Future Stock Returns

As Mark Twain once said,  "Prediction is difficult - especially about the future." And while investors would wish otherwise, predictions about the stock market are especially difficult. Many investors will use historical returns as an estimate of future returns. However, the job of an analyst is to make stock market predictions based off additional evidence. Recently, Vanguard, one of the largest mutual fund companies in the world, released its 10-year annualized forecast for financial markets. Vanguard is estimating only a 4.7% to 6.7% annual return for large-cap U.S. stocks and a 5.0% to 7.0% annual return for small cap stocks. So will the stock market achieve its historical average return over the next 10 years, or is Vanguard correct? Check back with us in 2033!

Bad Luck Investing

Hopefully you realize that the best time to invest is when stock prices are low and the worst time is when prices are high. But patience is a virtue and can have rewards. A recent article introduces Betty Badluck, who just happened to invest at the stock market tops during the past 35 years. So what happened to Betty? As you will see, while the returns were not fantastic, over time, the stock market has historically rebounded and she still has three times her investment in real terms. This is an important note on stock market history: While we can't predict the future, over the long-term, the stock market has historically provided positive returns.

Rockin' In The Free Markets

Investors have been looking for alternative investments and will be able to invest in a guitar from an alternative metal band. Gibson is using Rally to sell ownership of collectible guitars. The company recently sold 13,000 pieces of a guitar owned by Guns N' Roses guitarist Slash for $5 each. Of course, the company did not cut up the guitar, but sold a fractional share. Other guitars by Tony Iommi of Black Sabbath and Adam Jones of Tool are scheduled for sale. Of course, as with any collectible market, it appears that guitars that are not especially rare are having prices plucked up with the prices of rare guitars. The real question is will investors fret over the investment in the future or will it turn into real Money?

Identifying A Ponzi Scheme

If you are not familiar with a Ponzi scheme, it is generally a fraud in which early investors are paid out from contributions made by later investors. The Ponzi scheme usually ends when new investments dry up. A recent article on CFO.com highlights how to avoid a Ponzi scheme. We would like to make sure you read one particular concept, that is, "high returns with little or no risk." As we discuss extensively in the textbook, the only way to a higher return is with increased risk. Although we would all like higher returns with little or no risk, centuries of investment history show that such an investment is not possible. If it were, investors would flock to that investment, driving the return down.

I Bonds

While most people are familiar with EE savings bonds, fewer are familiar with I bonds. A recent article in the Wall Street Journal highlights I bonds and the advantages of these bonds. One major advantage is that I bonds are yielding an currently very high interest rate of 3.54 percent. This is impressive when you consider the bonds are virtually risk-free. By way of comparison, 30-year Treasury bonds are yielding about 2.25 percent. I bond yields are based on the inflation rate and can change every six months. You cannot redeem I bonds for 12 months, and if you redeem within five years, you pay a penalty of the last three months of interest. You can buy electronic I bonds at www.treasurydirect.gov in any amount from $25 to $10,000, or paper I bonds in $50, $100, $200, $500, or $1,000 as a tax refund. One way to tell that I bonds are good investments is that the government caps the annual electronic purchase at $10,000 per individual, with another $5,000 possible through the tax refund purchase.

Women Outperform Men

Who are better investors, women or men? A recent interview with proprietary trader Kathy Donnelly discusses reasons why the evidence suggests that women tend to outperform men as investors.

A Short Squeeze

A short sale occurs when an investor sells a stock they don’t own to hopefully buy it back later at a reduced price. Recently, Gamestop and AMC have seen a short squeeze. When you short a stock, if the stock price increases, you must make a margin deposit, that is, make an additional deposit of cash into your account, or repurchase the stock and take the loss. In a short squeeze, a group of investors buy the stock, forcing short sellers to make more deposits or take a loss. In the past two weeks, Gamestop has gained about 1,800 percent, which in our opinion, means the stock is in a bubble.

Day Trading For Profit?

In our opinion, a negative financial outcome of the COVID-19 pandemic is the rise of day trading. Dave Portnoy, the CEO of Barstool Sports, has named himself "Davey Day Trader" and helped popularize day trading. And although not all are day trading accounts, Robinhood added 3 million accounts during the first quarter of 2020. One new investor, a 20-year old from Nebraska, tragically committed suicide after his account balance showed a loss of over $700,000. In fact, his account balance may have only been temporary until trades settled. It is important to note that short-term investors tend to do worse than longer term investors, and for day traders, the success rate is less than 10 percent, with only 1 percent or so who really make money. We do believe that investing is worthwhile, but do your research, diversify, and make longer term decisions.

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.

An ICO Bubble?

