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Based on its strong natural resources, Argentina should, in theory, be a gold mine for investors. With arguably the third-largest shale gas reserves in the world, the Argentinean economy is only one close step behind Brazil for the top spot in South America.

So why did today an analyst quote in a NASDAQ article that on a one to 10 rating for investors, 10 being the riskiest, he would give Argentina a nine? This statement addresses one of the biggest problems with investing in an emerging market: its governance.

Argentinean president Cristina Fernandez has enacted policies that have made foreign investing in this country an uncomfortably volatile thing. Dissonance amongst varying economic growth predictions has raised suspicion of a government that could very well be laced with corruption and in potential need of reform.

In fact, it could also be possible that the Argentinean government is evading Western investment altogether, seen in their nationalization of YPF (Treasury Petroleum Fields). This move sent the only Argentina ETF down over 20 percent since mid-April (NASDAQ) and demonstrated government hostility to the free market principals.

MSCI, an investment tool and index firm, is considering the removal of Argentina from its Frontier Markets index due to the government’s aversions. What’s further unsettling is that due to their richness in mineral resources, the country hosts a few popular stocks, such as Pan American Silver and Yamana Gold. With their removal from this MSCI index, further pressure could be placed on these stocks, as well as their ETF.

Their tempting potential continues to make emerging markets alluring to investors. Its unfortunate that this potential is often overshadowed by less than stable governance, making increasing the chance of risk for investors over that of return. Do these factors make investing in emerging markets more speculation than investment?

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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

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 recent discovery of an interesting article on portfolio diversification got me thinking about this commonly accepted strategy amongst investors.  Walter Upgrave, senior editor for Money Magazine and “Ask the Expert” financial columnist, was the composer of the piece and in it, he addressed the question “I have about $1 million spread into 33 funds. Is that too many?”

Though having so much capital to invest that this even becomes a concern at all isn’t a ‘problem’ everyone shares, the question can still pervade portfolio inquiries of investors of any kind. In short, the answer was yes; with the premise of the article being “diversifying your portfolio is a good thing, but is it possible to have too much of a good thing?”

In this case, it is.

One of the reasons for this is that having too many mutual funds or ETFs within a portfolio exposes the investor to more company or sector risks. This, in turn, can negate the returns they were hoping for in the first place.

Though Upgrave can’t provide a finite number of funds that will best suit any investor, a good rule-of-thumb he offers is that anywhere between five and 10 should do the trick. Go beyond this and you’re likely to see things get a bit sticky. Something else to consider when seeking a diversification equilibrium is that it isn’t so much the number of funds you have, but rather, that your portfolio is meeting your financial needs. Depending on your age, will your portfolio be generating enough income without risking complete decimation should the financial markets take another dive?

When building a portfolio with diversification in mind, it is possible to achieve it with fewer funds spanning a wider variety of investments. Different advisers will provide varying allocation percentages, but most remain congruent with a roughly balanced mix of stocks (both US and foreign), bonds, mutual funds, and alternative investments.

Though still experiencing a relatively new serge in popularity (think post financial crisis), alternative investments are establishing a more permanent spot in an increasing number of investor portfolios. Hedge funds, managed futures (metals, foreign currencies, etc.), real estate, commodities, and derivatives contracts are some examples of popular alternative investments. In terms of diversification, the most alluring aspect of allocating a portion of your capital into investments of this kind is their obvious non-correlation to the stock market (i.e. the stock market crashes, this component of your portfolio won’t always go down simultaneously).

We all know that too much of a good thing can often mitigate desired results, and the same idea seems to apply to portfolio diversification. I think Warren Buffett says it best: “wide diversification is only required when investors do not understand what they are doing.”

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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.

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The secular bear market in stocks that began during the autumn of 2000 is at an end; at least, that’s the verdict of the uber-bulls, who argue that a sustained multi-year upswing in equity prices is now underway.  Unfortunately, the bullish thesis is predicated on suspect assumptions; perhaps none more so than the argument that the individual investor – following four consecutive years of net outflows – is set to embrace the stock market once again.  This view is not supported by the historical evidence however, and displays an almost complete ignorance of individual investor behaviour amid a protracted period of sub-par returns.

It is important to appreciate that mutual funds’ net cash flows are determined not only by the level of new sales, but also by redemption activity.  Both variables are positively correlated with stock market returns, whereby higher equity values precipitate an increase in new sales AND redemptions.  Further, new sales typically exceed redemptions during secular bull markets, while the converse is generally true through a prolonged period characterised by declining stock market valuations.

