Author Bio

US stock prices have made little headway in more than thirteen years, and the cumulative real returns generated by the major market averages have lagged Treasury bonds by a substantial margin over the period.  The uber-bulls are confident however, that the more than decade-long stagnation has led to attractive valuations that should pave the way for strong returns in the years ahead, and some investment practitioners have gone as far as to predict a doubling in equity values by 2022.  Is the optimism justified?

It is important to appreciate the sources of historical real stock market returns, which can be decomposed into three building blocks – the dividend yield, real growth in earnings-per-share, and changes in valuation.  Since 1871, US stocks have delivered annualised real returns of 6.5 per cent, of which more than seventy per cent is attributable to the dividend yield, roughly one quarter to real growth in earnings-per-share, and the remainder to an increase in the valuation multiple attached to current per share profits.

Looking forward, future returns seem virtually certain to fall short of the historical experience, simply because the dividend yield is little more than two per cent today or less than half its long-term mean.  The uber-bulls will undoubtedly argue that the dividend yield understates the total payout to shareholders, due to sizable increase in share repurchase activity in recent decades.

However, share buybacks are already included in per share numbers, and adjusting the payout ratio upwards would be double-counting.  In other words, an existing shareholder can either participate in the buyback and miss out on the earnings-per-share accretion, or forego the cash distribution and benefit from the capital gain.  Thus, forecasting future returns on a per-share requires no adjustment to the dividend yield.

The second building block in estimating future returns is the real growth in earnings-per-share, which is linked to the economy’s long-term growth rate.  However, existing shareholders have a claim on publicly-quoted per share earnings and not economy-wide profits.

Initial public offerings and secondary issues account for a considerable portion of the growth in aggregate earnings through time, and as a result, the growth in per share numbers falls well short of the cumulative increase in total profits.  Indeed, real earnings-per-share have increased at an annual rate of just 1.7 per cent since 1871, or roughly half the pace of economic growth.

The optimists put forward a variety of reasons as to why earnings-per-share growth will be higher in the future, but none stands up to serious scrutiny.  It is argued that share repurchases will provide a boost to earnings, which conveniently ignores the fact that the reduction in share count through time is largely a myth.  Indeed, new share issuance in excess of buybacks has averaged 1.25 per cent a year over the past half century, and repurchases have exceeded new issuance in just eight years.

The second argument relates to the growing share of profits generated overseas in high-growth markets.  The share of revenues sourced in foreign markets has increased from about thirty per cent more than a decade ago to almost fifty per cent today.  However, roughly sixty per cent of overseas revenues come from mature European economies, with a further ten per cent coming from Canada.  All told, just one in every eight sales dollars is generated in high-growth economies, which is simply not large enough to provide a meaningful boost to earnings growth.

The bulls also fail to appreciate that globalisation is a two-way process, and just as American multinationals have made impressive share gains in overseas markets, the same is true of foreign companies in the US.  Indeed, foreign subsidiaries have captured an increasing slice of economy-wide profits over the past two decades, with the share rising from just five per cent in the early-1990s to about fifteen per cent today.

Finally, the global financial crisis and the calamitous drop in economic activity have had a lasting impact on corporate sector behaviour with elevated unemployment levels and a relatively low business investment rate threatening to lower potential future growth rates in the developed world.  All told, there is no reason to believe that long-term growth in real earnings-per-share will stray too far from its historical trend.

The final input to the return estimation process is valuation change.  The market looks reasonable value on current earnings, but the greater than twenty multiple on cycle-adjusted profits is closer to previous secular bull market peaks than bargain basement levels seen in the past.

The bulls argue that the multiple is inflated due to the collapse in corporate profitability during the crisis, but using median earnings over the past decade or a denominator based on twenty-year average earnings to correct for the recession does not paint a different picture; the stock market is expensive.

