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Q&A: Why Did You Buy THAT?

Once is a while, I have a client ask why I bought a particular stock. While that kind of question might make some managers defensive, I welcome it. It keeps me sharp, and it give me an opportunity to reevaluate the investment. If I can’t answer the question effectively… well… perhaps that’s not a stock I should own after all!

A client wrote in with the following question about McDonalds (MCD): “Hi Charles, regarding your McDonalds stock purchase, all that I have read is that this is not a great stock.  At $97.00 I am sure you could have bought something far better. Please explain your thinking. Thank you.”

Very valid question. McDonalds is not a popular stock right now, and the company has been getting terrible press. Here is my response:

Regarding McDonalds, there are a few things to keep in mind. By all means, there is always “opportunity cost,” or the risk that we could have made more money buying something else. We run that risk with anything we buy, though we certainly try to keep it to a minimum by being selective and buying quality stocks at good prices.

In the case of McDonalds, I believe we are actually getting a very good price on a very good company. McDonalds is going through a transition right now, just as they have multiple times in their multi-decade past. In the early 2000s, you heard a lot of the same arguments you hear today: That McDonalds is an old company with a tired menu that has fallen behind the times.Well, from 2003 to 2011, McDonalds made improvements to its business and the stock went from $14 per share to over $100 per share. The stock hasn’t budged since 2011, as investors have grown cold towards it again. As a value investor, I like to see that. At current prices, we’re getting one of the most adaptable companies in US history trading at a nice 3.5% dividend yield. And while I don’t expect McDonalds’ dividend growth to be as aggressive as it was in the last decade given its current payout ratio, it’s worth noting that McDonalds is one of the most shareholder friendly stocks in America with a long history of rewarding its shareholders with very handsome dividend hikes.

And finally, I consider MCD a nice diversifier. In a portfolio that is heavily invested in real estate and pipelines, a consumer-focused, recession-resistant stock like McDonalds is a nice complement.

Thank you,

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The Bangladesh Butter Indicator Says Buy!

Get ready to buy. Our most reliable technical indicator—one that has historically been 99% accurate—is  suggesting that stocks are poised for a major breakout.

Bangladesh butter production surged in February, as moderating grain prices allowed Bangladeshi dairy farmers to boost production by getting higher milk yields from their existing stock of cows. Meanwhile, butter production in neighboring India dropped significantly in February, as a change in government farm subsidies forced Indian dairy farmers to cull their herds. With Bangladeshi butter production set to rise further, we should be looking at a massive rally in the S&P 500 throughout March and April.

By now, I sincerely hope you realize I’m joking.

Whether the S&P 500 goes up, down or sideways over the next two months will have absolutely nothing to do with the Bangladesh butter indicator. But in a paper published two decades ago, David Leinweber and Dave Krider found that butter production in Bangladesh had the tightest correlation to the S&P 500 of any data series they could find. It wasn’t GDP growth…it wasn’t earnings…it was Bangladeshi butter, which “explained” 99% of the S&P 500’s movements.


The authors weren’t quacks. They knew the correlation was a random coincidence and completely meaningless. But they published the paper to get a good laugh and to make an important point about number crunching. Correlation does not mean causation, and if your model doesn’t make intuitive sense, it’s probably bogus.

I’m not bashing quantitative models here. Done right, they can help you build a really solid trading system. Various value and momentum models have been proven to work over time. But the trading system needs to reflect some sort of fundamental reality or it’s one (small) step removed from voodoo.

Adam touched on the same idea two weeks ago in Economy & Markets. As Adam wrote, “Computers, databases and statistically sound algorithms can only refine the discovery and implementation of a fundamentally sound investment strategy. At the end of the day, computer algorithms or not, you still need a rock-solid investment strategy.” The model isn’t the strategy. It’s a tool to help you execute; nothing less, nothing more.

Whenever you see someone touting a trading strategy, ask them to explain why it works. Back-tested returns aren’t good enough. If they can’t explain the fundamentals behind their model, it’s probably a matter of time before they blow up.

Oh, and one more thing about Bangladeshi butter. Leinweber wrote in Forbes a few years ago that he still gets phone calls—20 years later—asking for current butter production figures.