The pattern-seeking nature of humans means that individual investors react slowly to a pronounced change in the climate for equity investing, such that the level of new sales weathers the first marked decline in stock prices – during a secular bear market – relatively well.

However, a second strike has a lasting impression and leaves deep scars, such that the level of new business falls well short of that recorded at the height of the previous secular bull.  Further, it takes several years of strong returns to entice the individual investor back into the stock market.

While increased risk aversion depresses the level of new sales as a secular bear market progresses, loss aversion means that individual investors are typically unwilling to liquidate their positions during a period of stock market weakness, and postpone redemptions until equity prices stage a cyclical recovery.  The bottom line is that the combination of weak sales and elevated redemptions means that equity mutual funds can expect to endure net cash outflows for an extended period.

It has been argued that the net cash outflows suffered by equity mutual funds from 2007 to 2011 is an unprecedented development, but this observation simply confirms the dangers of utilising data that extends back no further than the mid-1980s.  The Investment Company Institute, the national association of U.S. investment companies, maintains a far more instructive data set that documents mutual fund activity since 1945.

A multi-year advance in stock prices began during the summer of 1949, and although net cash flows were positive throughout the 1950s, the deep scars left by the collapse in equity values during the ‘Great Depression,’ meant that it took more than a decade of robust returns for a new generation of investors to embrace stock market risk.  Net cash inflows gathered momentum as the 1960s progressed, and the net assets of equity mutual funds surged from $17 billion at the start of 1961 to $48 billion by the decade’s end.

The secular bull market struck a speed-bump in 1966, but individual investors remained unfazed in the face of falling equity values, and net cash inflows continued uninterrupted.  However, the near-thirty per cent decline in stock prices from the winter of 1968 to the summer of 1970 tempered investor enthusiasm, and the surge in redemptions as the equity market recovered – combined with lacklustre new sales – saw equity mutual funds suffer their first net cash outflow in post-war history.

The net cash outflow recorded by equity mutual funds in 1971 marked the beginning of a sustained period of negative flows, which persisted until 1982 or almost twelve years – far longer than the current four-year period.  Importantly, cyclical rallies in stock prices, which ranged from the 28 per cent advance between late-1971 and early-1973 to the 57 per cent gain from late-1974 to the autumn of 1976, did not ease the industry’s woes, as the surge in redemption activity on each occasion overwhelmed the increase in new sales.

Data for the period show that net cash outflows from equity mutual funds were consistently greater during cyclical recoveries in stock prices than they were during cyclical declines.  For example, the cumulative outflow during the upturn in the stock market’s fortunes from the spring of 1978 to the winter of 1980 was 27 per cent of assets, or more than double the level recorded during the previous downturn.

Recent trends in equity mutual fund flows are consistent with historical experience.  The annualised rate of new sales versus net assets is running at little more than half the level recorded during the latter half of the 1990s, and is well below the rate observed during the five-year cyclical advance in stock prices beginning in the autumn of 2002.  Meanwhile, redemption activity is responding to the surge in stock prices since the autumn of last year, such that net cash flows remain decidedly negative.

Increased enthusiasm for equity investment by individual investors is been used as one of the reasons to support the thesis that a multi-year upswing in stock prices has just begun.  A review of the historical evidence however, suggests that this particular hypothesis is bunkum.

Previously posted on 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

U.S. stocks have more than doubled in price from the crisis-induced low registered during the spring of 2009, and posted the strongest quarterly performance since the late-1990s during the first three months of the current calendar year.  The sharp reversal in the stock market’s fortunes, following more than a decade of dismal returns, has prompted previously hibernating uber-bulls to call an end to the secular bear market.  They argue that a sustained multi-year upswing in equity prices is now underway.

One sell-side strategist has gone as far as to predict a near-doubling in the Dow Jones Industrial Average to 25,000 over the next ten years, and urges both existing and prospective clients to accumulate exposure now.  The arguments employed to justify the high expectations are seductive, but the analysis is less than thorough and does not stand up to serious scrutiny.  In fact, a more probing investigation reveals that the decade ahead may well prove to be no more rewarding for equity investors than the ten years that has just passed.

