Bond funds of doom

chihuaThe Treasury bond market has sold off sharply in recent weeks,  which means that bond investors must be huddled under bridges, trying to piece together the shattered pieces of their lives.


The average intermediate-term government bond fund has fallen 0.18% this year, and 1.02% this past month, including reinvested interest. Most bond investors are probably not waking up and shouting “I’m ruined!”

Nevertheless, it’s alarming for investors, who have plunked down nearly $57 billion into bond funds this year, according to the Investment Company Institute, the funds’ trade group. Anyone who owned bonds during the financial meltdown — government bonds, that is — was glad to have them.

But the 10-year T-note yield has fallen from 15.84% in September 1981, making it one of the longest bull markets in history. Bond bear markets, unlike those in stocks, tend to be incremental, slow-motion disasters — a bit like being mauled by old, fat chihuahuas.

The bellwether 10-year Treasury note now yields 2.49%, up from 1.67% in February. The average 10-year T-note yield since 1962 — which is far as the data on Yahoo Finance goes — has been 6.43%. The median — half higher, half lower — is 6.11%. Either way, yields have a long way to go before they reach a relatively normal yield. And if history is any guide, markets typically overshoot on the way up and the way down.

A while ago, I suggested a no-bond portfolio for those worried about rising interest rates. Basically, you’d substitute money funds for bond funds in your portfolio. After all, the Fed is likely to raise short-term interest rates, which, in turn, could push bond yields higher as well. While the bond market could certainly settle down, it’s hard to argue that yields will stay this low for a long period of time.

Image courtesy of Angry Chihuahua meme generator. Somehow, I don’t think this one will go viral. 

Death to U.S. stock funds!

A billion here, a billion there, pretty soon you’re talking real money. — Misattributed to Senator Everett Dirksen

“Oh, I never said that. A newspaper fella misquoted me once, and I thought it sounded so good that I never bothered to deny it.”Senator Everett Dirksen.

The Investment Company Institute is the trade group for the $16.8 trillion mutual fund industry. Each week, it puts out an estimate of how much money has flowed into (or out of) mutual funds. If you’re looking for evidence of a stock mania, you won’t find it here.

Angry villagers with pitchforks.
Angry villagers with pitchforks.

Last week, for example, investors withdrew $223 million more from stock funds than they put in. The past 12 months, they have withdrawn a net $12.2 billion, according to ICI estimates.

The figures are even more stark if you look at the flows for U.S. stock funds. Investors have yanked $113.2 billion from U.S. stock funds since May 31, 2013. During the same period, they have put $21 billion into hybrid funds, which invest in a mix of stocks and bonds, as well as $57.4 billion into bond funds.

These are outflows from traditional, garden-variety stock funds. Some of that money has flowed to exchange-traded funds, although it’s difficult to tease out the exact amount from ICI stats. Nevertheless, it’s safe to say that flows are nowhere near the pace set in 2000, when investors poured more than $26 billion a month into stock funds.

What’s most surprising, however, is U.S. investors’ appetite for foreign stocks. While they have been yanking money out of domestic stock funds, international funds have been the happy recipients of nearly $101 billion of fresh new cash. Part of this may be because most investors use financial advisers, who typically recommend a 20% stake in foreign stocks. U.S. investors have about 25% of their assets in international stocks now, up from 8% in 2000.

How has that all worked out. Sadly and predictably, not too well. The average large-company blend fund has gained about 8.2% the past 12 months, says Morningstar. The average large-company blend foreign fund? It’s lost about 1.4%.

And it’s not because foreign stocks have fared so poorly, although they have been unusually volatile. (We’re looking at you, Greece.) German’s stock market is up 10.4% the past 12 months, and Japan’s market has soared 35%, according to MSCI, which tracks world markets. But that’s in local currency. Translated into U.S. dollars, that’s a 9.9% loss for Germany, and a 13.4% gain for Japan. Unfortunately, many U.S. international funds are underweight Japan, because that’s been a safe bet for nearly a quarter of a century.

Despite how stretched valuations are in the U.S. stock market — and they are stretched — it’s hard to argue that individual investors are getting caught up in stock mania, at least from flows to U.S. stock funds. In fact, it’s easier to argue that investors are still exceptionally wary of U.S. stocks, and that the scars from the last two bear markets are taking a very long time to heal.

Short stop

One night in the 1850s, a well-known Wall Street speculator named Daniel Drew appeared at the Union Club on Fifth Avenue, a place frequented by stockbrokers. Drew, a devout Methodist and teetotaler, looked anxiously about, sweating profusely. As he mopped his brow with a handkerchief, a piece of paper dropped to the floor. One of the brokers quickly put his foot on it.

