Show Me the Money

Remember: Stock rallies are ultimately dependent on corporate earnings growth. As Ben Graham, the father of security analysis, reputedly said, “In the short run the market is a voting machine, but in the long run it’s a weighing machine.”

What the market weighs is earnings.

So how to assess “abnormal items” (such as merger costs, natural disasters, one-time sales, or any other unusual event) that skew earnings?

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So About Those Big Corporate Profits

Jeremy Grantham, an astute investment strategist, recently raised doubts about American exceptionalism in such areas as health care and education. But as my Bloomberg News colleagues noted in an article about Grantham’s concerns, the U.S. has managed to maintain its exceptionalism in at least one category – making money.

Corporate America has been handsomely profitable since the financial crisis that erupted in 2008, outstripping the performance of overseas competitors. The earnings per share of U.S. companies, as represented by the S&P 500 Index, have grown by 105 percent since 2008. In the developed world outside the U.S., as represented by the MSCI EAFE Index, earnings per share have grown by 30 percent over the same period. In emerging markets, as represented by the MSCI Emerging Markets Index, earnings per share have grown by 8 percent over the same period.

Such success was hardly a forgone conclusion seven years ago. At the height of the financial crisis, the survival of many U.S. companies – to say nothing of their future profitability – was in doubt. By contrast, emerging markets were lauded for their growth and comparatively low levels of debt.

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There’s No Place Like Home

Jason Zweig recently suggested that homeowners make far less money selling their houses than they believe. He cites Yale University economist Robert Shiller’s data, which finds that “real estate generally keeps pace with inflation but seldom offers any return premium above that.”

Homes have done a bit better than that, but not by much. The S&P/Case-Shiller U.S. National Home Price Index, which measures the changes in value of single-family homes, has grown at a real rate of 1.1 percent annually since 1975. In reality, even this pittance overstates homeowners’ fortunes since it doesn’t account for the myriad expenses that also accompany homeownership and eat away at returns.

So how did homes get confused with goldmines? It turns out that a short-lived period of unusually high returns is to blame. As expected, that period coincides with the boom years of the real estate bubble, but the seeds were planted during the tech bubble that preceded it. This becomes apparent when looking at the NHPI’s rolling ten-year real returns.

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Vanguard Should Get Active

As my Bloomberg News colleagues reported earlier this week, the financial juggernaut known as Vanguard added $185 billion to its low-cost and passively-managed funds so far this year, “which puts it on pace to…” wait for it, wait for it, “…bring in more money in one year than any asset manager in history.”

Vanguard deserves its success. It’s brought low-fee, principled investing to the masses in a singular and admirable way.

According to Bloomberg, the average asset-weighted fee of a Vanguard fund is 0.13 percent, compared with 0.66 percent for an active mutual fund. On $185 billion, this translates into fee savings of nearly $1 billion this year alone – a boon to Vanguard’s legions of investors.

But as the industry leader, there’s much more that Vanguard could and should do.

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Diverging Markets

Everyone has grown accustomed to thinking about emerging markets as a monolith — a collection of undifferentiated countries aspiring to the big leagues, with all of the heft and stability of more developed economies.

Emerging markets share similar traits, oftentimes the market prices them similarly, and so they all get wrapped into the familiar and popular one-size-fits-all basket called THE EMERGING MARKET FUND.

Today, that’s the wrong way to think about emerging markets.

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