Unexpected Inflation

As we discussed in the textbook, stock prices move when unexpected news comes to light. Economists expected that inflation for July would be 8.7 percent, lower than June's 9.1 percent. Instead, it was announced today that July's inflation was "only" 8.5 percent. The stock market reacted dramatically as the S&P 500 jumped about 2 percent and both the Nasdaq and Russell 2000 jumped almost 3 percent. And for investors in Disney the news was even better: EPS was $1.09 compared to the $.96 estimate, and the subscriber addition was 14.4 million streamers versus the expected 10 million. With the combined market news and company news, Disney stock jumped about 7 percent.

Peloton And The City

In HBO's limited series reboot of Sex and the City, a Peloton bike has a major role. And even though Peloton was aware that the bike would be used, it was unaware (spoiler alert) that a major character would suffer a fatal heart attack after using the bike. And while using a product in a television show is generally more of a Marketing topic, it is also related to Finance as Peloton stock crashed 11.35 percent the day after the show first aired. Shares of the company are down 73 percent for the year, so this is not the first time the stock's foot slipped off the pedal.

Hamsters Spinning Wheels

Early critics of the efficient market hypothesis claimed incorrectly that market efficiency meant that a monkey throwing darts at a list of stocks was just as good an investment strategy as any other. Now we have hamsters spinning wheels. Mr Goxx, a hamster, makes cryptocurrency investments by spinning a wheel. Two men in Germany have created a cage in which Mr. Goxx spins a hamster wheel. Where the wheel stops selects the cryptocurrency for investment. Then, Mr. Goxx enters one of two tunnels for a buy or sell order. Switches on the wheel and tunnels automatically execute the order. Since Mr. Goxx has begun investing in September 2020, his return is above all major stock market indices. Are you ready for a hamster investment advisor? We hope not!

Bitcoin Passes $1 Trillion

This week, the market capitalization of bitcoin topped $1 trillion for the first time. The popular cryptocurrency reached an all-time high of $56,399.99, an increase of 70 percent over the past month. So, what is the future for bitcoin? At this point, analysts are split, with some saying it could reach $200,000 and others arguing that the cryptocurrency is overvalued. One thing is certain: Bitcoin is expanding to mainstream investors, including Tesla, Mastercard, and BNY Mellon. Of course, with this more widespread acceptance, bitcoin's price has become more cyclical, meaning that it is less useful as a diversification asset.

Market Trounces Harvard

So how hard is it to beat the market? From 1993 to 2008, the portfolio managers of Harvard’s endowment fund beat the S&P 500 by almost five percent per year. A major contributor to that performance was a hugely successful investment in timber. Since then, things have not been so rosy (or even Crimson). Using the analysis in the article, the Harvard endowment fund has underperformed a blended portfolio of stocks and bonds by one percent per year over the past 20 years. Based on the current endowment value of $42 billion, this means the endowment potentially lost out on $420 million in growth per year, or roughly $8.4 billion dollars of growth over this period. It is tough for the best and brightest to beat the market.

A Stock Up In Smoke

As we discussed in the textbook, an unsystematic risk affects a small number of companies, often only one company. Investors in cannabis producer CannTrust learned about systematic risk today as the stock fell 14 percent when the company's license to grow marijuana was suspended. The stock has fallen since July, when it was discovered the company was growing plants in an unlicensed room, resulting in the destruction of thousands of pounds of plants. Investors received a bigger shock in in July when the unlicensed plants were discovered: The stock fell about 22 percent that day. The company's CEO has been fired, but whether the license will be reinstated is unknown.

A Digitized Athlete

Brooklyn Nets sixth man Spencer Dinwiddie signed a contract for $34 million over three years. Now, Dinwiddie hopes to digitize his contract into a digital token. The plan is to pay back investors principal plus interest from his future salary. For investors, an advantage is that the tokens will have little correlation with other financial assets. There are numerous examples of securitizing cash flow from future earnings, from Bowie bonds, physicians who sell part of the future revenue in their practice, to fledgling golfers, who get money from backers in exchange for future winnings. However, these assets are not without risk. In November 2015, Fantex pulled an IPO that planned to sell future earnings for running back Arian Foster. Foster retired from the NFL less than a year later after several injuries.

