Be Careful With Statistics

Mark Hulbert recently published a post,

"This is what the stock-market indicator with the best track record is telling us.",

 on MarketWatch.com, based on Ned Davis research arguing against those who believe that high "sideline cash" could lead to a strong upsurge in equities.

Let me say right off that I don't know where the market is going.  I believe that over the next 10 years stocks will do better than bonds and bonds will do better than cash equivalents. I believe that stocks could do a lot better given that the information age puts all kinds of information at the fingertips of very smart, creative, energetic people around the world. But...I could be wrong. Furthermore. I will be the first to stand up and admit that Hulbert is a lot smarter than me and I enjoy reading his posts.

Still, I think one needs to be careful with time series data on stock investing and this post by Hulbert is a prime example.

I wasn't investing in 1951 but I was investing in the 1960s. In the 1960s the investing world was dominated by defined benefit plans and the defined benefit plans were the responsibility of Trustees. Recency bias dominated the the investment process. Trustees looked over their shoulders and saw the markets of the 1930s. As a result allocations to stocks were low.

As an individual my investment choices were actively managed mutual funds that charged a lot expense wise or individual stocks at a high commission. If I wanted to buy or sell I had to talk to a broker who inevitably tried to up sell me by pressuring me into high commission product. To see how my stocks did the previous day I went to the mailbox and got the newspaper.

Today of course I can buy ETFs with the push of a button that track markets around the world. Today we live in a defined contribution world. Today, according to the Census Bureau, 79% of Americans have access to a 401 (k) at work. Today the small investor can easily and economically  invest in the overall market, a choice that has been shown to outperform most active managers over the longer term.

The point here is that using time series data from the 1950s on up even to the 1990s compared to today is comparing apples and oranges. In effect, arguing for the "reversion to the mean" maybe misleading as  the mean could be changing significantly over the period examined.

So maybe you say "no harm no foul", the data just needs to be taken with a grain of salt. Unfortunately I think the harm is greater in the following sense. Many investors can be persuaded by slick talking advisors using this kind of information to alter their investment approach. Using terms like "mean reversion", R-squared, and performance by "quintiles" gives the report seemingly expert opinion.

Just saying!

Update on Morning Routine

Source: Capital Pixel

I'm primarily an indexer and passive dividend stock investor.  Thus, I don't hunger after economic data during the course of the market day or breathlessly wait for the next pundit coming up on CNBC.  But I do like to feel like I know what is going on in the market and  like I understand the major influences.  To that end, I begin my day gathering data.

I go to MarketWatch and begin at the data source shown:

Source: MarketWatch

I first record the yield on the 10-year Treasury Note (1.79) and the German 10-year Bund yield (.32) and then calculate the difference.  That difference, as shown, is now 1.47%.  So, even though the U.S. rate is anemic, it is considerably higher than the German rate as well as most of the other yields shown in the table.  Other things equal, U.S. rates are enticing to many in the global markets.

Next I click "FX" and record  "WSJ $ Idx, a basket of currencies, as well as the euro.  Both of these have moved higher.  On January 14, for example, the WSJ Idx and the euro stood at 84.02 and 1.18, respectively.  Today they are at 85.40 and 1.12, respectively.  The bottom line is U.S. Notes and Bonds look very attractive to global investors both on a yield level basis and dollar appreciation basis.  This was the major factor confounding prognosticators in their prediction that rates would rise in 2014!

I next click "Futures" and record both the price of oil and gold.  In reading Barron's "Roundtable," I have gotten chuckles, as I'm sure some of you have, over the hand-wringing by participants of the failure to foresee the collapse in oil prices.  Some of the participants seem to question the whole pundit/prediction exercise!

One final data point I started picking up recently was the yield on the S&P 500 which, itself, has gone above the yield on the 10-year Treasury.  I get it by going to Yahoo! Finance and looking at the yield on SPY, the ETF tracking the S&P 500:

Source: Yahoo

As shown, the yield is 1.87%.

All of this takes less than 10 minutes in the morning and gives me a good feel for how markets are behaving.

A couple of years from now, I will surely be tracking different indicators.  That's the nature of markets - what is important at various times changes.  There was a time when the P/E ratio on internet stocks was a driving factor.  At another time, it was the rate on adjustable rate mortgages.  Today it happens to be the spread between U.S. interest rates and global rates along with the value of the dollar.

