Buybacks and tradebots

Is anyone trading? Not really. Except HFT players and corporate CFOs executing the buybacks that generate their compensation packages.

You got a 7%+ gain in the S&P this year on basically nothing and for no reason other than float-shrink initiatives that have zero to do with fundamentals. For every Disney, a company that is truly killing it right now, there are a dozen stagnant names masking slowing growth with a smaller overall pie to spread profits across.

If IBM and McDonalds were trading on the actual condition of their respective businesses, the Dow would be 500 to 1000 points lower.

But they’re not, and this is why short-term price predictions based on fundamental research are moronic, generally speaking. Because this is not at all unusual. Distortions based on non-fundamental factors are a permanent feature of both bull and bear markets. 1 +1 doesn’t equal 2 in the short run.

Back to Buybackpalooza…

Wall Street Journal (emphasis mine):

Corporations bought back $338.3 billion of stock in the first half of the year, the most for any six-month period since 2007, according to research firm Birinyi Associates. Through August, 740 firms have authorized repurchase programs, the most since 2008.

The growth in buybacks comes as overall stock-market volume has slumped, helping magnify the impact of repurchases. In mid-August, about 25% of nonelectronic trades executed at Goldman Sachs Group Inc., excluding the small, automated, rapid-fire trades that have come to dominate the market,involved companies buying back shares.

According to Barclays, companies in the second quarter spent 31% of their cash flow on buybacks, the most since 2008 and up from 14% at the end of 2009. At the end of the second quarter, nonfinancial companies in the S&P 500 index held $1.35 trillion of cash, down from a record of $1.41 trillion at the end of last year, according to FactSet.


If no one’s involved with the market directly – apart from buybacks and tradebots – then theoretically whatever sell-off may come should do very little damage to the real economy.

Comforting, a little.


Companies’ Stock Buybacks Help Buoy the Market (WSJ)

Photo credit: andreavallejos

Making snap judgments about Apple product launches

Here’s the stock market’s reaction to Apple’s massive roll-out of all new products and platforms today (via MoneyBeat):

Shares surged as much as 4.8% to $103.08, pushed close to a fresh record high, and at one point, was on track for one of its best days of the year. The rally contrasted with Apple’s previous product announcements, when the stock usually fell after the unveiling of new offerings.

UPDATE: Shares reversed course and dropped late in the trading session, falling by more than 1%.

LOL @ “reversed course”. As if there’s a course to begin with. It’s monkeys rattling their cages, tormented by emotion, armed with half-truths and misinformation, wracked by the need to do something, anything, in the presence of a new burst of stimuli.

I used to be in that game – making stuff up in my own head to justify why this or that stock should go up or down in the next few minutes, trading headlines with instant reactions and so forth. The further I get away from it, the harder it is not to laugh at the ridiculousness of the whole thing.

As if the people reacting at either 2pm or 4pm or at any point between even have the faintest idea of the import (or lack thereof) of what’s just been announced.

I don’t know if these new phones, the watch or the payment system will be world-changing or just an incremental win or loss for Apple. What I know for a fact is that anyone wagering big in either direction this early has absolutely no idea either. But I’m sure they’ve assured themselves that they do.

The hysteria in both directions today reminded me of this now-classic Seeking Alpha post, published the day after Apple’s initial rollout of its first-gen iPad in early April 2010:

Amazing, especially that last “pretty sure” part. To be “pretty sure” of anything in the seconds and minutes after something like that comes out? Based on what? Nothing.

By the time that blogger’s post was published, Apple was tabulating sales figures. It turns out the first iPad had been completely sold out in its first day in the stores, not even counting all of the pre-orders that had flooded into Apple beginning in March of that year. iPad has gone on to sell over 200 million units cumulatively since then.

Sometimes you’re allowed to not have such a strong opinion. Sometimes you can stay quiet and just digest, see how things shake out. Listening to people carry on about how they’ll “never wear a smart watch” or how they “can’t imagine anyone paying $500 for a phone!” is embarrassing. Maybe they’ll be wrong, maybe they’ll be right, but definitely they don’t know. No one does.

Go read about Ford’s can’t-miss launch of the Edsel in the late 1950′s if you want to see just how persistently hard these kinds of things have been to call throughout history.

