Economy & Markets

The Federal Reserve's revised outlook on interest rates was like a shot of caffeine to the stock market, which surged the most it has in a month led by tech giants like Apple. The central bank doesn't see raising rates again this year, a surprisingly cautious message considering most had forecast two hikes by the end of 2019. But the Fed did lower its economic forecast, which was in keeping with the view of several company executives, who said trade skirmishes and a slowdown in Europe and China were dampening their earnings outlooks. Corporate profits are supposed to contract in the first quarter and grow more slowly than previously expected for the year. But some see positive signs for the stock market regardless of these negatives. If interest rates stay low, corporate profit will grow and stocks should follow. The major indexes are near all-time highs even after plunging into bear market territory just a few months ago. The S&P 500 is up 13.9% this year, led by tech, energy and industrials. The index trades at a forward multiple of 16.5. The Dow Jones Industrial Average is up 10.4% and trades at 15.2.

Some positive numbers :

1. The Federal Reserve kept interest rates steady this week, and now the futures market is putting 50% odds on the chance of a rate cut by the end of January 2020.

2. Homebuilder sentiment is stabilizing after a slowdown at the end of last year, according to a monthly measure by the National Association of Home Builders.

3. The Commerce Department said orders for durable goods rose 0.4% in January, led by a 15.9% increase in commercial aircraft orders. The measure is a proxy for business investment.

Some not-so-positive numbers :

1. U.S. manufacturing output fell for the second straight month in February, the Fed said, held down by declines in output of cars, machinery and furniture.

2. Consumer prices rose in February for the first time in four months. The Labor Department's consumer price index rose 0.2% because of increases in the cost of food, gas and rent.

3. Jobs grew just 20,000 in February even though the jobless rate is also down to 3.8%.

Recommended Reading

Forecasts are tough, but the CFA Institute recently published a list of guidelines for those making economic forecasts. Data matters, but don't try to make something out of nothing. Stay away from extreme forecasts, which are often wrong or will not last because there will be a reversion to the mean. Humans are creatures of habit, meaning something that's broken can stay that way a long time before someone either fixes it or changes course. And, perhaps most important, ignore conspiracy theories. The simplest explanation is often the correct one. For more on this read here, and see below for links to articles and blog posts you may have missed.

Dumping Tobacco: European institutions like AXA and Aviva are abandoning tobacco stocks in a push to socially responsible investing, according to Bloomberg. That's pushing tobacco stocks down and the trend isn't likely to reverse any time soon. Read more

Emerging Markets: U.S. investors dramatically underweight their portfolios to emerging markets stocks, according to Larry Swedroe in an article in ETF.com. Investors suffer from country bias, believing their homeland to be the safest place to invest, and recency bias, in which the most recent returns influence decision making. Read more

Recession Outlook: A survey by the National Association for Business Economics says three-quarters of business economists see a U.S. recession by the end of 2021, Bloomberg reports. Nearly 10% of the 300 surveyed said the recession would arrive this year, while 42% project it to begin next year and 25% in 2021. Read more

Risk Factor: CFA Institute wrote about remarks by Oaktree Capital's Howard Marks at a recent CFA Society dinner. Marks said the two most important factors for investing success are managing risk and understanding where the market cycle is at any given time. Late in the cycle, risks are high and potential returns are low. But if you have an idea where the market is, that gives you a better chance to position for risk. Read more

Retirement Rules: Market volatility can be especially distressing for those reaching retirement. An article in the New York Times outlines common wisdom, such as checking portfolio allocations to make sure they match your risk tolerance, heeding the 4% withdrawal rule, considering an annuity for some of your retirement savings, and holding a cash reserve of two year's worth of expenses. Read more

Economic Bounce: Goldman's chief economist, Jan Hatzius, says the global economy may have already bottomed out. They see growth picking up and expect risk assets to rise as well as bond yields, strength in the dollar, growth in oil and a strong outlook for the U.S. Read more

Light Bulb: Value investors in General Electric are starting to feel vindicated. In the fourth quarter, investors snapped up $4 billion of the shares, the WSJ reported, citing S&P Global Market Intelligence. That could provide a foundation for the stock as the company goes through its turnaround. Read more

Hold 'Em: There's a self-made billionaire investor many people have never heard of and Forbes recently profiled him. Herbert Wertheim is an optometrist who uses a strategy that combines the views of Warren Buffett and Peter Lynch with the fee-averse attitude of Jack Bogle. He buys and almost never sells. Read more

Random Selling: Bloomberg's Barry Ritholtz notes that stock pickers know when to buy but not when to sell. He writes about a study that concludes fund managers would be better off selling holdings completely at random. Read more

Big Debt: The U.S. Treasury is expected to issue $1 trillion in debt for the second year in a row to finance the deficit, according to Bloomberg. But yields haven't spiked because of demand from investors. Read more

