Equity Reallocation Between US, Developed And Emerging Markets

January 8th, 2018
Within the equity allocation of portfolios, with tax awareness, we are taking these actions in discretionary accounts, and are recommending these actions in advice & consent accounts, and in coaching relationships:
  • Underweight US stocks (preferably to less than the 52% world weight)
  • Overweight non-US Developed Mkt stocks (preferably to more than the 39% world weight)
  • Overweight Emerging Mkt stocks (preferably to more than the 9% world weight)

We have been strongly overweight US stocks within the equity allocation for years, and that has been beneficial; but now evidence suggests that greater opportunity lies in other parts of the world.

A significant challenge we face is the pretty much across the board embedded gains in our stock positions.  Reallocation in tax deferred accounts is not a problem, but in regular taxable accounts, we need to understand the taxable gain preferences (and tax loss carry-forwards) of our clients versus their need to reallocate.

The following information supporting our view provides:

  • Comparative valuation measures for the three regions (US, non-US Developed and Emerging markets)
  • What is fair value of stocks today relative to bonds?
  • Recent and multi-year relative total return performance of the three regions versus the world index
  • Multi-period institutional forward return forecasts for the three regions
  • Net flow of funds to US and International/Global mutual funds and ETFs
  • Current short-term technical ratings for the three regions and the world
  • QVM intermediate-term trend ratings for the three regions and the world.


  • Price-to-Book Value Ratio
  • Price-to-Sales Ratio
  • Price-to-10yr Av Earnings Ratio (by Robert Shiller, Yale Economist, Nobel laureate)
  • Price-to-Highest Historical Earnings Ratio (by John Hussman, analyst and mutual fund manager)
  • Price-to-Total of Book Value and Debt (by James Tobin, deceased Yale Economist, Nobel laureate)

The short-story here is that by each measure, the US is the most expensive; non-US Developed markets are either somewhat less expensive or mostly significantly less expensive, and Emerging markets are significantly less expensive.  If we are seeking best relative value, and potentially least exposed to valuation contraction, regions with lower Price-to-Whatever ratios are generally more attractive.

The following comparative valuation measures were generated recently by Research Affiliates for their January article, ”CAPE Fear: Why CAPE Naysayers Are Wrong”. Valuations are compared between the regions and for each region relative to its own history.

Each of the following measures presents the current value inside of a “box and whiskers, explained by this image:

Price-to-Book Ratio: 

Price-to-Sales Ratio: 

Price-to-10yr Av Earnings:

This ratio (commonly called CAPE, for cyclically adjusted Price Earnings Ratio, where the adjustment is an inflation adjustment to historical earnings) was developed by Robert Shiller, Yale Economist, based on the idea published by Benjamin Graham many years ago.

Hussman P/E Ratio:

John Hussman divides the current price by the highest prior peak earnings, to present the lowest possible P/E (most favorable) based on actual historical results.

Tobin’s Q Ratio:

Tobin’s Q ratio, is the ratio of the market expressed value of a company (as measured by the market value of its outstanding stock plus debt) divided by the current replacement cost of the company’s assets (actual replacement cost is a complex determination, so for simplicity book value is often used for replacement cost, which typically overstates the true ratio, because book value is after depreciation and is not inflation adjusted — however in a time series for a single security, or between indexes, it is probably useful).


One expert to consult is Benjamin Graham (1894-1976), the acknowledged farther of value investing (as well as professor to and eventual employer of Warren Buffet).

He wrote the seminal books: “Security Analysis” (1934) with David Dodd, and the “Intelligent Investor” (1949) which Warren Buffet described as “the best book about investing ever written.”  I remember reading “Intelligent Investor” in the summer of 1968 while working trail crew on the Appalachian Trail between my Sophomore and Junior years in college.  It was my first exposure to investing ideas.  It was captivating then.

In “Common Sense Investing: The Papers of Benjamin Graham” (accessible here) he said:

“It seems logical to me that the earnings/price ratio of stocks generally should bear a relationship to bond interest rates.  …I should want the Dow or Standard & Poor’s to return an earnings yield of at least four- thirds that on AAA bonds to give them competitive attractiveness with bond investments.”

Today, AAA credit yields 3.47%.  Four thirds of that suggests an earnings yield is 4.63% (or a P/E ratio of 21.6).  Prospectively, with the Fed on course to raise short-term rates by 0.5% to 1.0% in 2018, it is reasonable to assume that the AAA yield will be higher than 3.47% at the end of 2018, and that an attractive earnings yield would be higher than 4.63% (a P/E lower than 21.6).

Today, according to Vanguard, the trailing P/E on each of the funds respresenting world stocks and three stock regions are:

  • World stocks (VT) P/E 18.9 (earnings yield 5.29%)
  • Total US stocks (VTI) P/E 22.7 (earnings yield 4.41%)
  • Large-Cap non-US Developed markets stocks (VEA) P/E 16.0 (earnings yield 6.25%)
  • Large-Cap Emerging markets stocks (VWO) P/E 14.8 (earnings yield 6.76%)

This is just one generalized way to look at fair value, but given the source, it is worth noting.  The US is somewhat expensive by this Graham metric.  The world and non-US developed markets are attractive.  Emerging markets are very attractive (and much more volatile – forecasted to be in the low 20’s versus mid-teens for US and non-US Developed markets).