Daniel Drew in 1872.
Daniel Drew in 1872.

After a few minutes, Drew left, and the brokers gathered around to read the paper. It was an order to Drew’s broker in his own hand. “Buy all the Oshkosh you can get, at any price you can get,” the note said. The next day, volume in Oshkosh was massive as the brokers bought, but the stock tumbled.

Drew was, of course, selling the stock, not buying, and most likely covering a short position. When you go short, you borrow shares from other brokers and sell them. To unwind the position, you have to buy shares, ideally at a lower price than what you sold them for. If you sell 100 shares at $90 and repurchase them at $70, you have a $2,000 profit.

One of the worst positions to be in on Wall Street is a “short squeeze.” Say you’ve borrowed 100 shares of Amalgamated Gadget at $80 per share, and the stock soars to $150 on news that it has found a way to teleport packages. If you had shorted, say, General Electric, you’d have no problem buying back shares. But if Amalgamated Gadget is thinly traded, you might have to pay dearly for the shares you need to cover your short.

Drew even wrote a little poem about it, which has passed into Wall Street legend:

He who sells what isn’t his’n

Pays it back or goes to priz’n.

This is what passed for humor on Wall Street in the 19th century.

"Ursus arctos - Norway" by Taral Jansen/Soldatnytt - originally posted to Flickr as Landskonferansen 2010. Licensed under CC BY 2.0 via Wikimedia Commons -
“Ursus arctos – Norway” by Taral Jansen/Soldatnytt – originally posted to Flickr as Landskonferansen 2010. Licensed under CC BY 2.0 via Wikimedia Commons –

Back in the 21st century, the New York Stock Exchange publishes lists of the companies with the highest level of short sales. At one, time, total short interest was a useful contrarian indicator. If short interest were particularly high, it could be a good time to buy stocks. After all, the crowd is usually wrong at peaks of bearishness. And sooner or later, all those bears would have to buy stocks to cover their positions.

That indicator has gone out of favor, primarily because there are so many other ways to make bets against the market, including futures, options and bear-market exchange-traded funds. But on an individual stock basis, short interest does provide some interesting guidance.

In terms of the number of shares sold short, AT&T stood out as the most hated stock, with 320,482,751 shares outstanding as of May 15, the latest data available. At AT&T’s average daily volume, it would take 11 days to cover all those shares sold short. That’s a lot of short-covering — and AT&T stock has gained 2.8% since May 15.

But the stock that Wall Street really, really hates is Gamestop, which at May’s level of short selling, would take traders 38 days to cover all its short interest. The stock has soared 12% since May 15, as its earnings topped expectations and, presumably, prompted a scramble by the shorts to cover their positions.

You shouldn’t buy anything on the basis of one indicator alone. But checking a stock’s short interest is probably a good idea. Sometimes, it helps you be smarter than the average bear.

Wall Street beauty contest: A tale of two funds

Let’s say a web site had a contest, and it worked like this. The site ran pictures of 100 people, and asked you to pick the most beautiful person. Whoever won the contest gets $1,000.

You picked the photo of someone you thought was exceptionally beautiful. And you lost, because that’s exactly the wrong strategy for this contest. You should have looked for the photo of someone you thought everyone else thought was the most beautiful.

by Unknown photographer, bromide print, 1933
by Unknown photographer, bromide print, 1933

John Maynard Keynes, economist and investor, used the analogy to describe how the stock market works. Your stock may be an exceptional value, with a fine dividend, low price-to-earnings ratio, and a CEO with a dazzling smile. But if that company, or that sector, is out of style, your stock will lag the broad market.

Let’s illustrate this by looking at two funds. The first is ProShares Dividend Aristocrats ETF (ticker: NOBL). The fund invests in stocks of companies that have raised their dividends every year for the past 25 years.

The second is PowerShares Dynamic Buyback Achievers (PKW). This fund invests in stocks that have shrunk their amount of outstanding stock by 5% or more.

For long-term investors, the Dividend Aristocrats should rule. A dividend is money in your pocket, and a company that raises its dividends regularly is clearly focused on its investors. Moreover, Wall Street normally shoots companies that cut their dividends, throws them out the window, and then shoots them again. A company that raises dividends has to be exceptionally confident that it has the financial wherewithal to keep paying the dividend.

