Sounds like a book title we know? Aivars Lode By Morgan Housel
This time it’s different.
These words are often uttered near the peak of bull markets, as dewy-eyed investors attempt to justify unsustainable market trends by arguing that the past is no longer a relevant guide to the future.
The phrase is often associated with the period just before the Internet bubble burst in 2000. The great investor John Templeton once called it “the four most dangerous words” in investing.
It is worth keeping the peril of those words in mind now. U.S. stocks increasingly look expensive, and Federal Reserve Chairwoman Janet Yellen said Wednesday that valuations seem “quite high.” When they have looked similarly expensive in the past, subsequent returns often have been underwhelming. So it is safer to assume this time isn’t different.
But there also is danger in assuming that nothing at all has changed—particularly if that conclusion leads you to make radical changes to your portfolio, such as selling all your stocks because prices might fall.
The stock market today is different in important ways, and those changes should underscore the reality that no one—including your adviser or your broker—knows what will happen next.
Today’s S&P 500, for example, bears little resemblance to the past.
When the index launched in 1957, it was comprised of 425 industrial companies, 60 utilities and 15 railroads. Today, about one-fifth of the index’s value is information-technology companies, and there are only four railroads.
Financial stocks, which devastated markets during the 2008 financial crisis, weren’t even included in the index until 1976.
The investing world is “totally different now than it was in the past,” says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. “The further back you go in time, the less things are comparable.”
How big companies spend their money also has changed in ways that affect investors significantly.
From 1900 to 1980, a diverse group of U.S. companies paid out an average of 61% of their profits as dividends, according to data from Yale University economist Robert Shiller. In the period from January 1980 through December 2014, that average was 44%, as companies used more of their profits for share repurchases and acquisitions.
All else being equal, higher share repurchases will lead to higher growth in earnings per share. Inflation-adjusted annual corporate profits per share grew nearly a full percentage point faster from 1980 to 2014 than in the eight decades prior, according to Mr. Shiller’s data.
This may not justify modestly higher stock valuations than in the past. But it should at least make you pause before predicting that market valuations will revert to a long-term average. The cyclically adjusted price/earnings ratio—which measures the S&P 500 based on 10 years of earnings adjusted for inflation—has been above its long-term average in all but 15 months over the past 25 years, according to Mr. Shiller’s data.
Investors themselves also have different options now. Individual retirement accounts and 401(k) plans didn’t exist four decades ago. At the end of 2014, they held a combined $12 trillion of savings, according to the Investment Company Institute, a fund-industry trade group.
The ease with which investors can move money in and out of the stock market stands in contrast with, say, the 1970s. When it comes to how we invest and the incentives influencing those investments, things truly are different.
The population of Americans in their 30s and 40s—which is when many people begin saving and investing in earnest—grew by 4.8 million people from 1994 to 2004, according to data from the Census Bureau. It declined by 3.3 million from 2004 to 2014. It now is forecast to rise by six million by 2024.
Tobias Levkovich, chief U.S. equity strategist at Citigroup, says in an email that the current cohort of Americans ages 35 to 39—some 20.3 million people—is actually bigger now than when many baby boomers were in that age group in the 1980s and 1990s, when their money helped push stocks higher. He considers this change bullish for stocks.
Investors comparing today’s market to the past “think they’re comparing apples to apples,” Mr. Silverblatt says, “but there’s lots of different fruit in the basket.”
You may remember a number of years ago, I could not believe the conversations about inflation and the value of gold because of the coming of hyperinflation. I saw capacity everywhere that was underutilized and being built. So, now the reality has hit us. Oversupply of just about everything. Aivars Lode
A coal shoot loads barges with coal outside Pittsburgh. Photo: Bloomberg News
By Josh Zumbrun and Carolyn Cui
The global economy is awash as never before in commodities like oil, cotton and iron ore, but also with capital and labor—a glut that presents several challenges as policy makers struggle to stoke demand.
