Investing, Posts

The Creative Destruction of Wall Street

I was taking a look at the different robo-advisors today and I’m just amazed at how fast technology is revolutionizing the investment industry. It’s a f***ing awesome thing to witness. I’m not specifically recommending any one of these companies but WealthFront now charges just 0.25% per year to do what most advisers charge at least 4 times as much for. Betterment charges just 0.15%. And WiseBanyan is FREE – yes, FREE. The robo-advisor price war is officially getting bloody.

It’s still very early in the game but what we are witnessing is nothing less than the creative destruction of Wall Street via Silicon Valley and it’s about time. WealthFront is the largest and fastest growing of the group and has nearly cracked $1 billion under management mainly because it’s become so popular with the tech community. As it expands outside of those early adopters into the general population it’s growth will only accelerate. The big Wall Street firms, Merrill Lynch, Morgan Stanley, etc. along with most independent investment advisers must be s****ing themselves watching this unfold. I don’t think there’s ever been a threat of this magnitude to their businesses.

I finally got around to watching The Wolf of Wall Street last night and, as a Wall Street insider, I have to say it really resonated with my personal experience (what I witnessed, not what I did, LOL). I spent just under a year at Bear Stearns before I migrated to the hedge fund world but I can tell you that that early scene movie, when Jordan Belfort first lands on Wall Street, absolutely nails it. The Matthew McConaughey character is spot on: “Fuck the clients…. The name of the game: move the money from your client’s pocket into your pocket.”

Robo-advisors now have the power to change the game entirely. Jack Bogle has been fighting this battle for decades and has surely made massive inroads in the world of investment products. In just the past ten years we’ve seen the explosion of ETFs that give investors access to every kind of index and sector at the lowest possible price. The price war between Vanguard and Schwab has now pushed the annual cost of owning the entire US stock market to just 0.04%. That’s insanely cheap!

Still, the gatekeepers, the brokers and advisers of the world, were the one thing separating the general public from these fantastic, low-cost products. They don’t make any money selling them so their clients just haven’t heard about them. It’s taken Silicon Valley stepping in to shake up the services side of the business so that Joe Retail investor can actually access these super-low-cost products. And it’s so cool to see it finally happening. Granted, there are some serious drawbacks (read this and this) but for 90% of investors robo-advisors are simply heaven sent. Do yourself a favor and look into them.

Investing, Posts

Less Than Zero

That’s the return investors should now expect from the stock market over the next decade… according to Warren Buffett’s favorite valuation measure: total stock market capitalization relative to GDP.

wmc140407cChart via John Hussman

The chart above shows the correlation between this valuation measure (blue line) and subsequent 10-year year returns (red line) and it’s pretty damn tight. I think the only possible argument one can make against “less than zero” returns over the next decade is something along the lines of, ‘companies are much more profitable now than they have ever been. For this reason, investors will be willing to pay higher valuations in the future so this correlation will break down.’ In other words, ‘its different this time.’ To those of us who have been around the block these are the four most dangerous words in the investment game. (See my thoughts on profit margins here.)

If investors are guaranteed to achieve nothing over the next ten years why would anyone in their right mind put money into the stock market right now? Or even keep a significant chunk invested right now? I keep asking myself this question because it just doesn’t make any sense to me.

I think there are two reasons. First, individual investors are deathly afraid to miss out on future profits EVEN if they understand that those profits are almost sure to be given back (and maybe they get off on the roller coaster ride). They just can’t stand to see their friends make money, even temporarily, and leave them behind. Second, professional investors are deathly afraid of underperforming because it may mean they get fired – even if they absolutely believe that the risk of owning stocks far outweighs the potential reward. They would rather lose money along with everyone else than forgo profits on their own.

It’s just very, very hard to put rational analysis above our natural “herding” instincts. In fact, for most people it’s nearly impossible which is why markets will never be efficient and we will always have booms and busts.

There’s only one reason I can think of for investors to keep money invested right now and to keep putting new money to work in stocks: you’ve got a time frame longer than 10 years AND you don’t have the time or wherewithal to pay attention to even the most basic investment merits of stocks as an asset class. In this case, dollar cost average into an index fund and put more into it every single month, without fail. Over 10, 20, 30 years you should do very well – the longer your time frame, the better.

Those who have a time frame less than 10 years or who can understand and pay attention to the investment merits of stocks as an asset class, however, have no excuse. There’s just no good reason to have undue exposure to stocks right now that I can think of.

Ultimately, the stock market right now is flying as high as Robert Downey, Jr.’s character in the movie that shares a title with this blog post. And now that the Fed is taking away its heroin (QE) it’s inevitably going to go through some painful withdrawals. And even if it doesn’t, you’d do better to put your money under the mattress.

