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Current Markets A Wealth Manager's Nightmare
Wolf Richter www.testosteronepit.com www.amazon.com/author/wolfrichter
A wealth manager told me last week that some of his elderly clients were now coming into his office, and they’d say, “I’m tired of getting ripped off on my CDs and Treasuries; my kids tell me that I can make 25% a year with stocks. Get me into some stuff that can do that.” How much were they were willing to lose? “Nothing,” they’d say.
They wanted a risk-free 25% return, something that’s readily available nowadays in the stock market, no problem. The S&P is scheduled to hit that point over the next few days. With two month left to go in the year, its gains will certainly exceed 30%. Stocks are no longer at risk of even a mild downdraft. Certainly not of a serious correction. Those belong to the past. They’ve been going up relentlessly, independent of corporate fundamentals or economic data, both of which have been dreary recently.
Which puts him in a quandary. He’s worried that he’ll lose some of his clients if he tried to protect their money. And he is worried that he’ll watch them destroy their nest egg if he follows their wishes.
When he tried to show his institutional clients with graphs and economic reports that there was a mismatch between ballooning stock valuations and reality, he got enormous pushback. No one wanted to hear it. Some people in his network are now refusing to answer his emails. They’ve blocked him out. They’ve blocked out information that is contrary to their beliefs. They’re seeing nothing but unlimited upside without risks. Social pressure is building on industry insiders to conform – or else they’ll be marginalized. We’ve experienced this paradisiacal era before: In early 2007 and in very early 2000 – each time at the cusp of a crash.
Even economists who can somehow manage to see some issues can’t accept that these issues mean anything for stocks. Late last week, Gustavo Reis, a senior international economist at Bank of America, wrote that global activity was ‘less than stellar” and that the data was “mixed.” The US outlook was “particularly foggy.” But he had his spin: “It is better than it looks.” Message: The data is crummy and the outlook is foggy, but stocks will go up.
It certainly has been one heck of a party, thanks to the Fed. How could anyone be crazy enough to want to miss out on this craziness?
Take the IPO market. What a blast we’re having. In October, 33 companies went public and raised over $12 billion. Then there was the Container Store. It has been around since 1978, but in July 2007, at the peak of the prior credit bubble, private-equity firm Leonard Green acquired most of it. On Friday, it was time to unload. That babe doubled on its first day of trading, from its IPO price of $18 a share to over $36. That’s what everyone wants. Not 25% a year, risk free. That’s lame. Any index fund can do that. But 100% in a single day. And yet, the company cranked out a loss last year and still doesn’t know how to make money.
It’s not unique. So far this year, 6 IPOs doubled on their first day, the Wall Street Journal reported. And 41% of the companies that went public had undergone LBOs, during which they’d been loaded up with debt. That debt, most of which continues to exist post-IPO, turns them into precarious structures if the Fed’s zero-interest-rate environment were to dissipate. Now their private-equity owners are unloading at peak valuations.
Then there’s Twitter, the shining star. Its losses are expected to continue to grow. Its IPO price was raised today in the general euphoria to give it a market capitalization of over $15 billion, compared to Facebook’s $16 billion when it went public and flopped. But Facebook is making money. And it’s much larger.
There have been 190 IPOs so far this year that raised nearly $50 billion. The average gain in share price for IPOs so far: 30%. Not bad, given that many happened over the last few months. In 2012, already a hot year, 132 IPOs raised $45 billion.
A new – or rather refurbished – rationalization for tech IPOs is being dragged out of the barn: disrupt. For example, “In a slower-growth environment, the newer names are much more likely to be disruptive,” explained Alan Gayle, senior investment strategist at RidgeWorth Investments. “Disruptive companies are more likely to grow their top line at a fast pace,” he added. The top line – revenues – is the only place apparently where there is room for hope in many IPOs, their bottom line being a hopeless affair for years to come.
And US IPOs of Chinese companies are becoming hot again. These deals are fraught with perils, ownership uncertainties, and a disastrous history. But I’ve already heard it again: this time it’s different. Shares of Qunar, an online travel-bookings service, soared 89% the first day. And shares of China’s Craigslist, 58.com, jumped 42%. Or rather their loosely connected American depositary shares did, because US investors can’t actually own real shares of these companies.
Year to date, 61% of the companies that went public have lost money in the 12 months before their IPO, the highest ratio since 2000 – at the tippy top of the dotcom bubble. It was obvious back then, too. And when all the people who’d planned on getting out when things turned iffy got out, it become a bottomless pit.
