What’s causing the volatility? Part 1


On Tuesday I responded to an email from a worried Mimi Ocelot about the free-fall the stock market is going through right now.  I provided a historical perspective of what is going on.  In this post I am going to give some reasons I think we’re experiencing all this increased volatility.

And I need to apologize.  I started writing this and it got so long (I try to keep my posts at about 1000 words) that I need to split this into a part 2 and a part 3.  So enjoy this and then tune in tomorrow for the exciting conclusion.


“The times they are a changin’”—Bob Dylan

As I wrote here, the volatility in the market is definitely going up.    Of those 17 two-week periods as bad as this one since 1950 that I mentioned on Tuesday, eight occurred in the fifty years from 1950 to 2000 which means that nine occurred in the fifteen years from 2000 to 2016.  There’s no question that the market has become MUCH more volatile lately.  Is this a temporary thing or a new normal?  Who knows, but I tend to lean towards “new normal”.  Now let’s try to figure out the “why” part of this mystery.


“Ready, Fire, Aim” –Tom Peters (1982)

Nearly everyone agrees that information is the lifeblood of the stock market.  Today, that information travels so much faster than in the past.  Something could happen in the most remote corner of the world, and you would know about it in everywhere in a matter of seconds or minutes.  Obviously quicker access to news is a good thing for society at large, and investing in particular, but it definitely exposes many investors to making big mistakes because they are acting so quickly.


A good example is July 12, 2013.  On that day a Boeing 787 caught on fire a Heathrow Airport in London.  Here’s some quick historic context: the 787 was Boeing’s next generation aircraft that was going to revolutionize air travel, a plane Boeing pretty much staked its entire future on.  In early 2013 two 787s caught fire, leading to the FAA and its counterparts around the world to ground all 787s until Boeing figured out the problem.  Boeing’s stock, as you would expect, got hammered.  It took Boeing several months, but they fixed the problems, got the 787s in the air again, and their stock recovered.

Then July 12 happened.  News broke that another 787 caught on fire.  Investors, understandably, concluded that the problems weren’t fixed after all and that the planes would be grounded again.  In a matter of minutes the stock cratered, falling from about $108 per share to $99.  Over the following hours and days, it became clear the July 12 fire had nothing to do with the previous problems; it was just one of those things that do happen every once in a while.  No big deal.  Two weeks later, Boeing’s stock was back to the pre-July 12 fire levels.  It was all like nothing happened; except it did happen and there was crazy volatility in the stock.

The morale of the story is that investors got the information so quickly and rushed to act on it so quickly, that they completely misevaluated the situation, and that led to a lot of volatility.  Had the news traveled more slowly, the world would have had more time for more of the facts to come out.  No matter how you slice it, the light-speed fast news makes the pace of investing faster, and when you do something faster, you tend to make more mistakes.


 “The chief business of the American people is business” –Calvin Coolidge (1925)

UNITED STATES - AUGUST 03: Official Portrait Of Calvin Coolidge On August 3, 1923, Then Vice President Who Succeeded Harding As President. He Was Elected In 1925. (Photo by Keystone-France/Gamma-Keystone via Getty Images)

We Americans are probably a bit spoiled.  There have been no wars fought on our soil since 1865 (I didn’t count Pearl Harbor, which reasonable people can debate).  There has been a consistent government since 1787 (or 1865 depending on how you think about the Civil War) without any coups or revolutions.  There’s never been a military takeover of the government, and the US government has never defaulted on its debt.  You could go on and on.

The reason that is important is that today about one third of all earnings in the S&P 500 come from outside the US.  It’s hard to find out what that number was in 1950 or 1960, but suffice it to say that that number was much, MUCH lower back then.  So we have a lot more international exposure now than in the past.

That’s a good thing because of diversification.  But it does expose us as investors to some of the geopolitical challenges that I just mentioned, that the US has been blessed to have avoided.

Also, to President Coolidge’s quote, the US tends to be oriented towards business (and some, but not I, would argue too oriented towards business).  This has definitely helped us become the largest and strongest economy in the world.  But other countries have other orientations (I’ll try not to use too blatant of stereotypes to offend my international readers): the Middle East is very theocratic, Japan focuses on saving face (keeping it from writing off bad debts which has stalled its economy for two decades), China is very authoritarian, Europe is more socialistic.  That doesn’t mean any of those other perspectives is bad.  But it does mean they are less likely to drive greater business and productivity, and those are not good if your goal is to have your stocks grow.

If you’re exposed to those geopolitical landmines as well as those competing priorities, it shouldn’t be surprising that the road won’t be as smooth.  And that’s just French for saying more volatility.


“The world is getting smaller” –Mark Dinning (title of a song from 1960)

Somewhat related to the above issue, the world is getting smaller (don’t think the irony is lost on me that a phrase we use to describe how fast the modern world is changing came from a song two decades before I was born).  Everything is so much more connected now, whether it be products (your car is connected to the internet which depends on satellites and under-water fiber optic cable) or countries (the components for your phone probably came from a dozen different countries).

All that interconnectivity is a good thing.  It means people/companies/nations can specialize in what they do best, allowing us to get the best products and services at the lowest prices.  But that connectivity also means that when the stone falls in the pond in one part of the world, the ripples hit everyone in some way, big or small.

Back in the day when the US economy was largely self-reliant, and even local economies were fairly independent, if crazy stuff happened across the world or even across the country, it didn’t affect things at home that much.  That impacts volatility because something is always going crazy somewhere.  And of course, that carries over to stocks which react to that craziness.  Gone are the days when General Mills was a regional foodstuffs provider for the Midwest; now its stock is affect by the Los Angeles longshoremen striking, the drought in sub-Sarahan Africa, and the revaluation of the Argentine peso.  Once again, more volatility.


This seems like a good stopping point.  We we’re almost done.  Come back tomorrow, same fox time, same fox blog, for the exciting conclusion to “What the hell is going on in the stock market?”

