markets act in ways that cause reactions in other markets.  Everything is connected.  What I have been looking into now are the the easy intermarket analyses.  I think you can google “dow vs gold” and get a great chart.  In fact, I did just that (below). 

Tracking stocks is easy – Yahoo or Google finance make it very simple to find information about stock prices and volumes and earnings and analyst recommendations.  Tracking gold and other commodities is more difficult.  Tracking the bond market is even trickier.  Finding free places for this info is not easy.  I am going to have to pay for stockcharts.com aren’t I?  Love the site, but hate paying for anything.  Anyways, that is besides the point.  GET TO THE DOW vs GOLD TALK ALREADY

Alright, alright

When I spoke back in 2008, the Dox/Gold ratio was about 10 – which is above its long-term historical average of 9.  On the chart below, you will see that they see the long term average as 10.  This is from Fred’s Intelligent Bear Site, which I found from googling “dow vs gold” (see, I told you so).  Click for a larger chart. 

This chart is very helpful because they provide a nice historical trend line, which I believe to be more relevant than a long term average.  Another thing that I’ve found to be very helpful is to look at charts of the Dow and Gold themselves – this might provide some insight.  Click for larger charts of the below.

People like to compare this market recovery to that of 1974.  There is is certainly a rhymingof 1974 to today.  The sharp recovery in the stock market after a sharp drop.  Look also at the behavior of gold after 1974 – it wasn’t long before the price of Gold went thru the roof. 

There are some people who say that the price of Gold is in the process of doing the same sort of parabolic price movement.  Looks to me like it already has, but what do I know?

Not that I remember too clearly, but the late 70’s and early 80’s were a time of high inflation, high interest rates along with high gold prices.  They also gave way to the stock market boom in the mid-late 80’s.  I think some people are already thinking this is a foregone conclusion for todays’ economy and markets. 

You can hear politicians and some economists warn of “hyperinflation” and comparing today’s US with the German Weimar Republic of the 1930’s.  They say buy gold because it is going to $2000 per ounce.

Slow down.  We’re not there just yet. 

What we have in the ratio chart above is a ratio of approximately 10 that is below the long term trend line.  We can see that historically, the trend line can act as more of resistance than support.  I’ll explain – then the ratio dives, the trend line usually does not provide support for a bounce.  However, in the 30-50’s and again in the 70’s, the line acted as resistance. 

We have to look at the Dow and Gold to see where this is going to go.

The ratio goes up because of two reasons:

• The Dow Jones Industrial average goes up
• The price of Gold goes down. 

It goes down for the exact opposite reasons. 

Gold – just like any other market – can be driven by news and trading activity.  I think one reason for the price increases of late is that the market is fearful of inflation.  The inflation fears come from the recent Federal reserve policy of low rates and increase money supply along with what some see as overspending by the Federal government.  Should the Fed successfully reduce the money supply and increase rates without sending the stock markets into a tailspin, I think you might see the inflation worries subside and the price of Gold will drop with it.  That does not mean it won’t see $2,000 before then …

That is one man’s take.  One student’s take.

I will keep my eye on the Dow vs Gold ratio however and see if it tells me anything.  Hopefully it won’t take me a year to write about it again.

Back last year, I mentioned that the way to make money off of this ratio was to get long Gold.  While that was not incorrect, the real trade was long the Dow – nice 50% run up (approx) – hindsight is 20/20. 

I will not make a similar call at this point.  I think there are reasons to think that the stock markets will correct further.  There will also be reasons that Gold might also dip further.  At this point, I would not be a trader in these markets.  I’m becoming less interested in short term and looking more into long term asset allocation.  From an allocation point of view, I think owning both stocks and precious metals is important in one’s portfolio. 

How is that for a cop-out?!

Dollar Weighted S&P 500

I’m fascinated by intermarket analysis.  I believe there is much that the everyday investor that does not understand.  OK, by that I mean there is much that I do not understand myself.  I once listened to a market professional talk about the “Dollar Weighted S&P 500″.  This sounds complicated, but in reality it is just the S&P 500 index divided by the US Dollar index. 

Some of you are thinking “great, now how do I do that?”.  Well stockcharts.com makes it easy.  You type in “$spx:$usd” … the $spx is their symbol for the S&P 500 and the $usd is the symbol for the US Dollar index.  You use the colon to create the ratio.  The result is the ratio of the S&P 500 to the US Dollar index.  I hope that wasn’t too basic for you – it is something I’ve done for some time now but never really explain. 

So let’s see what we can see from the Dollar Weighted S&P 500 …

I’ve added line charts for the S&P 500 and the US Dollar index below the ratio chart.  This gives us a little more understanding as to what’s happening.  Overall, it would appear that the indices tend to move in opposite directions.  The ratio chart seems to be an exaggerated version of the S&P 500 chart.

However, I see something different. 