“What we’re looking at is a low-growth, low-inflation, low-rate environment,” said Megan Greene, chief economist of John Hancock Asset Management, who added that the global economy could spend the next decade “working this off.”
The current state of plenty is confounding on many fronts. The surfeit of commodities depresses prices and stokes concerns of deflation. Global wealth—estimated by Credit Suisseat around $263 trillion, more than double the $117 trillion in 2000—represents a vast supply of savings and capital, helping to hold down interest rates, undermining the power of monetary policy. And the surplus of workers depresses wages.
Meanwhile, public indebtedness in the U.S., Japan and Europe limits governments’ capacity to fuel growth through public expenditure. That leaves central banks to supply economies with as much liquidity as possible, even though recent rounds of easing haven’t returned these economies anywhere close to their previous growth paths.
“The classic notion is that you cannot have a condition of oversupply,” said Daniel Alpert, an investment banker and author of a book, “The Age of Oversupply,” on what all this abundance means. “The science of economics is all based on shortages.”
The fall of the Soviet Union and the rise of China added over one billion workers to the world’s labor force, meaning workers everywhere face global competition for jobs and wages. Many newly emerging countries run budget surpluses, and their citizens save more than in developed countries—contributing to what Mr. Alpert sees as an excess of capital.
Examples of oversupply abound.
At Cushing, Okla., one of the biggest oil-storage hubs in the U.S., crude oil is filling tanks to the brim. Last week, crude-oil inventories in the U.S. rose to 489 million barrels, an all-time high in records going back to 1982.
Around the world, about 110 million bales of cotton are estimated to be sitting idle at textile mills or state warehouses at the end of this season, a record high since 1973 when the U.S. began to publish data on cotton stockpiles.
Huge surpluses are also seen in many finished-goods markets as the glut moves down the supply chain. In February, total inventories of manufactured durable goods in the U.S. rose to $413 billion, the highest level since 1992 when the Census Bureau began to publish the data. In China, car dealers are sitting on their highest inventories of unsold cars in almost 2½ years.
Central to the problem is a cooling Chinese economy combined with tepid demand among many developed countries. As China moves away from its reliance on commodity-intensive industries such as steelmaking and textiles, its demand for many materials has slowed down and, in some cases, even contracted.
“This fall in commodity demand is counterintuitive, and we have only seen the tip of the iceberg,” said Cynthia Lim, an economist at Wood Mackenzie.
Not all commodities are in excess. China’s strong appetite for materials such as copper, gasoline and coffee will keep supplies tight in these markets.
For nearly a decade, producers struggled to keep up with the robust demand from China. But with Chinese output now slowing—its gross domestic product is expected to rise 7% this year, down from 10.4% five years ago—no economy has emerged to take up the slack.
The slowdown has caught many producers off guard as inventories continue to build.
The backlog is causing a scramble in many markets to find storage for excess supplies, clobbering commodity prices across the board, and foreshadowing painful output cuts down the road for many producers. Over the past 12 months, a broad measure of global commodity prices, the S&P GSCI, has plunged 34%, leaving prices at 2009 levels.
“These inventories have to be drawn down at least to some extent. At that point, prices will be back up again,” said Jeff Christian, managing director at CPM Group, a commodities consultancy.
Countries facing a demand shortfall often move to juice their economies through deficit spending, especially with interest rates so low. But many nations are queasy about adding to their debt burdens.
The world’s major economies have all continued to add debt in the years since the credit crisis, according to calculations from John Hancock’s Ms. Greene. Government, business and consumer debt has climbed to $25 trillion in the U.S. from $17 trillion since 2008, a jump to 181% of GDP from 167%. In Europe, debt has hit climbed to 204% of GDP from 180%, while in China debts have jumped to 241% of GDP from 134% by Ms. Greene’s measures.
Even if governments have the capacity for more fiscal stimulus, few have the political will to unleash it. That has left central banks to step into the void. The Federal Reserve and Bank of England have both expanded their balance sheets to nearly 25% of annual gross domestic product from around 6% in 2008. The European Central Bank’s has climbed to 23% from 14% and the Bank of Japanto nearly 66% from 22%.