Picking your investments for 2016


The new year is a special time for me.  It’s a fresh start and a time of rebirth (even though it happens in the dead of winter).  You make resolutions, many of which you won’t keep, because this is the time to think about what you want to do before you get sucked into the rigmarole of actually doing it all.

For investing, it’s a natural time to reflect on your financial situation.  Am I saving enough to get where I want to go?  Am I investing that money in the places that make sense?  For this post I want to focus on the second question of where should you invest your money, and particularly should you change it from one year to the next.

Every year you have investments that do well and others that do poorly.  When you look on 2015 you’d see that international stocks (down about 4%) didn’t do nearly as well as US stocks (down about 0.2%).  Based on that what should you do?

One school of thought would be to invest more with US stocks.  If they did better last year, then it stands to reason that they’ll continue to do well since there probably hasn’t been a lot that has changed.  So stay with that winner.

The opposite school of thought is that the international stocks had a down year so they are probably “due” to do better.  Intellectually, I think this is the much more tempting strategy.  We know that stocks can’t continue incredible performance forever; eventually they will have an off year.  We also know that a well-diversified portfolio can’t continue to suck forever; eventually they will rebound (like stocks after 2008).


To answer this question with a little more analytic rigor I used my handy dandy computer and some free data from the internet.  Just to make things simple, let’s assume we live in a world with only two investments: US stocks (VTSMX) and international stocks (VGTSX).  As I mentioned, in 2015 US stocks did better than international.  So should we invest more in international?

Using data going back 19 years (that’s when the international index fund I am looking at started), the US fund has beaten the international fund 10 times.  That’s almost dead even—10 wins for US and 9 wins for international.

But the “wins” are very streaky.  US stocks performed better in 2015 as they did in 2014 and 2013.  On the other hand, International stocks outperformed US stocks for five years in a row starting in 2002.  Based on those snippets, you would have been worse off by switching your investments to last year’s underperformer.

If you look at all 19 years, there were 8 years when the lower performer from the previous year did better the next year.  Again, that’s about 50% of the time—8 years where the lower performer did better the next year, 10 years where the higher performer did better (it doesn’t add up to 19 because we don’t know which will do better in 2016).



Investment that did better that year

Investment that did better the next year


























































In a way the data is comforting, and it came out the way I predicted since I am a believer of efficient markets.  These theories on which stocks will do better tend to work about as often as it doesn’t.  Instead of spending a lot of time and effort trying to “figure out” which investment will do better, you’re probably best served just sitting tight.

The Fox family invests about equally between US and international stocks.  That means international stocks served us very well in the early 2000s but not so much the last couple years.  As far as next year goes, who knows?  I could tear the data apart and analyze it a million different ways, and I’d probably come out with something that said “doing it that way is better 50% of the time, and doing it the other way is better 50% of the time.”

So as the Fox’s take stock (pun intended) of our finances, we’ll continue plugging along with the same diversified investments we’ve used in the past.  Instead of trying to figure out which investment will do better this year, I’ll send that energy trying to figure out where Mini Fox hid the television remote.

Are you gambling or investing?



I’ve done a ton of posts on how over time stocks are a great investment, and I absolutely believe that.  However, like with all things, if you look at the extremes you start to see funny results.  Particularly, over the very short term, stocks aren’t really good investments at all.  In fact, if you “invest” in stocks and have a really short time horizon, you aren’t investing at all but rather you are gambling.  So investing or gambling, what’s the difference?  And when does stock ownership switch from gambling to investing?

As always, this is when I nerd out and get my handy dandy computer and free data from the internet and see what the numbers say.  Hopefully it’s not surprising that the longer you hold on to an investment, the lower the probability that you lose money.  But it is interesting how the numbers work out.

On any given day, there is a 46% chance that stocks will go down.  That’s not quite a flip of the coin (since stocks go up over the long run, you’d expect them to have more good days than bad), but that’s pretty darn close.  So let’s agree that if you’re investing for only a day, then you’re gambling.


Obviously, you can contrast that with the other end of the spectrum where historically there hasn’t been a 20 year period where you would have lost money.  0% chance of losing is not gambling, that’s clearly investing.

So where do you draw the line?  If you move from a day to a week, the chances of you losing money drop from 46% to 43%.  That’s a little better, but that still feels like a flip of the coin to me.  Go from a week to a month, and the chances of you losing money drop a little bit more, down to 40%.  It’s going in the direction that you would expect—probability of losing money drops the longer you hold on to the investment—but we’re still squarely in gambling territory.  If you do something and there’s a 40% chance of it coming out bad, I definitely don’t like those odds.

You can follow the table and see that at 5 years, the chances of you losing money on stocks is about 10% and at 10 years it’s at about 2%.  Clearly there is no right answer, and this is an opinion question so everyone is different, but I figure that somewhere between 5 and 10 years is when purchasing stocks ceases to be a gamble and starts being an investment.


Recreational investing

One of the things I try to do with this blog is help people better understand the stock market and how it behaves by looking at historic data.  I think this is a good example.

As I said at the start, the stock market is a great place to build wealth but you have to be smart about it and you have to have your eyes wide open.  If you’re investing just for a month or a week or a day, just understand that what you’re doing looks a lot less like investing and a lot more like gambling.  If that’s what you want to do that’s great.  Just be honest with yourself.

This brings me to an interesting topic which is “recreational investing”.  A lot of people come up to me and say they understand that slow and steady, and index mutual funds, and a long-term view are probably the best way to build wealth.  But it’s boring (a sentiment I totally agree with), and they want to keep a small portion of their money so they can “play,” investing in particular stocks they like, similar to the way someone would pick a horse at the track or play the table games in Vegas.  To this I say: “go for it”.