Since some of you may go to the MarketWatch site, it is a good time to tout the "RetireMentors" which can be found by clicking the "retirement" link at the top of the homepage.  IMHO, this is the best ongoing collection of articles online for people interested in retirement.

Following the Market

Birdwatching is like market watching

I'm an indexer and dividend investor.  As such, you might think I don't follow the markets closely.  That would be wrong.  Like active stock pickers and market timers, I like to try to understand what is going on and. yes, even guess (knowing that it is a guess is, I believe, a quantum jump in investment sophistication that many ego maniacs in the markets can't make) where the market is headed.

As an economist, I like to keep the market tracking process efficient.

Over the years, I have come to understand that the market is driven by broad themes over various time periods; and understanding these themes is important.  For example, in the mid-70s and early 80s, it was all about energy because of OPEC.  Being underweighted or overweighted, energy drove relative performance.  In the late 1990s and early 2000s, of course, it was all about internet-related stocks both on the way up and the way down.  In 2008, you needed to get the impact of the housing crisis on financial services and, especially, the banking sector right.

Today, I look at relative yields, the dollar, oil prices, and the price of gold.  In particular, I go to

Marketwatch

and record the difference between the U.S. 10-year and the German 10-year.  Here you see that difference at 2.24 - .70 =  +1.54%  (154 basis points).  Eyeballing the other rates shows the advantage of the U.S. 10-year Note as well.

Source: Marketwatch

But for foreign investors, the currency conversion is also important.  Click the FX link, and you find a broad FX index, WSJ$IDX, and the Euro.  I record each of these first thing each morning.  To the extent that foreign investors invest in the U.S.10-year and yields drop and the dollar strengthens, it is a very good investment compared to investing in their home country.

This hasn't gone unnoticed by market observers as an important  influence that has kept U.S. interest rates low despite an aggressive Fed policy and an expanding U.S. economy.

As an aside, I once knew a man who explicitly  sat down and waded through numerous investment publications whenever he felt he didn't understand the markets.  This is the process that many needed to go through earlier this year as their confident predictions of a sharp rise in interest rates didn't just materialize but actually moved in the other direction.  This would have led to an understanding of relative yields and the influence of global yields on U.S. yields.

I also click on "Futures" and get the price of oil and the price of gold.  Each has had, and will have in the future, a major role in moving markets.

The whole process of collecting this data takes just a few minutes and is, I believe, useful in understanding broader markets.  For example, dividend-paying stocks should continue to at least hang in and provide decent performance as long as their yields stay above the yield on the 10-year UST and global yields remain low.

Benzinga - Market Data Source

Most market watchers have a routine they go through each morning to get up to speed on overnight market action and important events for the day ahead.  When I first started in the investment management business, my day started by reading The Wall Street Journal, followed by several phone calls to get market color.  In all, it typically took over an hour to get a feel for how the market day was likely to shape up.  Today, it is literally a matter of minutes.

My day begins with a report on the clock radio from a local broker typically giving an update on futures along with a couple of headlines - the day's first indication if stocks are likely to open higher or lower.

Once I get a little cereal and coffee in me, I go online and check out Yahoo! Finance and Bloomberg. More recently, I have come across Benzinga, a site I  recommend, especially if you don't have much time but want a comprehensive overview.  Let's take a look.

Benzinga Market Primer

The Market Primer is where you want to go:

You'll find it begins with a short summary of the main story of the day.  Today that's Cyprus.  It then follows with other "Top News."  Today this includes items such as foreign direct investment in China, Quantitative Easing in Japan, the value of the Euro, and S&P 500 futures.  The movement in the yields on 10-year Spanish and Italian bonds overnight, the most widely watched indicators of the impact of developments in the Euro zone by market watchers, is included as well.

Next there is a paragraph about Asian Markets, followed by paragraphs on:

• European Markets
• Commodities
• Currencies
• Pre-Market Movers (Stocks affected by overnight news)
• Earnings
• Economics

The site includes much, much more--especially if you are looking for investment ideas.  Check it out - I think you'll like it!

Matt Andersen - Ain't No Sunshine

Is he singing about the bull market? Eurozone 1st quarter GDP on Weds., China data all through the week. Lite data week for U.S.