In more normal times, this would have been sufficient to get economies rolling again, but Harvard University’s Lawrence Summers is among economists who say interest rates need to fall still lower to reconcile abundant savings with the more limited opportunities for investment, a scenario termed “secular stagnation,” which implies diminished potential for growth.
Not all agree. Former Fed Chairman Ben Bernanke wrote recently that the U.S. appears to be heading toward a state of full employment in which labor markets tighten and inflation will surely follow.
Just as a U.S. economy nearing full employment may help, new demand from emerging markets could help offset China’s waning influence. Enter India. Demand for energy and other commodities from the world’s second-most populous country has been growing rapidly.
But analysts are skeptical if the increased demand is enough to fill the void left by China.
The latest glut also underscores a challenging global trade environment as the dollar appreciates against almost all other currencies.
Exporters in countries such as Brazil and Russia are churning out sugar, coffee and crude oil at a faster pace, as they can fetch more in local-currency terms when it is converted from the dollar.
Producers have their own share of the blame. In a lower commodity price environment, producers typically are reluctant to cut production in an effort to maintain their market shares.
In some cases, producers even increase their output to make up for the revenue losses due to lower prices, exacerbating the problem of oversupply.
“Generally, this creates a feedback cycle where prices fall further because of the supply glut,” said Dane Davis, a commodity analyst with Barclays.
Good advice it is interesting how people quickly forget the past: Morningstar is moving beyond the style box. Aivars Lode
A new record 15 years in the making ought to give investors pause
By Cullen Roche
It took only 15 years, but the Nasdaq Composite has finally set a new record high. I always like to say that the biggest mistakes make for the biggest lessons. So what can we learn from this grueling 15-year round trip?
1. Diversification works. The biggest lesson from the Nasdaq COMP, -0.63% bubble is diversification. Having your savings concentrated in one high-beta sector of the financial markets can expose you to substantial risk of permanent loss. While the Nasdaq took 15 years to break even, an investor who owned a 60%/40% stock/bond portfolio starting on March 1, 2000, was in the red for less than four years. More importantly, while the Nasdaq was clawing its way back to break-even, you generated an annualized return of 5.5%. Not bad for buying in at the peak.
2. Price compression creates tail risk. I’ve described the concept of price compression as an environment in which investors essentially price in years worth of future returns into a very short time period. Imagine a linear 10-year, 8% annualized return line being compressed into a two-year period. If you have a $100 stock, then that stock will get repriced at $215 in two years. Of course, the market is forward-looking, so it is trying to stay ahead of actual operating earnings. So if the underlying entity does not actually produce the value that was priced in, then this creates a disequilibrium. That is, you’ve got investors who priced in high growth, which doesn’t actually come to fruition. And when this is realized, the price decompresses. The bigger the compression, the bigger the decompression.
When the Nasdaq bubble expanded, investors were essentially looking at the potential profitability of the Internet and they priced in years worth of profits into a very short period. Loosely speaking, we could say that they priced in 15 years worth of profits in just a few years. And this ties nicely into lesson 1: When you fail to properly diversify, you expose your savings to tail-risk events. Price compression isn’t something that should pose a huge risk to your portfolio if you’re properly allocating your savings.
3. Stop chasing the next hot thing in the pursuit of maximizing returns. If you’re like most people, you are maximizing your primary source of income (your real investment) and allocating your savings in a prudent manner that allows you to plan for the future. The goal with your savings isn’t actually return maximization, but return maximization within the parameters of appropriate risk-taking. If you’re a real saver who is looking for stability, then this means your primary portfolio goal isn’t simply protecting against purchasing-power loss, but also the risk of permanent loss. And this means accepting the reality that it’s probably imprudent to excessively overweight your portfolio in favor of purchasing-power protection.
