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Markets
This Week |
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Investment
Idea
Quiz
Our Portfolio
Market Highlights
S&P 500 Charts
TSX Canada Charts
Behavioral Finance Indicators
Answer to the Quiz
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Question:
What is the trade-off between return and risk?
Answer: The return-risk trade-off can be illustrated in a
return-risk diagram. For instance, let's consider the performance
of the following asset classes during the last 30 years (Table
1 and Chart 1).
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T-bills |
Real Estate
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Bonds |
S&P 500
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| Return % |
6.00 |
6.19 |
9.37 |
12.70 |
| Risk % |
3.20 |
3.65 |
11.30 |
15.60 |
Source: Ibbotson (T-bills, Bonds and S&P 500) and OFHGO (Real Estate)
The straight red line illustrates
the trade-off between return and risk. As our potential returns
increase, our risk rises accordingly. Although we are using
US data, the comparison is quite valid in the international
context.
N.B. The low numbers for real estate
are not a mistake (please refer to the OFHGO source). The
performance of real estate has been outstanding over the last
five years, but mediocre when measured over 30 years. Please
keep in mind the numbers do not account for the effect of
taxation (some forms of real estate are tax exempt) and interest
deductibility (in the US, interest rates on mortgages are
tax deductible).
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Which of the following investments
shown in Chart 2 represents the most optimal return-risk trade-off?
A) A
B) B
C) C
D) D
Answer to the Quiz at the bottom of the document
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(%)
Since inception, the S&P 500 has
outperformed our passive and conservative 60/40 portfolio by 2.06%.
Still, our portfolio realized a lower volatility and a respectable
6.24% return.
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March 11 - 17, 2006
- This week, the markets moved strongly up (Charts 4 – 7), reaching their highest level in almost five years. The market strength was related to the low inflation data and high profits reported by financial companies (e.g., Bear Stearns, Lehman Brothers and Goldman Sachs).
- The S&P 500 index surpassed its high of January 11, 2006 by 1.01%. It is still uncertain if the market can hold the gains. As we stated before, the market has been trading in a channel since January 2004 (see Chart 8) and the recent action suggests the market is looking for either an up or down breakout.
- H & R Block shares plummeted over 10% as New York Attorney General Eliot Spitzer charged the company in a lawsuit claiming that its retirement-savings product generally depleted account balances instead of building nest eggs. Indeed, the set-up fee, re-contribution fee and termination fee exceeded the interest paid for 85% of account holders.
- The housing starts statistics reached a new high in February. We are waiting for this Thursday’s housing sales data to check if demand matches the new supply. The housing market may soon enter interesting times.
- We are concerned about the Toronto Stock Market (TSX) setting new highs without broadly based stock participation (Chart 9). Note that the prices shown in Chart 9 are moving higher (black line) and the advancing-declining ratio (red line) has been flat since March 2005. The situation reminds us to some degree of the Nortel price surge that propelled the TSX index to its new high in 2000 and then pulled it down fiercely. There is a similarity here given that many of the resource stocks are trading on high expectations rather than actual profitability. Could it be that the resource stocks have become the new Nortel?
- Since February 2006, despite high oil prices, the equity markets in the Middle East have taken a pounding, with declines as much as 30%. The fall in share prices was proceeded by unrealistic expectations (with a P/E ratio of over 30). The traders in Dubai called for government intervention to reverse the decline (interestingly enough, a few years ago the same traders asked the government to free up the financial markets). We are reminded once again, “Investors of the world – diversify!”
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Charts 4 - 5. 10 Years and Last 10
Days
 
Charts courtesy of StockCharts.com
Charts 6 - 7. 10 Years and Last 10
Days
 
Charts courtesy of StockCharts.com
Chart courtesy of StockCharts.com
Chart courtesy of StockCharts.com
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(see
explanation)
The market has surpassed the January
11th high by 1.01%. The indicators are mixed (some pointing
to the continuation of the advance, and others showing that
the market is heading down). For now, we continue to believe
that the new high is not sustainable but we are ready to change
our mind if the situation changes. Investing is more about return-on-investment
than being right.
Please consider the following factors:
Chart 10 - divergence between prices (went up) and advancing/declining
line (declining)
Chart 11 - high degree of optimism (at the beginning of January)
by small investors as represented by AAII
Chart 12 - low put/call ratio, confidence exhibited by equity
option buyers (in January) who tend to be reliably wrong at
important market junctures
Charts courtesy of StockCharts.com
and DecisionPoint.com
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B is correct. B offers the highest
return combined with the lowest risk. D is clearly the worst
option as it has the lowest return and the highest volatility.
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InvestWELL Financial’s first priority, as a provider of independent and unbiased financial information, is to educate our clients. Not only do we provide practical information about securities, but we also coach our clients to become successful independent investors. As such, InvestWELL Financial does not assume any responsibility whatsoever for the use of any information from the website or related publications. Although all sources of information are vetted and the information is believed to be reliable, it is not provided as investment advice. Past performance is not an indicator of future performance in securities. Each portfolio must be balanced and based on personal circumstances. High-risk investment decisions should be made in consultation with an investment professional.
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This Week.
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