Snap judgments and table-pounding predictions about something totally new like iPad, ApplePay, the iWatch, the iMac, the iPod, the smartphone etc are utterly ridiculous. Make a few of these calls and then find out how little you know. I sure have.

And as to the ol’ “wisdom of crowds” nonsense…give me a break. How many more episodes like this do we need to see before we end this deification of markets business altogether?

The emperor has no clothes and the crowd has no clue.

Photo Credit: Kevin Krebs

2015 will be the year of the stockpicker

2015 will be The Year of the Stock Picker, the year that professional active management makes its long-awaited comeback.

I feel pretty confident in making this forecast. Mostly because if it doesn’t happen, I can just roll it over into 2016, with a whole new set of reasons.

In 2013, something like 98 cents of every dollar of inflows to US stock funds went to Vanguard or a passive index product. In December, we were told that with almost no one attempting to pick winning stocks anymore, this would bring about an excellent climate for active managers in 2014. Furthermore, the drop in correlations meant more dispersion of returns between stocks – another boon for the stock selecting managers, who would surely be able to identify and benefit from owning the best names.

Bob Doll told my writing partner Jeff Macke back in January that this was going to be it! After a five year stretch during which 77 percent of active managers trailed their benchmarks, 2014 would mark the turning point:

Doll says this is finally the year when active managers start making up for lost ground. In the attached clip, Doll makes his case that 51% of active managers beating the market in the 3rd quarter was the start of something big. His argument starts with the high correlation between stocks over the course of the rally of the last 5 years. More than 400 of the 500 members of the benchmark S&P rose last year.  Active management is based on the idea of discriminating between companies and industries. When everything moves in the same direction any fees and friction lead to underperformance.

Only it hasn’t worked out that way.

2014, when all is said and done, may in fact turn out to have been one of the worst years for active management of all time.

We’ve been talking about this abysmal showing all year here on The Refor`med Broker. In August we mentioned that only 25 percent of US stock fund managers were ahead of the respective benchmarks. But it’s somehow gotten even worse.

Here’s Goldman Sachs vis Steven Russolillo’s MoneyBeat column:

Only 23% of large-cap mutual fund managers have outperformed the S&P 500 this year, rivaling the worst performance in the past decade, according to David Kostin, chief U.S. equity strategist at Goldman. By comparison, about 37% of fund managers have outperformed the benchmark since 2003. Only performances in 2006, 2010 and 2011 have been as bad or worse than the current year’s pace.


Why is this happening?

The explainers are out in force. Here’s Suzanne McGee at the Fiscal Times with a fair description:

We’re caught in the kind of market that only the most agile of traders can love. It is one characterized by rapid shifts in direction, a lack of clear leadership, inconsistent economic data and general confusion about what’s going to happen next. In other words, it favors those who are willing and able to take short-term positions and switch them at a moment’s notice.

For obvious reasons, this is not what the majority of active managers are able (or willing) to do in the mutual fund complex. That kind of activity is better left for traders who want to chop their own money to pieces, not for pros who have a responsibility to others.

I have some trader friends who are doing really well this year in the stock picking arena – they’ve focused on areas like tech and biotech that have been chock full of winners. It can be done. Just not by the majority of people – even among the best and the brightest. While the majority of stock picking mutual fund managers struggle, their more highly compensated brethren in hedge fund land aren’t doing much better, with the average fund up just 2 percent year-to-date – but that’s just par for the course.

In the meantime, the S&P 500 is up close to 9 percent including dividends, US small caps are up just under 2 percent and the bond indices are all higher as well (especially the long-bond). Developed International stocks (Europe and Japan) are flat and Emerging Markets are crushing it, up mid-teens on the broad average and much more for some specific countries. With performance like this, for the basic and broad asset classes, it’s a total non-sequitur that anyone should feel as though they need (or are entitled to) more.

They’re not getting it, in most cases, in 2014.

Maybe 2015 will be the year it all turns around!