Unfortunately, most people view the stock market as a place where they will “get rich” and generate Warren Buffett-style returns. They tend not to view it as a place to allocate their savings. And this leads to many behavioral biases, which prompt people to take more risk than they’re actually comfortable with. If you’re a real saver, then stop running with the herd into crowded trades in pursuit of a goal that isn’t in line with your portfolio’s actual goals.
Sports network says new FiOS TV packages breach distribution contract
ESPN, in its suit against Verizon, argues that while distributors have the right to create smaller packages for customers that may not include its networks, they can’t then put its channels into a separate sports bundle. Photo: Reuters
By Joe Flint
ESPN filed a lawsuit against Verizon Communications Inc.alleging the telecom company’s new FiOS TV packages breach a contract covering how the sports TV network is to be distributed.
Verizon began offering “Custom TV” plans last week starting at $55 a month that allow viewers to buy a basic set of channels, including broadcasters and some cable networks, and layer on tiers of channels in genres like sports, kids and lifestyle.
The packages are aimed at consumers seeking more flexibility in how they buy TV, but several media giants have been pushing back hard, arguing the offering violates their distribution deals with Verizon.
The issue of how channels are sold to subscribers has taken on greater urgency in the media industry as more consumers seek to lower monthly TV bills and are embracing streaming services such as Netflix and Hulu. Verizon serves about 5.7 million TV households, ranking it sixth among U.S. pay-TV providers.
Walt Disney Co.’s ESPN filed its suit Monday in New York Supreme Court. In a statement, the sports network said it is “at the forefront of embracing innovative ways to deliver high-quality content and value to consumers on multiple platforms, but that must be done in compliance with our agreements. We simply ask that Verizon abide by the terms of our contracts.”
ESPN argues that while distributors have the right to create smaller packages for customers that exclude its networks, distributors can’t then put ESPN channels into a separate add-on sports bundle.
Verizon says it is trying to give consumers more choice and is within its rights. “Looks like they are suing consumers to force them into a one-size-fits-all bundle,” a Verizon spokesman said. Verizon added that CBS Corp. is allowing its sports channel to be placed in a separate tier of similar networks.
The spokesman declined to say how many people had subscribed to the new service since it was launched last week.
ESPN sues Verizon over a new set of pay-TV cable packages, alleging breach of contract. WSJ's Sarah Rabil reports. Photo: Getty Images
Other content companies, including 21st Century Fox Inc. and Comcast Corp.’s NBCUniversal unit, have also said Verizon’s plans violate current programming agreements. Both declined to comment on whether they would pursue legal action against Verizon. (21st Century Fox and News Corp, owner of The Wall Street Journal, were part of the same company until 2013.)
“Verizon’s current skirmish speaks to the trouble distributors will have in creating a slimmer package that is attractive, both from an economic and content perspective,” according to a report Monday from the research firm MoffettNathanson.
Besides the lawsuit from ESPN, Verizon’s new packages could also hurt its negotiations with programmers for content for an online video service it is planning to launch. “We are not sure what is gained from going to war with their largest content providers,” MoffettNathanson said in the report.
Verizon’s new packages don’t go as far as making TV channels subscriptions a la carte. But the company’s push—along with the growth of streaming services— has led to speculation that the traditional big bundle of channels, which is the economic backbone of the pay TV industry, is on the verge of extinction.
However, that may be an exaggeration, at least according to one top industry executive.
“I don’t think the cable bundle is going to crash in the next six to 12 months,” said Liberty Media Corp. Chief Executive Greg Maffei during a panel discussion at the Milken Conference in Los Angeles on Monday.
Unprecedented times, lenders owing money to borrowers. Aivars Lode
Subzero rates have put some lenders in an inconceivable position
ByPATRICIA KOWSMANN in Lisbon and JEANNETTE NEUMANN in Madrid
Tumbling interest rates in Europe have put some banks in an inconceivable position: owing money on loans to borrowers.
At least one Spanish bank, Bankinter SA, the country’s seventh-largest lender by market value, has been paying some customers interest on mortgages by deducting that amount from the principal the borrower owes.