Which is what the wealth manager asked: “How can I explain to my clients afterwards that we had a third crash in 15 years?”
It won’t be easy. But how can anyone look at this without concern? Many portfolio managers are riding the wave but are prepared to dump their investments at the first alarm – but who is then going to buy? Read.... "Don’t-Fight-The-Fed" Confidence Turns To Worry That Fed Might Take Us Over A Cliff
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BS on this article. You're telling me that an army of clients who have locked in CD rates and now clamoring for stocks? People's risk profiles don't change that quickly.
Let's say markets are always random, but today there is a MUCH higher chance of a major collapse (including an inflationary runaway that would count as a form of collapse), and hedging against that leaves a rational portfolio flat. That's what makes today and every year since 2008 different from average years.
And it's only getting worse the longer Obambus squats at 1600 Pennsylvania.
"Don’t-Fight-The-Fed" Confidence Turns To Worry That Fed Might Take Us Over A Cliff"
Silly rabbits, don't dey tink at all mon?
Those rottenchisds had a plan long before 1913. It was to create this beast to finish off the last profiting nation of freedom and liberty. It was created for the sole purpose of crashing everything like it is going to do. World-wide. Just ask the rottenchids and the rest of the filthy evil foreign banksters that own the fed, profit from printing paper money, and then lend it to the American people with interest. What a scam. Imagine if the America Treasury printed it's own money like the constitution said it is supposed to do, and then let the American People use it for free trade and stuff like that?
Hummm...stupid is...as stupid does. Ignorance is NOT bliss...it is just stupid. It grows funnier and funnier every day to see all the puppets playing their little darling roles in the world dominance and population reduction games. All for what, ego? Imagine those babylonians actually call that little piece of paper money, god. Wow huh!
Sooner or later that hundredth monkey is going to wake up and take a battalion of real American servicemen and women in to that rat infested rottenchid empire of dust, and clean it out. Really, really good! Imagine what the world would be like with NO MORE CENTRAL BANKSTERS or other minion slaves that call money god. These folks that worry about their precious money, should be better worried about the armed mercenaries that are coming to take all they have where ever they live. After the crash that might come after a bank holiday and revaluation, all that is going to be on most peoples minds is food.
Say to your neighbor this; "Hey neighbor, if the stores all closed for six months, and I came to ask you for some food, would you give it to me?"
Asking around the local area, some say yes, and some say no. Plant the seeds of change...grow victory gardens! The paper money will make for good mulching material, and we ALL will trade fairly. No banksters allowed.
Perhaps it will be lost by FED software algos but the FED will have to make that decision.
Right now they are giving out money so you sure missing plenty if you ain't had none.
Did someone say "markets?"
Take it from Widowmaker, smart money is long gone from stocks. The author, his puppet "advisor," and commenters are absolutely clueless - addicted to propaganda and hope. Speculation is all gains until it isn't. Wealth is the new vulnerability.
The only tangible assets appreciating are land and lead.
Book it.
How to tell your clients afterwards that there were 3 crashes in 15 years ? That's easy, clue them in that the stock market is a casino designed to take money from dumb shits like them on the 'investment advice' of dumbshits like you who believed all the propaganda.
This has been a great conversation and i have enjoyed the comments.
For those in all cash that is a risky portfolio in my judgment compared to the return. Not very efficient. At least have a mix of cash and real assets.
For those who wish to speculate have at it. For every great fortune made there are hundreds of thousands of speculators who lose. We hear about winners and think it is more common and easier to come up a winner than it actually is.
For those expecting a collapse in X time frame with assets adjusted accordingly, then you are a speculator and market timer.
Return definitely depends on your investment era. I am afraid we are in for 20 more years of low real returns. But low efficient return is better than the alternative of speculating or weighting in all cash.
"Its IPO price was raised today in the general euphoria to give it a market capitalization of over $15 billion, compared to Facebook’s $16 billion when it went public and flopped."
What are we supposed to do when the "debunkers" need debunking themselves?
The Facebook IPO raised approximately 18 billion dollars, valuing the company overall at over 100 billion. By contrast, the Twitter IPO is going to raise around 1.75 to 2 billion dollars, giving the entire company a valuation of about 17 billion dollars, or a total value equal to just about what Facebook raised in its IPO.
Expressing it differently, Facebook's IPO consisted of 400 million+ shares at $38, vs. Twitter's 70 million shares whch will likely be priced between $23 and $25.
As the kids today might say. learn to fact.
Or as I'll say it, don't misrepresent the facts to make your point, because then you aren't really making a point, are you?