Buybacks, however, may or may not affect stock price. And buyback programs tend to be ephemeral — here one year, gone the next. And companies that do buy their own stock may or may not be savvy buyers of their own stock. When stock prices were in the third parking level of historical norms in 2009, buybacks virtually ceased.

Which fund has done better? The buyback fund, of course. NOBL, the dividend fund, has gained 0.88% this year, vs. 3.2% for the Standard and Poor’s 500 stock index with dividends reinvested. PKW, the buyback fund, has gained 3.6%.

The reason, of course, is that buybacks have become the most popular strategy on the block the past 12 months. Companies bought back $148 billion of their own shares in the first quarter, topping the record set in the second quarter of 2007. (Quiz: What major market event started in the third quarter of 2007? Anyone?)

PKW is not without its beauties. It buys shares of companies that actually shrink their share count, rather than those that simply announce new buyback programs. (Companies often announce new programs, but don’t get around to actually buying all the shares they promise to.)

But the lesson of this story is that, at least for the moment, share buybacks are what other investors think is the most beautiful strategy on Wall Street. And for that reason, PKW is the winner.



And to think I saw it on Mulberry Street

This time of year, mulberry trees turn sidewalks into purple jelly, and birds  commit acts of purple outrage on cars, houses and hats. And it’s also the time of the market season for people to look for bubbles. What do the two have in common? Quite a lot, actually.

Mulberries on the tree.
Mulberries on the tree.

At least some of the mulberries you see are not native American white mulberries (morus alba), but an imported Asian mulberry, morus multicaulis. And we have morus multicaulis because of speculation in the silk trade in the early part of the 19th century.

Americans had always wanted be silk manufacturers, and to make silk, you need mulberries, because that’s what silkworms eat. The American mulberry was OK for feeding silkworms, but in 1828, Congress decided to encourage the silk trade further by publishing a manual extolling the virtues of morus multicaulis. Apparently, the imported version grew lower to the ground and had bigger, tastier leaves than the native species. Some state legislatures even paid farmers to grow mulberries.

Mulberry mania took off swiftly, according to this wonderful article at

“By 1830, John D’Homergue and Peter Duponceau reported to the U.S. Department of Agriculture that “suddenly and by a simultaneous and spontaneous impulse the people of the United States have directed their attention to this source of national riches…Everywhere, from north to south, mulberry trees have been planted and silkworms raised.” The Niles Weekly Register, based in Baltimore and considered by historians to be one of the nation’s most influential newspapers of its time, reported that at one agricultural fair more than 70,000 mulberry trees had been entered for various prizes.”

Prices for mulberry cuttings and trees rose sharply the next few years. Seedlings of morus multicaulis sold for $4 per 100 trees in 1834, $10 per 100 in 1835, and $30 per 100 in 1836. By 1839, prices peaked at $500 per 100 trees.

Japanese ladies making silk prints.
Japanese ladies making silk prints.

What speculators hadn’t realized, of course, was that silkworms eat prodigious amounts of mulberry leaves to make silk, and the mighty morus multicaulis couldn’t make enough leaves at a low enough cost to make silk manufacturing worthwhile, even if you used a whip. Farmers also learned that making silk was a wearisome, labor-intensive process that was rarely worthwhile at U.S. wages.

A gargantuan national depression and two severe winters killed the demand for silk and many of the mulberry trees. Disgusted farmers burned their trees or used them for feed, and multicaulis mania slipped into history.

Manias are, and have been, a part of the financial world for time out of mind. Soaring prices are one hallmark of a mania. But true manias are marked by soaring prices that are disconnected from the real value of the item. Multi-million dollar valuations for companies with no earnings in the 1990s was what distinguished the technology bubble from a run-of-the-mill bull market. Million-dollar three-bedroom ranch houses, purchased with no money down, distinguished the housing bubble of 2004-2006.

Pointing a finger at the Dow’s rise since 2009 and calling “bubble!” does a disservice to the term. Bubbles are an extraordinary phenomenon that involves an irrational break between value and price. Soda isn’t a bubble because it cost a nickle in the Depression and costs $1.25 now.

A gypsy moth.
A gypsy moth.

Stock prices in 2009, as well as corporate earnings, were in an extraordinary depression. They’re high now, but probably aren’t really in bubble territory, especially given that earnings are at near-record highs. Other areas — pre-IPO technology companies, for example, and Chinese stocks generally — could well be in a bubble. But U.S. stocks are where they usually are at the later stages of a bull market: Stretched, but not insane.