Life is too short, and that stuff can be really fun.  If it’s fun for you to “play the market” and gamble on some stocks, rock on.  Just know that you’re gambling and not investing.  But I’ll tell you, if you have a gambling bug, I’d much rather do it with stocks than blackjack or the ponies.  With stocks, as we saw above, even over a short time frame, you have the “house advantage”.  With other types of gambling, the house has the edge.  So I totally support recreational investing if that’s what you’re in to.


What do you think?  At what point does buying stocks change from gambling to investing?  I’d love to hear.

Down 1000, up 900, down 500

Holy Crap!!!  What a wild day today was.  I come back after two months off, and my first day back doing the blog has the market going bonkers.  I was already to publish a post on the top 5 investing blunders we make by following our instincts, but that’s just going to have to wait until Thursday, because the roller coaster that was Monday’s stock market must be addressed.


What happened?

First, let’s just appreciate the utter insanity that was the market today.  That chart for the Dow Jones Industrial Average doesn’t look like much until you realize that each of those tick marks is 250 points.

Down intraday 2015-08-24

Sunday night most people knew Monday would be a rocky day.  The Asian markets were getting bloodied, especially China’s markets (more on that in a minute).  Maybe it would be another 200-300 point down day; that would suck but we’re starting to get used to it.  But holy cow, the Dow opened and instantly fell 1000 points.  1000 POINTS!!!  Go ahead and let that sink in for a second.  When the market reopened after the September 11 terrorist attacks, it didn’t fall that much.  1000 points.

At that point all the people at CNBC were having kittens, lamenting on how the market was ready to crater.  But then things turned around like a light switch was flipped.  In 30 minutes the Dow recovered 500 points—again just wrap your head around stocks moving 500 points in 30 minutes.  Wild.

By noon the Dow had nearly recovered all its losses, all 1000 points.  The talking heads had done an about face and started back slapping on how things were fine, and then stocks steadily slid 500 points over the next two hours.  Just a wild, wild day.


What does it all mean?

I think pretty much everyone agrees we go hit by a Chinese typhoon.  China’s the #2 economy in the world, they started liberalizing their stock markets which led to a huge bubble, and now their economy is slowing which is blowing up that new stock market.  On Monday the Shanghai index was down about 10% so we should feel pretty good about things, right?

Things have been dicey for a while.  Remember on Friday the Dow was down 500 points and down 1000 points last week.  So things were already on edge.  Monday the markets had a bit of a freak out.  But how serious should we take this?

Certainly, it’s serious since the markets have lost 10% in less than a week, but I think there is a silver lining that we can see just in the path of today’s craziness.  There wasn’t a ton of news that justified the 1000 drop at the opening—it just kind of happened.  Okay, I can accept it.  But then there was no news that turned things around and recovered the 1000 points.  That just kind of happened to.  And then there was no news that brought it down again.

In a perverse way, that should be comforting.  Yeah, China’s going through some tough stuff right now, but that can’t come close to justifying a 10% drop in stocks.  It just seems like a mob on the streets going crazy, rushing from one street corner to the next, not really knowing where it’s going or why.  Eventually those mobs just lose steam and disperse.  That’s what I think will happen here.

Dow Oct 2014

Will it recover in a few weeks like the swoon in October of 2014?  Remember that one?  Probably not because it was just a hiccup.  But over the course of a week stocks fell 1000 points and everyone was freaking out, but then a week later all those losses were recovered and the world was okay again.  Maybe it will happen like that, or maybe it will be a longer grind like after the 2000 internet bubble.


What are you doing to do?

This is going to shock you, but I’m not really doing anything.  I’ll keep plugging away with my buy and hold strategy using dollar cost averaging.  In the meantime, I’m enjoying the craziness for its entertainment value.

Wait a second.  That’s not entirely true.  Foxy Lady and I are buying a house in Greensboro.  Since our Los Angeles house hasn’t sold yet, we’ve had to sell some stock for the down payment.  I look at it as a temporary thing because once the LA house is sold, we’ll reinvest the money.  The good thing now is we’ll reinvest that money at a discount.

But that horseshoe did its work.  We sold most of the stuff we needed over the past few weeks, so we avoided all this carnage.  So we have that going for us which is nice.

But seriously, I don’t think there is anything that has fundamentally changed since two weeks ago when everything was worth 10% more.  If you can stomach it, I think this will prove a great buying opportunity.


That’s my take on what happened yesterday.  What do you think?

Come back Thursday to see the post on investing blunders that I originally meant for today.

Too many eggs in your company’s basket


A common question investors have is “How much of my investments should be in my company’s stock?”  Many of us work for publicly traded companies (Stocky works for Medtronic and Foxy Lady used to work for Pepsi).  Many of those companies include stock as a significant part of their employees’ compensation.  So what is an omnivore to do?  The short answer is: Don’t invest a lot in your employer.


It adds up

The general thinking among companies is that it’s good for their employees to own company stock.  It motivates them to work hard, so then the company does better, which then raises the stock, and that finally makes the employee richer.  See everyone wins.

My sense is that before 2000 compensation in the form of stock was much more prevalent.  I can speak to my experience at Medtronic:  The default for your 401k investments was Medtronic stock.  When they did the 401k match, the match was in Medtronic stock.  They also have a program where you can buy Medtronic stock at a 15% discount compared to the market price.  You had the option to take your bonus in cash or get a larger bonus in Medtronic stock options.  Long-term incentives are given in stock and options.  High performers can get awards of stock or options.

I don’t think Medtronic is all that different from most companies.  And you can imagine that adds up to the point where a very large portion of your portfolio is in your company’s stock.  The Fox family has about 15% of our portfolio in Medtronic stock and I think that’s way too high.  Anecdotally, a lot of my coworkers have 50% or even more of their portfolio in company stock.  Over the past 6 months or so I’ve been selling Medtronic stock to lower that.  Of course, we have to have a minimum amount in stocks just because some of those options and stock awards haven’t vested, but what we can sell, we have.