This article first appeared on Economy & Markets.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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What Is the Smart Money Buying?

It’s that time of year again. Every September, Barron’s polls its “all-star team” of Wall Street strategists to get their favorite sector bets and their best estimates for the S&P 500 and the 10-year Treasury, among other market calls (see “Steaming Ahead”).

Let me summarize in words that should surprise no one: They see stocks trading sideways and bond yields rising.

I’m a big believer in taking anything a Wall Street strategist says with a large grain of salt. They are paid to look after the interests of their respective employers, which may be (and generally are) very different from yours and mine.  That said, they also tend to be very bright and have access to the best research departments in the world.   And in certain situations—such as when they show clear signs of groupthink—their calls can be useful contrarian indicators.

Let’s take a look at what Barron’s nine big-bank strategists see for the remainder of this year:

Macro Call




S&P 500 Year-End 2014




10-Year Treasury Year-End 2014




GDP Growth, 2nd Half of 2014




GDP Growth 2015




For a crowd with a reputation for being permabulls, expectations for the S&P 500 are quite modest.  The highest estimate is only about 5% higher from today’s level, and the lowest estimate is less than 3% below today’s level. In other words, they don’t see a major move either way between today and the first of the year.

Interestingly, all nine strategists saw bond yields going higher from here.  The average estimate—3.1%—is within rounding error of where the 10-year started 2014.  I should note that, back in December, the consensus was for yields to go sharply higher.  The strategists swung and missed on that call, as yields have drifted lower for all of 2014.

And on the GDP front, there was a fairly tight range of estimates—2.5% to 3.5% for the second half of 2014 and 2.6% to 3.5% in 2015.

What conclusions can we reach from this?

Well, to start, I’m not seeing much in the way of independent opinion. There is near unanimity in forecasting for stocks to trade sideways and bond yields to rise. This is a clear sign of herding, and a contrarian warning sign to expect the unexpected. The strategists have consistently been wrong in forecasting a sharp rise in yields.  Given that U.S. yields have fallen even as the Fed has progressed with an aggressive tapering schedule and given that the European Central Bank is about to pick up where the Fed left off with a modified quantitative easing program of its own, I would expect yields to continue to drift sideways in a range of about 2.2% to 3.2% over the next several years.

I also see signs of herding in the strategists’ favorite sectors. Literally all nine strategists listed technology as one of their favorite sectors.  There was less consensus on the sectors to avoid, though six of the nine strategists recommended avoiding telecom.

Perhaps the contrarian trade of the next 6-12 months should be to sell or underweight tech and go long telecom and yield-sensitive investments.

This piece first appeared on MarketWatch.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

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Forecasts are Useless

It’s tough to make predictions.  Especially about the future.

The quote above is alternatively attributed to the physicist Neils Bohr and to the New York Yankee catcher Yogi Berra.   But it is nonetheless true, particularly in the financial markets.

Of course, that doesn’t seem to stop us from trying.

I bring this up because Barron’s recently polled its “10 Street Seers,” an elite group of Wall Street strategists, to get their forecasts for S&P 500 year-end value, the 10-year Treasury yield and more.  The results were a little underwhelming.

On average, the analysts expected the S&P 500 to rise by 65 points—or about 4% from current levels.  The most bearish analyst saw the S&P 500 shedding 33 points. The highest forecast was also the most popular; three out of the ten saw the S&P 500 adding 117 points to 1750 by year end.  The entire range of forecasts was only 150 points; not a lot of independent thought here.

The forecasts for the 10-year Treasury yield were even less diverse.   The average forecast was for a 0.12% rise in yield.  Four of the ten analysts had a target yield of 3%, and the range from highest estimate to lowest estimate was a pitiful 50 basis points.

These are ten extremely bright people with ten forecasts that are noteworthy only for their lack of originality.  What gives?  Why the excessive conservatism?

Wall Street analysts aren’t that different from the rest of us.  They suffer from a recency bias, or a tendency to give a disproportionate importance to recent events. Yet at the same time, they have a tendency to anchor and adjust their forecast rather than start a fresh forecast with revised assumptions.  And capping it all off, they are prone to groupthink and herding behavior.  And finally, there is what I like to call the “save your ass” bias.  If a forecaster makes a bold call—and turns out to be wrong—he is probably going to be out of a job.  This incentivizes them to make their forecast within a tight band of acceptable, consensus thinking.