The best the bulls can really hope for is no change in valuation multiples, which could prevail if macroeconomic volatility drops from its currently elevated levels.  However, should macroeconomic volatility remain high, it is far more likely that valuation multiples will contract, and at the very least, return to their historical mean.

Careful analysis suggests that equity investors can reasonably expect annual real stock market returns of 3.5 to 4 per cent at best in the decade ahead – well below the historical experience, and could deliver far worse should valuation multiples contract.  The bullish optimism is unfounded.

www.charliefell.com

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Despite yesterday’s surge in investor confidence that provided Asian markets a boost, things appeared to have fallen a bit flat this morning. As reality set in that Spain’s bond yields have hit record-breaking highs and Greece’s electoral success might not be enough to negate prior monetary upset, investor’s optimism wasted no time in fizzling out.

Bloomberg reported early this morning a slip of 0.8 percent in Japan’s Nikkei 225 Stock Average, 0.1 in Hong Kong’s Hang Seng Index, and 0.7 in China’s Shanghai Composite Index. Tim Riordan of Australian hedge fund Parker Asset Management Ltd., elucidated how he sees European problems increasing, as opposed to reaching a resolution. With bond yields hitting 7.29 percent, Spain is becoming somewhat of the elephant in the room. Riordan states that this is could really be a red flag indicating a downward spiral should be reason for caution.

Borrowing costs of this caliber can be indicative of a country potentially in need of a bailout in the near future. Despite the notion of this possibility, European markets were able to rise Tuesday. Currently, the strongest fear amongst investors seems to be a contagion of Spain’s monetary battles over to Italy, who’s facing issues of its own.

A few weeks back I happened upon a very economically fitting Warren Buffett quote assuring American’s they needn’t fear a recession relapse lest things in Europe get out of control and leech into the US economy. If investors’ uneasiness over debt spilling across Europe is foreshadowing for imminent future fiscal events, will Buffett’s words prove true?

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The events of this past weekend were pretty monumental for the world currency industry (and the world in general). Up until Greece’s Sunday elections, animosity regarding the stability of the euro in the event of a Greek exit had been running rampant amongst investors.

Now, with the results finally established, they were able to enjoy a brief moment of revelry in the electoral success of the pro-bailout New Democracy party.

An Article in The New York Times provides a good outline of what potentially could have happened to the euro had the leftist Syriza party won. Vowing to repudiate the country’s bailout agreement with the “troika” of the European Union, the European Central Bank, and the International Monetary Fund, this move would have siphoned financing of Greek banks. In turn, this would have rendered them unable to continue operating and eventually drop the euro and revert back to the drachma.

But alas, this was not the case, and so being within hours of the election, investors applauded the win by reorienting the falling euro in a much-needed upward direction. Unfortunately, the vivacity didn’t carry into Monday market action. The euro fell flat once again as concerns regarding Spain’s astronomic bond yields crept back into investor’s psyches. With interest rates having breeched the 7 percent mark, these loans are being viewed as unsustainable.

But amongst the angst, some positivity prevails arriving in the form of Asian market success. Emerging Asian currencies gained as a result of investor’s newfound comfort in the pro-bailout results, enthusing them to add a few riskier assets. Overall, Asian markets experienced widespread lifts with the Japanese Nikkei index prevailing with a rise of almost 2 percent.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The Forex market gets a bad rap in the media and other segments of the financial markets for being risky. It’s not a deserved reputation. In fact, the volatility of currency exchange rates is markedly lower than that of most other markets.

Not surprisingly, in the five year period ending December 2010 the fixed income market represented by 2yr and 10yr Treasury Notes was the least volatile. The major US dollar exchange rates make up the next lowest volatility group. After that come the major stock indices, with small cap stocks (Russell) unsurprisingly more volatile than big cap ones (S&P 500). Oil has been comparably volatile to individual stocks, which have demonstrated the most volatility.