Each chart shows cumulative returns for total world stocks (VT) versus the total US stock market (VTI) and the large-cap non-US Developed markets (VEA) and the large-cap Emerging markets (VWO).  The US has been the clear winner since the stock market bottom in March of 2009, but international markets have recently pulled ahead.  Since the US has stretched the valuation rubber band more than the other two regions, that suggests greater forward opportunity internationally.

3 Months cid:image020.png@01D387EF.3F0AC400

 1 Yearcid:image021.png@01D387EF.3F0AC400

 3 Years


 From the 2009 US Stock Market Bottomcid:image023.png@01D387EF.3F0AC400


The Net Flow of Funds to mutual funds and ETFs has favored international and global funds over US domestic funds over the past 3 years.  US domestic funds still outperformed international and global funds, but investor preference is clear in this chart.  Until international and global funds show signs of overvaluation, “follow the money” may be a good thing to do.


While institutions vary in the magnitude of multi-year forward annualized total returns, they are in essential agreement in forecasting Emerging markets being the highest return opportunity among the three regions ( with significantly higher volatility than in the US or non-US Developed markets).  US stocks are generally seen as offering the lowest returns.  Institutional forecasts are consistent with the pattern of Net Flow of Funds.


These ratings come from BarChart.com.  In their parlance, “short-term” is in the vicinity of 20 days; “medium-term” is in the vicinity of 50 days; and “long-term” is in the vicinity of 100 days – all of which we view as short-term.


Our proprietary trend indicator is measured on a monthly basis over a period in excess of 1 year, and we believe indicates the intermediate trend condition.   A description of the measurement method  can be found here:

Note that while the world and all three regions are in strong positive up trend; but they are “running hot” and are “overbought” — suggesting a likely slowing or Correcting to cease being “overbought”.



Bitcoin Bubble Warning Follow-Up

December 22nd, 2017

We wrote to you on the December 12th warning to stay away from Bitcoin.

We posted that comment on our blog and received some outraged comments from Bitcoin “fanboys”. That is the price of skepticism expressed about any bubble.

We said we can’t be involved in Bitcoin as fiduciaries, and have been recommending to clients that they not become involved on their own.

As Bitcoin went from less than $500 to more than $18,700, our concern was increased, while some people felt we should not have missed the boat.

We are in good company with those who warn about involving in Bitcoin, including the CEO of  JP Morgan; the CEO of the largest hedge fund in the world; the CEO of the largest pure short-only hedge fund, the founder and former CEO of Vanguard; the former CIO of Harvard Endowment, the CEO of the largest money manager in the world, a Nobel Laureate in Economics, and Warren Buffet.

Bitcoin may bounce back to new highs, but it is simply not investable. It may be better than roulette as a fun thing to play, but is not an investable asset.

Maybe just dumb luck, but we did call at least an intermediate top on December 12th. We continue to believe it is not a good idea to own Bitcoin, and advise clients not to see the current decline as a buying opportunity.

Prices that go up vertically (an unsustainable pace) almost always turnaround and go down vertically until the speculative element is washed out.  That appears to be happening now with Bitcoin.

Futures may amplify that process, because now there is a way to be short, whereas before one could only be long.

Our warning post “Clients Ask, Should I Own Bitcoin?” can be found here.

Here is the chart of Bitcoin price on December 12th.

(click images to enlarge)

Here is the chart of Bitcoin today, December 22nd


Clients Ask, Should I Own Bitcoin?

December 12th, 2017
  • Bubble, but not systematic risk
  • Regulated , cleared futures contract key step toward mainstream asset
  • Distributed technology limits scale potential
  • Get rich or get busted — no thanks — I’m just a watcher

The media is atwitter (no pun intended) about Bitcoin, which is up like a rocket, and just became available in futures contracts.  I am not onboard with this asset at this time, but with all the publicity and a smattering of inquiries from clients, I need to provide some background information.

First a regret (I suppose) to one client who a few years ago suggested a little taste of Bitcoin; but I told him I did not see it as real — didn’t know how to safely get involved — and passed on it.  Well, $1,000 in Bitcoin at that time, which would have been a round-off number him, would be worth around $1.7 million today (unless, of course, the platform we used was one of those early platforms that  failed, where all investor funds simply went “poof”).

In hindsight, I wish I had made that tiny investment for him and for me — the “poof” would not have hurt either of us — although I probably would have lost my client for reckless behavior.

I know I made a reasonable decision at the time, based on what was known at the time.  I did the right thing as a fiduciary — just feel envious now of those with a love of casinos who took a shot.  I could always use an extra $1.7 million.

A friend of mine bought some Bitcoin, because her son bought some.  So far she is very happy to have done so.  I bought some Canadian marijuana penny stocks, because my son bought some.  So far I am very happy to have done so as well — just not nearly as happy as she is.

Your children may talk to you about Bitcoin; or you may find Bitcoin to be topic of discussion among enthusiasts at a cocktail party.   This article may help you hold up your end of the conversation.

(click images to enlarge)


In August 2015, PwC published are report on cryptocurrency titled: “Money is no object: Understanding the evolving cryptocurrency market “. It said,

“Cryptocurrency: media sensation and investment fad? The issue is no longer whether cryptocurrency will survive, but rather how it will evolve. Each of the five key market participants— merchants and consumers, tech developers, investors, financial institutions, and regulators—will play a critical role in this process.