What difference can you really make?

The company wants you to do it because collectively if a lot of their employees own stock, they are probably motivated to do better.  But as an individual, what difference can you really make?  I know that sounds anathema, like when people say they don’t vote because one vote doesn’t make a difference (I do vote in every election, but the way).

Let’s think about that for a minute.  Stocky works at Medtronic, a company which has about 50,000 employees and earns $17 billion each year.  Actually, I think I do really good work, and let’s imagine that because I worked my furry little tail off, I was able to develop programs that led to an extra $2 million in sales.  That’s a lot actually (I think I might be underpaid), but compared to the bigger picture, that such a tiny drop in the bucket that it wouldn’t affect Medtronic stock in any possible way.

On the other hand, if I bust my tail and work hard, my bosses will see that and I’ll get a raise and a promotion.  That’s where the real upside for me is.  Not in the impact on the stock.  I’m sorry to say that, but it’s true.  The payoff in owning stock (compared to owning a diversified mutual fund) just isn’t there.  But the downside is very real if things don’t go well (more on this in a second).

Since Medtronic is a really huge company, maybe an individual can’t make much of a difference.  But wouldn’t an individual employee be able to have a bigger impact on the company’s stock if they were at a smaller company?  Maybe it makes sense for people in smaller companies to own more of their company stock for that reason.

The logic is sound—certainly if you work at a smaller company your individual contributions will have an outsized impact.  But the negative is that your risk goes up as well.  Larger companies tend to have greater margins for error when things go bad.  If you’re in a smaller company, the risk of bankruptcy or some other catastrophic event with the stock is so much higher.  And remember, as an investor you’re looking to lower risk not raise it.  So with all this I don’t the think argument for an individual to be a shareowner so they can drive the stock upwards holds a lot of weight, especially when you compare it to the downside.


What happened to loyalty?

If you own a lot of your employer’s stock, you’re violating the first rule of diversification.  The whole point of diversification is to make sure that one company or one sector or one “something” can’t hurt you too much if everything goes to hell.  Think about that with your own company.  The single most valuable “financial asset” you have is probably your career and the future earnings that go with that.

Now imagine that something goes terribly wrong with your company (a product recall, losing a lawsuit, missing the boat on a market trend, etc.).  If you’re an employee that sucks because you’ll probably get smaller bonuses and raises; at the extreme you might get let go.  If you’re a shareholder that sucks because the value of your stock will go down.  If you’re an employee and a stockholder you get the double whammy.  That is what diversification is trying to save you from.

But wait a minute.  I can hear some people say stuff about loyalty and having faith in your company and putting your money where your mouth is.  To that I say “hooey”.  If you’re working hard every day to help your company succeed, isn’t that loyalty and faith?

Remember that your portfolio is ultimately meant to support you in your life’s goals.  For most of us that probably means securing a comfortable retirement.

Just to put things in perspective, in 2013 there were a total of 7 stocks that got removed from the S&P 500 because of “insufficient market capitalization”.  That is French for “the stock went down so much the company wasn’t considered S&P 500 material any more.”  7 stocks out of 500 doesn’t seem like a lot but that’s about 1.5% of the entire index.  And remember that the S&P 500 as a whole was up 29%!!!  That was an awesome year for the entire index, yet still 7 companies couldn’t make the cut.  Imagine what would happen in an average year or even a bad year.

Let’s think about the fate of the employees at those companies for a second.  Being kicked off the S&P 500 is a bit of a slap in the face so you know things at the company aren’t good.  There’s probably a lot of things happening like stores closing, people being laid off, salaries being frozen, moratoriums of new hiring so the existing employees have to work more.  Just a bunch of bad stuff, right?  So if you’re working there life probably isn’t awesome, and the idea of polishing up your resume is probably pretty top-of-mind.

Now imagine all that is happening while a big portion of your portfolio is taking a dive (remember, these companies got booted off the S&P 500 because their stocks went too low).  Ouch.  That is definitely rubbing salt in the wound.  In the investing world managing risk, and minimizing it where you can without impacting your return, is super-duper important.  When you own a lot of stock in your company, you’re just taking on unnecessary risk.


So there we are.  There’s definitely some romantic notion of owning stock in the company you work for.  It seems like the right thing to do.  But you’re just taking on risk needlessly.  My advice is that you should really keep that to the absolute minimum.  In the Fox household, we sell the Medtronic stock when we can.  It’s not that we don’t think it’s a great company (it is) or we don’t have faith in its future prospects (we do).  It’s just we don’t want to bear the risk that something really bad could go down, leading to me possibly losing my job just as your portfolio is doing a belly flop.

How much of your portfolio is of your company stock?

Commodities—Stocky’s worst investment of all time

I know you look up to me and imagine that all my investments are good ones.  Oh, if only that were true.  I have had my share of lousy investments, but far-and-away the worst is my investment in a commodities ETF (ticker symbol DJP).

My general philosophy with investing is pick a broad index mutual fund.  Over half of the Fox portfolio is in a US stock index mutual fund (VTSAX) and an international stock index mutual fund (VTIAX).  Yet, back in 2010 Foxy Lady and I made the decision that we should also dabble commodities.  Over the past five years, that investment has lost about $40,000.  Here is our sad tale.



What we did?

In 2010 Foxy Lady and Stocky Fox engaged in a nuptial extravaganza that Chicagoans still talk about (not really).  Now as a married couple, we decided that investing in commodities (after we maxed out our 401k’s, of course) might be a good idea.  The financial world was still licking its wounds from the 2008 financial crises so there was still an underlying discomfort with stocks.  Plus, the world’s central banks were doing a lot of crazy shenanigans like Quantitative Easing and other things that might lead to major inflation if not handled just right.  Finally, commodities had an amazing run up in the previous few year, but then got hammered during the 2008 recession, so they were well off their highs; they seemed like a bargain at the time.