Photo Credit: MIchael Becker

Where are the wage gains?
Bank of America Merrill Lynch put out a tidbit on the “downward wage rigidity” suggesting that this cycle has been very abnormal in terms of wage gains. Historically, a drop in unemployment meant a quicker uptick in how much employers were willing to pay in raises to retain workers. My partner Barry went into detail on this topic for our monthly client letter yesterday. Suffice it to say, the labor market is doing just fine, but would “feel” considerably better if this last component of recovery – bigger paychecks – would finally materialize.Here’s Ethan Harris & Co of Merrill’s global economics team:More jobs, no pay increases: A recent paper from the San Francisco Fed argues that if wage growth is already low and there is a major recession, many companies will face a choice of either cutting workers or cutting wages. Those who choose to hold the line on wages, end up paying the workers more than they would like, resulting in “pent-up” wage deflation. Hence, when the recovery occurs, they will not raise wages initially, but will wait until higher wages are fully justified. The data suggest that downward wage rigidities are particularly severe in this cycle. The share of workers reporting no changes in nominal wages is currently 16%, up from 11% prior to the crisis. This is historically high and has remained notably elevated despite the drop in the unemployment rate.
Josh here – no wage gains, no inflation – at least from where I sit.Source:A boost from constructionBank of America Merrill Lynch – September 3rd 2014 Zoom Permalink

Where are the wage gains?

Bank of America Merrill Lynch put out a tidbit on the “downward wage rigidity” suggesting that this cycle has been very abnormal in terms of wage gains. Historically, a drop in unemployment meant a quicker uptick in how much employers were willing to pay in raises to retain workers. My partner Barry went into detail on this topic for our monthly client letter yesterday. Suffice it to say, the labor market is doing just fine, but would “feel” considerably better if this last component of recovery – bigger paychecks – would finally materialize.

Here’s Ethan Harris & Co of Merrill’s global economics team:

More jobs, no pay increases: A recent paper from the San Francisco Fed argues that if wage growth is already low and there is a major recession, many companies will face a choice of either cutting workers or cutting wages. Those who choose to hold the line on wages, end up paying the workers more than they would like, resulting in “pent-up” wage deflation. Hence, when the recovery occurs, they will not raise wages initially, but will wait until higher wages are fully justified. The data suggest that downward wage rigidities are particularly severe in this cycle. The share of workers reporting no changes in nominal wages is currently 16%, up from 11% prior to the crisis. This is historically high and has remained notably elevated despite the drop in the unemployment rate.

Josh here – no wage gains, no inflation – at least from where I sit.


A boost from construction
Bank of America Merrill Lynch – September 3rd 2014

How corporate share buybacks are destroying America

Profits Without Prosperity, an incredible article at the Harvard Business Review, shows exactly how corporate share buybacks have gotten out of control in the last decade. It then goes on to point out the various ways in which buybacks-gone-wild are killing the capital formation process in America, holding back the investments needed to keep us competitive and decimating the middle class workforce that actually built this country.

The evidence is presented by William Lazonick, professor of economics at the University of Massachusetts Lowell, and one of the nation’s foremost experts on corporate buyback activity. Having studied the subject for some three decades, Lazonick concludes that an SEC rule rewrite in the early 1980′s meant to drive Value Creation has instead ushered in an era of Value Extraction – wherein an increasingly smaller group of corporate executives and hedge fund managers reap an increasingly larger share of the productivity benefits of the economy.

For example, buybacks and dividends – which serve to drive compensation higher, enriching shareholders while diverting resources away from investment and innovation – accounted for over 75 percent of net income for long-time S&P 500 member companies last year. Contrast that with the retain-and-reinvest model that the economy ran on from the end of World War II to the end of the 1970′s, in which corporations were much less preoccupied with “maximizing shareholder value” and padding CEO salaries.

The chart above illustrates this point starkly.

Lazonick writes:

Since the early 1980s, when restrictions on open-market buybacks were greatly eased, distributions to shareholders have absorbed a huge portion of net income, leaving much less for reinvestment in companies. (Note: Data are for the 251 companies that were in the S&P 500 Index in January 2013 and were publicly listed from 1981 through 2012. If the companies that went public after 1981, such as Microsoft, Cisco, Amgen, Oracle, and Dell, were included, repurchases as a percentage of net income would be even higher.)