… It has been called one of the “greatest technological breakthroughs since the Internet.” It also has been called “a black hole” into which a consumer’s money could just disappear. The subject at hand is cryptocurrency—a medium of exchange created and stored electronically, and using encryption techniques to control the creation of monetary units and to verify the transfer of funds”


Schwab posted an article about the price behavior or bubbles and their risk to the financial system.  They suggested that asset categories that rise 10 fold over 10 years without fundamental underpinnings tend to be in bubbles that pose systematic risk.

The importance of 10 years is to have given the asset time to be widely held and embedded in portfolios across the breath of investors.

In this chart, they show the price pattern in the 10-years prior to the bubble peak for the NASDAQ (dotcom era), Homebuilders, Oil and Silver bubbles.  When those broke they had systematic impact.

The chart also shows the short-term meteoric rise of Bitcoin, which any technical analysis would say is in a massive bubble — however, the bubble has inflated so fast that it has not become widely held or embedded in a broad spectrum of portfolios.  The implication is that if it crashes, it will not have systematic impact.  That means we will not become concerned about our stock and bond positions if Bitcoin speculators get wiped out.



This chart of the NYSE Bitcoin index (in black), and the only Bitcoin ETF (GBTC, in gold), and the daily price changes as a percent (in red), shows that the ETF had some devastating drawdowns that would have flushed out most people who had anything more than lunch money at risk.

It also shows that nearly 60% of the gain occurred in the last month.

Projectiles fired straight up into the air almost always come back down just as straight.  Could happen here.  Maybe not, but my stomach isn’t fit for that much excitement, and none of my clients are either when it comes to their retirement portfolio.

Clients are welcome to experiment with the ETF on their own, but not through me as a fiduciary.

Here are a few data points about the ETF:

This table shows the 1-mo, 3-mo, 6-mo and 12-mo returns of the Bitcoin ETF versus the ETFs for Total World stocks, S&P 500 stocks, non-US Developed market stocks, Emerging market stocks and US Aggregate bonds.  No contest, of course, but thought you might like to know.

Here is the discount or premium above the underlying asset value for the Bitcoin ETF and the other ETFs in the list.

You can see that while the premium for GBTC is high at over 20%; it is way down from the 130% 1-year high premium, and the 56% 12-month average premium.

That is a small good sign, in an otherwise boiling hot bubble.  Or maybe it shows the bubble is losing some followers.


Here are the expenses of the funds.

At 2%, the management fee of GBTC is very high as ETFs go: but not of any consequence under bubble conditions. Total expenses are not yet known, but they couldn’t compare to the price appreciation.


GBTC is the ticker symbol for The Bitcoin Investment Trust, a trust run by Grayscale that holds Bitcoins. You can buy it at your broker, but it is not “listed”.

They say this on their website:

“Eligible Bitcoin Investment Trust shares are publicly quoted on OTCQX [under the Alternative Reporting Standards] under the symbol: GBTC. Investors can buy and sell unregistered but freely tradeable Bitcoin Investment Trust shares through their personal brokerage account in the same manner as they would other unregistered OTC securities.”

Note: Alternative Reporting Standards means they are not held to the same standards as other funds you find registered with the SEC and listed NYSE or NASDAQ. That is a buyer beware fact.


Attorney Kathleen Moriarty,  a partner at Chapman and Cutler LLP, advised on the creation of SPY, GLD and leveraged ETFs for ProShares. She attempted to obtain SEC approval for an ETF to hold Bitcoins on behalf of the Winklevoss brothers, but was rejected. She said,

“In turning down the listing rule for the Winklevoss ETF, the SEC said, in effect, the market’s too young and too unregulated.  Normally, when you apply for a listing rule, you have to show the underlying things you’re buying are subject to some kind of regulatory control. … There isn’t any regulator to speak of, and there aren’t any real regulated exchanges. It’s just like the Wild West, and they felt it was too soon to go ahead and promote the product when all the underlying stuff was completely in the air. … The whole idea of a bitcoin ETF was already a strange idea, in that you were creating something highly regulated out of something unregulated. … But then, look at the futures; you’ve got bitcoin futures … and they’ll be regulated by CFTC. There is beginning to be regulatory overview.”

The SEC statement on their rejection of the application to list a Bitcoin ETF said:

“the Commission is disapproving this proposed rule change because it does not find the proposal to be consistent with Section 6(b)(5) of the Exchange Act, which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.”


The facilitation of criminal activity with Bitcoin is a major concern of law enforcement.

CNN Money reported North Korea is hacking and stealing Bitcoin, because Bitcoin is untraceable and enables them to get around sanctions. Remember, when it’s gone, it’s gone — no recovery process or government protections — no guarantee funds — no solutions.

The article included this “It is a fact that North Korea has been attacking virtual currency exchanges,” said Lee Donggeun, a director with South Korea’s state-run Korea Internet and Security Agency. “We don’t know how much North Korea has stolen so far, but we do know that the police have confirmed the regime’s hacking attempts.”

The untraceable feature is also attractive to the hackers who take over your computer and demand ransom to release it back to you. Jim Cramer reported that hackers seeking ransom demand payment in Bitcoin, and even advise victims on how to set up Bitcoin accounts to be able to pay the ransom.


