Are You Smarter Than a Monkey? Course Syllabus. How Are Our Stocks Doing? 9/24/2017

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1 Are You Smarter Than a Monkey? Course Syllabus Human Psychology with Investing / Indices and Exchanges Behavioral Finance / Stocks vs Mutual Funds vs ETFs / Introduction to Technology Analysis Our Economy & The Stock Market / Style Investing Managing Risk / Understanding Sectors & Industries / Using Relative Strength / Factor Investing Investing for Income / Using REITs, MLPs, CEFs and Preferreds Guest Speaker: Travels of a Self Taught Investor Understanding Important Fundamental Ratios / International Investing / Learning from the Masters Portfolio Construction & Risk Management / The Importance of Diversification / When to Sell How Are Our Stocks Doing? 1

2 Question of the Day What is the 12b-1 fee? There Are Two Approaches to Investing Active Passive Stocks, mutual funds, hedge funds, CEFs, ETFs (very few) Stock picking strategy Expensive fee-based model Try to beat the market (or seeking alpha) Better for factor-based or international funds Index funds (mutual funds or ETFs) Natural momentum strategy Extremely low cost model Try to match the market (or maintaining beta) Better for broad market indexes ETF vs MF Feature ETFs Mutual Funds Transparency Prior-day holdings are disclosed on a daily Regulatory requirements only mandate basis, which can give investors the assurance quarterly disclosure of holdings. However, that comes with knowing exactly what they many funds choose to publish holdings on own. a monthly basis. Liquidity All ETFs including those actively managed trade intra-day on an exchange like a stock. Actively managed mutual funds are structured such that investors can only buy and redeem shares at the end-of-day net asset value (NAV). Cash Drag ETFs are structured such that buyers and sellers of shares are matched up in the marketplace. This secondary market liquidity reduces trading in the underlying securities that could affect existing Since mutual funds don t trade in the secondary market, cash drag can be a significant consideration. Portfolio managers for these funds generally keep a few percent in cash for redemptions, shareholders. As a result, portfolio managers which may impact performance over time may not need to keep as much cash on hand either positively or negatively. for redemptions, thereby reducing the potential for cash drag. 2

3 Settlement Timing Fee Structures Fractional Shares Option Trading ETF vs MF Many ETFs settle T+2 (recent change Generally settle one day after the from T+3), which means three days transaction date (T+1). This timing may not after the transaction date. This timing match the settlement of the underlying matches the standard settlement of holdings, potentially requiring a greater the underlying securities, which may cash position and/or higher transaction reduce the amount of cash held for costs. redemption. Investors transacting in ETFs incur Although mutual fund investors don t pay trading costs, including the bid/ask a bid/ask spread or commission, a mutual spread and potentially a commission. fund s management fee may include 12b-1 However, ETFs generally don t include fees and other fees associated with 12b-1 fees, which are annual servicing the vehicle. marketing or distribution fees on the fund. Cannot be traded in fractional shares, Ability to trade fractional shares, making it hindering the ability to trade small easier to accommodate regular, smaller amounts regularly. trades. ETFs are used extensively for option N/A trading. Index Weightings How to Invest in the Market? Most Popular S&P 500 ETFs S&P 500 ETFs With a Twist 3

4 Always Look Under the Covers Apple (AAPL) is a component of 15 growth ETFs at the same time that it is part of 8 separate value ETFs. This overlap makes achieving diversity less simple than it sounds. Consider an investor who holds the ishares Core S&P 500 ETF (IVV) as a primary longterm holding, then bolts on both ishares S&P 500 Growth (IVW) and ishares Edge MSCI USA Value Factor (VLUE). This mix sounds well-balanced, yet the top holding for each of the three ETFs is: Apple, Apple, and Apple. The Stock Market & Our Economy Here s Our Economy(ies) 4

5 Our U.S. Economy Source: Here s our Stock Market Economic Cycle The stock market relies on two things to make it move higher or lower. First are the fundamentals earnings, valuations, cash flow, etc. The second thing is investor psychology, or sentiment. Real Market Cycles At tops, you have fundamentals that are over-priced but with very high investor sentiment (making it a contrarian indicator). At the tops, things like corporate profitability start to decline (not profits but profitability). This is mainly due to higher wages. Investors are experiencing euphoria due to higher employment, higher wages and more consumption, becoming more leveraged. Investors also start investing more of their money into the stock market. 5

6 Real Market Cycles At bottoms, you have very strong, low-priced fundamentals but very low investor sentiment. Where is the Market Valuation Advanced Systems Today? Group (Warren Buffet s Favorite Stock Market Indicator) Where is the Market Valuation Today? (Warren Buffet s Favorite Stock Market Indicator) 6

7 Thank You FOMC Advanced??? Systems Group QE stops Oct 14 QE begins Dec 08 Quantitative easing is an unconventional monetary policy in which a central bank purchases government securities or other securities from the market in order to lower interest rates and increase the money supply. The Fed & Interest Rates As interest rates drop, consumer spending increases, and this in turn stimulates economic growth which can spur inflation... The right level of economic growth, and thus inflation, is somewhere in the middle. It's the Fed's job to maintain that delicate balance. Interest Rates Can Remain Low for a Very Long Time 7