Josh here – No one is denying that stock prices haven’t gone up as a result of this trend. The claim, however, is that much more value has been extracted as a result of this than has been created for the real economy and other stakeholders – like taxpayers, employees and society at large.

You may not agree with all of Lazonick’s points or his prescriptions for a better way forward, but I guarantee this piece will change the way you think about how markets are currently working and whom they’re actually working for.

Find the time to read it (free registration may be required, just do it):

Profits Without Prosperity (Harvard Business Review)

The financial advisor’s challenge

The hardest part about what we in the advice business do is managing investor expectations and behavior. The other stuff may be more interesting or get lots of attention – but it’s largely secondary. My friend James Osborne did an important post about asset allocation last summer that got me thinking more about this topic today.

Thanks to quantitative databases filled with market stats, software programs brimming with options and spectacular advances in asset management products, the portfolio allocation part is much easier than ever before. We can all create models or use the portfolios of outside managers and demonstrate their efficacy with a nearly unlimited array of backtesting and projection tools.

This is an age of miraculous efficiency, unprecedented innovation and incredibly democratized market knowledge.

But that’s the fun part. That’s not the challenge.

The real challenge is keeping our clients from acting on their worst instincts. It’s keeping the Recency Bias in check, the performance-chasing impulse restrained and the grass-is-greener wolf away from the door. Easy in theory, hard in the real world.

If we can do these things day-in and day-out, with the vast majority of our practice, we are going to be successful advisors whose clients are able to retire and fund their hopes and dreams.

If we cannot, then our clients will fail and, eventually, so will we.

It’s very simple.

I don’t care how “optimized” our models are or how much math we have behind them – if we can’t keep our clients in them, what’s the difference? A fantastic portfolio that our clients can’t stick to is worthless, we may as well be throwing darts at ETFs.

It won’t merely be the depth of the next sell-off, but the duration of it that will give us the most trouble. Investors will have the urge to sell or to trust the first charlatan they hear crowing in the media about how they called the top. They’ll be drawn to strategies and funds that happened to have done well in a short period of time because they will be convinced that they offer “the answer” – all of the upside, none of the downside. They will second-guess everything that once made sense to them once the old stress fractures of the market become visible again. They will forsake the data that tells them not to act rashly, opting instead for whatever seems to be the quickest fix – a move to cash, a move to gold, a Black Swan fund…anything!

They will, once again, ignore history and even common sense. They will forget all about the things that matter and the time frame that is relevant.

They will, in short, behave as investors always have since the beginning. And in some cases, it will cost them everything.

The automated (robo) advisors will run into this problem during the next downturn, as will I and virtually all of my industry peers. Our responses will be all over the map.

Some advisors will emerge from this period having done more for their clients than others. Some will fight the tide and work their asses off on education and communication to get their clients through. Others will fail. They will rely on email blasts or try to run out the clock or even worse – they’ll give in to the worst requests and demands of the clients they’ve sworn to protect. They’ll violate a sacred trust in the name of expediency, allowing investors to work against themselves out of a misplaced fear of “losing the relationship.”

It’s best to start thinking about this sort of thing now, in the salad days, and to be preparing ourselves for the inevitable. Even if it doesn’t begin this year or next. It’s coming. How we prepare our practices and our people in advance will be critical.

This is the challenge. This is how advisor fees are either earned or not.

Portfolios are now free – valueless. Advice, on the other hand, is invaluable – but only if it’s delivered with meaning and when it counts.

Photo credit: pikadilly

“Millennials don’t care about money”


The New York Times is out with its latest catch-all piece on how strange and different the millennial mindset is from the rest of the nation.

I straddle the fence between Gen X and the millennials; born in ’77, I have way more in common with the millennials than with the “slackers” and Gen-X’ers who were born in the early 1960′s and think Caddyshack is the pinnacle of comedy.

From my vantage point, I can tell you that some of the insights shared in the piece are spot-on while others confuse a difference in ages for a difference in attitudes.

Take this howler, which you’ve probably seen repeated elsewhere in some version or another:

Consider the approach many take to the workplace. Thanks to the 2008 economic crash, millennials know how fleeting wealth can be. Their solution? For many, it is to acquire not more, but less.