All holders of Bitcoin must record and account for capital gains.  The IRS determined in 2014 that Bitcoin is property, and thus is subject to capital gains taxes.

You, as the investor, are required to keep detailed records, including purchase date, purchase price and sale date and sale price. Although you may not receive a Form 1099 from whatever exchange you trade on, you remain responsible for paying taxes on gains.

For those paying bills or purchasing items with Bitcoin, or converting Bitcoin to make purchases, you have to record all those transactions and determine the intra-day price of Bitcoin at the time you made the transaction. With the wild swings in price during the day, the task is formidable, and thoroughly impractical.

Presumably, compliance is low and reporting by the exchanges isn’t there yet (that’s why criminals like to transact in Bitcoin). But governments are moving to capture more violators. Like with offshore accounts, the US government is using its muscle to find who owes taxes  to get their share of the pie.

For example, a U.S. District Court judge in California ordered Coinbase, a popular platform for buying and selling bitcoin and other cryptocurrencies, to turn over identifying information on accounts worth at least $20,000 during 2013 to 2015. It’s unclear whether the exchange will comply or contest the ruling.

I don’t know about you, but I already spend to0 much of my life keeping records for the IRS without adding this headache.  I would never consider using Bitcoin as a medium of exchange, unless the exchange or bank keeps the records and provides me with a Form 1099.


[from a Price Waterhouse Coopers 2015 report] “What is cryptocurrency? A cryptocurrency is a medium of exchange such as the US dollar.

Bitcoin, the first cryptocurrency, appeared in January 2009 and was the creation of a computer programmer using the pseudonym Satoshi Nakamoto.

Like the US dollar, cryptocurrency has no intrinsic value in that it is not redeemable for another commodity, such as gold. Unlike the US dollar, however, cryptocurrency has no physical form, is not legal tender, and is not currently backed by any government or legal entity. In addition, its supply is not determined by a central bank and the network is completely decentralized, with all transactions performed by the users of the system.

The term cryptocurrency is used because the technology is based on public-key cryptography, meaning that the communication is secure from third parties. This is a well-known technology used in both payments and communication systems.”


[from a Price Waterhouse Coopers 2015 report]  “The blockchain is a ledger, or list, of all transactions, and is the technology underlying Bitcoin and other cryptocurrencies. This decentralized public ledger keeps a record of all transactions that take place across the peer-to-peer network.

This technology allows market participants to transfer assets across the Internet without the need for a central third party. Specifically, the buyer and seller interact directly with each other and there is no need for verification by a trusted third-party intermediary. Identifying information is encrypted, and no personal information is shared. However, a transaction record is created. For this reason, transactions are considered pseudonymous, not anonymous.

The blockchain public ledger technology has the potential to disrupt a wide variety of transactions, in addition to the traditional payments system. These include stocks, bonds, and other financial assets for which records are stored digitally and for which currently there is a need for a trusted third party to provide verification of the transaction.”


Wired magazine published a 12/12/2017  article about technology limitations for Bitcoin titled, “Bitcoin Is Soaring, Here’s Why It’s Not Ready For the Big Time”.  Here are extracted portions of that article:

Bitcoin creator, pseudonym Satoshi Nakamoto, publish a 2008 white paper launching the cryptocurrency movement by describing employment of a peer-to-peer network backed by unbreakable math to verify transactions, removing the need for centralized institutions.

Participants in Bitcoin transactions pay fees to assure that the global network of computers that manage the currency will process the transaction. Tuesday afternoon [12/12/17], Eastern time, it cost around $19 to have a transaction processed in 10 minutes. By one estimate, paying a smaller fee of $3 would leave your transaction taking an estimated 24 hours.

Bitcoin’s transaction fees are so high because the peer-to-peer network that powers the currency has very limited capacity by the standards of modern digital infrastructure. Emin Gun Sirer, a Cornell professor who has studied Bitcoin’s design, estimates that at best the Bitcoin network could process seven transactions per second, but typically achieves 3.3. Visa reports processing 29.2 billion transactions in the three months through September, a rate of 317 million a day, or 3,674 a second.

Blockchain entrepreneur Preethi Kasireddy, who previously worked at Goldman Sachs and VC firm Andreessen Horowitz, recently wrote a detailed post cautioning of the technical limitations of Bitcoin and related systems. She says the underlying technology of what are dubbed blockchains is wholly unready for widespread use. “To make anything mainstream you have to make it scalable,” she says. Bitcoin transactions are powered by people who set up shop as “miners,” running software originally designed by Nakamoto that creates the network that does the work of processing transactions.

Kasireddy cautions that there are no technically proven options implemented at scale. Even if there were, Bitcoin lacks a clear mechanism for implementing upgrades, thanks to Nakamoto’s decentralized design. “There’s no real governance process,” she says. There’s a lot more to bitcoin than just the price.


Because the code to create Bitcoins is open source, different developers have modified the code to create hundreds of other cryptocurrencies; but BitCoin was first; is the dominant cryptocurrency; is the only one with a fund; and now is institutionalized with regulated and cleared futures contracts.

Here are the names of the 10 other cryptocurrenices (called “Altcoins”):

  • Ethereum
  • Ripple
  • Litecoin
  • Dash
  • NEM
  • Ethereum Classic
  • Monero
  • Zcash
  • Decred
  • PIVX


To purchase Bitcoins with Dollars, or heaven forbid, sell Bitcoins for Dollars, you have to go through an exchange.  In the past, a few have imploded, devastating investors.