This is good: http://www.uitzendinggemist.nl/afleveringen/1377389 (english spoken)
Modern Portfolio Theory, my ass.
The stock market today is all about the next OXBT.
Take a look at the action in this one.
It has 12 employees, did 1.2 million in revenue, and the stock traded 40 million shares today.
On Friday Oct. 29 the stock was $1.50 and today it closed at $8.38 off it's high of $9.75.
So if you think the stock market is about investing, you are just nuts.
http://finance.yahoo.com/q/hp?s=OXBT+Historical+Prices
No, it's certainly not about investing. It never has been. All the people who made significant fortunes trading in the Stock Market, were; well, traders. It's a speculation, and the participants are called speculators. It's extremely important that you understand this. Wall Street, INc. spent many millions of dollars on carefully crafted opinion creating, and consensus manufacturing, (AKA brainwashing; or advertising), to convince you that you were an investor; this is simple because it is a benign word, and the spin makes it easier for you to put you money in someone elses game. This is a very convincing post; and all the very convincing data rich posts I see point to the same thing; the coming crash. It's very important to sell too soon; when there are still plenty of greater fools. Right now, would be ideal. But understand that Sell; means everything. It represents a decision that the Stock Market is not the right place for your money; so you remove it; all of it. A trade consists of two operations; a buy order and a sell order. Until you execute the sell order; you have nothing. NOthing. There are some people who have done very well on this stock market run-up; but the only thing they know to do about it is brag about their paper gains in the local bar; they don't understand that it means nothing until you pull the trigger.
I thought those who made significant fortunes were those managing or trading other peoples' money and grabbing some sweet bonus.
HFT's have made the stock market into a money suck for morons. It does not matter what side of the equal sign has the negative variables, you will get strangled regardless.
This is definetely a false statement; it's an excuse, and an attempt to blame the market for one's poor performance. NOthing has changed from the POV of the individual speculator; it was the same in 1921, 1929, 1947;1974; exactly the same; the HFT pardigm means nothing to the individual speculator.
Apparently you've never held equities that have flash crashed right before your eyes; I have. You apparently have never purchased equities and seen the price jump 200% mid order; I have. You apparently have never had to get into screaming match with a brokerage house that had suspended or reversed your positions and erased thousands in profits because of HFT interference (had a standing Hail Mary order at -90% of market value and trade got triggered when HFT's drove it down); I have.
You apparently think it is OK and totally acceptable for investment firms to execute billions of trades with no actual capital to back them up and paying pennies on the dollars for transaction costs while individual investors get the doormat treatment; I do not.
*edit* Oh yeah, and lets not forget the countless times I have been shaken out of a position from HFT activity agitating a stock price so much it causes a sell trigger to activate and POOF its gone at a loss only to jump up 20% in the next minute. *edit*
Saying nothing has changed for the individual investor is the false statement here.
Managing one's own money is hard, let alone someone else's. This year every time I've dipped my toe in the water, I end up with one less toe. I feel like a friggin' leper at this point!
Reading John Hussman's weekly comments helps a little.
There are a lot of markets; not just a stock market. The commodities markets offer many very different markets. Feeder Cattle is a small market, suitable for an individual, it's not hustled by big internationals; it's seasonal; it has a repeatable tendency year after year. Before you say, "I don't know anything about commodities"; remember you don't know anything about Stocks either ! Admittedly, I haven't gotten around to writting my book about how to live off the commodities markets, but there is some good information out there. It's more important to understand the operation of a market, and the history of a particular market, and do some very, very basic chart reading, than "knowing" anything about commodities. I made a lot of money off a particular inter-month spread in corn earlier this year; but if I had known anything about Corn, I probably wouldn't have been able to put the trade on in the first place ! As it was, all I knew was that the price charts were irrational and had been becoming more irrational for months; I though it had "gone about as far as it could go"; so I took the opposite position; it started paying off with in 48 hours; so I started increasing the position; I got out too early, of course, as I always do; but thats alright; it was good 400%; which covers several mistakes and still allows for the usual 100%+ per year. I've shorted the S&P500 three times now; and I lost a total of $13,000 doing it; this last time I got out on a zero loss stop order; so it didn't cost me anything. Does this bother me? Nope. Next time, or the time after that, this bitch will fall apart and I'll get that back plus multiples. It is somewhat important to understand that what follows overpriced enthusiasm is crashes; but that's not that hard to grasp.
I'm pretty vanilla with my investments. No telling who the new Corzine is,
But he's out there.
Save in physical PMs, and you'll be doing superbely, eventually.