Investing, Markets

George Soros’ Big Bearish Bet

The man who ‘broke the bank of England’ has taken aim at the US stock market. From Marketwatch:

Within Friday’s 13F filings news was the revelation that the firm, founded by legendary investor George Soros, increased a put position on the S&P 500 ETF SPY by a whopping 154% in the fourth quarter, compared with the third. (A put or short position basically gives the owner the right to sell a security at a set price for a limited time, and in making such a bet, an investor generally believes the security is going to decline.) The value of that holding, the biggest position in the fund, has risen to $1.3 billion from around $470 million. It now makes up a 11.13% chunk of all reported holdings.

It’s not clear whether Soros is using the put options as a hedge or a bet on an outright decline in stocks. My guess is it’s probably a combination of both.

He did write an op-ed recently about his worries over China:

The major uncertainty facing the world today is not the euro but the future direction of China. The growth model responsible for its rapid rise has run out of steam… There are some eerie resemblances with the financial conditions that prevailed in the US in the years preceding the crash of 2008.

Should China experience a bust along the lines of what our country went through five years ago it would have major implications for the world economy. And we’re beginning to see signs of the massive debt cycle in China turn south.

I linked this story in my Friday post. It details the growing problem with defaulted “trust products” in the China and it is precisely the type of catalyst that could kick off a larger crisis.

Last month, China’s banking sector dodged a potential catastrophe when a mystery group stepped in at the 11th hour to pay investors in the now-infamous “Credit Equals Gold #1, a defaulted $495-million trust product. Barely two weeks have passed and now another trust product has failed to pay back investors. This product—known as “Songhua River #77 Shanxi Opulent Blessing Project”—is unlikely to cause more than a minor scare. But episodes like Credit Equals Gold and Opulent Blessing Project are just the beginning, says Mike Werner, senior analyst at Bernstein Research, in a note today. One reason is that more than 43% of the 10.9 trillion yuan ($1.8 trillion) worth of outstanding trust products come due in 2014… Rising rates will make it hard for bankrupt companies to find the cash to pay back investors, he says.

Of course all of this is just speculation on my part. Soros obviously has his own reasons for putting the trade on. But the clues are all pointing in the same direction.

The Great Crash

Don’t Dismiss The Possibility Of A Stock Market Crash

This analogue (discovered by Tom Demark) between the 1929 Dow Jones Industrial Average and today’s index has been around for months. It hasn’t gone away because the current market keeps fitting itself to the pattern:

MW-BU310_scary__20140210132547_MGvia Marketwatch

Before you dismiss it as mumbo jumbo consider a couple of things:

Option skewness (indicating the probability of a crash) recently hit its highest level ever recorded:

wmc131230avia John Hussman

And the massive growth of margin debt and leveraged ETFs over the past few years poses a systemic risk to the stock market that has also never before been witnessed:


mw 02-05-2014via Distressed Volatility

Now I didn’t post this to scare you. I just think it’s worthwhile to consider these things because they do happen from time to time and when they do it’s best to be prepared – to have a game plan.


Hit The Links

Here’s a little reading for the weekend:

Robot holding money

One Reason I’m Worried About The Rise Of The Robo-Advisor

We are enormously indebted to those academics [Eugene Fama & Co.]: what could be more advantageous in an intellectual contest – whether it be bridge, chess, or stock selection than to have opponents who have been taught that thinking is a waste of energy? -Warren Buffett, 1985 Berkshire Hathaway Letter to Shareholders

I’m a huge fan of low-cost, index-based investing. Hell, it’s the focus of my book, “FIRE Wall Street.” And I believe that robo-advisors like WealthFront will and should take over the majority of investable assets around the world.

BUT… there’s one major issue I’m beginning to worry about: as this form of investing becomes more and more popular, the risk of mispricings (and even bubbles) in the markets grows with it because it completely abandons the basic process of analyzing value and risk. When you have a growing stream of buyers who are agnostic when it comes to value – meaning they will continue to buy regardless of price – it’s hard not to see problems arising.

Imagine it this way: You and your family like to eat bacon for breakfast. However, if the price of bacon tripled overnight on your next shopping trip you would probably decide to substitute breakfast cereal or fruit or anything cheaper until the price of bacon came back down. BUT, if everyone decided to buy bacon every week no matter the cost, bacon prices could conceivable go up 10-fold before somebody decided that their bacon addiction wasn’t worth paying through the nose for. Then a few other folks might follow suit and soon you have a bacon crash.

This could conceivably happen in stocks or bonds or any other asset class for that matter simply due to the fact that we now have a growing chorus of investors who have decided to employ an investment process that abandons fundamental investment analysis. This is all well and good for investors looking to take advantage of mispricings like Mr. Buffett and me. We may well see greater and more frequent opportunities as a result. However, for mom & pop this could work out rather poorly.