The largest exchange is CoinBase.  To work with the platform you have to associate your bank account with the exchange.

I remember when hardly anybody thought online banking would be safe, and one bank CEO (I think he was of Chase or Citi) said his bank would go online over his dead body because of the risks.  I think he may actually be dead at this time.  He was wrong.  And now we can even deposit checks to our banks by taking pictures of them with our mobile phones.

That said, I am still in the “over my dead body” state of mind about hooking my bank account up to an unregulated virtual Bitcoin exchange.  No, not me.

Here is a screen shot from the CoinBase site about setting up an account:

They are still evolving, but there are over 1600 Bitcoin ATMS, where you can put in cash and own Bitcoins out there in digital space; and there are  some where you can sell your Bitcoins and get paper Dollars out of the machine — just in case your next purchase requires paper fiat money to get your stuff.


The really big development toward making Bitcoin a mainstream asset is the initiation of regulated and cleared futures contracts.

The CBOE launched one this week (symbol XBT), and the expectation is that the CME will do the same next week.

Here is a description of the CBOE contract (contract size is 1 coin):

Not too much has traded yet, but it will grow.

Here are the prices, price change, volumes and open interest so far for the three contracts initially available:

What is really important to notice is that there are no open positions. An open position is holding a contract after the close of the market for the day. That means people bought and sold, or went short and covered intra-day; but nobody had the conviction to be long or short overnight — it’s just been too volatile.

And, here is price chart for the first three days of trading — not exciting so far


The margin requirement for most futures is in the 10% range. The current margin requirements for Bitcoin futures is 44%. Your money could double or go to zero overnight.  It tends toward being an overnight binary outcome — enriched or busted.

It will be fun to watch; and that is all I am for now — a watcher.


There are very many quotes from all sorts of people making positive statements about owning Bitcoin.  I won’t add to the hype by repeating them, but I will supply a few cautionary quotes from very prominent individuals whose opinions should not be discounted

Summary of comments below: Most people aren’t buying into the value of the technology, they’re buying into the hype. This is gambling, not investing.

BlackRock CEO, Larry Fink
“Bitcoin just shows you how much demand for money laundering there is in the world … That’s all it is.”

JP Morgan CEO, Jamie Dimon
“I could care less what bitcoin trades for, how it trades, why it trades, who trades it. If you’re stupid enough to buy it, you’ll pay the price for it one day. I’ve also told people that it can trade at $100,000 before it trades to zero. Tulip bulbs traded for $75,000 or something like that.

“The only value of bitcoin is what the other guy’ll pay for it. Honestly I think there’s a good chance a lot of the buyers out there are out there jazzing it up every day so that maybe you’ll buy it too, and take them out.

…. governments are going to crush it one day. Governments like to know where the money is, … governments like to control their currency, like to control their own economy. So China’s already put curbs on it.

So there is a use case for bitcoin. If you live in Venezuela, North Korea, if you’re a criminal, great product.”

Vanguard Founder, Jack Bogle
“Avoid bitcoin like the plague. Did I make myself clear? … Bitcoin has no underlying rate of return, …You know bonds have an interest coupon, stocks have earnings and dividends … There is nothing to support bitcoin except the hope that you will sell it to someone for more than you paid for it.”

Goldman Sachs Research Note
“Cryptocurrencies are not the ‘new gold’ despite their recent popularity … The use of precious metals is not a historical accident – they are still the best long-term store of value out of the known elements,” [gold] “is clearly better at holding its purchasing power, and has much lower daily volatility.” Goldman further said that Bitcoin’s volatility averaged almost seven times that of gold in 2017; and that gold is not subject to competition from alternatives. Bitcoin has rival virtual currencies. There are over 1,000 cryptocurrencies in existence.

Ray Dalio, CEO, Bridgewater Associates ($160 Billion hedge fund)

Jim Chanos, founder of Kynikos Associates (a major short seller)
“It’s a speculative mania. .… The allure of Bitcoin is to use it in Black Markets ..or currency flight .. by almost definition it has the regulators and law enforcement arrayed against it, due to its very nature. That’s one of the problems.”

Paul Donovan, UBS WM Global Chief Strategist
Bloomberg’s Tom Keene asks whether the CBOE and CME futures markets legitimize Bitcoin. Donavan answers, “No, I don’t think they do. … in 1636 the City of Amsterdam created a cash based futures market for Tulip bulbs, that doesn’t mean Tulip bulbs were a good investment, as was discovered in 1637. … I don’t think this legitimizes it. It gives you a way to have exposure, but it’s a bubble, and a bubble is a bubble, now matter how you look at it.”

Robert Shiller, Yale (Nobel Price in Economics)
“I think that the thing that’s driving bitcoin at the moment, like other examples of bubbles, is a story. And it’s the quality of the story that’s attracting all this interest, and it’s not necessarily sustainable. … I keep thinking there’ll be other currencies, other ideas that will come up and will eclipse this one. So it’s risky.”

Warren Buffet
“You can’t value bitcoin, because it’s not a value-producing asset. … a real bubble in that sort of thing. … Stay away from it …It’s a mirage, basically …the idea that Bitcoin has some huge intrinsic value is just a joke, in my view.”


