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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Financial Advisers Need Steady Learning to Keep Earning

It’s time for financial professionals to become a profession in substance, not just in name.

The Securities and Exchange Commission proposed new rules for brokers and financial advisers last week. Observers have understandably focused on the big change, which requires brokers to disclose their conflicts and look after clients’ best interests.

But a more modest proposal deserves discussion. Namely, the SEC would subject financial advisers to continuing education requirements.

It’s a wise move. Financial innovation is happening at a dizzying pace. More investment options are available today than ever before, spanning many different types of assets, geographies and investing styles, and new products are coming to market all the time.

That’s a challenge for an aging industry. The average age of financial advisers is 50, according to Cerulli Associates, and just 11.7 percent of advisers are younger than 35. Whatever advisers learned when they were trained for the job decades ago is most likely outdated.

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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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Users Built Facebook’s Empire, and They Can Crumble It

Facebook’s true value resides in its 2.1 billion users, and investors need to worry about what happens if enough of them decide that free social media isn’t worth the cost.

First,  a disclosure: I’ve never used Facebook. I get that it’s an awesome way to keep in touch with family and friends, meet new people and get a personalized online experience. But I value my privacy, and it’s hard to reconcile that with the fact that Facebook is in the business of selling its users’ information.

And it’s a great business. Facebook generated earnings from continuing operations of $15.9 billion in 2017 on revenue of $40.7 billion, 98 percent of which came from advertising.

If it isn’t already obvious that Facebook is a money-making dynamo, consider how it stacks up with digital ad rival Alphabet Inc., the parent of Google. Facebook’s gross margin was 87 percent last year, and its net income margin was 39 percent. That compares with 59 percent and 11 percent, respectively, for Alphabet.

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Theranos Crackdown Offers Welcome Check on Tech Startup Frenzy

Theranos did no favors for its investors, but it may have unwittingly helped the next generation of innovators.

The Securities and Exchange Commission last week accused the company and its CEO, Elizabeth Holmes, of misleading investors. According to the SEC’s complaint, Theranos lied about the capabilities of its blood-testing technology on its way to raising $700 million from 2013 to 2015.

As my Gadfly colleague Max Nisen rightly pointed out, “the sheer extent and audacity of the fraud perpetrated by Theranos’s leaders separates it from the pack.” But Theranos couldn’t have pulled off its elaborate fraud without the help of two larger forces.

The first is investors’ eagerness to throw money at startups on a scale that not long ago was available only to publicly traded companies. So-called unicorns — startups valued at $1 billion or more — raised $70 billion from 2014 to 2017, including a record $19.6 billion last year, according to financial data company PitchBook. To put that in perspective, that’s roughly three-quarters of the total net flow to all U.S. mutual funds over those four years, according to fund flows compiled by Bloomberg Intelligence.

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Bitcoin Isn’t an Investment Until Buyers Sweat the Fees

If you want to know where cryptocurrencies are in their development, keep an eye on fees.

When a new “investment” comes along, investors are often too busy counting their anticipated bounty to care about cost. Shrewd purveyors predictably seize the opportunity to charge excessive fees. But reality inevitably falls short of investors’ expectations, and the focus eventually turns to how much they’re paying to invest.

That’s a short history of stock investing. Investors had little access to stock market data a century ago. They didn’t have the luxury of knowing, for example, that the S&P 500 Index would generate a real return of 7.1 percent annually from 1926 to 2017, including dividends. Or that the index’s real return would fall short of that long-term average 52 percent of the time over rolling 10-year periods.

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High Times for Marijuana Stocks

Marijuana stocks would be the ultimate growth play if investors weren’t already so fired up.

It just got easier for U.S. investors to bet on pot’s big plans. Toronto-based Cronos Group Inc., which invests in medical marijuana producers, on Tuesday became the first marijuana company listed on a major U.S. exchange. Analysts expect its revenue to reach $34 million this year, up from $400,000 in 2016.

Cronos’s debut follows that of ETFMG Alternative Harvest ETF on Dec. 26, the first U.S.-listed marijuana exchange-traded fund. If ETFMG’s popularity is any indication, Cronos will soon be awash with money. Investors have already poured $386 million into the ETF through Tuesday.

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Warren Buffett Is Even Better Than You Think

Warren Buffett is an even better investor than you think.

The Oracle of Omaha released his latest annual letter to shareholders of Berkshire Hathaway Inc. on Saturday. It’s a good excuse to marvel anew at Buffett’s track record, particularly at a time when stock pickers are losing their aura.

Buffett famously likes to invest in companies that are highly profitable and selling at a reasonable price. That formula has routinely beaten the market, according to University of Chicago professor Eugene Fama and Dartmouth professor Kenneth French.

The Fama/French US Big Robust Profitability Research Index — which selects the most profitable 30 percent of large-cap companies — beat the S&P 500 Index by 1.2 percentage points annually from July 1963 to 2017, including dividends, the longest period for which returns are available. The profitability index also beat the S&P 500 in 81 percent of rolling 10-year periods.

Similarly, the Fama/French US Large Value Research Index — which selects the cheapest 30 percent of large-cap companies — beat the S&P 500 by 2.3 percentage points annually from July 1963 to 2017, and in 82 percent of rolling 10-year periods.

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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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