Clearly Forex is no more risky than other markets, and in most cases can be described as less so. In other words, when the media and others portray the foreign exchange market as highly risky they do so on a really faulty basis because the volatility readings just don’t support it. Relatively low volatility, though, does not mean there aren’t any real opportunities to profit in the foreign exchange market.

Clearly there are investment opportunities in the currency market – ones that are no more risky than playing the stock market. It’s a question of finding the way of taking advantage of them that is right for you and your financial objectives. So why do so many folks consider the foreign exchange market highly risky?

The answer is leverage. Those who call the currency market highly risky fail to differentiate between the market and the participants. It’s not that the Forex market itself is risky. It’s that traders and investors are offered the opportunity to play the market with a high degree of leverage. In the stock market leverage is limited to 2:1, meaning you can buy twice as much stock as you have cash in your account by borrowing the difference (day traders often are allowed to use somewhat higher leverage). In Forex it is possible to trade at 50:1 or higher leverage. Successful traders know how to use leverage judiciously and to their advantage – this takes experience, time and diligence. Many traders in the Forex market do not know how to use leverage to properly manage risk. This aspect of risk management is a key consideration as we review new Trade Leaders for our investment program.

Forex gets a bad rap – a big part is due to irresponsible traders who have no experience or risk management strategy. I also believe Forex gets a bad rap because of misinformation. People hear a story here or there and see liquidity and leverage and make assumptions. And, you know what happens when you make assumptions.

Are you a Smartie? Get the facts. Check out our free e-book “The Smarties’ Guide to Alternative Investing in the Foreign Exchange Market”.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

New traders and investors in the financial markets are usually focusing on profits and seeking strategies that have the highest yields or have shown high yields in the past. The more astute trader knows however, that the most important thing in investing, is handling risk properly. Entering the financial markets exposes capital to loss, and the risk has to be reduced as much as possible. The well-known technique for that problem is the creation of a portfolio of a variety of asset classes. The idea here is that the losses in one asset class are offset by the gains of another. This sounds great but the devil is in the details as always: the correlation among instruments must be as low as possible. If the portfolio assets are selected properly this works well under ‘normal’ market conditions, but during big market collapse periods, like the one in 2008, almost everything aligns in the same direction – down.

The liquid pairs of the currency market are correlated to a great extent, so a portfolio of different pairs doesn’t make too much sense. A much higher level of diversification can be achieved by choosing a portfolio of different strategies instead of different pairs. These strategies can exploit different market inefficiencies, like market momentum, break-out of a volatility range, entering on trend pullback, etc. In other words instead of picking low correlated instruments we choose low correlated performance or equity curves of different systems or strategies. Of course individual systems must have a statistical edge by themselves in order to produce a profitable portfolio. A portfolio of low correlated trend-following systems can work well even if panic rules the markets, when stock indices all go down. Forex is symmetric, which means that the short side can be as profitable as the long side provided a stable downtrend evolves. This is what happened in the Fall of 2008 during the sub-prime mortgage crisis and during the first wave of the European debt crisis in the first half of 2010. During these periods, risk aversion ruled the markets and investors escaped back to the US dollar by selling the riskier asset classes. Long lasting dollar up-trends developed and trend-following strategies could make good profits.

The portfolio of low correlated strategies is not a holy grail either. When markets are in a highly-random phase, without firm medium term direction, consecutive losses can be generated. However, during directional periods – up or down – gains can add up and overcome the losses of the unfavorable periods.

The Currensee Trade Leaders Investment Program offers just that: diversification by combining strategies or performance characteristics of different systems of the Trade Leaders. Even more sound portfolio creation can be achieved when the long-term statistical attributes of the included systems are known by analyzing their historical performance. These attributes are:  longest/deepest draw downs, monthly distribution of returns, draw down distribution in time, etc. For example, my “C” system on the Currensee Leaderboard was compiled with that intent, to reduce the losing periods as much as possible by examining the 10 year monthly distribution of gains/losses of the different system back tests.