1-Yr Daily Volatility of Key Asset Categories Over 10+ Years (Watch Out)

December 12th, 2017

The level of calmness in the markets, as evidenced by daily volatility, is unusual and disconcerting.  Rising interest rates and probably peaked out corporate leverage and profit margins are likely to increase volatility; and unintended consequences of US tax law changes may add surprises on top.

There is not much room for less volatility.  Don’t get too comfortable.  2018 is likely to be a bumpier ride than 2017.

These charts of 1-year daily percentage volatility beginning in 2005  or 2006 show the very low, in some cases 10-year low volatility for key asset categories.  The exception is very short-term Treasuries which are increasing in volatility from a depressed level, as the Fed begins to raise the overnight rate.

(click images to enlarge)

S&P 500 Stocks (SPY)

Non-US Development Markets Stocks (EFA)

Emerging Market Stocks (EEM)

Gold (GLD)

Long-Term Treasuries (TLT)

Short-Term Treasuries (SHV)


10-Year Future Returns For Model Portfolios From 5 Thought Leaders

October 16th, 2017

Let’s look at what 5 important thought leaders had to say about constructing a portfolio for the long-term (10+ years); and how their portfolio models are expected to perform over the next 10 years, based on asset returns, volatility and correlations according to JP Morgan Asset Management and Research Affiliates.

Here’s the spoiler:

  • Ray Dalio’s “All Weather” portfolio has the best risk adjusted expected return
  • David Swensen’s “Reference” portfolio has the highest expected return
  • John Bogle’s traditional “60/40 Balanced” model using global stocks is a contender
  • Harry Browne’s “Permanent” portfolio isn’t a contender
  • Warren Buffet’s “Estate Plan” portfolio has the highest potential, but the worst risk adjusted return
  • For all portfolios, the expected returns are significantly below returns of the last several years.

Here are mug shots of the 5 thought leaders.

(click images to enlarge)

Their portfolio models in our approach, would be for the Broad Core sleeve.  More income intensive securities would go into the Income Core sleeve of the portfolio.   And, when, as and if it makes sense to make some tactical bets, we can add narrowly focused assets we believe will do particularly well in the Tactical Opportunity sleeve of the portfolio.  This discussion is only about portfolio models for the Broad Core sleeve.

  • David Swensen is the long-time CIO of the Yale endowment.  He is acknowledged as one of the best at that job, if not the best.  In 2005, he translated his 2000 book for institutional portfolio managers (“Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment”) to one suitable for individual investors.  In that book (“Unconventional Success: A Fundamental Approach to Personal Investment”), he described a “reference portfolio” for the long-term.  He made it clear that adjustments are needed to fit the specific needs, goals, limitations and psychology of each investor; but that the reference portfolio is a good place to begin the thinking process about a suitable portfolio. In his reference portfolio he stresses the functions which must be provided (capital growth, inflation protection, deflation protection, and protection in times of crisis).  He specified assets for the portfolio and how much of each function each asset provides.
  • Ray Dalio is the founder and CEO of Bridgewater Associates, one of the oldest and largest private funds (about 40 years old and about $160 billion in assets).  He wrote about his All Weather strategy in a white paper in January 2012.  His fund has been very successful with the core All Weather portfolio model, and around which they make certain other tactical investments.  Their core portfolio is equally weighted to deal with 4 scenarios (rising corporate profits, falling corporate profits, rising interest rates, and  falling interest rates).  Then within each of those 4 segments of the All Weather portfolio, he specified suitable asset categories, which are then equal weighted for volatility (“risk parity”).
  • Harry Browne (deceased) was an investment advisor and author, who in his 1999 book “Fail Safe Investing” was focused on limiting losses in a portfolio that would be profitable in any market, which he posited was best accomplished with equal amounts invested in stocks, long-term Treasuries, T-Bills and Gold.  That was dubbed a “permanent” portfolio.
  • John Bogle is the founder and former CEO of Vanguard.  He virtually created the index mutual fund industry, launching the first ever index fund (dubbed “Bogle’s Folly”) on December 31, 1975, to track the S&P 500 index.  He is a firm believer that no amount of effort can predict the future of markets, and that active management is not competitive with index funds over long periods.  He recommends simply owning a broad index stock fund, such as one based on the S&P 500, and a broad bond index fund, such as one based on the aggregate US bond market.  He is an advocate of a 60% stocks, 40% bonds allocation.
  • Warren Buffet is the CEO of Berkshire Hathaway, which has made him one of the richest people in the world.  He is a fierce critic of the expense drag created by actively managed funds and their trading costs due to high turnover.  He believes that low cost index funds are the only way to go, and that a domestic focus is at least good enough, if not best.  In his 2013 letter to Berkshire Hathaway shareholders he gave investment advise which he felt was good enough for most investors by revealing his instructions to his estate trustee:  “… instructions I’ve laid out in my will … cash will be delivered to a trustee for my wife’s benefit … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”

Using the 10-year forecasts for asset returns, volatilities and correlations published by JP Morgan Asset Management (optimistic) and by Research Affiliates (less optimistic), let’s see how the recommended portfolios from those 5 thought leaders would be expected to perform in the future.

It is important to know that any single value projection of portfolio return is not a good idea.  Because assets go up and down in price over time, it is more reasonable to think of future returns in terms of a probability range of return; with the most likely return near the middle of the distribution, and the increasingly less likely, but still possible returns spread out above and below the middle.  That is how our first image is presented.  The probability distribution is developed through Monte Carlo simulation.