8 Japan s Interest Rates Our Economy & the Stock Market For equity markets, macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day-to-day or even monthto-month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes. The Reality is The relationship between stock prices and the economy is that it is not a linear one faster growing economies do not equal better stock returns. Rather, it is the degree and direction of surprise relative to expectations that determines the stock market s reaction, good or bad. This explains the Brazilian stock market s 30% advance in 2016 and Argentina 47% YTD! Expectations were too hideous for the reality, which is bad, just not as bad as feared. 8

9 Why The Market is So Frustrating? Periods Going Nowhere How Often Do They Occur? 9

10 Taking a Pause for the Cause So, Are We in a Cyclical or Secular Bull Run? Markets Generally Trend Upward As long as people have babies, capital depreciates, technology evolves, and tastes and preferences change, there is a powerful underlying impetus for growth that is almost certain to reveal itself in any reasonably well-managed economy. Tim Duy Economist, University of Oregon 10

11 Styles of Investing Large caps are covered heavily by Wall Street and everyone pays attention to small caps because they are something of a gauge of risk, but few people ever talk about mid caps. Value vs Growth Growth vs Value 11

12 Is a Value Comeback Overdue? Value premium of US stocks since 1926 A Plug for Growth Stocks There is no reason to expect that in any short period of time low-multipliers would outperform high-multipliers. The latter were well thought of in the market and thus had a considerable degree of momentum behind them, which might continue for an indefinite period. Ben Graham Overpriced is not the same as going down tomorrow. Howard Marks A Plug for Value Stocks If all analysts agree that one particular stock was better (read looking for growth stocks) than the rest, that issue would quickly advance to a price which would offset all of its previous advantages. Being different (read looking for value stocks) than everyone else offers a chance for better than average results. 12

13 Be Careful Value investing works, but it kind of works like molasses. You can go an incredibly long time without making money. A lot of value investing is like watching paint dry Some of these really cheap stocks just sit there. And that s understandable. They get cheap for a reason. They re a boring business. People don t care. Not a lot of money flowing into them. And that can last for a really long period of time. What to Avoid Value traps stocks whose prices continue to fall the so-called falling knife or stocks whose value will never be recognized by the market. Value stocks which have great potential, but whose value takes an inordinate amount of time to be recognized by the market. Speculative momentum (growth) or irrational highyielding stocks (value) whose technicals are unsupported by their fundamental valuation. Show Me All the Value ETFs List compiled at 13

14 How to Pick Growth Stocks Have increasing sales and increasing profits (earnings are usually negative) Stand at the forefront of innovation (usually tech or biotech) Products or service change the way we live Have entrepreneurial management Have increasing institutional support So What s the Difference between Value and Growth? Really Nothing Just looking for mispriced future expectations. Lower expectations equate to long term performance advantage But generally lower valuations for value stocks and higher valuations for growth stocks. More risk does not mean more return, but to get more return you need to take more risk. 14

15 Growth and Value are Not Opposed to Each Other Growth should be an input into value. Growth at a Reasonable Price Short Time Long The golden bullet is a value stock with price momentum and relative strength Growth vs Value 15

16 Let s Look at Market Cap Major Market Size Categories Mega Cap Market cap of $200 billion and greater Large Cap $10 billion and greater Mid Cap $2 billion to $10 billion Small Cap $300 million to $2 billion Micro Cap $50 million to $300 million Why Prefer Small Cap Stocks? Less government regulation They receive most of their revenue from the domestic economy Tax reform would greatly benefit them They are not included in the top percentage of holdings of any market cap index They have the small cap premium Beware: smaller companies can t absorb higher financing costs as easily. 16

17 Stability is important metric; usually less risk ; usually more risky Momentum & earnings growth are important metrics Small cap value works better overseas? Small Cap vs Large Advanced Cap Systems Group (YTD) Small Cap vs Large Cap (over 3 years) 17

18 There Are More Than Advanced 100 Systems Group Ways to Play Small Caps Obvious ways are ishares Russell 2000 (IWM) or Vanguard (VTWO) or SPDR (TWOK) Or consider ishares S&P Small Cap (IJR) which tracks the S&P 600 index Companies are decided by committee based on criteria such as earnings and liquidity Rudimentary screen but with value tilt With the Russell 2000 you get the good and the bad, but what you want are small companies that have good growth, strong balance sheets, and profits. What About Equal Weighting Funds? (Hint: use mid caps instead!) Smack Dap in the Middle 18

19 Focus on Down-side Capture Midcap is generally a neglected asset class. Most analyst either focus on small- or large-cap Investing at Level 3 Or Just be a Contrarian? Traders are most bullish at market tops and most bearish at market bottoms! 19

20 Should We be a Contrarian? Crude oil MLPs Emerging markets especially their currencies Retail malls (via REITs) Healthcare When we hear viscerally negative sentiment, our ears should perk up. We should investigate further, we should do deeper research, we should look into the fact that a broad-based, prevailing sentiment has provided us a potentially great opportunity to own good companies at reasonable prices. 20