The first line of reasoning to support the bullish forecast rests on the notion that a sustained period of high returns like previous episodes that began in the late-1940s and early-1980s, can be expected simply because the past decade has been so poor.  This argument completely ignores the inconvenient truth that U.S. stocks enjoyed a boom unparalleled in American history during the 1980s and 1990s, which saw prices reach unprecedented levels versus their long-term trend line.  The uncomfortable reality is that much of those previous excesses have not been erased, despite the dreadful returns of the past twelve years.

Drawing a regression trend line through the real monthly average of the daily market closes dating back to 1871, reveals that the long-term uptrend in real stock prices is less than two per cent from year to year, which not coincidentally, happens to be the same as the annualised increase in real earnings-per-share through time.  In other words, stock prices follow the uptrend in the market’s earnings power over protracted horizons.

Unfortunately, the powerful bull market that extended from the autumn of 1982 to the summer of 2000 saw stock prices overshoot the trend by more than 150 percentage points – almost twice the overshoot registered at the secular peak of 1929 and nearly three times greater than the exuberance recorded in the late-1960s.  Twelve years later and stock prices are still trading almost 50 per cent above trend.

Simply eliminating this excess would equate to the Dow trading below 9,000 today, but previous secular bear markets have seen real stock prices drop to more than 50 per cent below trend.  If history is a reliable guide to the future, the lows registered during the spring of 2009 can be expected to be retested – at least in real terms – at some point in the years ahead.

The second line of reasoning employed to support the bull case is that stocks are currently trading at valuation levels that are close to 25-year lows.  However, valuations were already trading above their long-term historical averages by the fifth anniversary of the previous secular bull market in 1987, and moved to the most expensive levels in American history by the late-1990s.

Simply put, an assessment of value that goes no further than comparing current valuations to the most extreme stock market bubble in more than 140 years, can hardly be described as reliable.  Indeed, valuation levels at previous secular bear market troughs in 1921, 1949 and 1982 were only a fraction of what they are today.  The price multiple on trend earnings dropped to less than seven during each of these previous episodes, which allowed for several years of robust stock market performance, before valuation levels even returned to their historical averages.

In contrast, the U.S. stock market is trading at more than 20 times trend earnings today, which is closer to the levels that prevailed at previous secular bull market peaks than it is to those that were registered at important long-term bottoms.  Further, the historical record demonstrates that multiples of 20 to 22 have led to average annual real returns of minus 2.2 per cent over the subsequent ten years, with a median value of minus three per cent – hardly the stuff of wealth accumulation implied by Dow 25,000.

The Dow 25,000 target in 2022 is seen to be achievable given that it implies an annualised nominal price return of less than seven per cent.  However, the objective can hardly be described as conservative, since it implicitly assumes that stock price increases will outpace the underlying growth in earnings-per-share for several years.

Assuming that inflation averages between two and three per cent per annum over the next ten years, and observing the fact that real earnings-per-share have grown at an annualised rate of no more two per cent through time, means that the annual growth in nominal earnings should average between four to five per cent in the future.  Thus, Dow 25,000 implies that price increases are expected to exceed earnings growth by roughly two to three percentage points a year, which results in a price multiple of 23 to 25 times trend earnings in 2022 – a level that exceeds both the secular peaks in 1901 and 1966 – hardly a conservative outlook.

The uber-bulls are back with extravagant forecasts that appeal to the all-too-human desire for instant rewards.  The more astute will be aware that investment professionals are in the business of selling product, a task that is made all the more easier by rising prices and rosy expectations.  Those that are seduced are likely to be disappointed.

Previously posted on 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

US stock markets staged their most impressive quarterly performance since the late-1990s during the first three months of the year, as the myriad of concerns weighing on investor sentiment at the start of January slipped into the background.  The major market indices jumped more than ten per cent in the three-month period to bring the cumulative price gains from the lows last October to 28 per cent, though the upward move lacked conviction with average daily trading volumes dropping to the lowest levels since before the technology bubble began in earnest fifteen years ago.

The stellar price action meant that the optimistic year-end targets divined by the Wall Street sales machine just months ago were either matched or exceeded by the quarter’s end, but rather than temper their enthusiasm, the perennial bulls sharpened their pencils and revised their projections higher with some daring to declare that a multi-year bull market was underway.

http://www.neonsign.com/

As the propaganda machine cranked into high gear, more than one strategist likened the decade ahead to the 1950s when stock markets enjoyed a ‘golden age’ following a prolonged period of hibernation.  Back then, as memories of the ‘Great Depression’ faded and fears that a repeat episode lurked in the long grass subsided; investors increasingly shunned the unappealing yields available on default-free Treasury bonds, and embraced the attractive valuations on offer in the stock market.