For each portfolio, the return probability distribution is represented by a box with whiskers.  The line in the middle of the box is the 50th percentile return, which is equal to or near the mean expected return.  Half of the probable returns expected to be higher than the 50th percentile, and half lower than that value.  The entire box encompasses the middle 80% of probable returns (from the 10th to the 90th percentile).  The whiskers extend out above and below the box so that the entire box and whiskers encompass 98% of probable returns (only 1% are expected to be higher, and only 1% are expected to be lower).  Because of shocks and crises, the lower 1% could be a lot lower.  For that, we present what could be thought of as a worst case (at least a very bad case) year, when the return is 3.5 standard deviations below the expected mean return.

This chart is the main one we used to decide our spoiler alert at the beginning of this letter.

The green colored boxes and whiskers are based on the more optimistic JP Morgan assumptions.  The yellow colored boxes and whiskers are based on the less optimistic Research Affiliates assumptions.

Note, that only the deeper green and deeper yellow colored boxes and whiskers have their 1st percentile above zero. If the bottom whisker is above zero, it means that the forecasts expects a 99% chance that at the end of 10-years, your portfolio will be worth more than at the beginning.

The portfolio models with the bottom whisker above zero when using JP Morgan assumptions are the Swensen Reference, Dalio All Weather, and Bogle 60/40 with global stocks. The models with 99% chance of a positive 10-year outcome when using the Research Affiliates assumptions are only the Dalio All Weather portfolio, and the Simple 2 Asset Risk Parity model (which uses the S&P 500 and intermediate-term Treasuries in a ratio that expects the same risk from each asset).

The lighter colored boxes and whiskers have varying probabilities less than 99% that the portfolio will grow in value over 10 years.  In fact, the simplified Dalio All Weather portfolio (published  by Tony Robbins, based on his discussions with Dalio), has about a 10% chance after 10 years of being worth less than the starting value.  The Warren Buffet “estate plan” portfolio has by far and away the higher upside potential (because it is 90% stocks), but also something near a 10% chance of a cumulative negative return.

The best “worst case” year is with the Dalio All Weather portfolio with both the JP Morgan and Research Affiliates assumptions, but it has an unsatisfying most likely return below 5%.  The highest most likely return is the Swensen Reference portfolio, which has a 99% chance of a positive 10-year return under JP Morgan assumptions, but has a small chance of a negative 10-year cumulative return with assumptions from Research Affiliates.

The Bogle 60/40 with global stocks fares well under JP Morgan assumptions, but has a small chance of a negative 10-year return under Research Affiliates assumptions.

The Swensen portfolio and the Bogle portfolio have the highest current yield, which is somewhat of a hedge against the downside, at 2.35% and 2.36% respectively — essentially the same yield.

Overall, for the more risk averse folks who can tolerate returns below 5%, the Dalio All Weather portfolio is attractive.  For those who require return of 5% or more, with limited risk of a 10-year negative return; the Swensen mode is attractive.  The Bogle 60/40 with global stocks is a close runner-up to the Swensen model, but not quite as attractive based on the two sets of assumptions we used.

The 90% stocks approach from Buffet is just fine if you very young and have more than 10-years for “time in the market” to work for you; or, you are wealthy enough to start, and would continue to be wealthy enough with no retirement lifestyle change even if you had a cumulative 5% annualized 10-year negative return.  Otherwise, 90% in stocks may be a bit to aggressive for most investors over 50 to 55 years old, particularly at this time in the market cycle.

Here is a different way to look at the same data.  These next two tables are color coded to show 10-year annualized returns:

  • greater than 7% in dark green
  • from 5% to 7% in light green
  • below 5%, but positive in light pink
  • negative returns in dark pink.

With JP Morgan Assumptions:

With Research Affiliates Assumptions: 

And here is yet one more way to use color coding to gain perspective on the relative merits and demerits of the portfolio models.  All of the returns taken together are coded red, yellow or green on a sliding scale from lowest in red to highest in green.

With JP Morgan Assumptions:

With Research Affiliates Assumptions:

Now for the grand reveal.  What is inside each of these portfolios?  Focus on the category, not just the proxy ETF. We did the projection without any specific security in mind.  The securities we show here as proxies are not the only ones that fit into those models, but they are representative of those that do.

The ETFs used to label the allocation in this next table are simply short-hand to identify the asset classes from the table above.  The numbers are all percentages.

I’d to ask each of you to think about these projections for these model portfolios as general approaches, and tell me which appeal most and least to you as they relate to your Broad Core sleeve (as distinct from the Income Core sleeve and Tactical Opportunity sleeve of your portfolio) to see if we are still on the right track for your personal situation and needs.

Looking forward to our discussion.


[symbols identified in this article: SPY, VXUS, VWO, VGIT, TIP, VNQ, GLD, DBC, VGLT, BND]


How to prepare a portfolio for war with North Korea

August 10th, 2017

QVM Clients:

I have received some calls asking whether and how to prepare portfolios for possible war with North Korea. Whether a war is likely is beyond my capacity to respond, but whether portfolios should be prepared for extreme market conditions resulting from any number of catastrophic situations is something on which I will comment.