Agreed. Speculate for dollar gains and put your savings in Silver; Dollars are not suitable for savings; as I think most people know here on Zero Hedge.
Container Store. That babe doubled on its first day of trading, from its IPO price of $18 a share to over $36.
I see an open at 35.00 and a close at 36.20 on the first day of trading. A low of 32.10.The IPO price might have been 18, but i would have had to pay at least 32, to buy the stock.
Shareholders have claims on wealth, not wealth. Question is, when do you want to change that claim and spend it? After all, somebody is BTFATH.
As far as I'm concerned, if I buy the rights to 4 Railroad TankCars full of Crude Oil, I have the rights to the four Tank Cars, and I can take delivery of it, if I want to; but stock holders don't "own" anything as far I'm concerned. I consider commodities trading to be much more conservative than Stock Market "Investing"; it's not actually investing, of course.
I love you man, but you money managing types try to pretend this shit is hard.
This market is no less uncertain than any market over the past 100 years. Try investing in 1941 when it looked like the germans would win.
Investing is simple. Find your risk tolerance, i,e. how much volatility you can handle and still sleep well. 90 percent of return is based on asset class allocation, not on individual picks within and across assets.
Set your self up a portfolio of passive index funds of various asset classes that give you the optimal return for your risk tolerance. Rebalance annually or with some other rigid formula.
Then go chase some pussy and get on with your life. Anybody who can handle mid level algebra can do this by reading a book on modern portfolio theory.
Within your risk tolerance you will beat 80 percent of actively managed funds with the same risk and volatility parameters each year. Over a lifetime you will beat them all
Your mis-understanding is tragic. It all depends on which years you cherry-pick to represent your lifetime. Starting today, for instance; you will be tragically and horribly wrong; you'll be destroyed.
MPT isnt hard to understand. The hard part is cramming an elegant theory into a world that isnt normally distributed.
Did you forget the SARC/ Carl?, if you din't then your an idiot. Modern Portfolio Theory is a scam using high math and calculas to justify keeping the sheep in the market at all times so they can be fleeced every few years. The "market" is all about debt and the increasing levels of debt which fuel the ponzi. If the FED were removed from the equation and we had true price discovery on all assets, you would quickl and painfully learn that nearly all assets are correlated and 90% of all your perceived wealth would vaporize.
Get an education
and your welcome
Granted assets are correlated to a greatwr degree than one might expect in a FEd driven market. I am an agnostic about the future but you can put your portfolio through an internet portfolio analyzer and test it with various scenarios. If financial collapse occurs some real assets in your portfolio will lower your volatility if you worry about that. I do of course.
The point is that boyz will blow up your modern porfolio theory allocation in a hearbeat with the next crash. So yes, it is hard. That manager is being prudent. I spend most of my time in cash these days. I sleep very well at night.
90 % of return is based on your strike price
There's no reason for any individual speculator to own any type of Option. Nor should they do so. This is another example of a "financial product" that has been merchandised to you.
I know many speculators make great returns in the short run. People chase those returns and get hurt.
I have tilted my assets to ten percent gold, the pitiful remains of a divorce that they are. That makes me an oddball in the investing world.
However someone holding more than 15 percent gold thinking that it will do well in a collapse is a market timing speculator. They are not "investing." They just dont realize it. They may turn out to be right and make out like bandits, but it was still a speculation not an investment.
Modern Portfolio Theory is an excellent read for those with an interest in investment theory and how portfolio managers think. Basic algebra is all that is necessary, although if you understand a bit of calculus you will appreciate it on a more complex level.
Modern portfolio theory is a beautiful theory in terms of the underlying math. However, to apply it, you have to make untenable assumptions about earnings growth of the individual securities. In this respect, it is like so many economic theories that look great on paper but lead to disastrous policy. Caveat emptor.
Edit: looks like lewy14 is way more knowledgeable in this than Escapeclaws...
@Escapeclaws, I've just learned enough to learn that I have a lot to learn... ;)
You've got the "untenable assumptions" part right - and to pick up on something Carl Popper asked, moar data won't help - I think I recall that you'd need the S&P 500 data back to before the last ice age to get tight enough confidence intervals.
Oh, and then there's the assumption of "stationarity". By the time an asset class even begins to have enough data to estimate params, then the underlying params change, violating the assumptions. In particular vol is itself time varying...
If Eric Zivot offers his course again on Coursera, take it. The whole thing is an exposition on MPT - the motivations and assumptions, and then what the data series say about each of those assumptions using more modern stats approaches (specifically the bootstrap techniques).
Almost. Not quite.
