Stock Buyers Lose Bond Foundation for Steep Valuations

Apologists for high U.S. stock prices just lost their favorite defense.

Ten-year Treasury yields rose above 3 percent on Tuesday for the first time since 2014, and bond investors are hysterical. Chris Verrone, head of technical analysis at Strategas Research Partners, told Bloomberg Television on Monday that breaching 3 percent would ring in “a 35-year trend change in bonds” in which investors in long-term bonds would stop making money.

Let’s take a breath. For one thing, no one knows where interest rates are headed. Moreover, bond investors need not fear rising rates. Yes, bond prices decline when interest rates rise, but higher rates also mean higher yields on new bonds. Over time, those higher yields should more than offset lower prices.

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Classic Safe Haven Hides in Plain Sight

Watch volatility spike, and then watch investors scatter for safety. Only this time, they don’t seem to know where to hide.

After years of calm, market turbulence has returned. The annualized daily standard deviation of the S&P 500 Index — a common measure of volatility — has been 18.6 percent from 1928 through March. But the market was much quieter from 2012 through January, with a standard deviation of 12 percent.

That quiet ended abruptly in February. The S&P 500 tumbled 8.5 percent in just five trading days from Feb. 2 to Feb. 8, and its standard deviation has spiked to 23.4 percent since February.

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A Not Terribly Bright Idea for Harvard

A group of 11 Harvard alumni has a plan to boost the university’s straggling endowment, but it’s not the magical fix the members imagine.

In an open letter to Harvard’s new president, Lawrence Bacow, the group recommends that the endowment move at least half its assets to a low-cost S&P 500 index fund. It’s a “radical new endowment strategy,” the alumni acknowledge. Harvard, along with other big university endowments, pioneered and still uses the so-called endowment model of investing, which calls for investments in high-priced hedge funds and private assets alongside traditional stocks and bonds.

A radical step is necessary, the alumni say, because Harvard faces a “fiscal crisis” from a new tax on wealthy university endowments. According to Bloomberg News, Harvard estimates that “the new 1.4 percent tax would have cost the endowment $43 million last year.” The group’s plan would use the money saved on well-compensated managers to pay the tax.

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Ray Dalio’s Short-Bet Puzzle Is Missing Some Pieces

Hedge fund titan Ray Dalio is famously enigmatic, but his latest wager may be the most puzzling yet.

Bloomberg News reported on Thursday that the fund Dalio founded, Bridgewater Associates, has made a $22 billion bet that many of Europe’s biggest companies in the blue-chip Euro Stoxx 50 Index are poised to decline.

Bridgewater didn’t respond to Bloomberg’s request for comment, so Dalio’s motivation is not entirely clear. But according to Bloomberg News’ Brandon Kochkodin, Dalio “has a checklist to identify the best time to sell stocks: a strong economy, close to full employment and rising interest rates.”

It’s an old idea. Economic fortunes are reliably cyclical, even if no one can precisely predict the turns. Booms tend to be followed by busts, and vice versa, and stock prices often go along for the ride.

By that measure, it seems like a precarious time for U.S. stocks. The U.S.’s real GDP has grown for eight consecutive years, by 2.2 percent annually from 2010 to 2017. Unemployment has declined to 4.1 percent from 10 percent in late 2009. And the yield on the 10-year U.S. Treasury is up to 2.9 percent from 2.1 percent in September — an increase of nearly 40 percent.

The problem with Dalio’s checklist, however, is that stock prices take their cue from companies’ fundamentals, not the economy. Yes, companies’ collective fortunes often reflect those of the broader economy, but not always. And when the two diverge, the relationship between economic results and stock prices breaks down, too.

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Not Everything Is Expensive If You Know Where to Look

Investors love to complain that asset prices are too high, but they have only themselves to blame.

Investors bid up the S&P 500’s price-to-earnings ratio to 26.8 at the end of 2017 from 11.1 when the 2008 financial crisis eased in February 2009, based on 10-year trailing average positive earnings from continuing operations.

They drove down yields on the Bloomberg Barclays US Corporate High Yield Bond Index to 5.6 percent at the end of 2017 from 16.1 percent in July 2009. They squashed the yield on the Bloomberg Barclays US Corporate Bond Index to just 2.7 percent from 7.2 percent in May 2009. And they did the same to real estate. The FTSE Nareit U.S. All REITs Index yielded 4.1 percent as of November, down from 11.1 percent in February 2009.

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Calpers Needs to Think a Few Moves Ahead

The largest U.S. pension fund, the California Public Employees’ Retirement System, is chasing investing’s holy grail: Buy low and sell high.

Calpers is considering whether to reduce its stock allocation to as little as 34 percent from 50 percent and discussed it at a board workshop on Nov. 13.

The temptation to lighten up on stocks is understandable. The MSCI ACWI IMI Index — a collection of large-, mid- and small-cap companies from around the world — is up 40.2 percent since its low in February 2016 through October, including dividends. That’s well above the index’s average 20-month return of 14.7 percent since inception in June 1994.

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Investing: A Random Talk With Malkiel

For decades, Burton Malkiel has been a leading advocate of the efficient market hypothesis and its logical extension, the low-cost, passive approach to investing — as outlined in his bestselling book, “A Random Walk Down Wall Street.” Dr. Malkiel is a Princeton economist and Chief Investment Officer of a robo-adviser, Wealthfront.

I had the opportunity to chat with Dr. Malkiel recently about smart beta, his Wealthfront portfolios, and how investors should think about rock-bottom interest rates.

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Does Buffett Really Love the S&P 500?

Warren Buffett crooned one of his greatest hits for groupies attending Berkshire Hathaway’s annual meeting in Omaha last weekend: “Just buy an S&P index fund and sit for the next 50 years.”

Buffett has a well-deserved reputation as a legendary investor, but if ordinary folks want to mimic the master, the last place they should be parking their funds is the S&P 500.

Buffett is a big fan of the S&P 500. He has already declared that 90 percent of the money he leaves to his wife will be invested in Vanguard’s S&P 500 index fund. He also wagered a million dollars that Vanguard’s S&P 500 index fund would beat a basket of hedge funds over ten years from 2008 to 2017. (The S&P 500 index fund is currently crushing the hedgies.)

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Don’t Let McKinney Scare You Millenials

Poor millennials. Up to their ears in student debt. Facing stagnant wages. Beset by obscene housing costs in the big cities where they are most likely to land a job – if they can land a job, that is.

And now a high-profile consulting firm, McKinsey & Co., is adding to millennials’ woes with a Debbie Downer report that warns that millennials will have to work seven years longer or save twice as much in order to live as well in retirement as their parents. The reason, according to McKinsey, is that returns for U.S. and Western European stocks and bonds will be far lower over the next 20 years than they were over the previous 30 years.

Well, take heart Millennial Investors. Your futures are better than McKinsey would have you believe.

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