The problem is just one of many challenges caused by interest rates falling below zero, known as a negative interest rate. All over Europe, banks are being compelled to rebuild computer programs, update legal documents and redo spreadsheets to account for negative rates.
Interest rates have been falling sharply, in some cases into negative territory, since the European Central Bank last year introduced measures meant to spur the economy in the eurozone, including cutting its own deposit rate. The ECB in March also launched a bond-buying program, driving down yields on eurozone debt in hopes of fostering lending.
In countries such as Spain, Portugal and Italy, the base interest rate used for many loans, especially mortgages, is the euro interbank offered rate, or Euribor. The rate is based on how much it costs European banks to borrow from each other.
Banks set interest rates on many loans as a small percentage above or below a benchmark such as Euribor. As rates have declined, sometimes to below zero, some banks have faced the paradox of paying interest to those who have borrowed money from them.
Lenders, hoping to avoid the expense of having to pay borrowers, are turning to central banks for guidance. But what they are hearing is less than comforting.
Portugal’s central bank recently ruled that banks would have to pay interest on existing loans if Euribor plus any additional spread falls below zero. The central bank, however, said lenders are free to take “precautionary measures” in future contracts. More than 90% of the 2.3 million mortgages outstanding in Portugal have variable rates linked to Euribor.
In Spain, a spokesman for the central bank said it is studying the issue.
The vast majority of Spanish home mortgages have rates that rise and fall tied to 12-month Euribor, said Irene Peña, an economist with Spain’s mortgage association. That rate stands at 0.187%.
Bankers in Italy said they are awaiting guidance from their local banking association, because loan contracts don’t include any clause on what happens if benchmark rates go below zero. About half of the mortgages outstanding in Italy have variable rates, most of them linked to Euribor, according to mortgage broker Mutuionline. Some other countries, such as Germany, often use fixed rates.
In Spain, Bankinter has been forced to deduct some clients’ mortgage principal payments because an interest-rate benchmark tied to Switzerland’s currency has dipped into negative territory.
In January, the Swiss National Bank ended a 3½-year policy of capping the strength of the franc against the euro, sending the Swiss currency soaring against the common currency and U.S. dollar, and cut bank deposit rates into negative territory. The move to end the cap on the franc was designed to relieve pressure on Swiss exporters, many of which are reliant on the eurozone for sales.
During Spain’s home-building frenzy in the middle of the last decade, Bankinter issued mortgages tied to the one-month Swiss franc iteration of the London interbank offered rate, or Libor. At the time, clients were attracted to the offer because Swiss franc Libor was lower than Euribor, the traditional reference for Spanish mortgages.
“I’m going to frame my bank statement, which shows that Bankinter is paying me interest on my mortgage,” said a customer who lives in Madrid. “That’s financial history.”
The client in 2006 took out a roughly €500,000 ($530,000) home mortgage loan based on Swiss franc Libor, plus 0.5 percentage point. Since then, Swiss franc Libor has fallen far enough into negative territory to make his mortgage rate negative.
It is hardly a windfall for this customer, however, because, while Swiss franc Libor has fallen, the Swiss franc itself has risen in value against the euro. That means the value in euros of the total mortgage debt he owes Bankinter has also increased, because that debt is denominated in Swiss francs.
Bankinter has few such mortgages tied to a negative Libor rate, a spokesman said, declining to provide a figure.
An executive at another Spanish bank said the lender in recent months has started to put in place an interest-rate floor on thousands of short-term business loans that are tied to short-term variations of Euribor. Two-month Euribor, is at minus 0.004%. For new loans, the bank is increasing the cushion it charges customers above Euribor.
Hundreds of thousands of additional loans would be affected if medium-term Euribor rates enter negative territory, the executive said. The six-month rate is currently at 0.078%.
Meanwhile, some borrowers in Spain haven’t found relief.
