The last 30-year Treasury bonds issued with 10% coupons are maturing this week, according to Reuters. These bonds were issued in the summer of 1985, just a few weeks after Coca-Cola gave into public anger over New Coke and reintroduced the original formula (aka, Coca-Cola classic).
Investors who owned these bonds now face a far less enticing interest rate environment. The 30-year Treasury bonds auctioned earlier today have a coupon (interest) rate of 2.875%. Of course, inflation is far lower today than it was 30 years ago, as are borrowing costs. Still, the difference in coupon rates shows how timing matters.
Timing also matters when you look at past performance. This fact is very evident to me as I backtest components of a new stock strategy I’m developing. The flipped versions—ones where I screen for stocks with the opposite characteristics of what I actually want—are doing as well as or better than the screens I’m intending to use. Sounds like I’m going down the wrong path, doesn’t it?
Before you answer, re-read the last paragraph and think about what information I’ve given you, and what information I haven’t. There is a behavioral economics reason for asking you to do this. Nobel laureate Daniel Kahneman theorizes that our brains operate with two systems: System 1 and System 2. System 1 is quick, intuitive and relies on heuristics. (Heuristics are mental reference points we use to solve problems and analyze situations.) System 2 is slow and deliberate. Most of the time we operate on System 1, with System 2 justifying the actions of System 1.
The key piece of information that I did not share with you is the time frame I’ve looked at so far. The backtests started with January 1988 monthly data. I have now made it through July 1999, which is near the height of the tech bubble. (The backtesting is a manual process, hence the slow rate of progress.) As many of you may remember, this was not a particularly good period to be a value manager. And it’s not a period of time where one should expect low-valuation strategies to beat high-valuation strategies in backtested results. (I’m looking for stocks with a low price-to-book ratio and a low price-earnings or price-to-sales ratio.)
My expectation is that as I move past the technology bubble and into the years 2000 through 2003, the comparisons will change dramatically. As investors began to sell off excessively valued dotcom companies at the start of the new millennium, the sun started to shine again on value strategies. It’s important to consider how the screens perform over a variety of market conditions, however, because of the volatile nature of stock price movements.
Purposely restricting analysis to a short period of time falls into the realm of lies, 'darn' lies and statistics—which is why fund and investment newsletter marketers like doing it. If you are intending to follow a strategy for a long time, you should look at its past performance for as far back as is reasonably possible to do so. What’s reasonably possible will vary and, particularly with newsletters and funds, you may have to make decisions without the benefit of extensive past—or simply relevant—data. Investing is never exact; it’s messy and can require us to make decisions based on incomplete information.
It would be great if we could pick when we want to invest. It would also be great to be able to correctly forecast what’s going to happen over the next few years so we could adjust our portfolios accordingly. Unfortunately, neither is a realistic option. Even if you can identify a current or emerging trend, unanticipated events can and do alter outcomes. This is why it’s useful to understand how a strategy has performed over a long-term period of time—when the data is available—so you can better judge if good or disappointing returns are typical for a given set of market conditions (e.g., a correction in domestic stocks) or if something is truly not working.
Finally, don’t anchor your expectations based on what was available in the past. Conditions change over time, and just because you once could safely lock in a 10% coupon on a bond doesn’t mean you can now. Make the best decisions based on the investments and data currently available to you, not on what you wish was available.
- Believing Performance Claims: A Triumph of Hope Over Experience – Mark Hulbert says advisers and marketers take advantage of rare successes to tout seemingly good performance.
- Historical Performance and Future Stock Market Return Uncertainties – The long-term average return for large-cap stocks, which is now 10.1%, masks a large amount of variance among annual returns.
- What Was the Highest Coupon Rate Paid by a Bond You’ve Owned? – Tell us on the AAII.com Discussion Boards.
Retailers will dominate the earnings news next week, comprising many of the 20 S&P 500 members scheduled to report. Among them will be Dow Jones industrial average components Home Depot (HD) and Wal-Mart Stores (WMT), which will both report on Tuesday.
