Toro's Running of the Bulls Market Blog

If You Want Higher Returns, Give the CEO Less

From The WSJ

[T]wo new studies ... suggest that when chief executive officers get paid more, shareholders end up earning less.

The first study, led by corporate-governance expert Lucian Bebchuk of Harvard Law School, looked at more than 2,000 companies to see what share of the total compensation earned by the top five executives went to the CEO. The researchers call this number—which averages about 35%—the "CEO pay slice."

It turns out that the bigger the CEO's slice of the pie, the lower the company's future profitability and market valuation. "These CEOs," says Prof. Bebchuk, "seem to be trying to grab more than they should."

Finance professor Raghavendra Rau of Purdue University and two colleagues looked at CEO pay and stock returns for roughly 1,500 companies per year from 1994 through 2006. They found that the 10% of firms with the highest-paid CEOs produce stock returns that lag their industry peers by more than 12 percentage points, cumulatively, over the next five years.

Companies at the top of the pay pile, Prof. Rau concluded, award their CEOs an annual average of $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO's pocket takes $100 out of shareholders' pockets.

America Held Hostage!

From Tom Toles.

China's Coming Financial Crisis

I would suggest you pop on over to Zero Hedge and read the article published a few days ago from SocGen on the coming crisis in China.

I am currently reading the book, This Time is Different, which details eight centuries of financial crises.  The authors note that financial crises are usually presaged by an explosion in credit growth, like what now occurring in China.  Throw in an antiquated and opaque banking system priced to perfection, enormous imbalances particularly in foreign reserves, overcapacity, too much fixed investment, too heavy of a reliance on exports to the West, and reports of housing bubbles, and this will ultimately not end well.

That does not mean that China is about to roll over right away, nor that the country's future is not bright.  The United States went through many financial crises in its development.  China will as well, and we must be aware of this.

Gold v Stocks, 1971 to Present

In an article on Monday, Bloomberg compared the returns on gold to CDs since gold hit its last peak.

Gold’s best year in three decades has yet to match the returns of an interest-bearing checking account for anyone who bought the most malleable of metals coveted for at least 5,000 years during the last peak in January 1980.

Investors who paid $850 an ounce back then earned 44 percent as gold reached a record $1,226.56 on Dec. 3 in London. The Standard & Poor’s 500 stock index produced a 22-fold return with dividends reinvested, Treasuries rose 11-fold and cash in the average U.S. checking account rose at least 92 percent. On an inflation-adjusted basis, gold investors are still 79 percent away from getting their money back.

Generally, buying and holding assets at peak valuations is not a prudent investment strategy, as anyone who has continuously owned stocks this past decade knows.  Gold, of course, is no different.

Comparisons between asset class returns are very end-point sensitive but illustrative nonetheless.  So how has gold done relative to stocks?

One comparison is gold to equities since the United States abandoned the last vestiges of the gold standard.  On August 15, 1971, President Nixon suspended convertibility of dollars held by foreign central banks into gold, thus setting in motion the greatest orgy of credit creation the world has ever seen, arguably culminating in the credit crisis of 2008.

Using end of month levels, at the end of August 1971, the S&P 500 was 99.03 and gold was $42.73.  At the end of November 2009, the S&P 500 was 1095.63 while gold was $1173.52.  Over that time period, the S&P 500 price index returned 1006%, or 6.5% annually, whereas gold rose 2646%, or 9.0%.  On a price basis, gold has handily beaten stocks.

Of course, price appreciation is only a part of the return on equities.  Stocks pay dividends.  If one includes dividends reinvested, stocks returned 4192%, or 10.3%, besting gold, although not by as much as one might expect.

More interestingly, there have been long time periods when stocks and gold have outperformed relative to each other.  Upon suspending gold convertibility, gold began outperforming stocks almost immediately.  From September 1971 through September 1980, stocks returned 27% including dividends reinvested, or 2.6% per year.  Gold rose 1460%, or 35% per year.

Stocks started to outperform gold in October of 1980, and did so for two decades until August 2000, returning 2429% including dividends reinvested, or 17.6% per year.  Gold was a dog, declining 58%, or 4.3% per year.

Relative performance turned once again in September of 2000 and has continued ever since.  Total returns including dividends for equities up to the end of November of this year has been -18%, or -2.1% per year.  Gold has been a big winner, rising 323%, or 16.9% per year.

Everything has its time and place.  Wall Street will tell you that you should always be in stocks.  They are dead wrong.  Stocks have been horrible investments at various times throughout history.  Likewise, there have been great times to own gold and other times when you do not want to own an ounce of the stuff.

Gold may be topping.  I do not think it is, but we must be aware that it might be.  When it does top, you want to be as far, far away as possible, just like any other asset, including stocks.

UPDATE  Going back to September 1971, I constructed a portfolio of stocks and gold, investing half in stocks and half in gold at the beginning of each year.  If stocks outperformed gold in the previous year, at the beginning of the next year, stocks were sold and the corresponding amount was bought for gold such that the portfolio was rebalanced to an equal weight between the two.