A Madrid judge in November ruled against a client of Banco Santander SA who claimed that Spain’s largest bank inappropriately established a floor on his mortgage in 2013 and therefore owed him money. The plaintiff had taken out a mortgage in 2005 that offered a fixed rate of 2% in the first year and Euribor minus 1.1 percentage points thereafter. The plaintiff said he was now owed money from the bank.
To buttress his argument that a bank shouldn’t have to pay a borrower for a loan, the judge quoted from a June 2014 statement from the Bank of Spain that “a payment in favor of the client in these situations would never apply, but rather the application of an interest rate of zero by the entity.” The Bank of Spain spokesman said the statement cited in the case was issued by the central bank’s customer-complaints service, which typically responds to particular cases. The Bank of Spain hasn’t issued a systemwide decision on how banks should treat negative interest rates, he said.
In Portugal, interest rates on most mortgages are linked to a monthly average of three- and six-month Euribor. Both have been steadily sinking and are hovering just above zero.
João Coelho da Silva, a 53-year-old real-estate agent in Lisbon, has seen his mortgage payments fall from about €450 a month when his loan began in 2008 to €235 now, thanks to a falling three-month Euribor. “With the economy in such a bad state, these monthly savings are more than welcomed,” Mr. da Silva said.
Amazing how we said the world was ending in 2008 and it has not. Aivars Lode
By Tatyana Shumsky
Gold prices pulled back below $1,200 an ounce on Monday as a stronger dollar overwhelmed interest from foreign buyers.
The most actively traded contract, for June delivery, fell $5.30, or 0.4%, to settle at $1,199.30 a troy ounce on the Comex division of the New York Mercantile Exchange.
The Wall Street Journal Dollar Index, which tracks the dollar against a basket of other currencies, was recently up 0.2% at 88.35 as the dollar neared a 12-year high against the euro. Gold is traded in dollars and becomes more expensive for buyers in other countries when the greenback strengthens against their home currency.
Gold denominated in euros rallied to a 2½-month high, trading at €1,139.20 an ounce.
Still, noted Bob Haberkorn, a senior commodities broker with RJO Futures in Chicago, “There’s a lot of support here despite the move in the dollar.”
Negative bond yields in Switzerland and other European countries are burnishing gold’s appeal to investors there, Mr. Haberkorn said. Gold doesn’t pay interest or dividends and has an easier time competing with yield-bearing assets when yields are negative.
Gold is seen as a store of value and a currency alternative by some investors, who buy it as a haven from those risks. Europe’s recent efforts to jump-start economic growth have focused on pumping cash into its financial system. Some traders worry this will further erode the value of the euro and have been buying gold as a hedge.
No mention of man in here. Aivars Lode By The Economist
TWO hundred years ago, Tambora, a volcano in Indonesia, blew its top in the most violent eruption in recent history. Damage from the volcano and an associated tsunami was immense; perhaps 100,000 people died immediately, or starved in the aftermath. The effects on the wider world, though, were even greater. Like all large eruptions, Tambora’s was to change the climate around much of the planet for years.
But just how do volcanoes change the climate? Eruptions spew out not just lava and ash, but also gases—indeed it is these gases, trapped under great pressure in molten rock, that give an eruption its explosive power. For the climate, the key gas is sulphur dioxide. Once it gets into the stratosphere, sulphur dioxide from a volcano mingles with water, forming tiny sulphate particles.
These particles reflect some sunlight back into space, and the surface below cools. They also absorb some sunlight, warming up the stratosphere. These temperature changes have big knock-on effects. A cooler surface means less evaporation, and thus less rainfall. A warmer stratosphere means stronger jet streams. In the year after Tambora’s eruption, scientists estimate the stratosphere's sulphate veil caused a three percent drop in rainfall and cooled the planet by one degree Celsius. That is a temperature drop in one year twice as large as the long-term warming the Earth has seen over the past half-century. The climate upheaval caused a hiatus of the Indian monsoon, drought in southern Africa and widespread crop failures in Europe, where it was known as the year without a summer.
No one can say when an eruption large enough to have such drastic effects will happen next. That one will happen, though, is a certainty.