A couple of years ago, coins or tokens, were the new frontier of investing. Now, it appears that the fantastic returns offered in this investment were often only temporary, as are most fantastic returns. A recent Twitter post post notes that the median ICO return in U.S. dollars is negative 87 percent and continues to go lower. Although several ICOs have outperformed bitcoin, most have not. Of course, many of these ICOs were likely destined to be poor performers and sold by being hyped to uninformed investors. 

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.

Stocks In The Really Long Run

While we discuss stock returns for a fairly long historical period in the textbook, what about the really long run? Global Financial Data has constructed a World Index that extends back to 1601! When evaluated over four distinct economic regimes, total stock returns have varied from 5.05 percent to 9.98 percent and dividends yields have varied widely as well. The equity risk premium has also varied significantly, from .87 percent to 3.02 percent. Over the past 318 years, the equity risk premium has averaged 1.46 percent. Of course, we should caution that this is not a definitive risk premium going forward. For anyone interested in stock market history, we would recommend a look.

Illusory Superiority

Illusory superiority is a behavioral concept in which people believe they are above average in traits such as intelligence, relationship status, professional achievement, and driving. Obviously, everyone cannot be above average. But one area that many people do not believe they are above average is investing skills. As a result, investors tend to either hire a money manager, or invest on their own. Advice from money managers can be expensive and eat into your return. Additionally, if you go this route, you must be cautious as there are unscrupulous advisors and outright scam artists. We should note that there are also reputable money managers who can help you. By investing on their own, investors often find themselves chasing stock returns. Small investors often suffer from overconfidence, which typically involves a lot of buying and selling, racking up trading costs and taxes. We hope your education and this textbook has prepared you on your journey to becoming and educated investor.

A Great Risk-Free Rate?

Generally, savings accounts are considered to be close to a risk-free investment. Given what you have learned about risk and return, you would expect a low return, and you would be right. Bankrate.com states that the current average savings account interest rate is .10 percent, although the highest rate offered is 2.35 percent. But what if you could get a 6.2 percent return on your savings account? You can with a BlockFi Interest Account. BlockFi allows you to deposit bitcoin or ether and will pay you a 6.2 percent APY (or EAR). BlockFi is regulated by the New York Department of Financial Services, but does not have the FDIC protection carried by most banks. As with banks, BlockFi depends on charging borrowers a higher rate than it pays to savers. Now the question remains: Is a savings account with BlockFi truly risk-free?

Dumb Money

A common belief among professional Wall Street traders is that dumb money, better known as retail investors, will flock to the market when stock prices are rising, then get out of the market after the stock has fallen. This sort of trading strategy will create a lot of losses, hence the term dumb money. During the stock market downturn in December, professional investors had a very low level of sentiment toward the market and left the stock market. And dumb investors poured $22 billion into passive index funds, reaping the reward from the recent market upturn. One possibility is that retail investors have become  believers in efficient markets, resulting in the money flowing into index funds, or at least they have been conditioned to understand that a market downturn can mean that stocks are on sale.

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.

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.

A Blockchain Bubble?

Many would argue that the rapid rise of internet stocks in the late 1990s was a bubble and blockchain company stocks may be following a similar path as internet stocks. Long Island Ice Tea Corp., which sells nonalcoholic beverages and lost $11.9 million on sales of $3.9 million in the first 9 months of 2017, saw its stock price jump as much as 289 percent when it rebranded itself as Long Blockchain. The company stated that it would seek out partners that develop blockchains. Long Blockchain has no agreements with any other company to partner on blockchain technology nor is there any assurance that one will be found. While Long Blockchain may eventually find a partner, we would advise you to be careful of FOMO (fear of missing out) investing.

Dow 150,000!

With the DJIA at about 18,500, it may be hard to imagine the DJIA hitting 150,000, yet there is a good chance the Dow hitting or exceeding that mark in your lifetime. Even though the number may seem impossible, such is the power of compounding. As this article points out, for the Dow to hit 150,000 by 2046, the annualized return only needs to be about 7.25 percent. One important note on the Dow is that it is a price index, not a total return index, so it excludes dividends. Unfortunately, many people, including business writers, have little idea of the effect of compounding. In 1995, when mutual fund pioneer Bill Berger predicted that the Dow would hit 116,200 by 2040, the business writer audience laughed. However, based on the level of the Dow when he made the prediction, such a move only required an annual return of about 7.5 percent. While we hope you take many things from this textbook, time value of money and compounding is perhaps the most important. 

First Quarter Returns

The S&P 500 finished up about .8 percent for the first quarter, but what were the best and worst performers? Among all assets, gold and the Bovespa (Brazilian stock market) performed the best, with both up about 15 percent for the quarter, while silver prices increased about 11 percent. Among the losers were DJStoxx 600 Banks (European banks), the FTSE MIB (Italian stocks), and the Chinese yuan renminbi.