At first glance, comparisons with the ‘fabulous fifties’ seem quite seductive.  Just like today, the stock market enjoyed impressive gains off the lows set in the summer of 1949 and though prices climbed almost 80 per cent in just three years, equities still looked attractively priced relative to current earnings.  Meanwhile, just like today, the market-determined price of Treasury bonds was distorted by official policy and looked mispriced given the high level of public debt to GDP.

The potent combination of ‘cheap’ stocks and ‘expensive’ bonds saw the former outpace the latter by more than nineteen percentage points per annum over the ten-year period from 1949 to 1959.  Can investors reasonably expect a repeat performance?

As seductive as the comparison might be, there are simply too many differences between the two periods to take the argument seriously.  It is true that the public debt-to-GDP ratio was at similar levels to today following the end of WWII, but private sector debt levels were minimal, which allowed for the expansion of private credit at a more rapid clip than economic growth.

Further, demographics were favourable with young families moving to the suburbs and satisfying their demand for discretionary items such as cars and household appliances through the use of instalment credit for the first time.  The population explosion that occurred during the ‘fifties’ – with an almost twenty per cent increase in the number of American citizens – opened up vast business opportunities, particularly in suburban housing investment where eleven million new homes were built over the decade.

Fast forward to today and private sector fundamentals are completely different.  Demographics are turning less favourable, as the children of the young couples that moved to the suburbs in the 1950s are approaching retirement with insufficient savings to maintain their lifestyles.  Their balance sheets remain in need of repair following the excessive credit growth of previous decades, and the wealth destruction that accompanied the collapse in house prices.

Needless to say, continued household deleveraging will exert a drag on growth for some time to come and restrict the investment opportunities available to the corporate sector.  In this regard, it is not difficult to appreciate why companies hold relatively more cash today than in the recent past.

Not only is the future level of economic growth likely to more than disappoint relative to the ‘fabulous fifties’, which will make the reduction of private and public debt-to-GDP ratios all the more difficult, but stocks are not obviously cheap as they were then.  The stock market may well look undemanding relative to current earnings, but given that corporate profitability is so far above trend, the use of such a metric simply beggars belief.

The ratio of current earnings to their ten-year average is at the highest level since the autumn of 2007 – just before corporate profitability reached its apex.  Some might argue that the use of a ten-year average earnings figure distorts the analysis given the steep decline in corporate profits during the ‘Great Recession.’  However, a longer twenty-year average paints a similarly disturbing picture.

This is only the eighth cycle in more than a century that the ratio has managed to reach levels as high as today, and on each of the seven previous occasions a profit recession was not far away with the corporate sector enduring an average earnings decline of more than twenty per cent over the subsequent three-year period.  The historical evidence suggests that it is safe to say that corporate earnings cannot be relied upon to push stock prices higher from here.

Some perm-bulls expect a repeat of fifties-style equity performance in the years ahead, but the arguments made are a misrepresentation of the facts at best.  Growth prospects are relatively poor today, while equity valuations are far higher.  The yields available on default-free Treasury bonds may well be unattractive, but that does not mean that an investor stampede into equities is imminent.

Previously posted on 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.

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In an optimistic article published by Bloomberg Businessweek, it is predicted that despite March’s minor employment setback, the US job market will continue to grow throughout April. Predictions by Deutsche Bank economists Joseph LaVorgna and Carl Riccadonna illustrate that due to increased consumer confidence, the hiring world will expand at a rate of about 200,000 new positions per month during 2012.

As companies sales increase, investing in new workers becomes an attractive prospect for upping productivity. Thanks to strong consumer spending up climbs, the jobless rate appears to be doing the opposite. This is clearly demonstrated in March’s numbers, where it fell to 8.2 percent – the lowest it’s been in three years. In a recent Bloomberg survey of 70 economists, it was determined that the US economy is healing at an estimated median of 2.2 percent; a bit heftier than last years 1.7 percent.

With all the positive outlooks swirling around the US job market, inevitably a balance must be struck meaning someone’s gotta suffer. The stocks are assuming that role as they fell, bringing with them the S&P 500 Index to 1.2 percent. Asian stocks also declined for a fourth day, while China’s recent inflation increase killed hopes of the government easing monetary policy.