Take the time to consider diversification in your portfolio. With the seesaw of the stock market and turbulent times, low correlation is key along with a variety of strategies and asset classes.

Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

Last week I attended my first academic conference. It was held at UCLA and focused on the field of Behavioral Finance. This is the area of academic research which has been challenging the tenets of Efficient Market Theory. As such, it’s a field of study that is highly applicable to the way most market participants I’ve met and talked with over the years think. I look at it as the study of traders, at least in certain sub-set areas.

One of those sub-sets of Behavioral Finance is the field of neurofinance, which attempts to see how our brains impact on how we trade and invest. During the conference there was a presentation by Dr. Paul Zak (Claremont Graduate University) outlining the findings of research he’s done on learning and market bubbles.

Bubble experiments
For some time now, researchers have studied the development of market bubbles in laboratory experiments. The version used by Zak in his study is one where the participants are given the opportunity to trade an instrument which has a fairly easily calculable value based on its proscribed cash flows (think dividends or interest payments), one which declines steadily toward zero over the span of the experiment.

One would think in a situation like this that trading would be pretty straightforward, but that doesn’t end up being the case. These experiments repeatedly feature the creation of significant bubbles in the price of the asset – meaning it trades well above its fundamental value.

Learning comes into play
It is worth noting, though, that as participants go through the experiment repeated times their behaviors change. The bubbles gradually reduce in size. The implication there is that as people learn they are less likely to act in a manner which drives the market price well above the baseline value of the asset.

Learning is important. Who’d have thunk it?

Bring on the drugs!
To take a closer look at the impact of learning on bubble formation, Zak and his fellow researchers divided the participants into three groups. One was given a drug which impaired learning. A second group received a caffeine pill on the idea that might actually improve learning. The final group was given a placebo. As it turns out, caffeine didn’t end up having any real impact above that seen from the placebo.

The impairment drug, however, did act as advertised. Traders on the drug took longer to see their bubble formation reduced, reflecting slower learning. Part of that was from reduced trading activity. They just simply didn’t trade as often as their un-drugged peers. Less trading equals less learning.

The conclusions
Dr. Zak presented three conclusions from his research (and that which went before).

1)    Traders who learn market history are less prone to inflating bubbles.

2)    Market/trading learning must be salient, meaning there must be a risk/reward factor (participants in these studies always have monetary rewards at stake as the results are different when there is no real risk/reward element). In other words, to learn you need to trade real money, not paper money.

3)    Infrequently traded markets are more subject to bubbles (real estate being the obvious example).

So basically you would do well to invest considerable time and effort in your trading and markets education and make sure it involves real money, not demo trading. Also, be aware of the markets which are more prone to mispricing (smaller, less actively traded ones) as they may either present opportunities or represent unnecessary risks.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

The market is talking about QE3 again after last week’s shock miss on US payrolls. Those who think it’s coming are pointing to the minutes of the last FOMC meeting as evidence in support of their case as they noted that “some” Fed officials said some more easing might be need in the unemployment rate doesn’t start moving down and inflation returns to low levels. That latter part is the important one, as I think most folks right now will have a hard time suggesting we’re in a low inflation environment and “a number” of Fed officials see the inflation risks as biased to the upside.

In other words, if you’re expecting QE3 you may not want to hold your breath. One of my colleagues here actually thinks it would take the stock market falling about 20% to spur Bernanke & Co. into action. That would put the S&P 500 on the way down to 1000. I wrote a post recently on stock traders positioning themselves bullishly because they expected the Fed to protect their downside with more QE. Not sure how they’d be feeling 20% down. On the plus side, if that were to happen, it would likely mean the dollar had strengthened a fair bit, giving the Fed some market cover to do further easing.

But guess what? The Fed is actually tightening right now.

Follow me here.

The Fed has indicated its intent to roll over maturing securities to maintain a steady balance sheet. That means when they receive the principle back on a bond or note they are holding, they turn around in use the proceeds to buy Treasury securities. That’s why you’ll continue to see the Fed doing their reverse auctions periodically. What that will serve to do is slowly shift the composition of the holdings away from mortgage and agency paper to Treasury debt.