Dang!!!  Do you see two or three basic invest rules that we broke there?

I started doing research on what type of investment would suit our needs.  There were some mutual funds out there, but they invested in companies that were related to commodities.  Vanguard’s Precious Metals and Mining Fund (VGPMX) was composed of stocks whose companies owned mines and things like that.  That didn’t make sense because we already had broad stock mutual funds that probably already invested in those companies.  We wanted to own the actual commodity, the actual gold so to speak.

There were a lot of ETFs that tracked a specific commodity like oil (ticker symbol, surprisingly, is OIL), natural gas (GAZ), livestock (COW), grains (JJG), and on and on.  I liked the sound of that, but I wanted to be really diversified with commodities, so I didn’t want to have to buy 10 or 20 different ones.  I kept searching and I found DJP—it seemed like everything I wanted.  In a single investment we got a mix of energy, precious metals, industrial metals, livestock, and foodstuffs.

We found our winner.  It took a day or two to set up our brokerage account with Vanguard, and then we started making monthly investments into DJP.


What happened?

Things started off well.  After a year, commodities prices had gone up about 20% or so, and we had made a few thousand dollars on this investment.  I was congratulating myself for being a financial genius, and all seemed right in the world.

And then the wheels came off.  DJP peaked in April 2011 at around $50 and then it began its unrelenting, free fall down to about $30 where it sits today.  From a fundamental perspective, it’s easy to see what happened.  The economy started to slow which curbed the demand for commodities, putting major downward pressure on their prices.  At the same time, the fracking revolution happened in the US, unlocking tremendous amounts of oil and natural gas.  Those are the two largest components of DJP, and when all that new supply came on line, it just hammered our investment.

Keeping faith in “dollar cost averaging” we continued to make our monthly investment all the way through November of 2014.  At that point, for tax reasons that aren’t worth getting in to, we stopped continuing to invest, but we still currently hold a pretty decent chunk of DJP.  In March 2015 it hit bottom at about $28 and has since rallied to about $30.  Small victories, right?  That said, we still have a loss on this investment of about $40,000.


Why were we so stupid?

You heard our tale of woe.  So why was Stocky so stupid?  Why does he continue to hold this investment when it’s been so bad?

First, let’s understand the whole reason to invest in commodities.  Unlike stocks, commodities don’t produce anything of value.  When you invest in them, you’re just betting that their price goes up.  Over the long-term commodities have been a horrible investment compared to stocks (which are companies that actually create something of value).

So with all that, why invest in commodities at all?  They are really a hedge or “insurance policy” against the double nightmare of inflation and stagnant economic growth—stagflation.  If central banks started printing money, inflation would rear its ugly head and the pieces of paper we call dollars and euros and yuans would not be worth as much.  However, things like gold or corn or oil or cows would maintain their intrinsic value.

But wait a second.  Aren’t stocks a good hedge against inflation?  After all, they are real assets like property, plant, and equipment.  The answer is “yes”.  However, the largest portion of a stock’s value is the expectation of future earnings.  If the world economy really takes a body blow, stocks are going to lose a lot of value.

Look at these two charts—one is for the price of gold and the other is for the price of oil, the two most common investment commodities.  They had two major run-ups nearly at identical times, in the late 70s/early 80s and right around the 2008 financial crisis.  Those were the two most pessimistic times for stock investing in the past 70 years.



In the 1980s the Cold War was at its peak, OPEC was flexing its muscles, the US economy was crap, interest rates were at 20% and inflation was at 13%.  People legitimately thought that capitalism wasn’t going to survive.  The best thing to own was real stuff that people valued in the here and now.  Similar story with the 2008 financial crisis.  The banking system collapsed and it seemed like central banks were just going to wallpaper the world with paper currency.  Similarly people thought capitalism might be dead, and similarly the commodities had a tremendous run.

In both cases, capitalism did survive and did in fact thrive.  Commodities crashed and the world went on.  But all this illustrates that commodities do act as a real hedge against the armageddon scenario.  Diversification is an unambiguously good thing, so that is why the Foxes hold commodities.  Like all insurance, it’s not something you expect to make money on when things are going well, and keep in mind the stock market has done tremendously well since we started investing in commodities in 2010.  Rather, you want insurance to be there when everything goes to hell.


So that’s our story.  As I said, we still hold a small portion of our portfolio in commodities, but it is far and away our worst performing investment.

How about you?  What was your worst investment?

Era after 1930—inflation adjusted


A few weeks back I wrote a post saying that the chances of losing money in the stock market over the long run are really low, at least based on a historical perspective since 1871.  Yesterday I revised the analysis to look at the era since 1930, and I found that stocks performed even better.

However Andrew H, a reader from Chicago, commented that my analysis only scratched the surface.  I just looked at whether an investor made or lost money, not how much they made or lost.  Also, I didn’t take inflation into account (you know my reasons).  They are very valid criticisms, so I am taking up Andrew H’s gauntlet.

As an aside, Andrew H and I went to junior high together.  He was the smartest (or possibly the second smartest while I on the other hand was maybe the 40th smartest) student in our school, and I admit that I always looked up to him.  This one’s for you Andrew H.


Refresher from last time

We’ve already seen that if you look at returns since 1930 (I’ll explain why I’m starting with 1930 instead of 1871 in a second), the chances of you losing money in the stock market after a year is about 26%.  Of course we know time is on your side, so if you look at a five-year period, the chances of you losing money go down to 10%.  At 10 years it’s 2%, and at 20 years and 30 years it’s 0%–there is not a single 20 or 30 year time period since 1930 where dollar cost averaging in the US stock market would have resulted in a loss.  Let that sink in for a second.

Losing money

But Andrew H raised some very valid points, so let’s see what the data says.