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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

U.S. stock prices continued their upward climb through the months of February and March, and the near 30 per cent gain in just five months has seen the major indices move above the levels that prevailed just weeks before the world’s capital markets descended into freefall during the autumn of 2008.

All too predictably, the sharp reversal in the equity market’s fortunes has prompted the perma-bulls to confidently declare that the path of least resistance is up.  There has rarely been a better time to buy stocks, they argue, given valuations that have seldom offered such high returns relative to Treasury bonds.  Could the soothsayers be right or is this just one more opportunity to lighten equity allocations in the face of the negative secular trend that has persisted for more than a decade?

It must be stressed that strategic allocation to equities should be consistent with the output of a properly-constructed valuation model that provides a relatively reliable estimate of potential future returns.  In this regard, it is unfortunate to observe that the industry appears to have learned little from the near-zero real returns earned from stocks over the past fourteen years, a disappointing outcome that stemmed in large part from overinflated valuations.

Indeed, far too many professionals continue to employ the very same techniques that failed to preserve capital so spectacularly through the two brutal market setbacks endured since the turn of the new millennium.  The inability to spot trouble ahead is typically blamed on unforeseeable events but, the plain truth of the matter is that reliable measures of valuation were pointing to meagre long-term return potential well before the markets completely exposed the industry-preferred methods that lacked theoretical substance.

The price/earnings multiple is the most widely employed valuation tool, but the standard calculation is deeply flawed given the use of single-point forward-looking projections of operating profits per share.  The denominator should reflect the market’s long-term earnings power and not a number that is unduly influenced by the stage of the business cycle.

In this regard, it is simply not reasonable to use an earnings estimate that incorporates profit margins that are at a multi-decade high, as is the case today, since the historical record demonstrates that this measure of profitability is one of the most mean-reverting of all corporate fundamentals.

Further, the traditional analysis calculates earnings before once-off items such as discontinued operations, extraordinary items, and the cumulative effect of accounting changes.  A top-down perspective suggests this practice is dubious, since asset write-downs and once-off charges are neither exceptional nor extraordinary in an economy-wide context, but an inevitable product of competitive rivalries, not to mention the ups and downs of the economic cycle.

The historical record since Standard & Poor’s first began compiling operating earnings data reveals that the level of once-off charges moves in tandem with the economic cycle.  Indeed, reported profits i.e. after write-offs, have moved to as high as 98 per cent of operating earnings during the past two economic expansions, only to drop to as little as 16 per cent during the subsequent downturn.  Simply put, bad investment decisions that seemed sensible during the boom are exposed during the bust that follows.

Those of a bottom-up persuasion argue that reported profits do not represent an accurate picture of a company’s ongoing earnings power, because the write-off truly is a once-off event.  However, if this argument had merit whereby one-off events are random, then one would reasonably expect the odds of a negative charge to be equal to the chance of a one-off gain.

The historical evidence however, paints a completely different picture.  In fact, there has only been eight quarters over the past 24 years in which reported profits have been greater than operating earnings, and only one quarter since the first three months of 1995.  Further, the gap between the two earnings measures has grown through time as the level of write-offs has increased at more rapid clip than operating profits.  Needless to say, the operating number is not a true and fair representation of the market’s long-term earnings power and should be discarded.

The price/earnings multiple popularised by Robert Shiller of Yale, uses ten-year average earnings as the denominator, and the historical data demonstrate that it has considerable predictive ability.  The current reading is close to 23 times, a level that has always been followed by lacklustre long-term real returns.  Indeed, investors could consider themselves fortunate if they go on to earn real returns of anything more than three per cent per annum over the next ten years given current valuations.

For those who doubt the message emanating from the Shiller price/earnings model, consider Tobin’s Q-ratio, which measures the market value of equity relative to its replacement cost.  The stock market is currently trading at more than 20 per cent above the long-term average, and as with Shiller’s measure, this technique suggests that investors can reasonably expect low real annual returns in the decade ahead.

The favourable stock market outlook espoused by the bulls is based not only on dubious absolute valuations, but also on the attractive yields relative to Treasury bonds.  However, several academics and practitioners have shown the comparison to be a form of money illusion with no ability to predict long-term stock returns.