But here’s the rub. The Fed hasn’t said anything about reinvesting the income they get from those holdings – the periodic interest (coupon) payments. The income the Fed makes from those interest payments is largely getting passed along to the Treasury as part of its annual remittance of excess profits. That’s been tens of billions of dollars in recent years because of the size of the Fed’s balance sheet.

The money supply math of the Fed is that when it buys securities from the market it prints money, thus increasing the money supply (at the monetary base level). Flipping that around, when the fed sells securities to the market (as it’s expected to do when it finally gets around to unwinding QE) it drains money from the market. When the Fed is repaid its principal the money supply is reduced, so it goes out and buys more to keep the money supply level.

Interest payments to the Fed are just like principle repayments in terms of reducing money supply. It’s money from the market that goes to the Fed and is effectively destroyed. These interest payments are not being reinvested, so the money supply is slowly drained from the system.

Now, by comparison, these interest payments are a small fraction of the total money supply (only a few % given interest rates), so it’s not like we’d expect to see a major drop in M2 money supply as a result. Also, as the mortgage and agency holdings are slowly converted to Treasury holdings through the mature-and-reinvest process, the impact of the drain will decline. This is because the mortgage and agency interest is coming from the private sector while interest on Treasury debt is government money which isn’t part of the private sector money supply, and is largely returned to the government anyway.

Obviously, the small relative size of the interest income makes this money supply drain little more than a trickle (though tens of billions does sound like a lot). My point isn’t that the Fed has engaged in a noteworthy stealth tightening since ending the QE2 purchases. It’s more than we need to make sure we understand the mechanism of things to know what’s really going on.



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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.

Author Bio

It goes without saying that what happened in Japan – and is continuing to happen there – is a tragedy. As is often the case with these sorts of developments, though, it’s also an opportunity for to reflect and learn. In this particular case, I want to use recent market developments to make a point, particularly to all those forex detractors out there.

Tuesday the NIKKEI 225 index in Japan lost 10.55% on the day. That’s a very big one day drop, and we can point to examples of even bigger ones in major stock indices from years gone by. The Crash of 1987 certainly comes to mind. The Dow lost over 22% that day. It’s worth noting, however, that none of the major currency pairs has ever moved as much in one day as the percentage the NIKKEI lost in Tuesday’s session.

Here are the worst 1-day changes found in the Reuters data set which goes back as far at 1971 for some pairs.

It should be noted that these figures aren’t just looking at close-to-close change. They also factor in close-to-high/low changes to get the maximum percent difference covered in a single day. The NIKKEI closed Tuesday at 8605.15, down from 9620.49 on Monday. Tuesday’s session low for the index was 8227.63. That means at its worst it was down nearly 14.5%. That’s a 45% bigger maximum % change than the largest in the table above.

Actually, it’s worth noting that forex data before the middle 1980s is a bit spotty, especially where highs and lows are concerned. Here’s how that table would look if we only went back to 1986.

These figures probably are more appropriate to use in any case given that they better reflects how active and liquid the forex market is today. Daily volumes now are much, much higher (literally multiple trillions of dollars) than they were in the 70s and 80s.

This is one more piece of evidence to counter those who call forex a very risky market (see Looking at Volatility Across Markets for more on the subject). Of course if you’re highly levered, even a small move can do major damage to your account equity. That’s not the fault of the market, however. It’s your poor use of a tool.

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Be sure to read the full risk disclosure before trading Forex. Please note that Forex trading involves significant risk of loss. It is not suitable for all investors and you should make sure you understand the risks involved before trading. Performance, strategies and charts shown are not necessarily predictive of any particular result. And, as always, past performance is no indication of future results. Investor returns may vary from Trade Leader returns based on slippage, fees, broker spreads, volatility or other market conditions.