Return distribution

Going back to 1930, we already said that you don’t have a single instance where if you invested the same amount of money every month, that you would have lost money over a 20-year time period.  If you assumed that you invested $10 every month, over 20 years your total investment would have been $2400.

Of all the 20-year time periods since 1930 (there are 768 of them if you’re curious), the worst you would have ever done was starting in March 1989 (ending at the depths of the 2008 financial crisis) and you would have ended up with $3388.  So your $2400 investment increased over 40%.  Of course if you annualize it, that is only 3.3% per year.  But that’s still pretty good isn’t it?  The best it ever got was starting in April 1979 (ending as the tech bubble was peaking in 1999) where your $2400 would have become $20,236 (over 18% annualized).

You can do the same thing for the 30-year-time periods (648 of those) and you get similar results.  You would have invested $3600.  Your worst outcome would have been starting in October 1952 (ending as inflation peaked and the US was in the recession of the early 1980s) where you would have ended up with $12,827.  Just like before, that doesn’t really seem all that bad.  Over 30 years your money quadrupled and that was the WORST it ever got (7.5% annualized).  The best was starting in February 1970 (again, ending with the 1999 tech bubble) where $3600 would have become $62,868 (16% annualized).

If you graph out the distributions you get this:

without inflation

For both time horizons, you see that most of your returns are in the 8% to 16% range.  As we just mentioned, you have some down years where the returns get a bit low, but even then they stay well above 0%.


Including inflation:

You can run a similar analysis but include inflation.  Even I would agree that inflation during some of those time periods were substantial (although of course, not as substantial as the CPI would lead you to believe).  The reason I chose to do this analysis starting in 1930 instead of 1871 is because of inflation.  The CPI started 1913.  You can estimate data before that but I really don’t trust that data.  I think inflation is a questionable enough factor as it is, so there you go.  Either way, I don’t think it changes the conclusions we’ll come to.

So when you invested each month $3600 starting in 1952, how much would your $12,827 buy you in 1982.  Remember that the 1970s and early 1980s had tremendous inflation (peaking at well over 10%), so it is going to have a major impact.

As we expected, those distribution curves shifted to the left (the real returns got worse when we accounted for inflation).  Looking at the 20-year time horizon, you had negative real returns* about 5% of the time.  So there you go.  That’s a bit of a bummer but that’s reality.  There were some periods that started in the 1950s and early 1960s (so they ended in the late 1970s and early 1980s) when inflation would have eaten away your returns and taken you into the red.

However, Father Time comes riding in on his white horse and saves the day.  While there were a few negative periods if you just used 20 years, if you push your time horizon up to 30 years there are no negative returns.  In fact, the worst time period was October 1952 (same as when we didn’t include inflation).  Remember that if you didn’t account for inflation your return over those 30 years was 7.5%, but now if you account for inflation it drops to 1.3% per year.  That’s a big drip and it definitely sucks, but remember, that’s the WORST.  As bad as it gets, the stock market has historically delivered a positive return even after you strip out inflation.

With inflation


I want to thank Andrew H for keeping me honest.  This little exercise has just further reinforced my faith that investing over the long term will make you money (ha, you thought I was going to forget—historic performance does not guarantee anything in the future).  No one knows what the future holds, but if history is any guide, putting your money in the stock market over your investing career is a pretty solid move.


*When I say “real returns” that means returns that have been adjusted for inflation.

Era after 1930


A while back I did a post on the likelihood of an investor losing money in the stock market.  Going back to 1871 the data showed pretty conclusively that if you dollar cost average and give yourself enough time, the chances of losing money approach zero.

As a follow up, I did the same analysis but instead of looking all the way back since 1871, I only went back to 1930.  1871 was a long time ago and reasonable people can debate how relevant investing in the stock market back then is to today.  Fair question.  In 1871 trains and horses were the main modes of transportation; cars and airplanes hadn’t even been dreamed up yet.  Oil had been discovered just 12 years before, slavery had been abolished only 8 years before, and there were a total of 37 states in the US.  So I agree it’s probably too different to be comparable.


On to the results

I ran the same analysis, looking at the percentage of time that a person investing equal monthly amounts in the stock market would come out profitable, but this time I started in January 1930.  Despite the different time period, the data looks largely the same.  The data from 1871 showed that looking at a one-year time period, investments were down 28% of the time; looking at the data from 1930 it’s 26%.  In fact the data seems to be in lock-step, and you can see from the graph, that the bars are virtually identical.

Losing money

But there is a curious feature.  In every instance the data from 1930 is better than the data from 1871—the chances of you losing money were reduced in the later time period.  Why is that?  It isn’t inflation: inflation was worse in the earlier period than the later period (plus you know I think inflation data is suspect anyway).  It couldn’t be geopolitical: both periods had world wars, but the earlier period was more peaceful in the US at least than the later period.  Technology made huge strides in both periods: cars, airplanes, oil in the first period; computers, satellites, internet in the second.  But the data sets are big enough that those differences are definitely statistically significant.


Securities reforms in the 1930s

My theory is the difference is caused by investing becoming a much safer place after 1930 than it was before.  After the stock market crash of 1929 which led to the Great Depression, legislatures passed a host of reforms to better regulate the securities industries, including the establishment of the SEC in 1934.  Reasonable people can take jabs at these reforms, especially when felons like Bernie Madoff, Ivan Boseky, and Jeffery Skilling, cheat investors out of millions and billions of dollars.

But difference between the pre-1930 and post-1930 investing environments is night and day.  Nowadays we can be fairly confident that the companies whose stocks we own are real and that their accounting is legitimate.  Certainly the system breaks down, but before all the regulations were passed it was the Wild West.  Stock scams were rampant instead of being the exception, and it seems to me that successful investing had less to do with investing in good companies and more to do with avoiding thieves.  We’re investing in much, much better times.

The other big difference I see is the Federal Reserve.  Although it was originally established in 1913, it was emboldened in the 1930s in response to the Great Depression and started to take the form that exists today.