The August Empire State manufacturing survey and the National Association of Home Builders’ August housing market index will lead the economic calendar with Monday release dates. Tuesday will feature July housing starts and building permits. The July Consumer Price Index (CPI) and the minutes from the July Federal Open Market Committee meeting will be released on Wednesday. Thursday will feature the August Philadelphia Federal Reserve survey and July existing home sales. The August PMI Manufacturing Index Flash will be released on Friday.
The Treasury Department will auction $16 billion of five-year inflation-adjusted securities (TIPS) on Thursday.
August option contracts will expire on Friday.
- Why Buy Bonds If Interest Rates Will Rise?
- How Interest Rate Changes Affect the Price of Bonds
- How Much Is Needed to Start Investing?
Neutral sentiment plunged to a four-month low, as both optimism and pessimism rose in the latest AAII Sentiment Survey. Nonetheless, neutral sentiment still matched a record set last year.
Bullish sentiment, expectations that stock prices will rise over the next six months, jumped 6.1% percentage points to 30.5%. The rise is not large enough to prevent optimism from being below its historical average of 39.0% for a 23rd consecutive week, the longest such streak since a 29-week stretch in 1993.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, fell 10.6 percentage points to 33.4%. This is the lowest neutral sentiment has been since April 2, 2015 (32.6%). Even with the large drop, neutral sentiment is above its historical average of 31.0% for a 32nd consecutive week. This ties the record for the longest streak of consecutive weeks with an above-average reading, which was set between January and August of last year.
Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded by 4.5 percentage points to 36.1%. The rise keeps pessimism above its historical average of 30.0% for a third consecutive week.
This is only the second time in approximately two years that bearish sentiment has been above 30% for a period of three consecutive weeks. The last time this occurred was October 16, 2014. We point this out to show how pessimism has largely been staying at low levels. During the past two years, the level of pessimism registered by our survey has averaged 26.5%. It is too early to say whether the recent occurrences of above-average bearish sentiment (six out of the past 10 weeks) is a sign of the pendulum swinging back the other way or if it’s just just a temporary blip in a longer-term trend.
Giving AAII members reasons for caution are concerns about the possibility of a sizable decline in stock prices occurring, the pace of economic growth, the lack of wage growth, valuations, the impact of the stronger dollar on earnings and geopolitical events. The lack of market breadth and ongoing volatility are also playing a role. Keeping other AAII members optimistic is the Federal Reserve’s still-accommodative monetary policy, the ongoing bull market, sustained economic expansion and earnings growth.
This week’s special question asked AAII members what they think about the new requirement for companies to disclose how CEO compensation compares to the median compensation for all employees. Half of all respondents were in favor of the rule. Many favor the increased level of transparency, saying shareholders have a right to the information. Several others brought up the issue of excessive CEO compensation. About 4% of all respondents used the word “great” to describe the new requirement.
Not everyone was in favor of the new rule. Slightly more than a quarter of all respondents (26%) disfavor the new rule or think it’s a bad idea. Common themes in their responses were that the rule amounts to government interference, it’s unnecessary or it is politically motivated. An additional 13% of respondents said the rule won’t lead to any significant changes in compensation.
Here is a sampling of the responses:
- “I think this is great. CEO compensation for a lot of companies has gotten out of hand.”
- “Excellent idea! This can be another metric for CEO accountability to shareholders.”
- “The more transparency the better. I like the rule.”
- “Do not like, it is a politically correct activity and not something to protect investors.”
- “I see no value in it. Regulators are again overstepping their authority.”
- “I’m not sure what effect it will have. We already know that many CEOs are overpaid.”
Bullish: 30.5%, up 6.1 points
Neutral: 33.4%, down 10.6 points
Bearish: 36.1%, up 4.5 points
Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Local Chapter Meetings
August 6, 2015 Using Debt to Find Attractive Small-Cap Stocks
July 30, 2015 Don’t Judge Diversification by Its Short-Term Performance
July 23, 2015 Harder to Value Stocks When Interest Rates Are Uncertain
July 16, 2015 Consider Your Tolerance for Risk Before Abandoning Bonds
