Mid-Cap Stocks Aren’t Ready for a Starring Role

I can’t open a web browser lately without seeing a banner promoting State Street Corp.’s new digital series “Crazy Enough to Work” starring actress Elizabeth Banks — who, I must confess, I think is fabulous.

The series profiles four midsize companies. The first two episodes showcase EPR Properties and the New York Times Co. and have already been released. The final two feature Dunkin’ Brands Group Inc. and the Boston Beer Co. and will be available on Aug. 29 and Sept. 12, respectively.

It’s all a plug for State Street’s SPDR S&P MidCap 400 ETF, which makes me wonder about those algorithms supposedly customizing my online experience. I’ve never expressed any interest in buying a mid-cap stock fund.

It’s not that I have anything against mid-caps. On the contrary, I own them like nearly everyone else. I’m defining mid-caps as stocks with a market value of $1 billion to $10 billion. If you own a large-cap stock fund, chances are you own some mid-caps, too.

Consider that there are 458 mid-cap stocks in the Russell 1000 Index, which collectively make up 8.9 percent of the index. Mid-caps make up an even bigger chunk of the broader market. There are 1,429 mid-caps in the Russell 3000 Index, accounting for 14.6 percent of the index.

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Stock Investors Pick the Wrong Exit in Emerging Markets

Here’s a brainteaser: While investors fret about trade wars and rate hikes, U.S. stock prices keep climbing.

Answer: Investors are indeed running for the exit — just through the wrong door.

Emerging-market stocks, not those in the U.S., are taking the brunt of investors’ fears. The MSCI Emerging Markets Index is down 7.7 percent this year through Wednesday, while the S&P 500 Index is up 5.3 percent. The EM index is also down 16 percent from its high on Jan. 26, just shy of the 20 percent decline that signals a bear market.

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Target-Date Funds Aren’t the Retirement Bull’s-Eye

The Vanguard Group published recently its “How America Saves 2018” report, a trove of data on more than 4.9 million retirement savers in 401(k)s, 403(b)s and other defined-contribution plans.

My colleague Barry Ritholtz has already noted many of the highlights, but one detail deserves more exploration: Target-date funds are taking over retirement accounts.

The numbers are astonishing. Roughly half of retirement savers invested their entire account in a single target-date fund in 2017. None did so as recently as 2004. Vanguard estimates that number will grow to 70 percent by 2022.

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Pretty Soon, You’ll Get to Invest Just Like Ray Dalio

Ray Dalio may be slowing down, but the investment strategy he popularized is just getting started.

Bloomberg News reported recently that Dalio, founder of the world’s largest hedge fund, Bridgewater Associates LP, will spread the firm’s ownership among more employees and give them a say about management and governance.

Dalio founded Bridgewater in 1975, but he will most likely be remembered for the All Weather fund the firm launched more than two decades later in 1996. That fund was the first to offer a strategy that has come to be known as “risk parity.”

Investors may not yet be familiar with risk parity, but that’s about to change. Putnam Investments introduced a risk parity mutual fund last year. Robo-adviser Wealthfront Inc. launched one this year and added it in February to accounts with more than $100,000 in taxable assets, raking in $780 million for the fund so far, according to Morningstar. More funds are likely to follow.

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Trade War Would Cause Trouble on Home Front for U.S. Investors

President Donald Trump’s looming trade war is no friend of the U.S. stock market, and that’s bad news for U.S. investors who like to keep their money at home.

Free trade is under siege. The White House imposed $50 billion in tariffs on Chinese imports on Friday. China responded in kind. President Trump is now threatening up to $400 billion in additional tariffs, and China is vowing to retaliate again. Its Ministry of Commerce called for “comprehensive quantitative and qualitative measures” if the U.S. imposes additional tariffs.

The intensifying trade dispute should worry investors who are reluctant to venture overseas, and there are many of them. According to one estimate, U.S. investors, on average, allocate just 15 percent of their stocks to foreign markets. That’s a huge home bias given that the U.S. accounts for roughly half of global stocks by market value and a quarter of the world’s economic output.

Proponents of home bias argue that U.S. stocks provide plenty of exposure to foreign markets because large U.S. companies sell their wares all over the world. The percentage of S&P 500 sales from foreign countries was 43.2 percent in 2016, according to S&P’s most recent global sales report. That percentage has been reliably between 43 percent and 48 percent since 2006.

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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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