A Flight To Cash

We have discussed risk and return in the textbook, so by now you should have a grasp on the concept of financial risk. A recent article notes that ultra-wealthy individuals have been moving assets into cash or cash alternatives. In the first quarter of 2019, high-net worth individuals held nearly 28 percent of investable assets in cash. And while cash itself is desirable for liquidity and diversification, this number appears high. There is one sentence in particular we would like to point out:

“Yet perception of risk is an emotional thing.”

We can measure an asset’s total risk by standard deviation, or an asset’s market risk by beta. However we measure risk, it is unemotional. But there can be behavioral factors, such as the fear of risk, that can affect an individual’s decisions.  

As a final point, the article discusses a family that moved money into gold bars and buried them and implies this is moving assets into cash. While gold is a physical asset and often performs well in a bad economy, the volatility of gold prices can often be quite high.

Portfolio For 2019-2028

One thing that students seem to really get interested in during class are market returns and portfolios. Recent commentary from the well-known investment advisory and mutual fund company Vanguard can provide some food for thought. First, notice that Vanguard estimates the annual return on U.S. stocks will be 4 to 6 percent over the next decade. This is significantly lower than the historical annual return of about 12 percent. Second, Vanguard is recommending that investors allocate 40 percent of equities to international stocks, up from the current recommendation of 30 percent. The reasons for Vanguard's recommendation is based off lower fees for international investing, resulting in higher returns for investors, and the company's projection that international stocks will outperform domestic stocks over the next decade.

The Benefits Of Diversification

We have discussed how diversification works and shown examples, but what about how it works in your portfolio? A recent article in Money discusses how much you should have invested in stocks depending on your age. And while we don't want to take a position in this, we would like to point out the "Finding the Right Mix" figure shown in the article. As you can see, in general, the range of possible returns declines as you increase the percentage of bonds in a portfolio. This is the decline in volatility that is also exhibited in the lower standard deviation from adding bonds to a stock portfolio. 

Market Quiz

CFO.com has a seven question quiz on current capital markets. There are some interesting questions, including the relative size of the venture capital market compared to IPOs, the issuance size of the preferred stock market (keep in mind that Apple's market capitalization is over $1 trillion), and the slope of the Treasury yield curve.

From 1.68 million to 1

In June, Greek shipping company DryShips executed a 1-for-5 reverse stock split. While this itself is not unusual, it was the 7th reverse stock split by the company in the last 13 months! In fact, if you had owned 1.68 million shares of the company stock on March 12, 2016, you would currently own only one share. And the company stock has dropped over 99.9 percent. The stock would have to increase by 17.79 billion percent to reach its all-time high. One investor, who had invested $220,000, the bulk of his nest egg, currently has less than $1 invested in the company. Hopefully, this will drive home the importance of diversification. The story of DryShips is long and may involve "pseudo-underwriting", and one investor, Kalani Securities, Ltd., appears to have made millions on the stock.

Correlations They Are A Changin'

From what you have learned about what is often referred to as Modern Portfolio Theory (MPT), a diversified portfolio can significantly lower the risk of your investment. To create a diversified portfolio, you should choose assets with low correlations (covariances). However, this can be more difficult than it seems. A recent article on Bloomberg discusses how correlations between various asset classes have changed over time. For example, if you look at the 1988 to 1997 period, the correlation between the S&P 500 and the S&P GCSI Total Return Index, which measures the return on a broad class of commodities, you would find the correlation between these two asset classes was –.20, a very low correlation that would provide substantial diversification benefits. However, in the past 10 years, the correlation between these two asset classes has increased to .50, which would only provide moderate, if any, diversification benefits. We agree with the author's conclusion that even with a high correlation, owning a greater variety of assets is safer than owning only a few assets.  However, we would like to extend this conclusion and state that you should rebalance your portfolio based on the changing correlations.

Golf And Investing

A recent article discusses how golf and investing may be related, but also talks about several behavioral biases that can affect investors. For example, loss aversion shows up in golf as golfers are more likely to make a putt of the same difficulty for par than they are to make the putt for birdie (one under par). Another behavioral bias discussed is probability neglect, that is, people tend to worry about bad outcomes that have a very low probability, such as a plane crash or losing 40 percent of their investment. By overweighting events with a low probability, investors can incur large opportunity costs. Finally, an informational cascade occurs when investors believe the signals from other investors, even if they do not agree. For example, if a stock you view positively begins to drop, you may sell based off what other investors are doing, rather than what your research has revealed to you. As the article notes, smart investors aren't loss averse, they don't neglect probability, and believe in their own analysis. 