“Almost two-thirds (64 percent) of millennials said they would rather make $40,000 a year at a job they love than $100,000 a year at a job they think is boring,” the Brookings Institution recently noted in a report by Morley Winograd and Michael Hais titled “How Millennials Could Upend Wall Street and Corporate America.”

This is clever but misleading. Those “almost two-thirds” of millennials also don’t have children of their own yet, nor do they have mortgages in most cases. In general, they are in their twenties and responsible to no one but themselves – for the moment. Call me when that changes and tell me if they’re any different from any other generation before them, in the aggregate.

They won’t be.

And once this generation hits its mid-30′s, we’ll finally see the all-important household formation process kick into high gear – perhaps the only thing that will truly rescue the economy, the one ingredient that’s been missing so far.

I think this will happen, despite all the zeitgeist articles about how millennials don’t care about money and just want to be able to pogo-stick their way to the open-plan, non-traditional office space so they can hack-a-thon all night on their wireless devices, fueled by energy drinks and dreams of a sequined hoodies. It’s largely nonsense.

Besides, this is a generation whose most notable cultural icon is the mega-billionaire uber-capitalist hustler Mark Zuckerberg, not Jack Kerouac or John Lennon or Kurt Cobain. Let’s stop pretending that people born between 1980 and 2000 have some kind of mythical, altruistic ethos that frees them from the shackles of need and want that the rest of us have been encumbered with since the dawn of time.

Give it a rest.

Photo credit: Moyan Brenn

On George Soros: Process and instinct of a speculative genius

It’s something that the pastor don’t preach
It’s something that a teacher can’t teach

- Kanye West, ‘No Church in the Wild’

I met with a money manager earlier this year who walked my colleagues and I through his firm’s investing process, which was a trading scheme based on a combination of 19 different technical analysis metrics. The outside rep who came to see us was young and enthusiastic about his firm’s approach, even though he couldn’t answer basic questions about whether or not those 19 variables had actually been measured for efficacy in terms of returns and risk. In the absence of these details, he relied heavily on the mantra of “process.”

When we asked a hypothetical about a period of prolonged large drawdowns and what the portfolio managers’ response might be, we were told that “We’re process oriented, but if something big’s going on, we can totally step in and do what we have to do.”

On the surface, this statement is obviously hilarious. We showed him the door shortly afterwards, with a non-committal “we’ll be in touch.” Even more hilarious was the fact this gentleman’s firm manages over $5 billion – mostly for other professionals, but I digress…

The thing is, some of the greatest investors of all time have tossed out their playbooks and improvised at opportune times. Either they got lucky or they saw something obvious that no one else did, but either way, it was the key to their transcendence. It’s literally the thing that allowed them to rise above.

We don’t hear much about the majority of people who did this and failed. We do tend to deify the ones who pulled a miracle out of their asses. That’s the mythology of the markets at work.

And then every once in awhile, we come across an investor who is able to do this repeatedly – break the “rules” and trade on pure instinct right at the moment when it counts.

According to his son, Robert, Soros’s trading was always influenced by more than reflexivity. “My father will sit down and give you theories to explain why he does this or that”, he once said, “but I remember seeing it as a kid and thinking, ‘Jesus Christ, at least half of this is bullshit’.

“I mean, you know [that] the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm and it’s this early warning sign.”

Soros has admitted to relying greatly on “animal instincts”, saying the onset of acute pain was often “a signal that there was something wrong in my portfolio”.

His decisions, then, “are really made using a combination of theory and instinct”.

The above comes from a piece at the Irish Times this week celebrating the 84th birthday of one of the world’s most successful and brilliant investors, George Soros. Soros is an exceptionally deep thinker and clearly has a winning investment process. He’s the only hedge fund manager to have earned $40 billion in profits for his investors and the biggest money-making fund since inception on the planet (having pulled ahead of Ray Dalio’s Bridgewater again after last year’s $5.5 billion bonanza).

This $40 billion in proft is even more impressive when you contemplate the fact that this is all money he’s taken out of the market – over the course of decades – from other skilled traders who’ve been on the other side of his moves. He’s an alpha predator on a global scale – there’s never been anyone quite like him, before or since.

And for Soros and his Quantum fund, process has only been a part of the story.

