INVESTMENT INTELLIGENCER

Now Who's The Boss

Remember the days when New York ruled the financial world?  It will be an amusing irony if what finally torpedoes our overvalued stock market is the crumbling of the formerly "emerging market" known as China.  The Shanghai casino tanked a sharp 9% yesterday, taking all the Asian markets down with it.  And now New York is playing caboose...

About That Housing Market Stabilization...

Amid glowing reports that the housing market has stabilized come anecdotes like this one, about a spike in foreclosures in Massachusetts. 

Mass. foreclosure filings smash record (From Boston.com)

January had the highest number of monthly Massachusetts foreclosure filings in at least two decades as local consumers struggled to hang onto their homes, according to a new report.

Last month, 2,207 foreclosure filings - or 110 every business day - were submitted in Massachusetts, more than double the number of a year ago; filings in January 2007 were up 105 percent from 1,076 filings in January 2006, according to ForeclosuresMass.com, a Framingham firm that provides online Massachusetts foreclosure data to investors, real estate agents, and lenders.

"The flood of foreclosures in Massachusetts is not only continuing; it has reached a new high," company president Jeremy Shapiro said in a statement. "The fact we are starting the year with the highest number of foreclosures we've ever recorded for a single month is more than significant - it's ominous."

Because housing is one of the sectors that could bring the whole economy down (similar to tech/telecom/media in 2000), resolving the "stabilization" question is important.  Although the Massachusetts and other "subprime" anecdotes concern mainly the low-end of the market (and all those poor folks who hoped that interest rates would stay at Japanese levels forever), the contagion could still spread--especially if long rates ever tick up.  Given this, combined with the fact that down cycles in housing usually last about 5 years, not 1 year (and usually trough well below the long-term trend line), the wise conclusion is probably that we're still closer to the beginning of the housing "correction" than the end.

New GMO Forecasts: Equity Investors Are Screwed

The methodologies underlying most market forecasts do not have much predictive value, and as a result, the predictions are no better than the standard market odds (and in many cases worse).  What are these odds?  To pick one example, the odds that the S&P 500 will go up over any given year are about 2-in-3.

One firm that produces forecasts using a thoughtful, defensible methodology is Boston's GMO.  The firm makes no claim that it can predict performance over short and intermediate-term timeframes (Chairman Jeremy Grantham's recent foray into "Presidential Cycle" forecasts produced a few bad calls, so he has since returned to his valuation-based knitting).  Instead, it estimates the likely performance of a half-dozen major assets over a seven-year period. 

GMO's forecasts are based on a "cyclically adjusted P/E."  Unlike most P/E analyses, the cyclically adjusted P/E takes into account the business cycle, "normalizing" today's record-high profit margins under the theory that they will eventually regress to the mean.  (If they don't, Grantham is fond of saying, capitalism is broken.)  Work by Andrew Smithers of London-based Smithers & Co. has shown that such "cyclically-adjusted" analyses have predictive value, while those that look at a single year's earnings in isolation don't.  The one caveat (there's always one) is that this valuation metholody depends on mean-reversion.  On the rare occasion when things are, in fact, "different this time," it doesn't work.

In any case, GMO recently published its asset-class forecasts based on prices at the end of January.  For those who like their bad news delivered graphically, GMO's own publication is vivid.  For those who prefer text, here's a snapshot:

Real Seven-Year Asset Class Return Forecasts (Expected annual return over 7 years. Source: GMO)

U.S. Equities (Large cap):  -1.7%

U.S. Equities (Small cap):    -2.6%

Int'l Equities (Large cap):     -0.3%

Int'l Equities (Small cap):     -2.3%

Emerging Equities:              +1.6%  (Hallelujah)

U.S. Treasury Bonds:            +2.0%

The bottom line?  Unless you can limit your equity exposure to "high-quality" stocks, GMO expects you'll lose ground to bonds.

Henry Blodget

Henry Blodget is a former Wall Street stock analyst and the author of The Wall Street Self-Defense Manual: A Consumer’s Guide to Intelligent Investing (companion site here).  Henry is CEO of Cherry Hill Associates, LLC, an industry research and consulting firm.  He serves as an advisor to several Internet companies, edits an award-winning business blog, Internet Outsider, and is a frequent contributor to Slate, Newsweek International, The New York Times, and other publications.

 

From 1994-2001, Henry worked in corporate finance and equity research at Prudential Securities, Oppenheimer & Co., and Merrill Lynch & Co.. where he specialized in the software and Internet sectors.  In 2000, Henry was voted the No. 1 Internet/eCommerce analyst on Wall Street by Institutional Investor, Greenwich Associates, and thestreet.com and was one of the most widely followed analysts in the world.  In 2002, after leaving Wall Street, Henry was named in a wide-ranging regulatory investigation about conflicts of interest between brokerage firm research and banking functions; he participated in the global settlement and is now precluded from working in the industry. Henry earned a B.A. from Yale.

Investment Intelligencer

Investment Intelligencer provides news, commentary, and insight for intelligent investors.  The site is edited by Henry Blodget, a former top-ranked Wall Street analyst.  The opinions expressed on Investment Intelligencer are those of the site's writers and are not investment advice.  We welcome intelligent comments and submissions, and we will be glad to consider publishing the latter as formal posts (please send to share at investmentintelligencer dot com). 

At Investment Intelligencer, we respect smart traders, but we are not a trading site.  We focus on investing instead of trading because we believe it is the best strategy for the vast majority of investors, including professionals.  We believe that the insights unearthed by academic-quality researchers can be extremely valuable for ordinary investors, and one of our goals is to make this work as useful and accessible as possible.

8-Year Old Beats Market, Pros

It would be nice if that headline were a joke, but, sadly, it isn't.  How did he do it?  The same way most smart people do.  By owning a diversified portfolio of index funds: the Vanguard Total Stock Market fund, the Vanguard Total International Stock Market Fund, and the Vanguard Total Bond Market fund. (Paul Farrell explains.) Thanks to the bonds in the mix, the portfolio has a lower risk (standard deviation) than the S&P and has delivered higher returns.

This, of course, is the smart way to try to beat the pros (the dumb way is to try to out-trade them).  And the nice thing is, because the pros can't buy low-cost index funds, it's almost guaranteed to work.