Timing The Stock Market

Students (and a lot of investment professionals) think that timing that market, that is leaving the stock market before it goes down, is a good strategy. And while we would like to sell our stocks before a price drop, it is easier said than done. A recent article highlights the danger of missing the good days in the stock market. Fidelity Investments calculated the return from investing $10,000 in the S&P 500 from January 1, 1980 through March 31, 2015. If you were invested every day, your portfolio balance would have grown to $503,741. However, if you missed the five best days in the market, your balance would have been about $309,431, a 40 percent decrease! Missing the 50 best days would have dropped your portfolio balance to $41,803, or about eight percent of the value of being invested every day. There are about 252 trading days per year, so missing 5 days (or 50 days) out of about 8,800 days can have a serious impact on the value of your investments.

Startup Investing Expanded

Yesterday, the Securities and Exchange Commission approved Title III of the 2012 Jumpstart Our Business Startups Act (JOBS Act). Title II of the JOBS Act, which was approved in in 2013, allowed accredited investors to in startups. The approval of Title III allows anyone to invest in startups, small businesses, and real estate through crowdfunding. The total amount of investment in such ventures is limited to 5 or 10 percent of the investors annual income, which provides protection to small investors from themselves. But, it does allow small investors into startups, which can provide very high returns. However, before you make these investments, remember the lessons from Chapters 12 and 13: The only way to increase your return is to increase the level of risk you take. 

Cat's Good Bad News

Caterpillar Inc., announced lower quarterly profits and that it expected sales in 2016 to decrease 5 percent, the company's 4th consecutive yearly sales decline. On this announcement of seemingly bad news, the stock was up as much as 5.7 percent on the day. So why was the stock price up today? The news in the announcement today was consistent with the company's warning last month.

An Unsystematic Risk

Often, we get asked by students for examples of unsystematic, or firm specific, risks. We are sure that you have heard about Dieselgate, or Volkswagen's deliberate programming of emissions devices in its diesel vehicles to fool emissions tests. Dieselgate is a perfect example of unsystematic risk as it affects only Volkswagen, although it appears that other auto makers may face unsystematic risks as well as several other manufacturers may have similarly created programming to cheat emissions tests. If you think about Volkswagen's actions and the risk, the news will likely greatly affect VW's sales as some consumers will avoid the company's vehicles. And while these consumers will be forced to look elsewhere, the sheer number of alternative manufacturers means that it is unlikely any particular manufacturer will receive a huge spike in new customers.

Correlation With Apple

A recent article discusses the correlation that various stocks have with Apple and some of the stocks are surprising. For example, industrial products manufacturer Illinois Tool Works (ITW) has the highest correlation at .61. Payment technology firm Fiserv and Honeywell have the next highest correlations with Apple. Facebook and Texas Instruments also have high correlations with Apple, which is expected since Facebook is a tech stock and Texas Instruments is a major supplier to Apple. By now, we hope you understand how important correlation is to diversification, but, as with most numbers, we need to apply economic rationale to the numbers. There is no reason that ITW and Fiserv should have such high correlations with Apple, and in the future, these correlations will likely fall. Remember, what we really want is the correlations going forward, not correlations in the past. As Eric Chemi, the author of the article, states in the accompanying video: "That's where the data can get you and I think people need to be careful to not get trapped in these types of numbers."

Stock And Gold Correlation

Historically, the correlation between the stock market and gold prices is low, or even negative during some periods. Because of this, gold is often seen as a good asset for a diversified portfolio since a low or negative correlation can increase diversification. However, just because it happened in the past does not mean that it will happen in the future. For example, while the market dropped on Monday, gold prices also took a hit. While one day does not a trend make, both the stock market as a whole and gold are down year-to-date. All of this should be taken as a warning. Just because two assets have had a low or negative correlation in the past does not mean that the correlation will hold going forward. In other words, when using correlation, we want the correlation going forward but are often forced to use historical correlation.