Robo Scanner: American Century is using a computer to scan through conference call comments by company executives to find any red flags. So far there are four things executives do that the computer is able to detect: when they don't report a metric they previously reported, when they use happy marketing speak, when they explain things in a complicated way, and when they blame bad luck. Read more

Defending Momentum: Momentum as a factor has underperformed for a long time but that's not reason to abandon it, argues BlackRock. A Bloomberg story recently outlined the asset manager's contrarian case. Read more

Bull & Bear: MarketWatch's Mark Hulbert says the bull market that began in March 2009 ended a while ago, even though we're now back in a bull market that has lasted about three months. He says there have been three bear markets over the last decade. Read more

News on Hot List Stocks

Royal Dutch Shell told workers at its 275,000 barrel-a-day Deer Park, Texas, refinery to stay at home or remain inside if they've already arrived at work. Operations are normal but it is near the site of a massive fire recently extinguished at a Houston chemical storage complex.

Bruker Corp. said acquired Arxspan LLC, a provider of cloud-based scientific software and workflow solutions, for undisclosed terms.

Insight Enterprises was named a Nvidia advanced technology partner, certifying its ability to work with customers on artificial intelligence and high performance computing.

Balancing the Simple and the Complex

It's a particular talent to be able to take a complex thing and simplify it so anyone can understand it. But as Jim O'Shaughnessy recently pointed out on Twitter, it's very human to associate complexity with intelligence.

If something takes a lot of steps and requires complicated analysis and strategic planning, it must somehow be better. Sometimes that is true, but a lot of other times we run the risk of overthinking it. Simple can be the best approach, even when it comes to investing.

Of course, there's also the risk of going too far in either direction. It's not beneficial to make things overly complicated, but then again, it is possible to oversimplify. The trick is to find the right balancing point.

At Validea, we've built model portfolios based on factors tracked by some of the investing world's leading thinkers. Warren Buffett, for example, has developed a stunning track record on a seemingly simple premise: Buy quality companies at an attractive value.

Buffett has parlayed this into tens of billions of dollars in personal wealth since he began picking stocks as a boy in the 1940s. Yet his value approach, which he developed by reading and following Benjamin Graham, hasn't done well lately and some argue value factors like price to book are dead.

Nobel winner Eugene Fama studied the price/book factor with Kenneth French, both of them former professors at University of Chicago's business school. Their research found that value stocks outperform growth stocks over the long term and that book value was correlated to performance. Specifically, they used price/book to identify value stocks, which led to excess return over long periods. Other researchers have reached the same conclusion.

Boiling this down to the simplest form, you could try to put together a portfolio of stocks that are cheapest using one factor, price/book. Or you could focus on one other factor, such as price/sales. This very simplistic system could work and beat a market cap weighted index over time. But it's not going to capture as much upside as it could. For one thing, it's hard to settle on just one factor to build a portfolio around. Price/book worked really well when companies owned a lot of equipment and that made up most of their assets. But it starts to break down when you talk about modern companies that have a lot of intangible assets, like tech companies. Even Buffett has stopped talking about book value as a meaningful indicator of value. If that's the case then it might be better to use a bunch of factors rather than trying to build around just one.

Another way value investing breaks down is on price. The idea is to look for stocks that aren't valued as they should be based on the company's operating numbers. But sometimes stocks are cheap for reasons that aren't completely apparent. Value investing odds of success improve when the low quality stocks are eliminated from consideration.

Both of these actions -- building multi-metric models and screening out for certain attributes - add complexity to what began as a simple process. But at least it strikes a balance between overly an overly simplified approach and one that is unnecessarily complex.

You could apply this lesson to trend following, too. This is a strategy where you try to determine the direction of the market to identify stocks to buy. One way is to follow the 200-day moving average and to stay invested above the line and sell or hedge below it.

Like value investing, you have to pick which barometer of trend you are going to use and then you have to figure out how you're going to use it. So if you pick the 200-day average, you have to decide how often to adjust your portfolio. Over a long time, this system is likely to work. But in the very short-term it can be extremely volatile and risky. Trends throw off false signals, for example. And the portfolio can get out of whack with the market quickly if the strategy is to wait to rebalance each month. Trend investors learned this the hard way this year when they got out of the market after last year's downdraft and stayed out until the end of February, missing the rally.

You could fiddle with the outcome by changing the frequency of time you wait to rebalance, and eliminate a lot of that risk, but of course that's another layer of complexity. Having greater odds of success means investors are more likely to stick with the strategy.

That last point is probably the main point. We are constantly trying to overcome the human inclination to complicate things and stumble on our own mistakes. Frustrated investors might give up on a strategy too quickly if it isn't delivering for them. Striking the right balance, where you err on the side of simplicity and only layer on complexity where it is the better option, makes it far more likely to get you to your investment goals.

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