Bob’s Journal 02/13

When Having a Crystal Ball Helps and When It Doesn’t

More than a crystal ball is needed to improve investment returns.

A simple test was created by a couple of members of wealth management firm Elm Wealth. They gave headlines to some investors a day in advance and had them make investment decisions.

They provided 118 young adults trained in finance $50 each and the opportunity to grow that stake by trading in the S&P 500 index and 30-year US Treasury bonds. The participants were given the information on the front page of the Wall Street Journal one day in advance, but with stock and bond price data blacked out.

The game covered 15 days, one day for each year from 2008 to 2022.

The investment returns were less-than-stellar. About half of the investors lost money, and one in six lost their entire stakes. The average payout was $51.62 (a gain of 3.2%), which the researchers said is statistically indistinguishable from breaking even.

The researchers identified two causes of the poor investment performance. One cause, of course, was doing a poor job of anticipating how stocks and bonds would react to the news. As a group, the young investors anticipated market moves correctly only 51.8% of the time.

The other cause was the poor use of leverage. The confidence of most of the participants exceeded their ability to anticipate market moves. They often took aggressive, leveraged trading positions that lost money.

The researchers then decided to see how more experienced traders would fare, and they found the seasoned pros did markedly better.

The five professional investors who participated in the second study correctly anticipated market responses 63% of the time.

Probably more importantly, the professionals did a good job of anticipating when they had an edge and when they didn’t. They varied the size and risks of their trades during the study.

All the experienced traders profited. On average, they grew their starting wealth by 130%, with a median gain of 60%.

The study indicates that, while having tomorrow’s news a day early can be helpful, it isn’t enough. An investor needs some experience to determine how much risk to take with a particular trade and to avoid big losses.

How Mark Cuban Lost $20 Million

After becoming a billionaire, Mark Cuban began doing what many wealthy people do. He invested a portion of his wealth in new or young companies, making bets that one or more of them would become big winners.

One thing Cuban did differently was to make a lot of his investments publicly, on the television show “Shark Tank.”

On the show, founders of new or early-stage companies describe their businesses and products to a panel of wealthy investors. The panelists ask questions of the founders and decide whether or not to invest their own money in the companies.

After appearing as a panelist on the show for 16 seasons from 2009 through 2024, Cuban estimated that he had a net loss and put about $20 million in the companies.

The results make clear that early-stage investing, often called angel investing or venture capital investing, is very risky. Even people who’ve built successful businesses often can’t identify other businesses with the right combination of good ideas and good people.

An investor can make a lot of money when an early-stage investment is a winner. But an investor also can lose a lot of money trying to achieve that success.

That’s why it’s important for an investor to put only a small portion of their net worth in the strategy and to invest in a diversified group of opportunities instead of betting it all on one company.

While Cuban invested $20 million over the years, it was a very small percentage of his net worth and was spread over a large number of start ups.

Making a deep dive into a company and its personnel also is essential. Cuban and his fellow panelists didn’t invest based only on the short presentations on the show. After expressing interest in a company, the panelists examined the company more closely and could decline to invest after the examination.

Angel investing can be a good activity for someone who is financially independent and has some knowledge about what makes a company successful. But even for someone like that, it’s a risky proposition.

Is the Era of Conglomerates Over?

When I was making my way through college, business conglomerates were the big thing and continued to be well-regarded for a long time.

But some high-profile changes have cast doubt on conglomerates.

A conglomerate is a company composed of several different businesses that operate more or less independently.

One stated advantage of a conglomerate is that a stronger or more established business can help fund an entity that is trying to expand or increase its growth rate.

Another advantage is that the businesses might have different business cycles. They’ll have downturns at different times. That can make the conglomerate’s earnings more stable over time.

It also creates the potential for the cash flow or borrowing power of the company that’s doing well to support the business that’s in a downturn.

Several business leaders made their reputations building conglomerates. They took the helms of established companies and acquired disparate businesses.

But in recent years, high-profile conglomerates have been on the way out, and that seems to have been more profitable for investors than having all the businesses under one umbrella.

GE is the most striking example.