Having a process is fine, but when a process meets the Real World, as Soros’s process surely has over the last four decades, it’s not going to beat the market on its own. At the end of the day, instinct is what’s going to be the difference between mediocrity and outstanding returns. Luck will surely play a role too – but the longevity and consistency of this track record is proof of another element at work. Most of us – statistically – won’t possess an instinct like that or won’t be able to reliably use it.

That won’t stop most of us from trying.

Process is helpful, being lucky is great too, but unhinging one’s jaw at just the right moment and devouring an entire gazelle in mid-sprint – that’s the thing. Many people believe they can be like Soros, and some will point to their process as proof of their seriousness. Unfortunately, merely showing up each day and being diligent in the execution of a process won’t make them the next world-beating macro player.

Sometimes the deciding factor is what’s in your gut. Or the pains in your back.

Sharpe ratios don’t measure this, nor do pedigrees, years of experience, credentials after one’s name or the address at which one keeps an office.

Because it’s animal, and, as such, it’s also unpredictable.


Buy bubbles, bet big and backache – Soros’s secrets (Irish Times)

George Soros’s hedge fund regains title of world’s most successful (MarketWatch)

Exclusive Excerpt: The Man Who Moved Markets

I want to thank all of you for keeping my new book, Clash of the Financial Pundits, on the charts and in the news.

Most new books are able to get a good amount of attention during the week of their launch – but a book having legs beyond that initial barrage of media is much less common. The fact that Jeff Macke and I are still seeing comments and reviews come in from new readers is immensely gratifying. We even got a nice write-up from TIME this week, check it out here.

Anyway, today I have something really special for you – the first full-chapter excerpt of the book published anywhere. What you’re about to read below is one of my favorite parts of the book – it’s Chapter 7: The Man Who Moved Markets.

The chapter tells the true story of “Calamity Joe” Granville, one of the all-time great pundits and disastrous market-timers. Before there was CNBC, before Cramer and before the Internet, Granville was touring arenas and ballrooms around the country, giving trading advice to sold-out crowds and bringing the ruckus wherever he went.

I really hope you enjoy reading it as much I enjoyed researching and writing it! – JB

Chapter 7: The Man Who Moved Markets

I hope you liked it. To buy the book, follow the links below:

Clash of the Financial Pundits (Kindle)


Clash of the Financial Pundits (Hardcover)

All Eyes on Junk Bonds


This weekend’s Barron’s cover story was about what could go wrong in the markets thanks to the massively important ETF complex, which, as Rick Ferri points out in the story, has tripled in size since the Credit Crisis era. There are some really good points in the story, especially the stuff about how there are lots of ETFs that are highly specific or niche-y, and their underlying securities may not be able to bear a mass liquidation that catches the authorized participant traders by surprise.

Another area of concern – very much related – is the high yield bond sector. There’s been quite a bit of jitters of late thanks to huge, sudden outflows from the funds that play there. This week there will be more people watching junk than during the series finale of Sanford & Son back in ’77.

Here’s FactSet with a quick primer on what’s been going on in junk bonds:

One of the big topics of interest this year has revolved around a combination of correction expectations and bubble concerns. The bubble concerns seem much narrower, but tend to be viewed as potential tipping points for a broader market selloff. Such thinking was prevalent this week as junk bonds, a pocket of the market in which the Fed has highlighted stretched valuations, remained under scrutiny. A WSJ article noted that some of most successful fund managers during the financial crisis are starting to turn bearish. It highlighted junk bonds as a particular area of focus. Mutual funds and ETFs focused on high-yield debt saw net outflows of $1.5B this week. This followed redemptions of ~$2.5B in the prior week and ~$1.9B in the week before that. In addition, according to Lipper, investors pulled more than $5B from these funds in July, the most for any month since the record monthly outflow of $15.6B in June 2013, when the taper tantrum was in full swing. High-yield spreads also pushed out to six-month wides, while the iShares high-yield ETF, HYG (2.1%), fell for its sixth straight session on Friday and suffered its biggest weekly pullback in just over a year.

Mark my words, it’s all eyes on high yield starting tomorrow – everyone’s using it as a proxy for risk appetite now given the threat of higher rates sooner that has gripped the market.