Friday, June 26, 2015

How The Home Bias Phenomenon Impacts Investors: Domestic Purchases

In the past I have discussed the psychological phenomenon known as "home bias," which in simple terms means investors are more likely to purchase stocks from their own country. See How The Home Bias Phenomenon Impacts Investors.

 Investopedia defines it as:

"The tendency for investors to invest in a large amount of domestic equities, despite the purported benefits of diversifying into foreign equities. This bias is believed to have arisen as a result of the extra difficulties associated with investing in foreign equities, such as legal restrictions and additional transaction costs."

I am reading a book this week called "Misbehavior: The Making Of Behavioral Economics," which is the best book I have ready this year by far. It reviews the journey of the author, Richard Thaler, from the early days of his behavioral economic research through present day. Throughout the book he provides steady examples of the irrational behavior humans engage in due to the way we are made up psychologically.

The home bias phenomenon is a perfect example of this irrationality. As a United States citizen I see it every day. The majority of finance articles published by U.S. media outlets are about U.S. stocks. Why would that be in today's borderless financial world?

Numerous studies have shown investors in the United States have an irrationally large percentage of their portfolio composed of U.S. stocks. This comes at a time when U.S. companies in general are far more expensive than foreign markets, due in large part to the explosive move higher in price over the past 4 years.

Over this period the rational investor would allocate a larger percentage of his or her portfolio to less expensive global stocks as prices in the U.S. move higher, but usually the exact opposite occurs.

Barry Ritholtz put some charts up on his site today showing how home bias even exists within the borders of countries. The visual below shows investors favor technology out west, energy in the south, financials in the northeast and industrials in the midwest.

Why? Investors are surrounded by these companies so they are familiar with the names. This makes them more likely to purchase these stocks over a company they are less familiar with (even though another company or sector may be far less expensive or have greater earnings growth potential in the future).

Digging even deeper you often see employees have an over sized weighting of shares of companies they work for in their portfolio. This again shows home bias and investor irrationality at work.

Thursday, June 25, 2015

Carl Icahn On The Extreme Danger He Sees In U.S. Stocks & Bonds

Billionaire Carl Icahn provides an incredibly honest assessment of the danger he sees ahead for the average investor in U.S. stocks and bonds. While he thinks stocks will fall, he believes the bond market is even more dangerous.

"I think the public is walking into a trap again as they did in 2007. I think it's almost the duty of well-respected investors, like myself I hope, to warn people, to tell people, that really you are making errors."

Part One:

Part Two:

Part Three:

Wednesday, June 24, 2015

Agriculture Beaten Down & Hated: Buying Opportunity?

The chart below from Short Side Of Long shows the dreadful price performance for agriculture since early 2011. The commitment of traders report has investors net short on agriculture for the first time in over a decade. Not only have investors sold out of positions, but they are betting heavily on further price declines.

The fundamentals look rough for the market in the short term. The U.S. dollar is currently strong, supplies are already plentiful for many different types of food and it has been a great few years of weather for farming. This has caused many farmers to either cut back or redirect their crop production.

I believe it's likely the perfect farming weather will not remain uninterrupted for another 10 years. I also believe the rapidly growing population around the world is going to continue to need food over the next decade, while new supply to feed that population is not being put into place today. A common term in the commodities market is "the cure for low prices is low prices." The exceptionally low prices seen today combined with horrific sentiment should be a welcome opportunity for long term investors.

I have been buying corn (CORN), sugar (CANE) and wheat (WEAT) steadily for the past year, and I began purchasing the broader agriculture ETF (DBA) when it fell below 23 in March. I plan on continuing to buy each of these unless they move higher or positive sentiment returns to the market. My hope, as with the other commodity sectors I am accumulating in today (precious metals, uranium, oil) is that prices stay low and sentiment stays miserable for a long time.

Monday, June 22, 2015

CEO Pay Back Above 300 Times The Average Worker

In an article on Quartz this week they provided a chart showing how much the CEOs at the top 350 companies in America make relative to the average worker (currently 300 times the average worker's salary).

This massive gap in pay has been common knowledge for some time, but I found it interesting how directly this ratio correlates to the performance of the S&P 500. You can see in the chart above the booms and busts in CEO pay track in line with the performance of the general U.S. market (below).

There are a few thoughts I have looking at these charts.

1. The wealthy receive the bulk of the benefit when financial markets are booming, and they are hurt the most when markets crash (the middle class and poor have relatively low savings so a 50% decline in the stock market may only be a loss of $7,000 to their net worth). Market booms create a greater divide between the haves and the have nots, while market crashes bring the rich closer in line with "the rest."

2. CEOs are paid based on stock performance. When their stock price booms, even if that boom is mostly due to a general asset market mania (see the last three stock market booms starting in 1995), they are rewarded heavily. When stocks fall, even if it is due to market conditions outside of their own control, they are punished. This provides CEOs an incentive to "cash in" during the booms and explains why corporations today are spending an enormous amount of money (and even borrowing when possible) to purchase their own shares and drive prices artificially higher. 

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