Let me state right out of the gate, preparing a portfolio for a generalized Black Swan or catastrophic event is prudent. We should all have a protective component of our portfolios, all of the time – more for the older of us and less for the younger of us, based in great part on the time horizon before calling on the portfolio for withdrawals. However, tailoring a portfolio against a specific catastrophic event is generally not prudent, unless you are dead certain it will happen. And in that case, everybody else is probably dead certain too, and the event would already be substantially priced into the market.

So, while I can suggest a portfolio specifically tailored for a war between the USA and North Korea, I do not recommend implementing it. Such a portfolio would not represent your long-term strategy (which should include a protective component), and if that specific event did not materialize you could find yourself way off course.

With that caveat, let’s think about what a portfolio specifically tailored for an anticipated war between the USA and North Korea.

Don’t think me cold-hearted in discussing portfolio war preparation, because the tragic death of 100’s of thousands of people, including thousands of US troops stationed in South Korea would be horrific almost beyond imagination. According to former US Defense Secretary Cohen today, North Korea could lay waste to Seoul South Korea in about 1 minute from the 10,000 artillery pieces trained on that city at all times. But some of you asked about portfolios, not human tragedy. I am not inclined to plunge into portfolio war preparation, unless an individual should prevail upon me to do so, but I am prepared to say what portfolio might fare better in the event of such a war.

So whether it is war with North Korea, or worldwide plague, or hackers shutting down our electrical grid and somehow disabling our Internet for a prolonged period; the assets that provide clear defensive protection are:

• Cash (insured bank accounts or Treasury money market funds)
• Gold (proxy: GLD)
• Treasury bonds (proxy: VGIT).

Holding any of these three assets creates a current drag on portfolio income, and with the possible exception of gold, a drag on total return. Any form of protection (like insurance) has a cost, and that cost is a lower long-term total return than a flat-out equity market exposure. Except for investors with a very long time horizon before entering the withdrawal stage, some level of cash and bonds is appropriate in any event

Now for the specific war preparation portfolio, keep these index weights in mind, which will help interpret the allocation suggestions below:

  • South Korea is almost 15% of the Emerging Markets index followed by iShares; but 0% of the index followed by Vanguard
  • South Korea is almost 5% of the non-US Developed Markets index followed by Vanguard; but 0% of the index followed by iShares
  • China is about 29% of Emerging Markets indexes
  • Taiwan is about 16% of Emerging Markets indexes
  • Hong Kong is about 3% of non-US Developed Markets indexes
  • Japan is about 21% to 23% of non-US Developed Markets indexes
  • Apple is about 4% of the S&P 500 and about 5% of the Dow Jones Industrials

Changes one might consider (excluding shorting and options) to specifically prepare for possible war with North Korea are:

  • Above target cash
  • Target or above target level gold (proxy: GLD)
  • Above target intermediate-Treasuries (proxy: VGIT)
  • Add defense industry exposure (proxy: ITA)
  • Below target Emerging Markets allocation – to reduce China, Taiwan, Hong Kong and South Korea Exposure
  • Within reduced diversified Emerging Markets allocation; Hold VWO not EEM – to eliminate South Korea Exposure
  • Within non-US Developed Markets exposure, hold EFA not VEA – to reduce South Korea Exposure
  • Possibly replace diversified non-US Developed Markets funds with Europe funds (VGK) – to reduce Japan exposure (proxy: EWJ)
  • Reduce broadly diversified US stock holdings (proxy: SPY) beyond lowered target levels, and rebuild to lowered target levels with sector funds, not including technology sector (proxy: XLK)
  • Sell single stock Apple holdings (AAPL).

Note, there may be significant non-recoverable tax costs to such a portfolio reconfiguration in regular taxable accounts. That would need to be evaluated in terms of each investor’s embedded gains, and how much of which assets are held in tax deferred or tax-exempt accounts, as well as other aspects of the investor’s general tax situation.

Why sell Apple or reduce technology sector exposure? Because, South Korea (think Samsung) is a key part of the technology supply chain (including parts for iPhones). It could take a couple of years to build replacement chip foundries to supply the needed chips for Apple, unless they could find non-Asia suppliers.

Think of the war a step farther out. China decides not to fight the USA on behalf of North Korea, but does decide the war is the perfect time to invade Taiwan to reclaim it. The USA might well be unprepared to defend Taiwan while fighting North Korea, and might accept the invasion of Taiwan in exchange for China not involving itself in the North Korea conflict. Such an invasion could further damage the technology supply chain. Then, of course, Vladimir might decide to take the rest of the Ukraine or some other land grab, which would be very hard on the Europe stock markets.

What happens after the early war stages is unknowable, but as past wars have shown, the world rebuilds, and capital continues to work. So be prepared to restore equity allocation once hostilities are clearly over and stock markets begin to recover.

There would, of course, be no option to do those things to the portfolio once a shooting war opened up, as the pricing adjustments would be near instantaneous. For myself, I am not making such drastic single scenario preparations, but rather holding some level of generally protective assets along with a diversified global equity exposure. That is what I suggest to you.

This is a quite unpleasant topic to contemplate, but to make sure we’re always thinking, this is what we can fathom at the moment, as preparation for first order effects. Where second and third order effects go, is beyond pure speculation.


[securities mentioned in this letter: GLD, VGIT, ITA, VWO, EEM, VEA, EFA, VGK, SPY, EWJ, XLK, AAPL]