To put things in perspective, in 1907 there was a financial crisis somewhat similar in severity to the 2008 crisis (from peak to trough, stocks were down about 50% in both the 1907 and 2008 crises).  Both were crazy times that caused people to legitimately worry about the future of the US economic system.  The difference was that in 2008 it was the Federal Reserve and the Treasury Department (led by Ben Bernake and Hank Paulson, respectively) that guided the country through the mess, while in 1907 it was a private citizen name JP Morgan.


Go ahead and let that sink in for a second.  In 1907, during the worst financial crisis in a generation, it was a banker who rallied the troops to ensure that healthy banks didn’t get killed in bank runs, maintained the credit worthiness of the US and New York City, fended off the palpable crisis of confidence, and ultimately pulled the economy through.  That’s amazing that a single man with no government affiliation had such power, but it’s also unsettling.  Morgan didn’t owe the average US citizen anything; he was serving his own interests (although he certainly positioned his actions as patriotic) and the country was fortunate that its interests lined up with his.

The Federal Reserve has a defined mandate to serve the interests of the American people; some may argue how well it does that, but you’re always going to have that.  Also, in the last 100 years, we as a society have become much more knowledgeable and sophisticated about the tools which can be used to guide an economy.  Back in 1907 I don’t think they had a clue what the concept of “Quantitative Easing” was, but in 2008 it saved the economy.  It’s impossible to know, but I personally believe that had the crisis of 2008 happened a century earlier, it would have led to another Great Depression.


Who knows on all this stuff, but you have my theories.  I absolutely believe that as an investor we are better positioned to succeed than ever before, and that is just one of the many reasons why I have a ton of confidence in the stock market.  This is confirmed when I look at the data.

As a follow-up, a reader suggested that I look at the data and take inflation into account.  Although it pains me to give that much credence to inflation, I will take up the challenge.  Stop by tomorrow to see how the data looks when you adjust for inflation.  If that’s not a cliffhanger on par with “Who shot JR?” I don’t know what is.

What are your thoughts?  Did I get it right, or have I been drinking the Fed Kool-aid?

Putting the Great Depression in perspective

Every time the stock market sneezes, hiccups, or God-forbid vomits, all the pundits start comparing this time to the Great Depression.  “Things haven’t been this bad since the Great Depression.”  You start to hear it so much you kind of get a little numb.  So I’m going to see how the worst financial crisis in my lifetime, the financial crisis of 2008 (diminutively dubbed the “Great Recession”) compares to the big boy.


Just a quick history lesson: Great Depression–Like in so many examples before and after, post World War I prosperity and an expanding economy led to increases in the stock market which led to increased stock market speculation in the late 1920s.  Confidence had been shaken in September 1929 by a fraud scandal in England, causing the US market to swing wildly up and down over the next month.  On October 24, 1929, the stock market crashed 11%, setting off a chain of events that led to the Great Depression.

Great Recession–About 80 years later, a similar script was followed.  In August 2007 a French bank began to have liquidity issues.  This began to unravel the intricately connected international banking system.  As liquidity dried up, questionable loans, especially sub-prime mortgages from the red-hot US housing market, began to go belly up.  The dominos began to fall and the entire banking system seized up.  In the infamous words of President George W Bush “this sucker could go down.”

So here you have the gold and silver medal winners in the “Worst Financial Crisis in the US Since 1900” event.  How do they compare?  You know how they say a picture is worth a thousand words?


That kinda puts it in perspective for me.  Both had crazy steep falls, with the Dow Jones Industrial Average losing about 40% in the first two years of the crisis, but that’s where the similarities end.  In the Great Recession things turned around pretty quickly, while in the Great Depression stocks fell another 40%.  At the Great Depression’s nadir stocks were down nearly 90% from when things started.  Imagine that for a minute.  Today the Dow is at about 18,000; imagine if by 2017 it got down to 2000.  I’m not sure we can really comprehend that.

As crazy as the falls were, the divergent stories of the two recoveries seems even wilder.  For the Great Recession, the Dow rebounded almost as quickly as it had fallen.  It took only about two-and-a-half years to recover from its trough to its starting point.  Then it didn’t stop there; as of this writing it was up about 40%.  Think about that for a second.  As bad as the Great Recession was, today we sit as far above where we started we were down at its depths.

But it’s a totally different story with the Great Depression— it was a long, long grind.  After the Dow hit bottom, it pretty much lingered there for about 20 years.  TWENTY YEARS!!!  Twenty years after the Great Depression started, stocks were still down 50% from their highs!!!  I feel I’m using too many exclamation points, but I feel they’re necessary.  Seven years after the Great Recession the Dow was up about 40%.

And I’ve just been looking at this from an investor’s point of view.  The Great Depression had brutal unemployment that maxed out at 25%; to put that in perspective, the Great Recession’s worst unemployment rates were about 8% and everyone was freaking out.  The Great Depression caused immense human suffering all over the world and played a central role in bringing about the greatest tragedy in human history—World War II.  All that stuff makes the Great Recession look like a paper cut.

So I propose a new rule.  From now on, when stocks take a dive, no one should even try to compare the latest financial crisis to the Great Depression.  Just the same way no basketball player should be compared to Michael Jordan, no band to the Beatles, no scientist to Albert Einstein, and no president to Abraham Lincoln.  The Great Depression is in a class by itself, the likes of which I don’t think we’ll ever see again.  I’m glad we got that out of the way.

The skinny on the Grexit

Cracked euro and Greek flag


“I’m sorry but this relationship just isn’t working.  It’s not me, it’s you.”

The Greek financial crisis continues to dominate the financial press.  Last Friday, when the European finance ministers reached a last-second agreement, the Dow Jones Industrial Average rose over 100 points.  Monday there started to appear fissures among Greek legislators with some thinking Alexis Tspiras gave too much, causing markets to drop.  Then on Tuesday the lenders approved Greece’s plan, and the markets surged.  So what is an investor to make out of all of this?  In this post, I’m going to break down what I think will happen and how that will affect us as investors (as always, this is just my opinion and I am not guaranteeing the future).