(As a footnote to the mulberry saga: Étienne Léopold Trouvelot, an amateur etymologist, discovered what he thought were an improved species of silkworms in Europe and brought them to his home in Medford, Mass., in 1869.  A few escaped. We know them now as gypsy moths.)

The Amish portfolio

One of the biggest arguments I hear for having a professionally managed account runs like this:

“Hey, it’s a big, complex world. You have so many investment choices: Emerging markets bond funds! Long/short funds! Bank loan funds!You need me to tell you what to invest in, because only I can figure out the right proportion of all these funds for you.”

What’s not usually mentioned, of course, is that much of this complexity is an invention of the financial services industry. No one ever went broke because they didn’t have 2.3% of their portfolio in a long/short fund. Did you miss the runup in REITs last year? Most managers did, too.

An Amish buggy in Lancaster, Pa.
An Amish buggy in Lancaster, Pa.

There are plenty of good reasons to hire professional financial help, but this big old complex world really isn’t one of them. In fact, there’s virtue in Amish-like simplicity. You can construct a low-cost, extremely diversified portfolio with three funds.

We’ll use Vanguard funds because they’re cheap. You could probably construct a similar portfolio with offerings from other companies, although you might not be able to match on cost. The portfolio:

* Vanguard Total World Stock Index fund (ticker: VTWSX). The beauty of this fund is that you don’t have to fret about how much to have in international stocks and how much to keep at home. It’s all in there, according to market capitalization: 54.1% North America, 22.1% Europe, 14.2% Pacific, and 9.4% emerging markets. Cost for the investor shares: 0.27% a year, or $2.70 per $1,000 invested.

* Vanguard Total Bond Index fund (VBMFX). You get broad exposure most types of U.S. bonds. Current yield: 1.9%. Cost: 0.20%, or $2.00 per $1,000.

* Vanguard Prime Money Market. Hey, it’s a money fund. It yields 0.02% after its 0.2% expenses.

That’s it. A conservative mix would be 60% Total World Stock, 20% Prime Money Market and 20% Total Bond Index. You can adjust your stock portion up or down, depending on your risk tolerance. Rebalance whenever the stock portion is 10 percentage points higher or lower than your target.

If you want to add other funds to this basic portfolio, go right ahead. But as any Amish person would tell you, the more you tinker with it, more likely it is to be a little buggy.

Working like the Dickens

No man but a blockhead ever wrote, except for money – Samuel Johnson

Charles Dickens supposedly wrote for a penny a word, which my high-school English teacher offered up as a reason why his books were so long. Just how miserable a wage was that? Even worse than it sounds.

Dickens_Gurney_headDickens lived in a largely deflationary era. From his birth in 1812 to his death in 1870, the pound dropped in value to £0.59, an average annual decline of 0.8% a year, according to the Bank of England’s inflation calculator.  Publishers cut prices relentlessly to get new readers; the first penny newspaper in London appeared in 1855. As publications cut costs, they had to cut their writers’ pay as well. Sound familiar?

How poorly was Dickens paid? Converting an 1836 English penny to a 2014 penny is a bit tricky. In Dickens’ day, there were 240 pennies to the pound. (Back in Merrie Olde England, 240 silver English pennies equaled one pound of silver.)  One pound in 1836 is the equivalent of £102.02 in 2014. At 240 pennies per pound, Dickens earned the modern equivalent of 43 English pennies a word, or 66 U.S. cents a word at the current conversion rate of $1.54 U.S. per pound.

Depending on your output, that’s not horrible. If you can sell 200 1,000-word pieces a year, you’d have income of about $132,000. And, of course Dickens – writing longhand – had prodigal output.carol_manuscript2

The Pickwick Papers, published in serial form from March 1836 through November 1837, weighs in at about 396,000 words. Assuming the penny-a-word formulation is correct, and that one pound equaled 240 pennies, that would have been 1,650 pounds, or the equivalent of £168,333 today — $259,232 in greenbacks. Pretty good for a 26-year-old first-time author, right?

Not really. As it turns out, Dickens was paid £20 an installment for The Pickwick Papers, or £400 total. He earned no royalties. That’s equal to £40,808 pounds today, or $62,844. It’s still good money for a first-time author, but well less than a penny a word. (It’s probably closer to a farthing a word: A farthing was a quarter of a penny).

Dickens did become quite wealthy, in part because The Pickwick Papers taught him the value of owning his works and the royalties that came with them. Of course, two other factors probably helped, too: He was an incredibly hard worker, often editing and doing other work while writing at a feverish pace. And, of course, he was Charles Dickens.