All of these combine to make a foul cocktail of conflicting mental impulses that give us forecasts that are consistently too bland to be useful.

I have a piece of advice: Don’t waste your time forecasting. 

You should have a basic understanding of the macro environment you are in, and you should have an opinion of, say, the direction the stock market or interest rates are likely to go.  But this kind of thinking shouldn’t occupy a lot of your time, and there is no value in being overly precise in your estimates.

Instead of focusing on the precise interest rate, think in terms of contingencies.  What would happen to my portfolio if interest rates shot higher?  And what can I do to mitigate that risk?  And importantly, at current market prices, am I being compensated adequately for the risks I’m taking?

As a practical example, I expect bond yields to fall from current levels, as I believe that the tapering fears are vastly overdone.  But I also know that I could be wrong about that.  To protect my Dividend Growth Portfolio from this risk, I am focusing on companies with a history of aggressively raising their dividends rather than focusing on high current yield.

As they say, past performance is no guarantee of future results.  A company with a long history of paying dividends can abruptly stop. We saw plenty of that in 2008 and 2009.  But I would trust a good company’s dividend record before I put my faith in a Wall Street forecast.

This piece first appeared on MarketWatch.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management.  Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

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The Importance of Scaling

My style is a little different from most contributors to TraderPlanet.  At heart, I’m a value investor, and my holding periods for quality stocks can be months, years, or even decades under the right set of conditions.

This is not to say I’m an ideological believer in “buy and hold” investing, however.  Absolutely not.  But I am a big believer in letting a solid investment thesis play itself out.  If a stock is attractively priced and I judge it to have appealing prospects going forward, then I feel no need to sell it simply because it has enjoyed a recent run-up in price.

But while my approach to the investing process is different from that of a short-term trader, I’m a big believer in a concept that many successful traders follow: scaling.

When you scale in or scale out of a position, you enter it and exit it in stages rather than in a large lump sum, and there are several reasons why this is a good idea.  By taking a small initial position, you can test out an investment idea before committing a large sum of money to it.  This was a favorite tactic of Jesse Livermore, the legendary trader who was the inspiration for the fictitious biography The Reminiscences of a Stock Operator

For me, it is more a case of managing my psychological temperament.  Nothing is more frustrating to me than committing a large allocation of my portfolio to a well-researched position only to see it take an immediate nosedive.  I may eventually prove to be right, and the trade may still end up being as profitable as I hoped.  But seeing a new position in the red rattles me and distracts me from the task at hand of managing the overall portfolio.

It is also a way for me to split the difference during times of indecision.  If a stock looks fundamentally sound and attractively priced,  my head tells me to buy.  But if a stock has already had a large run-up or if the market doesn’t “feel” right, my gut tells to wait.  When I have a conflict between my head and my gut, I split the difference by entering a position in increments.  If the stock continues to rise, I have exposure.  But if there is a pullback, I also have my powder dry to take advantage of it.

The same is true of exiting a trade.  I hold several positions I’d love to hold forever.  But now and then, one of those stocks will get a little on the pricey side, or the position will grow to become too large relative to the rest of the portfolio.  In these cases, it makes sense to take a little money off the table.  A trader would call this taking profits; an asset allocator would call it rebalancing.  I call it being prudent.

I’ll leave you with an example.  Mortgage REITs recently took a beating in the market, as investors feared that a hike in bond yields would wreck their book values.  I took the view that any reduction in book value was already reflected in the stock prices of the REITs; as a group, they traded well below their stated book values.

But after the bloodletting in the sector, my gut felt queasy about allocating a large chunk of capital to something that volatile.

Splitting the difference, I’ve been averaging in to the UBS E-TRACS 2x Mortgage REIT ETN ($MORL) over the past month.

Incidentally, I recommended mortgage REITs in TraderPlanet three weeks ago.  I’d like to reiterate that call today.

Disclosures: Sizemore Capital is long MORL.  This piece first appeared on TraderPlanet.

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