As a conglomerate built over many decades, GE grew rapidly and was a stock market leader. In the 1990s and early 2000s, it was one of the largest components of the S&P 500. Its longtime CEO, Jack Welch, largely was considered the manager to emulate.

But GE hit hard times after the financial crisis and Welch’s retirement. GE struggled for more than a decade, changing CEOs several times. It sold or spun off several businesses. Finally, it decided to split the remaining businesses into three separate companies.

The stock prices of each of the companies have done very well. The combined stock market values of the three companies recently were four times GE’s 2022 value.

In recent years, other companies had similar results after splitting up, including United Technologies, Danaher and Alcoa.

Honeywell recently announced that it will try to emulate GE.

After a new CEO took over in 2023, the company made some relatively small spinoffs, acquisitions and sales. But the stock price has lagged.

Most recently, it decided to split into three separate companies. The CEO recently said the aerospace operation has been doing extremely well, much better than the other two businesses.

The expectation is that the market will reward the aerospace spinoff with a significantly higher stock price while the stocks of the other two businesses won’t do as well.

But split ups and spinoffs aren’t a sure thing for investors. A study by Bain & Co. of 350 public spinoffs between 2000 and 2020 concluded that, after two years, half the maneuvers failed to improve shareholder value. Specifically, value was reduced after one quarter of the transactions.

Also, conglomerates aren’t dead. Warren Buffett’s Berkshire Hathaway, for example, is an old-fashioned conglomerate and is doing well.

The Data

The Consumer Price Index (CPI) increased 0.5% in January following a 0.4% rise in December. The 12-month increase in the CPI was 3.0% through January and 2.9% through December.

The core CPI, which excludes food and energy prices, rose 0.4% in January and 0.2% in December. The 12-month rise in the core CPI was 3.3% through January and 3.2% through December.

The Consumer Sentiment Index from the University of Michigan dropped to 67.8 in mid-February from 71.1 at the end of January. Assessments of current conditions fell sharply while expectations fell less.

The index had increased for five consecutive months before declining in January and the first half of February.

The Small Business Optimism Index from the National Federation of Independent Business (NFIB) fell to 102.8 in January from 105.1 in December. That’s the first decline since August 2024. December’s reading was the highest since October 2018.

Inflation and finding qualified workers tied as the most important problems faced by business owners.

Consumer credit outstanding surged 9.6% in December after falling 1.3% in November. Revolving credit (mostly credit cards) popped 20.2% higher in December, while nonrevolving credit (mostly vehicle and student loans) increased 5.8%.

The number of jobs increased by 143,000 in January, according to last week’s Employment Situation reports. That’s much less than the 307,000 jobs created in December but still a solid number.

Some economists believe job growth in January might have been kept down by the California wildfires and severe winter weather in much of the country, but the Labor Department said those weren’t factors.

Average hourly earnings increased by 0.5% in January compared to 0.3% in December. The 12-month increase in average hourly earnings was 4.1% through both January and December.

Productivity increased at an annualized rate of 1.2% in the fourth quarter, according to the first estimate. There was a 4.2% increase in hourly compensation for the period.

The combination resulted in a 3.0% increase in unit labor costs. That’s a jump from the 0.5% increase in the third quarter but below economists’ forecasts of a 3.4% increase in labor costs.

New unemployment claims increased by 11,000 to 219,000 in the latest week.

Continuing claims, which lag a week behind new claims, increased to 1.886 million from 1.850 million.

The Markets

The S&P 500 rose 0.59% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 0.13%. The Russell 2000 fell 0.54%. The All-Country World Index (excluding U.S. stocks) added 1.46%. Emerging market equities advanced 0.88%.

Long-term treasuries were unchanged for the week. Investment-grade bonds lost 0.12%. Treasury Inflation-Protected Securities (TIPS) added 0.02%. High-yield bonds fell 0.04%.

In the currency arena, the U.S. dollar rose 0.17%.

Energy-based commodities increased 1.10%. Broader-based commodities rose 1.83%. Gold advanced 1.86%.

Bob’s News & Updates

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