Your basic approach is sound and if you just allocate evenly and rebalance mechanically you will end up ahead.
But - naive application of traditional MPT (the kind you only need some algebra for) has a precision which far exceeds its accuracy.
Specifically, if you apply modern statistical boostrapping methods to the data series, it is very difficult to reject the hypothesis that any damn random portfolio is on the efficient frontier.
You need to go at least one more level in - look at Black-Litterman, some of the more advanced VaR calcs, etc. It's possible to construct portfolios where the confidence intervals around "efficiency" are much tighter. I'm in the process of working something up here. Happy to collaborate.
The bigger risk is that financial assets themselves just go fail. MPT and other kinds of "passive agressive" investing (e.g. Risk Parity) count on an underlying convexity in the financial asset universe, which could be a long running anomaly, an illusion. In the brave new future, what goes down always goes down more than what goes up goes up, and so you bleed wealth no matter what rebalancing strategy you folllow. That, or the next crisis brings the Diocletian end game.
I think you could develop a way to tighten up the confidence intervals with a larger data series. I am not sure there is any other way which you seem to be suggesting. This thread will stay up a bit longer if you happen to come back to answer or a statistician cares to jump in.
Carl - when I said "random portfolio" what I meant was in fact random weighting of asset classes.
The whole thing about MPT is that you are estimating the parameters of random variables from existing datasets.
Vol - fairly easy to get decent estimates (as long as you don't worry too much about the tails - what could possibly go wrong?)
Expected return - this is where you're hosed. The equations which determine what your asset allocation weightings are extremely sensitive to expected return of the asset class - which is a parameter you can't estimate for shit.
Say you have five asset classes. You assemble historical data series for all the asset classes, estimate mean and variance, and optimize. OK, you got your weights.
Now, apply error bands to the estimated returns. You will find that it is difficult to reject the hyposthesis that nearly any damn random vector of weights is "efficient". Small excursions of estimated return result in big changes to the weightings, and you just can't get estimates of expected return that hold up statistically.
[Source - Eric Zivot - U Wash - he had a course on Coursera this year. Hope he has some more.]
So - what Black-Litterman does is derive expected return from the weightings of assets seen in the market, assuming the "market portfolio" is efficient, and then lets you make adjustments based on outlook which are incorporated into the weighting using Baysean methods. The cool thing is the resulting formulas are robust; even relatively large changes in outlook ("I think tech is going to outperform what the market seems to expect - by 300%) result in small changes to the weightings.
I don't invest with them, and they seem kinda smarmy, but actually I think the people at WealthFront might be on to something:
https://blog.wealthfront.com/tag/modern-portfolio-theory/
When I did a deeper dive into the whole Black-Litterman thing, it kinda made sense to me.
There are other techniques out there too which I'm sussing out.
As to TEOTWAWKI: my conjecture is that the happy condition I call "global convexity" (where rebalancing works) is a function of ever expanding debt. In a world where total debt is steady or decreasing, negative convexity will prevail: rebalanced portfolios will ratchet down.
One is left with the task of allocating capital the old fashioned way, via exploitation of information asymmetries.
Interesting reply, but for a group of four or five uncorollated assets classes, I can get very close to the efficient frontier. Tighter confidence intervals bring diminishing marginal returns for the effort. If I am 95 percent of maximal efficiency potential that is good enough for me.
If I understand your other point correctly it does not falsify the concept of portfolio efficiency. Within each asset class you are absolutely righ that a random sampling of those is as efficient as any other random sampling within that same asset class. 90 percent of your returns depends upon your mix of asset classes, not mix of assets.
3rd point. To attempt to predict the end game and weight your assets for it happenning in the next ten years makes you a speculator and market timer, not an investor. It will end someday. My portfolio has a slight teotwawki weighting to it with ten percent gold. I have sacrificed some potential upside to reduce my volatility if the world ends. Hence my portfolio is has a subtle speculative bent to it.
Buy UPRO
Buy Beer
Drink beer.
This current environment is driven by the easy money policy of the fed, super, super, super easy...what happens when that changes? Can money keep being printed forever without fear of inflation and actual inflation setting in?
How many more other classes are left to blow up?
Good observation there vx. I'm generally not one to even speak the phrase "This time is different."
But judging by the Central Planning insanity I see in halls of academe and power these days, it just might be.
wouldn't want fully invested when this tanks. there will be no exit to run to.
lock limit down with the markets frozen. pick your window and jump. yea you-
jump fucker cause everything you got is gone; might as well jump. cause your wife
is gonna shoot ya anyways...