This portfolio out-gained both stocks and gold, rising 5620%, or 11.2% per year.  Volatility was less at 15.4% for the portfolio whereas volatility for stocks was 18.3% and for gold 29.1%.

There were only seven years when the portfolio generated a loss, and only two a double-digit loss; -18.5% in 1981 and -16.7% in 2008.  The average loss for the seven negative years was -8.2%.

Stocks had nine losing years, with five years of double-digit losses, including -25.9% in 1974, -21.7% in 2002 and -38.5% in 2008.  The average decline was -15%.

There were more negative years for gold at 14 in total but the average decline was less than stocks at -11.8%.  There were six years of double-digit losses, including -23.7% in 1975, -32.6% in 1981, and -22.2% in 1997.

Gold and Interest Rates, 1979-80

Gold was hammered on Friday as investors stampeded out of a crowded trade, me included.  The impetus for the sharp decline was the stronger than expected jobs report, and a fear that the Fed would start raising interest rates and withdrawing quantitative easing sooner than expected.

But does higher interest rates automatically mean lower gold prices?  The answer eventually is "yes" but not necessarily immediately.  In the last peak during the 1979-80 run-up, yields on the 10-year T-bond rose from 9% to 11% as gold rose from $200 to $850.

This does not mean that gold is impervious to rising interest rates in the short-term.  Gold may have topped.  However, it does not mean that gold has topped.

Remember, tech stocks kept rising when interest rates rose in the late 1990s, and housing prices went up this decade as the Fed tightened.  Asset bubbles usually do not pop at the beginning of the tightening cycle.  Asset bubble usually pop near the end of the tightening cycle.

Again, that does not mean that gold has not popped.  Gold may have.  These are not usual times.  The amount of monetary and fiscal stimulus in the economy is unlike anything we have experienced before, which is almost certainly changing the dynamics of asset markets.  However, do not assume that simply because interest rates may start rising soon, the gold run is over.

Aaannnddd I'm Back Out Again.

Making my broker happy, I blew out of my gold position Friday.  Had I not sold my position on Friday, November 27, I still would have sold it anyways. 

Gold was down 5.7% intra-day. One difference Friday compared to the Friday over Thanksgiving was that volume was huge. This is worrisome. Another big difference is that there was no intra-day reversal as there was over the Thanksgiving holiday.

So I blew out my position. We bounced a little at the close, but we ended the session near the day’s lows, which is usually a sign of more selling to come.

I don’t think this is the end of the gold bull market. I think that we are going to get to $1500-$2000 eventually. But I might be dead wrong. This may be the top in gold. Large declines on huge volume after a parabolic run is not a good sign.

If you study past parabolic moves, there is often a correction and a period of consolidation. This may be such a period. If gold behaves in a similar manner, I expect a period of backing and filling for 2 to 6 weeks and then another move higher. However, when you trade, you have to be intellectually flexible. If we run immediately back up on light volume, then begin to roll over, that might signal the top and a shorting opportunity.

Momentum Works

As an investor that had Graham and Dodd drilled into my DNA, it took me many years to reconcile that you could make money in momentum stocks.  More importantly, it took even longer to learn how to deal with the emotional aspects of being a value investor investing in momentum names.  ("I've got to sell! It is hitting new highs!")

The analytical and emotional dynamics of value and momentum investing are very different.  However, it is all about making money, not dogmatically dismissing something that works.  In the end, the only thing that matters is the size of my account.  And if my account can grow investing in momentum names, I am going to do it.

Motivated by both statistical and psychological evidence on under and over-reaction, we propose two proxies for the degree to which traders under- and over-react to news, namely, the nearness to the Dow 52-week high and the nearness to the Dow historical high, respectively. We find that nearness to the 52-week high positively predicts future market returns. We further show that our proxies contain information about future market returns that is not captured by traditional macroeconomic variables and that our results are robust across G7 countries. In cross-sectional analysis, for stocks that have more likely experienced underreaction (to either good news or bad news) in the past, the momentum effect is about 3 times stronger. For stocks that have more likely experienced overreaction in the past, the value premium is also much stronger.

Canada v US Housing

The Cleveland Fed has written why it believes Canada's housing market did not collapse the way America's did.  They conclude that it was because lending standards were not as lax in Canada as they were in America, and financial "innovation" had not been adopted in Canada to the same extent as it had been south of the border, though that may have been because Canada tends to adopt innovation a few years after the States, and thus Canada may have been somewhat "lucky" in that the US market collapsed before Canada could fully adopt American financial "innovation."

 
I expand on why I believe Canada's housing market has behaved differently than America's here.

Back In

After selling my gold position two days ago, I have re-established my position.  I may be doing this totally wrong, but following Friday's sell-off, it appears gold wants to go higher.

We are in a melt-up in gold, and I believe one must be quick on the trigger if you want to play it here, because when it does sell off, you are not going to want to hang around.  It will be ugly.

I have not re-established my long position in stocks, though I may do so if we break to the upside.

Of course, I could change my mind tomorrow and sell gold again, making my broker happy.