The bulls are back in charge, but studied analysis shows their valuation arguments to be flawed and even dangerous.  As the late Humphrey Bancroft Neill, author of the 1954 classic, ‘The Art of Contrary Thinking’ observed “The crowd rides the trend and never gets off until it’s bumped off.”  Investors would do well to remember that it wasn’t raining when Noah built the Ark.

Previously posted on 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

Have you been paying attention to the changing dynamics in the markets of late?

We’re no longer in a world where the dollar moves in the opposite direction from stocks on a consistent basis – the risk-on/risk-off pattern. Of late, in fact, stocks and the buck have moved in the same direction, as we can see in the chart below (USD Index in green, S&P 500 in black). For the last few weeks that direction has been higher.

As we can see from the weekly chart below, things have been pretty muddled all year long. The stock/dollar correlation (based on a 20-period calculation) has been a bit positive since December, though only slightly so. Basically, the two markets have been mainly uncorrelated, taking us back to a time when the financial markets mainly traded on their own factors.

Ahhhh…the gold old days. :-)

Right now the thing that has the two markets moving in unison is something that was actually part of the story even back during the financial crisis. The US markets are benefiting from the view that the US is well into recovery mode while the Europeans (the USD Index being heavily weighted in those currencies) still have a lot of stuff to work through to get themselves on track.

Now, the European problem has been in place for a while now, which is why if we look at the relative performance of the S&P 500 and the German DAX index below we can see that while US stocks have pushed above last year’s highs, German one still have a ways to go.

What’s changed of late where the dollar is concerned is the view on what the Fed will be doing – or more correctly, what it won’t be doing. The better US data has lessened the need for Bernanke & Co. to further loosen monetary policy by piling on new quantitative easing (QE) at some point, and statements out of the central bank have indicated that these figures aren’t being viewed as some kind of anomaly, but rather as part of a developing pattern. This reduces even further the odds of QE3, and as the chances of the Fed pumping more dollars into the system decline, the dollar is at least less pressured, if not outright supported from buying by those who expected QE3, especially in the face of the ECB dumping close to a trillion euros into the system via the LTROs.

So we’ve got improving economic data helping stocks and also helping reduce the chances of Fed action which would be negative for the dollar. That’s what’s causing the two markets to move in tandem of late. Just keep in mind, however, that the dollar tends not to do great when (all things being equal) when the US economy is very strong because of our increasing demand for imports. We’re not exactly in strong economy mode yet, but it’s something that will become a factor as things improve.

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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

Harvard Professor Andrew Lo has been in the media of late, including a recent interview on the Wealthtrack program with Consuelo Mack. The conversation is about 25 minutes long (including lead-in stuff), so you’ll need to allow for sufficient space in your busy schedule to fit it in. There are some interesting aspects to what he talks about and what he’s doing in his money management business.

In the conversation, Lo talks a lot about diversification and introduces the term “diversification deficit disorder”. He uses that to describe the current situation where the high correlation between the major investment markets (primarily stocks and bonds) has created an environment where putting together a diversified portfolio is much more challenging.

None of this is really new, of course. Financial planners and market professionals have been talking about this for some time now. Lo suggest that we need to be expanding into alternative investments like commodities and foreign exchange. Again, nothing new there. The bigger point he makes, however, is that investors need to be much more active in their investment management these days. He doesn’t mean turning into day traders, but rather being much more aware of what’s going on with our investments, and in particular with our portfolio volatility (and thereby risk) levels.

The one aspect of diversification that Lo doesn’t talk about is what I like to refer to as “diversification of approach” or “diversification of management”. By that I mean investing in people and/or operations which can generate returns for you with little correlation to the returns generated by more standard investments – even more alternative investments. You’re not investing in a market or asset class, but rather the skills of a manager or firm. In many ways, this is the core of hedge fund investing.

The Currensee Trade Leaders program is this sort of diversification. Yes, its focus is on foreign exchange, but that’s as far as things go in terms of creating a currency market allocation. I documented this in the post Trade Leader Non-Correlations to the Markets. The numbers there show that taken as a whole, the Trade Leaders were only about 24% (negatively) correlated to the US Dollar Index and basically not correlated at all with the other major asset classes. If the Trade Leaders were just investing in currencies, we’d see much higher correlations. Instead, we have a diversified non-buy-and-hold methodology that’s offering up considerable diversification opportunities for investors.

And to Professor Lo’s point about paying close attention to risk, one of the primary statistics Currensee presents for each Trade Leader is their volatility. This is important information you should have for any investment you’re considering.

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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.