As I said in my Feb 13 weekly review, there are broadly three options on how this situation can play out:

  1. Greece uses the loans as a bridge to reforming its economy so it can reestablish itself as a self-sustaining country which can support itself without foreign intervention.
  2. Germany and the European community continues to subsidize the Greeks in spite of their failure to drive the sufficient reforms necessary to become fiscally solvent.
  3. Germany and Greece don’t agree, Greece defaults on its debt package, and they will ultimately leave the Eurozone–Grexit.


The first option—Greece stands on its own—is the one everyone has been hoping for, and really the reason for all the effort in the first place.  Yet, it also seems incredibly unlikely.  Greece spends too much money and it takes in too little in taxes.  Their pension system is incredibly generous and expensive; some estimate that last year 40% of the people who started collecting pensions were below the official retirement age.  Their public sector is enormous and inefficient, and their tax system is corrupt and totally ineffective with so many loopholes it reminds you of Swiss cheese (thank you, I’ll be here all week).  But most damning is they just aren’t very productive.  Quick, name a product that is made in Greece that you’d want to buy.  Not easy to do.

Put all that together and it’s a total recipe for disaster that has led us to where we are.  That’s not to say a country can’t dig itself out of this hole with the proper motivation and a willingness to sacrifice–Ireland comes to mind as a country in a similar place that has started down the slow, long, painful path to recovery–but the Greeks seem to have neither.  Just a month ago they elected a prime minister who ran on the platform that he would repeal all the austerity and reform measures that were imposed on Greece to get them back to self-sufficiency.

If Greece were able to pull this off, then it would be a huge boost to all the stock markets, especially the European markets, and most especially the Greek markets.  But I just don’t think the Greeks have it in them.  I hope they prove me wrong.


The second option—Greece continues to get loans without meaningfully improving—seems to be where we have been for a while now.  If you accept the reality that Greece will never be able to right itself, then this seems like the best option except for ONE MAJOR PROBLEM—eventually the Germans and the rest of Europe will get tired of subsidizing Greece’s reckless spending problems.  And by the looks of it, “eventually” might be soon.  Just like the parents of their 26-year-old, unemployed son living in the basement are one day going to say “enough is enough” so that will happen with the Germans and the Greeks.

So long as the loans keep coming, Greece has shown very little motivation to make the hard choices to get better.  Remember in 2012 when Tspiras and his Syzria party first started making waves, he basically was calling Germany’s bluff, saying that the loans would continue even if Greece rolled back the reforms because no one was willing to kick Greece out of the Eurozone.  Incidentally, isn’t that just a massive “screw you” he gave to the Germans?

This whole drama started 7 years ago and has Greece been able to fix its problems in that time . . . no.  Germany and others continue to lend money which creates a drag on their economies and lowers their stock markets, while Greece takes the money and fritters it away.  Believe me, I would love to be partying all the time while someone else pays the tab, but life isn’t like that.  If we continue down this path, I would expect returns from European markets to continue to be lower than those in the US, as has been the case for the last five years.


The third option—Greece leaves the Eurozone—seems to be eventually where we end up once Germany cuts up Greece’s credit card–Grexit.  Since no country has ever left the Eurozone, no one really knows what will happen.  People with a vested interested in keeping the status quo use scaremonger tactics to paint a picture of economic catastrophe if this happens.  But what would really happen if Greece left the Eurozone?  Here’s my take:

Undeniably, it would be bad for Greece and anyone investing in Greek stocks, really bad.  They’d have to introduce their own currency which would start trading against the Euro, and because of the shambles of the Greek economy it would depreciate rapidly.  Greece would experience huge inflation and imports would become much more expensive which would have a huge negative effect on the quality of life for the Greek people.  Also, when they went to borrow money internationally, their past track record would make it so they would only be able to do so at interest rates much, MUCH higher than they are getting now from the subsidized loans from Europe.  Greece would tumble into a huge recession that would make the past five years look like a day at Mykonos (again, I’ll be here all week).  After many, many years, things would start to normalize but Greece would be firmly entrenched in the ranks of a 3rd world economy rather than a peer among Europeans.  That would really suck if you were Greek.

The major unknown is what would happen to the other European countries in the Eurozone.  Probably for a little bit it would be rough sailing just because the maneuver of a country exiting the common currency has never been done before, but what would really change over the long-term?  Would Seimen’s x-ray machines (Germany) be any less accurate; would Heinekens (Netherlands) taste any less good; would Michelin tires (France) be any less durable; would Ferraris (Italy) be any less of a status symbol?  No, they’d all maintain their competitive positions, continue to sell, and maintain the value of their stocks.  After the brief hiccup when Greece leaves and things get settled, the European economies would probably be even stronger because they wouldn’t be dragging Greece along with them.  Sure, their imports to Greece would be hurt, but remember the Eurozone is about the size of the US economy while Greece’s economy is about the size of Connecticut’s; not a huge deal in the grand scheme of things.  I would predict that within two years (and probably even less), the European stock markets would be higher than they would on the day of Grexit.

As far as the rest of us go, the whole Greek saga really has no bearing.  As I mentioned before Greece is tiny in terms of its economy.  If/when Greece exits the Eurozone and its economy implodes it will go unnoticed except by our news organizations which are going to have to find something else to talk about, but that’s really it.  In fact, because Grexit will be good for Europe, it will benefit the other global economies just because we will have a healthier and stronger Europe to work with.


So there you have it.  That’s my take.  The sooner we face reality, the sooner we accept that Greece just isn’t capable/willing to support itself, the sooner we’ll be able to move forward.  And that moving forward will help all our economies and be positive for the stock market.