I’ve added vertical lines to correspond to major shifts in both indexes:

• August 2008 when the US Dollar started to rally
• October 2008 when the S&P tanked
• March 2009 when the Dollar topped and the stock market bottomed
• November 2009 when the Dollar began a turnaround

What stuck out to me is the way the ratio performed when the US Dollar was rallying and the stock market was trending sideways.  Sideways could describe the market form late 2009 to early this year – minor rally but nothing like what was seen between March and November.  Sideways could also describe the stock market in August and September of 2008 …

I think you might see where I’m going with this. 

The ratio of the S&P to the US Dollar took a dive in September of 2008 … right before the overall market followed suit.  Currently you can see a dive in the ratio.  Could this be foretelling a similar precipitous drop in the stock market? 

I am not ready to call for another huge drop in the stock market.  I tried that in 2009 and it didn’t work.  Kidding.  Although, I have been feeling more bullish lately – which would make it the perfect time for the market to go nice and bearish. 

Eddie Mush of the Market … that should be the name of the site … not Student of Markets. 

We will have to see where the ratio goes.

Asset Allocations – what I’ve learned so far

I began my Asset Allocation exercise several months ago.  I wanted to learn to manage my money more effectively.  I looked into the asset classes that most people have available to them in their own retirement plans.  Retirement plans are where the bulk of investment takes place – it’s all I have right now. 

I have to admit that I have not been 100% satisfied with this mutual fund methodology.  I believe there are more ETF’s that are specialized enough to give us more asset allocation choices.  However, many of these ETF’s are fairly young and untested for the long run.  Managed Mutual Funds have a track record.  Who can say that there won’t be an ETF that blows up someday completely ruining your portfolio.  I’ll have to spend more time on this later.

I looked for mutual funds that were part of the following classes:

• Stocks
• Bonds
• Real Estate
• Commodities
• Precious Metals
• Money Market (i.e. cash)

Within the stock and bond categories I found sub-asset classes that are included in my allocations.   These include:

• Government Bonds
• Municipal Bonds
• Tax Free Bonds
• Growth Stocks
• Value Stocks
• International Stocks
• Emerging Market Stocks
• Small and Microcap Stocks

I whittled down a list of 30+ mutual funds down to a manageable list of 14 funds.  I played with balanced portfolios, a bond heavy portfolio and a risky portfolio.  Each of the specifics is available in the individual posts.  Here is a table summarizing the performance:

(Wordpress note … I try to cut and paste from excel and it just doesn’t work so well, so I used my trusty snagit to get the formatting that I wanted to come through … still not perfect, but it’s better this time)

I’ve highlighted the best performing fund in a given year.  So … what is this showing you?

Balanced portfolios perform OK, but if you want the best performance, you have to lean towards risk in bull markets and safety in more bearish conditions.  The trick, of course, is knowing the difference between the two.

Even with a constant risky mix, the overall performance is stellar. 

Now then, one might conclude by looking at this performance that all this talk about a “lost decade” for stocks is pure hogwash (technical term).  I am not ready to say that.  People love cool headlines like that – Lost Decade … sounds cool right? 

Please avoid headlines like that … not because they’re not true … but because they’re incomplete pictures.  The S&P 500 did kind of have a lost decade.  But nobody strictly invests in the S&P 500 … or the Dow … or the Nasdaq.  Anybody who takes their retirement seriously – or any investments, not just retirement – anybody will have some sort of asset allocation.  This allocation will help you avoid the risk of a single asset class – like stocks – which might have a Lost Decade from time to time.  

Smarter investors will rebalance their portfolios from time to time.  Which is something to keep in mind in this exercise.  I have rebanced the portfolios at the start of each calendar year.  I want to make you smarter by proving to you how this works out in the long run.  OK, I really want to make myself smarter, but in doing so I hope you get smarter too.  There will have to be an additional step in this analysis because I have not just “set it and forget it” and not rebalanced … I’ll have to tinker with my spreadsheets at another time.

Another thing to keep in mind in this exercise is the start date … 2001 … by that time much of the “tech bubble” had already burst.  I did not choose this date to bring about better numbers.  I chose this date because that gave me more mutual funds to choose from.  I have not even included some funds I selected because they were not around for the start date. 

I do believe that by spreading your investments across different asset classes you can avoid any Lost Decades … ok I’ve successfully beaten that term to death.  Any asset class can have its down periods.  If all your money is in stock funds, just change it … just do it … any allocation mix is better than no allocation mix.  You can learn and refine it later.  Long term it will work out. 

So here are my lessons learned so far in my Asset Allocation Project:

• Any allocation is better than too much exposure to stocks only
• Rebalancing helps – although I don’t know exactly how much just yet
• Weigh your allocation mix toward risky investments in bull markets and toward safe investments in bear markets
• That last step is more easily said than done
• A balanced portfolio that lets you sleep at night will leave money on the table … but you will sleep at night

So that’s where I am right now.  I’ll keep tinkering and keep posting.